The danger of stability

Let’s look at some practices that are optimized for stability and see if you recognize them in your organization. If you do, this might be a signal that your organization is still focusing too much on stability rather than dealing with change.

Process efficiency

Looking at efficiency is important in any situation. Why waste money if you don’t have too, right? But many organizations have an active focus on efficiency that is deeply embedded in everyday practice. It is often part of the culture of the organization. A telltale of this is the default reaction of “but that is not efficient” on new proposals that are somewhat long term, risky, and unpredictable. They often make it an explicit part of strategy and targets. They launch projects to analyze, improve, and write down process descriptions and procedures. The occasional Lean Six Sigma initiative is launched.

If your situation is relatively stable and predictable, focusing on efficiency can bring significant gains. As the outcomes of a process are always more or less the same, it is worthwhile to optimize the process on costs and time. The problem is, it has become such an intrinsic part of every business, that we have stopped asking ourselves whether a situation needs a focus on efficiency or effectiveness. We routinely state we want both. But in a highly unstable and complex situation effectiveness and efficiency can be each-others foes. Being effective might not always be efficient. Relying on a procedure in a complex situation seems efficient from a cost and time perspective, but it is not effective in terms of the outcome. Complexity and unpredictability force us to try things without exactly knowing the outcome upfront. The practice of experimenting can be highly effective in complex situations, but at the expense of a little inefficiency.

A focus on effectiveness means the focus is on achieving the desired result. A focus on efficiency means the focus is on the process towards the result. The latter works fine in a stable environment, because the result is predictable, anyway. We can afford to focus on the process. But if the result is not predictable, an overly focus on following the correct procedures is dangerous. It might go at the expense of the desired result.

Many organizations realize they have to innovate and make this part of the strategy. Meanwhile, the still overly focus on efficiency has squeezed the last drop of creativity, slack, and innovation capacity out of the processes.

Economies of scale & centralization

Economies of scale is another important and highly visible concept in many organizations. It is also connected to the focus on efficiency. For example, the practice of central procurement is meant to safe costs. Centralizing IT infrastructure is another such example. And again, it seems to make sense at first glance, and I won‘t deny potential benefits in some situations. But the benefits potentially come with a price tag. Centralizing IT systems often has the effect of all business departments getting a compromise of the functionality that would most optimally suit their needs. Plus any department has to wait longer for IT to process any specific functionality request because all departments will file requests.

Again, if your market and your position in it are relatively stable, the cost saving gains might outweigh the potential disadvantages. But as soon as things get more complex, less predictable, and less within your own control, it becomes increasingly important to support customer value-adding activities and people by providing them what they need, when they need it. Tailer made. A centralized system might not give them what they require to win the battle. Centralized procurement procedures might slow down decision making and actions too much.

In theory, this would just be a matter of weighing pros and cons. But unfortunately in many organizations it does not work that way. We tend to focus on the cost saving and forget about the drawbacks. This is reinforced by two things:

• Many organizations are preoccupied with the short term. Many times the gains of economies of scale and centralization are short term and easy to see and calculate. But the drawbacks often come with a delay and are much less easy to identify and calculate.
• The silo organization we will discuss next gets in the way too. The procurement department will probably have a KPI based on costs or even cost savings. The disadvantages for the business department are much less visible for procurement because their KPI does not measure it. They might happily declare victory for themselves because they met their targets, while the damage done by cost savings might be significantly bigger than the gains.

I recently encountered an exemplary situation: A central procedure demanded that the payment terms for a sole trader (freelance) consultant being hired was sixty days. It is easy to calculate or estimate the yearly gains in liquidity, which I am sure the department responsible for the procedure has done and uses as the justification for it. Sixty days is a long time for a freelancer. If you invoice every month, you can only send an invoice at the beginning of the next month. Then you have to wait for sixty days. If they pay on time, that is. The best consultants have a choice which project to accept. I am convinced this rule hurts business departments as they will find it difficult to get the best consultants, however they don’t have the flexibility to waive the rules as they see fit. But it is much harder to calculate the downside of this procedure and to put it bluntly: the responsible department doesn’t really care because they are not held accountable for these disadvantages, anyway.

It is like requiring a factory worker to ask for permission to get a new tool if his old one is worn down, to save costs. But now the worker has to abandon his work, go to some office, and find a supervisor. The supervisor now has to spend time as well. After inspection of the old tool they assign the worker a new one. I can guarantee you that this practice will cost more than it saves. Or what about the potential costs of letting a worker work with suboptimal tools just to save a little on buying new ones?

