Who should lead Procter & Gamble out of the crisis?

Procter & Gamble (P&G) has had poor financial results as of late, and the Wall Street Journal is reporting that its CEO Robert McDonald is under pressure from hedge fund manager William Ackman. Ackman is convinced that Mr. McDonald is not the right person to lead P&G because of apparent inaction in the face of a three-year run of profit declines. I have earlier argued that it is simplistic to just argue for CEO replacement when things go poorly, and I could make the same case here: P&G has a high-quality, high-price position in many markets, which means it will temporarily suffer when the economy is doing poorly. In the long run it may do better by holding firm and waiting for the recovery than by changing its position.

However, the Wall Street Journal on P&G also documents clear mistakes that cast doubt on their current leadership. They may need to rethink their strategy. Is Mr. McDonald the right person to do that? Recent research by Adam Kleinbaum in Administrative Science Quarterly suggests that we can know the answer by looking at Mr. McDonald’s career. Mr. McDonald was a Tide brand manager before becoming a laundry business manager, then had stints in the Philippines and Japan before taking over regional responsibilities in Northeast Asia. His last functional job before COO and CEO was (surprise!) Fabric Care. In other words, Mr. McDonald was a laundry manager in a company that gets a large bulk of its revenue from laundry products. I don’t know for sure what a typical P&G managerial career looks like, but his seems pretty typical.

Adam Kleinbaum’s point is that managers with typical career paths get narrow interpersonal networks with limited opportunities to connect people (broker) across different areas of the organization. This matters because brokerage across different areas of the organization lets the manager contact friends who have different types of information than their immediate reports and learn about ideas and opinions that they would not otherwise have known. Such ideas from separate parts of the information, in turn, can be assembled like pieces of a puzzle to form new initiatives and renew the strategy. The usual tools for making new strategies, like working groups and committees, are often more political than such networks of friends and can be less frank. It is reported that they have been pure talking shops during Mr. McDonald's time.

There is a good chance that William Ackman wants to force renewal of P&G by replacing Mr. McDonald with someone from outside the organization. Given the size and complexity of P&G, it would probably be difficult to find anyone who could take on that job and be effective right away, so that would likely be a mistake. On the other hand, if my guess about Robert McDonald’s career path is correct, he is not a likely source of renewal for P&G either. The upside is that a large organization such as P&G should have a large pool of the type of manager that Adam Kleinbaum calls “organizational misfits”: people whose experiences have been so unusual that they have much better connections across the organization than the average P&G manager. Maybe the P&G board of directors should be looking for a few good misfits from within its ranks?

Glazer, Emily, Ellen Byron, Dennis K. Berman and Joann S. Lublin. 2012. P&G’s Stumbles Put CEO on Hot Seat. Wall Street Journal, Sep 27 2012.

Kleinbaum, Adam M. 2012. Organizational Misfits and the Origins of Brokerage in Intrafirm Networks. Administrative Science Quarterly, 57.

Wikipedia. “Robert A. McDonald.” Accessed Sep. 27 2012.

Renesas Electronics: When the Network Cares about the Firm

Today there was news that a government-backed Japanese investment fund may be entering the fray to buy domestic firm Renesas Electronics corporation after takeover firm KKR has issued a bid. A piece of everyday protectionism, or is there a bigger story behind this action? Well, let us start with the fact that the current high yen means that there are more Japanese firms and funds buying abroad than the other way around, so Renesas is special.

Renesas makes specialized controllers that are used in a variety of industrial applications, and is best known for its high market share in the automotive market. In fact, car makers, who are normally wary of being too dependent on any one supplier, trusted Renesas so much that it came as a nasty shock to them when the great earthquake and Tsunami one year ago devastated some of its manufacturing facilities and caused delays in the delivery of essential parts. It was able to recover quickly in part from a massive recovery effort from its suppliers and customers, but it is still not healthy economically. As a high-quality firm with economic problems, it is a classic takeover target.

Strictly speaking that should not worry the government, because good takeover houses can inject necessary capital and improve their target before reselling them. These firms make a living by improving their target, not by destroying them. But the likely reason the government is worries is probably that Renesas’s customers are worried. As an essential supplier to firms across a wide range of industries, it sits as a hub in a network that creates a lot of value in aggregate. No doubt some of that value goes to Renesas, but not all: its customers also benefit a lot. What worries them now is that a new owner will take a cold hard look at each relation and cut those that don’t seem to pay off. That could destroy significant value for the customer firms and even the economy as a whole.

