Business at a Crossroads The Crisis of Corporate Leadership_7 pdf

Two other “big four” firms, Deloitte and PricewaterhouseCoopers, also made it To begin our examination of what can be done to adapt big business to its more challenging environment, this

effective way to run large enterprises The question we turn to in the

next chapter is whether other forms of enterprise could emerge to

chal-lenge CEO-led companies

References

1 “Bankers Can Learn from Sport about Fair Play on Pay,” Financial Times, February 28,

2009.

2 Times Books, 2002.

3 “Thain Behavior Bankers Need to Start Seeing Themselves as Others See Them.”

Finan-cial Times, January 24, 2009.

4 “Why do Dominant Personalities Attain Influence in Face-to-face Groups? The

Competence-Signaling Effects of Trait Dominance.” Journal of Personality and Social Psychology, 2009,

Volume 96, Issue 2.

5 Time, February 11, 2009.

6 “Seven Ways to Attract Analysts and Investors,” Corporate Board Member, Spring, 2001.

7 Simon & Schuster, 1989.

8 “Empowerment: The Emperor’s New Clothes,” Harvard Business Review, May–June

1998.

9 Allen & Unwin, 2006

Reforming big business

The hierarchical corporation run by, or rather under the control of, an

omnipotent CEO, is not the only form of enterprise making a decent

living these days There are well-established traditions of dual

leader-ship in publishing (editor/publisher) and the theatre (director/

producer) Joint ventures, strategic alliances and other inter-firm

collab-orations comprise another class of enterprise in which control is in more

than one pair of hands (see Chapter 9) and the partnership model still

thrives in professional services, such as law and accountancy

By and large, professional partnerships seem to have done a better

job at adapting to what people want from their work, and in their

work-places, than large joint stock companies KPMG in the U.K., the U.K

member of one of the “big four” global accounting networks and an

organization I happen to know quite well, was ranked “the best big

company to work for,” in the Sunday Times 2009 “Best companies to

work for” survey It was the third time KPMG had come first in the

five-year-old ranking It has never come lower than third Two other

“big four” firms, Deloitte and PricewaterhouseCoopers, also made it

To begin our examination of what can be done to adapt big business

to its more challenging environment, this chapter will discuss other

enter-prise forms that are emerging from the undergrowth, which may

chal-lenge and, in some cases, are already challenging, the CEO-led MuBE

The large CEO-led company is vulnerable to challenge, because it’s

not as solidly based on foundations of contemporary economic logic as

it appears We have already discussed, in earlier chapters, its accidental

origins and contingency – its emergence, in the mid-19th century, from

a number of fortuitous circumstances that prevail no longer

Moreover, a case can be made for arguing that the MuBE wasn’t just

the creature of the economic circumstances prevailing at the time of its

birth, but was also a social construction that emerged from the personal

prejudices, interests, relationships and ambitions of its creators, as much

as from those natural economic laws to which Adam Smith attributed

the rise of capitalism

To paraphrase Khurana when he describes the external CEO market

as a “social construction,”2 to call the CEO-led MuBE a socially

constructed institution is not to say that it is an institution in the normal

sense It is an institution in the sociologist’s sense: a pattern of practices,

relationships and obligations so taken for granted that they assume the

status of rules governing thought and action

This isn’t to say there are no natural economic laws Any business

institution, whether or not it’s socially constructed, must comply with

fundamental economic logic if it is to survive and prosper But there is

scope, within that constraint, for a wide variety of enterprise forms, all

of which will be socially constructed to some extent As Khurana

pointed out, one of the most important lessons of the sociology of

knowledge is that “very little in society had to be the way it is.” An

institution that was socially constructed in one way could have been

constructed in many other ways “Part of the process of social

construc-tion is to camouflage this fact, since society becomes more stable, when

people accept institutions as simply given and share a common

explana-tion for events.”

