Thursday, May 31, 2007

Does Six Sigma Inhibit Breakthrough Innovation?

Business Week has a thought-provoking article about the tension between innovation and efficiency at 3M. When Jim McNerney came over to 3M from General Electric, he brought with him many GE processes and systems, including Six Sigma. During McNerney's tenure at 3M, profitability soared. Operating margins increased from 17% to 23%, and earnings grew 22% per year on average. However, some people wonder whether the Six Sigma process, as well as the emphasis on improving efficiency, harmed the creative culture at 3M and dampened the likelihood of breakthrough innovation. Drawing on 3M's experiences as well as the work of several academics, the article suggests that Six Sigma may drive a large amount of incremental improvement and innovation, but perhaps makes it difficult for employees to pursue discontinuous/disruptive innnovations. Simply put, one cannot completely systemize the process of innovation.

It will be interesting to watch how new CEO George Buckley's efforts to stimulate creativity play out in the years ahead. Can the company stimulate more breakthrough innovation without compromising its efforts to continuously improve quality and efficiency? The 3M story takes us back to a very interesting issue that academics have been studying for years, namely the tension between exploitation activities and exploration activities. Exploitation refers to the systematic refinement and improvement of existing processes and products, while exploration involves more open-ended experimentation and discovery. Can firms simultaneously perform both sets of activities well? Often, a firm's resource allocation process exhibits a strong bias toward one form of activity or the other. Senior management teams often have skills and capabilities that are well-suited for exploitation, but not exploration, or vice versa. The incentive system also often leans one way or the other. Some managers and academics believe that the best firms can strike a balance between exploration and exploitation, but it has not been easy identifying how to achieve this balancing act. It strikes me that we will learn a great deal about this issue by watching how events unfold at 3M in the years ahead.

Predicting Hit Products

Seth Godin has an interesting new post on his blog entitled "Pundits are (nearly) always wrong." He examines why many so-called experts are wrong in predicting the next big hit in technology, books, music, etc. Godin argues that the experts often "measure the wrong thing." They focus on the presentation more so than the substance of the idea. To some extent, a slick and clever pitch can overcome many flaws of logic.

Moreover, Godin suggests that experts often judge a pitch based on their existing worldview. Their mental model becomes the filter through which they judge whether something will become a hit. Of course, that mental model is largely shaped by past successes and failures. However, as Godin rightly points out, "The problem is that hits change worldviews. Hits change our senses. Hits appeal to people other than the gatekeepers and then the word spreads."

Godin's argument reminds me of the famous quote by legendary screenwriter William Goldman, who once remarked that “nobody knows nothing” in Hollywood, meaning that picking hits remained a formidable challenge even for industry veterans like him.

Friday, May 25, 2007

The Eclipse of the Public Corporation

Nearly two decades ago, Michael Jensen was criticized by many people, including many of his academic colleagues, for his thought-provoking article, The Eclipse of the Public Corporation, published in Harvard Business Review. People dismissed him when the LBO boom of the 1980s faded. They laughed when he wrote, "By the turn of the century, the primacy of public stock ownership in the United States may have all but disappeared." Well, in January 2000, with the dot com bubble raging, Jensen's far-reaching prognostications did seem completely off base. What about today? The dramatic expansion of private equity has validated Jensen's predictions from 18 years ago. Private equity has expanded rapidly, in part because it does solve some of the governance problems posed by the large publicly traded corporation, with its separation of ownership and control.

It's worth revisiting Jensen's arguments for a moment. At the time, Jensen argued that the public corporation's "decline is real, enduring, and highly productive." He explained the benefits of private equity and leveraged buyouts using agency theory, of which he was one of the founding fathers. Jensen wrote, "By solving the central weakness of the public corporation - the conflict between owners and managers over the control and use of corporate resources - these new organizations are making remarkable gains in operating efficiency, employee productivity, and shareholder value."