Many of these practices are penny wise pound foolish in any situation because we only calculate the gains. But in an unstable, complex situation that requires innovation and fast market response, the drawbacks of these practices become even more relevant.

Silo organization based on specialization

The dominant organizational structure is still that of the vertical silo organization. We form departments, or silos based on the specialization of workers. Sales people sit with sales people. Customer service sits with customer service. We group together legal specialists. Each department has its own manager and its own KPI. The KPI is measuring the performance of the local job of the department only. So the sales department has a KPI based on sales numbers, and customer services on the rate of handling support calls. I think the structure is easily recognizable in your organization or the ones that surround you. This way of organizing is over one hundred years old and stems from the time of Frederick Taylor, Henri Fayol, and Max Weber. It was in fact Weber who has popularized the term we generally use for this organizational form: the bureaucracy. Weber described the bureaucracy in an essay from 1922 and it still stands today.

The logic behind this structure makes sense: It is much easier to share and build knowledge across a ‘job’ or specialization if you group them. We can put a manager in charge of the department that has proven skills and experience in the area concerned. And we can easily measure the performance of the department because the workers more or less execute the same jobs.

The flow of decisions and information tends to stay within the borders of the silos. Silos have their own management hierarchy, their own KPIs, their own processes and procedures, and even their own language and culture. This leads to an interesting phenomenon we have witnessed several times: even if all the individual silo’s KPIs are more or less in the green, the organization as a whole can still be in serious trouble. The organization faces the risk of not identifying the problems because everyone sits happily in their own silo bubble, and in their local world the grass is green. This is because of the effect of local optimization: we optimize the local department which often goes at the expense of the optimization of the whole system. The reason for this is that while we organize the organization vertically, value creation for our customers is horizontal. It crosses the border of many departments. But we optimize the departments for their own part, not their contribution to the whole. A local process optimization can easily lead to delays or other problems elsewhere. What’s worse is we tend to overlook these issues because of the strong borders between departments. Department A simply doesn’t recognize it if they cause a problem for department B.

In a complex volatile environment a razor-sharp focus on creating customer value is essential. The entire value chain makes up the customer’s experience with the organization, not individual parts represented by individual departments. Little disturbs a customer more than being send from one department to the other to get an issue resolved. In today’s world customers have access to all the information they need to compare options, and switch suppliers. And customers are only as loyal as yesterday’s weather.

The silo structure is not the most ideal organization design to deal with this. It is marked by local optimization, many hand-offs between departments, and delays because of this.

Hierarchal decision making

Max Weber’s bureaucracy is not only characterized by the silo structure but also by hierarchal decision making. Decisions flow downward from the top to the bottom of the organization, while information flows upwards to provide the information needed by the top to make decisions. Although many organizations have been trying to flatten their hierarchies somewhat lately, and delegation towards self-organizing teams is booming, the hierarchy is still there and recognizable. An organization that empowers teams and individuals to take initiative and make decisions still relies on the hierarchy. After all, delegation requires a manager to delegate.

In the relatively stable and predictable times of the origin of this practice, the chain of command made sense. As the work of workers was highly predictable and easy to learn, you needed a manager to supervision the work and make sure the workers followed the rules of how to do the work to maximize results. As the span of control of a manager is limited we add more managers as the company is growing. And we group some managers and their units together under another manager. And so on. Decisions were made relatively fast and reliably because of the stability and predictability of the environment. The local workers needed little information to do their jobs, but management up the chain needs increasingly aggregated performance data to base decisions on. All is well.

But if the processes are not that stable and predictable local workers need more information to do their jobs effectively. In most organizations of today workers perform cognitive tasks rather than just mechanical ones. They need to think and to think they need information. So the one-sided upwards flow of information is limiting effectiveness. Actually, the workers at the bottom of the chain are often better equipped to decide than management. So, we should encourage local workers to consume data and information rather than aggregate it and send it upwards the chain in the form of dreadful reports. This increases the speed of decision making which is exactly what you need in a fast moving world. Hierarchal decision making is just too slow. It is also inaccurate because it is based on forecasts derived from past data aggregated from the hierarchy. Forecasts perform poorly in an unpredictable world. They are like navigating on a road with just looking in your rear-view mirror.

Defend a sustainable competitive advantage

Companies have based their strategies for decades on the notion of a sustainable competitive advantage. This concept, popularized by Michael Porter in the early eighties, assumes a company can select a market to operate in and successfully defend its position in that market based on some competitive advantage like high entry barriers for competitors, or an aggressive pricing or cost policy. The advantage does not guarantee the companies long-term success of course, but it is an important enable for it.

