Saturday, June 23, 2012

Pressure and Clever Ideas: How Teams Mess Up

This week we have been treated to news of firms under pressure trying clever new ways of competing. Microsoft wants to improve its revenue from Skype, and is going to place advertisements during calls. The ads will be linked with what Microsoft knows about the users in the call, but they have decided against making the ads responsive to the conversation topic because of concerns it might be "creepy." Best Buy are launching a sales associate training program in order to reduce "showrooming," or people looking at a product in a store before buying it from a competitor online.

Both of these initiatives might irritate customers. Skype users have been mostly left alone after Microsoft acquired the company, and are now going to have to get used to two changes: ads, and possibly ads that are so well targeted that they cause discomfort. Of course, we still don’t know how well Microsoft can target the ads, but they will clearly profit more from the ads the more accurately they can target them. Training sales associates to reduce showrooming sounds fishy because the main reason for showrooming is the price difference between items bought in the store and items bought on the web. If Best Buy wants to reduce showrooming by training instead of by reducing that gap, it is reasonable to assume that the training will include high-pressure sales tactics.

So who came up with those ideas? Probably there was a team in action in both cases. Teams are great ways to come up with solutions to problems, especially creative solutions, and they can be made to work hard under pressure. Pressure that naturally comes from a firm needing to improve its performance and pressure artificially piled on by supervisors of a team influences how teams work. But there is a problem. As Heidi Gardner has shown in recent research, pressure not only makes teams likely to come up with solutions, it can also reduce the quality of those solutions. This is because teams under less pressure are better able to pool the expertise of their members to produce solutions that integrate knowledge, while teams under high pressure are too quick to settle on solutions and too deferential to their leading members.

So is there a cure to this problem? For major decisions or development efforts it seems strange that teams should be put under pressure at least initially, because the first steps are too important to rush through. Also, because any team, not just one under pressure, might go off on a wrong path, others should also check the solutions. Of course, all these steps may have been taken by Microsoft and Best Buy, and the initiatives may turn out to be successful in the end. We can still be skeptical because of the poor track record of organizations under pressure, and because of what we know about teams under pressure.

Monday, June 18, 2012

Rajat Gupta’s Insider Trading Conviction: One Network to Bring Them All and in the Darkness Bind Them

Former McKinsey & Company head and Goldman and Procter & Gamble board member Rajat Gupta has been convicted of securities fraud and conspiracy for giving away confidential information from boardroom meetings. This makes him the latest in a string of convictions related to the insider trading scandal centered on hedge fund Galleon Group. The court cases since the scandal have revealed a pattern of information collection from board directors followed by quick and profitable trades, with involvement all the way to Galleon’s top. Its founder Raj Rajaratnam was convicted in October 2011, and many Galleon traders have also been convinced, as have their information sources.

An irony of Rajat Gupta’s conviction is that he appears not to have profited from the inside information he passed on. Rather, he passed on information, and Galleon traded on it, without any trades on his own behalf or (traceable) kickback. Indeed, prosecutors were quoted saying that his information leaks were “motivated not by quick profits but rather a lifestyle where inside tips are the currency of friendships and elite business relationships.” This quote sounds familiar to me, because along with Gerald Davis I have studied how boards of directors form their own norms of conduct, as reflected in the type of governance innovations they adopt. We found that they indeed determine norms through interacting with other board members, though we did not study anything illegal such as violating confidentiality.

But the investigation and conviction has another irony as well. A recent Wall Street Journal article has a map of the network of individuals implicated in the Galleon trades, as well as their current status in the court system. Of particular interest are those with status pleaded guilty (cooperating witness), because they were used (along with wiretaps) to break the case open. I study networks, and one glance at the map is enough to be impressed with the investigation. The central person they targeted, Galleon head Raj Rajaratnam, is surrounded by cooperative witnesses, and his closest associates are also nicely bracketed by cooperating witnesses. Clearly the investigators were able to follow the network of individuals involved through traces like suspicious trading patterns, phone call records, and eventually wiretaps, and once they knew who was spilling information to whom they went to work turning some witnesses in order to get at the main targets of the investigation. And hedge fund traders and leaky board members appear to be easy to turn cooperative compared with other organizations that the FBI has dealt with in the past. In Rajat Gupta's case they did not even need a direct wiretap or cooperative witness because the other evidence from phone records and suspicious trades was so compelling.

So, this incident really deserves the Tolkien headline: One network to bring them all and in the darkness bind them.