Roads not taken

An irony in the evolution of forms of enterprise is that while the early

American railroads were producing Chandler’s MuBE (multi-unit

busi-ness enterprise) they were experimenting with a different form of

enter-prise which, had it been allowed to develop, may well have stopped the

MuBE in its tracks, so to speak.3

The weakness of the early railroad systems was that roads entering

a terminal city from different directions had no direct rail links and,

because they used different gauges and equipment, the cars of one

road could not be transferred to the track of another In 1865 the

Boston Board of Trade put the cost of unloading and reloading freight

between Boston and Chicago at over $500,000 a year These high

trans-shipment costs were in no one’s interests, so the roads got

together and agreed to standardize gauges, equipment and

proce-dures As a result of this inter-firm cooperation, by 1880 a rail

ship-ment could travel from one part of the country to another without a

single trans-shipment But standardization increased the intensity of

competition between roads Because railroads are capital-intensive,

they have steeply declining marginal costs and their economics are

extremely volume-sensitive A small change in traffic could turn a

profitable line into a loss-maker and vice versa Railroad managers

were, for this reason, under considerable pressure to poach business

from rival lines by aggressive advertising and rate cutting Such

competition is dangerous in a highly capital-intensive industry, because

once the line has been built, it is worth taking new business at prices

that cover variable costs Since a road’s variable costs were only a small

proportion of its total costs competitive rate-cutting, if left unchecked,

would continue to way below breakeven The solution was for rival

lines to cooperate on setting rates in the same way as adjacent lines

had cooperated on connections

Federations were established with their own legislative, executive

and judicial bodies to set standard rates When they too failed to prevent

periodic outbreaks of rate cutting, the major trunk lines signed various

agreements, culminating in the formation in 1878 of the Joint

Execu-tive Committee, chaired by Albert Fink, to approve rates calculated by

sub-committees and associations throughout the country Fink believed

this cartel arrangement was the only way to prevent the “centralization

and absorption of the roads under the absolute control of one or a few

persons It makes the separate, individual existence of these roads

possible … puts a check on the consolidation of [the industry, and]

secures all the advantages of consolidation without its disadvantages.”

But he realized this solution relied on “the intelligence and good faith

of the parties composing it” and when he and his allies were unable to

persuade Congress to give his committees’ rulings legal sanction, the

whole system of associations and sub-committees fell apart, and it was

just a matter of time before the “centralization and absorption” Fink

feared became a reality

Chandler admitted “such co-operation might have worked” –

managers might have been more rigorous in maintaining rates, and

might have worked more closely with Fink in seeking out and fining

violators of agreements It’s certain that if the cartel agreements had

been legally enforceable the costs of breaking them would have been far

higher “Given the basic nature of railroad competition,” Chandler

concluded, a “legalization of the cartel arrangements was probably the

only effective method to control competition and so remove the

incen-tive for system building.” Sadly for this early flowering of a form of

enterprise which might have challenged the MuBE for the position of

“boss” institution in business, Congress was in no mood to sanction

what seemed, to most Americans, to be price-rigging The 1887

Inter-state Commerce Act outlawed the Joint Executive Committee’s pooling

arrangements and the scene was set for the epic battle between the

speculators, led by the “Mephistopheles of Wall Street,” Jay Gould, and

the “system builders,” led by the Vanderbilts

Insofar as Fink’s failures opened the way for system builders, the

MuBE itself, like the CEO market (see Chapter 5), can be seen as a

social construction built not by inexorable economic logic, but by a

scheduler’s blunder on the Western Railroad in 1841, the failure of the

American railroads to adopt the telegraph earlier, the lack of price

disci-pline in Fink’s cartel, Congress’s refusal to give legal sanction to the

cartel’s price agreements, and the prejudice against price-fixing, which

led to the Interstate Commerce Act

The pooling arrangements Americans had objected to as price-fixing

(and Congress duly outlawed) effectively developed anyway, within the

“systems” built by Cornelius Vanderbilt and others They were required

by the industry’s capital-intensity When effecting them by a cartel

within a disintegrated industry was proscribed, system building became

the only option

The U.S electricity utility industry is also a socially constructed

institution, according to economic sociologists Mark Granovetter,

Patrick McGuire and Michael Schwartz In their paper Thomas

Edison and the Social Construction of the Early Electricity Industry in

America,4 they argued that, when the industry was born in the

1880s, three development roads were open: power generation at the

household, or neighborhood level; public ownership of generation

and distribution grids; and private companies, serving large areas

from central power stations That the U.S electricity industry took

the third road was not due, according to Granovetter, McGuire and

Schwartz, to any compelling economic case for such an

arrange-ment, but to interactions within a social network consisting of trade

associations, interlocking directorships, and generating equipment

manufacturers

Another road not taken was the plan to split “Big Blue” (nickname

of IBM, until it was robbed of the PC market it had dominated by a

“multi-agent enterprise”; see under Linux below) into a brood of “Baby

Blues.” Louis Gerstner abandoned the Balkanization plan when

appointed CEO of IBM in 1993, and gained much kudos for turning

the ailing giant into a different, and subsequently successful, IT services

company But who’s to say the Baby Blues would not have, collectively,

been equally if not more successful?

