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From the Editor | The Trouble with Risk I FIRST STARTED to worry about the economy two years ago during a conversation with George Soros, the legendary investor, at an event in Manhattan Someone ventured that Wall Street had effectively mitigated risk with its sophisticated mathematical modeling “I don’t believe that,” Soros said “I don’t understand any of it, and I don’t think anyone else does either.” The markets, he concluded, had become vulnerable to excessive risk Yes, they had And two years later, we’re still digging out from the rubble As the economy begins to right itself, we at HBR feel it’s time to revisit the issue of risk It’s clear that the global financial system tolerated too much of it in the past But only a fool would try to straitjacket it – it’s risk taking, after all, that lubricates the markets This month’s Spotlight on Risk is an effort to advance the dialogue: Going forward, what’s the right level of risk, and to what extent can legislation, or perhaps just prudent management, keep us in check? Our centerpiece is a lively and thought-provoking discussion among some of the world’s smartest thinkers on the topic: Harvard Business School professors Robert S Kaplan, Anette Mikes, Robert Simons, and Peter Tufano, and Koch Industries’ chief risk officer, Michael Hofmann In considering ways to minimize risk, these experts focus on the sometimes perverse role of incentives “The more we tie incentives to short-term performance,” says Kaplan, “the more we encourage managers to take on high degrees of risk to generate high returns.” In the recent past, he continues, those risks were “hedged” by society, as the Fed frequently bailed out troubled firms and sectors, adding to our moral-hazard woes The challenge, then, is to create a system that tolerates risk taking within individual companies but limits the kind of systemic risk taking that helped lead to the current crisis And everyone needs to prepare for Black Swan scenarios, 16 Harvard Business Review 1524 Oct09 EditorLetter Layout.indd 16 | October 2009 | which are deemed unlikely but are catastrophic when they occur Along those lines, we asked Nassim Taleb, author of The Black Swan, for his thoughts on the current state of risk management In his article, “The Six Mistakes Executives Make in Risk Management,” coauthored with London Business School’s Daniel Goldstein and Universa Investments’ Mark Spitznagel, Taleb talks about the common folly of focusing only on incentives: “No one should have a piece of the upside without a share of the downside.” And he would eliminate bonuses for workers in inherently risky establishments like nuclear plants or even banks We also provide a conversation with Nobel Prize–winning economist Robert Merton, one of the architects of modern risk management He offers some concrete suggestions on how to make our financial system safer and how to handle derivatives trading in a manner that affords greater protection against the possibility of a systemic breakdown He also offers an important reminder that innovation of any kind – including financial innovation – comes with risk The only way to avoid bearing the risks from innovation is to abstain from it altogether, which would be rather shortsighted Lastly, we serve up some advice on understanding your company’s exposure to risk Investment banker William Jarvis and Wharton professor Ian MacMillan give readers a tool for determining their vulnerability to a largely unrecognized risk to businesses: consumer debt And Deloitte Financial Advisory Services’ Toby Bishop and Frank Hydoski outline how risk managers can map the likelihood and significance of major fraud risks at their institutions It’s a risky world out there, and we hope this issue provides some insight on how to make it all more manageable Adi Ignatius hbr.org 9/3/09 12:44:21 PM STRATEGIC HUMOR Minding Your Manners “ Real social savvy involves not only knowing an organization’s or country’s customs and rules of etiquette, but also knowing when they can be broken Joanne B Ciulla “Elbows Off the Boardroom Table” Harvard Business Review September–October 1986 ” “Enough with the chitchat, people I think it’s time we cut to the chase.” 22 Harvard Business Review 1524 Oct09 StratHumor.indd 22 | October 2009 | Roy Delgado, Susan Camilleri Konar, and Michael Maslin “Hey, everybody, you know what I’m thinking? I’m thinking the correct expression is actually ‘Let’s roll up our sleeves and get to work.’” hbr.org 9/3/09 12:50:35 PM A survey of ideas, trends, people, and practices on the business horizon GRIST “IF YOU WATCH an ant try to accomplish something, you’ll be impressed by how inept it is,” said Stanford biologist Deborah Gordon in a National Geographic article about swarm theory “Ants aren’t smart…ant colonies are.” If you’re familiar with the ideas behind the wisdom of crowds and swarm intelligence, you’re probably nodding knowingly Under the right conditions, groups – whether ant colonies, markets, or corporations – can be smarter than any of their members In 24 Harvard Business Review 1524 Oct09 FT layout.indd 24 | these complex adaptive systems, hardto-predict behaviors emerge from the interaction of the individuals Executives make three common mistakes that show they don’t really grasp how such systems work What they miss is that you can’t understand the behavior of a complex system, let alone manage it, by analyzing a few key individuals First, managers extrapolate individual behavior to explain collective behavior October 2009 | by Michael J Mauboussin Early in my career as an equity research analyst on Wall Street, I was told that earnings per share is the key to a company’s stock price (Investors, executives, and the media still beat that drum.) But then I saw studies by financial economists who concluded that cash flow, not earnings, drives the stock price The earnings camp listened to what people talked about day to day in the investment community, on television, and in the Wall Street Journal’s pages By contrast, the Jesse Lefkowitz When Individuals Don’t Matter hbr.org 9/4/09 12:29:31 PM not, however, newly transplanted stars fail to deliver, because they’re separated from the people, structures, and norms that helped make them great in the first place In one study, professors from Harvard Business School tracked more than 1,000 acclaimed equity analysts over a decade and monitored how their performance changed when they switched firms The dour conclusion of the research: “When a company hires a star, the star’s performance plunges, there is a sharp decline in the functioning of the group or team the person works with, and the company’s market value falls.” All three mistakes have the same root: wrong assumptions about the relevance of individual agents to the behavior of a complex adaptive system When trying to achieve system-level goals, think twice about agent-level changes They’re unlikely to have the effects you intend Michael J Mauboussin (mmauboussin@ lmcm.com) is the chief investment strategist at Legg Mason Capital Management and an adjunct professor at Columbia Business School He is the author of Think Twice: Harnessing the Power of Counterintuition (Harvard Business Press, 2009) Reprint F0910A LAYOFFS Downsizing Lost Its Bad Rap BIG COMPANIES FORMERLY took a reputational hit when they laid off massive numbers of workers But according to E Geoffrey Love and Matthew Kraatz, of the University of Illinois, U.S business culture norms gradually changed from 1985 to 1994 as new ideas about boosting shareholder value took hold in executive suites and boardrooms At the beginning of that period, the researchers report in the Academy of Management Journal, layoffs significantly harmed companies’ standing in Fortune’s list of most-admired firms, drawn from surveys of thousands of executives and securities analysts (Fortune ranks the reputations of the 10 largest firms in each industry.) Back then, however, layoffs were relatively rare By 1994, when they were commonplace, downsizing caused virtually no change in reputation – Andrew O’Connell Reprint F0910B Impact of downsizing on firms’ reputations 1994 Firms’ decline in reputation economists looked at how the market behaved One group focused on the components, the other on the aggregate The latter was the better approach Research in experimental economics, for example, shows that markets can generate very efficient prices even when each participant has limited information Just as watching one ant won’t help you understand the colony’s behavior, listening to individual investors will give you scant insight into the market It can even be harmful for executives to heed individuals, who generally dwell on earnings, rather than collectives, which tend to appreciate cash flow Those who may cost their shareholders and themselves substantial value A survey by Duke University’s John R Graham and colleagues reveals that 80% of chief financial officers would decrease valuecreating spending in order to meet an earnings target Second, executives often fail to recognize that changes in one component of a complex system may have unintended consequences for the whole The U.S government’s decision to allow Lehman Brothers to collapse in September 2008 is a good illustration Since the market largely understood Lehman’s poor financial condition, the argument went, it could absorb the consequences But because Lehman’s losses were larger than people had initially thought, the bankruptcy announcement roiled global financial markets, contributing to an increase in risk aversion Even parts of the market that were perceived to be safe, such as money market funds, received a jolt Third, there is a tendency to prize a few standout individuals while ignoring how much they draw on their surrounding systems for support For instance, many companies, sports teams, and entertainment businesses hire a star when they want to quickly improve the organization’s results More often than By 1994, the effect of downsizing had become negligible – the average drop was only 24 positions In 1985, downsizers slid an average of 1.3 positions in their Fortune industry rankings 1990 1985 hbr.org 1524 Oct09 FT layout.indd 25 | October 2009 | Harvard Business Review 25 9/4/09 12:29:40 PM COMPANIES HAVE GOTTEN very good at getting customers to ENERGY The Power of Unwitting Workers by Gardiner Morse free work – pumping their own gas, conducting their own checkouts, filling out online forms In each case, the mutual benefit is clear, and customers tacitly agree to an exchange of value: “I’ll pump my gas if you give me a price break.” But some organizations are finding ways to tap people’s mental and physical energy on the sly, siphoning off a little extra value Proponents typically say they’re capturing “wasted” energy; detractors argue there’s no such thing as a free lunch Power Walking Reprint F0910C Free Transcription Thomas Edison reportedly liked to lead unsuspecting visitors through a If you’ve ordered tickets online, set up turnstile that pumped water to a tank on his roof (though legend has it that an e-mail account, or created a Facebook he owned up to the scheme when questioned) This same principle, but on page, you’ve encountered a CAPTCHA a larger scale, lies behind myriad projects that harvest energy from human like this one movement and divert it to the harvester’s ends – an idea MIT graduate stu- (CAPTCHA stands dents Thaddeus Jusczyk and James Graham aptly labeled “crowd farming.” for “Completely Many such efforts depend on the piezoelectric effect: the ability of some Automated materials to generate electricity when they’re Public Turing test to tell Computers and pressed or otherwise deformed The East Humans Apart.”) By having you decipher Japan Railway Company piloted power- distorted words that computers can’t generating floors at Tokyo Station read, the test confirms that you’re hu- that captured tiny amounts of man and shuts out automated spammers energy from the footsteps of the and such thousands of commuters who What many people don’t know is that passed through certain ticket their test responses are put to secondary Bryan Christie Design gates The railway hopes to use people to power gates and information boards, though that would require improved efficiency and quite a scale-up: In early tests, the swarming commuters produced only use Through a clever program developed by Luis von Ahn and colleagues at Carnegie Mellon University, words that stump optical readers struggling to digitize old books are displayed in CAPTCHAs for translation by humans When you correctly decipher a word that enough electricity each a computer can’t, your effort aids the day to light a 100-watt digitization CAPTCHA solvers are now bulb for a couple of helping to transcribe the equivalent of minutes nearly 150,000 books a year – labor that would otherwise require 37,500 full-time workers JR New York Office 1.8 million Number of people passing through Tokyo Station each day 26 Harvard Business Review 1524 Oct09 FT layout.indd 26 | October 2009 | 10 million Number of words deciphered each day by CAPTCHAs hbr.org 9/4/09 12:29:45 PM Electric Parking In June, a Sainsbury’s supermarket in Gloucester, England, installed Europe’s first energy-harvesting parking lot Cars driving over the “kinetic road plates,” made by Highway Energy Systems, are expected to produce enough electricity 30 kilowatts to power the store’s checkouts This and similar systems extract a small amount of energy from the cars’ motion If a car is slowing anyway, that’s energy that Amount of energy collected per hour from cars in Sainsbury’s parking lot would have been spent on braking Car drives over spring-loaded pairs of plates, engaging a flywheel that turns generators Revolving Renewable As visitors push through a revolving door at the Driebergen-Zeist railway station in The Netherlands, generators Bryan Christie Design capture some of their energy to power ceiling lights In this case, people are alerted to the door’s dual role Even the door’s manufacturer, Boon Edam, thinks it’s more about green awareness than Electricity produced by the generators is used to power the store’s checkouts about producing electricity Still, other companies, including New York studio Fluxxlab, are pursuing similar revolving-door Unscored Questions concepts for capturing what Fluxxlab calls “wasted human Most students toiling their way through standardized tests like the SAT don’t energy.” realize that many of the questions are unscored problems dropped in for the examiners’ own purposes There’s no way to know which questions are scored and which aren’t, so test takers are cautioned to give all the problems equal attention – even though they derive no direct benefi t from sweating the fakes Of the 225 minutes a student spends on the SAT, 25 are devoted to unscored problems, which help the test makers create future exams and ensure that different current versions are the same level of difficulty Thus, more than 10% of the student’s time goes to mandatory yet uncompensated work Royal Boon Edam Group Holding B.V 50 million istockphoto Number of minutes SAT takers spend on unscored questions each year hbr.org 1524 Oct09 FT layout.indd 27 | October 2009 | Harvard Business Review 27 9/4/09 12:29:56 PM FINANCE Are Your People Financially Literate? by Karen Berman and Joe Knight