Tuesday, September 29, 2009

Can we please stop saying that the market is efficient?

The economist Jovanovic wrote, about a quarter of a century ago, “efficient firms grow and survive; inefficient firms decline and fail”. What he meant is that the market is Darwinian; it will rule out the least efficient firms, with habits and practices that make them perform comparatively badly, and it will make sure efficient firms prosper, so that only good business practices prevail.

Yeah right.

When you look around you, in the world of business, one sometimes can’t help wonder where Darwin went wrong… How come we see so many firms that drive us up the wall, how come we see silly business practices persist (excessive risk taking, dubious governance mechanisms, corporate sexism, grey suits and ties to name an eclectic few), and how come so many – sometimes well-educated and intelligent – people continue to have an almost unshakable belief that the market really is efficient, and that it will make the best firms prevail if you just give it time?

That’s because the logic is not entirely wrong. The market is Darwinian, and the firms with the highest level of “fitness” are the ones most likely to prevail. However, our Darwinian view of business is also so incomplete and simplistic that I am unsure whether it would make Mister Charles Robert Darwin cringe, burst out laughing, or pull the hairs from his famously bulging beard in agony. Darwinian mechanisms – or market mechanisms if you prefer – namely work at different levels. And sometimes they conflict. Let me explain.

Some business practices, like the ones mentioned above, will actually reduce the fitness levels of the firms that adopt them, and make them less efficient, yet they persist. That’s because these practices have a fitness level of their own. They survive just like viruses survive among humans. The flu kills many thousands of people every year, and at first glance it seems a slightly flawed strategy of this virus to kill one’s host, yet it persists. Why is that? That’s because it spreads quicker than it kills. It doesn’t matter much, for a virus, that it reduces the fitness of its host, as long as it jumps to someone else before the host snuffs it! And in a way that is what bad business practices do too. They spread easily and kill slowly and stealthily.

Moreover, the flu doesn’t kill everybody that gets it; it often just makes them perform worse. And that is what bad practices do too. Just like an extremely lethal virus dies out – because it kills its host before it can spread – terrible business practices also never quite see the light of day. It is these stealthy, annoying, nasty, creepy, sneaky, and irritating, pains-in-all-sorts-of-bodyparts practices that tend to persist. They don’t kill instantly, but gradually wear a firm down.

And there is another advantage to that – for the practice that is. Firms don’t quite know that the practice is bad. Very bad practices are easy to spot, so nobody adopts them, but not these ones! They’re like a sneaky virus – you catch it before you realize it, and the negative effects only become apparent in the long run.

An example you say? Well, take ISO9000 and apply it in a very innovative industry. Research – by professors Benner from Wharton and Tushman from the Harvard Business School – has shown that ISO9000, in the long run, can have a severe negative impact on a firm because it hampers innovation. Yet, the short-term benefits are clear; adopting ISO9000 often comes with some good reputational effects, an immediate increase in customers, and satisfied stakeholders. However, the negative effect on innovation, in the long run, may outweigh all of this.

Nevertheless, firms adopt the practice because they do see the short-term benefits, but are quite unaware of the long run detrimental stuff. To managers in charge of improving their firms’ performance now, the practice seems attractive because they noticed that companies in other industries (perhaps not so reliant on innovation) benefited greatly at the time they adopted it, many of the firm’s competitors are currently adopting it, and they all see a surge in customer applications too! Of course it looks attractive!

Moreover, once we start to suffer from a shortage of internal innovation, many years will have passed, and no-one quite realizes that the creeping troubles were originally triggered by the adoption of the ISO9000 practice a long time ago. The practice gets adopted by many many firms and continues to persist, despite the fact that everybody would be better off without it.

The same may very well be true for quite a few of our popular governance mechanisms, the practice of excessive risk taking as we saw it in investment banking, many forms of performance management systems, and certainly for corporate sexisms, and pin-striped suits with purple ties on hot summer afternoon. It is not that Darwin is wrong – and the mechanisms he discovered do not rule our markets – it is just that they’re just as difficult to shake off as a common cold. And that they are just as annoying.

