Issuu on Google+


38 The Big Idea

The Truth About Holacracy Ethan Bernstein et al.  87 Fixing Health Care

Bundled Payments vs. Capitation Michael E. Porter, Robert S. Kaplan, Brent C. James, and Gregory P. Poulsen 114 Experience

When You Have to Negotiate with a Liar Leslie K. John

Most programs don’t work. Here’s what to do about it. PAGE 51

You’ve earned your money, but are you owning it?

In life, you question everything. The same should be true when it comes to managing your wealth. Do you know what your investment recommendations are based on? 'RHV \RXU áQDQFLDO SURIHVVLRQDO VWDQG E\ WKHLU ZRUG" 'R \RXNQRZKRZPXFK\RXÚUHSD\LQJLQIHHV"$QGKRZWKRVH IHHV DIIHFW \RXU UHWXUQV" $VN \RXU áQDQFLDO SURIHVVLRQDO and if you don’t like their answers, ask again at Schwab. We think you’ll like what we have to say. Talk to us or one of the thousands of independent registered investment advisors that do business with Schwab. Ask questions. Be engaged. Own your tomorrow.TM

Schwab ranked “Highest in Investor Satisfaction with Full-Service Brokerage Firms.� *


Brokerage Products: Not FDIC Insured â&#x20AC;˘ No Bank Guarantee â&#x20AC;˘ May Lose Value To see how Schwab stands by our word, visit &KDUOHV6FKZDEUHFHLYHGWKHKLJKHVWQXPHULFDOVFRUHLQWKH-'3RZHU)XOO6HUYLFH,QYHVWRU6DWLVIDFWLRQ6WXG\EDVHGRQUHVSRQVHVIURPáUPVPHDVXULQJRSLQLRQVRILQYHVWRUV who used full-service investment institutions and were surveyed in January 2016. Your experiences may vary. Visit There are eligibility requirements to work with a dedicated Financial Consultant. Wealth management refers to products and services available through the operating subsidiaries of the Charles Schwab Corporation of which there are important differences including, but not limited to, the type of advice and assistance provided, fees charged, and the rights and obligations of the parties. It is important to understand the differences when determining which products and/or services to select. 7KH&KDUOHV6FKZDE&RUSRUDWLRQSURYLGHVDIXOOUDQJHRIEURNHUDJHEDQNLQJDQGáQDQFLDODGYLVRU\VHUYLFHVWKURXJKLWVRSHUDWLQJVXEVLGLDULHV,WVEURNHUGHDOHUVXEVLGLDU\&KDUOHV6FKZDE  Co., Inc. (â&#x20AC;&#x153;Schwabâ&#x20AC;?), Member SIPC, offers investment services and products, including Schwab brokerage accounts. Its banking subsidiary, Charles Schwab Bank (member FDIC and an Equal +RXVLQJ/HQGHU SURYLGHVGHSRVLWDQGOHQGLQJVHUYLFHVDQGSURGXFWV$6.48(67,216%((1*$*('2:1<2857202552:LVDWUDGHPDUNRI&KDUOHV6FKZDE &R,QF Š2016 The Charles Schwab Corporation. All rights reserved. (0516-FTV3) ADP77864-02

July–August 2016






Why Diversity Programs Fail

Designing a Bias-Free Organization

We Just Can’t Handle Diversity

Diversity training often fails. But behavioral design works— by preventing biased choices. Iris Bohnet of Harvard Kennedy School, interviewed by Gardiner Morse

Cognitive roadblocks keep getting in the way. Lisa Burrell

Most firms try to check discrimination by policing managers’ decisions, which backfires. Effective approaches, in contrast, promote engagement, contact, and accountability. Frank Dobbin and Alexandra Kalev

ABOVE Roger Clarke The Deadliest Toxins (cnc) 2009, polyester resin, fiberglass, varnish

July–August 2016 Harvard Business Review 3


Features July–August 2016








Beyond the Holacracy Hype

Where Financial Reporting Still Falls Short

How to Pay for Health Care

The Case for Capitation

Bundled payments will finally unleash the competition that patients want. Michael E. Porter and Robert S. Kaplan

It’s the only way to cut more than $1 trillion in waste from the U.S. health care system. Brent C. James and Gregory P. Poulsen

Most organizations shouldn’t embrace self-management wholesale—but elements of the approach can be valuable tools for companies of all kinds. Ethan Bernstein, John Bunch, Niko Canner, and Michael Lee

How executives game financial results in a world of tighter regulation and what to do about it H. David Sherman and S. David Young

4 Harvard Business Review July–August 2016



Can you keep up with your customers’ changing expectations? CAN SALESFORCE?

PEGA CAN. Today’s customers’ needs and expectations are constantly changing. Businesses require solutions agile enough to meet these shifting needs and powerful enough to handle the most demanding enterprise-level requirements. This is possible with Pega.Æ Our CRM applications seamlessly streamline your business, connecting customers across all channels.



2016 Pegasystems. All rights reserved.


Departments July–August 2016 There’s little downside to telling an unsuccessful joke. page 24

“I’m being embraced as a whole person.”

136 8 10 16 30 133

From the Editor Contributors Interaction Strategic Humor Executive Summaries



22 MARKETING How to Make the Most of Omnichannel Retailing

114 MANAGING YOURSELF How to Negotiate with a Liar

The most profitable play is to coax online shoppers into your physical store. PLUS The risks and rewards of humor at work, the things that stress high-status employees, and more

28 DEFEND YOUR RESEARCH CEOs Shouldn’t Try to Embody Their Firms’ Culture New research indicates that leaders with a different orientation may get better results.

33 HOW I DID IT WPP’s CEO on Turning a Portfolio of Companies into a Growth Machine Investments in people, in real estate, and in creating “horizontality” across the group have been key to the parent company’s success. Martin Sorrell

6 Harvard Business Review July–August 2016

Five ways to encourage your counterpart to be truthful Leslie K. John

119 CASE STUDY Stick to the Strategy or Make the Sale? A manufacturer of high-tech streetlights wants to convert customers to a subscription model. Mitchell Weiss

128 SYNTHESIS Can Capitalism Be Redeemed? A review of three new books on the subject Jeff Kehoe

136 LIFE’S WORK Greg Louganis The Olympic gold medalist talks about his early training and finally winning a place on the Wheaties box.

Negotiators must take steps to prevent deception. page 114 IAN SPANIER; ERIC NYQUIST; BROSMIND


# hellowork Culture – some assembly required. Building a workplace people are excited about requires finding people you can get excited about. That’s why ADP offers insight-driven recruiting and talent management services to help your company create a work culture that is one of a kind. Visit and see how we can provide a more human resource for your business.

ADP and the ADP logo are registered trademarks of ADP, LLC. ADP A more human resource. is a service mark of ADP, LLC. Copyright © 2016 ADP, LLC.

HR Solutions | Payroll | Good Job


From the Editor Fixing a Broken System


emember the “boring headline” contest Michael Kinsley launched in The New Republic 30 years ago? Kinsley had been “inspired” by a New York Times op-ed titled “Worthwhile Canadian Initiative.” Readers sent in their own favorites, but in the end nothing was deemed more boring than the Times’s gem. (Yes, the whole afair was insensitive to Canadians. But it did become

a journalistic legend.) I concede that we’re in similar territory this month with “Fixing Health Care.” It’s not

exactly clickbait. But bear with us. The headline frames a debate by some of the smartest people in the ield on one of the most important (worthwhile!) issues facing the United States. The debate isn’t about Obamacare; nor is it overtly political. It’s about how to ix a broken health care system currently built on a fee-for-service model that rewards the quantity rather than the quality of medical care. By one estimate, at least 35% (and maybe more than

50%) of all U.S. health care spending is wasted. We present two views on how to ix things. In “The Case for Capitation,” Brent James and Gregory Poulsen, of Intermountain Healthcare, argue for a system that would give care delivery groups a ixed payment per person per year to cover all health care services. The authors show how that could align providers’ inancial incentives with the goal of eliminating major waste. In the counterargument, Michael Porter and Robert Kaplan, of Harvard Business School, say that approach doesn’t go far enough. In “How to Pay for Health Care,” they propose that providers be paid for the entire care cycle of a patient’s medical condition. That would make the whole provider team accountable for achieving outcomes that matter to patients. Technical as it is, the debate is raging inside the health care community—but it’s rarely discussed elsewhere. We hope these articles will deepen the discussion and accelerate the search for a better solution.


Adi Ignatius, Editor in Chief

8 Harvard Business Review July–August 2016



A series of sculptures by Roger Clarke is featured in this month’s Spotlight package, beginning on page 51. The sculptures are based on molecular structures, but they can be seen as anthropomorphic, anime-like figures. Clarke explains that he has always had “a fascination for the models and diagrams… produced by scientists to represent phenomena that are too large or too small to be seen or too complex to be explained.”

In her negotiation course at Harvard Business School, Leslie John runs a simulation in which some students lie to their negotiating partners, who are invariably shocked when the deception is revealed. “Humans are credulous creatures,” she says. “We’re terrible at detecting lies.” Tired of being duped herself, John gathered behavioral science tactics that can help negotiators get the truth out of their counterparts (page 114).

David Sherman has been interested in accounting since he was an MBA student at Harvard Business School, where he learned how informative and how misleading financial reports can be. Now teaching at Northeastern, he focuses on the ways companies can manipulate profits—and how analysts and investors can see through those attempts (page 76).


When Brent James first met the quality expert W. Edwards Deming, in 1987, Deming shared a startling idea: Higher-quality medical care should reduce costs, not increase them. James took the idea back to colleagues at Intermountain Healthcare who were testing methods of preventing surgical infections. A few months later they proved Deming right: Infection rates fell, setting a new national standard, and so did costs. On page 102, James and his coauthor, Gregory Poulsen, describe how a capitated payment system that supports efforts to eliminate waste can reshape the delivery of health care.

In his former life as a BCG consultant, Ethan Bernstein helped organizations redesign to better fit their shifting environments. Curious about why some flourished and others flopped, he entered academia; since then he has been intrigued by daring experiments in organizational structure, like the ones in “Beyond the Holacracy Hype” (page 38).

10 Harvard Business Review July–August 2016

“We want a banker who will work with us and be part of the team.” WHOLESALE BANKING Asset Management*1 Capital Finance Commercial & Corporate Commercial Real Estate Government & Institutional Insurance*2 International Investment Banking & Capital Markets* 3

When you need someone to strategize with, we’ll be ready to talk. Our relationship managers take the time to learn your business and gain a deeper understanding of your expansion goals. We’ve successfully partnered with mid-sized to large corporations to help them meet their global business needs. With our full suite of products backed by our time-tested strength and stability, we’ve never been more ready to support your business today and for years to come. To learn more about how our capabilities can work for you, visit

Treasury Management

* Investment and insurance products: NOT FDIC-Insured • NO Bank Guarantee • MAY Lose Value 1

Wells Fargo Asset Management is a trade name used by the asset management businesses of Wells Fargo & Company. Certain investments are distributed by Wells Fargo Funds Distributor, LLC, Member FINRA/SIPC, a subsidiary of Wells Fargo & Company.


Insurance products and services are ofered through non-bank ailiates of Wells Fargo & Company including Wells Fargo Insurance Inc. and Wells Fargo Insurance Services USA, Inc.


Wells Fargo Securities is the trade name for the capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Securities, LLC, a member of FINRA, NYSE, NFA and SIPC, Wells Fargo Institutional Securities, LLC, a member of FINRA, NFA and SIPC and Wells Fargo Bank, N.A.

© 2016 Wells Fargo Bank, N.A. All rights reserved. Deposit products ofered by Wells Fargo Bank, N.A. Member FDIC. Deposits held in non-U.S. branches are not FDIC insured. WCS-2539348 (05/16)


Where the future goes for answers. Stanford Graduate School of Business is no stranger to the future. Neither are its alums. Leadership, innovation, and entrepreneurship have been the presiding principles in our Executive Education programs for over 50 years. Our world-class faculty channels the imaginative energy that powers Silicon Valley. And equips you with insights that ignite and skills that sustain. Come to the source. There’s only one: Stanford.

UPCOMING PROGRAMS Executive Program in Leadership: The Effective Use of Power September 25 – September 30, 2016 Leading Change and Organizational Renewal October 30 – November 4, 2016 Executive Leadership Development: Analysis to Action January 8 – 20 and April 23 – 28, 2017 (two-module program) The Emerging CFO: Financial Leadership Program February 26 – March 3 and April 30 – May 5, 2017 (two-module program)

EDITOR, HBR Amy Bernstein EDITOR, HBR.ORG Katherine Bell EXECUTIVE EDITOR Sarah Cliffe


SENIOR EDITORS Alison Beard Scott Berinato Lisa Burrell David Champion (Paris) Sarah Green Carmichael Eben Harrell Maureen Hoch Jeff Kehoe Daniel McGinn Melinda Merino Gardiner Morse Curt Nickisch Steven Prokesch Ania Wieckowski MANAGING EDITOR, HBR PRESS Allison Peter SENIOR ASSOCIATE EDITORS Kate Adams Walter Frick ASSOCIATE EDITORS Courtney Cashman Susan Francis Gretchen Gavett Erica Truxler ARTICLES EDITORS Christina Bortz Susan Donovan Amy Meeker Martha Lee Spaulding ASSISTANT EDITORS Kevin Evers JM Olejarz Nicole Torres EDITORIAL DEVELOPER Tyler Machado EDITORIAL ASSISTANT Kenzie Travers STAFF ASSISTANT Christine C. Jack CONTRIBUTING EDITORS Karen Dillon Amy Gallo Jane Heifetz John Landry Andrew O’Connell Anand P. Raman

ART DIRECTOR, PRODUCT Karen Player ART DIRECTOR, HBR Matthew Guemple DESIGN DIRECTOR, HBR PRESS Stephani Finks EDITORIAL PRODUCTION DIRECTOR Dana Lissy SENIOR PRODUCTION EDITORS Adria Reynolds Jennifer Waring Christine Wilder SENIOR DIGITAL DESIGNER Marta Kusztra SENIOR INFORMATION DESIGNER Matt Perry DIGITAL DESIGNER Laura Guillen SENIOR PRODUCT MANAGER Kimberly Starr PRODUCT MANAGERS Adam Buchholz Emily Ryan SENIOR PROJECT MANAGER Lisa Gedick PROJECT MANAGER Theodore Moser PRODUCTION EDITORS Jodi Fisher Dave Lievens PRODUCTION SPECIALIST Alexie Rodriguez CONTRIBUTING STAFF Melissa Allard Kathryn K. Dahl Steven DeMaio Robert Eckhardt Kelly Messier Andrew Nguyen Katie Robinson Kristin Murphy Romano Dana Rousmaniere Bonnie Scranton Loann West


Enroll. Re-boot. Transform: Change lives. Change organizations. Change the world.

60 Harvard Way, Boston, MA 02163 617-783-7410 | fax 617-783-7493 Volume 94, Number 7/8 July–August 2016 Printed in the U.S.A.

8th Global Peter Drucker Forum Nov. 17 - 18, 2016 Vienna


Sara Armbruster

Steve Blank

Tim Brown

Clayton Christensen

Erica Dhawan

VP Steelcase


CEO Ideo

Harvard Business School

CEO Cotential

Gary Hamel

Herminia Ibarra

Eyal Kaplan

Philip Kotler

Roger Martin

Mgmt Innov.eXchange


Walden Israel


Martin Prosperity Inst.

Mariana Mazzucato

Sarah Oâ&#x20AC;&#x2DC;Connor

Sally Osberg

Alex Osterwalder

Rajeev Vasudeva

University of Sussex

Financial Times

CEO Skoll Foundation

Founder strategizer

CEO Egon Zehnder


the world`s management forum


Unlock Exclusive HBR Content IN THREE EASY STEPS


Download the free Shazam app from iTunes or the Google Play app store.


Look for the Shazam logo in this issue.


When you see the logo, scan the page to unlock bonus digital content exclusively for Harvard Business Review readers.



WORLDWIDE ADVERTISING OFFICES NEW YORK 3 Columbus Circle, Suite 2210 New York, NY 10019 212-872-9280 | fax 212-956-0933

Maria A. Beacom, Account Manager Daniel Cohen, European and Finance Manager Molly Watanabe, Luxury and New England Account Manager CHICAGO 847-466-1525 | fax 847-466-1101

James A. Mack, Central U.S. Sales Director MIDWEST AND SOUTHEAST 312-867-3862 | cell 312-401-2277

Samuel K. White, Midwest & Southeast Sales Director


LOS ANGELES 310-216-7270 SAN FRANCISCO 415-986-7762 FRANCE 33-01-4643-0066 HONG KONG 852-237-52311 INDIA 91-11-4353-0811 JAPAN 81-03-3541-4166 KOREA 82-2-730-8004 UAE 971-4-228-7708 UNITED KINGDOM 44-20-7291-9129 For all other inquiries, please call 212-872-9280. For advertising contact information, please visit our website at

Copyright 2016 Harvard Business School Publishing Corporation. All rights reserved.



800-274-3214 Harvard Business Review, P.O. Box 37457 Boone, Iowa 50037-0457

The views expressed in articles are the authors’ and not necessarily those of Harvard Business Review, Harvard Business School, or Harvard University. Authors may have consulting or other business relationships with the companies they discuss.

LIBRARY ACCESS Libraries offer online access to current and back issues of Harvard Business Review through EBSCO host databases.

ARTICLE REPRINTS To purchase reprints of Harvard Business Review articles, go to ALL OTHER COUNTRIES Asia Pacific region: 612-8296-5401 All other regions: 44-1858-438412 Harvard Business Review, Tower House, Lathkill Street, Market Harborough LE16 9EF, United Kingdom

RATES PER YEAR United States, $119 | Canada, US$139 International, US$165 | Mexico, US$139

SUBMISSIONS We encourage prospective authors to follow HBR’s “Guidelines for Authors” before submitting manuscripts. To obtain a copy, please go to; write to The Editor, Harvard Business Review, 60 Harvard Way, Boston, MA 02163; or e-mail Unsolicited manuscripts will be returned only if accompanied by a self-addressed stamped envelope.



Online Exclusives

Solve It With HBR Video Constantly expanding, consistently informative, HBR Video bring you the latest research and best practicesâ&#x20AC;&#x201D;on your desktop, tablet, and phone. Start watching today. SHAZAM THIS AD TO VISIT THE VIDEOS PAGE ON HBR.ORG

Interaction I’m convinced that initial successes would snowball into cheaper, faster, better business outcomes throughout the company. But if leaders have not shifted from control to trust, from compliance and preconceived plans to sensing and adapting, they will fail to support the new agile culture. Frederic Etiemble, business transformation adviser

Master the Process That’s Transforming Management HBR article by Darrell K. Rigby, Jeff Sutherland, and Hirotaka Takeuchi, May

Agile innovation has greatly increased success rates in software development, improved quality and speed to market, and boosted the motivation and productivity of IT teams. Now it’s spreading across industries and functions. But executives often manage in ways that run counter to its principles and practices, undermining its effectiveness. The authors have discerned six crucial ways to capitalize on agile’s potential. I helped bring agile into a Fortune 50 company. The more crossfunctional the team, the higher up your sponsor or product owner needs to be. Start from where you are, experiment, get results, and build momentum and support. That’s what I did, and it eventually proved itself in software and hardware. Brett Hoffstadt, PMP, aerospace innovation and management consultant

This article portrays agile as a way to change the act of management. Could it be a Trojan horse for a bottom-up organizational transformation?

16 Harvard Business Review July–August 2016

The authors respond: Agile is not a Trojan horse for transforming organizations—it is a frontal assault on command-andcontrol cultures. Although some companies (such as Spotify and have been agile since birth, most incumbents must change. We’ve seen senior executives (at General Electric and Mission Bell Winery) discover agile and drive change from the top, and we’ve seen senior executives (at Systematic and OpenView Venture Partners) embrace agile as its benefits and reputation spread across operations. But those who are unwilling to trade their egos for better results will surrender their profits and their best people to more-agile competitors before being banished. I look forward to the day when senior management has daily scrums that the rest of the company can look in on, retrospectives that are shared with the whole organization, and a backlog of work that any employee can add to. Scary? Maybe. But change is getting faster, and the challenge is to not be left behind by competitors. Many companies that didn’t move fast enough are now no longer with us: Blockbuster, Borders, Woolworth’s, and others. Craig Cockburn, independent agile consultant,



Don’t End a Meeting Without Doing These 3 Things BY BOB FRISCH AND CARY GREENE

How to Not Fight with Your Spouse When You Get Home from Work BY ED BATISTA

Improve Your Résumé by Turning Bullet Points into Stories BY JANE HEIFETZ

If There’s Only One Woman in Your Candidate Pool, There’s Statistically No Chance She’ll Be Hired BY STEFANIE K. JOHNSON, DAVID R. HEKMAN, AND ELSA T. CHAN

Uber’s New Tipping Policy Is a Mistake BY RAFI MOHAMMED

Even the Thought of Earning Less than Their Wives Changes How Men Behave BY DAN CASSINO

â&#x20AC;&#x153;When the time came to open a business account, First Republic was the natural choice.â&#x20AC;? A P O O R V A M E H TA

Founder and CEO, Instacart

(855) 886-4824 or visit New York Stock Exchange Symbol: FRC Member FDIC and Equal Housing Lender


Interaction Learn to Love Networking HBR article by Tiziana Casciaro, Francesca Gino, and Maryam Kouchaki, May

“I hate networking” is a familiar refrain. But in today’s world, networking is a necessity. Drawing on laboratory experiments and on studies at a large law firm, the authors identified four ways people can become more excited about and effective at building relationships: focus on learning, identify common interests, think broadly about what you can give, and find a higher purpose.

INTERACT WITH US The best way to comment on any article is on HBR.ORG. You can also reach us via E-MAIL: hbr_ FACEBOOK: TWITTER: twitter. com/HarvardBiz Correspondence may be edited for space and style.

Successful networking is not simply about getting a name and a business card; it is about earning someone’s trust. Those who are uncomfortable with networking may need a mindset change. I consider myself an extrovert, but networking can still make me feel disingenuous and dirty. So I thank the authors for suggesting these strategies. Caleb Ryan Nissley, analyst, JPMorgan Chase

We are trying to get young women to connect with colleagues across companies and industries, and the steps outlined in this article have given me a different approach to try.

own agenda and being altruistic— especially since I just started my own business and could use some new clients. Ultimately, I believe that if you simply focus on others, those you meet are more likely to come back for further engagement. Dan Konig, owner and head consultant, Creative Town

Increase Your Return on Failure HBR article by Julian Birkinshaw and Martine Haas, May

Management processes are built on predictability and efficiency, and executives get promoted by showing they’re in control—so they do everything possible to avoid failure. But when things don’t go well, you can rigorously extract value from failure—measuring and improving your return on it to boost benefits while controlling costs. The authors outline three steps you can take.


We asked HBR readers to use the Perceived Stress Scale to assess the frequency with which they’ve experienced stressful events over the past month. A tally of the results shows that:


scored in the average range, indicating that their stress, attention, and interest are at the proper level, allowing them to be productive at work

50% 4%

scored higher than average, which may indicate an unproductive level of stress

B. Santhanam, president and managing director, Saint-Gobain Glass India

I am an introvert by nature and need internal motivation to get out and network at various events. But I often meet at least one interesting person, and it feels great to help others move along in their own journeys. I struggle, however, with striking a balance between my

18 Harvard Business Review July–August 2016

scored very low, which may signal an insufficient degree of engagement SOURCE “ARE YOU TOO STRESSED TO BE PRODUCTIVE? OR NOT STRESSED ENOUGH?” BY FRANCESCA GINO

Yes, fear of failure is a big issue for organizations, as is the failure to learn lessons. But we shouldn’t underestimate managers’ powerful will to keep things as they are to ensure a steady paycheck. Yuval Dvir, head of EMEA Online Partnerships, Google for Work

It can be helpful to acknowledge that sometimes a success was simply a bad choice that happened to work out. Of course, that takes real courage. As much as people want to find external excuses for failure, they want to take full credit for success. Andy Webb, president, Execusolve

I own an innovation consultancy that helps small organizations design good businesses and projects. It is interesting to discover that big and small companies have the same fears. Even though it’s easier for small businesses to experiment and fail, I think they’re more reluctant to do so. They believe they have only one shot when investing their money. We advise our clients to follow a model similar to the one described in the article: Try to make small investments over months and years, and follow a strategic plan to build a solid business model. We also try to help them find and define a good and honest value proposition based on real differentiation. But when we are close to finishing a project and we propose assessing a pilot or an experiment, some of our clients feel unsure and afraid. We still haven’t found a way to make them comfortable running experiments and learning from the results. This article provides insights we can explore. Carlos Martínez Domínguez, partner and strategy designer, Brodmann52

Why is profitable growth so hard to achieve and sustain? Bain & Company’s Chris Zook and James Allen have researched this question and found that managing the challenges of growth requires a “founder’s mentality”—behaviors typically embodied by a bold, ambitious founder—to restore speed, focus, and connection to customers. Through rich analysis and inspiring examples, this book shows how any leader can instill and leverage a founder’s mentality throughout their organization and find lasting, profitable growth.


HUMOR 24 The risks and rewards of joking at work GLOBALIZATION 26 What firms need for success overseas DEFEND YOUR RESEARCH 28 CEOs shouldn’t embody company culture

Idea Watch Compiled by HBR editors


Why you should push the “bricks” in “bricks and clicks” shopping PAGE 22

July–August 2016 Harvard Business Review 21



costs of getting to a store were low, so no

Your best bet is to get online customers to visit your stores.

customers to visit a store increased profits,

added motivation was needed to prompt a trip. Among customers who lived farther away and had previously shopped only online, the online coupon generated twice as much profit as among the control group, and the flexible coupon increased profits by 800%. But when distant shoppers who’d previously bought only in stores were given online-only coupons, proits from them fell by 51%. In other words, encouraging online but incentivizing in-store customers to shop online decreased them. This may seem counterintuitive: Most


ne of the biggest challenges for

8,692 who shopped exclusively online and

retailers want customers to shop in both

brick-and-mortar retailers is find-

24,804 who shopped only in physical stores.

channels, in the belief that it shows the cus-

ing a strategy to compete with on-

(They dropped the remainder, who already

tomer has a stronger relationship with and is

line-only sellers such as Amazon. Although

shopped in both channels, from the study.)

buying more from them. Driving customers

Walmart and JCPenney, for example, have

Some of the 33,496 targeted customers were

online also helps physical retailers rational-

invested substantially in e-commerce op-

sent coupons redeemable only online; some

ize the huge investments they’ve made in IT

erations to complement their physical stores,

were sent coupons good only in physical

to support their websites and mobile apps.

the economics facing these hybrid retailers

stores; and some were sent coupons good in

However, incentivizing a store-to-online

remain daunting. Both chains announced

either channel. Members of a control group

shopping migration ignores several key

store closings in 2016.

got no coupons at all.

points: Customers who shop in stores tend to buy more, partly because they make more

For retailers that operate both stores and websites, the conventional “omnichannel” strategy is to encourage shopping across channels so that customers who shop only in stores will begin also buying online, and vice versa. Promotions and coupons are one way to promote this behavior, and retailers such as Macy’s, Bed Bath & Beyond, and Home Depot routinely use them.

Encouraging online customers to visit a store increased profits, but incentivizing in-store customers to shop online decreased them.

However, few retailers have closely ex-

impulse purchases. They’re also more willing to buy tactile, “experiential” goods such as apparel, shoes, and makeup. And they’re less likely to compare prices, because that’s harder to do in-store than online. “If customers come to your [physical] stores regularly, you should not encourage them to shop online,” Luo advises. The more proitable play is to coax online shoppers to come into your

amined the proitability of such promotions.

The researchers then monitored pur-

And they typically pay little attention to a

chases over the next week and compared

them to spend more. “That’s the winning

variable that may be particularly important

the coupon recipients’ behavior—and the

omnichannel strategy,” Luo says.

when customers are deciding whether to

effect on the chain’s profits, net of coupon

How to do that? The research shows

shop online or in-store: the distance between

costs—with that of the control subjects. For

that coupons redeemable only in stores and

home and the nearest store.

stores, where the environment can induce

their analysis, they divided the shoppers into

targeting previously online-only shoppers

To understand how these variables

two categories according to their proximity

who live some distance away can work well.

interact to affect customer behavior and

to a physical store. The dividing line was ive

Another strategy, which Walmart and some

retailer profitability, a research team led

kilometers, a distance that makes sense in a

other retailers are already implementing, is

by Xueming Luo, a marketing professor at

densely populated urban area where many

Temple University, worked with a Chinese

shoppers rely on public transportation.

department store on its coupon strategy.

Among customers who lived close to a

The researchers randomly selected 56,000

store, no type of coupon made a signiicant

members of the store’s loyalty program. On

difference to shopping or profits. For those

the basis of purchase records, they identiied

customers, the researchers concluded, the

22 Harvard Business Review July–August 2016

For more about retail and online strategies, see these articles on “Competing on Customer Journeys,” by David C. Edelman and Marc Singer; “Digital-Physical Mashups,” by Darrell K. Rigby; and “The Future of Shopping,” by Darrell K. Rigby.

HBR.ORG An analysis of performance reviews at a large tech company showed that women received 32% more comments containing vague praise, and 33% less developmental feedback linked to business outcomes, than men did. “VAGUE FEEDBACK IS HOLDING WOMEN BACK,” BY SHELLEY CORRELL AND CAROLINE SIMARD

to give online customers incentives (such as free shipping) to have orders sent to a local store for pickup rather than delivered to their homes. Finally, reducing the real or perceived costs of traveling to a store (by, for example, locating stores near public transit or ensuring ample parking) may make distant online customers more inclined to visit. The researchers are confident that their insights apply to retailers in the United States and other markets, although what constitutes living “close” to a store will vary according to population density, car ownership, and suburbanization. The results of this research are also surprising given that many outside observers believe that physical retailers should be shuttering stores more aggressively. For example, a report issued in April by Green Street Advisors, a real-estate research irm, says that U.S. department stores should close a combined 800 stores— about 20% of their locations—to bring costs in line with sales per square foot, which have dropped by 24% over the past decade. The retailers reject this advice: They say it assumes that the sales from a store that closes can be easily shifted online, but that in fact it is very diicult to win those sales back. Luo points to another trend that illustrates the advantages of having a physical store as part of an omnichannel strategy: Companies that began as online-only have started to invest in brick-and-mortar locations. For example, in May Amazon announced plans to open additional physical stores (it already operates one in Seattle). In these expansions, Amazon joins formerly online-only retailers such as Warby Parker (eyeglasses) and Bonobos (apparel) that have opened physical stores. “Online shopping is very goal-oriented and transactional,” Luo says. “Traditional retailers’ strength is the in-store shopping experience, and they need to play that up.” ERIC NYQUIST

HBR Reprint F1607A

ABOUT THE RESEARCH “Omnichannel Couponing,” by Fue Zeng, Xueming Luo, Yifan Dou, and Yuchi Zhang (working paper)


“THIS RESEARCH CHANGED OUR WAY OF THINKING” MMGO Mall is a chain of 15 department stores in Guangxi Province, China. Like most brick-and-mortar retailers, it’s trying to get online and in-store customers to buy more from both channels. Xiao Qin, MMGO’s director of electronic business, spoke with HBR about how the research on omnichannel couponing has influenced the chain’s strategy. Edited excerpts follow. How much online competition do you face?  Online-only competitors such as Alibaba and are potent market forces. They can offer lower prices and wider assortments. But our physical stores have a long-term, trusted reputation, and our in-store customers can try on clothes, smell perfumes, listen to electronics, and play entertainment systems before purchasing. This helps us fend off online competition. Were you surprised by the conclusions in the research? We expected that home-to-store distance would be an important variable in offline shopping, because faraway customers incur higher travel costs to visit our stores. But we were quite surprised by how much distance affected channel migration. The research changed how we think about promotional coupons within and across channels. What do you do differently? We now recognize that promotional money can be wasted if we’re just mindlessly sending discounts to customers regardless of their initial channel preference. We’ve also learned that it’s a mistake to try to get customers to migrate from physical stores to online. The study shows the importance of conducting rigorous research—beyond simple A/B testing—to assess individual customer values before, during, and after coupon and other marketing interventions. We also realize that if we reduce the pain points of shopping offline (such as travel costs and product returns), we can enhance long-term customer value and loyalty-based repeated purchases.

July–August 2016 Harvard Business Review 23


IDEA WATCH Teams whose members had read positive testimonials about themselves performed better in a crisis simulation; researchers say the affirmations reminded people of their strengths. “PREPARING THE SELF FOR TEAM ENTRY: HOW RELATIONAL AFFIRMATION IMPROVES TEAM PERFORMANCE,” BY JULIA J. LEE, FRANCESCA GINO, DANIEL M. CABLE, AND BRADLEY R. STAATS



or many years social scientists assumed that people in high-status jobs find work less stressful than people

in low-status jobs do, because elite workers

have more authority, autonomy, and stability. This assumption has been challenged re-

cently by studies suggesting that long hours and greater demands create more stress for high-status workers. But because research on the subject has been based on after-thefact recollections, such as diary reporting, it’s been hard to know which view is correct. A new study that captures real-time impressions lends empirical support to the

feelings correlated with stress and mood: In

“stress of higher status” hypothesis. A team

moments when workers thought they had

led by Sarah Damaske, of Pennsylvania State

sufficient resources or felt positive about

University, recruited 115 full-time workers

their work and colleagues, they said they

and assessed their socioeconomic status—

were happier and less stressed.

“high” or “low”—according to income and

The research also suggests that stress

education. Using handheld computers, the

is closely related to how demanding a job



magine that you’re interviewing a job candidate and you ask the classic question

workers rated their mood and stress when

is, but the picture is murky. High-status

prompted by audio signals several times a

workers more often feel they are falling

day for three days. They answered survey

short—but in moments when workers said

questions about “momentary perceptions”

they were succeeding, they felt less happy

of their jobs—how they felt at the time of the

and were more stressed, according to both

She took a risk. It showed conidence. It sug-

prompt rather than in general. And they col-

their subjective evaluations and their cor-

gests that she’s lighthearted and prefers a fun

“Where do you see yourself in ive years?”

She says, “Celebrating the ifth anniversary of

your asking me that question” (rim shot). It’s not a great joke, but give the candidate credit:

lected saliva samples so that the team could

tisol levels. “Although meeting demands

office environment. Odds are it didn’t hurt

measure their cortisol levels—a biological

seems positive, doing so may entail physical,

your perception of her—and there’s some

marker of stress.

emotional, and cognitive costs [and] may

chance it may have boosted it.

clude doctors, managers, and professors)

require a stress-inducing level of efort,” the researchers write.

That’s one conclusion from a series of experiments that examined how people re-

reported much more stress and less happi-

Damaske and her colleagues emphasize

spond to humor attempts in the workplace—

ness than did low-status workers (fast-food

that their findings don’t mean low-status

speciically, how perceptions of competence,

servers, janitors, home health aides, and so

jobs are better for people; future research

status, and confidence are affected when

on). What accounts for their elevated stress?

may show that the stresses of those jobs sim-

someone tells a funny, not-so-funny, or inap-

They were far more likely to say they lacked

ply play out more at home than at work, they

propriate joke. Researchers led by T. Bradford

the resources to do their jobs and slightly less

say. For now, they suggest that managers pay

Bitterly, of the Wharton School, utilized various scenarios, including job interviews and

likely to feel positive toward their work and

close attention to whether employees feel

colleagues. The reasons for those responses

able to meet the demands of their jobs and

business presentations, in the first study

aren’t entirely clear, the researchers say: For

have the resources needed to succeed.

aimed at establishing a causal link between

example, it could be that high-status jobs require resources that aren’t available, such as time or personnel, or that high-status workers expect more resources than are available. Whatever the explanations, those immediate

24 Harvard Business Review July–August 2016

humor and status.

ABOUT THE RESEARCH “Stress at Work: Differential Experiences of High Versus Low SES Workers,” by Sarah Damaske, Matthew J. Zawadzki, and Joshua M. Smyth (Social Science & Medicine, 2016)

Some of the findings are unsurprising. Joke tellers benefit more from successful jokes than from unsuccessful ones, and an inappropriate joke hurts perceptions of the


High-status workers (these might in-

EVEN THE MOST COMPETITIVE EDGE NEEDS SHARPENING Today’s global economy requires visionary leadership. Each year, senior executives from around the world meet at our Advanced Management Program to explore best-in-class management practices and strategies for sustaining a competitive edge. Are you ready to join this dynamic network?

Advanced Management Program 06 SEP–26 OCT 2016 04 APR–24 MAY 2017

Learn more



FROM THE ARCHIVE “Until top management ceases to be enamored of its own words, the language of business will continue to blunder along. It will continue to be shamefully heavy, long-winded, confused, and difficult….Such gobbledegook causes the greatest waste in business today.” “ADVERTISING COPY—HIT OR MISS?” BY LANGLEY CARLETON KEYES (HBR, MAY–JUNE 1953)


joke teller’s status and competence—though it increases estimates of his or her confidence. (The researchers drew on The Office for the sexually charged punchline “That’s what she said”; results conirmed that using this line is always a bad idea.) However, the study offers practical insight about the asymmetric relationship between humor attempts and outcomes. Although there’s a decided upside to telling a funny joke, there’s little downside to telling an unfunny one; in various contexts, the researchers found no signiicant diference

Despite careful planning, many firms fail when they expand into foreign markets. Although external factors such as unexpected channel complexity or competitor response may play a role, often the problem lies inside the company. To understand the qualities needed to go global, researchers created a 28-question diagnostic tool (, which they tested with more than 300 executives with extensive international experience. They divided the respondents into “winners” (whose expansions met sales, profit, and market-share goals) and “losers” (whose expansions fell short of objectives), and found that the two groups differed in seven areas. The researchers concluded: “[Successful companies] had more-flexible internal processes, a clearer vision for international expansion, and greater determination to navigate the challenges that awaited them.” Firms should measure and invest in these qualities before launching businesses overseas. PERCENTAGE OF RESPONDENTS FROM WINNING AND LOSING FIRMS WHO SAY THEIR COMPANY EXHIBITS:

in people’s perceptions of someone who an-


swers a question with an unsuccessful joke and someone who gives a serious response.




