Develop Teams, Not Just Individuals

Fortune recently published an article on how great companies develop future leaders. While the article did not provide any earth-shattering new insights, it did point out some key practices that are often discussed, but not always put into practice. One technique that warrants a great deal of attention has to to with team development. The article suggests that companies should "develop teams, not just individuals." They point out that General Electric now sends entire management teams to Crotonville, and each team goes through a developmental experience in which they apply what they are learning to their business. Given that many leadership development programs seek to address topics such as team dynamics, communication, decision-making, and the like, it makes sense for intact teams to experience these programs together.

Of course, organizations must not allow the intact teams to isolate themselves in these types of leadership development experiences. One key benefit of leadership development programs is that emerging leaders have the time to network with their peers in other parts of the organization. Often, these peers work in far-flung parts of the world, and they don't know one another quite well at all. The leadership development program offers them time to get to know one another, share best practices, and explore collaboration opportunities to advance the business. If intact teams attend these leadership development programs, one has to be careful that managers don't spend all their time with their own team, thus spending far too little time networking, sharing, and learning from their peers in other parts of the business.

Apple Video Rentals

Yesterday, Apple made major headlines with news of a possible deal with Fox to offer video rentals via iTunes. The fundamental question, in my view, is how Apple will leverage a movie rental business into the sale of more hardware. It's hard to imagine a dramatic new surge in iPod sales because of the movie rental launch. Moreover, it's easy to imagine price battles among the major players, such as NetFlix, who compete in the movie rental business . On the other hand, perhaps Apple is poised to build upon its early Apple TV product, or launch an altogether new product designed for consumers to easily view movies downloaded via iTunes. If Apple can couple the on-line movie rentals from iTunes with an easy-to-use piece of hardware, then they can generate substantial profits. Once again, they will have executed a successful blades and razors strategy, i.e. selling inexpensive blades (movie rentals) to generate high profits from hardware sold at a price premium (Apple TV or some other product used to view the movies, transfer them easily from PC to TV, etc.).

Moneyball & The Lessons for Business Leaders

Several months ago, I was interviewed by Bret Dougherty, author of The IronDog Chronicles, a very interesting blog about sports, media, and entertainment. Bret co-hosts WXYC’s ‘Sports Rap’ on Sunday nights in Chapel Hill, North Carolina, while also pursuing his MBA at UNC-Chapel Hill. Here is the link to the recorded interview, which focused on my case study about the rise of sabermetrics in baseball, and some of the lessons for business decision-makers.

Dsylexics as Entrepreneurs

Business Week had a fascinating article about new research suggesting that dyslexics may tend to become successful entrepreneurs, particularly in the United States. Here is a brief excerpt from the article:

That kind of rejection, along with a penchant for creativity, may help explain why so many dyslexics are inclined to become entrepreneurs. Julie Logan, a professor of entrepreneurship at Cass Business School in London, believes strongly in the connection.

In a study to be published in January, Logan found that 35% of entrepreneurs in the U.S. show signs of dyslexia, compared to 20% in Britain. Logan attributes the gap to a more flexible education system in the U.S., vs. rigid tracking in British schools, and better identification and remediation methods. "Most of the people in our study talked about the role of the mentor and how important that had been," Logan says. "The difference seems to be somebody who believes in you in school."

The broader implication, she says, is that many of the coping skills dyslexics learn in their formative years become best practices for the successful entrepreneur. A child who chronically fails standardized tests must become comfortable with failure. Being a slow reader forces you to extract only vital information, so that you're constantly getting right to the point. Dyslexics are also forced to trust and rely on others to get things done—an essential skill for anyone working to build a business.

The article raises some interesting points regarding dyslexics as entrepreneurs, but I think it also should cause us to consider some more fundamental questions about our entire education system . In the era of self-esteem promotion during the 1990s, our schools often heaped praise on children. They sought to bolster each child's self-image. For me, this article suggests that we should make sure that we also focus on building our children's capabilities with regard to coping with failure. All of us fail many times in life, and entrepreneurs, in particular, must be able to deal with failure. They must be able to experiment, learn from those experiments, and then adjust or adapt their strategies.