SENIOR EXECUTIVES ROUTINELY share and discuss financial data with marketing directors, operations chiefs, and other direct reports But how much those managers really understand about finance? We recently investigated this question, and the news is not good Asked to take a basic financial-literacy exam – a test that any CEO or junior finance person should easily ace – a representative sample of U.S managers from C-level executives to supervisors scored an average of only 38% A majority were unable to distinguish profit from cash Many didn’t know the difference between an income statement and a balance sheet About 70% couldn’t pick the correct definition of “free cash flow,” now the measure of choice for many Wall Street investors (See the sample questions on this page.) Does this lack of financial literacy matter? From individual managers’ point of view, it surely does Those who can’t speak the language of business can’t contribute much to a discussion of performance and are unlikely to advance in the hierarchy They may be caught off guard by financial shenanigans, as many employees at Enron were They will be unable to gauge the health of a prospective employer One of us, Joe Knight, serves as the chief financial officer of a small manufacturing company He often asks candidates for engineering positions whether they would like to review the past two years of the company’s financials None yet have taken him up on the offer – knowing, perhaps, that they could make neither head nor tail of the statements Financial illiteracy in the managerial ranks can be a crippling weakness for the organization, as well Imagine a business that is attempting to increase operating cash flow, as many firms are at the moment Even experienced executives, accustomed to managing a P&L, may be unaware of the many balancesheet levers they can pull to affect cash – decreasing inventory, for example, or reducing days sales outstanding We recently worked with a health care services company seeking to increase its gross margin, and the first thing we had to was help the sales force understand the difference between making a sale and making a profitable sale Unfortunately, that’s a widespread problem Nearly two-thirds of our test takers thought that discounts offered by sales reps had no effect on gross margin If you don’t understand what goes into a number, you can hardly know how to improve it Why don’t people tell their bosses that they don’t speak finance? It’s the usual human reluctance to admit ignorance In a survey of a different sample of managers, we asked what happens in meetings when people don’t understand financial data The majority chose answers reflecting that reluctance, such as “Most people don’t ask because they don’t want to appear uninformed in front of their boss or peers.” Karen Berman (kberman@businessliteracy.com) and Joe Knight (jknight@ business-literacy.com) are principals at the Business Literacy Institute and the authors Financial IQ Test (with John Case) of Financial Intelligence: We developed a 21-question exam called the Financial IQ Test with colleagues at A Manager’s Guide to Knowing What the Alliant International University’s Marshall Goldsmith School of Management and Numbers Really Mean (Harvard Business then administered it to a random sample of more than 300 U.S managers Here are selected questions, along with the answers given by respondents (pie Press, 2006) For tools that help boost financial IQ, visit www.financedog.com You should be pleased about your company’s financial results if: A company has more cash today when: To investors and analysts, free cash flow is a key number because: A) There is a negative trend in operating margin A) Customers pay their bills sooner A) It reflects the cash that is “free” – that is, the company doesn’t have to pay interest on it B) It is the cash that can be used to pay shareholders their dividends D) It is the cash that investors have put into the business C) It reflects the operating cash that has flowed into the business in the current year D) Cash flow is coming from company investing B) There is an increasing trend in COGS C) Cash flow is coming from company operations D) Retained earnings increases Indicates correct answer 28 Harvard Business Review 1524 Oct09 FT layout.indd 28 | October 2009 | B) Accounts receivable increases C) Profi t increases Jesse Lefkowitz Reprint F0910D slices indicate proportion of respondents giving each answer) hbr.org 9/4/09 12:30:04 PM Conversation Pioneering entrepreneur Yoshiko Shinohara on turning temporary work into big business in Japan At age 74, Yoshiko Shinohara is a towering Subsequently, after I spent figure in Japanese business She has years lobbying alongside other created a wealth of job opportunities, temp agencies, the law was including many for women, by founding changed the temporary-staffing agency Tempstaff and lobbying to strike down laws that stifled the temp industry Tempstaff now has approximately 3,300 employees and is a public company For the past nine years, Shinohara has been on Fortune’s list of the 50 most powerful women in global business It all started, she told Harvard Business Why did you bring men into your once all-female company? Sales growth was slowing Tempstaff was a women’s company because all temps were female in the early days, and our firm’s managers were drawn from the ranks of former temps Japanese female executives are School’s Anthony J Mayo and Mayuka Yamazaki, with a somewhat different now, but back then, they weren’t personal choice she made when she was young always willing to go out and seek new business They tended to take more of a defensive posture, protecting What was it that set you on your the company’s gains rather than moving forward That is entrepreneurial path? not healthy Soon after my wedding, I realized that I would rather not So in 1988, I said, “How about if we put some men be married, that this was not the right person for me So in here?” The managers said, “No, thank you, we don’t I decided I had better divorce as soon as possible, a decision that my mother and brother were very angry about After the divorce, I said, “I have to something with myself.” At the time, most women in Japan were relegated to boring jobs such Lifetime employment was the norm in Japan, and temping by private companies was banned, so I was often summoned by the Ministry of Labor as serving tea, and unlike my mother, who was a midwife, I did not have special skills to live as a professional So I felt need any of those creatures.” But we did need them A I had to leave Japan I went to Europe and eventually to branch happened to hire a man as a part-timer, and wow, Australia, where I saw women working as temps, which did sales increase! That was the turning point The trick is how I learned about temping Mistakes are the sea of was achieving the right mix of men and women We now opportunity have 60% women But I wish there were more women Why did you decide to start a temping firm? adequate, so women with children must stay home, and When I came back to Japan, in 1973, none of the job pros- that makes it hard to change the ratio in top positions In Japan, the child care industry is in- pects interested me I remembered the temping I had Were the obstacles you faced in starting a business greater because you are a woman? ously However, I soon ran into opposition from the People often ask me that My answer is “How would Ministry of Labor Lifetime employment was the norm in I know? I have never been a man.” Starting a business Japan, and temping by private companies was banned is always difficult under law, so I was often summoned by the ministry I couldn’t understand why it was illegal to provide temporary employees to companies that desperately needed them I used to say to myself: “I wonder what it’s like in jail How big are the rooms? Is there a toilet or a window?” 30 Harvard Business Review 1524 Oct09 FT layout.indd 30 | October 2009 | Anthony J Mayo (tmayo@hbs.edu) is the Thomas S Murphy Distinguished Research Fellow and the director of the Leadership Initiative at Harvard Business School Mayuka Yamazaki (myamazaki@hbs.edu) is a research associate at HBS Reprint F0910E Courtesy of Tempstaff encountered in Australia and decided to start my own firm I launched the company without taking it too seri- hbr.org 9/4/09 12:30:12 PM STRATEGY Focus Intensely on a Few Great Innovation Ideas by Georg von Krogh and Sebastian Raisch THE GLOBAL COMPANIES that are the most successful at achieving growth through innovation (as opposed to acquisitions) tend to devote their energies to a small number of breakthrough ideas They select the initiatives with the greatest market potential and marshal their resources to develop them Leaders should be heartened by this as they continue to face severe cost pressures Obviously, pursuing dozens of innovations is less expensive than developing thousands But it also requires an intense focus on picking winners and commercializing them It’s uncommon to consistently generate revenue growth through innovation – but prerecession, firms that did earned handsome rewards Only about The Organic-Growth Advantage Companies with high rates of organic sales growth tend to outperform those with lower rates Annual averages from 1996 to 2005 20% Organic growth champions Organic growth laggards 0% Total return to shareholders Sales growth EBIT growth Champions (the 80 companies within Fortune’s Global 500 with at least 5% annual organic growth) Laggards (the companies in the Global 500 with less than 5% annual organic growth) 32 Harvard Business Review 1524 Oct09 FT layout.indd 32 | 80 of Fortune’s Global 500 turned in an annual average of at least 5% organic sales growth over 10 years In a study of these organic-growth champions – including GE, BMW, Nestlé, and Samsung – researchers at the Center for Organizational Excellence in Switzerland found that the firms’ shareholder returns were almost double those of the other managers, including CEO Jeffrey Immelt, to assess their potential and estimate the level of investment required As a rule, the board selects just a small number so that eight to 10 projects are in the pipeline at a time These are then sponsored by top managers and defended against budget cuts Nearly half the initiatives are geared toward changing the way existing products are produced or delivered – for example, consolidating the commercial finance business’s 44 sales forces into a single team Similarly, Procter & Gamble focuses its R&D on just eight to 10 core technologies, and Nestlé has slashed its number It’s uncommon to consistently generate revenue growth through innovation – but prerecession, firms that did earned handsome rewards Global 500 companies (which had lower rates of organic growth) Such success often relies on what we call “concurrent innovation” in processes, products, and business models Progress in one type of innovation spurs progress in another, triggering progress in the third Typically, savings from process improvements fuel product and business-model innovations When Peter Brabeck-Letmathe became CEO of Nestlé, in 1997, he initially focused on operational efficiency That allowed the company to more than double R&D expenditures, and one of the resulting products, Nespresso, created the market for portioned-coffee systems Take another example: In 2004, GE launched the Imagination Breakthroughs process in part to aggressively pursue areas such as nanotechnology and renewable energy The new process cut the number of initiatives at GE Global Research from more than 2,000 to 80, each of which had the potential to produce at least $100 million in organic growth over three years To maintain its intense focus on the most promising ideas, GE sends employee-generated ideas to an internal review board consisting of several top October 2009 | of innovation initiatives by about half Paul Bulcke, Nestlé’s current CEO, allocates large budgets to the 10 most promising innovations and personally tracks their progress at monthly meetings The organic-growth champions more than focus on breakthrough ideas They also put innovation at the top of the agenda, work across functional and divisional boundaries, and empower employees with an entrepreneurial mindset Doing all this at once is a formidable challenge But the companies’ success positions them well to profit from the downturn In the three difficult years following the 2000 recession, they maintained faster sales growth than the other Global 500 companies, and their return on equity suffered significantly less Recessions produce winners as well as losers, and the winners this time around may once again be the organic-growth champions Georg von Krogh (gvkrogh@ethz.ch) is a professor of strategic management and innovation at ETH Zurich Sebastian Raisch (sebastian.raisch@unisg.ch) is an assistant professor of strategic management and organization at the University of St Gallen Reprint F0910F hbr.org 9/4/09 12:30:22 PM Publicis Worldwide, the original agency in Publicis Groupe, became just another part of the Groupe running in parallel with Saatchi and other agency networks Saatchi’s CEO joined the Groupe operating committee, renamed P-12 to mirror a Saatchi designation Saatchi employees found themselves drawn to Publicis despite large dollops of pride and a continued desire for autonomy One executive who had been skeptical about the merger and said he didn’t want a new boss was won over and began to act in the interest of Publicis Groupe: He took it upon himself, after a slight comment by Lévy, to fire two Saatchi managers who were undermining merger integration by dragging their feet and indulging in other forms of passive aggression Another important Publicis Groupe acquisition – its 2007 purchase of the digital-marketing agency Digitas – was designed not only to add managerial know-how but also to dramatically accelerate Publicis’s online capabilities and eventually transform the company As A.G Lafley did with Gillette, Maurice Lévy presented his human face and personal values to the Digitas staff – values that had won him the acquisition in the first place over other large holding companies that coveted Digitas Lévy made the acquired employees feel they were in safe hands and excited about the central role they would play in Publicis’s future The CFO was so convinced about the merger’s potential that he worked extraordinarily hard on the transition, even though his own job would be eliminated David Kenny, the Digitas CEO at the time, joined the P-12 team and traveled to all major locations globally to form relationships with Publicis agencies’ leaders and employees while selling the digital message From the start, he led or joined collaborations across the highly diverse parts of Publicis to serve particularly important global clients Kenny and colleagues formed a new venture, VivaKi, to integrate Publicis’s media and digital units and take them to the next level ••• A slow economy tempts owners of distressed companies to hang “for sale” signs outside their headquarters It also tempts firms that have resources to buy those businesses cheaply and then little more than cut costs, figuring that acquired employees have no choice but to fall into line But a bargain-basement mentality may destroy both current and potential value once the economy strengthens The companies in my study