A fractured landscape

If you asked an alien economist from a distant star system how the

modern, CEO-led company could be adapted, to suit today’s business

environment, the dude might be either cryptic, and say: “Chop off their

heads,” or unhelpful, and say: “If it is adaptation you want don’t start

from here.”

Where would you start? If you had a clean sheet of paper how would

you go about constructing a business institution perfectly adapted to

the modern environment?

The first step, if you’re persuaded that the institution would, as well

as complying with natural economic laws, need to be “socially

constructed” to some extent, would be to list the qualities that most

people want in their work and workplaces The list suggested in Chapter

1 included “free,” “fair,” “reasonable” and “decent,” and distributions

of primary goods including income, wealth, power and the bases of

self-respect, consistent with Rawls’s “difference principle.”

The second step would be to consider the environment in which

such people with such desires will construct business institutions One

quality that will be immediately apparent is that the environment is

infinitely more varied and complicated than the environments in

which the U.S railroad and power industries chose their paths Many

more roads are open, to many more people, with a wider variety of

skills and aptitudes And modern communications, particularly the

internet, create a space for the social construction of a business

insti-tution that spans the globe For today’s business instiinsti-tution builders it

is this enormous increase in complexity and the vastly greater number

of challenges and opportunities it brings with it, that distinguishes

most clearly their environment from that of the mid-19th and early

20th centuries

To illustrate the importance of this difference and to introduce a set

of ideas, the sciences of complexity, that I believe are vital to any

under-standing of how new businesses will emerge and develop in the future,

consider Stuart Kauffman’s analysis of “patch” size on a “cost surface”

(see box below) Kauffman, whose conjecture about the origin of life I

quoted in Chapter 3 when discussing the origin of Chandler’s MuBE,

is a world-leading complexity scientist who pioneered the use of

Patches on landscapes

Kauffman says the size of the “patches” (in this context, units of organization or

departments) in a “system” (a business or company) travelling on a “cost surface” or

“landscape” (seeking to minimize costs, or maximize shareholder value), is a crucial

determinant of the entire system’s ability to find the global minimum (the lowest

possible cost, or the greatest possible value).

He says that, on complex cost surfaces, a system can be trapped in a poor local minimum and that one way to avoid the trap, and allow the system to search a wider

space, is to introduce the equivalent of heat a physical system tends to change in

ways that lower its internal energy and take the system “downhill.” But occasionally

a system will change in a way that increases internal energy, and so allow the system

to escape a poor local minimum.

it follows from this that if an organization wishes to avoid being trapped in poor local minima, it should try to contrive occasional injections of heat that will make

the system ignore the “minimize cost” imperative and move “the wrong way”

(increase cost).

one way to achieve this, is to change the size of patches that act independently and selfishly selfish action is desirable, because it can move the whole system the

wrong way, and allow it to escape poor local minima as Kauffman puts it “well

chosen partitions can produce markedly enhanced optimization.”

take the case of an integrated system or organization, acting as a single ment it will accept all opportunities to change that take the system downhill toward

depart-lower costs, but refuse all other moves such systems always descend to a nearby

minimum, and become trapped there.

When the organization is divided into independent departments, the criteria for screening opportunities change, because opportunities that can take the department

downhill will be accepted, even when they take neighboring departments uphill an

integrated system in which all departments are “singing from the same hymn sheet”

can’t escape a poor local minimum, but a system divided up into patches will only

remain trapped in a poor local minimum, if it is a local minimum for each patch, which

is unlikely if the minimum is poor.

the maths are difficult, but Kauffman shows that when connectivity nication) between patches is low, energy falls as patch size increases When

(commu-connectivity is high, however, systems are better at finding the global minimum

with smaller patches the degree of connectivity between the patches determines

the size of patch that will maximize the system’s ability to find the global minimum

as connectivity increases the system approaches a tipping-point or cusp it

works best at first with large patches, but then suddenly flips and works best with

small patches.