Back to the Blog

Sorry to those readers who have been wondering where I have been for the past two months. Well, it's been a busy time in the Roberto household, as we have welcomed a third child into the family. Baby Luke Roberto was born in November, and he's doing very well. I'll be posting again on a regular basis going forward.

Amazon vs. Apple

Amazon made big news lately when they launched a new digital music service to compete with iTunes. Some news reports suggested that Amazon would pose a threat to iTunes' dominance. Perhaps that may prove to be true, but there is one important way in which Amazon may actually HELP Apple. How is that?

iTunes songs and iPods are complementary goods. If consumption of digital music rises, it will fuel more demand for digital music players - and iPod is the dominant player in that market. Where does Apple make their money? They appear to make far more profit from selling iPods than from selling songs on the iTunes stores.

Think of it the way that Harvard Professor David Yoffie explains it in his classic case study about Apple. Yoffie draws on several sources that describe the Apple business model as razors-and-blades in reverse. He quotes Steve Jobs stating that Apple makes very little profit on a song sold through iTunes. Yet, the profit margins on iPods are very healthy. They essentially provide the blades (songs) at a low price as a means of driving demand for the razors (the very profitable iPods).

If this is indeed the business model, then Amazon's latest move in digital music may actually HELP Apple... by fueling further demand for iPods, iPhones, and iPod accessories.

The Ethics of Guerilla Marketing

This article, about a singer named Marié Digby, caught my attention. It appeared in the Wall Street Journal last week. One has to wonder about the ethics of such marketing tactics, in which a young woman presents herself on YouTube as a complete amateur, while in fact, she has been working with a large media company for some time. The record company helps create quite a stir on the web about this supposed amateur sensation. Then, the firm announces the signing of this young YouTube phenom, without making it clear that they had been supporting her rise in on-line popularity all along.

Selling Home Depot Supply

This article describes critics who think Home Depot should not be selling its Supply unit, which serves contractors. The critics argue that the firm is forsaking the potential growth in that segment simply because it wants to "exorcise Nardelli's ghosts." The critics argue that the private equity firms will make a great deal of money on the Supply unit.

The critics are missing a crucial point. The issue is NOT whether the Supply unit is an attractive and potentially quite profitable business. This issue is whether the Supply unit is BETTER OFF as an independent company vs. within Home Depot. Moreover, the issue is whether Home Depot's retail business is better off on its own or when combined with the Supply unit.

This example demonstrates a larger point. When firms consider diversification, they must not only look at whether a new business unit will provide higher growth and profits... they must also consider whether that new unit will perform optimally as part of the diversified firm, or whether it will be better off on its own or as part of some other corporation. Shareholders benefit most when a business unit is located in an organizational situation in which it can perform best.

Mike Watkins on The Mistakes New Executives Make

Michael Watkins has a wonderful new post on his blog about the mistakes executives make when they join a new firm. He points out that many executives stumble because they try to recreate the organizations from which they came. There is no question that this is true. I have seen this so many times in my research and consulting.

I can recall one remarkable incident in my class several years ago, when Emerson Electric's former Chairman and CEO, Chuck Knight, visited my class. We discussed Emerson's highly regarded strategic planning process. I told the class that there is no one best way to conduct strategic planning; instead, a firm must match its strategic planning approach to the industry dynamics, firm strategy, organizational culture, and leadership style of the CEO. To bolster this point, I shared a quote from Charlie Peters, one of Knight's top executives at Emerson. Peters once said, "

• "Many companies come to Emerson wanting to find out what we are doing and why it works. But often, the trip is wasted. Our process works for us because of the type of impact we are trying to have on our businesses and because of our CEO, Chuck Knight – how he likes to operate and his relationship and status with the divisions. Other companies can’t duplicate that."

Interestingly, a student then asked Chuck Knight if he would have tried to replicate the Emerson strategic planning process if he had gone on to another firm, rather than retiring after he stepped down as CEO of Emerson. Knight offered a fascinating answer. He said that it probably would have been the wrong thing to do, in that the new situation most likely would have called for a substantial adaptation of the Emerson process to fit the needs of that particular company. However, he said that he would have been tempted to simply transport what he done at Emerson to the new firm. He said that this is what CEOs do...they rely on what made them successful. It's easy to convince oneself that this approach will work anywhere.