Today most organization’s strategies are still one of Porter’s generic strategies and are easily recognizable as such: Does your organization for example offer no frills products at the lowest possible price? That’s Porter’s Cost Leadership strategy. Or does your organization bank on high quality or some other desirable trait like brand image? That would be the Differentiation strategy. Or perhaps your organization has chosen a niche market, or several niche markets, that you excel in? This is Porter’s Focus strategy.

The common denominator in all strategies is they are meant to build a long-term position in that market based on some advantage, whether it is knowledge of the market, economies of scale, access to cheap labor, efficient logistics, effective marketing, or good research. This works well in a relatively stable market. The effort of entering the market and the effort of defending your position in it are worthwhile because you’re in it for the long run. You can distribute and diversify investments and risks over many years.

But in today’s volatile world a sustainable competitive advantage doesn’t seem to exist anymore. One after the other of once rock solid names file for bankruptcy or lose most of their market relevance because their competitive advantage degraded over time but the company held on to it for too long. Names like Kodak, Toys ‘R Us, Radio Shack, Motorola, RIM, Nokia, Dell come to mind. It is too simple to conclude they just didn’t see the changes coming. There were smart people working there, and I am convinced many have expressed warnings and concerns. But the problem with banking on a sustainable competitive advantage is that the entire organization is also designed to defend it. This creates an oil tanker that is very hard to to turn around in time. In fact, most of the practices we discussed so far like an overly focus on efficiency, economies of scale and centralization, the silo organization, and hierarchical decision making are meant to defend a long term sustainable competitive advantage that simply doesn’t exist anymore.

These are the times of disruptive innovation of entire market segments like Uber has done with the taxi business and Airbnb with the hospitality business. These are the time of dramatically lowered barriers of entry for newcomers:

• Everyone has access to information, Google is your friend;
• Access to capital is easier than ever and besides, a company typically needs less of it to become a global player;
• Come to speak of it, you don‘t need to be an enormous company to be a global player anymore. Small startups can create products that serve the world.
• Access to talent is easy: the world is your recruiting area. And we don’t even have to be co-located anymore to work together.

These are times of what Rita McGrath calls a Transient Competitive Advantage in which a company continuously explores new opportunities, nurtures the most promising ones to adulthood, but also withdraws from the market way before the well has dried in favor or more promising opportunities. This means the company is in a constant flux of building up and pulling out of business models. The organization structure is a fluent one designed to quickly rally around new opportunities in small autonomous units, but also to withdraw in an ordered non-dramatic fashion recouping investments by re-using knowledge, technology and products.

Cynefin Obvious

Even in today’s complex world there are plenty of processes in organizations that are relatively stable, ordered, and predictable. It is okay to have best practices, procedures, and checklists for those. These are the processes that allow a focus on efficiency. To a certain extent…

Look at the Cynefin model above. It has four domains whose borders are more fluent than hard. On the lower right you find the Obvious, or Simple, processes. The appropriate tactic is sense-categorize-respond. Take a simple loan application process for example. We get the application and sense by looking at the information provided. We use this to categorize the application, maybe on risk, and then use the appropriate procedure for further processing the application and responding.

The pitfall of complacency

The risk of relying too much on procedures and best practices is complacency which leads to a number of issues:

There is a paradox in the desire for stability: organizations focusing on stability experience the most dramatic reorganizations. The organization keeps postponing changes until they no longer can. By then the change has become urgent. The result is a reorganization that is big, dramatic for all who are involved, and radical. The desire for stability causes us to try to anchor the new situation. But this leads to postponing and accumulating changes again which in the end will lead to yet another big painful transformation. Do you recognize this in your organization?

This is another related cause for these big transformations: they are A to B transformations. We are in state A and want to move to state B. Big jumps. Much better would be a constant flow of small changes.

Big bureaucratic organizations are like oil tankers. They are hard to turn. Even when the organization is aware, a change of course is needed it takes a long time before you see things moving. We aim everything at a status quo so new initiatives are hard to materialize. The CEO can stand up and declare change and still little moves. The risk is an actual change comes too late.

Silo structure

The silo structure we discussed hurts: they are like little kingdoms with stronger ties within the silo than between them. This gives department managers a lot of room for resisting change. It creates an attitude of ‘them’ against ‘us’. We hear things like: “It is not our fault the organization is in trouble. It is the Operations department’s fault. If they would just process orders in time”. Or: “They need to change first”. Local optimization causes us to miss the effects of local decisions on other departments.