This is why the customers are now rallying to have someone – either the government or themselves – rescue Renesas. There is a network creating value that might go away if one isn’t careful, and there is merit in having a friendly owner. As Renesas is currently managed, the network around Renesas is worth much more than Renesas itself. That might be changed under new ownership such as KKR, or even under the same ownership and a tougher set of managers, but its customers are pretty happy about the current arrangement. Later I plan to write more about what makes networks valuable. For now, let the games begin: KKR versus the Japanese government.

Schlesinger, J. M. and B. Frischkorn. 2012. Japanese Government-Affiliated Fund Weighs Renesas Bid. Wall Street Journal, Sep 23. 2012.

I See You: Face-saving Helps Negotiators Understand Each Other

We just completed a long education for executives for a World Fortune 500 corporation. The program included some negotiation exercises, and we talked to the participants about them afterwards. They found the negotiation stressful, and especially because the emotions were so strong when negotiating within the corporation and the same culture (all of them were from the same nation; I prefer not to say which one). It would have been easier to negotiate with outsiders, and even foreigners, they said.

It struck me as interesting that these managers were relatively unfazed by cross-cultural negotiation compared to negotiating with their compatriots. But, I should not have been surprised, because there is still much we don't know about negotiation. This is definitely odd given its importance for business. To take one example, the potential $34 billion merger between diversified commodities firm Glencore and mining firm Xstrata has been a long saga of negotiations between the two firms, as well as with large shareholders including some sovereign wealth funds. Currently, the tie-up seems to hinge on whether the Glencore can agree with Xstrata shareholder Quatar Holding on the price of Xstrata shares. One can imagine the stakes when representatives of these firms meet.

A key task in negotiations is to come to a common understanding of the situation – a mental model. When the parties even disagree on what is true and what is relevant and important, it is hard to even know how to negotiate, let alone reach an agreement. This is one of the key challenges in cross-cultural negotiations, where the gap in mental models is greater. It is one of the reasons I was surprised to hear managers express comfort with that situation. It turns out that we can explain who is more successful in reaching common understandings. In recent research, Liu and coauthors found that a concern for face-saving (for oneself and the other) helped negotiators get to a better common understanding and shared mental models. This was true for Chinese and US negotiators. Concern for face-saving also gave higher creation of value through finding win-win contracts, and higher satisfaction with the process.

It is easy to explain these findings, and to apply them. Face-saving means that the individual is paying attention to the concerns that the other is expressing, because face-saving in negotiations is something both sides have to collaborate to accomplish. Attention to the other also helps understanding and value creation. Concern for face-saving differs between cultures, but individuals also differ in face-saving within the same culture. In order to benefit from this knowledge, managers putting together negotiation teams need to be aware that the most assertive negotiators may be ineffective in inter-cultural negotiation: that style is the opposite of what a face-saving negotiator will use, and it risks destroying value.

Liu, L. A.,Friedman, R., Barry, B., Gelfand, M. J., & Zhang, Z.-X. 2012. The Dynamicsof Consensus Building in Intracultural and Intercultural Negotiations. AdministrativeScience Quarterly, 57(2): 269-304.

Sharing Less to Learn More: A Radical Rethinking of Productivity

Sometimes management scholars get findings that shake up established truths and make us rethink how firms function. These findings are often directly important to managers as well, because they question common practices that are used with the intention of producing better decision making, higher productivity, and greater competitive strength – but may turn out to have the opposite effect.

Ethan S. Bernstein published a paper "The Transparency Paradox: A Role for Privacy in Organizational Learning and Operational Control" that has just such a finding. The established truth is that transparency in production processes increases productivity because it allows faster learning from others, as problems are immediately seen and effective solutions can immediately be learned by others in the same situation. The idea is to use visibility along a production line to drive a fast learning curve of efficiency increases, and it is a key component of the vaunted Toyota Production System and Total Quality Management practices.

The problem is, his research showed it to be false. In a study design that combined observation of production practices with a controlled experiment, he made some very interesting observations. First, he showed that workers concealed production practices from managers even when production lines were fully visible. Their reasons for doing so was that they had formalized procedures for production steps (also a key quality control practice), and when they found ways to do things faster but still with high quality they preferred to do them under-cover rather than go through the procedure for changing the procedures. But that meant they were worried about getting caught. Second, he showed that the time and effort spent concealing these practices was a form of waste that was especially high when the production lines were visible, because managers could easily see far along the line. Third, he showed that the economic effect of this concealment was big. When some production lines were given privacy (through the kind of curtain that one sees between hospital beds!) while others were left open, the private lines outperformed the transparent ones by 10-15%. That’s a big number in manufacturing efficiency; especially for this firm, which was a contract manufacturer that got all its profits from making goods more efficiently than other contract manufacturers.