The study suggests that in general, failed jokes aren’t very costly as long as they’re not






That’s reassuring, because humor is inherently subjective, and even the best comedians misjudge what works and what doesn’t—illustrating that there’s much we don’t know about how people process jokes.



43 37

“The scientific evidence around humor is



shockingly limited, and navigating the inherent risk of humor is difficult—people constantly make egregious mistakes in the workplace,” says one of the researchers, Harvard Business School’s Alison Wood Brooks. “But great rewards await those who can navigate successfully.”

Some of these articles previously appeared in different form on

26 Harvard Business Review July–August 2016

ATTITUDE Prioritizes global business expansion

APTITUDE Has the knowledge and skills to succeed abroad

MAGNITUDE Aligns the scale and scope of the overseas opportunity with its own goals and capabilities

LATITUDE Adapts its marketing practices to the overseas opportunity

RECTITUDE Has legal and ethical practices that allow for flexibility overseas while maintaining compliance

EXACTITUDE Can tolerate some financial ambiguity and market uncertainty

FORTITUDE Is committed to global initiatives even in the face of setbacks



ABOUT THE RESEARCH “Risky Business: When Humor Increases and Decreases Status,” by T. Bradford Bitterly, Alison Wood Brooks, and Maurice E. Schweitzer (Journal of Personality and Social Psychology, forthcoming)


DEFEND YOUR RESEARCH CEOS SHOULDN’T TRY TO EMBODY THEIR FIRMS’ CULTURE The research: Arizona State University’s Angelo Kinicki and Georgia State University’s Chad Hartnell led a team that surveyed the top managers of 114 companies. The executives were asked to rate the leadership style of their CEOs and the culture of their organizations as either task/results oriented or people/ relationship oriented. In the best-performing organizations, the study showed, the CEO’s orientation differed from the corporate culture’s instead of aligning with it. The challenge: Should CEOs’ behavior really run counter to their firms’ ethos? Is culture clash a good thing? Professor Kinicki, defend your research.

Kinicki: “Clash” isn’t the right word. I think

Fiorina at HP, you can see that it’s

our research shows that a CEO’s style should

probably a matter of degree. He brought

complement the company’s culture, so he or

task leadership—discipline and an

she provides something the culture doesn’t.

execution focus—to an organization lacking

If your company is already very relationship

that orientation and produced positive

focused—emphasizing collaboration,

inancial results. But her attempts to do a

shared decision making, and interpersonal

very similar thing failed because her style

support—a leader with the same orientation would be redundant. What you really need is someone who will set expectations, clarify

was, by all accounts, too antithetical to “the HP way.” She took misalignment to an unproductive extreme.

rules, and push people to get things done. And the reverse is also true: If your company is results oriented, it needs a CEO who is good at building relationships.

Back to the study: How much better did companies perform when there was a mismatch? Among the small to midsize,

leadership and cultures, controlling for past performance. That’s a pretty signiicant diference in inancial results.

HBR: Where’s the line between good different and destructive different? The

we looked at, those with complementary

Did you go in expecting that outcome? 

CEO leadership and cultural styles generated

Not really, because management theory,

research doesn’t answer that question, but

returns on assets that were 1% to 4% higher

as well as real-world examples, suggests

anecdotal evidence might. If you compare

in the nine months after the survey than

that a similarity between CEO style and

cases like Alan Mulally at Ford and Carly

the returns of those with matching CEO

corporate culture is beneicial sometimes.

28 Harvard Business Review July–August 2016


mainly privately held technology companies


Look at Jack Welch’s tenure with General

fact, we’ve replicated our indings in a

Electric. Both he and the company had a

similar study involving small to midsize

strong results orientation, and it worked for

enterprises from a variety of industries in

many years. On the other hand, there are

the United States. We’ll need to do further

examples like Mulally at Ford. So we went in

research to see whether there are similar

with two contrasting hypotheses—matches

patterns in larger organizations, in publicly

between CEO leadership and culture will

traded ones, and in other countries.

boost performance, and mismatches will boost performance—not knowing which one would prove right. Very convincing arguments could be made on both sides.

Why did you focus on task and relationship orientation instead of other aspects of culture and leadership? In the years that I’ve spent working with CEOs, I’ve always

Join world-class faculty and a network of global peers in our Executive Education programs.

asked what they consider to be the most

It seems obvious that mismatches will work when the leader is supposed to serve as a change agent. But what about when you want to maintain the culture while still boosting performance? We don’t

And if you look at the literature on

know the particular circumstances of the

organizational culture and leadership,

important aspects of the job, and they’ve always given the same two answers: execution and relationship building.

companies covered in our study, but you

those two buckets crop up again and

can bet that some of the outperformers

again. The terms might vary—“production”

wanted to and did keep their existing


versus “employee,” “structure” versus

cultures. Remember, though, when you do

“consideration,” “market” versus “clan,”

research like this, it gives you a snapshot in

“outcome focus” versus “respect for

Advanced Management Program BEGINS 06 SEP 2016

Owner/President Management 11–30 SEP 2016

people”—but the idea is the same.

Real Estate Management Program 09–14 OCT 2016

For example, we know from research and

What about lower-level leaders? Should they also try to provide what the culture doesn’t? We haven’t studied it, but my

practical experience that leadership styles

gut reaction is yes. The point is to reduce

are contagious. So, if a CEO like Mulally

redundancies between leadership and

does strategy and implementation reviews

culture. But organizations have subcultures,

with his top team every other week for a

so this doesn’t mean that everyone should

year, it will have a trickle-down efect and

mimic the CEO. Also, as I said before, if

eventually change the culture of the whole

time. We’ve demonstrated that there’s an important interaction between leadership style and culture, but we’re not capturing the dynamic nature of that interaction.

Behavioral Economics 16–21 OCT 2016

the organizational ethos ultimately shifts

Changing the Game: Negotiation and Competitive Decision Making

enterprise. If that’s taken to an extreme, the

because all the bosses adopt an opposing

30 OCT–04 NOV 2016

company could become too micromanaged,

leadership approach, they might want to

resulting in a need to move away from that

swing back in the other direction. You’re

match. The CEO then might have to dial

looking for checks and balances.

back the task and results focus and start to emphasize relationships and collaboration

today and stick with it. You have to adjust

HBR prides itself on having a collaborative, employee-focused culture. We’re hitting our financial targets, but should the bosses be tougher taskmasters? Sounds as if

the dynamics for external changes and

you already have the right complementary

internal integration.

mix. That said, I would lean toward using

Is it possible that you should strive for mismatches only in fast-changing industries like technology? We suspect

publishing a world-class magazine on a

a bit more. That’s why the job of a CEO is so hard. You can’t just have one style

High Potentials Leadership Program 30 OCT–04 NOV 2016

Building and Sustaining a Successful Enterprise 28 NOV–03 DEC 2016

task leadership to reinforce the goal of

that it’s a broader phenomenon, and in

timely basis.

Interview by Alison Beard HBR Reprint F1607B

Get started at


IDEA WATCH To enter our caption contest, go to

STRATEGIC HUMOR I wish you wouldn’t pester me with things I can easily ignore in an e-mail.


“Now accepting bids on lot 7. Comes equipped with a pocket protector and $200K in debt.” This month’s winning caption was submitted by Ken Flamer of Westlake Village, California. 30 Harvard Business Review July–August 2016


Hey, look at this: After only a month, the idea that we spent the past two years developing has attracted $10 on Kickstarter.


AUTO epicenter meets

Knowledge and commitment merge in Michigan. Home to more than 75% of domestic automotive R&D. The worldâ&#x20AC;&#x2122;s irst and only research center dedicated to testing connected and autonomous vehicles in real-world settings. A growing leadership position in cyber security. And a high-tech population that rivals any in the world. Such is the road Michigan is traveling in the world of automotive. Leading the industry to a world of innovation and discovery. To a world thatâ&#x20AC;&#x2122;s Pure Michigan.





The Idea A financial crisis in the early 1990s led WPP to reorganize around a new strategy for growth, which included centralizing certain corporate functions and creating “horizontality” to give clients access to resources across the company’s various agencies.

July–August 2016 Harvard Business Review 33



arly in 1992 I went to the

agencies, which helped us win new

an IMG oice in London. After a few

London headquarters of J.P.

business. Managing our portfolio this

years I left to try to start a company with my dad, who was my closest

Morgan, which at that time

way allowed the agencies to focus on

was housed in a converted school

doing what they do best and gave top

adviser and mentor at that time. We

building. I felt as if I were being called

managers room to develop strategies

didn’t ind a business that made sense, so I signed on as a inancial adviser to

into the headmaster’s office. I was

to grow in digital markets, fast-growth

there to see WPP’s bankers, and they

markets, and new ields such as data

a very successful businessman. One

weren’t happy. Two years earlier we’d

investment management, which have

of the companies he’d invested in was

borrowed to make a giant acquisition;

become big sources of growth over the

an ad agency, and the Saatchi brothers

soon afterward, a global recession hit,

past decade.

had merged with that agency. They needed a CFO, so in 1976 I went to

and we struggled to make our debt payments. I had to meet with the

The Path to Advertising

bankers each quarter; they’d go over

I was born in northwest London. I had

I spent nine years at Saatchi &

all our expenses and question our ap-

a brother who died at birth, so I

Saatchi. Charles and Maurice were

work for them.

proach. Out of that near-death expe-

was raised as the only child of first-

very creative, but they didn’t have

rience was born the strategy that has

generation Jewish parents, whose

much business discipline—something

driven our growth for the past 25 years.

families came from Eastern Europe.

that’s vital if you’re trying to grow

WPP is now the world’s largest

My mother and father had a hard but

through mergers and acquisitions, as

advertising and marketing services

warm early life. My father left school

they were. Their expense structure

company, with 190,000 employ-

when he was 13. He eventually man-

was a mess, and we worked to ratio-

ees in 3,000 offices in 112 countries.

aged one of England’s largest televi-

nalize it. People tend to think that ad-

Particularly in our early years, we

sion and radio retail chains. I had a very

vertising agencies succeed or fail on

grew primarily by acquiring smaller

good private school education and

creativity alone, but inancial control

irms—even today some people think

then studied economics at Cambridge.

is equally essential. From watching

of WPP as a holding company. In truth,

I went straight from Cambridge to

the Saatchis, I began to learn how to create a clear strategy and a vision.

many of our acquisitions enjoy auton-

Harvard Business School, and I loved

omy, and some might be happy if we

it—it was two years in a pressure

In all these early jobs, I was work-

operated on the Berkshire Hathaway

cooker, doing three case studies a day

ing closely with and learning from

model, as hands-off owners in a de-

and learning to think like a CEO.

very good entrepreneurs. My father

centralized organization. But as I

After business school I spent

sorted through our inancial crisis in

two years working for a consulting

build a reputation in an industry be-

the early 1990s, I realized that making

firm in Connecticut. This was at the

fore going out on my own. By 1985

had always told me that I needed to

acquisitions and trying to grow into

height of the Vietnam War, and the

I was 40 years old, I had a $2 million

a very large company was pointless

U.S. government was starting to draft

stake in Saatchi & Saatchi, and I had

without a cohesive strategy. Unlike

young men who weren’t citizens but

built the reputation I needed.

Berkshire’s, all our acquisitions are

were working here, so my mother in-

in the same industry. We needed to

sisted that I return to England. I’d met

Early Acquisitions

ind a way to make one plus one equal

Mark McCormack, the sports agent

With help from a stockbroker, I looked

more than two—to leverage our size

who founded IMG, when he spoke

for a small, publicly traded business

for competitive advantage. That was

at Harvard, and he hired me to open

that I could take over as a shell com-

the only way we could add value. The crisis led us to reorganize around a new strategy for growth. We began to centralize certain corporate functions—talent management, finance, IT, real estate, legal—to provide coordination and keep down costs. We also began to create what we now call “horizontality,” giving clients access to resources across our various

pany and grow by acquisitions into

In advertising, “above the line” is the sexy, creative, Don Draper stuff. Below-the-line agencies never get much attention, but they can be good businesses. We bought 18 of them.

34 Harvard Business Review July–August 2016

a major global marketing organization. We settled on Wire and Plastic Products (WPP), which made shopping carts, among other items. It was worth about $1.3 million at the time. By coincidence, one of its advisers had worked with the Saatchis, and he knew the work I’d done for them. He recommended that the owners of


WPP go along with my plan, which

Talent and Real Estate

they did. On the day our stake in the

That brush with oblivion made us take

company was announced, the share

a hard look at the organization. We

price jumped by more than a third,

came to the conclusion that we needed

largely on the basis of my reputation.

to justify the parent company’s exis-

In our irst two years we made 18 acquisitions. We focused on irms special-

tence; otherwise it would only make sense to split up the business.

izing in what are called “below the line”

As we thought about how to add

marketing functions. In advertising,

value, we focused on our investments.

“above the line” is the sexy, creative,

Today about 60% of WPP’s revenue is

Don Draper stuf. Below the line is the

invested in people—the same share

unfancy, unsexy stuf—packaging, de-

as in the 1990s. Our second biggest

sign, promotions. Below-the-line agen-

investment, then and now, has been

cies never get much attention, but they

in property around the world. (In the

can be good businesses. We bought

1990s it was about 10%; today it’s ap-

15 of them in the UK and three in the

proximately 7%.) We also looked for

United States, using mostly our shares

common approaches to procurement

as inancing, and became the largest

and IT software and hardware.

player on either side of the Atlantic.

In this industry there were no

The stock market liked our strategy,

training programs. When a company

and our market cap kept growing.

needed to hire, it ���nicked” someone

In 1987 we made a bid for J. Walter

from a competitor. We saw that talent

Thompson, which owned two large ad

management was one area in which

agencies and a public relations irm. On

the parent company could add value

WPP Facts & Financials FOUNDED 1985 EMPLOYEES 190,000 (including associates) COUNTRIES 112 REVENUE (IN US$ BILLIONS) OPERATING PROFIT $19.0 $2.5 $16.1 $1.9






a revenue basis, it was 13 times our size.

for our operating companies. In 1995

WPP was worth about $250 million,

we launched a fellowship program in

them for even higher positions at

and we offered $566 million for JWT,

which WPP recruits and mentors un-

WPP operating companies. And our

paying half cash, half stock. The deal

dergraduates and graduate students

Worldwide Ownership Plan has given

put us into debt, but I thought it was

and rotates them among the compa-

share options to more than 84,500

a no-brainer. A piece of good fortune

nies, with the goal of developing our

employees to encourage taking a

in this deal was that JWT owned its

own multidisciplinary talent. The pro-

literal stake in the company.

building in Tokyo, and Japan was in

gram is regarded as the industry’s gold

In 1996 we launched the WPP

the middle of a property boom. We

standard and is harder to get into than

Space Program as a real estate manage-

sold the building for $100 million and

Harvard Business School.

ment process. Its natural culmination

immediately paid back nearly half

After trying various compensation

has been the opening of large-scale

of what we’d borrowed to make the

schemes, we laid the groundwork for

“campuses” in Singapore, Shanghai,


the Leadership Equity Acquisition

and soon Madrid. We have smaller

Two years later we acquired Ogilvy

Plan. Under LEAP, top operating and

colocations of operating companies

& Mather in an even bigger deal, one

parent company executives are of-

in multiple markets throughout the

worth $850 million. We paid half in

fered an opportunity to invest their

world. This not only reduces costs but

cash, half in convertible preferred

own money in WPP shares and are

also brings people into closer physical

stock. The stock required us to make

paid out a multiple of that investment

contact and enables collaboration.

payments every quarter, and when the

over a number of years—if WPP’s

We’ve sought to add value in a

economy went into recession, we dis-

share price outperforms its peer group.

number of other areas as well. WPP

covered that we were overleveraged.

That way our people put their own

hired its first procurement person

We never missed a payment, but we

skin in the game.

more than 20 years ago and now has

came very close. We renegotiated our

WPP has launched a number of

a department that is tasked with ei-

debt. It was a come-to-Jesus moment,

programs to cultivate and retain talent.

ciently buying goods and services for

and it forced me to reconsider what we

For example, The X Factor is designed

our portfolio companies. In IT we’ve

needed to do to fuel our growth.

to develop female leaders and prepare

looked at standardizing hardware and

July–August 2016 Harvard Business Review 35



software across the group, culminat-

deines it, digital today accounts for as

and scrutinize marketing spend. A

ing in an outsourcing agreement with

much as 40% of our revenue; some-

squeeze comes from activist investors

IBM. And we’ve established client

day that will probably be 100%. Here,

as well. A CEO’s tenure may average

practice areas in which companies can

too, we’ve used our size to find ad-

ive or six years, but chief marketing

share knowledge and pool resources:

vantages. For instance, WPP’s group

oicers are averaging only 24 months. Management is focused on the short

the Store (our global retail practice),

includes market research and insight

WPP Digital (to accelerate digital de-

firms (what we now call data invest-

term and is cutting back on R&D and

velopment in group companies), our

ment management firms), whose ca-

advertising, which are long-term

government and public sector practice,

pabilities have become increasingly

investments. I agree with Dominic

and others.

important as targeting individual

Barton, of McKinsey, and Larry Fink, of BlackRock, who argue that this is

At first some of our agencies re-

consumers has become easier. In 2007

sisted these changes. They had com-

we bought 24/7 Real Media. It merged

misguided. But it’s a powerful trend,

peted against one another iercely for

with our programmatic platform Xaxis,

and we’ve had to adapt. By offering

accounts, and it made sense that they

which, boosted by a partnership with

wanted to retain their identities. In the

AppNexus, has become a key com-

1990s, for instance, employees were

petitor to Google’s DoubleClick and

upset because the New York offices

Facebook’s Atlas.

of JWT and Ogilvy were going to have

The other big shift in our organiza-

the same telephone exchange (the irst

tional structure came from our efort

three digits of a local number), which

to create horizontality, which began in

might confuse clients and the public.

the 1990s but has accelerated over the

But we’ve moved on from that. And

past decade. We recognized that our

agencies used to think that running

largest clients don’t necessarily want

More than 20 years ago it was clear that Moore’s law was going to affect our industry. Digital today accounts for as much as 40% of our revenue. our biggest clients access to a broad

their own IT systems gave them a

to choose a single agency; they want

competitive advantage, but now they

access to the best talent and ideas

range of resources across WPP, we can

realize that they’re better of letting us

from across the group. So for each of

grow our business in an industry with

leverage our scale.

our top 45 clients, we have one execu-

limited top-line growth.

tive who manages the relationship and

When I think back on my 30-plus

The Lure of “Horizontality”

taps resources from a variety of agen-

years of running WPP, I’m aware that

This more centralized structure has

cies. For Ford Motor Company, for in-

luck has played a part in our success.

allowed us to focus on the issues that

stance, we’ve essentially created an

I’m also aware that whoever succeeds

will truly drive strategic growth in the

agency within WPP—one that draws

me will do things differently—prob-

21st century. One of those is global ex-

not only on ad agencies such as JWT,

ably better than I’ve done. When I

pansion. We were very early among

Ogilvy, and Y&R, but also on public

irst invested in this company, I took

marketing services companies to think

relations people at Burson-Marsteller

a gamble with my $325,000. Today

about the BRIC countries. By 2000

and Hill+Knowlton, and on market

WPP is worth $30 billion, and I own

about 12% of our revenue was coming

researchers and data specialists at

2% of it. The only time I ever sold

from Brazil, Russia, India, and China.

Kantar. We do the same thing for

shares was to fund my divorce, so all

Today nearly a third comes from what

Colgate and many others. Today about

my wealth is tied up in WPP. That’s the

we call fast-growth economies, and

38,000 WPP employees work for these

way I like it.

we have offices from Colombia to

very large accounts, which together

Bangladesh. We are considering what

make up $7 billion of our business.

Being entrepreneurial means taking a risk with your own money, not

the opening of Cuba will mean to the

Finding ways to better serve our

business, and we help our agencies

clients has been particularly impor-

to me that I put my assets on the

plan for growth in new markets.

tant in the current economic envi-

line. Wealth managers think that’s crazy, but my dad always told me to

somebody else’s, so it’s important

We’ve also helped them navigate

ronment. Some of those clients are

the shift to digital markets. More

facing disruption by upstarts such as

invest in the thing I know best. For

than 20 years ago it became clear

Airbnb and Uber. Others have been

me, that’s the company I’ve built over

that Moore’s law was going to affect

bought by private equity irms, which

three decades.

our industry. Depending on how one

implement zero-based budgeting

36 Harvard Business Review July–August 2016

HBR Reprint R1607A


Beyond the Holacracy

HYPE The overwrought claims—and actual promise—of the next generation of self-managed teams BY ETHAN BERNSTEIN, JOHN BUNCH, NIKO CANNER, AND MICHAEL LEE

38 Harvard Business Review July–August 2016



Ethan Bernstein is an assistant professor of leadership and organizational behavior at Harvard Business School. John Bunch is adviser to the CEO and holacracy implementation lead at Zappos. Niko Canner is the founder of Incandescent.

Michael Lee is a doctoral candidate at Harvard Business School.

It was a Thursday afternoon in Las Vegas. Five employees were camped out in a team room at Zappos, the largest company so far to implement holacracy—aa form of selfmanagement that confers decision power on fl flu uid teams, or “ccircles,” and roles rather than individuals. On this particular day, in July–August 2016 Harvard Business Review 39


May 2015, the circle charged with overseeing holacracy’s adoption was questioning the method’s effectiveness. A couple of months earlier, Zappos CEO Tony Hsieh had offered severance packages to all employees for whom self-management was not a good it—or who wished to leave for any other reason. Although most decided to stay, 18% took the package, with 6% citing holacracy. In exit interviews and surveys, the 6% shared their concerns. They talked about attending trainings to learn “shiny buzzwords” but seeing little difference in the way work was done; facing “ambiguity and lack of clarity around progression, compensation, and responsibilities”; getting “no definitive answers” to what they felt were basic organizational questions; and concluding that holacracy was a “half-baked” idea. Although many of their colleagues liked the system for a variety of reasons— they thought it shaped roles to “make the most of my talents,” for instance, and allowed “each person to inluence the governance of the organization”—a number of those who left hadn’t experienced it that way. For the sake of Zappos (and their careers), they had played along, but they were unhappy. The ofer of severance tipped them over the edge. Most observers who have written about holacracy and other types of self-managed organizations—the latest trend in self-managed teams—take an extreme position, either celebrating these “bossless,” “lat” environments for fostering flexibility and engagement or denouncing them as naive social experiments that ignore how things really get done. To gain a more accurate, balanced perspective, it is important to look beyond the buzzwords that describe these structures—“postbureaucratic,” “poststructuralist,” “information-based,” “organic,” and so on—and examine why the forms have evolved and how they operate, both in the trenches and at the level of enterprise strategy and policy. That’s what we’ll do here. Our research and experience tell us that elements of self-organization will become valuable tools for companies of all kinds. Yet we see real challenges in embracing the approach wholesale—Zappos is still grappling with them, even though its holacracy adoption circle has regained its footing. Other organizations have decided it’s just too consuming to go

40 Harvard Business Review July–August 2016

all in. Medium, a social media company that recently dropped holacracy, found that “it was diicult to coordinate eforts at scale,” Andy Doyle, the head of operations, explained in a blog post about the change. Using self-management across an entire enterprise to determine what should be done, who should do it, and how people will be rewarded is hard, uncertain work, and in many environments it won’t pay of. So we’ll also look at circumstances in which it makes sense to blend the newer approaches with traditional models.

What’s the Draw? To better understand the impulse behind self-management models, consider what leaders need most from their organizations: reliability and adaptability. Reliability means many things, such as generating predictable returns for shareholders, adhering to regulations, maintaining stable employment levels, and fulilling customers’ expectations. So does adaptability: For example, some situations call for many small adjustments in production or manufacturing to meet local needs, while others call for fundamental shifts in strategy or capabilities. All organizations must achieve both reliability and adaptability to some degree, but usually one eclipses the other. Too much standardization for the sake of reliability can make businesses insensitive to changing markets. Too much emphasis on adapting can cause them to fragment and lose the leverage that comes with focus and scale (recall how Apple cast about during Steve Jobs’s hiatus). Although managerial hierarchies can err in either direction, they most often skew in favor of reliability—and create rigidity and red tape. Employees, too, need both reliability and adaptability. To be efective on the job, people must have a stable working environment, access to critical resources, and clear goals and responsibilities. But they must also have leeway to adapt to changing conditions and make the right decisions in the moment— and managerial hierarchies often don’t provide that lexibility and discretion. When you’re an executive, it isn’t easy to know the right balance of reliability and adaptability—and even if you do, it’s hard to get an organization to perform accordingly. Hence the keen interest in having organizations “feel their way” toward the desired balance through self-management, which has actually been around for decades. You could say it began about 65


Idea in Brief THE HYPE Holacracy and other forms of self-organization have been getting a lot of press. Proponents hail them as “flat” environments that foster flexibility, engagement, productivity, and efficiency. Critics say they’re naive, unrealistic experiments.

THE REALITY Neither view is quite right. Although the new forms can help organizations become more adaptable and nimble, most companies shouldn’t adopt their principles wholesale.

years ago, when Eric Trist, an early member of the Tavistock Institute (a British nonproit that applies social science ideas to organizational life) observed self-managed teams’ ability to substantially raise productivity in coal mines. Back then, “longwall” mining was the unquestioned best practice. Each team performed a single task, and tasks were done sequentially—a model that fused Frederick Taylor’s scientiic management and Henry Ford’s assembly lines. One team had to inish its shift before the next could start. But miners in South Yorkshire, England, began spontaneously organizing their work diferently. Multiskilled autonomous groups, interchanging roles, and shifts with minimal supervision allowed them to mine coal 24 hours a day, without waiting for a previous shift to inish. In spite of that era’s prevailing belief that high productivity came with doing the same task over and over, productivity soared. Self-managed teams took different forms as they gained popularity in the 1970s and 1980s. In Europe they became synonymous with participative management and industrial democracy. In Japan they morphed into quality circles and continuous improvement eforts. In the United States they became the organizing framework for innovation

THE POTENTIAL A piecemeal approach usually makes sense. Organizations can use elements of selfmanagement in areas where the need for adaptability is high, and traditional models where reliability is paramount.

task forces. Moving to self-managed teams yielded breakthroughs in many companies, mainly in manufacturing and service operation contexts. The Volvo plant in Kalmar, Sweden, reduced defects by 90% in 1987. FedEx cut service errors by 13% in 1989. In the late 1980s and early 1990s C&S Wholesale Grocers created a warehouse of self-managed teams, which enjoyed a 60% cost advantage over competitors, and General Mills increased productivity by up to 40% in plants that adopted self-managed teams. Such teams became more common throughout the 1990s, fueled by the promise of higher productivity in work that was increasingly complex and dynamic. In most companies that used them, just a fraction of employees were involved, generally in areas that demanded more adaptability than reliability. In time they emerged in environments where individuals could readily monitor their own performance and iteratively alter how they worked.


#1 THERE’S NO ORGANIZATIONAL STRUCTURE. In fact self-management models are intricately nested. A holacracy circle, for example, may contain several subcircles, each with subcircles of its own. At Zappos the General Company Circle—the only circle not nested within another—has 18 subcircles, and the average number of subcircles is 1.8. July–August 2016 Harvard Business Review 41


Eventually people wondered, Why stop at selfmanaged teams? After all, the heavily matrixed structures and complex reporting relationships surrounding those teams often hem them in and thwart their effectiveness. For example, when C&S CEO Rick Cohen visited Harvard Business School, more than a decade ago, to speak about his company’s success with self-managed teams, he told students that “the hardest thing is to keep the managers out of the process and just let the teams do what they do.” Why not attack the matrix head-on by applying the principles of self-management to entire institutions? Indeed, organizations had begun to move in that direction. Management scholars Warren Bennis and Henry Mintzberg each noted a shift toward adhocracy—lexible, informal management structures— in the 1980s. A decade later the internet served as a model for what some called “the networked firm.” More recently the open-source movement, agile and scrum methodologies, and the sharing economy have inspired participative, responsive structures— holacracy, podularity (a model with roots in agile software development’s tendency to break tasks into

Zappos’s Structure: Circles Within Circles If all the talk about circles seems abstract and confusing, these visuals of Zappos’s structure may give you a clearer sense of what holacracy looks like in practice. Think of them as snapshots—they’ll change shape over time, as the work evolves.

small increments and to work with minimal planning and fast iterations), and a range of company-speciic variations on self-organization. These are just the latest attempts to use self-management to reconcile reliability and adaptability. The new forms resist hierarchical constraints— but in some ways, contrary to popular arguments, they resemble bureaucracy as sociologist Max Weber deined it in the early 1900s. Bureaucracy vested authority in depersonalized rules and roles rather than in status, class, or wealth. The idea was to liberate individuals from the dictatorial rule of whimsical bosses. Self-managing systems aim to accomplish the same thing, with less rigidity. In that sense, you could think of them as Bureaucracy 2.0. What’s fundamentally diferent here? It’s how the new forms go about balancing reliability and adaptability, and the balance they seek to strike. If traditional organizations strive to be machines governed by Newtonian physics, precisely predicting and controlling the paths of individual particles, then selfmanaging structures are akin to biological organisms, with their rapid proliferation and evolution.


















GENERAL COMPANY CIRCLE The GCC contains every other circle and subcircle at Zappos.

42 Harvard Business Review July–August 2016


ZAPPOS 2.0 This circle is a bit “meta”—its purpose is to keep the company “moving forward in a self-organized world” that’s built on core values. You can see a range of jobs to be done here, from operations to conflict resolution.


What Self-Managed Organizations Look Like Given their origins in self-managed teams, it’s not surprising that self-managed organizations have similar codes of conduct: Members share accountability for the work, authority over how goals are met, discretion over resource use, and ownership of information and knowledge related to the work. But what does it mean, in practice, to run a whole enterprise this way? A range of companies have made the leap, most notably Morning Star, a maker of tomato products; Valve, a developer of video games and gaming platforms; W.L. Gore, a highly diversiied manufacturer; and, of course, Zappos. (For more on Morning Star, see “First, Let’s Fire All the Managers,” by Gary Hamel, HBR, December 2011.) As mentioned, we’ve seen variations on the self-organization theme, but the best-known and most fully speciied of these systems is holacracy. Both because its formality makes it somewhat easier to pin down and examine and because it has been implemented more often and at greater scale than other designs, we focus signiicantly on it in this article.







Self-organization models typically share three characteristics: Teams are the structure. In holacracy, they’re “circles”; in podularity, “pods”; at Valve, “cabals”; and at many companies, simply “teams.” Whatever they’re called, these basic components—not individuals, and not units, departments, or divisions— are the essential building blocks of their organizations. Within them, individual roles are collectively defined and assigned to accomplish the work. As in traditional organizations, there may be diferent teams for diferent projects, functions (inance, tech, sales), or segments (customer, product, service). But self-managing enterprises have a lot more of them— the overall organizational structure is diced much more inely. After Zappos implemented holacracy, 150 departmental units evolved into 500 circles. The modularity allows for more plug-and-play activity across the enterprise than in a system where teams sit squarely in particular units and departments. And the teams come and go as employees perceive changes in the organization’s needs (just as task forces and project teams in traditional organizations do, but without the surrounding matrix structure, which has a way of holding ad hoc groups together even after they’re irrelevant). Some teams are more leeting than others. As new goals, tasks, and initiatives emerge, individuals create circles or pods or cabals to tackle them. For example, St. Louis’s public television station, KETC, mobilizes temporary teams to bring community voices and stories into programming in response to major events, such as the inancial crisis and recent events in Ferguson.

Teams design and govern themselves. BADGE DESIGN ADVISER



BADGING Awarding skill badges is one facet of that self-organizing work. The various roles in this circle are meant to support and connect learning environments, motivate growth, recognize achievements, and drive employees to develop personally and professionally.





Although self-organization largely avoids traditional patterns of hierarchy, teams are nested within a larger structure, which they have a hand in shaping and reining. Holacratic organizations ratify a constitution—a living document outlining the rules by which circles are created, changed, and removed. So the circles don’t just manage themselves; within those guidelines, they also design and govern themselves. The constitution doesn’t say how people should do their tasks. It explains in a broad-brush way how circles should form and operate: how they should identify and assign roles, what boundaries the roles should have, and how the circles should interact. At Morning Star, which developed its own form of self-management, employees (in consultation

July–August 2016 Harvard Business Review 43


with relevant coworkers) write up formal agreements known internally as “colleague letters of understanding” (CLOUs). These outline responsibilities, activities, and overall goals and contain highly detailed metrics for evaluating performance. CLOUs are essentially contracts that articulate employees’ work commitments to the organization—like annual performance previews that let your colleagues know what they can count on you to accomplish. The terms are renegotiated formally every year but can be changed at any point to relect new work requirements and individuals’ evolving skills and interests. Leadership is contextual. In self-managed organizations, leadership is distributed among roles, not individuals (people usually hold multiple roles, on various teams). Leadership responsibilities continually shift as the work changes and as teams create and deine new roles. Technology is essential for keeping these changes straight. In a holacracy, for example, enterprise software such as GlassFrog or holaSpirit is typically used to codify the purpose, accountability, and decision rights of every circle and role, and the information is accessible to anyone in the organization. At Morning Star, CLOUs are stored on an internal server that makes each individual’s commitments visible to everybody at the company. Transparency enables cross-team integration; all the thinly diferentiated roles are easier to ind than they would be in a traditional organization. When someone isn’t a good it for a role, it’s reassigned to someone else. Of course, assigning roles is work in itself. In a holacracy, there’s a role for that, too—the “lead link,” which also assumes responsibility for connecting a circle to the larger circles that encompass it (for instance, linking social media to marketing and communications). In more loosely defined forms of self-management, such as podularity, roles are lexibly reassigned, but it is left up to the organization to igure out how.

These three characteristics add up to an organization that is responsive to the requirements of the work rather than to the directives of any powerful individual. Traditional management goes wrong when the boss gets to prescribe what must be done— or how—because of a job description, not because he or she has particular insight into what will produce the desired outcome. Self-managed organizations strip away much of this ability to prescribe, using structuring processes (rather than a ixed structure) to maintain order and clarity.

What They Try to Accomplish on the Ground Recent experiments with self-managed organizations have zeroed in on a few ways of improving performance. In each area, they have seen success but also problems.

Designing roles that match individual capabilities with organizational goals. In traditional organizations, each employee works within a single, broadly deined role, and it’s often diicult for people to sculpt or switch jobs. In self-managing systems, individuals have portfolios of several very speciic roles (Zappos employees now have 7.4 roles, on average), which they craft and revise to address shifting organizational and individual needs. Negotiating with one another, employees allocate duties to those best suited to carrying them out. The process lets individuals play to their strengths and interests and serves as a safety check against roles that might be useful to one person but harmful to the team or the organization. At Morning Star, people jointly draft and adjust their CLOUs to match capabilities with work. Zappos has started a system of “badges” that let employees convey at a glance the skills they have to ofer. Badges are awarded to mentees by employees already proicient as, say, a “rookie writer” (someone with limited permissions who can respond to customer-facing e-mails in times of need) or a “GlassFrog genius” (someone with a thorough


#2 HIERARCHY NO LONGER EXISTS. Zappos has twice as many “lead link” roles as it had managers pre-holacracy. What’s different, other than the label? Leadership responsibility belongs to the roles, not to the individuals in them. Authority may be contextual, but it does exist. 44 Harvard Business Review July–August 2016


understanding of the holacracy software). In a holacracy, circle members can object to a suggested role change if it would “move the circle backwards.” The person proposing the change must address the issue raised or, as a last resort, drop the proposal. This approach to role design gives people room to grow on the job. Consider Ryan, a software developer at ARCA, a global manufacturing and services company where one of us spent more than a year observing the implementation of holacracy. Early on, Ryan— who was passionate about user interface design—saw an unmet need to ensure that ARCA’s software had a consistent look and feel. At one of his team’s structuring meetings, he pitched the idea of creating a role for this work: UI liaison. No one in the circle thought this would cause any harm, so the role was created and the lead link assigned it to Ryan, who also continued to ill the software developer role. This allowed him to simultaneously improve the group’s performance and pursue a professional growth opportunity. Unlike ixed structures built around specialists who dedicate themselves to one function full-time, these new organizational forms let employees become “utility players,” with highly focused roles they can ill in multiple areas of the business. Take Karl, who came to ARCA before it implemented holacracy. A recent law school graduate, he had little business experience but showed great potential with his legal and analytical skills. His versatility allowed him to take on multiple roles at the growing company, in sales, legal services, and operations. However, as he worked across functional groups, he felt his contributions were getting lost in the organizational structure. When the company adopted holacracy, Karl’s many roles across multiple circles became explicit and visible. He thought his value was more clearly recognized, which gave him even more conidence to initiate changes and make decisions. Karl said, “Pre-holacracy, I felt pretty empowered but always ran stuf by people. I think an org implementing holacracy is saying, ‘You don’t have to run stuf by us anymore.’ I’ve taken the opportunity to exercise more judgment and discretion.” As one of his peers noted a few months into the new system, “Holacracy has really expanded his inluence in the company.” How did Karl it all this work in? Holacracy let him jettison roles that weren’t a good use of his time. For instance, he used the structuring process to carve out some administrative responsibilities and pitch them

as a separate role, which the lead link illed with an enthusiastic new hire. Although this shift in responsibilities was initiated by an individual contributor, not by a manager, it was highly formalized and oicial. The upside of designing roles in this way is straightforward: Because employees are driving the process, they have a greater sense of making real progress on meaningful work. Teresa Amabile’s nearly 12,000 data points on the quality of “inner life at work” show that having a daily sense of forward movement—even the smallest wins—along with colleagues who provide resources, advice, and help are by far the two most signiicant factors differentiating good days from bad. These factors are strongly associated with creative problem solving, motivation, and engagement. Although studies of the efects of self-managed teams on employee engagement have shown mixed results, self-managed organizations are explicitly designed to remove impediments to day-to-day progress in everyone’s work and to set colleagues up to be positive “catalysts” for one another. Assuming that the connection is borne out, is the shift from traditional jobs to a larger number of microroles a net beneit? Possibly—but role proliferation has costs, too. It creates three kinds of complexity, all related to human capital: First, it complicates actually doing the work, because employees struggle with fragmentation. A signiicant body of literature on goal setting (aptly summarized by Marc Efron and Miriam Ort in their book One Page Talent Management) finds that employees perform less well on each goal as they take on more beyond just a handful. At Zappos, each of the 7.4 roles an individual ills contains an average of 3.47 distinct responsibilities, resulting in more than 25 responsibilities per employee. People grapple with where to focus their attention and how to prioritize and coordinate across circles—even with simple scheduling issues. To partially address these challenges, Zappos is trying out a tool (modeled after ordinary budgeting systems but expanded beyond dollar amounts or head-count limits) called People Points: Each circle gets a certain number of points with which to recruit individuals into roles, with senior management determining the points by assessing the business value of the circle’s work. (The company is exploring crowdfunding models to replace this top-down budgeting.) And each Zapponian gets a budget—100 points to allocate as he or she chooses.