Knight's remarkably thoughtful comments reinforce the point that Mike Watkins makes in his blog. It is incredibly tempting for executives to want to replicate the the methods and techniques that worked for them in other organizations in the past. However, in business, there is often not "one best way" to do things. Success in business is so often about fit or alignment. The methods and practices must be adapted to fit the current situation and context.

China, Outsourcing, and Transaction Costs

Each day seems to bring new headlines regarding tainted products from China. Mattel has been hit especially hard, with the discovery of many toys containing lead paint. For me, the news about tainted Chinese products offers an opportunity to remind students and executives how to think strategically about outsourcing, rather than focusing singlemindedly on manufacturing cost reductions.

Let's go back to the fundamental strategic choice regarding vertical integration. What should drive the decision by a firm to produce its own inputs (or to conduct its own manufacturing in-house) versus outsourcing these activities to external vendors? Firms need to consider more than simply the direct manufacturing costs of performing these activities in-house vs. outsourcing them. They must consider the transaction costs associated with outsourcing production. In other words, how expensive is it to write contracts with external vendors, to monitor vendor behavior, enforce contractual provisions, control quality, etc.? Many firms underestimate these "costs" associated with using the market (i.e. outsourcing to an external vendor) versus keeping certain activities within the firm.

Quality control can be a very important reason why production is kept in-house instead of outsourcing it. We are learning from the tainted Chinese products situation that the transaction costs associated with quality control of outside vendors can be very high. The transaction costs come not only in the form of expenses associated with monitoring external vendors, but also in the form of a damaged brand in the event of a major recall.

Let's take a simple example of how control can be a key reason for keeping certain activities in-house. Why does Apple choose to operate its own retail stores? One reason is that they want to control the customer experience and the quality of the customer service that people receive. Of course, there are other reasons as well, but control is a critical one. Similarly, Disney owns some hotels in and around its theme parks because it wants to control the quality of the customer experience. Consider the risks and costs associated with having external parties in charge of the experience that families have at a Disney resort.

My argument is not that outsourcing should never occur. I simply aim to remind managers that they must consider the nature of transaction costs when making the outsourcing decision. Of course, there are transaction costs associated with keeping production in-house. The key is to compare the transaction costs of using the market (outsourcing) vs. keeping production in-house.

Finally, firms have to remember these strategic decisions are dynamic in nature. It may make sense to keep certain activities in-house at this point in time, but then outsourcing may become more attractive down the road. For instance, Disney used to own its retail store chain. One can see why they might want to control that customer retail experience. However, once they had operated this chain for some 15 years, they made the decision that they now could establish a licensing agreement, and allow an experienced retailer (Children's Place) to run the chain. Think of it this way. In the 1980s, when they launched the retail chain, they might have felt it was quite difficult, costly, and risky to establish a contract with an outside firm to operate Disney stores. However, now that Disney has run the stores for many years, they may feel more comfortable that they can write an enforceable contract that allows them to maintain quality control without running the store themselves.

Merck & Sunk Costs

The sunk cost effect refers to the tendency for people to escalate commitment to a course of action in which they have made substantial prior investments of time, money, or other resources. If people behaved rationally, they would make choices based on the marginal costs and benefits of their actions. The amount of any previous unrecoverable investment is a sunk cost and should not affect the current decision. However, research demonstrates that people often do consider past investment decisions when choosing future courses of action. In particular, individuals tend to pursue activities in which they have made prior investments. Often, they become overly committed to certain activities despite consistently poor results. They “throw good money after bad”, and the situation continues to escalate.

Many companies face the problem of the sunk cost effect. In fact, it's particularly problematic for firms involved in extremely expensive and lengthy product development projects. In those situations, the sunk costs can be enormous, and it can be very difficult for managers, scientists, and/or engineers to walk away from a project in which they have not only invested a great deal of money, but also much time, energy, and personal reputation.