I can recall being one of Michael Jensen's students back in the early 1990s, long before I became his colleague on the HBS faculty. His class was the most popular elective at HBS back then. Not everyone agreed with him, but he offered thought-provoking theories, and he sparked some wonderful debates. This article, in particular, resonated with me and many of my peers back then, and it sure does seem quite prescient looking back today.

Back to Retail for Dell

Dell announced today that they will be selling several PC models in Wal-Mart stores. It's a very interesting development, not only because Dell is so well-known for its direct business model, but also because Dell did not succeed when it tried to sell PCs in the retail channel back in the early 1990s. What's the challenge for Dell as it tries to sell through retailers? It goes back to why many traditional PC makers had difficulty imitating Dell's direct business model. The two ways of doing business (selling through retail and selling direct) are somewhat incompatible with one another. Selling through retailers means producing and distributing large volumes of standardized products. Selling direct means producing customized PCs on demand. The processes and activities required for each business model are quite different. It's easier for a firm to completely optimize on one business model, rather than trying to operate two models simultaneously in the same corporation. That's one reason why Dell did so well in the 1990s, while IBM, Compaq, and others struggled to launch their direct businesses while still selling through value-added resellers and retailers. Dell was a "pure play" - those often trump firms that find themselves "straddling" between two somewhat incompatible business models. Hewlett-Packard ultimately figured out how to make the two models work together - now Dell must learn the same if they wish to succeed in the retail channel.

Sir James Dyson on Failure

Very interesting to read the current issue of Fast Company, given my recent post regarding managerial attitudes toward failure. Writer Chuck Salter interviews Sir James Dyson, the inventor of the best-selling vacuum cleaner in the U.S. - the famous Dyson bagless vacuum. Dyson points out that he made more than 5,000 prototypes before he discovered the model that became a commercial success. He notes, "There were 5, 126 failures, but I learned from each one. So I don't mind failure. I've always thought htat schoolchildren should be marked by the number of failures they've had. The child who tries strange things and experiences lots of failures to get there is probably more creative. " Of course, that sentence struck me because I had just written about Build-A-Bear CEO Maxine Clark's admiration for her schoolteacher who did precisely what Dyson suggests! Dyson goes on to say: "We're taught to do things the right way. But if you want to discover something that other people haven't, you need to do things the wrong way. Initiate a failure by doing something that's very silly, unthinkable, naughty, dangerous. Watching why that fails can take you on a completely different path."

Monday, May 21, 2007

Tuition Assistance and Employee Retention

Today's Wall Street Journal reports on research by Stanford graduate student Colleen Flaherty and Wharton professor Peter Cappelli indicating that employees are less likely to leave a firm if they have been enrolled in a tuition assistance program. The finding proves quite interesting, because many firms have worried in the past that employees would jump ship after taking advantage of a tuition assistance program. Economists too have questioned whether tuition reimbursement programs increase turnover among talented employees. After all, most MBA programs enhance an employees' general human capital, rather than firm-specific human capital; thus, they become more attractive to outside employers. Investments in firm-specific human capital, in contrast, would increase an employees' prospects within the firm, but not on the outside market. The findings from Flahery and Cappelli suggest that employees may stick around despite the increase in marketable skills. Perhaps employees feel a sense of loyalty to their employers, or they might find that the advanced degree offers numerous opportunities for internal promotion. Of course, the finding may also suggest that the kinds of firms offering generous tuition reimbursement programs also are quite likely to have other attributes that are highly attractive to talented, highly educated employees. Those other attributes may explain, in part, why turnover is lower for those enrolled in tuition reimbursement programs.

Wednesday, May 16, 2007

Attitudes about Failure

Tom Kelley, the co-founder of IDEO - one of the world's leading design firms, has a great saying about how to learn and innovate effectively: "Fail early and often to succeed sooner." At IDEO, a great deal of experimentation and prototyping occurs in the design process. People try lots of new things in search of progress toward a great design. Unfortunately, most organizations have the wrong attitude toward failure. They treat all failures in the same manner -harshly. Managers often create environments where people live in fear of making the smallest of mistakes, and thus, employees become highly risk averse. Yet, without risk-taking, innovation will not take place.