July–August 2016 Harvard Business Review 45


The system serves as a marketplace for the work that Communication is supposed to become more efneeds to be done, allowing a person to work across icient and accurate as a result, which is good for relimultiple teams without being told where to work. ability. But to make smarter decisions in this sort of It also puts the onus on employees to ill their time system, all members must exercise their power and with valuable roles. voices, which doesn’t always happen. One misconSecond, having so many roles complicates com- ception about self-managing organizations is that pensation. As people assemble their personal portfo- they eliminate diferences in status. Although those lios of roles, it becomes diicult to ind clear bench- differences may be mitigated, they still exist and must be managed. Some people have more power marks or market rates. For instance, what would than others, and managers who used to supervise you pay someone who divides her time between certain activities may at times try to reassert control, developing software, serving as the lead link for a making it hard for employees to know whether to software development team, working on marketing follow the new system or listen to their old boss. strategy, creating internal leadership training, doing It can also be tough for people to “step up” and community outreach, and planning events? Zappos claim their power. An employee at ARCA, observing is experimenting with basing compensation on the that members of her circle were not challenging a acquisition or application of its skill badges. But the top-down order from a former boss, said, “I feel that complexity is still daunting. Third, role proliferation complicates hiring, employees haven’t explored their agency within both into the organization and into particular roles. holacracy.” For such agency to thrive, both managAlthough new employees are brought on to meet ers and subordinates must unlearn old behaviors. speciic needs, they quickly start adding other roles Another employee, who formerly had a managerial to their portfolios. In the last three months of 2015, title, talked about how much time he used to spend Zappos’s roughly 1,500 employees made and re- approving others’ decisions. Since the move to holceived 17,624 role assignments (11.7 per employee), acracy, he’s had to shift to enabling mode, encouragor about 195 per day. Given that volume, the com- ing individuals to make decisions on their own. Self-managing systems reinforce this unlearning pany developed Role Marketplace, a tool to quickly to a point, through training on how to “work in” and post open roles and manage applications, with lead links ultimately deciding who fills the roles. “work on” the structure and through processes and norms that make it diicult for earlier forms of power The tool handled almost a quarter of those 17,624 to reemerge. For instance, 12 months into Zappos’s assignments. Using both People Points and Role Marketplace, an employee could potentially find, implementation of holacracy (and just a couple of months before the severance-package offer), 400 apply for, be assigned to, and start working in a role within a single day. That’s a lot of activity to keep employees had completed the three-day holacracy training, and 90 had become “certiied facilitators” track of, even if you’ve got software to help. Making decisions closer to the work. Self- of governance and working meetings. But trainings management aims to reduce the red tape and end- don’t in themselves eliminate problematic behavior, such as micromanaging others or infringing on the less sign-ofs usually needed to make decisions in bureaucracies. In traditional organizations, intri- autonomy of former subordinates. Old power rules can be deeply embedded in culture and institutions cate webs of titles, job descriptions, and reporting and may require continual attention to unravel. relationships can make it diicult to igure out who Even if employees want to speak up, it can be decides what. In some of the newer models, such as hard to absorb all the rules of engagement—and holacracies, everyone can see who holds each role once people start applying them, that “structuring” and what people are responsible for. The processes and norms for decision making are streamlined too. work can feel almost as onerous as the Byzantine hiRather than run ideas up the lagpole and wait for erarchy it replaced. If every circle has a monthly govanswers to come back down, individuals go directly ernance meeting, as is common in holacracies, and if to the people who will be afected. Within holacra- employees are in 4.1 circles, on average, the meeting time adds up. Zappos employees have so far dealt cies, this is known as “going role to role.” It means that messages are less likely to get watered down or with the challenge by making their meetings more efficient and using technology to reduce the need misinterpreted through layers of management.

46 Harvard Business Review July–August 2016


What They’re Talking About When They Say… A glossary of self-management terms ORGANIZATIONS




A new kind of organization designed to enable “whole” individuals (not narrow professional selves) to self-organize and self-manage to achieve an organic organizational purpose (determined not through hierarchical planning but incrementally, responsively, and from the bottom up).


The most widely adopted system of self-management, developed in 2007 by Brian Robertson. Authority and decision making are distributed among fluid “circles” (defined below) throughout the organization, and governance is spelled out in a complex constitution.


A system of self-management in which each basic unit, or “pod,” is treated as a microcosm of the whole business and acts on its behalf. Podul ular arit ityy ha hass it itss ro root otss in agi g le (de defin fined ed bel elow low)). ).


A theo eory ry of ma mana nage geme ment nt ori rigi g na gi nati ting ngg in so soft ftwa ft ware re dev evel elop opme ment nt. In an ag agilile system off work, cross-functional, self-managed teams solve compl p ex probl blem emss it iter erat ativ ivel elyy an and d ad adap apti tive vely ly—wh when possib iblle, face-to-face—with rapid i and flexible responses to changing customer needs.


In a hol olacracyy, a gr g oup p of “ro role les” s (d (defi efine ned d be belo low) w) wor orki king ng toward d th the same me pur urpo pose po se;; in ess se ssen ence en ce, a te ce team am tha hatt form fo rmss or dis rm isba band ba ndss as the org nd rgan aniizati tion’s ’ needs d change.


At the video game developer Valve, a multidisciplinary project team that forms organically to work toward a major goal. “Voting with their feet,” employees create or join a cabal because they feel the work is important.


In a holacracy circle, a set of responsibilities for a certain outcome or process. Roles can be created, revised, or destroyed; individuals usually have more than one, in multiple circles.


In a holacracy circle, the role responsible for assigning other roles and allocating resources. A lead link has some characteristics of a traditional manager but is subject to the circle’s governance process.



“Colleague letter of understanding”—at the tomato-processing company Morning Star, an agreement crafted by each employee in consultation with relevant colleagues, outlining the employee’s roles along with detailed performance metrics.

for direct interaction. For example, the company developed a Slack bot to run governance meetings according to holacratic rules. Although the automated facilitation and virtual discussions through Slack reduce the time investment, the structuring work is still relentless, with each person involved in roughly one governance conversation a week. At Medium, the social media company that stopped using holacracy, that work proved too much to sustain. Doyle said in his blog post, “The system had begun to exert a small but persistent tax on both our efectiveness and our sense of connection to each other.”

Responding to emerging needs in the market. We’ve traditionally romanticized our leaders as scouts with keen vision who monitor the horizon for developments that deserve the attention of the organization and its people. And thanks to increasingly advanced analytics, leaders’ observations have become far more precise. Yet a great deal of evidence shows that eforts to drive change programmatically from the top, solely in response to what senior leaders see, often fail. Self-managing organizations take a diferent approach. Consider how Valve made the decision to expand from PC games to hardware. The company’s 400-plus employees self-allocate 100% of their time to projects they feel are valuable to customers. They

collaborate in cabals, which people form and re-form, project by project, by wheeling their desks together, often several times a day. When a few employees got suiciently tired of repeated customer requests for hardware that would let people play games in the living room, they formed a cabal to investigate the idea. When others recognized Valve’s potential strategic vulnerability to a “closed” Windows store, they allocated some time to that issue. In neither case did a siren sound from a lookout on high; the problems were detected and addressed on the ground, through a steady accretion of talent. In November 2015 the cabals facilitated one of PC gaming’s largest hardware releases of the year, built on an open platform that signals Valve’s willingness and ability to protect against the threat of being closed out of customers’ PCs. It’s possible, however, to be too responsive to your customers. Steve Jobs famously pointed out that the market doesn’t always know what it wants. As Bain’s research on growth through simplicity shows, adding SKUs in response to perceived customer needs can mean less revenue. And Bob Moesta, whose Re-Wired Group advises organizations on demand-side innovation, distinguishes between what customers explicitly ask companies to supply and a more holistic view of demand. He says the latter is

July–August 2016 Harvard Business Review 47


where real value is created—but organizations need a level of relection that goes beyond simple responsiveness. Although it’s important to be close to your customers, it’s also critical to maintain a broader perspective so that you don’t follow them of a clif. You might assume that the three goals of selfmanagement structures—designing roles that match individual capabilities with organizational goals, making decisions closer to the work, and responding to emerging market needs—would make leaders less relevant. Yet one of the greatest challenges of implementing the goals at scale is insuicient leadership. When leadership is a shared responsibility, everyone must understand and practice it. You end up with more formal team leaders as the number of modules increases. Since adopting holacracy, Zappos has gone from 150 team leaders to 300 lead links, who are responsible for its 500 circles. Of course, managing looks different in these structures. It’s less about supervision and direction and more about designing, facilitating, and coaching. One former manager at ARCA said, “Leadership might be even more important in a holacracy than in a traditional management structure. You have to lead by example and round up the troops rather than rely on authority.” Members of self-managing teams have been saying similar things for decades.

Costs and Benefits “Above the Trenches” So far we’ve looked at self-management on the ground. But how does it work at a macro level— where organizations set strategic direction, oversee global operations, and shape their overall performance and trajectory? Consider a large consumer packaged goods company like PepsiCo. Suppose it is deciding whether to shift the ingredient mix of a product made for a certain market in response to consumer demand for fewer artiicial sweeteners. Self-management naturally facilitates such changes. The people who touch the decision get together, evaluate the opportunity, sort out the practical details (for example, discontinuing the use of certain suppliers), and then make it happen, all without interference from above. However, a company of PepsiCo’s scale has a multifaceted operational agenda, which may include simplifying the global supply chain and freeing up capital for acquisitions. To achieve such goals, you’ll need more than an array of small, local moves. In fact,

48 Harvard Business Review July–August 2016

you’ll probably have to take actions that are suboptimal in a number of speciic contexts. For example, consolidating suppliers will cut complexity and costs overall, but you’ll miss out on certain niche suppliers who could ofer higher quality and lower prices in emerging markets. Structures that transmit guidance from the top are better equipped than self-managed organizations to make local trade-ofs in service of scale—a critical advantage for a global CPG company. This is doubly true when it comes to corporate strategy. Most executives view strategy as an essential feature, but proponents of self-managed organizations—like holacracy cofounder (and coder) Brian Robertson—argue that it is actually a bug. Robertson writes in his book about holacracy, “When you impose a ‘should’—as in ‘I should be X in five years’ time’—you create an attachment to that outcome; the attachment limits your ability to sense when reality is not going in that direction, or when other possible opportunities arise that might conlict with what you first set out to achieve.” Because it’s a ground rule of holacracy that you can revisit any decision whenever you want, Robertson adds, “you will ind it very diicult to drive others’ behaviors on the basis of targets deined in advance.” Even though strategic planning isn’t explicitly prohibited, such plans are often replaced by continually updated rules of thumb that take the form of “emphasize X, even over Y.” At Zappos, providing the best customer service and increasing short-term proits are both guiding principles—but if employees ever have to choose between the two, they know to pick customer service. In our view, this approach to establishing direction isn’t viable for certain kinds of organizations. Take Sirius XM: It has invested billions of dollars to create a satellite radio infrastructure that will generate returns for decades, so it needs a clear, stable, consistent overarching strategy. W.L. Gore, with its portfolio of technology innovations that can be brought to market in diferent ways, requires much less top-down strategic maneuvering. Zappos is probably somewhere in between. Its strategic positioning has been clearly differentiated for many years—and much of what has transpired since it adopted holacracy represents an extension of that. However, Zappos has adapted to a shifting market by making signiicant changes in product mix, customer targeting, and pricing. Working within the framework of holacracy, the company achieved a 75% yearon-year increase in operating proit in 2015 as a result


of those strategic moves. So, although it’s hard to say whether holacracy would enable the company to navigate major changes in the competitive environment, early signs are promising.

Finding the Right Amount of Self-Management As we’ve learned from self-managing teams, blanket arguments for or against broadly applying the principles of self-management miss an important point: Most organizations, particularly large corporations, should adopt these techniques in part, not in whole. We’d be surprised if more than 20% of the Global 1000 looked “teal” in 2030, to use Frederic Laloux’s term for “whole,” evolutionary, self-managing organizations. But we’d also be surprised if more than 20% didn’t signiicantly draw on some of the techniques within their corporate frameworks. A great deal of piecemeal adoption is already happening. Procter & Gamble, for instance, operates a complex matrix organization in order to integrate its many brand categories, geographies, and functions. But it also has a vast open-innovation program, in which teams of people outside P&G’s walls organize themselves to solve problems for the company. Google and 3M provide familiar examples as well: For decades employees have been encouraged to devote a percentage of their time to self-directed work—a volunteer economy that exists alongside the managerial hierarchy’s more directed economy. Deciding where to apply self-management in an organization hinges on three questions: What needs to be reliable? What kinds of adaptation are important? And what organizational forms will produce the right balance in this case? Using self-management principles to design an entire organization makes sense if the optimal level of adaptability is high—that is, if the organization operates in a fast-changing environment in which the beneits of making quick adjustments far outweigh

the costs, the wrong adjustments won’t be catastrophic, and the need for explicit controls isn’t signiicant. That’s why many start-ups are early adopters. The business of designing and developing games also its these criteria well, as Valve discovered. But in reliability-driven industries such as retail banking and defense contracting, hierarchical structures prevail, even if there is room for niche competitors (in banking, think of Umpqua, famous for having a phone in every branch that enables customers to ring the CEO’s oice) or for certain units within the organization (such as the original Skunk Works at Lockheed Martin) to go against the traditional grain. Companies must also work out how much hierarchy and process they need to ensure coherence and what other kinds of “glue,” such as shared purpose and a common ethical compass, they can use. Dov Seidman’s “The HOW Report” quantiies the degree to which various companies rely on those other cohesive elements and links self-governance to a range of performance outcomes. Seeing how others have fared can help organizations sort out whether—and where—this particular glue makes sense for them. Ultimately, and somewhat ironically, the next generation of self-managing teams is demanding a new generation of leaders—senior individuals with the vision to see where it is best to set aside hierarchy for another way of operating, but also with the courage to defend hierarchy where it serves the institution’s fundamental goals. HBR Reprint R1607B


#3 EVERYTHING IS DECIDED BY CONSENSUS. The majority doesn’t rule—and not everyone has to agree with every idea that moves forward. In a holacracy, for example, any circle member can propose changes, and they are adopted unless another member objects on the grounds that they would harm the circle. July–August 2016 Harvard Business Review 49

HOW DOES ONE VISIONARY SEE THE FUTURE OF HEALTH CARE? BY THE NUMBERS. National trends, new models of care and other forces are driving the evolution of health care and the study of population health management. Rosalind Franklin University is employing the power of metrics to track performance in relation to our institutional goals and aspirations. As provost and visionary expert on interprofessional education, Dr. Wendy Rheault is leading this effort to align RFU’s priorities with the nation’s anticipated healthcare needs through the sheer, undeniable strength in those numbers. Her insights are helping align how we teach, train and professionally develop our students with the nation’s Triple Aim of improving healthcare costs, quality and outcomes.

Numbers reveal an impressive story that’s unfolding now at Rosalind Franklin University.






Why Diversity Programs Fail by Frank Dobbin and Alexandra Kalev

Designing a BiasFree Organization An interview with Iris Bohnet by Gardiner Morse

70 We Just Can’t Handle Diversity by Lisa Burrell

Building a Diverse Organization

ARTWORK Roger Clarke, Accidents Will Happen (cndm), 2010 Polyester resin, fiberglass, varnish

July–August 2016 Harvard Business Review 51



ARTWORK Roger Clarke, The Deadliest Toxins (dsdc), 2009 Polyester resin, fiberglass, varnish

Why Diversity Programs Fail And what works better BY FRANK DOBBIN AND ALEXANDRA KALEV

52 Harvard Business Review July–August 2016


Frank Dobbin is a professor of sociology at Harvard University. Alexandra Kalev is an associate professor of sociology at Tel Aviv University.

usinesses started caring a lot more about diversity after a series of high-profile lawsuits rocked the financial industry. In the late 1990s and early 2000s, Morgan Stanley shelled out $54 million—and Smith Barney and Merrill Lynch more than $100 million each—to settle sex discrimination claims. In 2007, Morgan was back at the table, facing a new class action, which cost the company $46 million. In 2013, Bank of America Merrill Lynch settled


July–August 2016 Harvard Business Review 53


a race discrimination suit for $160 million. Cases like these brought Merrill’s total 15-year payout to nearly half a billion dollars. It’s no wonder that Wall Street irms now require new hires to sign arbitration contracts agreeing not to join class actions. They have also expanded training and other diversity programs. But on balance, equality isn’t improving in inancial services or elsewhere. Although the proportion of managers at U.S. commercial banks who were Hispanic rose from 4.7% in 2003 to 5.7% in 2014, white women’s representation dropped from 39% to 35%, and black men’s from 2.5% to 2.3%. The numbers were even worse in investment banks (though that industry is shrinking, which complicates the analysis). Among all U.S. companies with 100 or more employees, the proportion of black men in management increased just slightly—from 3% to 3.3%—from 1985 to 2014. White women saw bigger gains from 1985 to 2000—rising from 22% to 29% of managers—but their numbers haven’t budged since then. Even in Silicon Valley, where many leaders tout the need to increase diversity for both business and social justice reasons, bread-and-butter tech jobs remain dominated by white men. It shouldn’t be surprising that most diversity programs aren’t increasing diversity. Despite a few new bells and whistles, courtesy of big data, companies are basically doubling down on the same approaches they’ve used since the 1960s—which often make things worse, not better. Firms have long relied on diversity training to reduce bias on the job, hiring tests and performance ratings to limit it in recruitment and promotions, and grievance systems to give employees a way to challenge managers. Those tools are designed to preempt lawsuits by policing managers’ thoughts and actions. Yet laboratory studies show that this kind of force-feeding can activate bias rather than stamp it out. As social scientists have found, people often rebel against rules to assert their autonomy. Try to coerce me to do X, Y, or Z, and I’ll do the opposite just to prove that I’m my own person. In analyzing three decades’ worth of data from more than 800 U.S. irms and interviewing hundreds of line managers and executives at length, we’ve seen that companies get better results when they ease up on the control tactics. It’s more effective to engage managers in solving the problem, increase their onthe-job contact with female and minority workers, and promote social accountability—the desire to

54 Harvard Business Review July–August 2016

look fair-minded. That’s why interventions such as targeted college recruitment, mentoring programs, self-managed teams, and task forces have boosted diversity in businesses. Some of the most effective solutions aren’t even designed with diversity in mind. Here, we dig into the data, the interviews, and company examples to shed light on what doesn’t work and what does.

Why You Can’t Just Outlaw Bias Executives favor a classic command-and-control approach to diversity because it boils expected behaviors down to dos and don’ts that are easy to understand and defend. Yet this approach also lies in the face of nearly everything we know about how to motivate people to make changes. Decades of social science research point to a simple truth: You won’t get managers on board by blaming and shaming them with rules and reeducation. Let’s look at how the most common top-down eforts typically go wrong. Diversity training. Do people who undergo training usually shed their biases? Researchers have been examining that question since before World War II, in nearly a thousand studies. It turns out that while people are easily taught to respond correctly to a questionnaire about bias, they soon forget the right answers. The positive efects of diversity training rarely last beyond a day or two, and a number of studies suggest that it can activate bias or spark a backlash. Nonetheless, nearly half of midsize companies use it, as do nearly all the Fortune 500. Many irms see adverse efects. One reason is that three-quarters use negative messages in their training. By headlining the legal case for diversity and trotting out stories of huge settlements, they issue an implied threat: “Discriminate, and the company will pay the price.” We understand the temptation—that’s how we got your attention in the irst paragraph—but threats, or “negative incentives,” don’t win converts. Another reason is that about three-quarters of irms with training still follow the dated advice of the late diversity guru R. Roosevelt Thomas Jr. “If diversity management is strategic to the organization,” he used to say, diversity training must be mandatory, and management has to make it clear that “if you can’t deal with that, then we have to ask you to leave.” But ive years after instituting required training for managers, companies saw no improvement in the proportion of white women, black men, and Hispanics in management, and the share of


Idea in Brief THE PROBLEM To reduce bias and increase diversity, organizations are relying on the same programs they’ve been using since the 1960s. Some of these efforts make matters worse, not better.

THE REASON Most diversity programs focus on controlling managers’ behavior, and as studies show, that approach tends to activate bias rather than quash it. People rebel against rules that threaten their autonomy.

black women actually decreased by 9%, on average, while the ranks of Asian-American men and women shrank by 4% to 5%. Trainers tell us that people often respond to compulsory courses with anger and resistance—and many participants actually report more animosity toward other groups afterward. But voluntary training evokes the opposite response (“I chose to show up, so I must be prodiversity”), leading to better results: increases of 9% to 13% in black men, Hispanic men, and AsianAmerican men and women in management five years out (with no decline in white or black women). Research from the University of Toronto reinforces our findings: In one study white subjects read a brochure critiquing prejudice toward blacks. When people felt pressure to agree with it, the reading strengthened their bias against blacks. When they felt the choice was theirs, the reading reduced bias. Companies too often signal that training is remedial. The diversity manager at a national beverage company told us that the top brass uses it to deal with problem groups. “If there are a number of complaints…or, God forbid, some type of harassment case…leaders say, ‘Everyone in the business unit will go through it again.’” Most companies with training have special programs for managers. To be sure, they’re a high-risk group because they make the hiring, promotion, and pay decisions. But singling them out implies that they’re the worst culprits. Managers tend to resent that implication and resist the message. Hiring tests. Some 40% of companies now try to fight bias with mandatory hiring tests assessing the skills of candidates for frontline jobs. But managers don’t like being told that they can’t hire whomever they please, and our research suggests that they often use the tests selectively. Back in the 1950s, following the postwar migration of blacks

THE SOLUTION Instead of trying to police managers’ decisions, the most effective programs engage people in working for diversity, increase their contact with women and minorities, and tap into their desire to look good to others.

northward, Swift & Company, Chicago meatpackers, instituted tests for supervisor and quality-checking jobs. One study found managers telling blacks that they had failed the test and then promoting whites who hadn’t been tested. A black machine operator reported: “I had four years at Englewood High School. I took an exam for a checker’s job. The foreman told me I failed” and gave the job to a white man who “didn’t take the exam.” This kind of thing still happens. When we interviewed the new HR director at a West Coast food company, he said he found that white managers were making only strangers—most of them minorities—take supervisor tests and hiring white friends without testing them. “If you are going to test one person for this particular job title,” he told us, “you need to test everybody.” But even managers who test everyone applying for a position may ignore the results. Investment banks and consulting firms build tests into their job interviews, asking people to solve math and scenario-based problems on the spot. While studying this practice, Kellogg professor Lauren Rivera played a ly on the wall during hiring meetings at one irm. She found that the team paid little attention when white men blew the math test but close attention when women and blacks did. Because decision makers (deliberately or not) cherry-picked results, the testing ampliied bias rather than quashed it. Companies that institute written job tests for managers—about 10% have them today—see decreases of 4% to 10% in the share of managerial jobs held by white women, African-American men and women, Hispanic men and women, and AsianAmerican women over the next five years. There are significant declines among white and AsianAmerican women—groups with high levels of education, which typically score well on standard

July–August 2016 Harvard Business Review 55


managerial tests. So group diferences in test-taking report discrimination. This leads to another uninskills don’t explain the pattern. tended consequence: Managers who receive few Performance ratings. More than 90% of mid- complaints conclude that their irms don’t have a problem. We see this a lot in our interviews. When size and large companies use annual performance we talked with the vice president of HR at an elecratings to ensure that managers make fair pay and promotion decisions. Identifying and rewarding tronics irm, she mentioned the widely publicized the best workers isn’t the only goal—the ratings “difficulties other corporations are having” and also provide a litigation shield. Companies sued for added, “We have not had any of those problems… discrimination often claim that their performance we have gone almost four years without any kind of discrimination complaint!” What’s more, lab studrating systems prevent biased treatment. ies show that protective measures like grievance But studies show that raters tend to lowball women and minorities in performance reviews. And systems lead people to drop their guard and let bias afect their decisions, because they think company some managers give everyone high marks to avoid hassles with employees or to keep their options open policies will guarantee fairness. Things don’t get better when irms put in formal when handing out promotions. However managers work around performance systems, the bottom line grievance systems; they get worse. Our quantitative is that ratings don’t boost diversity. When companies analyses show that the managerial ranks of white introduce them, there’s no efect on minority manag- women and all minority groups except Hispanic men decline—by 3% to 11%—in the ive years after ers over the next ive years, and the share of white companies adopt them. women in management drops by 4%, on average. Still, most employers feel they need some sort Grievance procedures. This last tactic is meant to identify and rehabilitate biased manag- of system to intercept complaints, if only because ers. About half of midsize and large irms have sys- judges like them. One strategy that is gaining ground tems through which employees can challenge pay, is the “lexible” complaint system, which ofers not promotion, and termination decisions. But many only a formal hearing process but also informal memanagers—rather than change their own behavior diation. Since an informal resolution doesn’t involve or address discrimination by others—try to get even hauling the manager before a disciplinary body, it with or belittle employees who complain. Among may reduce retaliation. As we’ll show, making managers feel accountable without subjecting them to the nearly 90,000 discrimination complaints made to the Equal Employment Opportunity Commis- public rebuke tends to help. sion in 2015, 45% included a charge of retaliation— which suggests that the original report was met with ridicule, demotion, or worse. Once people see that a grievance system isn’t If these popular solutions backire, then what can warding off bad behavior in their organization, employers do instead to promote diversity? they may become less likely to speak up. Indeed, A number of companies have gotten consistently employee surveys show that most people don’t positive results with tactics that don’t focus on

Tools for Getting Managers on Board

Managers made only strangers— most of them minorities—take tests and hired white friends without testing them. 56 Harvard Business Review July–August 2016


control. They apply three basic principles: engage managers in solving the problem, expose them to people from diferent groups, and encourage social accountability for change. Engagement. When someone’s beliefs and behavior are out of sync, that person experiences what psychologists call “cognitive dissonance.” Experiments show that people have a strong tendency to “correct” dissonance by changing either the beliefs or the behavior. So, if you prompt them to act in ways that support a particular view, their opinions shift toward that view. Ask them to write an essay defending the death penalty, and even the penalty’s staunch opponents will come to see some merits. When managers actively help boost diversity in their companies, something similar happens: They begin to think of themselves as diversity champions. Take college recruitment programs targeting women and minorities. Our interviews suggest that managers willingly participate when invited. That’s partly because the message is positive: “Help us ind a greater variety of promising employees!” And involvement is voluntary: Executives sometimes single out managers they think would be good recruiters, but they don’t drag anyone along at gunpoint. Managers who make college visits say they take their charge seriously. They are determined to come back with strong candidates from underrepresented groups—female engineers, for instance, or AfricanAmerican management trainees. Cognitive dissonance soon kicks in—and managers who were wishywashy about diversity become converts. The effects are striking. Five years after a company implements a college recruitment program targeting female employees, the share of white women, black women, Hispanic women, and AsianAmerican women in its management rises by about 10%, on average. A program focused on minority recruitment increases the proportion of black male managers by 8% and black female managers by 9%. Mentoring is another way to engage managers and chip away at their biases. In teaching their protégés the ropes and sponsoring them for key training and assignments, mentors help give their charges the breaks they need to develop and advance. The mentors then come to believe that their protégés merit these opportunities—whether they’re white men, women, or minorities. That is cognitive dissonance—“Anyone I sponsor must be deserving”— at work again.

While white men tend to ind mentors on their own, women and minorities more often need help from formal programs. One reason, as Georgetown’s business school dean David Thomas discovered in his research on mentoring, is that white male executives don’t feel comfortable reaching out informally to young women and minority men. Yet they are eager to mentor assigned protégés, and women and minorities are often irst to sign up for mentors. Mentoring programs make companies’ managerial echelons signiicantly more diverse: On average they boost the representation of black, Hispanic, and Asian-American women, and Hispanic and Asian-American men, by 9% to 24%. In industries where plenty of college-educated nonmanagers are eligible to move up, like chemicals and electronics, mentoring programs also increase the ranks of white women and black men by 10% or more. Only about 15% of irms have special college recruitment programs for women and minorities, and only 10% have mentoring programs. Once organizations try them out, though, the upside becomes clear. Consider how these programs helped Coca-Cola in the wake of a race discrimination suit settled in 2000 for a record $193 million. With guidance from a court-appointed external task force, executives in the North America group got involved in recruitment and mentoring initiatives for professionals and middle managers, working speciically toward measurable goals for minorities. Even top leaders helped to recruit and mentor, and talent-sourcing partners were required to broaden their recruitment efforts. After five years, according to former CEO and chairman Neville Isdell, 80% of all mentees had climbed at least one rung in management. Both individual and group mentoring were open to all races but attracted large numbers of African-Americans (who accounted for 36% of protégés). These changes brought important gains. From 2000 to 2006, African-Americans’ representation among salaried employees grew from 19.7% to 23%, and Hispanics’ from 5.5% to 6.4%. And while African-Americans and Hispanics respectively made up 12% and 4.9% of professionals and middle managers in 2002, just four years later those igures had risen to 15.5% and 5.9%. This began a virtuous cycle. Today, Coke looks like a different company. This February, Atlanta Tribune magazine profiled 17 African-American women in VP roles and above at Coke, including CFO Kathy Waller.

July–August 2016 Harvard Business Review 57


Contact. Evidence that contact between groups can lessen bias irst came to light in an unplanned experiment on the European front during World War II. The U.S. army was still segregated, and only whites served in combat roles. High casualties left General Dwight Eisenhower understaffed, and he asked for black volunteers for combat duty. When Harvard sociologist Samuel Stoufer, on leave at the War Department, surveyed troops on their racial attitudes, he found that whites whose companies had been joined by black platoons showed dramatically lower racial animus and greater willingness to work alongside blacks than those whose companies remained segregated. Stoufer concluded that whites fighting alongside blacks came to see them as soldiers like themselves irst and foremost. The key, for Stoufer, was that whites and blacks had to be working toward a common goal as equals—hundreds of years of close contact during and after slavery hadn’t dampened bias. Business practices that generate this kind of contact across groups yield similar results. Take self-managed teams, which allow people in diferent roles and functions to work together on projects as equals. Such teams increase contact among diverse types of people, because specialties within irms are still largely divided along racial, ethnic, and gender lines. For example, women are more likely than men to work in sales, whereas white men are more likely to be in tech jobs and management, and black and Hispanic men are more likely to be in production. As in Stouffer’s combat study, working side-byside breaks down stereotypes, which leads to more equitable hiring and promotion. At irms that create self-managed work teams, the share of white women, black men and women, and Asian-American women in management rises by 3% to 6% over ive years. Rotating management trainees through departments is another way to increase contact. Typically, this kind of cross-training allows people to try their hand at various jobs and deepen their understanding of the whole organization. But it also has a positive impact on diversity, because it exposes both department heads and trainees to a wider variety of people. The result, we’ve seen, is a bump of 3% to 7% in white women, black men and women, and Asian-American men and women in management. About a third of U.S. firms have self-managed teams for core operations, and nearly four-fifths use cross-training, so these tools are already 58 Harvard Business Review July–August 2016

The Downside of the Diversity Label Why can mentoring, selfmanaged teams, and crosstraining increase diversity without the backlash prompted by mandatory training? One reason may be that these programs aren’t usually branded as diversity efforts. Diversity language in company policy can stress white men out, as researchers at UC Santa Barbara and the University of Washington found when they put young white men through a simulated job interview—half of them for a company that touted its commitment to diversity, and half for a company that did not. In the explicitly prodiversity company, subjects expected discrimination against whites, showed cardiovascular distress, and did markedly worse in the taped interview.

available in many organizations. Though college recruitment and mentoring have a bigger impact on diversity—perhaps because they activate engagement in the diversity mission and create intergroup contact—every bit helps. Self-managed teams and cross-training have had more positive efects than mandatory diversity training, performance evaluations, job testing, or grievance procedures, which are supposed to promote diversity. Social accountability. The third tactic, encouraging social accountability, plays on our need to look good in the eyes of those around us. It is nicely illustrated by an experiment conducted in Israel. Teachers in training graded identical compositions attributed to Jewish students with Ashkenazic names (European heritage) or with Sephardic names (African or Asian heritage). Sephardic students typically come from poorer families and do worse in school. On average, the teacher trainees gave the Ashkenazic essays Bs and the Sephardic essays Ds. The diference evaporated, however, when trainees were told that they would discuss their grades with peers. The idea that they might have to explain their decisions led them to judge the work by its quality. In the workplace you’ll see a similar effect. Consider this field study conducted by Emilio Castilla of MIT’s Sloan School of Management: A irm found it consistently gave African-Americans smaller raises than whites, even when they had identical job titles and performance ratings. So Castilla suggested transparency to activate social accountability. The irm posted each unit’s average performance rating and pay raise by race and gender. Once managers realized that employees, peers, and superiors would know which parts of the company favored whites, the gap in raises all but disappeared. Corporate diversity task forces help promote social accountability. CEOs usually assemble these teams, inviting department heads to volunteer and including members of underrepresented groups. Every quarter or two, task forces look at diversity numbers for the whole company, for business units, and for departments to igure out what needs attention. After investigating where the problems are— recruitment, career bottlenecks, and so on—task force members come up with solutions, which they then take back to their departments. They notice if their colleagues aren’t volunteering to mentor or showing up at recruitment events. Accountability


Which Diversity Efforts Actually Succeed? In 829 midsize and large U.S. firms, we analyzed how various diversity initiatives affected the proportion of women and minorities in management. Here you can see which ones helped different groups gain ground—and which set them back, despite good intentions. (No bar means we can’t say with statistical certainty if the program had any effect.) POOR RETURNS ON THE USUAL PROGRAMS


The three most popular interventions made firms less diverse, not more, because managers resisted strong-arming.


PROGRAMS THAT GET RESULTS Companies do a better job of increasing diversity when they forgo the control tactics and frame their efforts more positively. The most effective programs spark engagement, increase contact among different groups, or draw on people’s strong desire to look good to others.


■ White Men ■ White Women


MANDATORY DIVERSITY TRAINING for managers led to significant decreases for Asian-Americans and black women.

■ Black Men ■ Black Women

TESTING job applicants hurt women and minorities—but not because they perform poorly. Hiring managers don’t always test everyone (white men often get a pass) and don’t interpret results consistently.

GRIEVANCE SYSTEMS likewise reduced diversity pretty much across the board. Though they’re meant to reform biased managers, they often lead to retaliation.

SELF-MANAGED TEAMS aren’t designed to improve diversity, but they help by increasing contact between groups, which are often concentrated in certain functions.

CROSS-TRAINING also increases managers’ exposure to people from different groups. Gains for some groups appear to come at a cost to Hispanic men.

COLLEGE RECRUITMENT TARGETING WOMEN turns recruiting managers into diversity champions, so it also helps boost the numbers for black and Asian-American men.

MENTORING has an especially positive impact. Managers who sponsor women and minorities come to believe, through their increased contact, that their protégés deserve the training and opportunities they’ve received.

DIVERSITY TASK FORCES promote social accountability because members bring solutions back to their departments—and notice whether their colleagues adopt them.

DIVERSITY MANAGERS sometimes put ineffective programs in place but have a positive impact overall— in part because managers know someone might ask them about their hiring and promotion decisions.

■ Hispanic Men ■ Hispanic Women ■ Asian Men ■ Asian Women

15 10 5 0% -5

VOLUNTARY TRAINING doesn’t get managers’ defenses up the way mandatory training does— and results in increases for several groups.

30 25 20 15 10 5 0% -5

COLLEGE RECRUITMENT TARGETING MINORITIES often focuses on historically black schools, which lifts the numbers of African-American men and women.


theory suggests that having a task force member in a department will cause managers in it to ask themselves, “Will this look right?” when making hiring and promotion decisions. Deloitte has seen how powerful social accountability can be. In 1992, Mike Cook, who was then the CEO, decided to try to stanch the hemorrhaging of female associates. Half the company’s hires

were women, but nearly all of them left before they were anywhere near making partner. As Douglas McCracken, CEO of Deloitte’s consulting unit at the time, later recounted in HBR, Cook assembled a high-proile task force that “didn’t immediately launch a slew of new organizational policies aimed at outlawing bad behavior” but, rather, relied on transparency to get results.