Davis, G. F. & Greve, H. R. 1997. Corporate elite networksand governance changes in the 1980s. American Journal of Sociology, 103(July): 1-37.
Bray, C. Rothfeld, M, and R. Albergotti. 2012/6/15. Insider Case Lands Big Catch. Wall Street Journal. Interactive graphic (may require subscription):

Monday, June 11, 2012

WaMu: The Mutual Bank that De-Mutualized and Melted Down

Wall Street Journal contributor Kirstin Grind has written a book on the downfall of WaMu, the second largest bank failure in the US (so far) and the name that has come to symbolize risky mortgage lending in the USA. I expect to enjoy reading it when it comes out, and learn more about the inside story. Here is some of what we know already.

WaMu started as a mutual bank, meaning that it was owned by its depositors. Mutual Banks come in different forms, but traditionally they are focused on savings deposits and mortgage loans rather than loans to businesses. They usually have low interest rates on loans and instead select their borrowers carefully to have low losses. Mutual banks are a traditional, one might even say old-fashioned, form of bank that is often heavily committed to the local communities and avoids having many branches. Hayagreeva Rao and I are doing research on such community organizations, and we have found that they can have a big and positive impact on the development of their communities.

For WaMu, however, the period as a mutual ended in 1983. Mutuals can de-mutualize, and this is done both in banking and in insurance (many insurers are also mutuals). De-mutualization means that they turn into regular joint-stock firms, but often they keep their name. There is nothing preventing a non-mutual from calling itself a mutual. They can keep their business practices too, but most often do not. Mutuals are very efficient organizations as long as they don’t grow, but de-mutualization means that they can grow quickly, adding branches and getting new lenders. Shortly before failing, de-mutualized WaMu had tens of thousands of employees and hundreds of branches, and a strong electronic-banking presence. More worryingly, due to permissive loan practices and incentives for loan generation, it has a loan portfolio that was bloated and risky when compared to its capital. Losses on loans started to mount, triggering a depositor bank run that was fast and furious thanks to the ability to transfer money electronically: it is estimated that 16.7 billion dollar in deposits left WaMu in nine days.

What happened? WaMu had become a commercial bank with commercial bank ambitions but a shortage of commercial bank experience. It also had some bad luck: 2008 was not a good year for having a large mortgage loan exposure, because the subprime loan crisis was in full swing. Its failure shows some of the problems of changing from one form of organization to another. Strategies can change quickly, but the capabilities to back those strategies take longer to develop.

In the book she reports another side to the story too, however, and one that shows in a better way how WaMu did not totally outgrow its roots as a mutual organization. When WaMu started experiencing problems collecting loans, they sent out a team to investigate how they might improve payments from their borrowers. This team made interviews on video tape documenting how people had been blindsided by the fall of the housing market and found themselves unable to pay. When they showed this footage to the president of WaMu's Home Loans Group, David Schneider, he ordered a revision of loan collections to take a softer approach. In the end, it is hard for a firm with mutual in its name and history to escape the idea that mutuals are a way for people to help each other.

Greve, H. R. & Rao, H. 2012. Echoes of the past: Organizational foundings as sources of an institutional legacy of mutualism. American Journal of Sociology, 118(November).
Grind, Kirsten. 2012. A Bank on the Run: How WaMu's Demise Hit Home. Wall Street Journal, June 12 2012.
Grind, Kirsten. 2012. The Lost Bank. The Story of Washington Mutual, the Biggest Bank Failure in American History. Simon & Schuster.

Friday, June 1, 2012

Technology Races: To the Victor belong the Spoils

J.P. Eggers just published an article that looks at the outcome of the technology race between LCD (liquid crystal display) and plasma display technology in the flat screen market. We know the broad story of how the market has developed over time: both technologies were tried initially, then LCD became dominant, and then the tables turned so that plasma is now resurgent. What the paper adds is an interesting take on what happened to each firm. It is useful knowledge for managers interested in how to place bets on competing technologies, and it also tells a lot about how organizations make decisions.

Firms that bet only on plasma early on did more poorly in the technology race as LCD became dominant, as one would expect from them having bet on the wrong technology. Firms that developed both technologies at once also did more poorly than those that bet on LCD only, again a reasonable result given that specialization is better if it is in the right decision. But here is the big surprise: when plasma re-emerged as the better technology later, the firms that entered with plasma technology initially still did worse than those that entered with LCD.

How is that possible? If knowledge stays in the firm, they should have been able to use the early investment to recover. But what seems to have happened is that managers learnt too much from the initial negative experience with plasma. Not only did they learn that plasma was the wrong choice early on, but the experience of placing the bet on plasma created greater skepticism either against that technology (even as it improved), or even against the effectiveness of research and development in general. Clearly they were over-learning from this experience, and that held back the firm technology development.

The disturbing lesson is that choosing the right technology has consequences beyond the first technology generation, but it is still necessary to do so before the advantages are known (late entrants also did poorly). So the spoils really belonged to the victors, who not only enjoyed LCD dominance but were also able to change to plasma with greater ease than the original plasma firms.