So what to do? Clearly, researchers need to find out whether there are conditions that make concealment likely and costly. It is not clear that visible production lines are costly at Toyota and all other firms using them too. If not, then we have to ask why. Managers need to reconsider the role of visibility in manufacturing efficiency. If privacy can give a 10 plus percent improvement in some firms, possibly also theirs, it is a good idea to reassess what they are doing and maybe hang some curtains as an experiment. In a decent-sized manufacturing facility, it takes less than an hour of more efficient production to cover the cost of those curtains!

Bernstein, Ethan S. 2012. "The Transparency Paradox." Administrative Science Quarterly 57(2):181-216.

See also his blog entry, which has a photo of the production line before and after.

Crocodiles in the Water: Incentive Plans and Employee Responses

Today I went to the Sungei Buloh wetlands reserve in Singapore and spent time looking at a flock of storks that were feeding in a pond. At some point four of them came across a crocodile party hidden in the water. They were interested in this unfamiliar creature, but decided that it was safer to cross it at the tail end than the front end (see the picture below). Good choice; even a full crocodile will be sorely tempted when food walks in front of its mouth.

I can imagine that bankers are also worried about crocodiles in the water these days, as they are putting in place new systems to control risk while rewarding high performance in response to rule changes and various cases of misconduct (see my earlier posting). The crocodile, of course, is that the newly designed systems will backfire and cause damage, just as the old ones did. I can imagine that much effort is spent thinking about the design of these systems, and probably it is also helped by economic models of how individuals respond to incentives.

What the bankers probably know, and anyone designing an incentive system should know, is that their best planning and the best economic models still is not enough ensure that the system will be passing the tail end of the crocodile, and not the rear. The problem has two sides: the manager creating the system is not sufficiently rational, and the employee inside the system is more creative than the manager thinks. As a result, the employee gradually learns to trick the system in ways that the designer had not imagined. Various pieces of evidence in favor of this proposition has been available before, often from blue-collar workers on piece-rate systems, but now Tomasz Obloj and Metin Sengul have produced strong evidence on incentive system in banking, no less.

They showed that a new incentive system initially increased productivity and gave a high share of this increase to the bank, while still rewarding the employees. Over time, two things happen. First, the employees learn to capture more of the value created by their extra productivity. Second, the tricks they use in order to make that happen are risky from the bank’s point of view, because they can raise costs and may lead to lost sales (the article has the details on why that happens, as well as many other interesting findings).

The storks could safely navigate the crocodile in front of them because it was only half hidden in the water. Managers designing incentive systems are facing future employee behaviors that are completely invisible because the employees themselves would not have thought of them until they saw the incentive system. How confident are we that the managers will be right more often than the storks?

Obloj, T. & Sengul, M. 2012. Incentive Life-cycles: Learning and the Division of Value in Firms. Administrative Science Quarterly, 57(2): 305-347.

Knight Capital Group: Did an Accidentally Evil Computer Knock Down a Trading House?

Knight Capital Group (www.knight.com) is a trading house that helps others access financial markets by executing their trades. It serves as a designated market marker, which means that it provides buy/sell orders so that others can always execute a trade against it, for more than 600 securities on the NYSE and NASDAQ stock exchanges. It also serves as a market maker for many other securities. Because market making and trading are key activities in financial markets, requiring reliable and honest dealing, it is no wonder that its web site carries the slogan “The Standard of Trust.”

So what is one to think of the incident that took place on August 1, where a flurry of trades from Knight led to it accumulating a trading position of $7 billion, far more than it could sustain, leading to a concerted effort to drive the position down to a less risky level? In its rush to reduce its risk exposure, it inevitably sold some of its holdings cheaply (also known as a fire sale), and ended up losing $440 million. Even against the standards of losses that we have become used to in this financial crisis, it was a very bad day for Knight. Since then, Knight has been able to find investors with fresh capital of $400 million, essentially the same amount that it lost, which will stabilize the firm if it suffers no more catastrophic losses.

It has also investigated the reason for the sudden surge in purchase orders. Here the information is a little unclear, but Wall Street Journal reports an unexpected reason: A botched update of computer systems. What seems to have happened is that the new computer systems were installed and worked correctly, but they were not installed on all trading platforms (each system has to be replicated across all trading platforms). This led to old systems trading on some platforms while new systems traded on others, and apparently it was the old systems that went awry. Exactly how this is possible is unclear because the old systems had obviously worked well before, but a possible reason is that the old systems no longer posted their trades to the risk management system, so the contribution of their trades to the total risk went undetected. This explanation is speculative, but if the reports that the new system functioned well are correct, then the huge buildup of buy orders suggests that there must have been some information being dropped from the risk assessment system.