July–August 2016 Harvard Business Review 59



Once it was clear that top managers were watching, women started to get more premier assignments. The task force got each oice to monitor the career progress of its women and set its own goals to address local problems. When it became clear that the CEO and other managing partners were closely watching, McCracken wrote, “women started getting their share of premier client assignments and informal mentoring.” And unit heads all over the country began getting questions from partners and associates about why things weren’t changing faster. An external advisory council issued annual progress reports, and individual managers chose change metrics to add to their own performance ratings. In eight years turnover among women dropped to the same level as turnover among men, and the proportion of female partners increased from 5% to 14%— the highest percentage among the big accounting irms. By 2015, 21% of Deloitte’s global partners were women, and in March of that year, Deloitte LLP appointed Cathy Engelbert as its CEO—making her the irst woman to head a major accountancy. Task forces are the trifecta of diversity programs. In addition to promoting accountability, they engage members who might have previously been cool to diversity projects and increase contact among the women, minorities, and white men who participate. They pay of, too: On average, companies that put in diversity task forces see 9% to 30% increases in the representation of white women and of each minority group in management over the next ive years. Diversity managers, too, boost inclusion by creating social accountability. To see why, let’s go back to the inding of the teacher-in-training experiment, which is supported by many studies: When people know they might have to explain their decisions, they are less likely to act on bias. So simply having a diversity manager who could ask them questions prompts managers to step back and consider everyone who is qualiied instead of hiring or promoting the irst

60 Harvard Business Review July–August 2016

people who come to mind. Companies that appoint diversity managers see 7% to 18% increases in all underrepresented groups—except Hispanic men— in management in the following ive years. Those are the gains after accounting for both efective and inefective programs they put in place. Only 20% of medium and large employers have task forces, and just 10% have diversity managers, despite the benefits of both. Diversity managers cost money, but task forces use existing workers, so they’re a lot cheaper than some of the things that fail, such as mandatory training. Leading companies like Bank of America Merrill Lynch, Facebook, and Google have placed big bets on accountability in the past couple of years. Expanding on Deloitte’s early example, they’re now posting complete diversity numbers for all to see. We should know in a few years if that moves the needle for them. STRATEGIES FOR controlling bias—which drive most diversity eforts—have failed spectacularly since they were introduced to promote equal opportunity. Black men have barely gained ground in corporate management since 1985. White women haven’t progressed since 2000. It isn’t that there aren’t enough educated women and minorities out there—both groups have made huge educational gains over the past two generations. The problem is that we can’t motivate people by forcing them to get with the program and punishing them if they don’t. The numbers sum it up. Your organization will become less diverse, not more, if you require managers to go to diversity training, try to regulate their hiring and promotion decisions, and put in a legalistic grievance system. The very good news is that we know what does work—we just need to do more of it. HBR Reprint R1607C

WANT TO READ YOUR CUSTOMER’S MIND? TOO LATE. SHE JUST CHANGED IT. ENGAGEMENT IS LIVE. Understand and act on customer needs – live and in the moment. With a consistent, omnichannel experience. End to end. And customer-driven. Run live and run simple with SAP Hybris solutions. Ÿ)'(-J8GJ<fiXeJ8GX]Ôc`Xk\ZfdgXep%8cci`^_kji\j\im\[%





ARTWORK Roger Clarke, Accidents Will Happen (dntt), 2010 polyester resin, fiberglass, paint


Designing a Bias-Free Organization It’s easier to change your processes than your people. AN INTERVIEW WITH IRIS BOHNET BY GARDINER MORSE


RIS BOHNET THINKS irms are wasting their money on diversity training. The problem is, most programs just don’t work. Rather than run more workshops or try to eradicate the biases that cause discrimination, she says, companies need to redesign their processes to prevent biased choices in the irst place. Bohnet directs the Women and Public Policy Program at the Harvard Kennedy School and cochairs its Behavioral Insights Group. Her new book, What Works, describes how simple changes—from eliminating the practice of sharing self-evaluations to rewarding oice volunteerism—can reduce the biased behaviors that undermine organizational performance. In this edited interview with HBR senior editor Gardiner Morse, Bohnet describes how behavioral design can neutralize our biases and unleash untapped talent.

July–August 2016 Harvard Business Review 63


HBR: Organizations put a huge amount of effort into improving diversity and equality but are still falling short. Are they doing the wrong things, not trying hard enough, or both?  Bohnet: There is some of each going on. Frankly, right now I am most concerned with companies that want to do the right thing but don’t know how to get there, or worse, throw money at the problem without its making much of a diference. Many U.S. corporations, for example, conduct diversity training programs without ever measuring whether they work. My colleague Frank Dobbin at Harvard and many others have done excellent research on the efectiveness of these programs, and unfortunately it looks like they largely don’t change attitudes, let alone behavior. [See “Why Diversity Programs Fail,” by Frank Dobbin, in this issue.] I encourage anyone who thinks they have a program that works to actually evaluate and document its impact. This would be a huge service. I’m a bit on a mission to convince corporations, NGOs, and government agencies to bring the same rigor they apply to their financial decision making and marketing strategies to their people management. Marketers have been running A/B tests for a long time, measuring what works and what doesn’t. HR departments should be doing the same.

What would a diversity evaluation look like? There’s a great classroom experiment that’s a good model. John Dovidio and his colleagues at Yale evaluated the efect of an antibias training program on irst and second graders in 61 classrooms. About half the classrooms were randomly assigned to get four weeks of sessions on gender, race, and body type with the goal of making the children more accepting of others who were diferent from them. The other half didn’t get the training. The program had virtually no impact on the children’s willingness to share or play with others. This doesn’t mean you can’t ever teach kids to be more accepting—just that improving people’s inclination to be inclusive is incredibly hard. We need to keep collecting data to learn what works best. So the point for corporations is to adopt this same methodology for any program they try. Ofer the training to a randomly selected group of employees and compare their behaviors afterward with a control group. Of course, this would also mean deining success beforehand. For diversity training 64 Harvard Business Review July–August 2016

Diversity training programs largely don’t change attitudes, let alone behavior. programs to go beyond just checking the box, organizations have to be serious about what they want to change and how they plan to evaluate whether their change program worked.

What does behavioral science tell us about what to do, aside from measuring success? Start by accepting that our minds are stubborn beasts. It’s very hard to eliminate our biases, but we can design organizations to make it easier for our biased minds to get things right. HBR readers may know the story about how orchestras began using blind auditions in the 1970s. It’s a great example of behavioral design that makes it easier to do the unbiased thing. The issue was that fewer than 10% of players in major U.S. orchestras were women. Why was that? Not because women are worse musicians than men but because they were perceived that way by auditioners. So orchestras started having musicians audition behind a curtain, making gender invisible. My Harvard colleague Claudia Goldin and Cecilia Rouse of Princeton showed that this simple change played an important role in increasing the fraction of women in orchestras to almost 40% today. Note that


this didn’t result from changing mindsets. In fact, some of the most famous orchestra directors at the time were convinced that they didn’t need curtains because they, of all people, certainly focused on the quality of the music and not whether somebody looked the part. The evidence told a diferent story.

So this is good news. Behavioral design works. Yes, it does. The curtains made it easier for the directors to detect talent, independent of what it looked like. On the one hand, I ind it liberating to know that bias afects everyone, regardless of their awareness and good intentions. This work is not about pointing ingers at bad people. On the other hand, it is of course also depressing that even those of us who are committed to equality and promoting diversity fall prey to these biases. I am one of those people. When I took my baby boy to a Harvard day care center for the irst time a few years back, one of the irst teachers I saw was a man. I wanted to turn and run. This man didn’t conform to my expectations of what a preschool teacher looked like. Of course, he turned out to be a wonderful caregiver who later became a trusted babysitter at our house—but I couldn’t help my initial gut reaction. I was sexist for only a few seconds, but it bothers me to this day. Seeing is believing. That is, we need to actually see counterstereotypical examples if we are to change our minds. Until we see more male kindergarten teachers or female engineers, we need behavioral designs to make it easier for our biased minds to get things right and break the link between our gut reactions and our actions.

What are examples of good behavioral design in organizations? Well, let’s look at recruitment and talent management, where biases are rampant. You can’t easily put job candidates behind a curtain, but you can do a version of that with software. I am a big fan of tools such as Applied, GapJumpers, and Unitive that allow employers to blind themselves to applicants’ demographic characteristics. The software allows hiring managers to strip age, gender, educational and socioeconomic background, and other information out of résumés so they can focus on talent only. There’s also a robust literature on how to take bias out of the interview process, which boils down to this: Stop going with your gut. Those unstructured interviews where managers think they’re getting

a feel for a candidate’s it or potential are basically a waste of time. Use structured interviews where every candidate gets the same questions in the same order, and score their answers in order in real time. You should also be thinking about how your recruitment approach can skew who even applies. For instance, you should scrutinize your job ads for language that unconsciously discourages either men or women from applying. A school interested in attracting the best teachers, for instance, should avoid characterizing the ideal candidate as “nurturing” or “supportive” in the ad copy, because research shows that can discourage men from applying. Likewise, a irm that wants to attract men and women equally should avoid describing the preferred candidate as “competitive” or “assertive,” as research inds that those characterizations can discourage female applicants. The point is that if you want to attract the best candidates and access 100% of the talent pool, start by being conscious about the recruitment language you use.

What about once you’ve hired someone? How do you design around managers’ biases then? The same principle applies: Do whatever you can to take instinct out of consideration and rely on hard data. That means, for instance, basing promotions on someone’s objectively measured performance rather than the boss’s feeling about them. That seems obvious, but it’s still surprisingly rare. Be careful about the data you use, however. Using the wrong data can be as bad as using no data. Let me give you an example. Many managers ask their reports to do self-evaluations, which they then use as part of their performance appraisal. But if employees difer in how self-conident they are—in how comfortable they are with bragging—this will bias the manager’s evaluations. The more self-promoting ones will give themselves better ratings. There’s a lot of research on the anchoring efect, which shows that we can’t help but be influenced by numbers thrown at us, whether in negotiations or performance appraisals. So if managers see inflated ratings on a self-evaluation, they tend to unconsciously adjust their appraisal up a bit. Likewise, poorer selfappraisals, even if they’re inaccurate, skew managers’ ratings downward. This is a real problem, because there are clear gender (and also cross-cultural) diferences in selfconidence. To put it bluntly, men tend to be more

July–August 2016 Harvard Business Review 65


overconident than women—more likely to sing their own praises. One meta-analysis involving nearly 100 independent samples found that men perceived themselves as signiicantly more efective leaders than women did when, actually, they were rated by others as signiicantly less efective. Women, on the other hand, are more likely to underestimate their capabilities. For example, in studies, they underestimate how good they are at math and think they need to be better than they are to succeed in higher-level math courses. And female students are more likely than male students to drop courses in which their grades don’t meet their own expectations. The point is, do not share self-evaluations with managers before they have made up their minds. They’re likely to be skewed, and I don’t know of any evidence that having people share self-ratings yields any beneits for employees or their organizations.

But it’s probably not possible to just eliminate all managerial activities that allow biased thinking. Right. But you can change how managers do these things. One message here is to examine whether practices that we thought were genderneutral in fact lead to biased outcomes. Take the SAT, for example. Your score shouldn’t have been afected by whether you’re male or female. But it turns out it was. The test once penalized students for incorrect answers in multiple-choice questions. That meant it was risky to guess. Research by Katie Baldiga Cofman of Ohio State University shows that this matters, especially for women. Among equally able test takers, male students are more likely to guess, while female students are more likely to skip questions, fearing the penalty and thus ending up with lower scores. Katie’s research reveals that gender diferences in willingness to take risk account for about half of the gender gap in guessing. An analysis of the fall 2001 mathematics SAT scores suggests that this phenomenon alone explains up to 40% of the gap between male and female students in SAT scores. The 2016 SAT has been redesigned so that it doesn’t penalize for incorrect answers. Taking risk out of guessing means that diferent appetites for risk taking will no longer afect students’ inal scores. This can be expected to level the playing ield for male and female students. Notice that the new SAT doesn’t focus on changing the students’ mindsets about risk but instead

66 Harvard Business Review July–August 2016

corrects for diferent risk tolerances. After all, the test is meant to measure aptitude, not willingness to take risk. Organizations should take a page from this book: Look around and see whether your practices by design favor one gender over the other and discourage some people’s ability to do their best work. Do meetings, for example, reward those most willing to hold forth? If so, are there meeting formats you can use that put everyone on an equal footing?

How can firms get started? Begin by collecting data. When I was academic dean at the Harvard Kennedy School, one day I came to the oice to ind a group of students camped out in front of my door. They were concerned about the lack of women on the faculty. Or so I thought. Much to my surprise, I realized that it was not primarily the number of female faculty that concerned them but the lack of role models for female students. They wanted to see more female leaders—in the classroom, on panels, behind the podium, teaching, researching, and advising. It turns out we had never paid attention to—or measured—the gender breakdown of the people visiting the Kennedy School. So we did. And our indings resembled those of most organizations that collect such data for the irst time: The numbers weren’t pretty. Here’s the good news. Once you collect and study the data, you can make changes and measure progress. In 1999, MIT acknowledged that it had been unintentionally discriminating against female faculty. An examination of data had revealed gender diferences in salary, space, resources, awards, and responses to outside ofers. The data had real consequences. A follow-up study, published in 2011, showed that the number of female faculty in science and engineering had almost doubled, and several women held senior leadership positions. Companies can do their own research or turn to consultants for help. EDGE, where I serve as a scientiic adviser, is a Swiss foundation and private company that helps organizations across the sectors measure how well they do in terms of gender equality. A irm named Paradigm is another. I came across it when I was speaking with tech firms in Silicon Valley and San Francisco. It helps companies diagnose where the problems are, starting by collecting data, and then come up with possible solutions, often based on behavioral designs.


For beliefs to change, people’s experiences have to change first. You said that “seeing is believing.” But given the lack of senior female role models in organizations, what else can we do? About a decade ago we noticed that of all the portraits of leaders on the walls of the Kennedy School, exactly zero were of women. The portraits we display afect what our employees and our students believe possible for themselves. I can attest that it was not our intention to signal to fully half of our students that they were not made to be leaders. Rather, this was done unthinkingly. Since then we have added new portraits, including Ida B. Wells, the U.S. civil rights activist and sufragist, and Ellen Johnson Sirleaf, the president of Liberia, winner of the Nobel Peace Prize, and a graduate of the Kennedy School.

You argue that it’s often a waste of time to try to debias people—but hanging portraits of women seems like a strategy to actually change individuals’ perceptions. I am not arguing that mindsets can never change. But what we generally ind is for beliefs to change, people’s experiences have to change first. Being surrounded by role models who look like you can afect what you think is possible for people like you. Sapna Cheryan of the University of Washington, for example, has shown that decorations in a computer science classroom can afect performance. Replacing the male-dominated Star Wars and Star Trek images with genderneutral art and nature pictures strengthened female students’ associations between women and careers in computer science. In another study, women who were shown a picture of Hillary Clinton or Angela Merkel before giving a public speech did objectively better than those who were shown a picture of Bill Clinton or no picture at all. So what do we do with our boardrooms and hallways that celebrate our (male focused) history? When asked this question at a recent talk I gave at the Organization for Economic Cooperation and Development, I answered that, sometimes, we have to “hurry history.” I think that presidents John and John Quincy Adams, spouse

and son of the thought leader and First Lady, Abigail Adams, would be proud that her portrait now is on Harvard’s walls—and of course, its presence makes a big diference to our female students.

Men may resist organizational changes favoring women because they view gender equality as zero sum—if women win, men lose. How then do you enlist men as agents of change? Few men oppose the idea of beneiting from the entire talent pool—at least in theory. But some are concerned about actually leveling the playing ield. In practice, of course, the blind auditions in orchestras have increased competition for male musicians. And the inclusion of women afects competition for men in all jobs. I understand that increased competition can be painful, but I am too much of an economist to not believe in the value of competition. There is no evidence that protectionism has served the world well. Enlisting men is partly about helping them to see the beneits of equality. Fathers of daughters are some of the strongest proponents of gender equality, for obvious reasons, so they can be particularly powerful voices when it comes to bringing other men along. Research on male CEOs, politicians, and judges shows that fathers of daughters care more about gender equality than men without children or with only sons. I would urge fathers of daughters to be outspoken in their own organizations and to advocate for equality not just as a broad goal, but to actively help drive the changes I describe here— collecting baseline organizational data, promoting experiments, measuring what works, changing processes to limit the impact of our biased minds and level the playing ield, and so on. A big part is, simply, continued awareness building—not just of the problem but also of the solutions available to organizations. I recently gave a talk on Wall Street to an audience that was male. I started by inviting people with children to raise their hands. Then I asked those with daughters to raise their hands. Many hands were up. I told them that this made my job easy as some of my biggest allies were in the room. It broke the ice, especially when I told the audience that my husband and I only have sons—who are great feminists, I might add, and in small ways have already brought behavioral insights to their school by reminding the principal to refer to teachers in general as both “he” and “she.” HBR Reprint R1607D

July–August 2016 Harvard Business Review 67







To Grow a Digital Business, Learn from the Startup Community BY JULIAN BIRKINSHAW

If you’re managing an incumbent company, you cannot predict, much less invent, the future on your own, so companies are increasingly seeking ways to tap into the creative milieu of the start-up world.

2 3


Over time, digital technology and the internet of things will transform virtually every sector and every business. Here’s how you can embrace them.

Why Winner-Takes-All Thinking Doesn’t Apply to the Platform Economy BY DAVID S. EVANS AND RICHARD SCHMALENSEE

The message is simple: beware of the siren song of network effects, winner-takes-all, and first mover advantages.


Stop Treating B2B Customers Like Digital Novices BY ALESSANDRO DI FIORE AND SIMON SCHNEIDER

Successful B2B online networks use digital platforms in new ways.


How to Launch Your Digital Platform BY BENJAMIN EDELMAN

For online platform businesses, customer mobilization challenges loom large.

Go to for the full Insight Center. These articles and many more will be available this month at




ARTWORK Roger Clarke, The Deadliest Toxins (dmm), 2009 Polyester resin, fiberglass, varnish


Lisa Burrell is a senior editor at HBR.

We Just Can’t Handle Diversity A research roundup BY LISA BURRELL

IT’S HARD TO ARGUE WITH THE BENEFITS OF DIVERSITY, given the decades’ worth of studies showing that a diverse workforce measurably improves decision making, problem solving, creativity, innovation, and lexibility. Most of us also believe that hiring, development, and compensation decisions should come down to who deserves what. Although the two ideas don’t seem contradictory, they’re tough to reconcile in practice. Cognitive roadblocks keep getting in the way.

The Trouble with Merit While merit sounds like an easy, obvious ilter for talent decisions, it’s anything but. We believe we know good talent when we see it, yet we usually don’t—we’re terrible at evaluating people objectively. That’s why orchestras started holding blind auditions decades ago. It’s why today algorithms often make smarter hires than people do. It’s why so many companies are searching for alternatives to traditional performance reviews. Even (and especially) when leaders proclaim a commitment to fairness in their organizations, stereotypes cause them to

July–August 2016 Harvard Business Review 71


In her book Pedigree, Lauren Rivera, of evaluate and treat equal performers diferently, as Northwestern University, also examines how we Emilio Castilla, of MIT, and Stephen Benard, of Indiana University, have demonstrated in their well- understand and evaluate merit and inds it to be a known research on the “paradox of meritocracy.” moving target. But where Frank applies a “macro” lens What’s tripping us up? Robert H. Frank, a Cornell to society, Rivera looks speciically at how students economist and the author of Success and Luck, pro- from elite schools and backgrounds get elite jobs— and at how employers judge the people applying vides one explanation: We just don’t see the large role that chance events play in people’s life trajec- for those positions. She studied hiring committees at professional tories. If someone lands a great job and makes lots services irms that believed they were ensuring rigor of money, we interpret those outcomes as evidence and counteracting bias through group discussions of smarts and hard work. (We look at our own lives the same way.) As for those who don’t thrive? Well, of job candidates from the school-recruitment pipewe tell ourselves, maybe they’ve caught a bad break line. But those conversations actually dampened dihere and there, but they could turn things around if versity by giving negative racial, ethnic, and gender they tugged on their bootstraps a bit harder. stereotypes greater sway over decisions—particuIf those in power think this world is basically larly “in ambiguous situations, where the quality of fair and just, they won’t even recognize—much less a candidate [was] not clear.” In those cases, Rivera worry about—systemic unfairness. Frank talks about points out, “stereotypes served as an unconscious inequity mostly in socioeconomic terms, but the im- navigational system, guiding interviewers’ attention to where they should focus and look for clues in orplications for underrepresented demographic groups are clear. He dips in and out of the abundant social sci- der to igure out if the candidate did or did not have the right stuf.” This gave evaluators “a common lens ence indings suggesting that good fortune accounts and shared language” when they didn’t immediately for a great deal of success, and that we’re hell-bent on believing otherwise. Framing efects, or our immedi- agree on someone’s value to the organization. One consulting firm invited Rivera to sit in at ate points of reference (living in suburbia or attending various points in the selection process—first dura posh school, for instance), shape how we perceive haves and have-nots in the wider world. Hindsight ing “calibrations,” or discussions between pairs of bias causes us to believe that random events are pre- interviewers about irst-round candidates, and then dictable and to manufacture explanations for the in- during the group discussions in later rounds. At each stage she consistently found that evaluators had evitability of our achievements. And winner-take-all markets—where “rewards tend to be highly concen- little or nothing to say about the “rock stars” or the trated in the hands of a few top performers”—intensify “rejects.” They deliberated mainly about candidates in the middle, which is where stereotypes about the consequences of our cognitive shortcuts. Of course, believing that merit will be justly re- women and minorities came into play. In the calibrations, the most common criteria for warded can come in handy for individuals. As Frank moving candidates from the middle to either the “yes” notes, it’s easier to muster the energy to overcome obstacles if you feel you’re on a well-earned, reason- or the “no” pile were communication skills (referred to as “polish”), analysis of a sample business case, ably certain path to high achievement and if you the math used to support that analysis, and cultural have an inlated sense of your own abilities. But, he it. But the interviewers weighed and judged those says, this mindset also keeps people from investing in public solutions that expand the economic pie for criteria diferently depending on the race, ethnicity, or gender of the candidates. For example, black and everyone. Perhaps the biggest reason we cling to it is that when it’s challenged, we feel attacked—as if our Hispanic men were often seen as lacking polish and talent and efort are being dismissed. Talent and ef- moved to the reject pile, even when they were strong in other areas, whereas white men who lacked polish fort matter quite a bit, Frank acknowledges. But very were deemed coachable and kept in the running. A often they’re not enough to ensure success. Changes similar pattern emerged among men who appeared in public policy and a dose of gratitude can help shy, nervous, or understated: Nonwhites were rerectify inequities, he says—but we’re a far cry from living and working in a meritocracy, because our jected for being unassertive, but in whites, modesty view of merit is so lawed. was seen as a virtue. Among candidates who made

72 Harvard Business Review July–August 2016



When Northwestern professor Lauren Rivera sat in on one firm’s “calibrations” (interviewers’ discussions about first-round job candidates), she found remarkable discrepancies linked to race, ethnicity, and gender. This table shows the demographic breakdown of 73 candidates whose performance was questioned or debated in four critical areas: communication skills (“polish”), sample business case analysis, math, and cultural fit. WHITE ASIAN FEMALE
















minor mistakes in math, women were rejected for not having the right skills, and men were given a pass— interviewers assumed they were having an “of” day. (See “Why Diversity Programs Fail,” in this issue.) Somewhat predictably, when discussing final decisions, evaluators shifted their focus away from the candidates’ performance and toward personal chemistry and gut instinct—their “feel” for people took over. They barely discussed technical skill toward the end unless they were evaluating women, particularly those in banking. Nodding to the sociologist Randall Collins’s argument that “emotion is a critical basis of social sorting, selection, and stratiication,” Rivera found that candidates in the “maybe” pool ultimately needed a passionate champion on the hiring committee in order to receive an ofer. And evaluators advocated most fervently for people who were most like them. Perhaps because women and minorities were more vulnerable in their status at the irm, they championed fewer people than white men did—they chose their battles, as one female evaluator put it. (There’s something to that reluctance. As Stefanie Johnson and David Hekman, of the University of Colorado, have found in their ield and lab research, women and minorities who actively push for diversity are punished by their organizations—they get lower performance ratings than those who don’t. Men who promote diversity don’t sufer the same penalty.) So, with white men doing most of the championing and having the greatest influence during

deliberations, candidates’ similarities to interviewers tilted the playing ield heavily in favor of “white, affluent, athletic graduates of super-elite institutions.” Similarity to evaluators who deviated from that norm sometimes helped women or minorities land a role—but those were isolated cases.

The Trouble with Diversity As Rivera suggests, the hiring conversations at the consulting irm were ultimately more about reaching consensus than about vetting people accurately. To fix that kind of conceptual problem, it’s necessary to sort out (at least somewhat objectively) what constitutes merit in a given context. Assuming that’s possible, and that we can send our biases packing (a gigantic if when we consider how stubborn they are), will diversity naturally follow? That’s diicult to say, since we don’t agree on how to deine it. According to one Deloitte study, Millennials think of diversity and inclusion as valuing open participation by employees with diferent perspectives and personalities. In contrast, older workers think of it as equitable representation and assimilation of people from diferent demographic groups. Even if we stick with the second, more traditional definition, how can we set goals and track our progress? As Ashleigh Shelby Rosette, of Duke University, pointed out at Wharton’s 2016 People Analytics Conference, we tend to boil things down into tidy dichotomies—male/female, white/black, dominant/minority, and so on. But reality is a lot

July–August 2016 Harvard Business Review 73


messier than that. No one is just female, or just black, or just Muslim. Each person is “a whole package of interlocking attributes,” Rosette said, and that’s a lot harder to analyze and balance in an organization. Further complicating matters, rhetorical framing skews how people perceive power. Rosette and her colleague Leigh Plunkett Tost, of the University of Michigan, discussed this dynamic in their Psychological Science article “Perceiving Social Inequity.” In general, describing inequities as privileges for certain groups (rather than disadvantages for others) gets our defenses up. Much like the notion of dumb luck that Frank writes about, it damages our self-image—haven’t we earned what we’ve got?—and makes us not want to see or rectify the problem. Plus, power is variable for members of any group. People can have high status on some socialhierarchy dimensions but low status on others. That mix, Rosette and Tost’s research shows, may help individuals recognize the privileges they enjoy as part of a dominant group, as long as they also believe they’ve experienced disadvantages as members of other, subordinate groups (and thus can identify with people who feel disadvantaged in comparison with them). White women overall, for instance, are more likely than white men to view themselves as beneiciaries of racial privilege; they get it because they, too, have had to deal with discrimination. Senior leaders need to recognize their organizations’ inequities—probably more than anyone else, since they have the power to make changes. But once they’ve climbed to their positions, they usually lose sight of what they had to overcome to get there. As a result, Rosette and Tost ind, “they lack the motivation and perspective to actively consider the advantages that dominant-group members experience.” This is especially true of successful white women, who “reported [even] lower perceptions of White privilege than did highly successful White men.” It’s fascinating that their encounters with sexism don’t help them identify racial advantage after they’ve gotten ahead. Perhaps, the authors suggest, their hard-earned status feels so tenuous that they relexively tighten their grip. Beyond murkily defined concepts and somewhat defensive motivations, we have an evenhigher-level conceptual obstacle to overcome: our bias against diversity itself. Recent research by Ohio State University’s Robert Lount Jr. and colleagues (Oliver Sheldon, of Rutgers; Floor Rink, of Groningen;

74 Harvard Business Review July–August 2016


and Katherine Phillips, of Columbia) shows that we assume diversity will spark interpersonal conlict. Participants in a series of experiments all read, watched, or listened to the exact same conversations among various groups. They consistently perceived the all-black or all-white groups as more harmonious than those with a combination of blacks and whites. If we expect people to behave less constructively when they’re in diverse organizations or teams, how do we interpret and reward their actual performance? Under the influence of those flawed expectations? Quite possibly.

So, Is It Hopeless? According to the renowned behavioral economist Daniel Kahneman, trying to outsmart bias at the individual level is a bit of a fool’s errand, even with training. We are fundamentally overconfident, he says, so we make quick interpretations and automatic judgments. But organizations think and move much more slowly. They actually stand a chance of improving decision making. Research by John Beshears and Francesca Gino, of Harvard Business School, supports that line of thought. As they have written in HBR, “It’s extraordinarily diicult to rewire the human brain,” but we can “alter the environment in which decisions are made.” This approach—known as choice architecture—involves mitigating biases, not reversing them, and Beshears and Gino have found that it can lead to better outcomes in a wide range of situations. The idea is to deliberately structure how you present information and options: You don’t take away individuals’ right to decide or tell them what they should do. You just make it easier for them to reach more-rational decisions. (For more on this idea, also see “Designing a Bias-Free Organization,” an interview with Harvard behavioral economist Iris Bohnet, in this issue.) There’s still an element of manipulation here: The organization sets the stage for certain kinds of choices. But that brings us back to what most of us can agree on, at least in the abstract: Diversity improves performance, and people who apply themselves and do good work should be treated fairly. If the members of an organization could get behind those broad ideas, would it bother them that they were being nudged to do what they wanted to do anyway? It might—and that would be another cognitive roadblock to clear. HBR Reprint R1607E

Have you registered at Your subscription entitles you to unlimited access to a wealth of exclusive online content—register and start exploring! HOW TO REGISTER IN THREE SIMPLE STEPS:


Find your account number—it’s right above your name on the mailing label of this issue


Go to


Enter your email address and account number, and then follow the instructions

In seconds, you’ll have full access to over 4,000 articles, the latest research, tools, interviews, and exclusive content from the Harvard Business Review archives.

Can’t find your account number? Contact customer service: In the U.S. and Canada: • For international subscriptions:


H. David Sherman is a professor of accounting at Northeastern University’s D’Amore-McKim School of Business and a former fellow at the SEC Division of Corporate Finance. S. David Young is a professor of accounting and control at INSEAD.


Where Financial Reporting Still Falls Short Even after a raft of reforms, corporate accounting remains murky. Here’s what you need to know to evaluate a company accurately. BY H. DAVID SHERMAN AND S. DAVID YOUNG July–August 2016 Harvard Business Review 77


IN a perfect world, investors, board members, and executives would have full conidence in companies’ financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash lows and to judge whether the resulting estimate of value was fairly represented in the current stock price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the eicient allocation of capital. Unfortunately, that’s not what happens in the real world, for several reasons. First, corporate financial statements necessarily depend on estimates and judgment calls that can be widely of the mark, even when made in good faith. Second, standard inancial metrics intended to enable comparisons between companies may not be the most accurate way to judge the value of any particular company— this is especially the case for innovative firms in fast-moving economies—giving rise to unofficial measures that come with their own problems. Finally, managers and executives routinely encounter strong incentives to deliberately inject error into inancial statements. In the summer of 2001, we published an article in these pages (“Tread Lightly Through These Accounting Minefields”) designed to help shareholders recognize the ways in which executives use corporate inancial reporting to manipulate results and misrepresent the true value of their companies. Enron imploded the following month, prompting the passage of the Sarbanes-Oxley regulations in the United States. Six years later, the financial world collapsed, leading to the adoption of the Dodd-Frank regulations and a global initiative to reconcile diferences between U.S. and international accounting regimes.

78 Harvard Business Review July–August 2016

Despite the raft of reforms, corporate accounting remains murky. Companies continue to ind ways to game the system, while the emergence of online platforms, which has dramatically changed the competitive environment for all businesses, has cast into stark relief the shortcomings of traditional performance indicators. This status report looks at the most important developments of inancial reporting in recent years, particularly the impact of the new rules governing revenue recognition, the persistent proliferation of unofficial performance measures, and the challenges of fairly assessing asset values. We also look at the more insidious—and perhaps more destructive—practice of manipulating not the numbers in inancial reports but the operating decisions that afect those numbers in an efort to achieve short-term results. Finding ways to reduce such behavior is a challenge for the accounting profession— but one that new analytic techniques can address. Let’s examine each of these problems in turn.


Universal Standards Back in 2002, the world seemed to be on the verge of an accounting revolution. An initiative was under way to create a single set of international accounting standards, with the ultimate aim of uniting the U.S. Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) that European countries were in the process of adopting. By 2005, all public companies in the European Union had, in theory, abandoned their local accounting standards in favor of IFRS. Today, at least 110 countries around the world use the system in one form or another. But in a broad sense, convergence has stalled, and further substantive changes seem unlikely in the near future. To be sure, progress has been made, but understanding the true value of a irm and comparing company accounts across countries continue to be major challenges. Consider the implications of failing to reconcile GAAP and IFRS. The analysis of investment targets, acquisitions, or competitors will in many cases continue to require comparison of inancial statements under two distinct accounting regimes: Pfizer versus GlaxoSmithKline, Exxon versus BP, Walmart versus Carrefour—in each case, one company uses GAAP and the other uses IFRS. The impact on results is hardly trivial. Take the British confectionary


Idea in Brief THE PROBLEM Despite tightening financial regulations, such as SarbanesOxley and Dodd-Frank, investors, board members, and executives are still unable to rely on financial statements in order to make wise decisions about whether to invest in or acquire a company, for several reasons.

WHY IT HAPPENS First, flawed estimates creep in to financial statements, even when made in good faith. Second, standard metrics often don’t capture the true value of companies, especially for innovative firms in new markets. And third, executives continue to face strong incentives to manipulate the numbers.

company Cadbury. Just before it was acquired by the U.S. irm Kraft, in 2009, it reported IFRS-based proits of $690 million. Under GAAP those proits totaled only $594 million—almost 14% lower. Similarly, Cadbury’s GAAP-based return on equity was 9%—a full ive percentage points lower than it was under IFRS (14%). Such differences are large enough to change an acquisition decision. To further complicate matters, the way that IFRS regulations are applied varies widely from one country to the next. Each has its own system of regulation and compliance, and in many countries (especially in the fastest-growing emerging regions) compliance and enforcement are weak. The quality and independence of the accounting profession are also often patchy. Just as troubling is the fact that many countries have created their own versions of the IFRS system by imposing “carve outs” (removal of ofending passages) and “carve ins” (additions) to the oicial standard promulgated by the International Accounting Standards Board (IASB). India and China are notable examples. So while several countries, among them Australia and Canada, have adopted the complete, unadulterated version of IFRS, it’s always worth checking to see if a company of interest has adopted a truncated or bastardized version.

PROBLEM 2 Revenue Recognition Revenue recognition is a tricky piece of the regulatory puzzle. Suppose you sell a smartphone or an internet service or a $30 million software package to an individual or a company. The contract for that product or service often includes future upgrades whose costs cannot be predicted at the time of the sale. Therefore, it is impossible to determine how much proit the sale will generate.

WHAT TO DO ABOUT IT In this article, the authors examine the impact of recent financial regulations and consider new techniques to combat the gaming of performance numbers.

Under current GAAP rules, if there is no objective way to measure such costs beforehand, a business is not allowed to record any revenue from that sale until all upgrade requirements have been delivered and their costs are known—which could take a few years. This regulation has prompted some software companies to write contracts that carve out and separately price upgrades and other hard-to-value services. In doing so, the companies solve an accounting problem—but compromise their ability to adopt a conceivably more attractive bundling strategy. The result is a perverse system in which accounting rules inluence the way business is done, rather than report on companies’ performance. The shortcomings of revenue-recognition practices have also caused companies to increasingly use unoicial measures to report inancial performance, especially for businesses operating in the virtual space. The colossal success of social networks such as Facebook, Twitter, and Ren Ren; fantasy sports and game sites such as Changyou and Zynga; and

Results under GAAP versus IFRS can be different enough to change an acquisition decision. July–August 2016 Harvard Business Review 79


businesses have been employing non-GAAP and online marketplaces such as Amazon, eBay, and non-IFRS measures of earnings for a long time. Alibaba quickly demonstrated that traditional Perhaps the most popular is EBITDA (or earnings guidelines for the recognition and measurement of before interest, taxes, depreciation, and amortizarevenue and expenses were preventing them from truly relecting their businesses’ value in reported tion), a particular favorite among private equity inaccounts. Unsurprisingly, these companies soon be- vestors because it’s thought to provide a quick proxy gan to adopt alternative ways to report on earnings. for the amount of cash low available to service debt. In the tech sector, non-GAAP measures are rife; durFor example, in 2015 Twitter reported a GAAP net loss of $521 million; it also ofered not one, but two ing the irst dot-com wave, companies began using non-GAAP earnings measures that showed positive “eyeballs,” “page views,” and so on to convince anaincome: adjusted EBITDA of $557 million and non- lysts and investors that their businesses had value GAAP net income of $276 million. despite the absence of proits (and sometimes even A change next year in the rules under both IFRS of revenue). and GAAP should alleviate the perversities of curToday, Sarbanes-Oxley requires companies on U.S. exchanges to reconcile GAAP measures of earnrent revenue recognition practices. The new rules will allow companies that bundle future goods and ings to non-GAAP measures, and IFRS has a similar services into contracts to recognize revenue in the requirement. In addition, the SEC requires that manyear it is earned by using estimates of future costs agement be able to support the reasoning behind inand revenues. cluding an alternative measure in its inancial discloHow will this work? Consider a company that of- sures. For example, a company might justify the use of a non-GAAP measure by noting that it is required fers a $30 million software contract composed of two parts: software and upgrades for ive years. The soft- by one of its bond covenants. Although these changes are steps in the right diware component, which cost $4 million to develop, sells for $20 million. The upgrades, whose costs are rection, they haven’t solved the problem, and huge unknown, are bundled into the price for an addi- discrepancies in reporting remain. For example, in 2014, Twitter reported a GAAP loss per share of tional $10 million. Current GAAP rules would have $0.96—but a non-GAAP proit of $0.34 per share. In the business recognize no revenue for the upgrades 2015, Amazon reported GAAP earnings per share until the end of year ive, when full cost information is available. But under the new rules (and under cur- of $0.37 and non-GAAP EPS of $4.14. The alternative measure yielded a relatively modest price-torent IFRS rules), the company may estimate the cost earnings ratio of 106, rather than the mind-boggling of delivering those upgrades to allow it to recognize revenue. If, say, it estimates the costs at $5 million, 1,192. This suggests that unoicial measures may be a better representation of earnings. IFRS will allow the company to recognize a profit The danger, however, is that alternative measures $5 million spread out evenly over the ive years. are usually idiosyncratic. Even commonly used But the change will not completely eliminate problems. After all, estimating costs requires man- measures such as EBITDA can be noncomparable from business to business—or in the same company agers to exercise judgment, introducing yet another opportunity to make good-faith errors or to delib- from one year to the next—because of diferences erately tilt estimates in such a way that the result- in what’s included or excluded in the calculation. ing revenues are closer to meeting inancial targets. Investors and analysts should continue to exercise Therefore, as these new revenue-recognition stan- great caution in interpreting unofficial earnings measures and should look closely at corporate exdards are adopted and implemented under GAAP and IFRS, investors will need to examine closely the planations that might depend on the use (or abuse) assumptions and methods used to estimate costs of managerial judgment. and report revenues.