A recent Business Week article suggests that Merck has found a way to try to combat this problem. Here's a snippet from the article (for the entire article, click here):

Merck is rewarding scientists for failure. One of the hardest decisions any scientist has to make is when to abandon an experimental drug that's not working. An inability to admit failure leads to inefficiencies. A scientist may spend months and tens of thousands of dollars studying a compound, hoping for a result he or she knows likely won't come, rather than pitching in on a project with a better chance of turning into a viable drug. So Kim (Merck R&D head Peter Kim) is promising stock options to scientists who bail out on losing projects. It's not the loss per se that's being rewarded but the decision to accept failure and move on. "You can't change the truth. You can only delay how long it takes to find it out," Kim says. "If you're a good scientist, you want to spend your time and the company's money on something that's going to lead to success."

Jensen vs. Langone

Business Week has a good wrap-up of an interesting exchange about private equity between Harvard Professor Emeritus Michael Jensen and Home Depot founding investor Ken Langone. These kinds of spirited discussions aren't typical for the Academy of Management meetings. I wish that we could find more ways to infuse the meetings with these kinds of exchanges between practitioners and academics.

Private Equity IPOs

Private equity seems to be all over the headlines these days, with a range of issues coming to the fore. I'd like to focus here on the issue of private equity shops going public. To me, the rationale is very weak. One of the fundamental reasons why private equity firms add value is their superior model of governance and control. As I have written previously, private equity firms have expanded rapidly, in part because they solve some of the governance problems posed by the large publicly traded corporation, with its separation of ownership and control. In short, I believe the ownership and governance structure of a private equity firm has the potential to dramatically reduce agency costs relative to a publicly traded firm.

Going public changes things significantly. For years, strategic management scholars and consultants have argued (and shown empirically) that conglomerates (unrelated diversified firms) trade at a discount, that they are worth less than the sum of their parts. You all know the reasons - they have been well-articulated over many years. Well, if a private equity firm goes public, then precisely what is the difference between it and the typical conglomerate? The private equity firm begins to look much more like the usual unrelated diversified firm. A private equity firm no longer can argue that its governance structure poses a substantial advantage over the old style publicly traded conglomerate.

I have heard many of the reasons why private equity firms are going public, beyond the fact that it offers an opportunity for enhancing personal wealth. Access to capital, ability to recruit and retain talent, management successsion... none of these seems like a persuasive argument. These firms have been wildly successful raising capital and attracting talent, while remaining privately held. Even if there were some advantages to going public, they must be weighed against the substantial disadvantage outlined here with respect to agency costs and corporate governance. To me, those disadvantages clearly outweigh the possible benefits of conducting an initial public offering.

Why More People Don't Buy Hybrids

Forbes.com has a very good article about how and why many hybrid automobiles have not become big sellers. Many people buy the Prius because they have a personal desire to reduce their energy use, and perhaps because they would like to make a social statement about environmental protection. However, hybrid technology comes at quite a cost. For many consumers, a hybrid's price premium proves far too substantial; affordability becomes a major concern. Let's do the math. According to the EPA, a Prius averages 46 miles per gallon. A Toyota Corolla averages 29 miles per gallon. Suppose that the typical person drives 12,000 miles per year, with gas at $3 per gallon. The Prius owner saves $459 per year in gasoline expenses over the course of one year. However, the sticker price for a Prius exceeds that of a Corolla by approximately $7,000. In other words, it would take roughly 15 years for the Prius owner to recoup his or her extra investment ($7000 divided by $459 per year), and that doesn't even take into account the present value of money. In conclusion, I think hybrid technology is very promising, with great potential to help us reduce gasoline consumption and carbon emissions. However, the automakers have quite a way to go before they can make hybrid technology affordable for many consumers.