Saturday, September 26, 2009


The push for government support for newspaper continues and this week publishers and their supporters—including the Newspaper Association of America—went before the House Joint Economic Committee detailing how the current economic climate has harmed their finances and arguing for preferential changes to tax and pension laws. They asked to be allowed to extend application of the net operating loss provisions from 2 years to 5 years and for changes in laws to allow them to underfund pension funds for a greater period of time. Both would improve their operating performance and balance sheets.

This is a case of the newspaper industry seeking long-term business benefits to solve a short-term crisis caused by poor management decisions and the recession. The leading newspaper firms and their representatives are making concerted efforts to dupe legislators and the public into believing their troubles are part of the general trends in the industry, rather than the result of management decisions and the financial crisis that is diminishing. If the provisions are passed, the public treasury will be diminished for years to come and risks for employee pensions will be increased.

Newspaper executives and other witnesses were sympathetically treated at the hearing this week, but it is unclear whether they will be able to achieve the policies they advocated.

Another proposal that the commercial firms are uninterested in themselves, but expressed sympathy for, would broadening laws regarding charities to include not-for-profit newspapers. Their support was astute because the House Joint Economic Committee’s chair, Rep. Carolyn Maloney (D-NY), has introduced her own bill (H.R. 3602) to allow newspapers to become tax exempt under section 501(C)(3) of the tax code. Her bill somewhat mirror Senate bill 673 by Sen. Benjamin Cardin, D-Md., that was discussed earlier in this blog (Analysis of the Newspaper Revitalization Act, http://themediabusiness.blogspot.com/2009/03/analysis-of-newspaper-revitalization.html). There are some differences in Maloney’s bill that need to be highlighted.

Under Section (b) of H.R. 3602, companies would qualify for tax exempt status through a 3-part test.

First, companies would have to be “publishing on a regular basis a newspaper of general circulation” to qualify. This provision stipulates no periodicity so it does not limit qualification to dailies, which are experiencing the greatest economic and financial difficulties. This language provides the exemption only to established papers and would thus exclude startups until after they were regularly publishing, requiring startups to initially obtain financing through other than tax-deductible donations.

The language in this first test requires that publications be “a newspaper of general circulation” and this will lead to questions whether it applies to newspapers focused on specific audiences in a community—such as African Americans or senior citizens—or papers providing more focused content—such as news and information for a specific neighborhood or devoted solely to politics or crime. This ambiguity could be used by IRS examiners against some papers and could be used by some publishers to take advantage of a policy not intended for them.

The second provision requires that qualifying papers publish “local, national or international stories of interest to the general public and the distribution of such newspaper is necessary or valuable in achieving an educational purpose.” The provision regarding type of coverage is better than the Senate bill because it does not require publication of all 3 types of news—something not done in many local papers.

The third provision requires that content preparation “follows methods generally accepted as educational in character.” This provision is exceedingly vague and its application is unclear because it does not deal with the content of the paper, but with the preparation of the paper. How “the preparation of the material” follows accepted educational methods would seem to require that the papers be part of an educational activity, such as being linked to training in schools or universities. This would highly limit the applicability of the bill to existing newspaper operations.

Like the Senate bill, Section (c) permits papers to carry advertising “to the extent that such newspaper does not exceed the space allotted to fulfilling the educational purposes of such qualified newspaper corporation.” This would require papers to publish no more than an equal amount of editorial and advertising content. This is lower than the limit of postal service limit (75%) and would force most existing papers to drop about 1/3 of their existing advertising or incur damaging costs by printing more news pages than they do now. This would cripple the finances of any daily paper.

Finally, Section (d) of the legislation permits qualified companies to accept tax deductable charitable donations to support their operations.

This bill, like its Senate predecessor, is likely to have limited affects on the newspaper industry because it will not interest newspaper owners because most of their papers are producing profits and it will preclude their abilities to benefit from greater profits when the advertising recovery occurs.