One way to picture the implications of Kauffman’s patch size model

for business, is to imagine that companies travel to their futures across

“fitness landscapes.” Their mission is to climb the highest peak in their

landscapes, because only there will their “fitness,” whether measured in

terms of cost, profits, cash flow, shareholder value or some other

vari-able, be maximized

In the past, the fitness landscape was even and although the climb

was strenuous, particularly close to the top, the goal was clear A single

peak with smoothly sloping flanks like Japan’s Mount Fuji beckoned in

the distance Visibility was excellent, the path was clear and the physical

demands were predictable Fuelled by a good breakfast, and armed with

intent, and the climbing method known as kaizen (continuous

improve-ment) the firm could confidently set out to conquer its Fuji

Nowadays, fitness mountaineering is not so simple

For one thing the landscape’s topography has changed Its previous

evenness has been puckered by valleys and foothills, and fractured by

gorges and chasms Fuji’s silhouette is less distinct, although whether

this is because it is no longer there, having been broken and eroded by

the forces that fractured the foothills, or whether it’s simply obscured

by intermediate peaks and the swirling clouds of unknowing that have

enveloped the landscape, the climber cannot be sure

For another thing the fitness landscape remains active The forces

that have fractured its former symmetry show no signs of abating New

peaks erupt constantly What were heights yesterday are depths today,

and may be heights again tomorrow The landscape is in a state of

constant chaotic deformation There’s no terra firma All is turbulence

and upheaval

As if that were not enough, climbers are becoming aware of another

new phenomenon; each time they take a step in what seems to be the

right direction the ground quivers They have become agents of the

landscape’s deformation, and there is no proportion to cause and effect

A small step can have huge consequences elsewhere, through a complex

series of amplifying resonances that occur far below the threshold of the

climbers’ awareness

Once quite separate entities, climber and landscape are now locked

in a process of co-evolution Neither can move without affecting the

other in potentially profound, but intrinsically unpredictable ways

What happened? What transformed this smooth, stable,

single-peaked landscape into a quaking, multi-single-peaked morass, where foresight

and resolve seem less important than luck and balance?

Part of the answer is that the fitness landscape of each firm is a

crea-ture of the fitness landscapes of other firms In the past, there were only

a few climbers and they were too far apart to affect each other

Nowa-days, the landscapes teem with climbers Some fall into chasms or are

crushed by rock slides, but each is replaced by several new climbers

And climbers are communicating more It’s not just that in crowded

landscapes others are within earshot; it’s also that all climbers are now

equipped with powerful communications equipment The air is alive

with climbing chatter

Kauffman’s model showed that, as the number of climbers

multi-plies and the connections between them rise, landscapes become steadily

more rugged and changeable, and reaching the highest peak becomes

progressively harder Unable to see the entire landscape, climbers have

to aim for nearby peaks If they’re kaizen climbers, they may reach

them, but might then see higher peaks they could have aimed for had

they been less intent on continuous improvement, or find that the

land-scape has deformed and what looked like the summit at the start has

become a ledge on the flank of another peak

Having been stranded on low local peaks once or twice climbers may

begin to question the value of route planning in poor visibility, through

a constantly deforming landscape, and even doubt the value of ascent

itself, when all that it achieves is a far from splendid isolation, on a far

from optimal peak

In this new, confusing world, structure becomes paramount The

key question becomes: “What enterprise shape is most likely to prevent

the company from becoming stranded in a sub-optimal position?”

Phase transition

Kauffman’s analysis suggests integrated MuBEs, run by all-powerful

CEOs, work better when communication between units is limited,

but that business enterprises consisting of many independent selfishly

optimizing units will work better when communication between units

is high

Let’s return for a moment to the two business institution builders

living in the late 19th and early 21st centuries The former faces an

environment in which connectivity is relatively low and favors

integ-ration and an omnipotent CEO The latter faces an environment in

which connectivity is much higher and favors disintegration and no

CEO (Perhaps the alien wasn’t being cryptic after all.)