Nintendo vs. Sony vs. Microsoft

The remarkable success of the Nintendo Wii offers a very important lesson for business leaders. It shows that the most sophisticated technological solution doesn't always win in the marketplace. Recall that, in the prior generation of video game consoles, Sony's Playstation 2 and Microsoft's Xbox outsold Nintendo's GameCube by a wide margin. The GameCube tried to compete with the technology of their rivals, and they failed. In this generation, the Playstation 3 and Xbox 360 became even more technologically advanced. They offer far more speed and graphic capability than the Nintendo Wii. However, the Wii has outsold its rivals and has become a smashing commercial success. The lower-tech Wii does not target the hard-core gamer who favors the technological superiority of the PS3 or Xbox 360. Instead, the Wii offers a unique new approach to gaming with its wireless motion-sensor controller. It has sought to appeal to a much broader audience of consumers who are more casual gamers, or who have never played video games. Even senior citizens have taken to playing the Wii games. With less technological wizardry, but a novel idea, the Wii has gained the upper hand against its rivals. Nintendo shows us that companies can succeed without getting into a technological arms race against rivals with deep pockets. The key is to take an indirect approach to competing against those rivals. Rather than confronting Sony and Microsoft head-on, Nintendo created a different kind of console that appealed to different customers than those typically interested in Sony and Microsoft products.

Diversification vs. Focus at Limited Brands

Limited Brands announced yesterday that it had agreed to sell a 75% stake in The Limited chain of apparel stores to a private equity firm. That announcement comes on the heels of the sale of a 75% ownership stake in the Express chain to a private equity firm. The company will focus on the two business units that have delivered far better growth and profits in recent years - Victoria's Secret and Bath and Body Works. With these divestitures, the company looks far different than it did twenty years ago, when it was one of the leading specialty apparel retailers in the nation.

The transformation of Limited Brands mirrors the situation that many diversified firms encounter. As firms operate multiple businesses, the corporate office finds itself trying to manage a complex internal capital market. Senior executives typically allocate resources to the business units that show more promise in terms of revenue and profit growth. After all, higher growth and profitability makes additional capital investments appear much more attractive. Executives understandably want the best return on their investment, and they do not have unlimited funds; they must make tradeoffs. Perhaps just as importantly, senior executives allocate more of their time and attention to the more promising business units as well. That, in turn, can lead to a downward spiral at the less successful businesses in the portfolio - weak results lead to a decrease in capital allocated to the business, as well as a decrease in management attention, which together further diminish the prospects for enhanced revenue and earnings growth. Moreover, slower growth and lower rates of capital investment make the businesses less attractive to talented current and potential employees, causing a drain in the quality of human capital in those businesses. That, in turn, further weakens the financial results in those units.

This scenario, which we see unfold in many diversified firms, points out the dangers associated with trying to manage a portfolio of businesses with differing levels of growth and profitability. Moreover, it demonstrates why focused firms often are able to capitalize on the distractions faced by executive teams who are trying to oversee a wide range of business units.

Limited Brands deserves credit for ultimately recognizing that its apparel chains could be better off under management whose sole focus is on that particular brand. Moreover, Victoria's Secret and Bath and Body Works are likely to benefit too. Now senior management can completely focus on these businesses, which face increasing competition as new entrants chase the high profits in those sectors.

Generational Differences

Carol Hymowitz has a good article in today's Wall Street Journal entitled, "Managers Find Ways To Get Generations To Close Culture Gaps." Hymowitz is correct when she argues that managers must find ways to tailor their approach to meet the needs of different generations of employees. I find the point about learning and development particularly interesting.

As a professor, I can see these generational learning differences very clearly. Young people gather and process information, develop new skills, and discover new things in very different ways than many people from prior generations. My younger students, for instance, love studying for exams by listening to and reviewing my weekly podcasts, which discuss key points from the case studies that we examined. They also tend to embrace active learning, i.e. classroom experiences in which they are engaged participants, as opposed to passive listeners to faculty lectures. Just as orofessors must adapt to this newer generation's distinct learning style inside and outside the classroom, so too must managers find ways to tailor the way that they monitor, motivate, and train employees of various generations.

The challenge, however, becomes one of fairness. While I believe tailoring approaches for different employees makes some sense, I worry that managers may end up creating perceptions of inequity. People often don't like to feel as though their peers are not playing by the same rules. Thus, as managers try to adapt their approaches to meet the needs of a multigenerational staff, they must be particularly careful that employees do not begin to perceive that they are being treated unfairly in comparison to peers of another generation.

How much is a reputation worth?