Maxine Clark, founder and CEO of Build-a-Bear Workshop, has a refreshing take on how to encourage risk-taking and use mistakes to drive innovation. She has built an incredibly successful company, growing it to over $350 milllion in sales over the past decade. She has done so by delivering a world-class customer experience in her stores. In her book, Clark tells us the story of her first grade teacher, Mrs. Grace. Like many elementary school teachers, Mrs. Grace graded papers using a red pencil. However, unlike most of her colleagues, Mrs. Grace gave out a rather unorthodox award at the end of each week. She awarded a red pencil prize to the student who had made the most mistakes! Why? Mrs. Grace wanted her students engaged in the class discussion, trying to answer every question - no matter how challenging. As Clark writes, "She didn't want the fear of being wrong to keep us from taking chances. Her only rule was that we couldn't be rewarded for making the same mistake twice." That is the key - making sure that you emphasize the importance of learning from each mistake, so that they do not happen again.

Clark has applied her first grade teacher's approach at Build-a-Bear by creating a Red Pencil Award. She gives this prize to people who have made a mistake, but who have discovered a better way of doing business as a result of reflecting upon and learning from that mistake. Clark has it right when she says that managers should encourage their people to "experiment freely, and view every so-called mistake as one step closer to getting things just right." Of course, her first grade teacher had it right as well when she stressed that people would be held accountable if they made the same mistake repeatedly. Failing to learn is the bad behavior that managers should deem unacceptable.

Monday, May 14, 2007

Chrysler Sold to Cerberus

DaimlerChrysler announced today that they would sell 80% of Chrysler to a private equity firm (Cerberus Capital Management) for $7.4 billion. Of course, Daimler bought Chrysler back in 1998 for $36 billion. Is it any wonder that Newsweek once called the merger, "the worst-executed big takeover since God invented corporations." If you want to learn more about how this merger took place back in the late 1990s, I would highly recommend reading Taken for a Ride: How Daimler Drove Off with Chrysler. Veteran auto industry journalists Bill Vlasic and Brad Stertz wrote this definitive account of how the deal unfolded. I had the pleasure of hosting the two gentlemen at a seminar at Harvard Business School several years ago. They impressed us with the thoroughness of their research, and the incredible access that they had secured with many of the key figures involved in the deal.

Wednesday, May 09, 2007

Breaking up General Electric?

The Wall Street Journal has an article today about the calls by some investors to break up GE. Some shareholders have clamored for a break-up, largely because GE shares have performed poorly since Immelt became CEO in 2001. The article points out that GE shares are down 7% since Immelt took charge, while the DJIA is up 35%. This discussion reminds us of the arguments surrounding the conglomerate discount. For years, studies have shown that unrelated diversifiers trade at a discount to their break-up value. (Note that this is true in the United States, where markets are relatively efficient, and many information intermediaries exist to facilitate the flow of products, capital, and labor. According to research by Harvard Professor Tarun Khanna, unrelated diversifiers tend to perform better in developing economies, where markets are less efficient).

The explanation for the conglomerate discount is that, in the presence of efficient capital markets, investors can diversify more effectively and inexpensively than the executives of the firm. In short, we don't need senior managers at the conglomerate to spread risk by being in a wide range of unrelated businesses; we can achieve risk mitigation much more effectively by buying a portfolio of stocks of more focused firms. Similarly, in the presence of efficient external labor markets, we would question whether a conglomerate could operate its internal labor market more effectively than the external market.

However, GE has been a famous exception to the general tendency regarding the conglomerate discount. It has performed quite well for decades, with its business units outperforming most focused competitors. Could this no longer be true? If the stock price performance continues to lag the overall market, more investors will be taking a look at the age-old question: is the whole worth more than the sum of the parts? Given GE's track record, I would tend to be cautious about breaking up the firm, but it will be interesting to watch what happens if the stock continues to lag the market.