think in a different way Whether integrating giant enterprises across many countries Running parallel operations during a transition helps people retain their identities and learn with open minds or putting two small offices together in one location, they not act like conquerors sending out occupying armies Instead, they act like welcoming hosts and eager learners Their leaders are attuned to emotions and culture, knowing the importance of symbols and signals in communicating with employees about change They establish transparent processes to reduce anxieties about changes that have not yet been made They invest in the future, adding more than they take away and letting people share in the fruits of success They try to be fixers rather than destroyers, which converts skeptics into fans They value and facilitate relationships All companies that seek profitable growth can benefit by thinking of merger integration as three sets of activities – which Shinhan Financial Group dubbed “dual companies,” “one company,” and “new company.” Dual companies: Run the old and the new side by side Having parallel operations during a transition period is more than a practical necessity in complex situations; it also helps people retain their identities, avoid too much hbr.org 1524 Oct09 Kanter.indd 125 change all at once, and learn new ways with open minds It can make sense in the long run to permit redundancies, allow old methods to be used for a time, refrain from changing performance metrics, or deploy experienced people to be mentors in the new world One company: Find common human bonds, and encourage relationships beyond tasks Paying the bill for big events, lots of travel, and other ways for people to meet might seem excessive on top of the acquisition cost, but it can help forge an emotionally unified culture even while operations are still | separate, thus motivating employees to connect and work across divides New company: Quickly start envisioning and building the future Creating a business model that’s not identified with any one legacy company turns attention away from territoriality and conflict, and toward collaboration that facilitates future success And that frame of mind, above all, makes the merger a source of value No matter how compelling the shortterm economics, a deal is never a bargain if you emphasize just the financial aspects of the transaction You’ll create real value only if you attend with equal zeal to the integration of talent Rosabeth Moss Kanter (rkanter@hbs edu) is the Ernest L Arbuckle Professor of Business Administration at Harvard Business School in Boston Her latest book is SuperCorp: How Vanguard Companies Create Innovation, Profits, Growth, and Social Good (Crown, 2009) She was the editor of HBR from 1989 to 1992 Reprint R0910P To order, see page 143 October 2009 | Harvard Business Review 125 9/4/09 12:36:03 PM Letters to the Editor The Buck Stops (and Starts) at Business School In his article “The Buck Stops (and Starts) at Business School” (June 2009), Joel M Podolny offers good suggestions for helping business schools regain trust He is right to say that MBAs will approach challenges more holistically if business schools integrate more “hard” and “soft” disciplines into their curricula However, MBAs need to more than assimilate new knowledge about value- affective and cognitive biases; connect their personal learning with their life story and values; and internalize their newly acquired insight at deeper behavioral and emotional levels Some of the most effective leadership programs also include cross-cultural exposure and field trips to less privileged areas of the world – yet another way to provide future leaders with an opportunity to broaden their humanistic worldview Vincent H Dominé SPOTLIGHT ON TRUST SPOTLIGHT ON TRUST Program Director and Leadership Coach The Buck Stops (and Starts) at Business School Title IDEA The Buck Stops (and Starts) at Business School squib Unless America’s business schools make radical changes, society will become convinced that MBAs work to serve only their own selfish interests by Author Name I by Joel M Podolny the American politician and gay rights activist, during a 1977 protest against the repeal of an antidiscrimination law Today, we find ourselves in an economic quagmire where people around the world feel that same kind of intense rage – this time, against big business Society has lost confidence in many economic institutions – investment banks, credit-rating agencies, and central banks, for instance – and prominent among them is one to which I devoted most of my professional life: business schools | June 2009 | hbr.org Art Credit Jesse Lefkowitz “I KNOW YOU’RE ANGRY I’M ANGRY!” declared Harvey Milk, 62 Harvard Business Review ecutives and companies seems small The resentment against the MBA is compared with the magnitude of the ofvisible everywhere The New York Times IN BRIEF fense To reprise the line: I know you’re printed several letters on March 3, 2009, » Many people believe that manangry I’m angry too reacting to a news story about the presagement education has contributed I’m angry about the inattention to sure these trying economic times have to the systemic failure of leadership ethics and values-based leadership in exerted on the teaching of the humanithat led to the current financial crisis business schools We didn’t need the ties The letter writers alluded to the current meltdown to tell us that; the fact that by studying the arts, cultural » That may be so because, one, a focus on values-based leadership Enron and WorldCom scandals proved history, literature, philosophy, and reand ethics has not been central it more than seven years ago ligion, people develop their powers of to management education And, I’m angry about the disciplinary critical thinking and moral reasoning two, even when B schools teach silos in which business schools teach Business schools don’t develop those leadership, they foster the belief management I obviously didn’t realize skills, they argued, which is why MBAs that CEOs should focus on the big that balkanization had affected my unmade the shortsighted and self-serving picture – not the practical details derstanding of the Royal Bank of Scotdecisions that resulted in the current » Business schools can regain soland, but many years ago, I did become financial crisis ciety’s trust by emphasizing values aware that carving up management Two days earlier, a former student as much as they analytics and challenges by function would leave acaof mine, Philip Delves Broughton, auby encouraging students to adopt a demics without a holistic appreciation thored an opinion piece in the Times holistic approach to business probof the challenges MBAs face of London I recall Philip as one of the lems As professional schools, they I’m angry that many academics better students I taught at Harvard must stop competing for students aren’t curious about what really goes Business School, and it is evident from only by advertising rankings – a on inside companies They prefer to dethe article that Philip remembers me practice that reinforces the idea that velop theoretical models that obscure He wrote that I “trumpeted” organizatheir only goal is to teach students how to make a lot of money rather than clarify the way organization design work I had done in 2000 tions work Many also believe that a with the now-troubled Royal Bank of » The time has also come for busitheory’s relevance is enough to justify Scotland and that other HBS profesness schools to develop codes of teaching it That’s a low bar; almost no sors had written case studies on the conduct for MBAs and to withdraw theory is entirely irrelevant to business, bank’s mergers and acquisitions, custhe degrees of those who break the manager’s code but only a few are truly important tomer service, and employee retenThese concerns prompted me to take tion strategies “Every trendy business the position of dean of the Yale School school idea was being implemented, it of Management in 2005, where I could seemed, while what really mattered – tackle the problems I had observed The the bank’s risk assessment, cash flow, changes that my colleagues and I implemented at Yale over and capital structure – was going to hell,” he pointed out the next four years are widely regarded as an improvement Philip saved his sharpest criticism for what he perceived as on the traditional curriculum However, I quickly realized Harvard Business School’s indifference to the role that some that the failings of today’s MBA education can’t be solved by of its graduates have played in recent business scandals changes at one, or even a few, business schools I would quibble with a few of the details in Philip’s account Fact is, so deep and widespread are the problems afflictand, having worked for several years at HBS, disagree with his ing management education that people have come to believe assessment that the school suffers from complete apathy Five that business schools are harmful to society, fostering selfyears ago, HBS introduced a compulsory course on leadership interested, unethical, and even illegal behavior by their graduand corporate accountability as a response to the collapse of ates How did we get into a situation in which MBAs are part Enron In addition, some members of the faculty have taken of the problem rather than the solution? the current crisis as proof that they haven’t done enough to equip students to make good judgments, and they’re thinking about introducing more changes to the school’s curriculum What They Don’t Teach You at Business School and teaching methods Fifty years ago, the Ford Foundation and the Carnegie FounAt the same time, I share Philip’s frustration The degree dation each commissioned a study of U.S business education of contrition not just at business schools but also among exBoth concluded that the quality of scholarship was terrible hbr.org | June 2009 | Harvard Business Review 63 based leadership and ethics They need to move from cognitive learning into developing or strengthening their personalities as ethical leaders Business schools can help by drawing from executive education programs where participants engage in courageous conversations; experience their leadership style and that of others; receive constructive feedback; increase their self-awareness; understand their Insead Global Leadership Centre Fontainebleau, France Innovation in Turbulent Times In their article “Innovation in Turbulent Times” (June 2009), Darrell K Rigby, Kara Gruver, and James Allen build a timely, legitimate case for focusing on innovation as a way to navigate the turbulent white water of today’s business environments Their solution, to make the best use of complementary cognitive skills by pairing right-brain thinkers with left-brain colleagues, is straightforward and elegant – but it does not go far enough The problem is that the complexity of how we all think, communicate, and learn goes beyond the simple rightbrain–left-brain framework Because of our strong cognitive preferences, we speak different “languages,” have differ- We welcome letters from all readers wishing to comment on articles in this issue Early responses have the best chance of being published Please be concise and include your title, company affiliation, location, and phone number E-mail us at hbr_letters@harvardbusiness org; send faxes to 617-783-7493; or write to The Editor, Harvard Business Review, 60 Harvard Way, Boston, MA 02163 HBR reserves the right to solicit and edit letters and to republish letters as reprints 130 Harvard Business Review 1524 Oct09 Letters Layout.indd 130 | October 2009 | hbr.org 9/4/09 12:46:45 PM ent preferred ways of making decisions, and interact with others in ways that reflect our preferences rather than theirs Not surprisingly, therefore, communication problems can easily escalate and the chasm widen In fact, attempting to pair right-brain and left-brain people can even backfire, resulting in polarization rather than an integration of perspectives (see “Putting Your Company’s Whole Brain to Work,” HBR July– August 1997) We need tools to describe our differences and help us learn how to work together effectively Ned Herrmann’s Whole Brain Model and Herrmann Brain Dominance Instrument (HBDI), for example, have helped people learn how to assess their thinking-style preferences to take advantage of their rightbrain or left-brain preferences while also recognizing their limitations Incorporating a more whole-brain approach in today’s high pressure and high stakes work environments can reduce the barriers to collaborative innovation and help us maximize our individual and collective intellectual potential Tom Boldrey Professor Emeritus Lumpkin College of Business and Applied Sciences Eastern Illinois University P2B Prepare to Breakthrough Stanford Executive Education: Redefining the Language of Business To thrive in today’s marketplace, you need more than strategic vision, reasoned decision-making, and impeccable execution to bring your organization through the storm You require inspiration, intellectual stimulation and fresh perspectives that will allow you to see the world and your business in a new context Charleston, Illinois Heed the Calls for Transparency In Sam Wilkin’s apt comparison between the financial services and extractive industries (“Heed the Calls for Transparency,” Forethought, July–August 2009), one commonality is clear: The public suffers in the absence of transparency and accountability Though the Extractive Industries Transparency Initiative (EITI) has indeed made significant progress, such a voluntary mechanism, which relies on the will of individual governments for compliance, will never capture the most egregious offenders Fortunately, members of the U.S Congress are considering Stanford Executive Education programs can help inspire your next breakthrough Join us Leading in Challenging Times February 24 – 26, 2010 Directors’ Consortium March – 5, 2010 Stanford Executive Program June 20 – July 31, 2010 Executive Program for Growing Companies July 11 – 22, 2010 Executive Program for Strategy and Organization July 11 – 23, 2010 www.gsb.stanford.edu/exed/hbr Change lives Change organizations Change the world 1524 Oct09 Letters Layout.indd 131 5STA-172_P2B_HBR_083109.indd 8/31/20093:28:54 3:55:58 PM 9/1/09 PM LETTERS TO THE EDITOR a legislative remedy that would require any mining or oil company registered with the Securities and Exchange Commission to fully disclose payments made to governments in countries where it operates As for the financial services industry, Wilkin’s call to proactively adopt transparency measures is welcome and necessary But as we’ve seen in the extractive sector, only a mandatory disclosure law will truly level the playing field Not only the financial services and extractive industries mirror each other, but they are also heavily intertwined With mandatory transparency, we can ensure that both industries bring about sustainable development, effective investment, and poverty relief in the areas of the world that need them most Raymond C Offenheiser the public interest For example, regulators are allowing, and sometimes encouraging, utilities to invest both in upgrading the transmission grid to deliver the power from wind and solar plants and in making the grid “smarter.” They are also setting customers’ rates