There is a place for not-for-profit media and journalism, but H.R. 3602 S. 673 will not do much to improve coverage or the overall condition newspaper industry. It is likely to continue to gain support from the commercial newspaper industry, however, because it can be used to provide cover for government policies that they really want.

Monday, September 21, 2009

Is Your Company Brave Enough to Survive?

As a professor of strategy, lately I've been getting asked quite a lot, "What can our company do to survive the downturn?" I'm sorry, but the real answer is, "Not a lot."

The market is Darwinian: the strongest ones survive. And an economic downturn is like winter in Alaska; many animals can live a happy life in Alaska all through spring, summer, and fall, but when winter comes, it's not a great place to be. It's a much tougher environment — and only the fittest survive.

If you're not very strong, if you haven't accumulated much body fat or haven't developed the ability to hibernate, I am afraid it is going to be tough for you, too. "But what can I do to become stronger? Get thicker skin? It's getting a bit cold here!" you might cry. Well, I am sorry (again), but winter in Alaska is not a great time to try and become stronger. It is a tiny little bit late for that...

But I do think there are a few survival techniques from looking at firms' downturn survival strategies, although they are not for the faint-hearted.

First, we see quite a lot of firms display what we in management academia call "threat-rigidity effects." When under threat, facing a shortfall in performance, firms are inclined to more narrowly and firmly focus on the one thing they do well (e.g. their core product or service), stop doing other things, and become more hierarchical and top-down in terms of management control.

Unfortunately, this often makes things worse, or at least prevents you from coming up with any solutions. What firms are better off doing, is opening up; exploring new sources of potential revenue and experimenting with bottom-up processes to generate such ideas and innovations. Let me give you an example.

I am in touch with a company, here in London, that provides custom-made software for all sorts of logistics systems, which they offer in combination with personnel training. Unfortunately, the vast majority of their customers are automotive companies, like General Motors and Ford... clearly not a great position to be in right now. This recession has definitely been winter in Alaska for them, and at first they went through the usual cost-cutting and rounds of lay-offs.

After a while, though, the CEO decided to try something a bit different. He initiated some processes for all employees to start generating ideas for potential new sources of revenue, which they enthusiastically participated in (it was not like they had anything better to do...). Most ideas were rubbish; some ideas were so-so, but a few ideas were really good! One of these ideas has now brought them a substantial new source of revenue.

One team had noticed that there was always one business unit doing rather well among their automotive customers; the unit providing spare parts. That's understandable; in a downturn, when people stop buying cars, more people need to have their cars repaired. And this greatly helps the spare parts units. So, this team decided to propose an inventory control product specifically aimed at the spare parts units of automotive companies. And it worked.

This is the opposite of the usual "threat-rigidity effects" — rather than focusing and becoming more narrow and top-down, this company opened up, organized bottom-up processes and tried something new.

This is a brave thing to do, when the winter blizzards are turning your ears frosty, because it feels like spending money rather than saving it. But finding the "spare parts division" among your customers might just see you through the downturn.

Sunday, September 13, 2009

CEOs seek external advice – if you pay them for it…

There is ongoing debate whether performance related pay for top managers – in the form of stock ownership, options, or other types of financial incentives – actually works. We know it alters their behavior but does it improve it?

I’ve quoted some of the research in this area before but, in a way, whether or not it does, it remains a bit strange that top managers would need performance related pay. As I have said before, do you really want someone at the helm of your company if he or she only works hard and smart if they are directly rewarded for it? On the other hand, I have to admit, no matter how rhetorical this question is intended, I do guess it is only human…

It is only human that our behavior is altered due to performance related pay; and you and I are probably no exception. The trick then, of course, is to get the right measurement system, and perhaps to no overdo it; too much performance related pay may alter the behavior of top executives in ways you had not quite in mind when putting the measures in place! We’ve seen ample examples of that over recent years…

So, how might it bias top executives behavior in useful ways? Professors Michael McDonald from the University of Central Florida, Poonam Khanna from Arizona State University, and Jim Westphal from the University of Michigan examined an intriguing aspect of CEO behavior, and that is their inclination to seek advice from others.