Business Week has a very interesting article on corporate reputation. The authors describe efforts by companies and consulting firms to determine the impact that a positive reputation can have on a firm's stock price, and then to develop programs aimed at juicing a firm's shares. What is especially interesting to me about this article is the reaction by investors. The article points out that, "Many investment pros scoff at suggestions they can be influenced by image manipulation." When it is suggested that reputation-building efforts can have a direct impact on a firm's stock price, one investment analyst responds, "The markets are smarter than that." In general, I believe that U.S. capital markets are reasonably efficient. However, I would not be as quick to dismiss the notion that reputation-enhancing initiatives can have a near-term impact on investor perceptions and share prices. Scholars in the field of behavioral finance have shown that investors can be affected by biases, thus demonstrating that markets aren't perfectly efficient.

Having said that, I think that sustainable long-term changes in stock price require substantive improvements on the part of a firm, not just image-oriented campaigns. Companies, in fact, can find themselves in deeper trouble if they try to build a reputation through advertisements and public relations, while consumers, journalists, and investors later learn that the reputation is not consistent with the underlying realities of the business. Take BP, for instance. It spent a great deal of money on its "green" campaign under former CEO John Browne. When it then encountered several accidents and mishaps at its facilities, the company faced a serious disconnect between what it was saying in its image campaigns and what it was revealed to be doing in its own operations. BP's market value fell by nearly $40 billion from mid-2006 until the announcement of the resignation of Lord Browne in early 2007.

The Power of Integrative Thinking

Roger Martin, Dean of University of Toronto's business school, has a wonderful article in the June issue of Harvard Business Review. He argues that successful leaders are integrative thinkers. By that, he means that they attack problems in the following manner:

• They examine problems as a whole, with careful consideration of how different parts of a situation fit together, rather than analyzing different elements in isolation.
• They consider multiple avenues of causation for a problem, as well as possible nonlinear relationships between cause and effect, rather than thinking of terms of simple linear relationships between a single cause and effect.
• They embrace the tension between opposing ideas, and they use that conflict to generate creative new alternatives, rather than making simple either-or decisions.

In short, Martin argues that successful leaders think holistically and embrace the power of conflict. In my work, I have argued that constructive conflict within a management team leads to better decisions. Martin stresses that successful leaders also have to embrace conflict within their own mind. They must "hold two conflict ideas in constructive, amost dialectic tension." Martin points out that many people find this internal tension uncomfortable, and thus they shy away from it.

While I would agree with Martin in general, I am reminded of the challenges associated with this type of integrative thinking, as described by Karl Weick in a famous 1984 article entitled "Small Wins." Weick argued that large, complex problems can sometimes be cognitively overwhelming. Thus, he argued that decision-makers should break complex problems into parts, and seek a series of "small wins" as a means of generating solutions to complicated issues. Martin explicitly argues against breaking problems into pieces. He says that holistic thinkers view problems as a whole. Here, I disagree slightly with Martin. I think one can approach a problem holistically, yet still follow Weick's advice to seek small wins while working through the organizational decision-making process required to solve the problem. Trying to achieve small wins in attacking a problem does not mean that a leader fails to think about how various elements of a problem fit together.

Supermarkets vs. Wal-Mart

Today's Wall Street Journal has an interesting article about how many supermarkets have learned to compete more effectively with Wal-Mart. The answer is straightforward: don't try to imitate Wal-Mart's low cost strategy. Instead, supermarkets have tried to create some differentiation by offering unique upscale products and high quality prepared meals along with the usual staples. They also have redesigned their stores to create an enhanced shopping experience for the consumer. Not all supermarkets took this path. Some tried to imitate Wal-Mart's low costs and low prices, and many of them found their way to bankruptcy.

The competitive dynamics in the supermarket industry remind me of what took place in the mass merchandising sector. Many chains went bankrupt trying to match Wal-Mart's low costs and low prices. Target took a different path. It chose a differentiation strategy, with higher quality products, better service, and a bright, clean store with easy-to-navigate aisles in which consumers love to shop. It didn't go head-to-head with the behemoth. Instead, it chose a form of indirect competition, moving slightly upmarket. In so doing, Target has prospered while many chains became extinct.

Firms in all industries would be well-served to consider the fate of those that have competed with Wal-Mart. Imitating the market leader often does not lead to bountiful profits. Finding a different path proves much more economically rewarding.