to provide an appropriate return on investment to utilities’ shareholders, regardless of whether kilowatt-hour sales are growing Rather than undertake a “colossal challenge” with the strategically vital energy sector, how about further supporting the utilities’ existing business model of infrastructure investment? Clearing away the roadblocks to infrastructure investment would stimulate the economy, make the energy sector more efficient, and, not incidentally, drive utility shareholder earnings Steven A Mitnick President Oxfam America Partner Boston Oliver Wyman Group New York Fix Utilities Before They Need a Rescue Peter Fox-Penner, in his article “Fix Utilities Before They Need a Rescue” (Forethought, July–August 2009), relies upon two assumptions to propose “a radical change with far-reaching consequences” in the business model of electric utilities First, he assumes that electricity sales will decline Yet a preponderance of the data indicates that, despite the present deep recession and the aspirational goals of many to make the country more energy efficient, electricity sales will continue to grow (albeit not as rapidly as in the past) Second, he assumes that, without radical change, such a decline in sales would cause utilities to collapse because their current business model depends on sales growth However, state regulators are increasingly decoupling utility profit from sales growth, so that shareholder earnings are more directly tied to investing in energy infrastructure deemed in 132 Harvard Business Review 1524 Oct09 Letters Layout.indd 132 | Fox-Penner responds: Steven A Mitnick has correctly noted two of my key assumptions, and there is room for legitimate discourse about each First, electricity sales have defied gravity, recessions, and everything else for a century But I am not so sure that this will continue; even the Energy Information Administration’s predicted growth rate barely cracks positive territory at 0.5% per year Second, I don’t think that decoupling is strong enough medicine Our Edison Foundation study (see www.edison foundation.net) found that utilities will need to invest about $2 trillion by 2030 to decarbonize and install the smart grid I worry that regulators who think only about volumetric rates, decoupled or not, will simply not allow them to increase by $150 billion or so a year to enable utilities to maintain their profit margins Finally, I fully agree with the goal of clearing away infrastructure roadblocks, and I spend hours pondering the methods October 2009 | Losing (Ownership) Control In Ken Smith’s article “Losing (Ownership) Control” (Forethought, June 2009), the United States stands out as the world’s largest net seller of billion-dollar corporations during the period 2000 to 2008 Using absolute numbers as Smith does, however, does not necessarily present the correct picture of the situation A more accurate measure would be to compare each country’s net gain or loss against its GDP When that ratio is applied, the country with the worst net loss turns out to be the Netherlands (−16.44%), not the United States (−1.54%), and the country with the largest net gain is Luxembourg (75%), not France (10.99%) It is certainly important for the United States to develop foreign trade policies that promote equal access, but it is crucial to view the situation correctly during the process Countries with smaller absolute losses but larger losses relative to GDP may be in far more perilous circumstances than the United States Similarly, countries with large net gains relative to GDP may need to reassess their foreign trade policies to ensure that protectionist measures are not preventing sustainable global economic growth Seth Roman Portfolio Manager Pioneer Investments Boston The 10 Trends You Have to Watch In their article “The 10 Trends You Have to Watch” (July–August 2009), Eric Beinhocker, Ian Davis, and Lenny Mendonca refer to the folly of relying on “financial models that assumed economic rationality, linearity, equilibrium, and bell-curve distributions,” observing that “the models failed badly.” Business models, however, can’t fail or make assumptions; they are only programs People write them, input data to them, and evaluate and inter- hbr.org 9/4/09 12:46:55 PM pret the results that programs generate When people poorly develop and use those programs, therefore, they – not failing business models – are the ones who contribute to businesses’ financial difficulties Alan Lester Principal R Ellis Advisors Manchester, Missouri How Gen Y and Boomers Will Reshape Your Agenda In their article “How Gen Y and Boomers Will Reshape Your Agenda” (July– August 2009), Sylvia Ann Hewlett, Laura Sherbin, and Karen Sumberg underscore the need for fundamental demand-side shifts to attract and retain the new talent supply Interestingly, in a previous issue, John Beeson (“Why You Didn’t Get That Promotion,” June 2009) offers one explanation for why a portion of the talent so attracted will depart in frustration or settle for so much less: The unwritten rules of executive progress are both real and elusive As Gen Ys will learn, it takes more than talent – or even results – to win advancement in organizations Getting promoted is significantly more challenging than being hired One reason for the difficulty is that promotion is inherently more dependent on the candidate than it is on the organization The individual’s own ability to learn the ropes, meet the needs of different audiences, and demonstrate distinctive value drives the outcome to a greater extent than any human resources or management development program could possibly do, no matter how innovative and meaningful the company’s Gen Y or Boomer appeal An effective framework for discussion can help companies reveal the unwritten rules of advancement more effectively and provide candidates with a way to discern core success cues more accurately The key lies in casting conversations about career growth in terms that realistically reflect the four forces govern- 1524 Oct09 Letters Layout.indd 133 ing advancement in any organization: probability, performance, perception, and process Deficiency in any of those categories can mean game over for a career and lost value for the organization This “4-P” framework helps in three ways: It reinforces the point that performance alone does not drive promotion, motivates a direct discussion about perception (perhaps the most obscure and most lethal deterrent to career progress), and highlights the pivotal role of chance (what successful executive has not been thankful for being in the right place at the right time?) For Gen Ys, who have little tolerance for the obfuscation suggested by unwritten rules, the discussion can be particularly meaningful Clarifying the rules for executives of any generation is both desirable and achievable What’s needed – perhaps now more than ever – is better tools for the job Executive Progress Chicago Rethinking Trust In his article “Rethinking Trust” (June 2009), Roderick M Kramer rightfully points out that although “the shadow of doubt lingers over every decision to trust,” one can reduce that doubt by adjusting one’s mind-set and behavior In my opinion, however, the author overemphasizes trust based on information outside oneself A betrayal of trust might not have occurred, for example, if we had resisted the urge to chase companies for our own greed and need for quick and huge returns on investment We need to assess our own motives before judging the trustworthiness of others Aneeta Madhok Director Craig M Watson Open Spaces Consulting Managing Director Mumbai Conquer Biz Bestsellers in a Flash the fastest way to expand your business knowledge with the world’s largest book summary company Books piling up on your desk or nightstand? 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Our subscriptions give you access to more than 5,000 book summaries, including the latest books from Harvard Business Press – summarized exclusively by getAbstract.Various formats for your computer, iPhone, BlackBerry and Kindle are available, including audio Nowhere else you find such breadth and depth Nowhere Subscriptions range from $89 (30 summaries) to $299 (unlimited access) Subscribe now and see why hundreds of thousands of business professionals use getAbstract! www.getabstract.com/harvard 100% GUARANTEED 30-DAY MONEY BACK Corporate Solutions getAbstract works directly with corporations to provide customized learning solutions for their organizations Leading global companies, such as Microsoft, Boeing, Chrysler, Pepsi and many others, have integrated getAbstract into their learning strategies 9/1/09 3:29:01 PM LETTERS TO THE EDITOR GLOBAL COMPETITIVENESS in the SPECIAL ISSUE NEW WORLD Restoring American Competitiveness Decades of outsourcing manufacturing has left U.S industry without the means to invent the next generation of high-tech products that are key to rebuilding its economy | by Gary P Pisano and Willy C Shih to recover from the current economic crisis, it’s going to discover an unpleasant fact: The competitiveness problem of the 1980s and early 1990s didn’t really go away It was just hidden during the bubble years behind a mirage of prosperity, and all the while the country’s industrial base continued to erode Now, the U.S will finally have to take the problem seriously Rebuilding its wealth-generating machine – that is, restoring the ability of enterprises to develop and manufacture high-technology products in America – is the only way the country can hope to pay down its enormous deficits and maintain, let alone raise, its citizens’ standard of living Reversing the decline in competitiveness will require two drastic changes: O  The government must alter the way it supports both basic and applied scientific research to promote the kind of broad collabo- 114 Harvard Business Review | July–August 2009 | Lloyd Miller AS THE UNITED STATES STRIVES hbr.org hbr.org | July–August 2009 | Harvard Business Review 115 Restoring American Competitiveness Through the discussion of the industrial commons concept in their article “Restoring American Competitiveness” (July–August 2009), Gary P Pisano and Willy C Shih compellingly demonstrate how short-term decisions can impact the long-term viability of an industry But rebuilding the industrial commons of the United States will require a robust workforce, and that may prove to be a substantial stumbling block Younger knowledge workers shy away from entering any industry they think might be vulnerable to outsourcing – even if their perception is inaccurate The information technology industry, for example, continues to grow and has a very strong industrial base coupled with a high demand for talent in the supplier and consumer sectors of technology Yet despite this evidence of a very strong industrial commons, the number of students graduating with a degree in computer science has steadily declined Over the long term, this can damage the health and vitality of the software industrial commons The bias against outsourcing, however, gets only part of the blame for the decrease in new graduates The remainder can be attributed to a general insecurity about the profession that persists eight years after the dotcom bust This places increased responsibility on parents, educators, and technology-intensive industries to rekindle student interest in technical education and enhance U.S global competitiveness in all engineering and technical fields Taimur Khan Business Development Manager Oracle Washington, DC 134 Harvard Business Review 1524 Oct09 Letters Layout.indd 134 | Pisano and Shih express concern that the United States is losing its ability to invent the next generation of hightech products, which are essential to economic recovery, and that a new approach by government and management is required They offer Amazon’s Kindle as an example, since most of its components are made in Asia Their analysis raises three questions First, is this uniquely an issue for America? Nintendo, a Japanese company, has had huge success with the Wii games platform The remote control unit, the Wiimote, includes designs and components made in companies across America, Europe, and Asia, and the final assembly is done in China Why can’t Japan make a Wiimote? The answer is that this is how globalization works The effect is something we are still coming to understand: Although product commoditization is a well-known phenomenon, manufacturing has become a commodity, too, and can be performed in many places around the world Second, is this a great economic disadvantage? Amazon, Apple, IBM, and Nintendo, among others, get the lion’s share of the profit pool They invest in designing the next great product and, once it’s produced, must figure out whom to sell it to, how, and what ongoing support will be required Those costs are considerable and not borne by the component manufacturers Undertaking such risks deserves high rewards, which benefit both the companies and the economy Finally, are the authors’ proposed solutions both necessary and sufficient? Pisano and Shih suggest that the government should invest more in basic science and that managers should refocus on R&D Yet the combined skills of management, marketing, and sales – in which America is preeminent – are critical for taking an invention to market and turning it into an innovation A focus on basic research to the exclusion of those skills may not produce the desired results To illustrate, consider one company’s experience following the discovery of October 2009 | the giant magnetoresistance (GMR) effect, which greatly increased the amount of data that can be stored on a disk drive The scientific breakthrough itself was of no commercial interest in France or Germany, where the government-funded research had been conducted But Seagate, a U.S company and a leader in digital storage, found ways to capitalize on it The firm’s engineers reworked the original idea using different materials and temperatures and then figured out how to mass-produce a reliable new product Many other U.S firms – from Procter & Gamble to IBM and even McDonald’s – have also captured great ideas and productive capabilities from wherever they arose and done the hard work of bringing innovations to market Scientists, technologists, and manufacturing experts are all needed to develop the basic ideas flooding in from around the world, and the need for their high-level skills at home is growing So, can America make the Kindle or Japan the Wiimote? Do they have to? Bob Clarebrough Independent Consultant Weymouth, England Pisano and Shih respond: Taimur Khan highlights the vicious cycle that contributes to the decline of the skill base embodied in an industrial commons As particular types of work leave a geography, there are fewer positions to be filled, and the decreased demand makes that field much less attractive for students How can we rekindle students’ interest in technical education in important fields? Perhaps the best way is to capture their imagination with the opportunities that bold new investments will bring That is why we favor renewed investment in big problems – problems that challenge and inspire Bob Clarebrough’s letter highlights an important distinction: We not think that all outsourcing is bad Outsourcing of assembly operations, for example, where a contract manufacturer can bring advantages of