Low Risk Innovation

Business Week has an interesting article about how Pixar's John Lasseter is re-invigorating innovation and creativity at Disney's animation studios. Lasseter has come up with a relatively low risk, low cost strategy for doing so. He's funding the development of a series of five minute shorts, and he's asking young talent at the studio to direct them. The budget for a short represents less 2% of the money required to fund a major animated film. Therefore, he's deploying a relatively small amount of capital, yet providing talented up-and-comers an opportunity to try their hand at directing their first animated film. Interestingly, Walt Disney built his studio back in the 1930s based on a series of popular shorts. Now, it seems that Lasseter is returning Disney animation to its roots in hopes of rekindling the creativity that, once upon a time, made the Disney animators the envy of the entertainment world. Other firms should take notice, and they should look for their own low risk, low cost opportunities to spark innovation and creativity, while simultaneously developing and evaluating young talented employees.

Friday, May 04, 2007

Have Boards of Directors Really Changed?

In the April 2007 issue of the Academy of Management Journal, Jim Westphal and Ithai Stern published a thought-provoking study of the labor market for directors of U.S. corporations. They found that directors are more likely to be appointed to other boards if they provide advice to the CEO frequently. That is the good news. The bad news is that directors are more likely to gain new appointments to other boards if they engage in a low level of monitoring and control activity with regard to strategic decision-making by the CEO and his/her management team. After the corporate scandals of Enron, Worldcom, and others, we saw the implementation of many corporate governance reforms intended to strengthen the monitoring and control activities of boards of directors. Yet, Westphal and Stern discovered that their findings hold even in the post-Enron era. The bad news does not end there. The scholars also find that women and minorities "are punished more for engaging in monitoring and control behavior." Those findings also hold in the post-Enron era. What do I conclude from this finding? We have focused far too much effort on structural reforms at the board level, rather than focusing on board process. Board chairmen and lead directors need to develop processes that stimulate open dialogue and induce constructive debate in the boardroom. We cannot simply expect a vigorous exchange of views because we have appointed a certain percentage of outside directors. Pressures for conformity will arise, even among a highly capable group of directors who are properly nominated and selected.

Chasing the Story

In the New York Times yesterday, Hal Varian wrote about a new study conducted by three finance professors at the University of Richmond (Thomas Arnold, John Earl Jr., and David North). These scholars published a paper entitled, "Are Cover Stories Effective Contrarian Investors?" They examined how a company's stock price changed after the appearance of a cover story published in one of the leading business magazines. Arnold, Earl, and North discovered that journalists tended to write cover stories after a period of unusually good or bad performance on the part of a company - positive stories about high performing firms and negative stories about poor performers. However, after the stories are published, the companies about which positive stories were written do not perform much differently than the firms about which negative stories were published. What's the lesson for investors? Do not try to time the purchase or sale of securities based on what you read in glossy cover stories. Of course, those of us who believe that the American capital markets are relatively efficient should not be surprised by this result. The cover stories often do not constitute breaking news to the investor community. They already know much of what is being written in these pieces, and thus, the stock price has adjusted to that information prior to the publication of the magazine.

Thursday, May 03, 2007

Learning vs. Performance

Harvard Professor Amy Edmondson, with whom I have co-authored several articles and case studies, has an interesting new paper about the tensions between organizational learning and performance. This paper is especially interesting because it synthesizes her outstanding work over the past decade. In this article, she argues that firms must engage in learning if they are to improve performance over time. However, efforts to enhance learning often appear at odds with an organization's performance orientation. For instance, she points out that many of her past studies have shown that learning requires a willingness to surface and discuss problems and mistakes. However, detecting and discussing errors makes organizations appear to be performing poorly. That makes managers and employees uncomfortable. Learning also creates another type of discomfort. When people learn, it typically involves a transition period, during which performance may lag as individuals and teams develop new capabilities. Therefore, Edmondson suggests that managers need to confront and assuage the discomfort that is created by a healthy learning process. If they do not, then the performance orientation of most organizations will stifle opportunities for improvement and innovation. For more on this interesting work, see