Fair Value Accounting

Unofficial Earnings Measures

Executives and investors have two measures at their disposal for determining the value of a irm’s assets: the price originally paid (that is, the acquisition

Although unofficial measures of revenue are relatively new for many companies, all types of

80 Harvard Business Review July–August 2016


cost or historical cost) and the amount those assets would bring in if sold today (fair value). Some 25 years ago, before the rise of the internet, corporate inancial statements relied on the former, which has the important virtue of being easily veriiable. Today, however, companies use fair value for a growing number of asset classes in the hope that an examination of balance sheets will yield a truer picture of current economic reality. But since not everyone agrees on what “fair value” means, the measure has injected enormous subjectivity into the inancial reporting process, creating new challenges for both preparers and users of inancial statements. As the financial crisis took hold in 2008, a myriad of adjustments to the methods of applying fair value were adopted by the U.S. Financial Accounting Standards Board, the SEC, the IASB, and the Public Company Accounting Oversight Board—a nonproit corporation created by Sarbanes-Oxley to oversee the audits of public companies. The goal was to

In 2014 Twitter reported a loss of $0.96 per share using one measure, but a profit of $0.34 using another. guide auditors on how to verify fair value, but the result has been more confusion, not less. The measurement process has proved diicult, often highly subjective, and controversial. Consider the accounting treatment of Greek bonds by European banks in 2011, during one of a seemingly endless stream of crises involving government debt in Greece. Write-downs of the bonds varied from 21% to 51%—a striking discrepancy when one considers that all large European inancial

institutions have access to the same market data and are audited by the same four accounting irms. The Royal Bank of Scotland, for instance, recognized a charge to earnings in the second quarter of 2011 of £733 million, after a 51% write-down from the balance sheet value of £1.45 billion for its Greek government bond portfolio. In doing this, RBS followed the IFRS (and GAAP) fair value hierarchy, which states that if observable market prices are available, they must be used. On that basis, RBS noted that market prices had dipped by just over half the price paid for those bonds when they were issued. Meanwhile, two French financial institutions, BNP Paribas and CNP Assurances, looked at the very same data and chose to write the bonds down by only 21%. They rejected the market prices on the questionable grounds that the market was too illiquid to provide a “fair” valuation. Instead, they resorted to so-called “level 3” fair value estimates in a process known as mark-to-model (in contrast to the mark-tomarket valuations used by RBS). If such diiculties arise with tradable securities, imagine how diicult it is to apply fair value principles consistently to intangibles such as goodwill, patents, earn-out agreements, and research and development projects. Making matters worse, disclosures about how intangible assets are valued must ofer only basic information about the assumptions that generated the estimates. It’s hard to see how the situation could improve: One can rarely find an SEC annual report (10K) under 150 pages as it is. If these reports included full disclosure of the assumptions behind fair value estimates—were such a thing even possible—the length of reports would be overwhelming.

PROBLEM 5 Cooking the Decisions, Not the Books When accountants, analysts, investors, and directors talk about accounting games, they usually focus on how costs are accrued in a company’s reports. Managers may, for instance, choose to overprovision—that is, deliberately overstate expenses or losses, such as bad debts or restructuring costs—to create a hidden cookie-jar reserve that can be released in future periods to artiicially inlate proits. Or a company might underprovision, deliberately delaying the recognition of an expense or a loss in the current year. In that case, proit is borrowed from future periods to boost proit in the present.

July–August 2016 Harvard Business Review 81


Recent changes in GAAP and IFRS rules have made such activities less egregious than they once were, although overprovisioning will most likely always be with us. Managers want the accounting lexibility that comes from having hidden reserves, and external auditors will let them get away with it (within limits) because companies are unlikely to be sued for understating proits. Auditors are much more fearful of their clients’ underestimating costs (and thus overstating proits).

Managers goose the numbers by manipulating operations, not reports. In general, regulations have weakened companies’ ability to manipulate financial reports—and in response, the gaming of results has moved to a place that accounting rules will struggle to reach: corporate decision making that serves the interest of short-term reporting but undermines long-term performance. A study published in the Journal of Accounting and Economics surveyed more than 400 senior executives on how their companies managed reported earnings. The researchers asked the executives to imagine a scenario in which their company was on track to miss its earnings target for the quarter. Within the constraints of GAAP, what choices might they make to reach the target? The study revealed that managers tend to manipulate results not by how they report performance but by how they time their operating decisions. For example, nearly 80% of the respondents said that if they were falling short of earnings targets, they would cut discretionary spending (such as R&D, advertising, maintenance, hiring, and employee training). More than 55% said they would delay the start of a new project even if it entailed a small sacriice

82 Harvard Business Review July–August 2016


in value. Nearly 40% said that if they were in danger of missing targets, they would provide incentives for customers to buy more in that quarter. Managers also goose the numbers by manipulating production. If a company has substantial excess capacity, for instance, mangers can choose to ramp up output, allowing fixed manufacturing costs to be spread over more units of output. The result is a reduction in unit cost and, therefore, lower costs of sales and higher proits. But this practice also leads to high inished-goods inventories, imposing a heavy burden on a company in return for that short-term improvement in margins, as one study of the automobile industry shows. When huge numbers of unsold cars sit on lots for extended periods, bad (and costly) things can happen to them: Windshields and tires may crack, wipers break, batteries wear down, and so on. The company has to ramp up marketing spend, slash prices, and ofer expensive extras such as 0% inancing just to get customers to buy. And the very act of cutting prices can sacriice an automaker’s hard-won brand equity. What makes these indings so disturbing is not just that gaming practices are widespread but that such actions are not violations of GAAP or IFRS. Corporate executives can do as they please in the comforting knowledge that auditors can’t challenge them. What’s more, such destructive behavior is exceedingly diicult to detect under current disclosure rules.

New Analytical Tools Can Help Investors and board members understand that manipulating operating decisions in order to report higher earnings in the short term introduces the very real risk of compromising a company’s longterm competitiveness. It’s also clear that as accounting regulations continue to improve and prevent more accounting fraud—but executives’ incentives to hit short-term targets stay strong—companies will be increasingly likely to cook decisions rather than books. So investors and directors will have to demand more disclosure on those operating decisions that are most susceptible to manipulation in order to determine whether they are being made for sound business reasons or to artiicially boost inancial results. Of course, that will create practical problems in terms of the sheer volume of information being reported and will still involve hard-to-verify


Strategy Managing Yourself Managing People Leadership The Essentials Change Management

The Most Important Ideas All in One Place We’ve combed through hundreds of Harvard Business Review articles on change, leadership, strategy, managing people, and managing yourself and selected the most important ones to help you maximize your own and your organization’s performance. This boxed set makes the perfect gift.

HBR’s 10 Must Reads Boxed Set #10948-PBK • 6-Volume Set • Paperback • $125 #10948-KND • 6-Volume Set • eBook format • $125



assumptions. In fact, regulatory requirements that produce ever more lengthy reports may be an exercise in diminishing returns. What we need, perhaps, are smarter approaches to analyzing the data available. The good news is that new techniques are increasingly being applied by analysts and investors. Benford’s Law. One approach to the analysis of company reports that has recently gained favor in inancial markets is based on Benford’s Law, about the frequency distribution of leading digits in numerical data sets. The law has been around for a long time, but only recently has it been applied in accounting and in the financial sector: Insurance companies have started using it to detect false claims, the IRS to detect tax fraud, and the Big 4 accounting irms to detect accounting irregularities. Named for an early-20th-century British scientist, the law states that in lists of numbers from any naturally occurring data source—credit card charges, procurement entries, cash receipts—the irst digit for each number will be 1 (for example, 1, 157, 1,820) about 30% of the time. The irst digit will be 2 about 18% of the time, and each successive number will represent a progressively smaller proportion, to the point where 9 will occur as the irst digit less than 5% of the time. This distribution has been found to hold for a practically limitless array of data sets: The length of rivers (in feet and in meters), the population of cities and countries, trading volume on stock exchanges, the number of ranking points for tennis pros, the molecular weights of chemicals, the height of the world’s tallest buildings, and so on. Accounting variables should also be distributed in accordance with Benford’s Law—and they are, as long as there has been no conscious gaming of the data. In fact, the distribution holds even if the igures are converted from one currency to another. If a set of accounting data deviates from Benford’s Law, that can be taken as evidence of manipulation. Suppose that an accounting firm is reviewing a company’s financial statements. If an unusually high number of first digits in the accounting data are 7s, 8s, or 9s, it may indicate a conscious efort by managers to inesse the numbers to achieve desired inancial results. Verbal cues. Another tool for detecting unscrupulous practices has emerged from the research of two accounting academics who analyzed the transcripts of nearly 30,000 conference calls by U.S. CEOs and CFOs from 2003 to 2007. The

84 Harvard Business Review July–August 2016


researchers drew on psychological studies that show how people’s speech patterns change when they lie. They discovered several verbal cues that could have tipped off a listener that something was not quite right with the company’s accounts. For example, in companies that were later forced by the SEC to make major restatements of key financials, deceptive bosses displayed the following patterns: • They referred to shareholder value relatively seldom (perhaps to minimize the risk of a lawsuit). • They used extremely positive words (for example, instead of describing something as “good,” they’d call it “fantastic”). • They avoided use of the word “I” in favor of the third person. • They used fewer hesitation words, such as “um” and “er” (which might suggest that they were coached in their deceptions). • They used obscenities more frequently. Of course, the problem is that managers who intend to deceive can be taught to avoid those markers. But in the meantime, verbal cues can be a useful tool for board members and other interested parties to ferret out dishonest practices. The first years. Manipulation of inancial results is most prevalent in the early years of a CEO’s tenure and decreases over time, a recent study shows. A possible explanation is that the early years are the period of greatest uncertainty about a CEO’s ability, so CEOs may distort earnings in an effort to keep their jobs. The lesson for board members and investors is that they should be especially vigilant regarding a company’s accounting practices when a new chief executive takes over. IN ORDER for inancial statements to fulill their important social and economic function, they must reveal the underlying economic truth of a business. To the extent that they deviate from that truth, scarce capital will continue to be misallocated and wealth— and jobs—will be destroyed. Of course, we will never reach a world in which all reports are perfectly and reliably true, but an understanding of their shortcomings and the availability of new tools to detect manipulation can help us continue to strive for that ideal. As companies increasingly use the timing of operating decisions to artiicially boost performance numbers—a practice that is harder to detect and regulate—vigilance becomes vital. HBR Reprint R1607F


You Can’t Manage Without These Nearly every management skill depends on your ability to communicate effectively—formally or informally, in person or in writing. And that makes the Communicating for Success collection a must for every manager. This collection will help you make inspiring presentations, manage meeting agendas efficiently, and deliver effective feedback.

Communicating for Success Collection #0005BN • 8-Item Set • $125.00


1-800-988-0886 OR +1-617-783-7500



knowledge of finance AT WHARTON Wharton has set the bar for academic excellence in finance education. And at Wharton Executive Education, our portfolio of rigorous programs is led by world-renowned faculty and financial industry experts. Whether you’re motivated to advance your role within your firm, increase your understanding of private equity to navigate the financial markets, or gain new insight into how to preserve wealth, Wharton has a finance program that will help you achieve your goals.

Learn from the finance leader.


Investment Strategies and Portfolio Management Oct. 10–14, 2016 The CFO: Becoming a Strategic Partner Oct. 10–14, 2016 NEW! Private Equity: Investing and Creating Value Oct. 17–20, 2016

Finance and Accounting for the Non-Financial Manager Oct. 17–21, 2016 • Jan. 30–Feb. 3, 2017 Mergers and Acquisitions Jan. 22–27, 2017




How to Pay for Health Care by Michael E. Porter and Robert S. Kaplan

The Case for Capitation by Brent C. James and Gregory P. Poulsen

Fixing Health Care The United States is about to radically change how it pays for health care. Experts agree that the prevailing method—fee for service—fuels waste and does not promote high-quality care. The big question is: What should replace it? In the following articles, we look at the two leading models. Michael E. Porter and Robert S. Kaplan argue for bundled payments, which they believe generates the kind of competition among providers that improves the value of health care.


Brent C. James and Gregory P. Poulsen make the case for capitated payment. They say that approach is the only one that would encourage health care providers to attack all types of waste.

July–August 2016 Harvard Business Review 87

Michael E. Porter is a University Professor at Harvard, based at Harvard Business School in Boston. Robert S. Kaplan is a senior fellow and the Marvin Bower Professor of

Leadership Development, Emeritus, at Harvard Business School. They are the authors of “How to Solve the Cost Crisis in Health Care” (HBR, September 2011).


How to Pay for Health Care Bundled payments will finally unleash the competition that patients want.

The United States stands at a crossroads as it struggles with how to pay for health care. The fee-for-service system, the dominant payment model in the U.S. and many other countries, is now widely recognized as perhaps the single biggest obstacle to improving health care delivery. 88 Harvard Business Review July–August 2016




July–August 2016 Harvard Business Review 89


Fee for service rewards the quantity but not the quality or eiciency of medical care. The most common alternative payment system today—fixed annual budgets for providers—is not much better, since the budgets are disconnected from the actual patient needs that arise during the year. Fixed budgets inevitably lead to long waits for nonemergency care and create pressure to increase budgets each year. We need a better way to pay for health care, one that rewards providers for delivering superior value to patients: that is, for achieving better health outcomes at lower cost. The move toward “value-based reimbursement” is accelerating, which is an encouraging trend. And the Centers for Medicare & Medicaid Services (CMS), to its credit, is leading the charge in the United States. That doesn’t mean, however, that health care is converging on a solution. The broad phrase “valuebased reimbursement” encompasses two radically diferent payment approaches: capitation and bundled payments. In capitation, the health care organization receives a ixed payment per year per covered life and must meet all the needs of a broad patient population. In a bundled payment system, by contrast, providers are paid for the care of a patient’s medical condition across the entire care cycle—that is, all the services, procedures, tests, drugs, and devices used to treat a patient with, say, heart failure, an arthritic hip that needs replacement, or diabetes. If this sounds familiar, it’s because it is the way we usually pay for other products and services we purchase. A battle is raging, largely unbeknownst to the general public, between advocates of these two approaches. The stakes are high, and the outcome will deine the shape of the health care system for many years to come, for better or for worse. While we recognize that capitation can achieve modest savings in the short run, we believe that it is not the right solution. It threatens patient choice and competition and will fail to fundamentally change the trajectory of a broken system. A bundled payment system,

We need a better way to pay for health care—one that rewards providers for delivering superior value to patients.

90 Harvard Business Review July–August 2016

however, would truly transform the way we deliver care and inally put health care on the right path.

The Small Step: Capitation Capitation, or population-based payment, is not a new idea. It was introduced in the United States with some fanfare in the 1990s but quickly ran into widespread criticism and was scaled back signiicantly. Today, a number of transitional approaches, including accountable care organizations (ACOs), shared savings plans, and alternative quality contracts, have been introduced as steps toward capitation. In the ACO model, the care organization earns bonuses or penalties on the basis of how the total fee-forservice charges for all the population’s treatments during the year compare with historical charges. In full capitation, the care organization absorbs the diference between the sum of capitation payments and its actual cost. Under capitation, unlike in the FFS model, the payer (insurer) no longer reimburses various providers for each service delivered. Rather, it makes a single payment for each subscriber (usually per patient per month) to a single delivery organization. The approach rewards providers for lowering the overall cost of treating the population, which is a step forward. However, under this system cost reduction gravitates toward population-level approaches targeting generic high-cost areas, such as limiting the use of expensive tests and drugs, reducing readmissions, shortening lengths of stay, and discharging patients to their homes rather than to higher-cost rehabilitation facilities. As a response to the failed experience with capitation in the 1990s, current capitation approaches include some provider accountability for quality. However, “quality” is measured by broad population-level metrics, such as patient satisfaction, process compliance, and overall outcomes such as complication and readmission rates. This all seems good at irst blush. The trouble is that, like the failed FFS payment system, capitation creates competition at the wrong level and on the wrong things, rather than on what really matters to patients and to the heath care system overall.

Providers are not accountable for patientlevel value. Capitation and its variants reward improvement at the population level, but patients don’t care about population outcomes such as overall infection rates; they care about the treatments they receive to address their particular needs. Outcomes


Idea in Brief THE CHALLENGE The United States stands at a crossroads as it struggles with how to pay for health care. Fee for service, the dominant model today, is widely recognized as the single biggest obstacle to improving health care delivery. The choice is between two fundamentally different approaches: capitation and bundled payments. The stakes are high, and the outcome will define the shape of the health care system for many years to come, for better or for worse.

THE DANGER Although capitation may deliver modest savings in the short run, it is not the solution. It entrenches large existing systems, eliminates patient choice, promotes consolidation, limits competition, and perpetuates the lack of accountability for outcomes. Like fee for service, capitation will fail to drive true innovation in health care delivery.

that matter to breast cancer patients are different from those that are important to patients with heart failure. Even for primary and preventive care, which the concept of population health rightly emphasizes, appropriate care depends heavily on each patient’s circumstances—health status, comorbidities, disability, and so on. And managing the overall health of a diverse population with high turnover (as ACOs do) is extremely diicult. Thus, capitated payments are not aligned with better or eicient care for each patient’s particular condition. Instead, capitation puts the focus on limiting the overall amount of care delivered without tying the outcomes back to individual patients or providers. The wrong incentives are created, just as is the case for fee for service, which reimburses for the volume of services but not the value. Providers bear the wrong risks. Because capitation pays providers a fee per person covered, it shifts the risk for the cost of the population’s actual mix of medical needs—over which they have only limited control—to providers. Some large private insurers favor capitation for just this reason. But bearing the actuarial risk of a population’s medical needs is what insurers should do, since they cover a far larger and more diverse patient population over which to spread this risk. Providers should bear only the risks related to the actual care they deliver, which they can directly afect. A more fundamental problem is that capitation payments are extremely diicult to adjust to relect each patient’s overall health risk, not to mention to correctly adjust for this risk across a large, diverse population. Risks are much better understood and managed for a particular medical condition—for example, the probable efects of age or comorbidities on the costs and outcomes for joint replacement—as is the case in bundled payments.

THE OPPORTUNITY Bundled payments trigger competition among providers to create value where it matters—at the individual patient level— and will finally put health care on the right path. Robust proof-of-concept initiatives in the U.S. and abroad demonstrate that the challenges of transitioning to bundled payments are already being overcome.

Because population-level risk factors are so complex, health systems under capitation have an incentive to claim as many comorbidities as possible to bolster their revenue and proitability. A whole segment of health care IT providers has emerged to help providers “upcode” patients into higher-risk categories. Such gaming of risk adjustment irst became a problem during the era of managed-care capitation in the 1990s, and it remains one today.

Patient choice is limited, and competition is threatened. Capitation creates strong incentives for a health system to deliver all the care within its system, because contracting for outside services reduces net revenue and results in underutilization of existing internal capacity. There is even a term for this in health care—“avoiding leakage”—and many systems explicitly monitor and control it. Capitated health systems encourage or require patients (and their referring doctors) to use in-house providers (the ultimate narrow network). Patients are often penalized with extra fees when they don’t use services within the system, even if outside providers have greater experience and get better results for treating the patient’s particular condition. Capitation creates, in essence, a monopoly provider for all the patients in the population. Consumers cannot choose the best provider for their particular needs. Since providers now bear actuarial risk, they also have a strong incentive to amass the largest possible population. This will accelerate the recent trend of providers’ buying up other hospitals and physician practices and merging systems, which reduces competition. To offset health systems’ rising bargaining power, insurers will feel pressure to merge. The two dynamics will reinforce each other as provider consolidation begets even more insurer consolidation. The end result will be the emergence of a few dominant systems—or even only one—in each region.

July–August 2016 Harvard Business Review 91


This would be bad for patients. No one organization can have all the skills and technologies needed to be the best in treating everything. We need multiple providers in each region to ensure enough choice and drive innovation in care delivery. The bottom line is that capitation is the wrong way to pay for health care. It is a top-down approach that achieves some cost savings by targeting lowhanging fruit such as readmission rates, expensive drugs, and better management of post-acute care. But it does not really change health care delivery, nor does it hold providers accountable for efficiency and outcomes where they matter to patients—in the treatment of their particular condition. Capitation’s savings also come at the high cost of restricting patient choice and i n h i b it i ng p r ov i d e r competition. Let’s consider the alternative.

Paying for Value: Bundled Payments

Bundled payments will empower and motivate providers—responsible for the overall treatment of a patient’s condition— to coordinate and integrate all the specialists and facilities involved in the care.

For virtually all types of products and services, customers pay a single price for the whole package that meets their needs. When purchasing a car, for example, consumers don’t buy the motor from one supplier, the brakes from another, and so on; they buy the complete product from a single entity. It makes just as little sense for patients to buy their diagnostic tests from one provider, surgical services from another, and post-acute care from yet another. Bundled payments may sound complicated, but in setting a single price for all the care required to treat a patient’s particular medical condition, they actually draw on the approach long used in virtually every other industry. Bundled payments have existed in health care for some time in isolated ields such as organ transplantation. They are also common for services that patients pay for directly, such as Lasik eye surgery, plastic surgery, and in vitro fertilization. To maximize value for the patient, a bundled payment must meet ive conditions:

92 Harvard Business Review July–August 2016

Payment covers the overall care required to treat a condition. The bundled payment should cover the full cost of treating a patient over the entire care cycle for a given condition or over time for chronic conditions or primary care. The scope of care should be defined from the patient’s perspective (“Delivering a healthy child”). Care should include all needed services, including managing common comorbidities and related complications. In primary and preventive care, bundled payments should include all the needed care for each deined patient segment (such as healthy adults or low-income elderly).

Payment is contingent on delivering good outcomes. Bundled payments should be tied to achieving the outcomes that matter to patients for each condition and primary care patient segment. Important outcomes include maintaining or returning to normal function, reducing pain, and avoiding and reducing complications or recurrences. Payment is adjusted for risk. Diferences in patients’ age and health status afect the complexity, outcomes, and cost of treating a particular condition, as do their social and living circumstances. These risk factors should be relected in the bundled payment and in expectations for outcomes to reward providers for taking on hard cases.

Payment provides a fair profit for effective and efficient care. A bundled payment should cover the full costs of the necessary care, plus a margin, for providers that use efective and eicient clinical and administrative processes. It should not cover unnecessary services or ineicient care.

Providers are not responsible for unrelated care or catastrophic cases. Providers should be responsible only for care related to the condition— not for care such as emergency treatment after an accident or an unrelated cardiac event. The limits of provider responsibility should be speciied in advance and subject to adjudication if disputes arise. Bundled payments should also include a “stop loss” provision to limit providers’ exposure to unusually high costs from catastrophic or outlier cases. This reduces the need for providers to build such costs into the price for every patient (unlike in capitation).

How Bundled Payments Will Transform Patient Care Decades of incremental eforts to cut costs in health care and impose practice guidelines on clinicians have failed. Bundled payments directly reward


How Fee for Service Destroys Value for Patients

providers for delivering better value for the patient’s condition and will unlock the restructuring of health care delivery in three crucial ways that capitation cannot. Integrated, multidisciplinary care. Specialty silos have historically led to fragmented, uncoordinated, and ineicient care. With bundled payments, providers with overall responsibility for the full care cycle for a condition will be empowered and motivated to coordinate and integrate all the specialists and facilities involved in care. Clinical teams (the experts) have the freedom to decide how to spend the ixed bundled payment, rather than being required to deliver the services that are reimbursed by legacy FFS payments in order to receive revenue. Teams can choose to add services that are not currently covered by FFS but that provide value for patients. Bundled payments are triggering a whole new level of care innovation. For example, hospitalbased physicians are remaining involved in care after patients are discharged. Hospitalists are added to teams to coordinate all the inpatient specialists involved in the care cycle. Nurses make sure patients ill their prescriptions, take medications correctly, and actually see their primary care physician. (A recent study showed that 50% of readmitted patients did not see their primary care doctor in the irst 30 days after discharge.) And navigators accompany patients through all phases of their care and act as first responders in quickly resolving problems. Bundled payments are also spurring innovation in the creation of tailored facilities, such as those of Twin Cities Orthopedics (Minneapolis), which performs joint-replacement care in outpatient surgery centers and nearby recovery centers, rather than in a traditional hospital. Bundled payments will accelerate the formation of integrated practice units (IPUs), such as MD Anderson’s Head and Neck Center and the Joslin Diabetes Center. IPUs combine all the relevant clinicians and support personnel in one team, working in dedicated facilities. Joslin, for example, brings together all the specialists (endocrinologists, nephrologists, internists, neurologists, ophthalmologists, and psychiatrists) and all the support personnel (nurses, educators, dieticians, and exercise physiologists) required to provide high-value diabetes care. IPUs concentrate volume of patients with a given condition in one place, allowing diagnosis and treatment by a highly experienced team. Numerous

Fee-for-service reimbursement, the dominant method used to pay for health care in the United States and elsewhere, has held back improvements in the quality of care and led to escalating costs. Overturning the status quo is not easy, but here’s why doing so is essential. Rewards Poor Outcomes: Because FFS reimburses providers on the basis of volume of care, providers are rewarded not just for performing unnecessary services but for poor outcomes. Complications, revisions, and recurrences all result in the need for additional services, for which providers get reimbursed again. Fosters duplication and lack of coordination. FFS makes payments for individual procedures and services, rather than for the treatment of a patient’s condition over the entire care cycle. In response, providers have organized around functional specialties (such as radiology). Today, multiple independent providers are involved in each patient’s treatment, resulting in poorly coordinated care, duplicated services, and no accountability for health outcomes.

Perpetuates inefficiency. Today’s FFS payments reflect historical reimbursements with arbitrary inflation adjustments, not true costs. Reimbursement levels vary widely, causing cross-subsidization across specialties and particular services. The misalignment means that inefficient providers can survive, and even thrive, despite high costs and poor outcomes. Reduces focus. FFS motivates providers to offer full services for all types of conditions to grow overall revenue, even as internal fragmentation causes patients to be handed off from one specialty to another. By attempting to cater to a diverse population of patients, providers fail to develop the specialized capabilities and experience in any one condition necessary for the delivery of excellent care.

studies show that this approach leads to better outcomes and greater efficiency (including less wait time and fewer visits). Bundled payments also encourage the formation of “virtual” IPUs, where even separate practices and organizations actively collaborate across inpatient and outpatient settings to coordinate and integrate care—something that rarely happens today. Accountability for outcomes. By deinition, a bundled payment holds the entire provider team accountable for achieving the outcomes that matter to patients for their condition—unlike capitation, which involves only loose accountability for patient satisfaction or population-level quality targets. Because bundled payments are adjusted for risk, providers are rewarded for taking on diicult cases. With a fixed single payment, they are penalized if they overtreat patients or perform care in unnecessarily high-cost locations. And because providers are accountable for outcomes covering the entire care cycle, they will move quickly to add new services, more-expensive interventions, or better diagnostic

July–August 2016 Harvard Business Review 93


tests if those will improve outcomes or lower the overall cost of care. Specialists operating under a bundled payment, for example, have added primary care physicians to their care teams to better manage the overall care cycle and deal with comorbidities. Most important, the accountability built into bundled payments will inally bring to health care the systematic measurement of outcomes at the condition level, where it matters most. We know from every other ield that measuring and being accountable for results is the most powerful driver of innovation and continuous improvement. Cost reduction. There have been repeated efforts to control health costs for decades without success, and top-down cost reduction initiatives have sometimes increased costs rather than reduced them. The core problem is that legacy payment models such as FFS have given providers no incentive to cut costs or even to understand what their costs are for treating a given condition. Bundled payments, by contrast, directly reward and motivate cost reduction from the bottom up, team by team. At the same time, they encourage accurate cost measurement not only to inform price setting but to enable true cost reduction. Bundled payments will be the catalyst that inally motivates provider teams to work together to understand the actual costs of each step in the entire care process, learn how to do things better, and get care right the irst time. By encouraging competition for the treatment of individual conditions on the basis of quality and price, bundled payments also reward providers for standardizing care pathways, eliminating services and therapies that fail to improve outcomes, better utilizing staff to the top of their skills, and providing care in the right facilities. If providers use inefective or unnecessary therapies or services, they will bear the cost, making bundled payments a check against overtreatment. The result will be not just a downward “bend” in the cost curve—that is, a slower increase—but actual cost reduction. Our research suggests that savings

The County of Stockholm’s bundled payment for joint replacement yielded cost savings of 17% and a reduction in complications of 33%.

94 Harvard Business Review July–August 2016

of 20% to 30% are feasible in many conditions. And, because bundled payments are contingent on good outcomes, the right kind of cost reduction will take place, not cost cutting at the expense of quality.

Overcoming the Transition Challenges Despite the now proven beneits of well-designed bundled payments, many hospital systems, group purchasing organizations, private insurers, and some academics prefer capitation. Bundled payments, they argue, are too complicated to design, negotiate, and implement. (They ignore the fact that capitation models continue to rely on complex, expensive fee-for-service billing to pay clinicians and to set the baseline for calculating savings and penalties. Bundled payments are actually simpler to administer than the myriad of FFS payments for each patient over the care cycle.) Skeptics raise a host of other objections: The scope of a condition and care cycle is hard to deine; it is unrealistic to expect specialists to work together; the data on outcomes and costs needed to set prices are diicult to obtain; diferences in risk across patients are hard to assess, which will lead to cherry-picking; and bundled payments won’t rein in overtreatment. If these objections represented serious barriers, we would expect to see little prog ress in implementing bundled payments and plenty of evidence that such programs were unsuccessful. To the contrary, bundled payments have a history of good results (see the sidebar “A History of Success”) and are currently proliferating rapidly in a wide range of conditions, organizations, and countries. In 2007, for example, the Netherlands introduced a successful bundled payment model for treating patients with type 2 diabetes, and, later, for chronic obstructive pulmonary disease (COPD). In 2009, the County of Stockholm, Sweden, introduced bundled payments for hip and knee replacements in healthy patients, achieving a 17% reduction in cost and a 33% reduction in complications over two years. More recently, Stockholm introduced bundled payments for all major spine diagnoses requiring surgery, and extensions to other conditions are under way there. In 2011, Medicare introduced the voluntary Bundled Payments for Care Improvement (BPCI) program, which currently includes more than 14,000 bundles in 24 medical and 24 surgical conditions. Numerous physician practices have embraced the BPCI model, a transitional bundled payment


A History of Success approach that covers acute-care episodes and often a post-acute period of up to 90 days to promote better management of post-discharge services. According to participating providers, BPCI bundles have achieved significant improvements and savings an order of magnitude greater than savings from ACOs. Building on that success, CMS launched a mandatory bundled payment program for joint replacements in 2016, which covers 800 hospitals in 67 U.S. metropolitan areas. Bundled payment contracts involving private insurers are also inally beginning to proliferate. For example, Twin Cities Orthopedics ofers a bundle for joint replacement with most of the region’s major insurers at a price well below the traditional hospital models. The practice reports better outcomes and cost reductions of more than 30%. To be sure, many existing bundled payment programs have yet to encompass all the components of an ideal structure. Most have made pragmatic compromises, such as covering only part of the care cycle, using important but incomplete risk adjustments, and incorporating limited outcome measures. But even these less-than-comprehensive eforts are resulting in major improvements, and the obstacles to bundled payments are being overcome. Let’s consider some of the main criticisms of bundled payments in more depth:

Only some conditions can be covered. Critics have suggested that bundled payments apply only to elective surgical care and other well-deined acute conditions, and not to nonsurgical conditions, chronic disease, or primary care. But this claim is inconsistent with actual experience. Of the 48 conditions designated for BPCI, only half were surgical. The other half were for care episodes in nonsurgical conditions, such as heart disease, kidney disease, diabetes, and COPD. Time-based bundled payments for chronic care are emerging in other countries and with private payers. Bundled payments work well for chronic conditions because of the huge beneits that result from coordinated longitudinal care by a multidisciplinary team. Bundled payment models are also beginning to emerge for primary and preventive care for welldefined segments of patients with similar needs. Each primary care segment—such as healthy children, healthy adults, adults at risk for developing chronic disease, and the elderly—will need a very different mix of clinical, educational, and administrative

Bundled payments are not a new idea or a passing fad. Successful pilots date back for decades and include initiatives spearheaded by the Centers for Medicare & Medicaid Services. Consider the Heart Bypass Demonstration, an initiative that ran from 1991 to 1996. CMS offered a bundled payment for coronary artery bypass graft surgery that covered all services delivered in the hospital, along with 90 days of post-discharge services. The pilot yielded savings to Medicare of $42.3 million, or roughly 10% of expected spending, at the seven participating hospitals. The inpatient mortality rate declined at all the hospitals, and patient satisfaction improved. CMS also implemented the Acute Care Episode program (from 2009 to 2011), in which Medicare paid five participating organizations a flat fee to cover hospital and physician services for various cardiac conditions and orthopedic care. Over a total of 12,501 episodes, the initiative generated an average savings to Medicare of 3.1% of expected costs.

services, and the appropriate outcomes will difer as well. Bundled payments reward integrated and efficient delivery of the right mix of primary and preventive services for each patient group. Primary care bundles need not cover the cost of treating complex, acute conditions, which are best paid for with bundled payments to IPUs covering those conditions. Instead, primary care teams should be held accountable for their performance in primary care and prevention for each patient segment: maintaining health status, avoiding disease progression, and preventing relapses.

Defining and implementing bundled payments is too complicated. Critics argue that it will be hard to negotiate bundled payments across all conditions and to get agreement on the deinition of a medical condition, the extent of the care cycle, and the included services. This objection is weak at best. A manageable number of conditions account for a large proportion of health care costs, and we can start there and expand over time. The care required for most medical conditions is well established, and experience in deining bundles is rapidly accumulating. Methodologies and commercial tools, such as the use of comprehensive claims data sets, are in widespread use. Service companies that help providers deine conditions, form teams, and manage payments are emerging, as are software tools that handle billing and claims processing for bundles. Initially, bundled payments may cover less than the full care cycle, focus on simpler patient groups

July–August 2016 Harvard Business Review 95


Why DRGs Are Not Bundled Payments Critics of bundled payments point to Medicare’s experience with a superficially similar approach: the diagnosis-related group, or DRG, payment model. DRGs, which date back to 1984 and were adopted in many countries, were a step forward, but they did not trigger the hoped-for innovations in care delivery. Why have DRGs failed to bring about greater change? DRGs make a single payment for a set of services provided at a given location; however, the payment does not cover the full care cycle for treating the patient’s condition. By continuing to make separate payments to each specialist physician, hospital, and post-acute care site involved in a patient’s care, DRGs perpetuate a system of uncoordinated care. Moreover, DRG payments are not contingent on achieving good patient outcomes. Indeed, many DRGs fail to cover many support services crucial to good outcomes and overall value, such as patient education and counseling, behavioral health, and systematic follow-up. Under the DRG system, therefore, specialty silos in health care delivery have remained largely intact. And providers continue to have no incentive to innovate to improve patient outcomes.

with a given condition, and require adjudication mechanisms for gray areas that arise. This is already happening. As experience grows, bundled payments will become more comprehensive and inclusive. And a large body of evidence shows that the efort involved in understanding full care cycles and moving to multidisciplinary care is well worth it. Providers won’t work together. Critics argue that bundled payments hold providers accountable for care by other providers that they don’t control; skeptics also claim that it will be hard to divide up a single payment to fairly recognize each party’s contribution. This is one reason many hospital systems have been slow to embrace the new payment model. We are selling doctors short. Many physician groups have enthusiastically embraced bundles, because they see how the model rewards great care, motivates collaboration, and brings clinicians together. As physicians form condition-based IPUs and develop mechanisms for sharing accountability, formulas for dividing revenues and risk are emerging that relect each provider’s role, rather than lawed legacy fee structures. At UCLA’s kidney transplant program, for example, a bundled payment was first negotiated with several insurers more than 20 years ago. An IPU was formed and has become one of the premier U.S. kidney transplantation programs with superior outcomes. To divide the bundled price, urologists

96 Harvard Business Review July–August 2016

and nephrologists—the specialists who have the greatest impact on care—pay negotiated fees to other specialists involved in care (such as anesthesiology) and bear the residual inancial risk and share the gain. This structure has reinforced collaboration, not complicated it. Another example is physician-owned OrthoCarolina’s 2014 contract with Blue Cross and Blue Shield of North Carolina for bundled payment for joint replacement. OrthoCarolina provides care in several area hospitals and has negotiated a fixed payment with each of them for all the required inpatient care. Each participating hospital now has a designated team, including members of the nursing, quality, and administrative departments, that collaborates with OrthoCarolina surgeons in a virtual IPU. This ensures that everyone involved with the patient and the family fully understands the care pathway and expectations. The initial group of 220 patients in the plan experienced 0% readmissions, 0% reoperations, 0.45% deep venous thrombosis (versus 1% to 1.5% nationally), and substantial improvements in patient-reported quality-of-life outcomes. Average length of stay dropped from 2.4 days to 1.5 days, with 100% of patients discharged to their homes rather than a rehabilitation center. The cost per patient, as reported by Blue Cross and Blue Shield of North Carolina, fell an average of 20%. Outcomes are difficult to measure. Critics claim that the outcome data at the medical condition level, an essential component of value-based bundled payments, doesn’t exist or is too difficult and expensive to collect. While this may have been true a decade ago, today outcome measurement is rapidly expanding, including patient-reported outcomes covering functional results crucial to patients. Many providers are already systematically measuring outcomes. Martini-Klinik, a high-volume IPU for prostate cancer in Hamburg, Germany, has been measuring a broad set of outcomes since its founding, in 1994. This has enabled it to achieve complication rates for impotence and incontinence that are far lower than average for Germany. In congenital heart disease care, Texas Children’s tracks not only riskadjusted surgical and intensive care mortality rates but also metrics of patients’ neurodevelopmental status and, increasingly, ongoing quality of life. Advances in information technology are making outcome measurement better, easier, less costly, and more reliable. Greater standardization of the set


of outcomes to measure by condition will also make measurement more efficient and improve benchmarking. The International Consortium for Health Outcomes Measurement (ICHOM) has published global standard sets of outcomes and risk factors for 21 medical conditions that represent a significant portion of the disease burden, and the number is growing. Early bundled payment programs are already achieving signiicant outcome improvement. As provider experience grows, bundled payments will expand accountability and lead to even greater improvements.