scale and scope, hbr.org 9/4/09 12:47:06 PM LETTERS TO THE EDITOR GLOBAL COMPETITIVENESS in the SPECIAL ISSUE NEW WORLD Restoring American Competitiveness Decades of outsourcing manufacturing has left U.S industry without the means to invent the next generation of high-tech products that are key to rebuilding its economy | by Gary P Pisano and Willy C Shih to recover from the current economic crisis, it’s going to discover an unpleasant fact: The competitiveness problem of the 1980s and early 1990s didn’t really go away It was just hidden during the bubble years behind a mirage of prosperity, and all the while the country’s industrial base continued to erode Now, the U.S will finally have to take the problem seriously Rebuilding its wealth-generating machine – that is, restoring the ability of enterprises to develop and manufacture high-technology products in America – is the only way the country can hope to pay down its enormous deficits and maintain, let alone raise, its citizens’ standard of living Reversing the decline in competitiveness will require two drastic changes: O  The government must alter the way it supports both basic and applied scientific research to promote the kind of broad collabo- 114 Harvard Business Review | July–August 2009 | Lloyd Miller AS THE UNITED STATES STRIVES hbr.org hbr.org | July–August 2009 | Harvard Business Review 115 Restoring American Competitiveness Through the discussion of the industrial commons concept in their article “Restoring American Competitiveness” (July–August 2009), Gary P Pisano and Willy C Shih compellingly demonstrate how short-term decisions can impact the long-term viability of an industry But rebuilding the industrial commons of the United States will require a robust workforce, and that may prove to be a substantial stumbling block Younger knowledge workers shy away from entering any industry they think might be vulnerable to outsourcing – even if their perception is inaccurate The information technology industry, for example, continues to grow and has a very strong industrial base coupled with a high demand for talent in the supplier and consumer sectors of technology Yet despite this evidence of a very strong industrial commons, the number of students graduating with a degree in computer science has steadily declined Over the long term, this can damage the health and vitality of the software industrial commons The bias against outsourcing, however, gets only part of the blame for the decrease in new graduates The remainder can be attributed to a general insecurity about the profession that persists eight years after the dotcom bust This places increased responsibility on parents, educators, and technology-intensive industries to rekindle student interest in technical education and enhance U.S global competitiveness in all engineering and technical fields Taimur Khan Business Development Manager Oracle Washington, DC 134 Harvard Business Review 1524 Oct09 Letters Layout.indd 134 | Pisano and Shih express concern that the United States is losing its ability to invent the next generation of hightech products, which are essential to economic recovery, and that a new approach by government and management is required They offer Amazon’s Kindle as an example, since most of its components are made in Asia Their analysis raises three questions First, is this uniquely an issue for America? Nintendo, a Japanese company, has had huge success with the Wii games platform The remote control unit, the Wiimote, includes designs and components made in companies across America, Europe, and Asia, and the final assembly is done in China Why can’t Japan make a Wiimote? The answer is that this is how globalization works The effect is something we are still coming to understand: Although product commoditization is a well-known phenomenon, manufacturing has become a commodity, too, and can be performed in many places around the world Second, is this a great economic disadvantage? Amazon, Apple, IBM, and Nintendo, among others, get the lion’s share of the profit pool They invest in designing the next great product and, once it’s produced, must figure out whom to sell it to, how, and what ongoing support will be required Those costs are considerable and not borne by the component manufacturers Undertaking such risks deserves high rewards, which benefit both the companies and the economy Finally, are the authors’ proposed solutions both necessary and sufficient? Pisano and Shih suggest that the government should invest more in basic science and that managers should refocus on R&D Yet the combined skills of management, marketing, and sales – in which America is preeminent – are critical for taking an invention to market and turning it into an innovation A focus on basic research to the exclusion of those skills may not produce the desired results To illustrate, consider one company’s experience following the discovery of October 2009 | the giant magnetoresistance (GMR) effect, which greatly increased the amount of data that can be stored on a disk drive The scientific breakthrough itself was of no commercial interest in France or Germany, where the government-funded research had been conducted But Seagate, a U.S company and a leader in digital storage, found ways to capitalize on it The firm’s engineers reworked the original idea using different materials and temperatures and then figured out how to mass-produce a reliable new product Many other U.S firms – from Procter & Gamble to IBM and even McDonald’s – have also captured great ideas and productive capabilities from wherever they arose and done the hard work of bringing innovations to market Scientists, technologists, and manufacturing experts are all needed to develop the basic ideas flooding in from around the world, and the need for their high-level skills at home is growing So, can America make the Kindle or Japan the Wiimote? Do they have to? Bob Clarebrough Independent Consultant Weymouth, England Pisano and Shih respond: Taimur Khan highlights the vicious cycle that contributes to the decline of the skill base embodied in an industrial commons As particular types of work leave a geography, there are fewer positions to be filled, and the decreased demand makes that field much less attractive for students How can we rekindle students’ interest in technical education in important fields? Perhaps the best way is to capture their imagination with the opportunities that bold new investments will bring That is why we favor renewed investment in big problems – problems that challenge and inspire Bob Clarebrough’s letter highlights an important distinction: We not think that all outsourcing is bad Outsourcing of assembly operations, for example, where a contract manufacturer can bring advantages of scale and scope, hbr.org 9/4/09 12:47:06 PM makes a lot of sense What’s dangerous is when companies outsource capabilities that are essential to systems design or customer understanding – which are precisely what a company gets paid for Apple understands this concept Although it outsources the assembly of iPhones and notebook computers, it invests in – and jealously guards – its design capabilities and systems know-how As Clarebrough points out, the company does the hard work of bringing innovations to market Unlike Clarebrough, however, we believe that manufacturing is often part of that hard work Moreover, quite a bit of “development” occurs inside manufacturing operations That’s particularly true for highly sophisticated products, where product innovation and process innovation are tightly intertwined In those sectors, losing manufacturing capabilities eventually erodes product innovation capabilities Seagate understands that concept and safeguards strong internal capabilities for integrating commodity components It was able to capitalize on the GMR effect precisely because the company retains both a strong systems view and deep experience in all aspects of disk drive design and manufacture It also maintains a global view of capabilities in all the regions in which it operates That’s why Seagate was quickly able to exploit the technology when it came into the commons If a company doesn’t outsource strategic capabilities, it preserves fertile ground for new ideas – even those that the company has not itself developed The GMR example also highlights what happens when a region does not have the ability to capitalize on discoveries and new inventions Although Europe has never been a center of disk drive manufacturing, it could potentially have profited from the invention under the right conditions Instead, the region lost the greatest amount of value for the discovery to manufacturers like Seagate, which had maintained the necessary capabilities 1524 Oct09 Letters Layout.indd 135 Save Your Back Issues Preserve, protect, and organize your issues of Harvard Business Review Each one contains information that is just as relevant now as it was in the past Keep these valuable resources fresh and available for reference These library-quality slipcases are constructed with heavy bookbinder’s board and covered in a rich maroon leather-grained material Three-inch opening holds a year’s worth of issues A gold label with the Harvard Business Review logo is included Give your home or office an elegant, professional look Great for gifts! Slipcase Quantities and Prices: one: $15 three: $40 six: $80 Add $3.50 per slipcase for postage and handling PA residents add 6% sales tax Order on-line: www.tncenterprises.net/hbr by telephone: 215-674-8476 by fax: 215-674-5949 or by mail: TNC Enterprises Dept HBR, P.O Box 2475 Warminster, PA 18974 Please include your name, address (no P.O boxes, please), telephone number, and payment with your order For credit card payment, send name as it appears on the card, card number, expiration date, and signature AmEx, Visa, and MasterCard accepted This offer is available to U.S customers only Order on-line: www.tncenterprises.net/hbr 9/1/09 3:29:06 PM | STRATEGY & COMPETITION | 56 | How GE Is Disrupting Itself Jeffrey R Immelt, Vijay Govindarajan, and Chris Trimble How OCTOBER 2009 Disrupting Itself For decades, GE has sold modified Western products to emerging markets Now, to preempt the emerging giants, it’s trying the reverse IN MAY 2009, General Electric announced that over the next six years it would spend $3 billion to create at least 100 health-care innovations that would substantially lower costs, increase access, and improve quality Two products it highlighted at the time – a $1,000 handheld electrocardiogram device and a portable, PCbased ultrasound machine that sells for as little as $15,000 – are revolutionary, and not just because of their small size and low price They’re also extraordinary because they originally were developed for markets in emerging economies (the ECG device for rural India and the ultrasound machine for rural China) and are now being sold in the United States, where they’re pioneering new uses for such machines We call the process used to develop the two machines and take them global reverse innovation, because it’s the opposite of the glocalization approach that many industrial-goods manufacturers based in rich countries have employed for decades With glocalization, companies develop great products at home and then distribute them worldwide, with some adaptations to local conditions It allows multinationals to make the optimal trade-off between the global scale so crucial to minimizing costs and the local customization required to maximize market share Glocalization worked fine in an era when rich countries accounted for the vast majority of the market and other countries didn’t offer much opportunity But those days are over – thanks to the rapid development of Tom Burns Executive Summaries GE Is by Jeffrey R Immelt, Vijay Govindarajan, and Chris Trimble 56 Harvard Business Review SHOULD YOU LAUNCH A FIGHTER BRAND?…page 86 aps 5Trof E MANC T EN PERFOR UREM MEAS page 96 hbr.org October 2009 IMMELT ON How GE Is Disrupting Itself SPOTLIGHT ON RISK MANAGING RISK in the New World Five Experts Discuss the Future of Enterprise Risk Management HBR TOOL MappingYour Fraud Risks BLACK SWAN EVENTS How to Reduce the Impact Nassim N Taleb, Daniel G Goldstein, and Mark W Spitznagel HOW VULNERABLE ISYOUR BUSINESS to Consumer Debt? Making Financial Markets Safe ROBERT MERTON “ If GE doesn’t come up with innovations in poor countries and take them global, new competitors from the developing world – like Mindray, Suzlon, Goldwind, and Haier – will –page 56 ” | October 2009 | hbr.org | October 2009 | Harvard Business Review 57 For decades, General Electric and other industrialgoods manufacturers based in rich countries grew by developing high-end products at home and distributing them globally, with some adaptations to local conditions – an approach known as glocalization Now they must an about-face and learn to bring low-end products created specifically for emerging markets into wealthy markets That process, called reverse innovation, isn’t easy to master It requires a decentralized, localmarket focus that clashes with the centralized, product-focused structure that multinationals have evolved for glocalization In this article, Immelt, GE’s CEO, and Govindarajan and Trimble, of Dartmouth’s Tuck School of Business, describe how GE has dealt with that challenge An anomaly within the ultrasound unit of GE Healthcare provided the blueprint Because China’s poorly funded rural clinics couldn’t afford the company’s sophisticated ultrasound machines, a local team built a cheap, portable ultrasound out of a laptop equipped with special peripherals and software It not only became a hit in China but jump-started growth in the developed world by pioneering applications for situations where portability is critical, such as at accident sites The team succeeded because a top executive championed it and gave it unprecedented autonomy GE has since set up more than a dozen similar operations in an effort to expand beyond the premium segments in developing countries – and to preempt emerging giants from disrupting GE’s sales at home Reprint R0910D | Month 2009 hbr.org hbr.org| October 1524 Oct09 ExecSumms.indd 137 hbr.org | Harvard Business Review 137 9/4/09 12:45:23 PM | IDEAS & TRENDS | | HUMAN RESOURCES | FORETHOUGHT HEALTH & WELL-BEING 36 | The Simplest Way to Reboot Your Brain A survey of ideas, trends, people, and practices on the business horizon Robert Stickgold Research shows that even a few minutes of sleep The Simplest Way to Reboot Your Brain can improve memory and problem- solving skills In light of the potential benefits to productivity and performance, you may want to encourage your employees to catch a few winks during the day Reprint R0910A Health & Well-Being GRIST something, you’ll be impressed by how inept it is,” said Stanford biologist Deborah Gordon in a National Geographic article about swarm theory “Ants aren’t smart…ant colonies are.” If you’re familiar with the ideas behind the wisdom of crowds and swarm intelligence, you’re probably nodding knowingly Under the right conditions, groups – whether ant colonies, markets, or corporations – can be smarter than any of their members In 24 Harvard Business Review | these complex adaptive systems, hardto-predict behaviors emerge from the interaction of the individuals Executives make three common mistakes that show they