CEOs often seek advice on strategic issues from executives of other firms. However, we also know from research that – just like humans – they are often inclined to solicit that “advice” from friends and other people who are just like them. In such cases, it is not really genuine advice-seeking, but it serves more in a self-confirmatory fashion; people seek confirmation that what they are doing is right, and what better way to get that by asking the opinion of your friends and look-a-likes.

To examine which CEOs engage in this pseudo-advice seeking and which ones truly turn to people who might actually disagree with them, McDonald and his colleagues surveyed 225 large American industrial and service firms. They managed to obtain information on how often their CEOs sought the input of other top managers outside their own firm and how well acquainted they were to them. Subsequently, they statistically correlated that to the extent to which these top managers received performance-contingent compensation packages, and found a very clear result.

Those CEOs who had a very small performance-related pay component in their compensation package sought very little true external advice. They relied on asking their friends – and perhaps their wife, uncles, and mother – whether they too thought that what they were doing was great, splendid, and spot-on. I guess it helps people feel more confident and self-assured…

In contrast, CEOs with a relatively large performance-contingent component in their remuneration package much more often sought advice from other executives who were not their friends and who had different backgrounds than themselves. These people may be slightly scary (they may actually tell you that what you’re saying is nonsense!) but perhaps also more useful. Moreover, McDonald and colleagues showed that this true advice-seeking significantly helped the financial performance of the CEOs’ companies, in the form of an increase in the company’s market-to-book and return on assets. Thus, the scary stuff actually led to hard cash!

The pay-for-performance construction paid off; it stimulated executives to repress their “it’s-only-human” inclination to avoid asking people’s opinion who might actually disagree with you. It is much safer and more pleasant to make sure to solicit advice from people who will say that you’re splendid, but it is much more useful – and lucrative – to really put yourself to the test. And if you reward them for it, and only if you reward them for it, CEOs – just like humans – will actually be brave enough to take this test.

Tuesday, September 8, 2009

Who can downsize without detriment?

Downsizing has always been a rather popular practice in the corporate world – even for firms not in distress, attempting to boost their share price – but my guess is that, at present, executive courses such as “how to downsize your company” are the last remaining strongholds in many business schools’ executive course offering. So I thought I might as well look into what we know about the effects of such programs from academic research, to see when they can be a good idea.

Let me start by saying: not very often. On average, they simply don’t work. For example, professors James Guthrie, from the University of Kansas, and Deepak Datta, from the University of Texas at Arlington, examined data on 122 firms that had engaged in downsizing and statistically analyzed whether the program had improved their profitability. And the answer was a plain and simple “no”. The average company did not benefit from a downsizing effort, no matter what situation and industry they were in.

So why do they usually not work? Well, for starters, as you can imagine, it is not a great motivator for the survivors. Academic studies confirm that usually organizational commitment decreases after a downsizing program and, for example, voluntary turnover rates surge. Hence, downsizing is not something to be taken lightly, and should be avoided if at all possible.

But sometimes, of course, a company’s situation may have become so dire that it may not be at all possible. What then? Who might be able to get away with?

Professors Charlie Trevor and Anthony Nyberg from the University of Wisconsin-Madison decided to examine exactly this question, surveying several hundreds of companies in the US on their downsizing efforts, voluntary turnover rates, and HR practices. As expected, they too found that for most companies, voluntary turnover rates increased significantly after a downsizing program. Many of the survivors, earmarked to guide the company through its process of recovery, decided to call it a day after all and continue their employment somewhere else – a nasty and unexpected aftershock for many slimmed-down company; they became quite a bit leaner than intended!

Next, however, professors Trevor and Nyberg examined who could get away with a downsizing program or, put differently, what sort of companies did not suffer from such an unexpected surge in voluntary turnover after their downsizing program. And the answer was pretty clear:

Companies that had a history of harboring HR practices that were aimed at assuring procedural fairness and justice – such as having an ombudsman who is designated to address employee complaints; confidential hotlines for problem resolution; the existence of grievance or appeal processes for nonunion employees, etc. – did not see their turnover heighten after a downsizing effort. Apparently, remaining employees were confident that, in such a company, the downsizing effort had been fair and unavoidable.