Current cost information is inadequate. Critics argue that bundled payments require an understanding of costs that most providers lack, which puts them at unfair financial risk. Yet numerous bundled payment programs are already in place, using prices based on modest discounts from the sum of historical fee-for-service payments. New service companies are assisting providers in aggregating past charges and in reducing costs. Providers will learn to measure their actual costs, as organizations such as Mayo Clinic, MD Anderson, and the University of Utah are already doing. This will inform better price negotiations and accelerate cost reduction. The failure of care delivery organizations to properly measure and manage costs is a crucial weakness in health care globally. Bundled payments will inally motivate providers to master proper costing and use cost data to drive efficiencies without sacrificing good patient outcomes. Providers will cherry-pick patients. Critics charge that bundled payments will encourage providers to treat only the easiest and healthiest patients. But as we have already noted, proper bundled payments are risk-stratiied or risk-adjusted. Even today’s imperfect bundled payment contracts incorporate risk adjustments that are often better than those used in current FFS payment and beyond the crude risk adjustment used in capitation. Innovators are developing pragmatic approaches that adjust for risk, such as restricting initial bundles to groups of patients with similar risk profiles for a condition. The County of Stockholm did this with joint replacements. Its initial bundle covered the 60% to 70% of patients classiied as ASA 1 (normally healthy) or 2 (mild systemic disease); more-complex patients remained in the old reimbursement system. Careful tracking showed no evidence of bias in the selection of patients. The county plans to extend the bundle to

more-complex joint replacement patients as better data becomes available. Recently, the county introduced bundled payments for nine spine diagnoses requiring surgery, with far more sophisticated risk adjustment. The bundled payment includes a base payment, a payment covering expected complications, and a performance payment based on pain reduction. All three elements are adjusted for multiple patient risk factors. Risk adjustment will only improve as experience with it grows.

Bundled payments will finally motivate providers to master proper costing practices and to drive efficiencies without sacrificing good patient outcomes.

Bundled payments will encourage overtreatment. Critics raise

concerns that bundled payments, like FFS, will lead to overtreatment bec ause payment is tied to performing care, incenting providers to manufacture demand. Note that capitation plans, which have limited accountability for individual patient outcomes, have the opposite incentive: motivating providers to deny or delay the treatments patients need. While deinitive results are not yet available, our conversations with payers and government authorities in the United States, Sweden, and elsewhere have revealed no evidence that bundled payments have resulted in unnecessary surgeries or other treatments. Bundled payments are risk-adjusted and introduce transparency on outcomes, and the ixed payment will discourage unnecessary procedures, tests, and other services. Bundled payments (and all care) should incorporate appropriate use criteria (AUC), which use scientiic evidence to deine qualiications for particular treatments.

Price competition will trigger a race to the bottom. Finally, some providers worry that bundled payments will result in excessive price competition, as payers demand discounts and lowquality providers emerge offering cheap prices. This concern is common among hospitals, which are wary of greater competition and want to sustain existing reimbursement levels. We believe this fear is overblown. Bundled payments include clear

July–August 2016 Harvard Business Review 97


accountability for outcomes and will penalize poorquality providers. At the root of all these objections to bundled payments are critical failures that have held back health care for decades. Bundled payments will inally address these problems in ways that capitation cannot.

How Bundled Payments Will Transform Competition


“The Strategy That Will Fix Health Care” Michael E. Porter and Thomas H. Lee HBR, October 2013

“What Is Value in Health Care?” Michael E. Porter New England Journal of Medicine, December 2010

“How to Solve the Cost Crisis in Health Care” Robert S. Kaplan and Michael E. Porter HBR, September 2011

“Redesigning Primary Care: A Strategic Vision to Improve Value by Organizing Around Patients’ Needs” Michael E. Porter, Erika A. Pabo, and Thomas H. Lee Health Affairs, March 2013

“Getting Bundled Payments Right in Health Care” Derek A. Haas, Robert S. Kaplan, Dereesa Reid, Jonathan Warsh, and Michael E. West, October 2015

As our multiple examples reveal, bundled payments are already transforming the way care is delivered. They unleash a new kind of competition that improves value for patients, informs and expands patient choice, lowers system cost, reshapes provider strategy, and alters industry structure for the better. With bundled payments, patients are no longer locked into a single health system and can choose the provider that best meets their particular needs. Choice will expand dramatically as patients (and physicians) gain visibility into outcomes and prices of the providers that treat their condition. In a transparent bundled-payment world, patients will be able to decide whether to go to the hospital next door, travel across town, or venture even farther to a regional center of excellence for the care they need. This kind of choice, long overdue in health care, is what customers have in every other industry. At the same time, the prices should fall. A bundled payment will usually be lower than the sum of current FFS reimbursements in today’s ineicient and fragmented system. For conditions where legacy FFS payments failed to cover essential costs to achieve good outcomes, such as in mental health care or diagnostics that enable more targeted and successful treatments, prices may initially rise to support better care. But even these prices will fall as providers become more eicient. In a world of bundled payments, market forces will determine provider prices and proitability, as they should. In today’s system, FFS pricing allows ineicient or inefective providers to be viable. With bundled payments, only providers that are effective and eicient will grow, earn attractive margins, and expand regionally and even nationally. The rest will see their margins decline, and those with poor outcomes will lose patients and bear the extra costs of dealing with avoidable complications, infections, readmissions, and repeat treatments. Given today’s hyperfragmentation of care, bundled payments should reduce the absolute

98 Harvard Business Review July–August 2016


number of providers treating each condition. But those that remain will be far stronger. And unlike the consolidation that would result from capitation, this winnowing of providers will create more-efective competition and greater accountability for results. Providers will stop trying to do a little bit of everything and instead will target conditions where they can achieve good outcomes at low costs. Where they cannot, they will partner with more-efective providers or exit those service lines. The net result will be signiicantly better overall outcomes by condition and signiicantly lower average costs. No other payment model can produce such a transformation. The shift to bundled payments will also spill over to drive positive change in pharmaceuticals, medical devices, diagnostic testing, imaging, and other suppliers. Today, suppliers compete to get on approved lists, curry favor with prescribing specialists through consulting and research payments, and advertise directly to patients so that they will ask their doctor for particular treatments. As a result, many patients receive therapies that are not the best option, deliver little beneit, or are unnecessary. With bundled payments, suppliers will have to demonstrate that their particular drug, device, diagnostic test, or imaging method actually improves outcomes, lowers the overall cost, or both. Suppliers that can demonstrate value will command fair prices and gain market share, and there will be substantial cost reduction in the system overall. Competition on value is the best way to control the costs of expensive drugs and therapies, not today’s approach of restricting access or attacking high prices as unethical or evil regardless of the value products ofer.

The Time Is Now The biggest beneficiary of bundled payments will be patients, who will receive better care and have access to more choice. The best providers will also prosper. Many already recognize that bundled payments enable them to compete on value, transform care, and put the system on a sustainable health care path for the long run. Those already organized into IPUs for speciic medical conditions are particularly well-positioned to move aggressively. Physician groups in particular have often moved the fastest. Many health systems, however, have been reluctant to get behind bundled payments. They seem to believe that capitation better preserves the status quo—a top-down approach that leverages their clout

HBR.ORG/STORE 1-800-668-6780 OR +1-617-783-7450

Learn what the numbers really mean. Companies expect managers to use financial data to allocate resources and run their departments. But many managers can’t read a balance sheet, wouldn’t recognize a liquidity ratio, and don’t know how to calculate return on investment. Can you? The Financial Intelligence collection gives managers mastery of the financial basics they need to plan, budget, forecast, and control resources with confidence. If you’re not a “numbers person,” this is the perfect way to learn what you’ve always needed to know. Don’t miss this chance to do it. SAVE MORE THAN 15% OFF THE INDIVIDUAL COMPONENT PRICES WHEN YOU ORDER THIS COLLECTION

Product #0003BN • $115


and scale. They also see it as encouraging industry consolidation, which will ease reimbursement pressure and reduce competition. However, leading health systems are embracing bundled payments and the shift in competition to what really matters to patients. Health systems with their own insurance plans, or those that self-insure care for their employees, can begin immediately to introduce bundled payments internally. Health systems that have adopted ACOs or other capitated models can also use conditionbased bundled payments to pay internal units. Doing so will accelerate learning while motivating clinical units to improve outcomes and reduce costs in a way that existing departmental budgets or FFS can never match. Adopting bundles internally will be a stepping stone to contracting this way with payers and directly with employers. P aye r s w i l l r e a p huge benefits f rom bundled payments. Single-payer systems, such as those in Canada, Sweden, and the U.S. Veterans Administration, are well-positioned to transition to bundled payments for a growing number of medical conditions. Indeed, this is already happening in some countries and regions, with CMS leading the way in the United States. But many private insurers, which have prospered under the status quo, have been disappointingly slow in moving to bundled payments. Many seem to favor capitation as less of a change; they believe it preserves payment infrastructure while shifting risk to providers. As an excuse, they cite their inability to process claims for bundled payments, even though bundled claims processing is inherently far simpler. Improving the way they pay for health care, however, is the only means by which insurers can ofer greater value to its customers. Insurers must do so, or they will have a diminished role in the system. We challenge the industry to shift from being the obstacle to bundled payment to becoming the driver. Recently, we’ve been heartened to see more private insurers moving toward bundled payments. Employers, which actually pay for much of health insurance in the United States, should step up to lead

Providers will stop trying to do everything and will target conditions where they can achieve good outcomes at low cost.

100 Harvard Business Review July–August 2016


the move to bundled payments. This will improve outcomes for their employees, bring down prices, and increase competition. Self-insured employer health plans need to direct their plan administrators to roll out bundles, starting with costly conditions for which employees experience uneven outcomes. Should their insurers fail to move toward bundles, large employers have the clout to go directly to providers. Lowe’s, Boeing, and Walmart are contracting directly with providers such as Mayo Clinic, Cleveland Clinic, Virginia Mason, and Geisinger on bundled payments for orthopedics and complex cardiac care. The Health Transformation Alliance, consisting of 20 large employers that account for 4 million lives, is pooling data and purchasing power to accelerate the implementation of bundled payments. THE TIME has come to change the way we pay for health care, in the United States and around the world. Capitation is not the solution. It entrenches large existing systems, eliminates patient choice, promotes more consolidation, limits competition, and perpetuates the lack of provider accountability for outcomes. It will fail again to drive true innovation in health care delivery. Capitation will also fail to stem the tide of the ever-rising costs of health care. ACOs, despite their strong advocates, have produced minimal cost savings (0.1%). By contrast, even the simpliied bundled payment contracts under way today are achieving better results. Medicare is expected to save at least 2% ($250 million) in its program’s first full year of operation. And experience in the United States and elsewhere shows that the savings can be far larger. Capitation might seem simple, but given highly heterogeneous populations and continual turnover of patients and physicians, it is actually harder to implement, risk-adjust, and manage to deliver improved care. Bundled payments, in contrast, are a direct and intuitive way to pay clinical teams for delivering value, condition by condition. They put accountability where it should be—on outcomes that matter to patients. This way to pay for health care is working, and expanding rapidly. Much remains to be done to put bundled payments into widespread practice, but the barriers are rapidly being overcome. Bundled payments are the only true value-based payment model for health care. The time is now. HBR Reprint R1607G


With a business clock that runs 24/7, success depends on managers who can quickly learn and apply new skills. But traditional leadership development approaches aren’t working. They’re too time-consuming, too costly, and too limited in scale. Harvard ManageMentor® is the premier on-demand learning and performance support resource for leadership and management skill development that can reach a globally dispersed workforce. Through an innovative work-based approach, Harvard ManageMentor guides learners to apply what they learn directly to their work, to accelerate learning and drive business impact. Concise, proven content from world-class experts allows managers to quickly apply new skills anywhere, anytime. Consistent leadership development that translates into lasting results.

102 Harvard Business Review July–August 2016


Brent C. James, MD, is Intermountain Healthcare’s chief quality officer and leads the Intermountain Institute for Healthcare Delivery Research. He is a member of the National Academy of Medicine and a professor of clinical medicine (affiliated) at the Stanford University School of Medicine. He holds adjunct faculty appointments at the

Harvard School of Public Health and the University of Utah School of Medicine. Gregory P. Poulsen is Intermountain Healthcare’s senior vice president and chief strategy officer. He is a trustee of the American Board of Internal Medicine Foundation and a national guest scholar at the Stanford University School of Medicine.


The Case for Capitation It’s the only way to cut waste while improving quality.



To rein in health care costs in the United States, we should look to the ideas of W. Edwards Deming, the legendary management guru who showed companies how to cut waste from work processes and lower operating costs by improving quality. Recent studies using Deming’s approach reveal that July–August 2016 Harvard Business Review 103


inadequate, unnecessary, uncoordinated, and inefficient care and suboptimal business processes eat up at least 35%— and maybe over 50%—of the more than $3 trillion that the country spends annually on health care. That suggests more than $1 trillion is being squandered. Ongoing reform efforts by the federal government and private insurers have had some success in prodding health care providers to improve quality and reduce waste. But it’s far from certain that they’ll be enough. Even after taking existing and proposed reform initiatives into account, federal projections show health care expenditures consuming larger and larger proportions of the GDP. Moreover, under the prevailing payment models, which are based on volume of services, providers often don’t receive any of the savings from waste reduction, which undermines both their inancial health and their ability to continue to invest in such eforts. The solution to this quandary is to change the way businesses, government, and other purchasers pay for health care to population-based payment. Under this approach, providers receive a ixed per person (or “capitated”) payment that covers all health care services over a deined time period, adjusted for each patient’s expected needs, and are also held accountable for high-quality outcomes. It’s the only payment system that fully aligns providers’ financial incentives with the goal of eliminating all major categories of waste. It fundamentally shifts the role of managing the amount, form, and cost of care from insurers to medical practitioners. It also ensures that providers receive enough of the savings that they can aford to fund the changes needed to bring down costs. A population-based payment model also has major implications for pure health insurers: Because it removes care oversight from their purview, it leaves them only traditional insurance functions such as claims processing, risk analysis, reinsurance, marketing, and customer service. Many nonproit health insurers competently provide a full range of such services for less than 10% of total health insurance payments, well below the portion that many health insurers now extract through current systems.

104 Harvard Business Review July–August 2016

In this article we’ll look at the diferent categories of waste in health care and then outline the various payment methods that have evolved in the United States and their effect on waste. We’ll then demonstrate how population-based payment, backed by good reporting, can improve clinical results, eliminate unnecessary spending, and lower costs.

Three Kinds of Waste In health care there are three basic categories of waste: production-level waste, case-level waste, and population-level waste. The first category involves inefficiencies in producing “units of care”—drugs, lab tests, x-rays, hours of nursing support, and any other item consumed in patient treatment. It accounts for about 5% of total health care waste. Eliminating it requires things like negotiating down prices for supplies, lowering handling and storage costs, streamlining processes for producing lab tests or x-rays, and reducing losses due to damage, misplacement, or expiration. The second category, which comprises about half of all waste in care delivery, is unnecessary or suboptimal use of care during a hospital stay, an outpatient visit, or some other treatment episode, or “case.” Examples include redundant x-rays ordered when the original images couldn’t be found, duplicate lab tests ordered because a physician didn’t know that someone else had already done the tests, and medications prescribed to treat avoidable complications. The third category, which accounts for about 45% of total waste, involves cases within a patient population that are unnecessary or preventable. It includes end-of-life intensive care given to people who’ve expressly asked not to receive it; elective surgical procedures that, with better information, patients would have forgone; and visits to specialists or hospitalizations that could have been avoided through timely, cheaper outpatient care. Waste here obviously feeds waste at the other two levels, since each unnecessary or avoidable case consumes care.

The Impact of Different Payment Models To understand what’s driving up health care spending, it’s critical to examine whether—and to what extent—health care payment methods encourage or discourage waste reduction. An optimal payment method must address two important challenges.


Idea in Brief THE PROBLEM Despite ongoing reform efforts, U.S. expenditures on health care as a percentage of GDP are still rising. And at least 35%, or more than $1 trillion, of the amount spent annually on health care is waste.

THE ROOT CAUSE Under the prevailing fee-forservice and per case payment methods, health care providers don’t get the savings generated by their efforts to reduce waste, which undermines their financial health and their ability to invest in programs that cut costs by improving quality.

One is how to divvy up the savings generated by eliminating waste. If most or all of the money goes to health care payers, providers have no incentive to cut waste. If most or all of it goes to providers, how do you ensure that they pass on some of it to customers—especially if there is no eicient market, which, we’d argue, you often can’t create in health care because of its complexities? Another issue is how a payment method afects the power of patients and their physicians to make decisions that are in patients’ best interests. Let’s look at the methods that have evolved in the United States over the years and see how each stacks up. Cost-plus. In 1965, as part of the War on Poverty, the U.S. Congress enacted the Medicare and Medicaid government-funded health insurance programs. Those programs paid physicians and hospitals on a cost-plus basis. Care providers estimated their cost for delivering each unit of care, and then the government paid that cost plus a markup. The result was that providers could basically consume whatever resources they wanted—and had no incentive to reduce spending. Today cost-plus payment persists only in small pockets of health care, such as some specialty hospitals and some small rural hospitals. Fee for service. Until the 1980s there was little standardization in the way hospitals and physicians billed payers for individual units of care such as lab tests, supplies, or medical services. Then, in a bid to control costs, Medicare began to organize some of the fee categories, and a degree of standardization emerged for the prices and nomenclature of most items, for commercial as well as government payers. Under the fee-for-service payment method, a provider supplies an approved billing code for (and may be required to justify) each unit of care consumed during a hospitalization, same-day procedure, or outpatient visit. It cannot bill for anything that lacks

THE SOLUTION Replace existing methods with a form of capitation that would pay care delivery groups directly for covering all of an individual’s health care needs for a defined time period. This would greatly reduce the role of pure insurers. The Intermountain nonprofit health care system has demonstrated that this approach works.

a code. For each billed item the government pays the lesser of the group’s actual billed charges or a federal maximum allowed rate. (The method it uses to calculate that rate isn’t strongly linked to true underlying costs and is controversial.) As a result, care delivery groups try to ensure that their billed charges are above the federal rates. Given that the rates change constantly as the government updates its estimates, the easiest way for a group to guarantee maximum payment is to set high prices for everything. Fee for service also encourages care deliverers to provide as much care as possible, regardless of whether it’s all necessary or optimal. Because of that, the types and volume of care used to treat a given disease vary widely, making it difficult to compare the true cost of care across providers. As a result, commercial insurers often base purchasing decisions on percentage discounts they’ve negotiated with c are delivery groups. That in turn leads some groups to apply very high markups—so that they can ofer large discounts to the insurers. Fee for service neither efectively promotes the elimination of all kinds of waste nor allocates savings among providers, payers, and patients in a way that would fuel continual improvements. Despite its widely acknowledged deficiencies, it remains the most common payment method in the United States. It forms the basis for nearly all accounting systems used by care delivery groups and health care insurers.

Half of all waste in care delivery is unnecessary or suboptimal care— such as redundant x-rays or medications to treat avoidable complications.

July–August 2016 Harvard Business Review 105


Per case. This payment method dates back to 1983, when the federal government introduced the “diagnosis-related group” (DRG) system for Medicare patients. Again, the primary purpose was cost control. Currently, DRGs classify hospital and same-day surgery patients into 753 unique categories, on the basis of each patient’s primary disease, specific treatment, secondary chronic conditions, and care intensity. For example, DRG 7 is a lung transplant, DRG 179 uncomplicated pneumonia, and DRG 343 a simple appendectomy. Medicare pays facilities, such as hospitals or surgery centers, a lat rate per case in each category. Meanwhile, it pays physicians involved in the same cases on a fee-for-service basis. Commercial insurers sometimes pay hospitals and surgery centers per case but pay the physicians providing treatment via fee for service. In 2016 the government introduced “bundled” per case payments in its Medicare program, following an approach irst tried by a handful of commercial health insurers. The initial federal experiment focuses on total hip- and total knee-joint-replacement surgery. It extends the single lat-rate DRG payment to include all physician fees and all costs of any related treatments, complications, or hospital readmissions within 90 days of the original operation. If the experiment successfully reduces costs, the government plans to extend it to other types of cases. Per case payment gives providers incentives to improve eiciency within cases but, like fee for service, is a volume-based system that fuels waste. The more cases a care delivery group handles, the more it gets paid. Therefore, it’s in the group’s inancial interest to maximize the number of cases it treats, even if some add no value or actively harm patients. Capitation. In contrast to fee-for-service and per case payment methods, per person payment methods can encourage waste reduction at all three levels and give patients and physicians the freedom to make the treatment decisions they think are best. But to function well, such systems must adjust payments for risk, which is easier to do at the level of a population than of an individual patient. (A typical population is a business’s employees and their dependents.) There have to be quality measures to ensure that providers don’t withhold necessary care. And inally, savings from waste reduction must go back to care delivery groups to keep them inancially viable. The last widespread use of capitation in the U.S. didn’t meet the last two criteria. In the late 1980s and 106 Harvard Business Review July–August 2016

into the 1990s, both government and private payers looked for ways to reduce health care inlation. The primary mechanism they turned to was health maintenance organizations (HMOs), which were usually owned and managed by insurance companies. While employers generally paid HMOs on a capitated basis, most HMOs continued to pay care delivery groups using fee-for-service and per case methods. HMOs employed a series of tools to limit health care consumption. For example, many mandated that primary care physicians act as gatekeepers. Care providers had to get permission from nurses and doctors based at insurance companies to make referrals to specialists and order surgical procedures, imaging, and hospitalizations. In some instances the HMOs passed along a portion of the capitated insurance payment to the provider groups to cover all necessary services, which transferred the inancial risk to them. HMOs succeeded in curbing expenditures. Health care costs as a proportion of GDP remained lat from 1993 through 2000—even though one reason was that the GDP was growing rapidly, hiding the price increases that did occur. However, the insurance companies weren’t in the best position to make health care decisions, because they were removed from patient-clinician interactions. The HMOs’ bureaucratic controls imposed hassles and treatment delays. Some physician groups, unable to manage care costs after accepting capitated payments, failed inancially. Patients and physicians rebelled, arguing that the inancial incentives built into capitated payments led HMOs to ration care and accusing insurance companies of putting proits before patients’ health. The resulting political backlash ended insurance-companybased cost control as a national movement.

A Better Capitation Model A population-based payment system would differ from the capitated method most insurance companies use in signiicant ways. With PBP, care provider organizations would receive a risk-adjusted monthly payment that covers all necessary health services for each person. Eliminating the gatekeeper and the third-party authorization for care that made HMOs so unpopular, PBP would put responsibility for considering the cost of treatment options in the hands of physicians as they consult with patients. Finally, unlike HMOs of the 1990s, PBP would include quality measures and standards. A care delivery group would pay independent physicians using existing


fee-for-service mechanisms but would adjust payments quarterly according to the levels of clinical quality and patient satisfaction achieved as well as total cost to care for the covered population. The advantage of this approach is that it would build on a system physicians already understand while rewarding them for improvements in quality and cost, which would compensate them for income lost if total care volumes decline as a result of waste elimination. Federal cost control efforts mandated by the Afordable Care Act of 2010 are pushing health care payments in this direction. Recognizing that volumebased payments fuel expenditures, increase waste, and potentially worsen quality, government oicials are moving toward “pay for value” systems, which give providers financial incentives to hold costs down by improving clinical outcomes and patient satisfaction. To do this, they’re implementing the initiatives below—each of which represents a step along the spectrum toward full capitated payment: • Mandatory reporting of quality and patient satisfaction for all care delivered under Medicare, with financial penalties for care delivery groups that don’t meet standards or that rank poorly compared with other groups. • The Medicare bundled payment experiment launched this year. • The Medicare Shared Savings Program, under which a care delivery group is paid via traditional fee for service and per case DRGs but receives a portion of any savings it achieves through care coordination and waste reduction. • Alternative payment models, including patientcentered medical homes and accountable care organizations (ACOs) for Medicare patients. These programs also pay via fee for service and per case but give care delivery groups a potentially larger share of the savings, provided their charges come in under preset spending levels. However, if charges exceed the preset levels, care delivery groups may have to absorb them. • Full capitated payment. The federal government is launching “next-generation ACOs,” in which a care delivery group receives a monthly capitated payment that covers all health services for Medicare patients enrolled with it, adjusted for their expected health needs. Diferent care delivery groups (including our organization, Intermountain

Healthcare) are proposing—and the government is likely to approve—diferent forms. It may take a few years, after these experiments produce results, for the deinitive form to emerge. We recommend that, where possible, care providers jump directly to population-based payment and that payers actively support them in that move. Of the pay-for-value methods just listed, it’s the only one that gives care delivery groups the inancial incentives to attack all three levels of waste. More speciically, it’s the only one that ensures that care delivery groups capture enough of the savings from waste elimination that they stay inancially viable and can continue to invest in such programs. Let us explain. To raise quality and eliminate waste in health care, we need to do more than end production ineiciencies and unnecessary or inappropriate treatments. Care providers also have to develop, test, and repeatedly improve new care delivery processes—and that requires investment. A major problem with fee-forservice and per case payments is that they redirect the savings away from those who must make the investment and into the pockets of insurance companies. Consider these two examples: Congestive heart failure and ischemic heart disease (compromised blood low to the heart) are very common conditions, especially among Medic are patients. Certain medications (beta blockers and ACE and ARB inhibitors), taken every day, can stabilize patients’ conditions and prevent death. The key is recognizing which people need the medications and getting them started on them. Nationwide, hospitals prescribe the right long-term medications for these two conditions to their patients only 44% of the time. Intermountain Healthcare’s LDS Hospital in Salt Lake City developed a system that boosted its accuracy rate from 57% to over 98%. As a result, mortality fell by more than 450 deaths a year, and hospitalizations by almost 900 cases a year. The majority of those cases were paid through Medicare, on the per case DRG system. The lower hospitalization rate meant that LDS Hospital lost $3.2 million a year in revenues, along with associated operating income.

To raise quality and eliminate waste, care providers have to develop innovative new processes—and that requires investment.

July–August 2016 Harvard Business Review 107


From a purely financial viewpoint, its investment in improving patient outcomes and lowering costs worked out very poorly indeed. Intermountain’s American Fork Hospital had a large birthing service. About 110 of its newborns each year were borderline premature—with a 34to 37-week gestation versus the normal 40 weeks. Often the lungs of premature babies are not fully developed, which means they can collapse. In the distant past, most of these “blue babies” died. Then clinicians learned to place a breathing tube through an infant’s mouth into its major airway and use a mechanical ventilator to keep the lungs inlated for a few weeks. This gave infants’ lungs time to mature, and mortality rates plummeted. Unfortunately, intubation and mechanical ventilation are highly invasive, and some babies sufered signiicant complications. A group of obstetricians and neonatologists at American Fork Hospital argued that since borderline preemies have lungs that are almost mature, a milder intervention, “nasal continuous positive airway pressure,” which involves blowing pressurized air through the newborn’s nose, might work. In a clinical trial, intubation rates fell from 78% to 18%. The children stayed in the nursery, not the far more expensive newborn ICU. With the simpler, less invasive care, the hospital’s total operating costs for these children fell by $544,000 a year. But fee-for-service insurance payments dropped by $873,000, causing a $329,000 dip in the hospital’s operating income. The hospital also had to bear the costs of developing and implementing the change. Moreover, when Intermountain decided to deploy the new methods across all its hospitals—clearly the right thing to do for the children—that $329,000 turned into more than $5 million in annual losses. These examples raise critical questions: Should care delivery groups invest in quality improvements that reduce costs if it could mean their own inancial demise? Even if a group does so because it’s the right thing for patients, where will it ind the resources to launch its next waste reduction project? Shouldn’t

When Intermountain rolled out a better, less invasive lung treatment for premature babies—clearly the right thing to do—it lost $5 million in income.

108 Harvard Business Review July–August 2016

the windfall that health insurers receive from waste reduction help fund further improvements? If sharing in the savings strengthened the care delivery group inancially, wouldn’t it become a more efective competitor, encouraging other groups to adopt the same cost-saving strategies? We believe that population-based payment addresses these issues, because it encourages providers to attack all waste, by ensuring that they beneit from the savings. Because per case systems, including the new bundled payment approaches, don’t ofer the right inancial incentives, close to half of all waste reduction opportunities are likely to go unrealized under them. Under fee for service, the situation is even worse: More than 90% of such opportunities will probably fall by the wayside. (See the exhibit “Who Gets the Savings from Waste Reduction?”) Population-based payment has other advantages as well: Higher returns. For care delivery groups, waste elimination under PBP has a far more positive inancial impact than revenue enhancements do under pay-for-volume systems. Only 5% to 9% of all new revenues from a successful, well-managed new feefor-service or per case service will ind their way to a care delivery organization’s bottom line. From 50% to 100% of the savings generated through waste elimination in a PBP system will.

A bigger opportunity for more providers. The total size of the opportunity—a minimum of $1 trillion a year in the United States—dwarfs any inancial gains from ofering new services. Any competent care delivery group can immediately act on that opportunity; that’s not true with new services. Eliminating waste often requires much smaller investments than launching new services, especially if those services rely on cutting-edge technologies.

Cheaper, higher-quality care for patients. PBP would create a market in which care delivery organizations would compete for patients on the basis of the cost and quality of their clinical services. Competition would prod them to pass some of the savings on to patients and to give them better care. Judging by what’s going on in the market beyond the Medicare initiatives, others seem to agree that the population-based payment model is best. An increasing number of care delivery groups have started their own insurance companies or partnered with existing insurers, and many large health insurers have purchased care delivery groups. Combining care


Who Gets the Savings from Waste Reduction?

delivery and insurance in one organization creates a de facto population-based payment system.

Finding the Tipping Point Most care delivery groups now navigate a complex mix of discounted fee-for-service (commercial insurance) and per case (Medicare, plus some commercial insurance) payment. Population-based payment—capitated payment made directly to care delivery groups—remains relatively rare. Yet if it were adopted more broadly, groups that aggressively cut waste, as Intermountain did, would beneit inancially; the revenues they received for treating each patient would hold steady, while their costs would fall. The key is identifying and reaching the tipping point: the proportion of a group’s total payment that must come through capitation in order for gains from waste elimination under PBP to outweigh losses under other payment systems. To explore that question, we built mathematical and empirical models. Under conditions simulating the operations of both community care groups and academic medical centers, the tipping point was consistently below 30%. If 23% to 29% of a group’s payments came through PBP, the group improved its inances by concentrating on waste elimination.

Answering the Critics Opponents of population-based payments raise three main concerns about them—all of which we believe are unfounded.

Objection 1: PBP’s financial incentives will cause rationing, leading clinicians to withhold necessary care. Some critics cite the 1990s HMO experience to support that viewpoint. But they are wrong for a number of reasons. First, the science of assessing clinical quality, while still imperfect, is dramatically better than it was in the 1990s. To a much greater degree than the HMOs of that era, all proposals for pay-for-value, including capitated payment, contain measures to ensure that each patient receives all necessary and beneicial care, at least to the degree achieved by the current fee-for-service and per case payment systems. Second, the HMO movement placed oversight of care decisions in the hands of an insurance company. That created conlict between patients and their clinicians on one side and a distant, inancially driven corporation on the other. Making capitated payments directly to care delivery groups and eliminating the

With most health care payment methods, much of the savings from waste cuts goes into the pockets of payers (mainly insurers and, to a much lesser degree, employers and patients), not to the care delivery groups behind the quality improvement initiatives. That undermines the groups’ finances and ability to invest in further innovations that rein in spending. Population-based payment is the only system that allows groups to benefit from reducing all three categories of waste. TYPE OF WASTE






















insurers’ supervisory role remove the fundamental conlict that doomed the HMO movement. Finally, there is solid historical evidence that when physicians are asked to take costs into account in treatment decisions, the vast majority consistently do what’s clinically best for the patient. During the 1930s and the 1940s, before broadly available thirdparty payment for health care, physicians routinely considered a family’s resources when providing care. During HMOs’ heyday, concerns about rationing were fears, not reality: Empirical measurement of quality showed, on average, a slight but signiicant increase in the quality of care. The healing professions select for ethical behaviors, train their members deeply in them, and monitor for violations. While failures do occur, they’re rare. When they happen, they’re corrected. The medical professions’ ethical codes of conduct actually work.

Objection 2: Care delivery groups are not best equipped to address problems of fragmented care and to promote population health. Most people agree on the need to better coordinate care delivery in the United States. The current system is deplorably fragmented, forcing patients to navigate a confusing maze of independent primary, specialty, and hospital care. There’s also consensus that the country should expand

July–August 2016 Harvard Business Review 109


population-wide eforts to promote healthful lifestyles and immunization to prevent diseases, and early detection to nip them in the bud. Some argue that health insurance companies are best positioned to achieve these goals. We disagree for several reasons. While it’s true that coordinated care is essential to reducing waste and increasing quality, it works most efectively and eiciently when embedded within an integrated care delivery organization—a network of providers that have agreed to ofer a continuum of care to a deined population and to be accountable for clinical and inancial outcomes. Such groups already account for between a third and half of all care delivery in the country, and their share is growing rapidly. Even if an integrated care delivery group doesn’t contain every essential service, it’s as well positioned as an insurance company to partner with other providers for additional services. Moreover, we estimate that at least one-third of all opportunities to improve population-level health reside exclusively within specialty and hospital-based care delivery—well outside the reach of insurance companies. The new way to treat newborns with immature lungs cited earlier is one of many such examples. Last, even when insurance companies do have some ability to address population-level waste, care delivery groups are still more efective at it. For example, Intermountain has found that embedding “appropriate use criteria” in clinical practice, where physicians consult with patients to make treatment choices, prevents unnecessary or harmful care better than insurance-based preauthorization does. Intermountain’s cardiologists, for instance, routinely employ such formal evidence-based criteria when counseling patients who might need heart catheterization, stents in the arteries that supply blood to the heart, or permanent heart pacemakers and deibrillators. The result is that the use of such treatments has fallen by almost 25% below Intermountain’s already low rates, eliminating about $30 million in waste annually. Meanwhile, quality measures showed slight improvements in clinical outcomes.

Objection 3: It would be better to expand bundled payments. The use of bundled payments has focused mostly on clinical conditions with welldefined boundaries, such as cataract eye surgery, total joint replacements, uncomplicated deliveries, and simple outpatient upper respiratory infections. Some propose applying it to more-complex cases,

110 Harvard Business Review July–August 2016

such as the management of chronic diseases like diabetes, heart failure, and asthma. That approach, they argue, would give patients greater choice and make health care markets more competitive. (See “How to Pay for Health Care” on page 88.) This approach to bundled payments is sometimes called “disease capitation.” It’s a very small step away from full capitation. It attempts to push actuarial risk analysis down to the individual patient level, rather than analyzing risk for a group of patients. Such analysis is technically diicult. In addition, this approach could create strong incentives for care delivery groups to select patients, conditions, and treatments based on financial returns rather than patient need. Most people who have chronic diseases such as heart failure, hypertension, asthma, and depression suffer from several at once. This is especially true with elderly patients, whose needs often include palliative care, help with bowel issues, and general pain control. Any care delivery group has to treat the whole person, not just the disease; it must supply comprehensive care for all of a patient’s conditions, either by providing it directly or coordinating with other groups. Bundled payment systems, however, spur patients to seek out highly specialized groups that treat only one disease and its related conditions. Finally, bundled payments don’t directly encourage prevention. In contrast, PBP gives care provider groups strong incentives to perform interventions so that their services aren’t needed in the irst place— something capitated care delivery groups are starting to do under the banner of “population health.”

Population-based payment gives provider groups strong incentives to perform interventions so that their services aren’t needed in the first place.