don’t really grasp how such systems work What they miss is that you can’t understand the behavior of a complex system, let alone manage it, by analyzing a few key individuals First, managers extrapolate individual behavior to explain collective behavior October 2009 | by Michael J Mauboussin Early in my career as an equity research analyst on Wall Street, I was told that earnings per share is the key to a company’s stock price (Investors, executives, and the media still beat that drum.) But then I saw studies by financial economists who concluded that cash flow, not earnings, drives the stock price The earnings camp listened to what people talked about day to day in the investment community, on television, and in the Wall Street Journal’s pages By contrast, the Jesse Lefkowitz When Individuals Don’t Matter “IF YOU WATCH an ant try to accomplish hbr.org 24 | When Individuals Don’t Matter Are Your People Financially Literate? Michael J Mauboussin Karen Berman and Joe Knight Executives overestimate the relevance of individuals to collective behavior Agent-level changes won’t help you meet system-level goals – and they’re likely to yield unintended consequences Reprint F0910A Asked to take a basic financial literacy exam, a representative sample of U.S managers scored an average of only 38%, which doesn’t bode well for either the individuals or their organizations Reprint F0910D Downsizing Lost Its Bad Rap A Conversation with Yoshiko Shinohara Big companies used to take a big reputational hit over layoffs That’s no longer the case, according to a recent study Reprint F0910B Tempstaff’s founder, a pioneering Japanese entrepreneur, wondered whether she would go to jail for launching her business Reprint F0910E The Power of Unwitting Workers Gardiner Morse Organizations are tapping people’s mental and physical energy on the sly and using it to power lights, digitize books, and other work Are they simply putting “wasted” energy to good use or extracting value they should be paying for? Reprint F0910C Focus Intensely on a Few Great Innovation Ideas Georg von Krogh and Sebastian Raisch The companies that consistently generate revenues through innovation – GE, P&G, Nestlé, and others – are highly selective about the projects they pursue Reprint F0910F ON A DAY OFF, taking a nap is a small but heavenly pleasure Dozing at your desk isn’t – especially if a colleague walks in on you – but sometimes exhaustion just takes over The 2008 Sleep in America poll, conducted by the National Sleep Foundation, found that nearly one-third of adults who work at least 30 hours a week have fallen asleep or become extremely drowsy on the job – behavior that employers often frown upon Should they lighten up? Perhaps In a knowledge-based economy that depends on sharp minds, a few minutes of shuteye could be good for business A report in the June 2009 Proceedings of the National Academy of Sciences showed that a nap with REM (or “dream”) sleep improves people’s ability to integrate unassociated hbr.org information for creative For more on the connection between problem solving, and study health and high after study has shown that performance, visit health.hbr.org sleep boosts memory If you memorize a list of words and then take a nap, you’ll remember more words than you would without sleeping first Even micronaps of six minutes – not including the time it takes to fall asleep, which is about five minutes if you’re really tired – make a difference My colleagues and I have found evidence that important memory processing occurs as you’re falling asleep, during the hypnagogic phase That’s when the 36 Harvard Business Review | brain appears to be “tagging” memories ductive way to sort his thoughts after he of unresolved problems for subsequent spent days talking with executives was to processing We’ve also discovered that deliberately set himself up to fall asleep, naps can help people separate the gist pen and notepad within reach, and wait of new information from extraneous defor a solution to pop into his head tails, and that catching some REM sleep How does an organization implemakes them better at finding connections ment a pro-napping policy? Some combetween weakly related panies have nap rooms; othwords – a good indication ers, like Google, offer nap A few minutes that napping gets the crepods that block out light of shut-eye ative juices flowing and sound Google says its at work could When you’re in need pods are an extension of the be good of sleep, though, certain company’s flexible schedule for business skills start to slide Visual policy – people work in ways discrimination, which althat best suit them If all that lows you to sort out what you see, can sounds expensive, you can institutionalfade over the course of a day (For more ize napping without spending a dime about negative effects of too little sleep, Simply announce that it’s OK to take see “Sleep Deficit: The Performance quick naps because they make people Killer,” HBR October 2006.) A 30-minute more productive Try it out in one divinap can stop the burnout, and 60 to 90 sion and see what happens Given the minutes that include some REM sleep millions of dollars spent on programs to will improve visual discrimination increase productivity, this small, low-cost The evidence that sleep aids memory, experiment is worth doing learning, and mental acuity comes from real-world situations as well as from careRobert Stickgold is an associate profesfully crafted experiments For instance, sor of psychiatry at Beth Israel Deaconin a recent New Zealand study, air trafess Medical Center in Boston and in the fic controllers working the night shift Division of Sleep Medicine at Harvard scored much better on tests of alertness Medical School This article was created and performance if they took a planned in partnership with Harvard Health nap of 40 minutes during the shift AnPublications other example: A consultant (and retired Reprint R0910A Harvard Business School professor) I met To order, see page 143 on a flight “confessed” that the most pro- October 2009 | hbr.org “ Paul clenched his eyes shut He kept seeing cinematic images of Allied code breakers battling the Germans’ Enigma machine Sunnylake’s situation felt every bit as urgent –page 39 138 Harvard Business Review 1524 Oct09 ExecSumms.indd 138 | Veer BY ROBERT STICKGOLD ” | hbr.org Month 2009 October 2009| hbr.org 9/4/09 12:45:33 PM | MANAGING TECHNOLOGY | | STRATEGY & COMPETITION | HBR CASE STUDY INNOVATION 39 | When Hackers Turn 51 | Major League Innovation to Blackmail Scott D Anthony Caroline Eisenmann If you’re an innovation manager struggling to asMajor League Innovation sess your pipeline and assemble a balanced portfolio of growth initiatives, you may find inspiration in Major League Baseball’s general managers They, like you, are constantly shifting their lineups under high degrees of uncertainty while trying to balance stakeholders’ demands for immediate results against history’s likely judgment of their own choices Here are some ways to adapt the solutions they’ve found Before the sabermetrics revolution in baseball, managers generally dismissed minor league statistics – which turned out to be highly useful predictors of success Business innovators who likewise learn to analyze information more insightfully can devise better tactics and make investment and personnel decisions more wisely A ball club’s depth chart, illustrating the bench strength for every position, signals strategic priorities Companies can think the same way about their innovation portfolios to balance offensive and defensive strategies, explore new channels or geographies, and significantly alter platform or marketing approaches Baseball’s farm system allows teams to identify and coach promising players in lower-pressure environments Innovation executives can similarly organize testmarket research and regional rollouts to expose new offerings to steadily increasing levels of scrutiny from prospective customers Procter & Gamble has been a leader on this front with its Swash fabric-care products and Tide-branded dry cleaners Reprint R0910C Innovation BY SCOTT D ANTHONY BY CAROLINE EISENMANN COMMENTARY BY PER GULLESTRUP, RICHARD L NOLAN, AND PETER R STEPHENSON Lives are at stake when extortionists shut down a hospital’s electronic medical records system Daniel Vasconcellos UR NETWORK SECURITY SUCKS, the message read But we can help u for 100K cash well insure your little hospital dont suffer any disasters “Ridiculous,” Paul Layman said to himself, deleting the e-mail “The things people try to get away with on the internet!” Paul, the CEO of Sunnylake Hospital, had been leisurely checking his inbox on a Friday afternoon when he found the illiterate e-mail from an unknown sender He’d come to Sunnylake five years earlier with a vision of introducing cutting-edge technology to the small hospital Paul was convinced that Sunnylake could grow only if it shook off outdated habits and procedures, and that switching from paper records to electronic medical records (EMRs) would improve the quality of care for the hospital’s patients After a careful search Paul had hired an earnest young man named Jacob Dale to be Sunnylake’s director of IT, and the two had worked to execute his vision The success of the EMR initiative had transformed Sunnylake from a backwater community care center to a role model for small hospitals everywhere The entire medical staff now used electronic readers to open patients’ files Many of the doctors had initially resisted the change, fearing that the new technology would divert attention from patients’ signs and symptoms As time passed, though, even the most devoted of the old school had been forced to admit that EMRs had increased efficiency – for example, by automatically checking for medication errors and drug interactions The shining success had turned Paul’s fledgling IT department into a valued part of the hospital The CEO considered EMRs to be his legacy – one that would serve the institution well for years to come The implied threat in the e-mail provoked no anxiety in Paul He had great faith in Jacob, whose custom-tailored shirts and Vandyke beard belied his aggressive energy While the system was under development, Paul had repeatedly insisted that patients’ privacy was critical Jacob had calmly and exhaustively explained that making records digital would also make them more secure Nevertheless, Paul had been nervous when the system went live, but the past three years had quieted his doubts Even though he knew that no computer system was perfect, he felt confident that the network was not in real danger – especially not from an HBR’s cases, which are fictional, present common managerial dilemmas and offer concrete solutions from experts hbr.org | October 2009 | Harvard Business Review 39 If baseball teams can win with better statistical analysis, maybe innovators can, too Daniel Hertzberg Sunnylake Hospital is being held up by When Hackers Turn to Blackmail online extortionists who have blocked access to its electronic medical records and are demanding $100,000 to restore it Paul Layman, Sunnylake’s CEO, didn’t take their first e-mail seriously, and now the hospital has ground to a halt Paul’s golden-boy IT director can’t seem to outwit the hackers Sunnylake’s legal counsel tells Paul, “Literally every second is a liability.” The chief of staff is in a mutinous fury What should Paul do? He should pay the extortionists, advises Per Gullestrup, the CEO of Clipper Projects, who in late 2008 was closely involved in negotiations with Somali pirates who had seized a Clipper Group ship But first Paul should hire a negotiator to prevent the extortionists from doing further mischief He should absolutely not acquiesce, says Richard L Nolan, a professor at the University of Washington’s Michael G Foster School of Business, because the hackers may have embedded further corruption in the system And Paul must communicate fully with the staff, his board, patients, and the public Peter R Stephenson, chairman of the department of computing at Norwich University, recommends shutting down the servers, running a malware scan on every workstation in the hospital, and watching what happens for 24 hours, in case the extortionists are insiders Reprint R0910B Reprint Case only R0910X Reprint Commentary only R0910Z HBR Case Study IT’S OCTOBER, AND if you’re an American sports fan, you’re probably choosing sides in the upcoming World Series – the culmination and champion crowner of Major League Baseball’s seven-month season But are you reflecting on what you as a manager could learn from the winning team? When you think about it, a corporate executive on the hook for delivering growth-fueling innovation has much in common with a ball club’s general manager Both are constantly shifting their lineups, making decisions to add or prune under high degrees of uncertainty Both have stakeholders demanding immediate results, but also deeply appreciate that history will be the judge of their true legacy Vindication for wise choices sometimes doesn’t come for years, and even the best leaders lose more games than they expect to along the way Is it possible that the similarities extend beyond the challenges? Could the ways that general managers solve their problems translate to business? In at least three major areas, it seems so If you’re an innovation manager struggling to predict the success of potential new offerings, develop promising ideas, and assemble a balanced portfolio of growth initiatives, the best kind of inspiration may come from the nearest ballpark (Whether you expense the ticket is your own affair.) hbr.org | October 2009 | Harvard Business Review 51 Managing Negotiators and the Deal Process November –13, 2009 Effective Strategies for Media Companies — California December 2–5, 2009 Global Energy Seminar December 6–9, 2009 Governing for Nonprofit Excellence December 9–12, 2009 Business Strategy for Partners in Law Firms January 13–16, 2010 Finance for Senior Executives January 17–23, 2010 Strategic Negotiations January 24–29, 2010 Intellectual Property and Business Strategy February 10–13, 2010 Learn more at www.exed.hbs.edu/pgm/hbr/ 1524 Oct09 ExecSumms.indd 139 9/1/09 3:25:54 PM SPOTLIGHT ON RISK | RISK MANAGEMENT| | RISK MANAGEMENT | | RISK MANAGEMENT | HBR ROUNDTABLE HBR TOOL 82 | How Vulnerable Is Your 68 | Managing Risk 76 | Mapping Your Fraud Risks in the New World Toby J.F Bishop and Frank E Hydoski Robert S Kaplan, Anette Mikes, Robert Simons, Peter Tufano, and Michael Hofmann Managing Risk | Fraud Risks | Black Swan Events | Consumer Debt | Merton on Financial Innovation HEAT MAP STRUCTURE Sanctions violations – wire transfer stripping Rogue TO AREA Trader WATCH | by Toby J.F Bishop and Frank E Hydoski Theft of Funds – transfers The world is awash in increasingly varied, sophisticated, and dangerous fraud schemes Although companies have be- come quite good at managing predictable, lower-level risks, many have a false sense of security about their ability to anticipate and deal with more hazardous threats be aware of their companies’ vulnerability to serious fraud, yet they may be out of the loop because risk assessment is IN THE NEW WORLD Theft of Funds – cashiers LIKELIHOOD Senior executives and directors need to MANAGING RISK FCPA violations Senior management and Mortgage boards can benefit from fraud periodically