A good example of the potential consequences of this is Kodak. Kodak’s demise is caused by the rise of digital photography at which Kodak responded too late. But the irony is that it was actually one of Kodak’s employees who invented the digital camera. Steven Sasson presented a working prototype of the first digital camera in 1975. Although management was unimpressed they allowed him to continue working on it. In 1989 he presented the first DSLR camera that still resembles current models a lot. The marketing department refused to sell it however because it would cannibalize the sales of film, which was Kodak’s biggest contribution to sales at the moment. This decision effectively sealed the fate of Kodak. We all know by know how digital cameras have changed the industry and of course Kodak saw it too at some moment. But by then it was too late. They did make billions from the digital camera patent filed by Sasson until that expired in 2007. In 2012 Kodak filed for bankruptcy.

Top-down change

Another reason for the low capacity for successful change in many large organizations is that changes comes from above. It is mandated and organized in a top-down manner. It is easy to see how this leads to resistance to change from those that are affected by the change, but have no say in it. Just take a moment and think of some changes in organizations you worked for. Which were mandated from above and which you or your team started? And which ones did you perceive as more positive: the ones you started or the ones that were organized top-down?

Forcing a change on people is just slow and painful. It takes a lot of money and time and it certainly does not guarantee success.

Top-down decision making is slow

The hierarchal decision-making model we discussed leads to painfully slow decisions. That might be acceptable under stable market conditions but it certainly isn’t in our volatile complex world. Decisions slowly drip down the hierarchy and get filtered and watered down in the process. Many decisions never reach workers at the bottom of the hierarchy because they are filtered or altered by local management.

What’s worse is that decisions from the top are not necessarily better. Take the Kodak case: an individual worker started a potentially disruptive change, but management decided against it. We often assume that ‘the top’ has a better view on things but reality is the information they get is so aggregated and colored it is almost useless to get an understanding of the market, customers, issues, threats, and chances.

Focus on efficiency drains execution power

Companies that focus on process efficiency get the most out of their processes which is fine under stable circumstances. But in a world of flux it can seriously harm the organization’s execution power of turning the ship around when it needs to. Take the case of Dell. Dell disrupted the traditional PC manufacturing market by their direct sales model coupled with low prices. This was made possible by a strict focus on the efficiency of their logistics processes. It turned Dell into the largest PC manufacturer bypassing traditional market leaders like Toshiba and HP. But there was a downside to this model that would have serious implications for Dell later. We all know that the PC market degraded with the rise of smartphones and tablets. However, this was an innovative market that needed substantial R&D effort. Dells success was rooted in a time where PC’s were already commodities. As a result, Dell had traditionally invested little in R&D compared to its competitors. The focus on cost leadership (remember Porter?) and the associated focus on efficiency left them little room for substantial R&D investments. Their margins simply did not allow it. This resulted in a slow change to adapt to a new reality. A new reality where Dell has lost most of its relevance.

Holding on to a sustainable competitive advantage

We already discussed the tendency to hold on to a perceived sustainable competitive advantage and the risks of it. A side-effect that reinforces the risks is the effect it has on the speed of executing change. The focus on defending the current business model’s competitive advantage easily leads to a structure where funding ‘running the business’ takes preference over funding innovation. Especially if budget authority lies with those responsible for the current business model(s). I have seen this several times. The organization does see the need for change and starts innovation initiatives. But as the current model slowly deteriorates but still makes accounts for most of the gross sales, supporting the current business model gets priority over innovation. Innovation projects get killed or stalled because budget is transferred to the failing current business model. This seriously undermines the capacity and speed of a necessary change.

An example is Toys ‘R Us. After being surpassed by Walmart as the largest reseller of toys, Toys ‘R Us faced another challenge: online sales and more specific, Amazon. In the beginning, Toys ‘R Us cooperated with Amazon and used their platform to sell toys. They were unpleasantly surprised when Amazon started to sell toys on themselves. Only then did they start to take building up their own e-commerce platform seriously. But by then it was too late. The company did not have the resources to build a successful online proposition anymore. This was mainly the result of the acquisition of Toys ‘R Us by KKR and Bain Capital in 2005. The acquisition was a so-called Leveraged Buy Out, meaning the company’s own assets are used to raise (leverage) its debt to buy the company. The assumption behind this is that the company can cut costs enough to pay for the debt. But then market conditions would have to remain relatively stable. But that did not happen because of the growth of Amazon in the toys business. The company’s focus on the current business model, the belief it could maintain a stable position in its current market for a long time, plus a cost-cutting efficiency focus had cost this company dearly.

Bibliography

List of notes and sources we reference from.