Proof That Population-Based Payment Works The experience of Intermountain Healthcare, which serves about 2 million people in Utah, Idaho, and surrounding states, shows that a population-based payment model is viable. Intermountain has its own insurance subsidiary: SelectHealth, the largest commercial health insurer


Waste Cutting That Works How Intermountain kept care affordable

2015 2014


in the region, which has some 800,000 enrolled members. Through its commercial insurance business, capitated Medicare Advantage programs, and a new capitated Medicaid program introduced by the state of Utah, SelectHealth now pays for more than 30% of all care delivered within the Intermountain system. Add true charitable care, and capitated care accounts for over 35% of Intermountain’s business. As a nonproit with a social mission, Intermountain regards the patients and communities it serves as its “shareholders.” Its leaders and trustees believe that access to care is paramount. In 2011, recognizing that access depends on afordability, Intermountain’s CFO set a goal of dropping the group’s year-over-year rate increases within 1% of the consumer-price-index inlation rate by the end of 2016. Intermountain is making good progress toward that goal. (See the exhibit “Waste Cutting That Works.”) Through 2015, waste elimination reduced its total cost of operations (“revenues,” under traditional fee-for-service-based health care accounting systems) by 13%. But since more than 35% of Intermountain’s care is now compensated through capitated payment—well past the tipping point—the group has been able to remain financially strong: With consistently healthy operating margins, it boasts the highest bond ratings in the industry. The cardiac-medication and newborn initiatives, which initially hurt Intermountain’s operating income, now make financial contributions. So do a whole host of other waste reduction innovations, such as a new supply-chain management system, the introduction of best-practice standards for high-volume diseases, and primary care clinics that coordinate all aspects of medical and social services. IF 35% to more than 50% of total health care spending is wasted, then the 13% drop in operating costs that Intermountain has achieved is merely a good start. Large inancial opportunities remain. In 2014, Intermountain, which employs more than 1,350 physicians, launched a new program that allows interested independent physicians to participate in population-health eforts and share in the savings they generate. Under the modiied fee-forservice system described earlier, these physicians, along with the employed group, receive signiicant payment when total costs are reduced, patient satisfaction is increased, and quality measures— which guarantee that no physician is withholding

2013 2012 4





EXPECTED TOTAL COSTS Population growth, the aging of the Baby Boomers, and new technologies promised to rapidly drive up health care costs for Intermountain’s community.

TARGETED COSTS The nonprofit’s leadership set out to hold increases to an affordable level: within 1% of the consumerprice-index inflation rate.

ACTUAL COSTS Because more than a third of its care is delivered through population-based payment systems, Intermountain has been able to hit its cost control targets without weakening its operational margins.

WASTE CHOPPED In 2015, Intermountain cut $688 million worth of waste. Today it maintains the highest bond ratings in the nonprofit health care sector.


beneicial care—improve. About 1,200 of the more than 4,000 independent physicians that work with Intermountain have signed up. In the fall of 2015, Intermountain used the savings generated by waste elimination to offer business customers a new insurance product. It limits total rate increases to 4% a year for three years—a level likely to be one-half to one-third of general insurance rate increases in Intermountain’s markets. The organization sees this as a “dividend” to its “shareholders”—the patients and communities it serves. In return for low rates, businesses have to participate in disease prevention and activities that promote better health—for example, encouraging their employees to exercise regularly and eat wisely, to stop using tobacco products, to avoid excessive alcohol consumption, and so on. Deming got it right. Raising quality by reducing process variations and rework can eliminate waste and bring down operating costs. Better products at lower costs generate higher value, which helps organizations achieve better market positions. Strategies based on that thinking have transformed other industries. We believe that they will do the same in health care. Population-based payment will play a critical role in helping care delivery groups make that leap. HBR Reprint R1607H

July–August 2016 Harvard Business Review 111


Ak[gddYZgjYlagf the new innovation? Industrial mash-ups: a powerful way of driving growth is emerging

Traditionally, companies looking to jump-start growth turned to acquisitions or joint ventures for faster results. But these arrangements can be costly, risky and hard to untangle. As the pace of technological change continues to accelerate, such complicated, binary deals might not always be right for a rapid response to changing markets. Today, a third way is emerging — the industrial mash-up.

which two or more entities combine resources lgY[[gehdak`Ykh][aÕ[gZb][lan]$af\mkljaYd mash-ups operate under simple collaboration Y_j]]e]flk&Mfdac]e]j_]jkYf\Y[imakalagfk$ industrial mash-ups do not tie participants to synergy targets or require complicated postmerger integration efforts. Industrial mash-ups offer an attractive alternative to doing deals in certain circumstances:

Industrial mash-ups follow the principles that sparked the sharing-economy revolution in the consumer space. Businesses such as car- or apartment-sharing services work because they allow individuals to extract new kinds of value from their underlying physical assets. The digital marketplace enables smooth and easily conducted transactions.

• They have lower barriers to entry, because costs and risk are lower.

In an industrial mash-up, a company shares an asset or capability with one or more partners in a way that gives them access to innovation creating new opportunities for all. This is done without infringing on the organization’s ongoing use of the asset for its original business. As in other sharingeconomy ventures, low-friction, internetbased transactions facilitate the sharing of the asset. Increasingly, application programming interfaces (API) will play an important role in enabling these alliances.

• As requirements on assets or capabilities Ydl]j$YjjYf_]e]flk[YfZ]Ö]p]\Yf\ untangled.

D]kk^ja[lagf$egj]Õ]paZadalq L`]k]hYjlf]jk`ahk[Yfg^^]j_j]YlÖ]paZadalq$ Y_adalqYf\]^Õ[a]f[q&Mfdac]bgafln]flmj]k$af

• Multiple partners can use the same assets or capabilities, thus enabling more new ideas to get to market faster. • The use of digital marketplaces and APIs reduces partnering friction.

• If a particular opportunity does not work out, it’s easier to exit. In short, mash-ups promise a 21st century approach to dealmaking that can keep pace with market participants’ fast-changing needs and produce a higher rate of innovation. Companies in the midst of digital ljYfk^gjeYlagfoaddÕf\af\mkljaYdeYk`%mhk immediately useful, but the arrangement is relevant to companies in every sector. EYk`%mhkoadddac]dqZ]mladar]\ÕjklafYkk]l%

The better the question. The better the answer. The better the world works.

intensive industries where assets aren’t heavily optimized. However, they can also replace traditional partnering approaches in situations where a streamlined or automated partnering process, lower cost and risk, or af[j]Yk]\Ö]paZadalqakY_gYd& Companies that don’t begin to plan strategy around mash-ups as they emerge are likely to fall behind competitors. They can begin the process by asking, and answering, a few key questions: • How will our strategy change in a world driven by industrial mash-up-style partnering? • Do we have assets or capabilities that we can share with others without infringing on our own business? • How easy would it be for us to do this? • What assets or capabilities might we use lgegj]jYha\dq^mdÕddgmjgofZmkaf]kk strategy? AfYf]oZja]Õf_hYh]j$=QYf\@YjnYj\ Business Review Analytic Services will take a closer look at the emergence of the industrial mash-up and explore how companies can use these partnerships as an innovative approach to driving growth. D]Yjfegj]Yl]q&[ge'[YhalYdkljYl]_q

© 2016 EYGM Limited. All Rights Reserved. EYG no. 01116-163GBL. ED None.

It’s time to think differently about deals.

CASE STUDY 119 Should a CEO stick to his strategy or make a big sale?

SYNTHESIS 128 Dealing with inequality

LIFE’S WORK 136 Diver Greg Louganis on overcoming adversity


Getting to the truth in negotiations PAGE 114

July–August 2016 Harvard Business Review 113


Managing Yourself How to Negotiate with a Liar


obust social psychology research indicates that people lie—and lie often. One

prominent study found that people tell, on average, one or two lies every day. Negotiators are no exception. Judging from studies done in 1999 and 2005, roughly half of those making deals will lie when they have a motive and the opportunity to do so. Typically they see it as a way to gain the upper hand (although it can actually cause backlash and prevent the kind of creative problem solving that leads to win-win deals). Deception is thus one of the intangibles that negotiators have to prepare for and take steps to prevent. Many people assume that the solution is to get better at detecting

114 Harvard Business Review July–August 2016

notion that one can reliably spot a liar through subtle behavioral cues—or “tells,” in the parlance of poker and


deception. There’s a widespread

Tactics for getting to the truth by Leslie K. John


other games that involve bluing. But

strangers—have divulged secrets

are selling a piece of land. The price

the evidence doesn’t support that

encourages reciprocation. In a series

it will command depends on how

belief. One meta-analysis (a study

of studies that I conducted with

it’s developed. So you might tell a

of studies) found that people can

Alessandro Acquisti and George

potential buyer that you want to sell

correctly identify whether someone

Loewenstein, we presented readers

the land for the best use. This could

is telling a lie only 54% of the time—

of the New York Times with a list of

prompt her to divulge her plans; at

not much better odds than a coin lip.

unethical behaviors, such as making

a minimum, you are encouraging a

Even the polygraph—a technology

a false insurance claim and cheating

conversation about interests, which is

speciically engineered to detect lies

on one’s tax return. People who were

critical to creating mutually beneicial

in a controlled setting—is riddled

told that “most other participants”

deals. This strategy has the added

with problems and comes to the

had admitted doing those things were

beneit of letting you frame the negotiation, which can enhance your

Humans are inept at recognizing lies that are cloaked in flattery. We’re wired to readily accept information that conforms to our preexisting assumptions or hopes.

chances of inding breakthroughs.

2 Ask the Right Questions Most people like to think of themselves as honest. Yet many negotiators guard sensitive information that could undermine their competitive position. In other

wrong conclusion about a third of the

27% more likely to reveal that they

time. Humans are particularly inept

had done likewise than were people

to volunteer pertinent facts. For

at recognizing lies that are cloaked

who were told that only a few others

example, consider an individual who

in lattery: your boss’s promise

had made such admissions.

that a promotion is coming any day

Reciprocity is particularly

words, they lie by omission, failing

is selling his business but knows that vital equipment needs replacing—a

now; the supplier’s assurance that

pronounced in face-to-face

problem imperceptible to outsiders.

your order is his top priority. We’re

interactions. In experiments led

It might seem unethical for him to

wired to readily accept information

separately by Arthur Aron and

withhold that information, but he

that conforms to our preexisting

Constantine Sedikides, randomly

may feel that by simply avoiding the

assumptions or hopes.

paired participants who worked

topic, he can charge a higher price

their way through a series of

while still maintaining his integrity.

Is there anything you can do to ensure you’re not duped in a

questions designed to elicit mutual

negotiation? Yes, if you focus on

self-disclosure were more likely to

prevention rather than detection.

become friends than were pairs

There are several science-backed

instructed to simply make small

story is why it’s so important to test

“If the buyer had asked me, I would have told the truth!” he might insist. The risk of not getting the whole

strategies that can help you conduct

talk. (One couple assigned to the

your negotiating partners with direct

conversations in a way that makes it

disclosure exercise eventually

questions. Schweitzer and Croson

more diicult for your counterpart

married!) Inducing a close

found that 61% of negotiators came

to lie. Though these methods aren’t

relationship is not the primary goal

clean when asked about information

fail-safe, they will leave you better

of most negotiations, of course. But

that weakened their bargaining power,

positioned in your deal making and

other research, by Maurice Schweitzer

compared to 0% of those not asked.

help you to create maximum value.

and Rachel Croson, shows that

Unfortunately, this tactic can backire.

people lie less to those they know and

In the same experiment, 39% of

1 Encourage Reciprocity Humans have a strong inclination

trust than they do to strangers. A good way to jump-start

negotiators who were questioned about the information ultimately lied.

to reciprocate disclosure: When

reciprocity is to be the irst to disclose

someone shares sensitive information

on an issue of strategic importance

avoiding that outcome by posing your

with us, our instinct is to match

(because your counterpart is likely

queries carefully. Research by Julia

their transparency. In fact, simply

to share information in the same

Minson, Nicole Ruedy, and Schweitzer

telling people that others—even

category). For example, imagine you

indicates that people are less likely

But you can go a long way toward

July–August 2016 Harvard Business Review 115


up in experimental research. In studies conducted by Eleanor Singer, Hans-Jürgen Hippler, and Norbert Schwarz, for example, fewer than half of the people who received a strong conidentiality assurance agreed to complete an innocuous survey, whereas about 75% of those given no such assurance agreed to do so. My colleagues and I have discovered that strong privacy protections can also increase lying. In addition, we’ve found that when questions are posed in a casual tone rather than a formal one, people are more likely to divulge sensitive information. Imagine you are negotiating a job ofer with a prospective employee and would like to assess the strength of her other options: Does she have competitive ofers? She’s likely to be more forthcoming if you avoid or at least to lie if questioners make pessimistic

prompted to remember the

minimize conidentiality assurances and instead nonchalantly broach the

assumptions (“This business will need

question—for example, when it is

some new equipment soon, right?”)

visible as the speaker replies. In a

topic: “We all know there are tons of

rather than optimistic ones (“The

negotiation, therefore, it’s a good

great irms out there. Any chance you

equipment is in good order, right?”).

idea to come to the table with a list of

might be considering other places?”

It seems to be easier for people to lie

questions, leaving space to jot down

Of course, you should still properly

by airming an untrue statement

your counterpart’s answers. Take

protect any conidential information

than by negating a true statement.

time after each response to consider

you receive, but there’s no reason to

whether it actually provided the

announce that unless asked.

3 Watch for Dodging

information you sought. Only when

Savvy counterparts often get around

the answer to that question is “yes”

5 Cultivate Leaks

direct questions by answering not

should you move on to the next issue.

People inadvertently leak information own questions. For example, suppose

what they were asked but what

in all kinds of ways, including in their

unfortunately, we are not naturally

4 Don’t Dwell on Confidentiality

gifted at detecting this sort of

Research shows that when we work

for a irm and you’re about to sign

evasiveness. As Todd Rogers and

to assure others that we’ll maintain

a contract with a supplier who has

they wish they’d been asked. And,

you are in charge of procurement

Michael Norton have found, listeners

their privacy and conidentiality, we

promised to deliver goods within

usually don’t notice dodges, often

may actually raise their suspicions,

six months. Before signing, he asks

because they’ve forgotten what

causing them to clam up and

you what happens in the event of

they originally asked. In fact, the

share less. As early as the 1970s,

late delivery. The question could be

researchers discovered that people

the National Research Council

innocent, but it might also signal his

are more impressed by eloquent

documented this paradox with

worries about meeting the schedule.

sidestepping than by answers that are

potential survey participants: The

So you need to pay attention.

relevant but inarticulate.

greater the promises of protection,

Dodge detection is improved, however, when listeners are

When people leak mindlessly, the

the less willing people were to

information tends to be accurate.

respond. This relationship holds

Astute negotiators realize that

116 Harvard Business Review July–August 2016

HBR.ORG Morning people (sometimes called “larks”) rate higher on measures of academic achievement, while those who prefer to stay up late (“night owls”) show stronger cognitive ability. Researchers speculate that this happens because larks’ circadian rhythms match school and university hours, while owls must develop greater flexibility to succeed. “CHRONOTYPE, COGNITIVE ABILITIES, AND ACADEMIC ACHIEVEMENT: A META-ANALYTIC INVESTIGATION,” BY FRANZIS PRECKEL, ANASTASIYA A. LIPNEVICH, SANDRA SCHNEIDER, AND RICHARD D. ROBERTS

had not. Participants in the latter

In the Hot Seat: Handling Tough Questions Honestly

group were roughly 1.5 times likelier to admit (tacitly) to bad behavior than were people asked point-blank about

Information exchange is integral to creating win-win deals, but it must be carefully managed. Disclose too much and your counterpart might take advantage of you; disclose too little and you miss opportunities to discover mutually beneficial trades. So what should you do when you’re asked a question that, if answered truthfully, would put you at a bargaining disadvantage?

their conduct. In a negotiation, you might use similarly indirect tactics to glean information. For example, give your counterpart a choice of two diferent



LIE. You will be tempted to lie. Don’t. Setting aside ethical, moral, and legal arguments, if you get caught, it can damage your reputation and your relationship with your counterpart and potentially put the entire deal in peril. Research shows that many positive interactions are required to restore trust after a single breach, and breaches entailing deception are among the most difficult to recover from.

REDIRECT. In the short term, the strategies deployed by politicians, who routinely face tough, direct questions, can be instructive—particularly for oneshot negotiations (when you are unlikely to meet your counterpart again). A familiar tactic is to dodge the question by changing the subject to something seemingly related. As noted earlier, people are generally not very good at detecting dodges, so you have an opportunity to selectively disclose information of your choosing. A second strategy is to turn the tables and question the questioner. Responding in this way can deflect attention and enable you to take control of the topic.

ofer packages—two possible ways

SHARE CAREFULLY. If you’re playing a longer game, disclosure can work in your favor; it can foster trust and facilitate better outcomes through collaboration and joint problem solving. To avoid being exploited, however, negotiators should start small: Share a substantive but not critical piece of information. Only if your counterpart reciprocates should you continue the tit for tat; disclosure without reciprocation leaves you vulnerable to your counterpart’s value-claiming tactics.

Request contingency clauses that

PALTER. Another common but misguided approach is what Todd Rogers and colleagues call “paltering,” or using truthful statements to convey an inaccurate impression. The researchers give the example of former U.S. president Bill Clinton’s answer to a question about whether he’d had a sexual relationship with Monica Lewinsky: “There is not a sexual relationship—that is accurate.” Technically that statement was not a lie, because his involvement with Lewinsky was in the past. But research shows that people view such legalistic skirting of the truth as unfavorably as they view outright lying. ABSTAIN. A third common workaround is to abstain from answering the question. However, Kate Barasz, Michael Norton, and I have shown that this tactic leaves a worse impression than disclosing even extremely unsavory information. For example, in one study, participants viewed people who had confessed to frequently stealing items worth more than $100 as more trustworthy than those who had simply refused to answer the question.

of dividing the spoils—both of which would be acceptable to you. If she expresses a preference for one over the other, she is leaking information about her priorities and giving you insight into her relative valuation of the issues up for negotiation. Here’s one more strategy that might encourage your counterpart to inadvertently show her hand: attach inancial consequences to her claims. If she balks at agreeing to them, it may be because she’s lying. At a minimum, such a reaction should prompt you to probe further. Suppose, for example, that your business is negotiating the acquisition of a small start-up. Your counterpart gives you sales projections that strike you as optimistic or even impossible. You could propose a contingency clause that would tie the acquisition price to the sales level achieved. That would motivate your counterpart to provide

valuable knowledge can be gleaned

information about their engagement

realistic sales projections, and it

simply by listening to everything

in sensitive behaviors than they are

would protect you if she’s wrong.

their counterparts say, even

to explicitly divulge it. In one study,

seemingly extraneous or throwaway

we probed New York Times readers


comments—in the same way that

about matters such as lying about

a real impediment to the creation of value in negotiation. The good news

interrogators look for statements

their income. We directly asked

from criminal suspects that include

people in one group if they had ever

is that deploying science-backed

facts not known to the public.

engaged in speciic activities. We took

strategies can go a long way toward

an indirect approach with the other

bringing out the best in negotiations—

determined to withhold information,

group, asking participants to rate

and in the parties involved.

you can still encourage leakage.

the ethicality of various behaviors

In a series of experiments, my

using one of two scales—one scale if

collaborators and I found that people

they themselves had engaged in the

are much more likely to let slip

behavior and a diferent scale if they

Even if your counterpart is

HBR Reprint R1607J

Leslie K. John is an associate professor at Harvard Business School. Twitter: @lesliekjohn.

July–August 2016 Harvard Business Review 117

HBR.ORG/STORE 1-800-668-6780 OR +1-617-783-7450 MENTION REFERRAL CODE 01598

Ready to Go to Market? An effective go to market strategy can mean the difference between a runaway success and a costly flop. HBR’s Go to Market series offers a rigorous approach for taking your products or services to market successfully. HBR’S GO TO MARKET TOOLS



Customer Lifetime Value

Pricing for Profit




1 2

HBR’s Go to Market Tool: Customer Lifetime Value helps you determine how profitable all your customer segments are—and what steps to take to increase their value. Product #GTM3TL • $75

HBR’s Go to Market Tool: Pricing for Profit equips you to confidently set the right price for your product or service. Product #GTM2TL • $75

Market Sizing NE ONLIOL TO

39% 34% 27%

HBR’s Go to Market Tool: Market Sizing helps you gather and interpret only the data you need, then confidently project the market potential. Product #GTM1TL • $75



Philly, Lumiscape now had customers

Case Study Stick to the Strategy or Make the Sale?

in nearly every U.S. state and a few European countries. Cameron felt contented about how well the system worked in some cities. But not here, he thought. And he’d seen and heard about similar cases of misuse elsewhere. Some localities had bought lights but failed to fully utilize the accompanying technology, which meant they couldn’t service them properly or achieve the hoped-for energy saving. Others had used their existing supplies of high-pressure sodium bulbs, rather

A manufacturer of high-tech streetlights considers an exception to its new subscription model. by Mitchell Weiss

than the smart LED ones, in the new lights. Some customers had failed to even install all the lamps they’d bought. Cameron hadn’t realized how diicult it would be for local


governments to change the way they that would use a mobile signal to

did business, even when they had

Burke’s son said, pointing to

notify public works departments

the best of intentions.

a darkened streetlight across

when the bulb needed to be replaced.

here’s another one!” Cameron

the park. “But it’s out too!” Cameron regretted having started this game with his four-year-old. His

company, Lumiscape, produced smart, connected streetlights, which had been installed in cities

all this, Lumiscape’s leadership had

Philadelphia at the time—his irst

decided to pivot from a sales model

job after graduating from Villanova—

to a subscription model. Instead of

and knew well how much time city

selling the streetlights and leaving the

workers spent documenting and

cities to manage them, the company

following up on complaints about

would rent them out for a monthly

throughout the United States—

broken lights. But Cameron also had

fee with installation, maintenance,

including Cleveland, where they

a bigger vision: Lumiscape’s products

and monitoring software all included.

were now, visiting his parents. He

were designed to gather all sorts of

In three sites Lumiscape had also

and Graham had decided to squeeze

data, including humidity, motion,

piloted a program to add Wi-Fi

in a walk to Forest Hill Park before

and seismic activity, and—most

connectivity to the lights, allowing those cities to ofer internet service

bedtime, and he’d challenged the boy

important—UVA, UVB, and ambient

to count all the lights he could ind.

light so that they could save

But they’d already seen three that

electricity by dimming

The board

weren’t working properly.

when appropriate. The

had unanimously

Even my hometown can’t get our products right, Cameron thought


Mitchell Weiss is a senior lecturer in the entrepreneurial management unit at Harvard Business School.

The year before, prompted by

He’d been an aide to the mayor of

innovative system

approved the proposal

promised to reduce

from Cameron and his

as he chased Graham over to the

local governments’

playground. He always vowed to stop

energy consumption

obsessing about work when he was

and maintenance

with his son, but it was a losing battle.

costs and improve

Lumiscape was six years old.

in public spaces.

COO, Stacy Hamiko, to shift to a subscription strategy. It would position Lumiscape’s

their image with

technology platform

Cameron had founded it with the


for growth as

idea of building an LED streetlight

Headquartered in

the smart-cities

July–August 2016 Harvard Business Review 119


Case Study Teaching Notes Mitchell Weiss teaches the case on which this one is based in his course Public Entrepreneurship.

WHAT DREW YOU TO THIS STORY? Many people believe that entrepreneurs can’t sell to government. But the global public sector is a huge segment we need to reach to solve big challenges.

HOW DO YOUR STUDENTS RESPOND TO IT? Often they underestimate the difficulties of changing customer behavior and of giving choices to organizations with elaborate procurement processes. They also admire the CEO’s determination to both do good and make money.

WHAT LESSONS DOES THE CASE OFFER? Governments don’t always believe companies’ claims about how much money they’ll save by buying new, high-tech products and services. They often mistrust the promises being made and their own ability to execute on the change and realize the saving. So focus on how you will help solve their problem and delight their citizens. Make “saving” secondary, and try to keep both product and procurement simple.

And now, according to Stacy’s text, it would be. There was just one problem: Lumiscape didn’t sell streetlights anymore.

$30 million in revenue the year before. But the company had committed to this new subscription

They’re Back Later that night, after Cameron had put Graham to bed, he called Stacy. She explained that she’d

strategy, and with good reason. In fact, he and Stacy had used Houston as one example

been copied on an e-mail to Neil

of why selling the streetlights didn’t

from Houston’s manager, who said

give customers enough beneits or

that he’d inally gotten approval to

Lumiscape enough control. It had

buy the additional 5,000 lights. “He

taken the city several years to install

mentioned something about surplus

its initial order—and it hadn’t even

in their public works budget and

installed all 1,000 lights. Worse, it

some federal money they needed to

apparently hadn’t hired or trained

spend,” she said.

anyone to use the software tools.

“It’s just horrible timing,” Cameron

“I should tell you that Andrew is

said, shaking his head. “Do we know

already talking about drawing up the

whether Neil has talked to them

purchase agreement,” Stacy said.

about subscriptions?” “Not yet,” she said. “We all

Cameron sighed. “Of course he is.” Andrew Lowell, Lumiscape’s CFO,

movement began to take of. And

assumed the deal was dead. They

had thought it was a mistake to move

it would give the company more

were on our list but pretty far down it,

exclusively to contracts. He felt that

control over its product and brand

to be honest.”

the company’s engineers should be

and a more stable cash low, which

“Would they consider it?”

held responsible for making a product

would translate into higher multiples

“Neil says not a chance. Even

that customers could use correctly

from would-be investors.

though this new pricing model

and that Cameron should push them

“Higher!” Graham shouted. As

would probably be better for them—

harder before changing the model.

Cameron pushed the swing, he felt

a lower procurement threshold and

Andrew had wanted to both sell and

his phone buzz. Assuming that it was

all—Neil thinks that if it took the city

rent the streetlights, preserving all

his wife, who was at a conference

manager this long to get approval for

sources of revenue and converting

on the West Coast, he looked at the

a purchase, there’s no way he’ll go

customers to the subscription model

text. It was from Stacy: “Houston’s

back and say, ‘Never mind. Could

over time if need be.

live again. They want to buy 5,000

we rent instead?’”


HBR’s fictionalized case studies present problems faced by leaders in real companies and offer solutions from experts. This one is based on the HBS Case Study “Bigbelly” (case no. 816005-PDF-ENG), by Mitchell Weiss and Christine Snively, which is available at

which had taken in

Cameron was torn. The mental

Stacy and Cameron had disagreed. Too many customers weren’t using

“Houston?!” he said aloud.

math was easy: 5,000 lights at $600

the lights to their full potential. The

“Texas!” Graham yelled.

apiece meant $3 million. It would be

straight sales model simply wasn’t

the largest sale to date for Lumiscape,

working. And given the budgeting

Cameron smiled and said, “That’s right, bud.” Houston had been one of

process in most city halls, it was far easier to go to market with only one

Lumiscape’s irst customers, six

type of ofering. Even with just two

years earlier. The city manager had

options on the table, oicials would

originally wanted 6,000 lamps but

feel obligated to run both to the

had cut the order back to 1,000

ground with all the agencies involved.

for budgetary reasons. Neil Hart, Cameron’s head of sales, had kept in touch, hoping that the larger deal could be resurrected at some stage.

120 Harvard Business Review July–August 2016

“I’ll e-mail Andrew and tell him to hold of,” Stacy said. “Good idea. But let’s call a meeting for irst thing tomorrow morning


and igure out our

opportunistic,” Stacy

light?) but also pulling more energy


chimed in. “This is a

from the grid.

“You’re going to ly back?” she asked, concerned.

moment to test the new model. If we can convert

He got up to walk home and noticed that someone had spray-

Houston to subscriptions,

painted LIGHTS OUT on the base of one of the broken street lamps

“No, but I don’t think this can wait.

we’ve got a great story to tell, not

Let’s do a video call. We don’t want to

only to other potential customers

his son had noticed before. It was

lose Houston’s attention.”

but to investors.”

as if the universe was telling him

The Next Morning

it’s not going to ly,” Neil replied. “He

control over its product. If cities

Cameron sat at his parents’

said they have the $3 million to spend

couldn’t maintain the lights on their

kitchen table and adjusted his

this year. How can we leave that

own, the company could help them

laptop screen so that he could see

money on the table?”

“I’ve already loated the idea, and

Andrew, Neil, and Stacy sitting in

“Exactly,” Andrew said. He clearly

that Lumiscape had to take better

by bundling the software in the subscription, installing the units, ixing broken hardware, upgrading

the small conference room at their

had a strong opinion on this, as any

Philadelphia oice.

good CFO would. But Cameron was

the lights as new features became

reluctant to go back on their strategy

available, and making the package

decision so soon.


“Sorry I can’t be there in person,” he said. “Is the picture okay?” Andrew spoke up. “Yes, except

Andrew seemed to have read his

for that grim look on your face, Cam.

mind. “I know I promised to support

Remember: This is good news.”

your decision on the model,” he

“I completely agree,” Neil said. “We’ve got their attention.” “We’ve got their business, it seems,” Andrew said.

said. “But I still don’t understand why we can’t do both. If

go. They provided more value to customers, relied less on them and their workers to make the product succeed,

diferent things, shouldn’t we

and guaranteed more

“Not so fast,” Cameron said. “We

meet them where they are?” “Not if where they are is

all the work we’ve put into the new

taking a pass on the best

strategy. Not with all the potential.”

aspects of our product once

“Moving to subscriptions is a long-

Cameron had felt sure that subscriptions were the way to

diferent customers want

can’t sell them 5,000 lights—not after

it’s in the ield,” Stacy said.

sustainable income for Lumiscape. It was a better model and would help him raise the valuation before the

term strategy,” Andrew said. “We

“And failing to take advantage of the

knew it wasn’t going to be a clean

upgrades we’re going to continue to

company went out for the next round of funding.

break from the product model. Lots

ofer. We have to consider the brand.”

of cities still own their lights, and we

Cameron sat back and watched

aren’t going to buy them back. It will

the three of them continue to debate.

But could the team really aford to say no to a $3 million bird in the

take years before we can convert our

He knew it was on him to make the

hand? Was Andrew right to suggest

existing customers to subscriptions,

call, but he was still uncertain.

a hybrid model? Or could they make

Lights Out

strategy once and for all?

so there’s no reason we can’t just grandfather Houston in.”

this inal sale and then shift their

“He has a point,” agreed Neil.

That night he went to Forest Hill

“But don’t you think it will be

Park on his own. He needed the

confusing to talk with potential

fresh air, and his parents were happy

customers about the subscription

entertaining Graham. He sat on a

product when they know that we

bench and looked across the park at

just sold Houston 5,000 lights?”

a lickering streetlight. He could tell

Cameron asked. “I think we can explain the rationale,” Neil replied. “We’ll look like we don’t have a strategy—like we’re being

Tell us what you’d do in this situation. Go to

from the way it was going on and of that it was using the wrong kind of bulb. This meant that it was not only creating an unpleasant experience (who wants to walk through a strobe

July–August 2016 Harvard Business Review 121


The Experts Respond

It would be a mistake to turn away a paying customer at this point.

Scott Burns is the CEO and a cofounder of GovDelivery. ANDREW IS exhibiting all the right instincts. I agree that Lumiscape has made a terrific decision to move toward a subscription strategy, but it would be a mistake to turn away a paying customer at this point. Success in bringing a new capability to the complex government market requires a mix of strategy and opportunism. If I were executing this deal, I’d secure the order and look for ways to convert Houston to subscription later. Don’t get me wrong. I’m a big fan of the model that Cameron and Stacy are pursuing, especially since their customers are in the public sector. Subscriptions can be a perpetual revenue source and a way to overcome the high client-acquisition costs in the long sales cycle with governments. My company, GovDelivery, has been selling subscriptions over the past decade; I believe the model aligns interests, motivates companies to deliver value and secure renewals, and drives a higher valuation. We provide a digital platform and add-on solutions for communicating with and improving the experience 122 Harvard Business Review July–August 2016

of citizens. U.S. and European governments use our platform to do everything from encouraging constituents to get flu shots to informing them about pet adoption to urging them to start a business. Nevertheless, Lumiscape would be foolish to rigidly stick to the strategy. Getting customers to buy into and migrate toward the new model will take time and effort. In this case, the company might sell Houston the 5,000 lights and add a component of the subscription service free so that the city has a proof of concept. I’ve learned in this business that government will buy the way it will buy, and you don’t want to stand in the way. I regret how GovDelivery handled customers at the outset. From 2000 to 2006 we grew slowly—largely because we were deaf to feedback that clients were more willing to pay for professional services than for subscription-based products. Today our services business is thriving. Organizations that can invest in Lumiscape lights now should be allowed to do so, especially with a commitment the size of Houston’s. Andrew is absolutely right that the company needs to meet its customers where they are. At the same time, it can focus on refining the subscription model’s value proposition to make it the more

compelling choice rather than the only one. A thoughtful, flexible model allows customers to move in increments toward a goal, which is how governments operate. Risking the Houston deal in order to stick to the long-term strategy prioritizes a simple message over actually growing the business. A sophisticated board will appreciate the benefits of flexibility. And other customers won’t complain if they find out that Houston bought 5,000 streetlights. Lumiscape should be able to distinguish the offerings that each city or county is getting. Jamming the subscription approach down customers’ throats simply isn’t going to work, now or over the long term. Lumiscape should claim the ground it has worked hard to take and make the deal. As a CEO I admire likes to say, “Never let your strategy get in the way of making money.”

Comments from the community Don’t Make Things Harder Selling Houston the lights outright will only make the new strategy harder to roll out and the next deal harder to land, and will tarnish Lumiscape’s brand reputation. Diane Escher, director of business development, Dolly, Inc.

How About a Trial Period? If Houston declines to subscribe, Lumiscape should make the sale but insist on delivering comprehensive maintenance for a trial period, thus demonstrating the model’s value. James Fitzpatrick, power assessment analyst, Shell Energy North America

Nothing Wrong with Selling The decision is easy: Sell the


streetlights. There will be no damage to the brand, no stakeholder will be duped, no societal value ignored, no ethical lines crossed. And by all means, try to convince Houston there is a better way; just don’t annoy the city manager too much. John Burger, owner, ONTWAR Consulting

Jack Kutner is the president and CEO of Bigbelly. CAMERON SHOULD resist making the deal with Houston—at least in the way Houston wants to. Instead he and his team should work with the city to deliver the best solution for the problem it’s facing. If Lumiscape is going to realize its long-term strategy, it can’t make exceptions. This case is very loosely based on our experience at Bigbelly, which started out by making solarcompacted waste and recycling bins. Over the past several years we have evolved our model by leveraging leading-edge communications technology and have paired our compacting stations with a suite of software tools that help customers monitor and optimize public waste removal and recycling. We are no longer selling bins; we’re selling a complete waste and recycling solution. 124 Harvard Business Review July–August 2016

That’s how Cameron needs to think about Lumiscape. It’s not selling streetlights; it’s selling safer parks and streets. And customers aren’t getting what they want and need if the lights are out. We endorse the subscription model at Bigbelly because it builds in all components of the product and service, and the customer ends up with a more meaningful long-term solution. We see that customers learn the technology faster and are better equipped to take advantage of all aspects of the software. The fleet is better maintained, and engagement with the product

Lumiscape is not selling streetlights; it’s selling safer parks and streets. has increased over time. All this leads to happier, more satisfied customers and a higher-quality product on the street. Houston’s city manager says that he wants 5,000 lights right now; if the city is sold on the product, which appears to be true, the mechanics of the business model are probably insignificant to him. Neil can persuade him to go with a subscription by explaining the benefits of the new model. I would urge Cameron not to go back on his strategy shift to make the sale to Houston. A hybrid model is also a bad idea. Customers that think there are two options and don’t have a good understanding of the system will take the path of

least resistance, which in the public sector usually means making a straight purchase. But equipment is just a small percentage of the value that Lumiscape provides for its customers. This exact dilemma has crossed my desk at Bigbelly many times. Instead of simply making the sale, we always lean toward educating the customer about exactly what we’re offering: a more encompassing, turnkey approach to waste and recycling. We push back and test the resolve of the marketplace, and frankly, we have had great success helping people understand that we have their best interests in mind with this change. Of course, Lumiscape has other considerations. Perhaps it isn’t going to hit its quarterly targets, or its growth rate is lagging. In either case, the company may be unable to decline or delay a $3 million sale. But that doesn’t mean it needs to say yes to selling the lights. It could allow Houston to pay up front for a subscription. The city would get the same services but would pay for them on a different timeline. When we made our shift, we knew that customers would have varying budget considerations, so our payment models take that into account. Lumiscape needs to take shortterm considerations out of this decision and focus on the long view. Change is hard for everyone. But the company shouldn’t alter its model for that reason; it has to provide a long-term solution that will deliver benefits to the city today and in the years to come. Cameron should stick to his guns and help Houston in the process.  HBR Reprint R1607K Reprint Case only R1607X Reprint Commentary only R1607Z




A Second Home for Business and Pleasure Access full interviews by scanning the QR codes THE RT. HON. PERRY G. CHRISTIE Prime Minister and Minister of Finance


ith capital city Nassau less than one hour from the worldâ&#x20AC;&#x2122;s largest economy, The Bahamasâ&#x20AC;&#x2122; location is the key to its attractiveness for investment. In addition to being on Eastern 6WDQGDUG 7LPH DQG KDYLQJ DQ (QJOLVKÄĽ speaking workforce, the archipelago has built on its proximity to the United States E\ HVWDEOLVKLQJ D EXVLQHVVÄĽIULHQGO\ OHJDO framework and pegging the Bahamian GROODUÄŞ%6'ÄŤWRWKH86GROODU Âł2XUFORVHQHVVWRPDLQODQG86$DÉąRUGVWKH investor easy access to the mainland when procuring building material and supplies for business purposes,â&#x20AC;? says Bahamas Consul General to New York, Forrester Carroll. The Bahamasâ&#x20AC;&#x2122; location makes it, however, more than a business or tourist destination. Âł:KHUHDVWRXULVWVFDQĂ&#x20AC;\DQ\ZKHUHDQGJR by cruise ships anywhere in the Caribbean, they choose in large numbers to have a second home here in The Bahamas,â&#x20AC;? says Prime Minister Perry Christie, highlighting the countryâ&#x20AC;&#x2122;s investments in infrastructure, especially in the areas of telecommunications, energy and medical facilities.