requesting and discussing fraud-risk maps The maps depicted Insider below show loan hypothetifraud cal assessments of fraud risks, prior to mitigation efforts, in companies from two industries While the red sections (likely and significant risks) will naturally draw your attention, pay heed also to the upper-left quadrants SIGNIFICANCE Five experts discuss the future of enterprise risk management | With Robert S Kaplan, Anette Mikes, Robert Simons, Peter Tufano, and Michael Hofmann Moderated by HBR senior editor David Champion Securization fraud FCPA LOW LIKELIHOOD violations Insider BUT POTENTIALLY Trading DEVASTATING HBR Tool RISK frequently handled further down the chain >> What are the unlikely >> How would you know but potentially most dangerous fraud risks at your organization? if schemes were actually under way? >> What is being done to prevent them? of command and captured in voluminous, hard-to-penetrate spreadsheets and Ideally, fraud-risk heat maps are built through collaboration among people at many levels and across functions, and they represent a consensus about the financial, regulatory, and reputational impacts that specific kinds of fraud could create The maps here illustrate how fraud risks can vary dramatically from one firm to the next Your company’s map might look quite different, could identify more risks, and would change over time databases A great way for risk managers to com- municate with their firms’ leaders is to plot on a simple heat map the likelihood and significance of various types of fraud at the organization A heat map can focus U.S CONSUMER PRODUCTS COMPANY MULTINATIONAL DIVERSIFIED BANK senior executives and the board on un- likely but potentially devastating risks that merit (but often don’t receive) board-level attention – so-called Black Swan events, such as the recent Madoff case and the rogue trading that cost Société Générale How should managers prepare for Black Swan events? | October 2009 | Getty Images Art Credit What makes a good CRO? 68 Harvard Business Review hbr.org hbr.org | October 2009 | Harvard Business Review 69 Five experts gathered recently to discuss the future of enterprise risk management: Kaplan, the Baker Foundation Professor at Harvard Business School, who with his colleague David Norton developed the balanced scorecard; Mikes, an assistant professor at HBS who studies the evolution of risk management and the role of the chief risk officer; Simons, the Charles M Williams Professor of Business Administration at HBS; Tufano, the Sylvan C Coleman Professor of Financial Management at HBS; and Hofmann, the chief risk officer at Koch Industries The panel was moderated by HBR senior editor David Champion Among the questions they addressed were: How predictable was the financial meltdown of 2008–2009? Did new tools for assessing risk give a false sense of security? How the challenges facing industrial companies differ from those facing the financial sector? Is outsourcing an effective risk-management tool? Have capital structures become a bit too efficient in many companies? What makes a good chief risk officer? Reprint R0910E 140 Harvard Business Review 1524 Oct09 ExecSumms.indd 140 | 10 com) is the Chicago-based director of the Deloitte Forensic Center and Frank E Hydoski (fhydoski@deloitte.com) is the New York–based leader of the Analytic 1) Manipulation of loan loss reserves and Forensic Technology practice, both at 2) Mortgage fraud Deloitte Financial Advisory Services They 3) Securitization fraud are the authors of Corporate Resiliency: When are risk-return trade-offs prohibitively dangerous? more than $7 billion Toby J.F Bishop (tobybishop@deloitte Has the development of tools for assessing risk lulled people into believing risk is now easier to control? William Jarvis and Ian C MacMillan Today’s sky-high personal debt levels portend a freeze in consumer spending and a rise in defaults They could threaten your company – even if you don’t sell to consumers Two experts explain how to calculate your firm’s risk Reprint R0910H SPOTLIGHT ON Risk managers should plot their organizations’ fraud threats on a heat map They’ll want to look carefully at the upper-left quadrant, where unlikely – but potentially devastating – risks lurk Reprint R0910F SPOTLIGHT ON RISK MAPPING YOUR FRAUD RISKS SPOTLIGHT ON Business to Consumer Debt? 4) Sanctions violations – wire transfer stripping Managing the Growing Risk of Fraud and Corruption (Wiley, 2009) 5) FCPA violations Reprint R0910F 76 Harvard Business Review | October 2009 | 10 6) Insider loan fraud 7) Rogue trading 8) Insider trading 9) Theft of funds – cashiers 1) Falsification of loan covenant compliance 6) Purchasing kickbacks with vendor overpricing 2) Overstatement of revenues 7) Diversion of cash – accounts receivable schemes 3) Overstatement of inventory 10) Theft of funds – transfers 8) Theft of inventory 4) Diversion of cash – accounts payable schemes 9) Concealment of product quality/safety issues 5) FCPA violations 10) False T&E expense claims hbr.org RISK Managing Risk | Fraud Risks | Black Swan Events | Consumer Debt | Merton on Financial Innovation HOW VULNERABLE IS YOUR BUSINESS TO CONSUMER DEBT? Struggling buyers are increasingly tapping – and tapping out – their credit Calculate your company’s exposure | by William Jarvis and Ian C MacMillan THIS PAST SUMMER a certain amount of optimism began to reemerge, with talk of “green shoots” and even a potential recovery as the stock market Companies that sell big-ticket consumer goods are the most obviously at risk, be- operating profits We’ve explained how you can these calculations in an article on cause credit-shy consumers can simply opt hbr.org, “How Exposed Is Your Business to to put off buying cars, cookers, and other Consumer Leverage?” Accompanying it is rebounded by 30% from its low in March durable goods for another year Very often That optimism may be misplaced, however these companies help consumers finance a useful interactive spreadsheet, into which you can slot numbers and working assump- Look at the graph below, which tracks purchases, so defaults hit them directly But tions appropriate to your company We think the ratio of U.S consumers’ debt to their you don’t have to be in the consumer credit the chances are good you’ll find you’re a lot disposable income While a little off its high business to suffer Any company that sees more exposed than you think point, the number now stands at around a large proportion of its sales come through William Jarvis (williamjarvis@hotmail 130% In other words, it will take American credit cards will experience significant drops com), an associate at a major investment consumers nearly 16 months (1.3 years), on in revenue, because people usually cut back bank in New York, previously worked in average, to pay off their debt, assuming that on credit card purchases before they on investment banking at JPMorgan and in they spend absolutely nothing on housing, cash ones What’s more, an increase in finance at GE Capital Ian C MacMillan hbr.org For more about the risks that consumer debt poses to your business and an online tool that will help you assess them, go to cle.hbr.org clothes, or food American defaults will most likely translate into higher is a professor at the University of Penn- consumers have maxed processing fees from the credit card com- sylvania’s Wharton School of Business in panies Even if your customers are all other Philadelphia out their credit, and with household wealth down as a result of the property prospects uncertain, Reprint R0910H businesses, you’re still not safe What if they 1.30 in turn sell cars, refrigerators, and furniture? collapse and employment It’s imperative to get a handle on what changes in household financial practices will they’re not about to take to your company To make that estima- on more Instead, they’ll tion, you need to calculate what we call your be looking to cut back on it Many will consumer leverage exposure (CLE) ratios, default Both the defaults and the waning which will help you identify precisely how consumer appetite for credit bode ill for reductions in consumer credit will affect businesses your company’s sales, gross margins, and Consumer Leverage Ratio 1.00 It will take American consumers around 16 months, on average, to pay off their debt, assuming that they spend absolutely nothing on housing, clothes, or food 0.60 1975 1985 82 Harvard Business Review | October 2009 | 1995 2005 hbr.org | RISK MANAGEMENT | 78 | The Six Mistakes Executives | FINANCE & ACCOUNTING | Make in Risk Management 84 | Making the Financial Nassim N Taleb, Daniel G Goldstein, and Mark W Spitznagel Taleb (who wrote the best-selling books Fooled by Randomness and The Black Swan) and his coauthors argue that conventional risk-management textbooks don’t prepare us for the real world For instance, no forecasting model predicted the impact of the current economic crisis Managers make six common mistakes when confronting risk: They try to anticipate extreme events, they study the past for guidance, they disregard advice about what not to do, they use standard deviations to measure risk, they fail to recognize that mathematical equivalents can be psychologically different, and they believe there’s no room for redundancy when it comes to efficiency Companies that ignore Black Swan (low-probability, high-impact) events will go under But instead of trying to anticipate them, managers should reduce their companies’ overall vulnerability Reprint R0910G Markets Safe A Conversation with Robert Merton SPOTLIGHT ON RISK Managing Risk | Fraud Risks | Black Swan Events | Consumer Debt | Merton on Financial Innovation THE SIX MISTAKES EXECUTIVES MAKE IN RISK MANAGEMENT Black Swan events are almost impossible to predict Instead of perpetuating the illusion that we can anticipate the future, risk management should try to reduce the impact of the threats we don’t understand | by Nassim N Taleb, Daniel G Goldstein, and Mark W Spitznagel 78 Harvard Business Review | October 2009 | hbr.org WE DON’T LIVE in the world for which conventional risk-management textbooks prepare us No forecasting model predicted the impact of the current economic crisis, and its consequences continue to take establishment economists and business academics by surprise Moreover, as we all know, the crisis has been compounded by the banks’ so-called risk-management models, which increased their exposure to risk instead of limiting it and rendered the global economic system more fragile than ever Low-probability, high-impact events that are almost impossible to forecast – In this edited conversation with HBR senior editor David Champion, MerMaking the Financial Markets Safe ton, a professor at Harvard Business School, casts light on the role of derivatives in the current financial crisis Merton was awarded the Nobel Prize in 1997 for his part in developing a new method to value derivatives, and after publication of that development, the markets in derivatives exploded: Today, the estimated notional value of derivative contracts exceeds $500 trillion Merton posits that derivatives themselves cannot be the cause of a financial crisis They are simply tools that can be used either functionally (to reduce risk) or dysfunctionally (in ways that increase risk without offsetting benefits) He also offers prescriptions for making the financial markets safer Reprint R0910J SPOTLIGHT ON RISK Managing Risk | Fraud Risks | Black Swan Events | Consumer Debt | Merton on Financial Innovation A Conversation with Robert Merton ANY DISCUSSION about the financial crisis and risk management involves some theorizing about derivatives Who better to cast light on the subject than one of the architects of modern risk manage- ment, Robert C Merton, a Harvard Business School professor and a winner of the 1997 Nobel Prize in economics Merton’s Nobel was awarded in recognition of his role in developing a new method for valuing derivatives Since the method’s publica- tion, in 1973, the markets in derivatives have exploded, and today the notional value of outstanding contracts is estimated to exceed $500 trillion The following interview is an edited version of recent conversations between Professor Merton and HBR senior editor David Champion 84 Harvard Business Review | Many people believe that financial innovation, particularly derivatives, caused the global financial crisis Do you agree? No Derivatives are ubiquitous in the financial system, and thus will be part of any crisis, but the instruments themselves cannot be its cause They are simply tools that can be used either functionally, to reduce risk, or dysfunctionally, in ways that increase risk without offsetting benefits That said, innovation is structurally linked fects of the innovation would be In finance, as elsewhere, you have to make a trade-off between the benefits and risks of innovation The only way to make us absolutely safe from innovation is to abstain from it alto- gether In any event, to argue that we should ban derivative contracts when no major financial institution, including central banks, can function without them is tantamount to saying that we should ban cars to reduce the risk of global warming It’s neither a meaningful nor a desirable aspiration to an increased likelihood of a crisis: Suc- cessful innovation by its very nature initially outstrips our ability to regulate it, since existing infrastructural supports will be insufficient to safely apply its full potential Out of 100 innovations, maybe only one or You’ve said that understanding derivatives provides insight into the riskiness of conventional banking assets How? Let’s suppose that you are a bank contem- two will work out It is not practical to spend plating a loan application from a company untold resources to build a full infrastructure Before approving the loan, you might look for all 100 at the get-go, before you know for a guarantor, someone whose credit you which will succeed Of course, even if you don’t doubt Once you have this guarantee did, you still couldn’t predict what all the ef- and you make the loan, you have a compos- October 2009 | hbr.org | hbr.org Month 2009 October 2009| hbr.org 9/4/09 12:45:52 PM | STRATEGY & COMPETITION | | PERFORMANCE MEASUREMENT | 86 | Should You Launch a Fighter Brand? 