This tale of computer error starts and ends with human error. People failed to install the new system across all trading platforms, and people failed to stop trades when NYSE trading-floor officials noticed the unusual trades and warned Knight that it was the source of unusual trading movements. But the key point here is that the computer systems were so fast and effective in their work that there was little time to stop them once they got going. This is a phenomenon well known from research on organizational accidents. It is also a major cause of misconduct, as I have noted in work with colleagues Don Palmer and Jo-Ellen Pozner. In the case of Knight, the trades were arguably so hazardous that it is a judgment call whether the firm has upheld its duties for proper risk management (lawsuits, anyone?). However, assigning responsibility will be difficult because these trades were accidental, and the accident occurred in the interface between fast and faulty computers, and slower humans trying to catch up.

Clearly this story has important lessons for how organizations think about management of risk and quality control, especially as they make more and more of their key systems automatic. It is also a reminder that financial markets contain human traders, who can be quite faulty in their judgments, and replacing them with computers sometimes makes the judgments even worse. And finally, if you have ever had a software upgrade go bad, think of Knight Capital and how much worse it could have been: I doubt you have ever experienced a computer upgrade that withdrew money from your bank account and distributed it to strangers.

Greve, H. R. , Palmer, D. and Pozner, J. 2010. Organizations Gone Wild: The Causes,

Processes,and Consequences of Organizational Misconduct. The Academy of Management Annals, 4: 1, 53 – 107.

Patterson, S., J. Strasburg, and J. Bunge. 2012. Knight Upgrade Triggered Old Trading System, Big Losses. Wall Street Journal, 15.8.2012.

The Academy of Management: Studying those who manage you

This week the Academy of Management has its annual meetings in Boston. The Academy of Management is a professional association for scholars who do research and teaching on management and organizations. It has more than 19,000 members, mostly professors but also others with an interest in management research. I will be there.

What do management scholars do, and why should there be an association for them? Maybe we can begin by asking whether management is an important occupation. Taking US data, simply because they are so easy to find, the Bureau of Labor Statistics reports that 6.183 million people are in management occupations in the US (267,000 of them are chief executives) of a total of 128 million persons employed. That comes to 328 managers per management scholar, which may seem like a lot of scholars per research subject! But a more relevant figure is that 4.8 percent of all employed individuals are managers. Those are just the professional managers, because it omits owner-managers who manage their own business. Still, it is only a small part of the picture. Management is important because it affects those who are managed as well as the managers, and as I just noted there are 128 million people employed in the US. That’s a more reasonable 6,734 per researcher, but the Academy of Management is an international association and its scholars seek to understand management all over the world.

What do managers do that might be interesting to study? At the smallest level, managers set the conditions and climate for individual work. For good or for bad, they have a big impact on well-being at work, personal and professional development, and teamwork. Remarkably, one of four persons in the US report having missed work as a result of work-related stress. It seems important to investigate how managers affect workers, and how workers affect each other. 

Moving to larger outcomes, managers are in charge of organizational units that function either for the regular production of the organization or for its future development, and though they rely on others for advice, they are often left with the final decision. Decisions matter. We just got news that the iPhone was nearly stopped during development because it seemed flawed beyond hope (yes, if you have one, pull it out of your pocket and look at the nearly-canceled product). That was a story that ended well, but many other close calls have gone the wrong way, leaving managers ruing missed opportunities. In some cases, incorrect decisions have had consequences that can be measured in lost lives, as when managers in charge the upkeep of safety standards have been slack. Managers also design organizational structures and procedures, and these can make a major difference to the effectiveness and quality of organizational work. The improvements gained by many organizations (not all!) through quality and six-sigma programs testify to the importance of organizational design.

At the broadest level, managers work together to form and execute strategies for their firms. Finnish company Nokia rocketed to prominence through its early and successful entry into the mobile phone market; it has fallen hard as a result of being slow to commit to the newer generation of smart phones. As is often the case with strategic decisions, it is a lot easier to point to a mistake afterwards than beforehand; it was by no means clear when and how the smart phone market would develop. 

Strategies in turn determine the viability of the firm and the livelihoods of many who depend on it, either in the firm itself or in the many other firms that depend on it, or its employees, for their business. I just clicked on a web site listing foreclosures in Detroit, center of the US auto industry, and I found 6,880 listings including 3-bedroom house going for $15,850 ($11 per square foot). I can think of no better illustration of what strategic decisions gone wrong can do for a community that is heavily dependent on a few firms. Going to the other end, the many successes in Silicon Valley has led prosperity in its communities, with a similar house as the Detroit one going for $567 per square foot. For that price, let’s hope the Silicon Valley house has been maintained well. And more importantly, let us make sure that the research done by the 19,000 management professors can provide some help for firm strategies, organizational structures, management decisions, and workplace conditions around the world.