A Diversifying Financial Sector KH FRXQWU\ÂśV ÂżQDQFLDO VHFWRU KDV traditionally been focused on trusts and private banking, and while the trust product continues to grow, private banking has been contracting due WRFRQWLQXLQJHÉąHFWVRIWKHFULVLVDQG international pressures.



&KULVWLQD 5ROOH ([HFXWLYH 'LUHFWRU RI WKH Securities Commission of The Bahamas, VD\V Âł'HVSLWH WKHVH FKDOOHQJHV , VHH D tremendously good opportunity for The Bahamas to reshape and guide the sector into new areas.â&#x20AC;? The Bahamas and industry players are GLYHUVLI\LQJLQWRRWKHUDUHDVZLWKLQÂżQDQFLDO services, as explained by independent SULYDWHEDQNDQGWUXVWJURXS'HOWHFÂśV&(2 'DYLG 0XxR] Âł(YHU\ SHUVRQ LQ WKH ZRUOG has problems whether they have money or they donâ&#x20AC;&#x2122;t. We just happen to work with clients that have a lot of money and they have problems too but you have to listen to their problems, you canâ&#x20AC;&#x2122;t just force them LQWR D VROXWLRQ WKDW ÂżWV \RXU EDQN RU \RXU own interests, you really have to focus on their interests.â&#x20AC;?

See for all Bahamas interviews

Tourism contributes some 70-75% to GDP and financial services are 15-20%

landscape,â&#x20AC;? says Lyrone Burrows, President RI)DP*XDUGZKLFKKDVLQLWV \HDUV RI H[LVWHQFH PDQDJHG WR JDUQHU D VL]HDEOH share of the insurance market. â&#x20AC;&#x153;Our focus was to provide security to an underserved PDUNHW RXU ORZ WR ORZÄĽPLGGOH LQFRPH population.â&#x20AC;? More opportunities for Bahamian growth lie in the potential to become an international arbitration center, as well in 3XEOLF 3ULYDWH 3DUWQHUVKLSV ÄŞ333ÄŤ ZKLFK have already shown their potential in the city of Freeport, the second largest city of The Bahamas. â&#x20AC;&#x153;The dream in 1955 was to connect the island of Grand Bahama globally; we achieved that by way of a private public partnership initiative called the Hawksbill Creek Agreement which, with numerous and generous concessions from the government, created all that you see in Freeport from 1955 to the present,â&#x20AC;? says 'U 0LFKDHO 'DUYLOOH 0LQLVWHU IRU *UDQG Bahama.

Prime Minister Perry Christie

Focusing on emerging markets in Latin America and Asia, Minister of Financial Services Hope Strachan sees plenty of room to grow. â&#x20AC;&#x153;We have to continue to reinvent ourselves by identifying new niche markets, creating new and innovative products while maintaining our professional service level,â&#x20AC;? she says. While the country is known for its favorable taxation framework, policy stakeholders also point out the jurisdictionâ&#x20AC;&#x2122;s compliance and tight regulations. Insurance Commission Superintendent Michele Fields insists itâ&#x20AC;&#x2122;s not business at any cost in The Bahamas. â&#x20AC;&#x153;We are very aware of the need to do all of our due diligence on persons who are coming to the jurisdiction.â&#x20AC;? â&#x20AC;&#x153;Our insurance sector is a vibrant mix of local, regional and international players with local companies dominating the World Investment News

THE HON. C.V. HOPE STRACHAN Minister of Financial Services

THE HON. DR. MICHAEL DARVILLE Minister for Grand Bahama

THE HON. FORRESTER J. CARROLL Bahamas Consul General to New York



winnenews |



HSUHVHQWLQJ QHDUO\ WKUHHÄĽTXDUWHUV RI WKH FRXQWU\ÂśV *'3 WRXULVP LV without a doubt the mainstay of the Bahamian economy. Âł+LVWRULFDOO\ D ÂżYHÄĽVWDU KRWHO LQ WKH Caribbean would have a beach, some rooms, a spa and an average gym. But today, the stakes are so much higher.â&#x20AC;? says Christopher Anand, Managing Partner of luxury resort community, Albany. â&#x20AC;&#x153;Our goal is to become the Monaco of the Caribbean.â&#x20AC;? Founders of the resort include Tiger Woods and Ernie Els.


THE HON. JEROME FITZGERALD Minister of Education, Science and Technology

University of The Bahamas A driver of academic vibrancy across the Bahamian archipelago and around the globe A university leaves a distinct mark on the society in which it operates; an imprint on the educational, socio-economic, cultural and even creative fabric of the citizenry. President of The University of The Bahamas and Harvard University alumnus Dr. Rodney D. Smith believes in the institution as a driver of academic vibrancy and relevance across the Bahamian archipelago and around the globe. â&#x20AC;&#x153;A university represents the strength of a country. It is an institution for a higher kind of education, an institution for research, an institution for innovation, one that treasures its culture and history. There must be a repository and an initiator of change, and that is what the University of The Bahamas represents for the Bahamian people,â&#x20AC;? states President Smith. Extension facilities of the University of The Bahamas system operate under separate yet integrated strategic plans, which ensures a robust academic environment throughout the country. The Universityâ&#x20AC;&#x2122;s campus in Grand Bahama, for instance, is destined to become the Centre of Excellence for Maritime, Industrial, Manufacturing and Entrepreneurial Studies.


Over the years, that strategy has proven successful; The Bahamas is the number one tourism destination among English-speaking CARICOM countries, is 12th in the Americas, and 58th globally. But given tourism is the largest contributing sector to the countryâ&#x20AC;&#x2122;s GDP and employs up to 60% of the countryâ&#x20AC;&#x2122;s workforce, it cannot afford to rest on its laurels. â&#x20AC;&#x153;After the recession, the market plummeted and we had difficulties,â&#x20AC;? says Bahamian Tourism Minister Obediah Wilchcombe. â&#x20AC;&#x153;We had to get back in the game. We used sports tourism to do it. The first visitor was the Miami Heat in 2013 and it was very effective,â&#x20AC;? he adds, remembering Dwayne Wade and Lebron James tweeting from The Bahamas. Regional competition intensified by Cubaâ&#x20AC;&#x2122;s


For more information or to apply, visit www.



Bimini Sands Resort

The country with a thousand faces: Adapting the Bahamian tourism industry Some may think of long white sand beaches, palm trees, and perhaps pigs swimming nearby; others will picture a luxury cruise; for the gamblers, casinos will come to mind. The tropical island vibe will forever be a part of The Bahamasâ&#x20AC;&#x2122; identity â&#x20AC;&#x201C; an immediate association, akin to Parisâ&#x20AC;&#x2122; Eiffel Tower or Veniceâ&#x20AC;&#x2122;s gondolas â&#x20AC;&#x201C; but the Caribbean nation strives to offer more to its six million yearly visitors.

As the 16th largest employer in The Bahamas, The University of The Bahamas is a global competitor and contributor. Todayâ&#x20AC;&#x2122;s University of The Bahamas offers baccalaureate degrees across a broad spectrum of disciplines in Liberal and Fine Arts, Social and Educational Studies, Pure and Applied Sciences, Business and Culinary and Hospitality Management. In addition to Masterâ&#x20AC;&#x2122;s Degrees in collaboration with overseas institutions, The University also offers its own â&#x20AC;&#x201C; including the Masterâ&#x20AC;&#x2122;s of Business Administration and Masterâ&#x20AC;&#x2122;s of Science in Reading with a concentration in Inclusive Education. Many of The Universityâ&#x20AC;&#x2122;s more than 12,000 graduates have established successful careers and leading industries and innovations across the world.

opening to the United States leaves the minister unfazed. â&#x20AC;&#x153;We donâ&#x20AC;&#x2122;t worry about the competition, rather we let the competition worry about us,â&#x20AC;? he says. The Bahamas is not even close to running out of ideas to develop. Its rich history â&#x20AC;&#x201C; from the time of the pirates to its role in Nelson Mandelaâ&#x20AC;&#x2122;s release â&#x20AC;&#x201C; is a mostly unexploited branding resource. â&#x20AC;&#x153;Cultural heritage is big for us. For example, last year we introduced our carnival but this year we mixed it with our Junkanoo street parades,â&#x20AC;? says Mr. Wilchcombe. The nationâ&#x20AC;&#x2122;s infrastructure and legal framework also play a key role in diversifying tourism, as stem cell research brings medical tourism while tax concessions and meeting spaces allow for international conferences and smaller corporate meetings.

Since 1998, Bimini Sands Resort has thrilled both visitors and residents alike with its serene marina and lovely accommodationsâ&#x20AC;&#x201D;both of which truly reflect the unique culture of The Bahamas. Located on the picturesque island of South Bimini, it is the only complex of its kind on the entire island. The resort offers condominiums for rent or sale for visitors looking for what is often considered to be the ideal â&#x20AC;&#x153;home away from home experience.â&#x20AC;? Mr. Rupert Roberts, the resortâ&#x20AC;&#x2122;s developer, has ensured the highest levels of quality and comfort for guests. The marina, beach club, gourmet restaurant, beach-front views, and nature trails are just a few of the perks to be enjoyed on a daily basis. With units going fast, now is the perfect time to buy or invest in this wonderful piece of Bahamian paradise.

Most of all, the archipelagoâ&#x20AC;&#x2122;s biggest resource, its geography, still has untapped potential, thanks to the widely varied experiences offered by the Family Islands; some of the major ones include: Abaco, Andros, Bimini, Eleuthera, Exumaâ&#x20AC;Ś â&#x20AC;&#x153;Although we donâ&#x20AC;&#x2122;t have a cruise that originates in Nassau and goes around the islands, the Ministry of Tourism through its current marketing strategy aims to differentiate the multiple island destinations.â&#x20AC;?

World Investment News



winnenews |


Investment Partners in The Bahamas


reeport, The Bahamasâ&#x20AC;&#x2122; industrial capital, is diversifying the countryâ&#x20AC;&#x2122;s economy, with the Grand Bahama Shipyard at the helm of the maritime industry, and PharmaChem Technologies


Securities Commission of The Bahamas

FamGuard LYRONE BURROWS President

CHRISTINA R. ROLLE Executive Director

The Insurance Commission of The Bahamas

Bahamas Investment Authority

MICHELE C. E. FIELDS Superintendent

Grand Bahama Shipyard


PharmaChem Technologies RANDY S. THOMPSON Chief Executive Officer

REUBEN BYRD Former Chief Operating Officer

Bahamas Telecommunications Company

Bahamas Power & Light

LEON WILLIAMS Chief Executive Officer

Bahamas Technical & Vocational Institute


KEVIN A. BASDEN Consultant to the BoD


DR. IVA DAHL President

SIDNE McKENZIE-STUBBS Assistant General Manager

This Promotional Case Study was produced by World Investment News for the July 2016 edition of HBR. Publisher: Pascal Belda; Executive Director: Manuel Sáinz; Project Director: Alejandro Rojas and Simone Goldsmith; Editor: Stan Aron; Creative Director: Daniel Martínez; Business Development Director: Maxine Gordon; Associate Editor: Gloria Starr Kins; Many thanks to: Rt. Hon. Perry Christie, Prime Minister and Minister of Finance; Sir Baltron Bethel, Senior Advisor to the Prime Minister; Hon. Philip E. Brave Davis, Deputy Prime Minister & Minister of Works and Urban Development; Hon. Obediah H. Wilchcombe, Minister of Tourism; Hon. C.V. Hope Strachan, Minister of Financial Services; Hon. Jerome Fitzgerald, Minister of Education, Science and Technology; Hon. Khaalis Rolle, Minister of State for Investment; Hon. Dr. Michael Darville, Minister for Grand Bahama; Hon. Forrester J. Carroll, Bahamas Consul General to New York; Dr. Valerie Carroll; Ambassador Carlton A. Masters; Gowon Bowe and Edison Sumner, Chairman and CEO of Bahamas Chamber of Commerce and Employersâ&#x20AC;&#x2122; Confederation; and Kevin D. Seymour, President of the Grand Bahama Chamber of Commerce. Special thanks to Bradley Roberts, Chairman of the Progressive Liberal Party, for his invaluable support in Nassau and to Melissa Forbes for her unparalleled assistance in Grand Bahama. WE CONNECT BUSINESS PEOPLE

World Investment News



winnenews |


by Jeff Kehoe


incomes of the top 10% have risen.

In “winners,” the person who

Best-selling economics tomes such

scores gets the next possession and

as Robert Gordon’s The Rise and Fall

a chance to do so again. In “losers,”

of American Growth and Thomas

whoever is scored against gets the

Piketty’s Capital in the Twenty-First

ball and a chance to even it up. As

Century have theorized about how

a kid, I played “losers” on the little

and why inequality grows and put it

court behind my house, because it

in historical context. Most recently we

seemed inherently fairer. But when

have seen the societal and political

I was on someone else’s court, or

efects playing out in a volatile

up against a bigger, stronger player,

U.S. presidential campaign, with

I often had to play “winners.” My

candidates railing against a “rigged

opponent made the rules.

system” and preying on people’s fears.

For a while now, mounting evidence has suggested that the

How did we get here, and what can we do? Three new books provide

United States’ economy and society

a deeper understanding of inequality,

are moving toward the “winners”

sharp arguments, and some ideas for

model, leaving more and more

ixing the problem.

citizens feeling like “losers”—

Saving Capitalism, by Robert

frustrated and resentful. We call

Reich, the former U.S. secretary

the result of this trend income

of labor, should be read irst, and

inequality—or just inequality.

it is likely to make you angry. The

Inequality is a lot like climate

128 Harvard Business Review July–August 2016

as GDP, corporate proits, and the

book (just out in paperback) aims to

change: Many denied or ignored it

clear a persistent smoke screen that

until the data became irrefutable.

prevents constructive discussion of

Today reams of research conirm

inequality—that is, the relentless

a 40-year decline in average hourly

refrain on one side that the “free

wages for the bottom 90%, even

market” can cure capitalism’s ills and


Synthesis Can Capitalism Be Redeemed?

ne-on-one basketball

ofers two ways to play:

HBR.ORG JOHN KOTTER: WHAT I’M READING To Explain the World: The Discovery of Modern Science, by Steven Weinberg (Harper, 2015) “I’m always interested in how we got to where we are because of what it might say about where we are going. Whether you’re a science or history buff or not, the exhilarating journey Weinberg takes readers on is not to be missed.” John Kotter is the author of That’s Not How We Do It Here!: A Story About How Organizations Rise and Fall—and Can Rise Again (Portfolio, 2016) and the chairman of Kotter International.

Saving Capitalism: For the Many, Not the Few Robert B. Reich Vintage, 2016

on the other that government must

people and leveling the playing ield.

has recently been debated in Silicon

be more interventionist in restraining

Among these, not surprisingly, are a

Valley circles.

market forces and spreading the value

higher minimum wage and stronger

they produce. Reich trenchantly

antitrust laws. Reich also calls for a

deconstructs this “debate” and

“reinvention” of the U.S. corporation

While Stern zeroes in on a speciic remedy for one country, economist Branko Milanovic’s book Global

reveals a reality that many have

toward a “stakeholder” model, in

Inequality zooms out to give the

recognized and reacted against: the

which organizations are responsible

world view. Drawing on two centuries’

to employees, customers, and the

worth of household survey data, the

“increasing concentration of political power in a corporate and inancial elite that has been able to inluence

book provides an important empirical

community as well as shareholders. A more unorthodox idea,

picture of inequality patterns within

the rules by which the economy runs.”

mentioned at the end of the book—

The real problem, he argues, is not an

paying a basic minimum income to

term the Industrial Revolution in the

activist government that “intrudes”

all citizens—is taken up in much more

West drove global inequality up; but

on the market by redistributing

detail in Raising the Floor, by Andy

more recently the remarkable growth

wealth downward through taxes

Stern, former president of the Service

of Asian economies has pushed it

and transfers; rather, it is the skewed

Employees International Union. His

back down. Also, during the past 25

pre-distribution of income inside the

big picture largely aligns with Reich’s,

years, as inequality has decreased

market, with an ever-increasing share

but the focus is diferent. Stern sees

worldwide, it has increased within

moving to those who are already rich.

rising inequality as an efect of the job

rich nations—the U.S. being example

Rules are the key. As the Nobel

losses caused by recent technological

number one. These are the two

Prize–winner Joseph Stiglitz has

transformation, including automation.

forces at play: a convergence of mean

pointed out, inequality is a choice—

The resulting economic insecurity, felt

incomes among countries and cycles of within-nation inequality.

Raising the Floor: How a Universal Basic Income Can Renew Our Economy and Rebuild the American Dream Andy Stern (with Lee Kravitz)

not by those who sufer its pernicious

by millions of families, has, he says,

efects, but by those who create the

turned the U.S.A. into “the United

game and decide, or at least inluence,

States of Anxiety.”

PublicAffairs, 2016

and among nations. Over the long

Milanovic’s marshaling and analysis of the data are an

how it is played. Saving Capitalism

The book’s key message is that

is not at all preachy, but one clearly

we are at what Intel cofounder Andy

appreciated his imaginative vision

feels the moral implications in its

Grove called a “strategic inlection

and probing sensibility, especially

arguments and evidence. Reich

point” in our society. The American

in the fascinating inal chapter, in

compares the annual income of a

Dream of getting ahead by “working

which he poses 10 big questions,

achievement in themselves. But I also

top hedge fund manager ($2 billion–

hard and playing by the rules” no

ofers predictions and proposals, and

plus) with that of a good teacher

longer holds, and mere economic

outlines a future illed with both

(perhaps middle ive igures) as a

policy ixes don’t address the core

possibility and peril. Will economic

way of refuting the oft-made—and

of the problem. What’s required is a

growth still matter? Will inequality

in his view, circular—argument that

clear-eyed reexamination of the role

disappear as globalization continues?

people are worth what they are paid

of work in our lives. Stern thinks that

Will winner-take-all remain the rule?

Global Inequality: A New Approach for the Age of Globalization Branko Milanovic

“earn” that huge sum? Which person

Belknap Press, 2016

because that’s the value the market

if citizens’ fundamental needs were

places on the work they do. Does

met with a universal basic income

the hedge fund manager actually

(UBI), we could stop worrying about

it may be necessary to treat inequality

mere economic survival and instead

as an economic problem, it is not

contributes more to the world? “If

engage in the long-ago-promised

suicient. The U.S. as a country

the rules governing how the market

pursuit of happiness—or at least

needs to ask, and answer, some basic

is organized took full account of the

consider taking a job that may not

questions—Who gets to set the rules?

One thing becomes clear after reading these three books: Although

beneits to society of various roles…

pay a lot but is truly fulilling. Sounds

What values should they relect?

some people would be paid far more,”

radical, right? Actually, the idea has

What’s fair? What do we owe to one

he concludes.

a long history, with diverse admirers

another?—and reshape our society

from Thomas Paine and Adam Smith


He goes on to ofer a range of thoughtful ideas for restoring what

to Milton Friedman and Martin

John Kenneth Galbraith called

Luther King Jr. It was almost adopted

“countervailing power” to average

by the Nixon administration and

Jeff Kehoe is a senior editor at Harvard Business Review.

July–August 2016 Harvard Business Review 129


INNOVATION IN THE AGE OF EXPERIENCE We live in an age where businesses need to look beyond the aesthetics of a product or the practicalities of a service…where consumer engagement and loyalty count far more than features Ž„‚…Ž…Ŵ”“ŒŽ…ē—ˆ…’…ƒŽ“•…’“…˜…ƒ””‰Ž”…’ƒ”—‰”ˆ’…–…Ž‰Žŵ•…Žƒ…“•Œ‰…’“ĥŽ”Š•“” be sold to. Products are no longer enough for today’s consumers who value experience over all else.

THE AGE OF EXPERIENCE HAS ARRIVED Executives and academics everywhere accept that in the modern economy, the key to success is delivering consumer experiences that demonstrate true differentiation. And yet, the task is a daunting one at best. What exactly is meant by experience? And, more importantly, ˆ—ƒŽ‚•“‰Ž…““‰Žŵ•…Žƒ…‰”ď given the complex array of emotional, rational and physical responses that inevitably drive consumer connection?


The key to making consumer experience the true focus of innovation is to capture insights and expertise from across a business’s entire ecosystem. Shaping the right consumer experience requires not only the involvement of but also the collaboration between all roles within a company – from marketing and management to sales and engineering. Only by connecting all the dots between people, ideas and data can a business drive consumer loyalty, engagement and value.

IF WE WANT TO THRIVE IN THE AGE OF EXPERIENCE, WHERE CAN WE TURN? The 3DEXPERIENCEÆ platform from Dassault Systèmes is a business experience platform: a new class of collaborative environment “…ƒ‰ŴƒŒŒ™„…“‰‡Ž…„”ˆ…Œ companies create differentiating consumer experiences.

It enables everyone within a company to play an active role in experience development.

The 3DEXPERIENCE Platform Explained The 3DEXPERIENCE platform

With a single, easy-to-use, compass-like interface, the 3DEXPERIENCE platform powers INDUSTRY SOLUTION EXPERIENCES – based on 3D design, analysis, simulation and intelligence software in a collaborative, interactive environment. The Age of Experience represents “‰‡Ž‰ŴƒŽ”’”•Ž‰”™†’ businesses prepared to place a new focus on creating unique and truly rewarding consumer experiences.

is a business experience platform. It provides software solutions for every organization in your company – from engineering to marketing to sales – that help you, in your value creation process, to create differentiating consumer experiences. With a single, easy-to-use interface, it powers INDUSTRY SOLUTION EXPERIENCES, based on 3D design, analysis, simulation and intelligence software in a collaborative interactive environment. It is available on premise and in public or private cloud.

It’s time to ask the right questions, understand the present and navigate the future – now made possible with the 3DEXPERIENCE platform. Discover the 3DEXPERIENCE platform and our INDUSTRY SOLUTION EXPERIENCES at 3DS.COM. It takes a special kind of compass to understand the present and navigate the future.

About Dassault Systèmes Dassault Systèmes, the 3DEXPERIENCE Company, provides business and people with virtual universes to imagine sustainable innovations. Its world-leading solutions transform the way products are designed, produced and supported. Dassault Systèmes’ collaborative solutions foster social innovation, expanding possibilities for the virtual world to improve the real world. The group brings value to over 190,000 customers of all sizes, in all industries, in more than 140 countries. 3DEXPERIENCE is a registered trademark of Dassault Systèmes or its subsidiaries in the U.S. and/or other countries.





Why Diversity Programs Fail by Frank Dobbin and Alexandra Kalev


Designing a BiasFree Organization An interview with Iris Bohnet by Gardiner Morse


We Just Can’t Handle Diversity by Lisa Burrell

Building a Diverse Organization

Diversity gives firms a decisive edge by improving their ability to innovate and solve problems. So why is it so hard to promote? This month’s package looks at what causes most corporate diversity efforts to fall short—and at the practical steps that actually have a positive impact.

ARTWORK Roger Clarke, Accidents Will Happen (cndm), 2010 Polyester resin, fiberglass, varnish

July–August 2016 Harvard Business Review 51




Why Diversity Programs Fail

Designing a Bias-Free Organization

We Just Can’t Handle Diversity

Frank Dobbin and Alexandra Kalev page 52

Iris Bohnet of Harvard Kennedy School, interviewed by Gardiner Morse | page 62

Lisa Burrell | page 70

After Wall Street firms repeatedly had to shell out millions to settle discrimination lawsuits, businesses started to get serious about their efforts to increase diversity. But unfortunately, they don’t seem to be getting results: Women and minorities have not gained much ground in management over the past 20 years. The problem is, organizations are trying to reduce bias with the same kinds of programs they’ve been using since the 1960s. And the usual tools—diversity training, hiring tests, performance ratings, grievance systems—tend to make things worse, not better. The authors’ analysis of data from 829 firms over three decades shows that these tools actually decrease the proportion of women and minorities in management. They’re designed to preempt lawsuits by policing managers’ decisions and actions. But as lab studies show, this kind of force-feeding can activate bias and encourage rebellion. However, in their analysis the authors uncovered numerous diversity tactics that do move the needle, such as recruiting initiatives, mentoring programs, and diversity task forces. They engage managers in solving the problem, increase contact with women and minority workers, and promote social accountability. In this article, the authors dig into the data, executive interviews, and several examples to shed light on what doesn’t work and what does. HBR Reprint R1607C

Most diversity training programs are a waste of money, says Iris Bohnet. Companies often conduct programs without ever measuring their impact. And unfortunately, research on their effectiveness shows they seldom change attitudes, let alone behavior. The solution? Focus on processes, not people. Behavioral science tells us that it’s very hard to eliminate our biases, but we can redesign organizations to circumvent them. Behavioral design makes it easier to do the unbiased thing by either preventing biased choices or changing people’s beliefs. Companies can start by collecting data on their current diversity training. Then they must bring the same rigor to people management that they apply to financial and marketing decisions. This means defining the desired change, implementing new programs, collecting hard data, and evaluating the results. Even simple changes can be effective. For example, hiring managers can use software that allows them to strip age, gender, socioeconomic background, and similar information out of résumés so that they focus only on talent. Bias affects everyone, despite efforts at awareness and the best of intentions. The good news, says Bohnet, is that behavioral design can break the link between our gut reactions and our actions, and allow our biased minds to get things right. HBR Reprint R1607D

Decades’ worth of studies show that a diverse workforce measurably improves decision making, problem solving, creativity, innovation, and flexibility. But most of us also believe that hiring, development, and compensation decisions should come down to merit. Although the two ideas don’t seem contradictory, they’re tough to reconcile in practice. Cognitive roadblocks keep getting in the way. The author looks at recent books and research studies on the subject, including Success and Luck: Good Fortune and the Myth of Meritocracy, by Robert H. Frank, and Pedigree: How Elite Students Get Elite Jobs, by Lauren A. Rivera. Frank points out, for example, that hindsight bias causes us to believe that random events are predictable and to manufacture explanations for the inevitability of our achievements. And winner-take-all markets intensify the consequences of our cognitive shortcuts. Rivera studied hiring committees at professional services firms that believed they were ensuring rigor and counteracting bias through group discussions of job candidates from the school-recruitment pipeline. But those conversations actually dampened diversity by giving negative racial, ethnic, and gender stereotypes greater sway over HBR Reprint R1607E decisions.

July–August 2016 Harvard Business Review 133






Beyond the Holacracy Hype

Where Financial Reporting Still Falls Short

How to Pay for Health Care

The Case for Capitation

Ethan Bernstein, John Bunch, Niko Canner, and Michael Lee | page 38

H. David Sherman and S. David Young | page 76

Michael E. Porter and Robert S. Kaplan | page 88

Brent C. James and Gregory P. Poulsen | page 102


Beyond the Holacracy


Where Financial Reporting Still Falls Short

The overwrought claims—and actual promise—of the next generation of self-managed teams BY ETHAN BERNSTEIN, JOHN BUNCH, NIKO CANNER, AND MICHAEL LEE

It was a Thursday afternoon in Las Vegas. Five employees p y were camped p out in a team room at Zappos pp , the largest g company p y so far to implement p e e t ho olacracy—a ac acy a for o mo of se selfmanagement that that confers deci decision sion power on fluid teams teams, or “circles” circles, and roles rather rather than individuals. th i di id l On individuals O this thi p particula ti l r d day day, y, iin

Most observers who have written about holacracy and other forms of self-management take extreme positions, either celebrating these “bossless,” “flat” work environments for fostering flexibility and engagement or denouncing them as naive experiments that ignore how things really get done. To gain a more accurate, balanced perspective, the authors—drawing on examples from Zappos, Morning Star, and other companies— examine why these structures have evolved and how they operate, both in the trenches and at the level of enterprise strategy and policy. Self-organization models typically share three characteristics: • Teams are the structure. Within them, individual “roles” are collectively defined and assigned to accomplish the work. • Teams design and govern themselves, while nested within a larger structure. • Leadership is contextual. It’s distributed among roles, not individuals, and responsibilities shift according to fit and as the work changes. Adopting self-management wholesale—using it to determine what should be done, who should do it, and how people will be rewarded across an entire enterprise—is hard, uncertain work, and the authors argue that in many environments it won’t pay off. But their research and experience also suggest that elements of selforganization can be valuable tools for companies of all kinds, and they look at circumstances where it makes more sense to blend the new approaches with traditional models. HBR Reprint R1607B

Even after a raft of reforms, corporate accounting remains murky. Here’s what you need to know to evaluate a company accurately. BY H. DAVID SHERMAN AND S. DAVID YOUNG

In a perfect world, investors, board members, and executives would have full confidence in companies’ financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash flows and to judge whether the resulting estimate of value was fairly represented in the current stock price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the efficient allocation of capital. Unfortunately, that’s not what happens in the real world, for several reasons. First, financial statements necessarily depend on estimates and judgment calls that can be widely off the mark, even when made in good faith. Second, standard financial metrics intended to enable comparisons from one company to another often fall short, giving rise to unofficial measures that have their own problems. Finally, executives routinely face strong incentives to manipulate financial statements. In recent years, we’ve seen the implosion of Enron, the passage of the Sarbanes-Oxley Act, the 2008 financial crisis, the adoption of the Dodd-Frank regulations, and the launch of a global initiative to reconcile U.S. and international accounting regimes. Meanwhile, the growing importance of online platforms has dramatically changed the competitive environment for all businesses. In this article, the authors examine the impact of those developments and consider new techniques to combat the gaming of performance numbers. HBR Reprint R1607F

134 Harvard Business Review July–August 2016


How to Pay for Health Care Bundled payments will finally unleash the competition that patients want. BY MICHAEL E. PORTER AND ROBERT S. KAPLAN

The United States stands at a crossroads as it struggles with how to pay for health care. The fee-for-service system, the dominant payment model in the U.S. and many other countries, is now widely recognized as perhaps the single biggest obstacle to improving health care delivery.

Bundled payments trigger competition to create value where it matters. The United States stands at a crossroads in how to pay for health care. Fee for service, the dominant payment model in the U.S. and many other countries, is now widely recognized as perhaps the single biggest obstacle to improving health care delivery. A battle is currently raging, outside of the public eye, between the advocates of two radically different payment approaches: capitation and bundled payments. The stakes are high, and the outcome will define the shape of the health care system for many years to come, for better or for worse. In this article, the authors argue that although capitation may deliver modest savings in the short run, it brings significant risks and will fail to fundamentally change the trajectory of a broken system. The bundled payment model, in contrast, triggers competition between providers to create value where it matters—at the individual patient level—and puts health care on the right path. The authors provide robust proofof-concept examples of bundled payment initiatives in the U.S. and abroad, address the challenges of transitioning to bundled payments, and respond to critics’ concerns about obstacles to implementation. HBR Reprint R1607G


The Case for Capitation It’s the only way to cut waste while improving quality. BY BRENT C. JAMES AND GREGORY P. POULSEN

To rein in health care costs in the United States, we should look to the ideas of W. Edwards Deming, the legendary management guru who showed companies how to cut waste from work processes and lower operating costs by improving quality. Recent studies using Deming’s approach reveal that

Recent studies suggest that at least 35%—and maybe over 50%—of all health care spending in the U.S. is wasted on inadequate, unnecessary, and inefficient care and suboptimal business processes. But efforts to get rid of that waste face a huge challenge: Under current payment methods, the providers who develop more-cost-effective approaches don’t receive any of the savings. Instead, the money goes mainly to insurers. The providers, who are paid for the volume of services delivered, end up actually losing money, which undermines their finances and their ability to invest in more cost-saving innovations. To address this quandary, say two top execs from the nonprofit Intermountain Healthcare system, we need a different way to pay for health care: population-based payment. PBP gives care delivery groups a fixed per-person payment that covers all of an individual’s health care services in a given year. Under it, providers benefit from the savings of all efforts to attack waste, encouraging them to do it more. And though PBP may sound similar to the HMOs of the 1990s, there are significant twists: Payments go directly to care delivery groups, and patients’ physicians—not insurance companies—assume responsibility for overseeing and managing the cost of treatment. Provider groups are also required to meet quality standards that further protect patients. By applying PBP in just part of its system, Intermountain, which serves 2 million people, has been able to chop $688 million in annual waste and bring total costs HBR Reprint R1607H down 13%.


How I Did It

Managing Yourself


WPP’s CEO on Turning a Portfolio of Companies into a Growth Machine

How to Negotiate with a Liar Leslie K. John | page 114

Martin Sorrell | page 33 In 1985 WPP was a small, publicly traded company, worth about $1.3 million. It manufactured shopping carts and other wire and plastic products. Today it is the world’s largest advertising and marketing services company, worth about $30 billion. Sorrell details how that growth occurred and why it continues, even in an industry with constraints on the top line. Within two years of buying WPP, which he always intended to use as a shell company, Sorrell and his team had made 18 acquisitions, focusing on firms that specialized in “below the line” marketing functions: packing, design, and promotions. (“ ‘Above the line,’ ” he writes, “is the sexy, creative, Don Draper stuff.”) They went on to acquire J. Walter Thompson and Ogilvy & Mather in deals worth a combined $1 billion plus. When the economy went into recession, WPP found itself overleveraged; the author concluded that he needed to justify the parent company’s existence. The leadership team focused on investments in its people and in real estate and launched a number of programs to cultivate and retain talent. It colocated operating companies in multiple markets throughout the world, centralized procurement, and standardized hardware and software across the group. Its effort to create horizontality, which has accelerated over the past decade, gives clients access to the best talent and ideas from WPP’s entire portfolio and keeps the company growing. HBR Reprint R1607A HOW I DID IT… WPP’S CEO ON TURNING A PORTFOLIO OF COMPANIES INTO A GROWTH MACHINE by Martin Sorrell

The Idea

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

Managing Yourself How to Negotiate with a Liar Tactics for getting to the truth by Leslie K. John


People, including negotiators, lie every day, so when you’re trying to make a deal, it’s important to defend against deception. The best strategy, says the author, is to focus not on detecting lies but on preventing them. She outlines five tactics that research has shown to be effective: Encourage reciprocity. You can build trust and prompt other parties to disclose strategic information by sharing information yourself. Ask the right questions. Negotiators often lie by omission, keeping mum about relevant facts, but if directly asked, they are more likely to respond honestly.

Watch for dodging. Don’t let your counterparts sidestep your questions—write them down in advance, take notes on the answers, and make sure you get the information you’re seeking. Don’t dwell on confidentiality. Studies show that the more you reassure others that you’ll protect their privacy, the more guarded and apt to lie they become. So be nonchalant when discussing sensitive topics. Cultivate leaks. People often reveal information unwittingly, so listen carefully for any slips and try indirect approaches to gaining information. HBR Reprint R1607J



Life’s Work

known. So, as I said in my book,

and learned visualization at

I was paralyzed by fear. But the

three. Before my very irst stage

one thing I knew was diving, so

performance, we had tech and

that’s what I focused on.

tux with a top hat—but my teacher knew that if I had to do the routine over and over, I would be too fatigued to perform that night. So she put me in the studio, played the music, and said, “Imagine yourself doing the routine.” It took four times to be completely luid, without a hitch, and then she turned up the tempo and said, “Do it again.” I did, and when I performed that night, I didn’t miss a step. So I took that tool into everything I did: dance, gymnastics, diving. That’s how I prepared.

When you hit your head during a dive in the 1988 Seoul Olympics, how did you go on to win gold? To get over something like that—to process, understand, analyze—takes time. I had 22 minutes until my next dive. My coach, Ron O’Brien, said, “You don’t have to go back. Whatever you decide, I’m behind you.” But my knee-jerk reaction was “We worked too hard to get here. I don’t want to give up.” So he said, “Well, hockey players get 30 stitches and get back on the ice, and you got ive.” We started laughing. Then he said, “Look, this was a total luke. So get up there like it never

Hear the complete interview online at

136 Harvard Business Review July–August 2016

that wouldn’t even have let me in had my HIV status been

acrobatics at one and a half

dress rehearsals—I wore a little

Greg Louganis dominated world diving competitions in the 1980s, scoring double gold medals in back-to-back Olympic Games. But a more meaningful triumph came years later, when he revealed to the public that he was both gay and HIV-positive and became an advocate for human rights. He now mentors top U.S. divers. Interviewed by Alison Beard

the realization: God, what is my responsibility? I was in a country

You’ve said you learned to love diving late in your career. What made the difference? Ron, because he knew I was a performer. I was winning competitions, but I wasn’t being challenged. So he devised goals for me, like breaking 700 points on the three-meter springboard and the 10-meter platform in the scoring system we had. To achieve that, you couldn’t be looking to the side and saying, “I have to beat that person.” You had to have the balls to leave everybody behind.

Why are you a mentor and not a coach? Ron was both a coach and a mentor. He would map out the calendar with us, saying, “OK, what are the major competitions, and what are our goals—diving-related or not?” There is less of that now. So when I meet with athletes, some of it’s about diving, but most of it is about what goes on outside the pool. What are their career aspirations? Where do they see themselves in two to ive years? Are they taking steps to pursue those goals? I have a more holistic approach.

You’re finally on a Wheaties box, after being passed over in your heyday. How does it feel? It’s

happened. I believe in you.”

more meaningful now, because

That’s how I was able to get

I’m being embraced as a whole

back on the board. It’s not that

person. I’m 56, a gay man, living

I got over it; I just set it aside.

with HIV, happily married. Who

We now know you were HIVpositive at the time. Did that affect your thinking? There was

would have imagined that back in the 1980s?

HBR Reprint R1607L


HBR: You were known for your focus. How did you mentally prepare for competition? Louganis: I started dance and

Harvard Business Review USA Julio 2016