96 | The Five Traps of Performance Measurement Mark Ritson Andrew Likierman Should You Launch a Fighter Brand? Customers are suddenly hyperconscious of value, and new low-price competitors are nipping at your heels Should You Launch a Fighter Brand? ★ BY MARK RITSON ★ The Five Traps of Performance Measurement I | by Andrew Likierman But times change Economic strains are now causing consumers to trade down, and many midtier and premium brands are losing share to low-price rivals Their managers face a classic strategic conundrum: Should they tackle the threat head-on by reducing prices, knowing that will destroy profits in the short term and brand equity in the long term? Or should they hold the line, hope for better times to return, and in the hbr.org | October 2009 | Harvard Business Review 87 With consumers tightening their belts, many premium brands are losing market share to low-price rivals Their managers face a classic conundrum: Should they tackle the threat head-on by cutting prices and risk damaging their profits and brand equity? Or should they hold the line and lose customers who might never come back? Faced with those two unpalatable alternatives, companies often turn to a third option: launching a fighter brand A fighter brand is designed to protect a premium offering by combating, and ideally eliminating, its cheaper competitors The textbook example is Busch beer, which Anheuser-Busch introduced in 1955 at half the wholesale price of Budweiser Busch fended off the inexpensive regional beers that were eating into Bud’s sales and, even better, opened up a brand-new market segment for the company Unfortunately, such victories are rare Too many fighter brands inflict little damage on their targets and instead cause significant collateral losses for the companies that initiate them What trips them up? Cannibalization of the premium product’s sales, failure to create an offering that can compete, unprofitability, inattention to consumer needs, and drains on management’s time and resources With detailed accounts of campaigns lost – and occasionally won – Melbourne Business School’s Ritson explains how to avoid those major hazards and launch an offering that wins on all fronts Reprint R0910K 1524 Oct09 ExecSumms.indd 141 Jude Buffum Jack Black M ANAGERS contemplating a new product launch during the prosperous early years of the twenty-first century typically looked only in one direction: up Thanks to consumers’ rising incomes and apparently insatiable desire for superior quality, the era began with a focus on “premiumization,” “trading up,” and “luxury for the masses.” 96 Harvard Business Review | October 2009 | hbr.org IN AN EPISODE of Frasier, the television sitcom that follows the fortunes of a Seattle-based psychoanalyst, the eponymous hero’s brother gloomily summarizes a task ahead: “Difficult and boring – my favorite combination.” If this is your reaction to the challenge of improving the measurement of your organization’s performance, you are not alone In my experience, most senior executives find it an onerous if not threatening task Thus they leave it to people who may not be natural judges of performance but are fluent in the language of spreadsheets The inevitable result is a mass of numbers and comparisons that provide little insight into a company’s performance and may even lead to decisions that hurt it That’s a big problem in the current recession, because the margin for error is virtually nonexistent So how should executives take ownership of performance assessment? They need to find measures, qualitative as well as quantitative, that look past this year’s budget and previous results to determine how the company will fare against its competitors in the future They need to move beyond a few simple, easy-to-game metrics and embrace an array of more sophisticated ones And they need to keep people on their toes and make sure that today’s measures are not about yesterday’s business model In the following pages I present what I’ve found to be the five most common traps in measuring performance and illustrate how some organizations have managed to avoid them My prescriptions aren’t exhaustive, but they’ll provide a good start In any event, they can help you steal a march on rivals who are caught in the same old traps hbr.org | October 2009 | Harvard Business Review 97 Evaluating a company’s performance often entails wading through a thicket of numbers produced by a few simple metrics, writes the author, and senior executives leave measurement to those whose specialty is spreadsheets To take ownership of performance assessment, those executives should find qualitative, forward-looking measures that will help them avoid five common traps: Measuring against yourself Find data from outside the company, and reward relative, rather than absolute, performance Enterprise Rent-A-Car uses a service quality index to measure customers’ repeat purchase intentions Looking backward Use measures that lead rather than lag the profits in your business Humana, a health insurer, found that the sickest 10% of its patients account for 80% of its costs; now it offers customers incentives for early screening Putting your faith in numbers The soft drinks company Britvic evaluates its executive coaching program not by trying to assign it an ROI number but by tracking participants’ careers for a year Gaming your metrics The law firm Clifford Chance replaced its single, easyto-game metric of billable hours with seven criteria on which to base bonuses Sticking to your numbers too long Be precise about what you want to assess and explicit about what metrics are assessing it Such clarity would have helped investors interpret the AAA ratings involved in the financial meltdown Really good assessment will combine finance managers’ relative independence with line managers’ expertise Reprint R0910L “ROTMAN MAGAZINE TACKLES REAL IDEAS WITH A VERVE AND STYLE THAT I HAVE NOT ENCOUNTERED ANYWHERE ELSE.“ – Peter Day BBC Radio Presenter, “In Business” and “Global Business” (March, 2009) Try a risk-free issue: rotman.utoronto.ca/must-read 9/1/09 3:26:03 PM | ORGANIZATION & CULTURE | | SELF-MANAGEMENT | | MERGERS & ACQUISITIONS | 102 | Making Time Off MANAGING YOURSELF BEST PRACTICE 115 | Three Keys to Getting an 121 | Mergers That Stick Overseas Assignment Right Rosabeth Moss Kanter Predictable – and Required Leslie A Perlow and Jessica L Porter Mark Alan Clouse and Michael D Watkins Making Time Off Predictable– BY ROSABETH MOSS KANTER AND MICHAEL D WATKINS Professional services firms typically have a 24/7 on-call culture But one management consulting company is getting better results by experimenting with downtime – even in this economy | Leslie A Perlow and Jessica L Porter PEOPLE IN PROFESSIONAL SERVICES | October 2009 Dongyun Lee | ASSUMING A NEW leadership role is hard even in the best of cir- hbr.org Susanna Vagt 102 Harvard Business Review How to tackle a management role in a new cultural and regulatory environment cumstances: relationships are undefined, routines are unfamiliar, and expectations are often unclear Now imagine yourself heading up a new unit or project in a corporate and national culture radically different from your own To strengthen their CVs, many ambitious executives willingly learn new languages, uproot their families, and puzzle over local laws and customs But an international management assignment can be a harrowing journey of sorts Indeed, if they’ve never made an international move before, emerging leaders can fall into common traps that severely stress their family bonds, negatively affect their performance at work, damage their businesses, and even derail their careers That’s what it was like for a leader we’ll call Oscar Barrow Six months into a new assignment in China, he had made several serious missteps with employees, the plant he’d been charged with turning around quickly was still struggling, and his tough corporate-lawyer wife was in meltdown mode What happened? Change Is Good – or Is It? Oscar had worked for 10 years at a U.S.–based pharmaceuticals firm, moving relatively quickly from an entry-level position in manufacturing all the way up to a post as general manager in one of the company’s biggest domestic plants The next logical step, he knew, was a trip overseas That path would dovetail with his wife’s decision to leave her job as a partner at a leading law firm to spend more time caring for their two toddlers The pharmaceuticals company boasted multiple operations in China, and he eagerly anticipated the challenge of living and hbr.org People in professional services believe a 24/7 work ethic is essential for getting ahead – and so they work 60-plus hours a week and stay tethered to their BlackBerrys This perpetuates a vicious cycle: Responsiveness breeds the need for more responsiveness When people are always “on,” responsiveness becomes ingrained in the way they work, expected by clients and partners, and even institutionalized in performance metrics There is no impetus to question whether the work actually requires 24/7 responsiveness; on the contrary, people work harder and longer, without stopping to explore how they could work better But four years of research conducted by the authors in several North American offices of the Boston Consulting Group suggests that consultants and other professionals can provide the highest standards of service and still have planned, uninterrupted time off They can this even in times of recession In this article, Perlow and Porter outline the lessons from BCG’s implementation of predictable time off – namely, impose a strict mechanism for taking days and nights off, encourage lots of talk about what’s working and what isn’t, promote experimentation with different ways of working, and insist on top-level support Reprint R0910M 142 Harvard Business Review 1524 Oct09 ExecSumms.indd 142 | | October 2009 | Harvard Business Review 115 Eager to snap up bargain acquisitions? Remember that merging talent is more important – and more difficult – than getting the numbers right it might seem like a shrewd move in a recession to swoop in and acquire firms on the cheap – buy low, cut costs, and defy the usual prediction that most mergers will fail to produce economic value in their first two years And there’s a grain of truth to that assumption While M&A activity has been severely depressed since 2008 and fell dramatically in early 2009, acquiring companies during that period tended to outperform their industry peers in market valuation, according to a global study by Towers Perrin and Cass Business School examining 204 deals, each worth more than $100 million But outperforming peers during the worst days of the economic crisis simply means that acquirers’ stock prices fell by a lower percentage; the companies lost less value than others but did not necessarily create new value The fact that they could afford to buy at all was a sign of financial health, a factor that alone could account for the better stock market performance Studies by Boston Consulting TO MANY EXECUTIVES, Jordán Federico BY MARK ALAN CLOUSE Required P An international assignment can be among the most exciting and challenging Three Keys to Getting an Overseas Assignment Right transitions that an aspiring leader can undertake With the right planning and attitudes, taking on that kind of leadership role can stretch capabilities, challenge assumptions, and steer both people and profits in a positive direction But an expat assignment can also be a harrowing journey Indeed, if they’ve never made an international move before, emerging leaders can fall into common traps that can severely stress their family bonds, negatively affect their performance at work, damage their businesses, and even lead to outright career derailment In this article, Clouse, the managing director of Kraft Foods Brazil, and Watkins, the author of The First 90 Days: Critical Success Strategies for New Leaders at All Levels, offer three best practices for handling the personal-change challenges that go along with an overseas assignment Settling the family in, adapting your communication style, and ensuring that you understand the new regulatory environment you’re operating in are all critical for a successful transition, they advise Reprint R0910N Managing Yourself & (consultants, investment bankers, accountants, lawyers, IT, and the like) simply expect to make work their top priority They believe an “always on” ethic is essential if they and their firms are to succeed in the global marketplace Just look at the numbers: According to a survey we conducted last year, 94% of 1,000 such professionals said they put in 50 or more hours a week, with nearly half that group turning in more than 65 hours a week That doesn’t include the 20 to 25 hours a week most of them spend monitoring their BlackBerrys while outside the office These individuals further say they almost always respond within an hour of receiving a message from a colleague or a client The mergers that thrive postrecession will be those Mergers that focus not just That Stick on the numbers but on integrating and motivating employees To extract lessons on how to manage the human side of M&A, Harvard Business School’s Kanter studied a dozen deals that overcame the usual barriers to success: employee shock, protests, and anxiety, all of which can fuel supplier unrest, government disapproval, and customer defections Procter & Gamble, for instance, faced the prospect of “blood on the floor” in its ranks when it bought Gillette, because headhunters went after Gillette managers Yet P&G managed to retain a large percentage of them, and it enlisted employees in keeping suppliers, distributors, and customers happy The company met cost and revenue targets within the first year, incorporated Gillette’s superior go-to-market processes, and continued to position itself for growth even as the current recession loomed Kanter highlights the key strategies behind effective integration by describing practices at P&G and two other companies: CEMEX, which needed to transfer know-how to acquired employees so they could absorb its processes quickly and meet global standards, and Publicis Groupe, which treated its mergers like reverse takeovers, allowing acquired talent to take the lead in building new capabilities Reprint R0910P Best Practice hbr.org | October 2009 | Harvard Business Review 121 | hbr.org Month 2009 October 2009| hbr.org 9/4/09 12:46:13 PM PANEL DISCUSSION | by Don Moyer Approach Avoidance I N NETWORKING, you’re only as good as your advice If you want people to think you’re wise and discriminating, you can’t afford to make poor recommendations But fear of falling short is only one reason managers resist networking Herminia Ibarra and Mark Hunter discuss others in “How Leaders Create and Use Networks” (HBR January 2007) Networking is “one of the most dreaded developmental challenges that aspiring leaders must address,” they write Some find it “insincere or manipulative – at best, an elegant way of using people.” Some think it’s a waste of precious time and energy, or dismiss it as political maneuvering Ibarra and Hunter have seen others who “let interpersonal chemistry, not strategic needs, determine which relationships they cultivated.” The authors advise managers who are hesitant to develop this crucial career skill to find a good role model; put outside interests to work inside the organization; engage with the network consistently, not just when they need help; and have faith that practice will pay off “People who work at networking,” they promise, “can learn not only how to it well but also how to enjoy it.” Don Moyer can be reached at dmoyer@thoughtformdesign.com 144 Harvard Business Review 1524 Oct09 PanelDisc Layout.indd 144 | October 2009 | hbr.org 9/3/09 1:00:39 PM ... Harvard Business Review September–October 1986 ” “Enough with the chitchat, people I think it’s time we cut to the chase.” 22 Harvard Business Review 1524 Oct0 9 StratHumor.indd 22 | October 2009. .. T Landry 34 Harvard Business Review 1524 Oct0 9 FT layout.indd 34 | October 2009 | have brought us a long, hard recession, we should adopt more-realistic attitudes about life and business Surely... Vijay Govindarajan, and Chris Trimble 56 Harvard Business Review 1524 Oct0 9 Immelt.indd 56 | October 2009 | Tom Burns We call the process used to IN MAY 2009, General Elecsold modified Western develop
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