Similarly, Trevor and Nyberg found that companies with paid sabbaticals, on-site childcare, defined benefit plans, and flexible or nonstandard arrival and departure times did much better in limiting the detrimental effects of a downsizing program. The surviving employees were more understanding of the company’s efforts, had higher commitment, or simply found the firm to good a place to desert!

In general, it shows downsizing can work, but only if you have always taken commitment to your people seriously. Instead, if your employees sense that you may be taking the issue rather lightly, they will vote with their feet. And you may end up losing rather more people than you had bargained for. Or as Fortune Magazine once observed, most firms that downsize, “rather than becoming lean and mean, often end up lean and lame”.

Wednesday, September 2, 2009


Fundamental market changes are pushing radio stations towards an uncertain future and managers and owners need to begin developing strategic responses to developments in their industry.

The challenges are being caused by declining demand for radio offerings due to lifestyle changes, the wide availability of substitutable audio platforms, and the primary content currently being offered. Audience behavior toward radio is changing and many U.S. stations now only make money for 4 to 6 hours each day. Overall, audiences are spending less time with radio and exhibiting less station loyalty than they did in the past, and young audiences are particularly difficult to attract and serve.

A major impetus of change is that audiences for music worldwide are progressively replacing radio listening with personalized playlists they have created on their computers, MP3 players, and mobile phones and by CDs on which they burned those favorites. They select music that suits their individual tastes and many have wider repositories of music in their own libraries than are offered on broadcaster playlists. Satellite and Internet radio are compounding the problem by offering hundreds of choices of highly focused music formats. These developments are increasingly making radio a less relevant platform for music entertainment delivery than it has been.

Concurrently, a wide variety of non-music programming is being offered by Satellite and Internet stations and audiences are increasingly using these services, as well as downloading podcasts on a variety of topics of individual interest from both broadcast and non-radio sources.

These problems are compounded in the U.S. because the rise of radio groups after deregulation in the mid 1990s led to national radio programmers making selections, reducing the range of genres of music and other content on radio stations. Overall, programming has become less local and less relevant as content decisions have been made elsewhere.

Advertisers sense the problem with audiences and the share of advertising expenditures going to radio is declining. Worldwide radio advertising expenditures are about 7 percent of total expenditures, down from a height of 9 percent in 1999. In the U.S. they peaked in 2002 at nearly 13 percent and are now down to about 10 percent. This downward trend is seen among most of the traditional leaders in radio advertising expenditures –Mexico, Japan, France, UK, Spain—and only in rapidly developing countries such as Brazil and China is the share spent on radio on a clear upward trajectory.

Another indicator of the problem is seen in the considerable weakening of sales prices for radio stations in recent years.

Radio station owners and managers need to start spending a good deal of time thinking about what is happening to their industry and how they will need to change their place in the media use mix. They need to seriously consider what business they are in and what unique value they produce so they can reposition their functions for audiences and advertisers.

The structure and offerings of the radio industry have been adjusted several times during its 9-decade history, but the last time the industry needed to recreate itself so dramatically occurred with the arrival of television. The arrival of television resulted in radio shifting from a general entertainment and information medium to a music entertainment platform in many nations. In the U.S., broadcasters on A.M. radio later shifted toward a talk and sports platform after F.M. developed and music migrated to that spectrum, creating new opportunities on both bands.

Repositioning radio again will not be a simple task, but it is one the industry needs to begin undertaking now. If radio managers do not start thinking ahead about the negative trends appearing in their industry, they will soon experience the alarm and fear that is pervasive in the newspaper industry. It is better for companies and industries to act before crises develop fully because they can respond to and help direct the course of change rather than merely experience its negative effects. Whether decisive action will emerge in the radio industry before we reach that point remains to be seen.