E - learning

Job Survival Advice: Don't Fear the Whitewater

2009-03-31T14:47:00.001+05:30

Change is the new status-quo, and success at work will require agility, talent and the ability to learn from -- rather than fear -- failure, according to Gregory Shea, adjunct professor of management at Wharton, and business writer Robert Gunther. The two recently co-authored a book titled, Your Job Survival Guide, a Manual for Thriving in Change. In an interview with Knowledge@Wharton, the authors compared the economy and job market to a whitewater river in which every kayaker is certain to spend a significant part of the journey under water.

Knowledge@Wharton: Robert, tell us a bit about Greg's whitewater comment that led to your collaboration on the book.

Robert Gunther: Well, I was sitting in a classroom, actually at the Wharton School, and listening to Greg speak. And he was talking about change in environments. This was a presentation to the large telecommunications firm, obviously going through lots of changes. And he used this phrase -- he dropped this phrase. He said, "We're in an environment that's permanent whitewater. It's not a steady -- it's not a change, steady-state change kind of environment, where you catch your breath between. It's a permanent whitewater." And when he said this word, "whitewater", it really caught my attention. Because I had grown up, since I was a teenager, paddling whitewater rivers. Paddling kayaks. And I knew that kayakers look at whitewater in a totally different way than other people do. You might say ordinary people, or "sane" people. And so if you were to look at, say, Lava Falls on the Colorado River, going down the Grand Canyon, you would think there's no way you can get through this thing without being killed. It is just huge water, and it's all over the place, and it's massive confusion. But if you have a certain set of skills, you understand how to meet that environment in a way where it's not only -- you not only can survive in going through it, you not only can live through it, which is what people think of when they see turbulent environments -- but that you can actually thrive in that environment. It's fun! There's play places. The bigger the water, the more the play.

And so this is a whole shift in perspective. And there are a number of shifts in perspective that kayakers have, such as failing is not something that you avoid. It's something that you prepare for, and you recover from quickly. You prepare to recover from it. And so there's a whole shift in mindset from what we typically have. Most of us go into our careers thinking that we're signing up on the crew of an ocean liner. We're a sailor, and we know our place. And as long as everyone does their job, you end up being -- everyone will be fine and safe and secure. And then they find themselves thrown into the water, and it's a totally different environment. And if you aren't in whitewater now, you probably will be. And if you don't recognize that you're in whitewater, you're gonna do all the wrong things. And that's what we describe in our book. Is, how do you survive and thrive in this environment?

And so the metaphor is really the key to the book. But it draws upon Greg's experience in working with individuals, CEOs, and organizations, and really addressing, "How do you work and live and thrive in fast-changing environments?"

Knowledge@Wharton: I see. Well, then, Greg, why don't you tell me what you would do if you consider yourself a kayaker, and you've learned those skills, but you find yourself on an ocean liner commanded by a real old time sailor?

Gregory Shea: Let me just say one other piece, back to the metaphor, and then I'll talk directly about the question youasked. One of the implications of the metaphor that Rob talked about -- which is actually one that Peter Vail came up with many years ago -- but what we've tried to do is both push the metaphor, but also introduce another metaphor, which is this kayaking metaphor. This takes us into your question about, "What would you do?"

My flippant, or first response would be, "Get outta there." Because there are so few parts of the economy -- and we've learned yet again in the last few weeks, that you can have Bear Stearns, you can have Merrill Lynch, you can have Lehman Brothers as a name on the door, and you can put those on with all the other large names that we've watched go through extremely turbulent times over the last 30 years. So unless you're in some remarkably exceptional part of the economy, if you're on what feels like an ocean liner, my first piece of advice would be, "Get outta there." Because in all likelihood, they don't understand the world that they're in. And if they don't understand it, you're going to pay the price for that. So it's better for you to understand it, and go someplace where other people do understand it.

Knowledge@Wharton: You tell the tale of a CIO who approached a huge six-week project by telling his team to spend the first week suspending or canceling all their other internal projects and commitments, and then take few days at the end of that week to go home, turn off their pagers and cell phones, and relax and recharge. How was that CIO able to do that within the organization? And how would you recommend -- or would you recommend such a strategy to most managers?

Shea: So, you asked, how was he able to do this? And the way he was able to do this is very much linked to your last question. Which was, he's working for a CEO who does understand this environment and gave him room to have a basic way that he operated. It worked because he was very good. He had a boss who understood the need to do this, and that you could burn up these employees -- and they had lots of job options. And he had a way to do it -- namely, this contracting. And he consciously spent time doing external bench marking, so people could tell that he was in the top-ten percent of people in that kind of a function in that kind of an organization. So he could prove he was doing very well. People inside knew he was on-time and often early, and at or under budget. So his internal and external measures. So that manages most of the whitewater.

And then when this particular event occurs, he can actually act quite paradoxically. So when he tells his staff that, "I want you to go cancel, postpone, delay -- if you need anything from me to clear the decks, I'll do that," it's so unusual, it's so different from the way that he normally operates. He doesn't have to tell them it's important. He doesn't have to tell them that he cares about them. They got all that just from the way that he's talking. And he has a back-up plan, which is, just as Rob will describe, giving them the advance time. Taking the time off up front, because I don't know if you can do it later. So it's multiple layers of him attempting to do the pacing. Both what was fairly creative in the beginning, and signing on with someone who he knew would understand what he was trying to do. And then when that breaks down, he's got another way in -- to use Rob's language, to move into the eddies about that.

Gunther: And yet, he was able to say, "I'm in whitewater. My job might be CIO, but my real job is change. And unless I get the change right, my entire team is going to be burnt out. I'm going to be dealing with rapid turnover of staff. I'm not going to get anything done, unless I concentrate on that first challenge." And one of the biggest challenges in a permanent whitewater environment is pacing. The water just races forward. And you see this, and -- you know, with the technology that we have, the Blackberry's and the e-mail and the cell phones -- everything is constant. And it's non-stop, and it's running at you. And in the old days, on the ocean liner, sometimes you'd hit a storm and you'd have all hands on deck, and everybody would be racing around to deal with an immediate crisis or change. And then you'd get some R&R. You'd get some time in your bunk. But now, you can't promise people that any more. Because the environment doesn't give you a natural pace. You have to learn to pace yourself.

And so what he did, which was really surprising, was he had the CEO give him this top priority project. He had six weeks to do it. He knew the team that he needed to do it, and he told them, basically, "Take the first week off. Take the first week clearing the decks, clearing your minds, and then take a long weekend to just take a vacation." And he didn't even tell them what the project was. He said, "come back Monday morning and be prepared to work." But he didn't tell them, because he knew they were so dedicated they'd work on it during their vacation time. And so he gave them the break before they plunged into the water. And that's a totally different way than we think of dealing with projects in our world. And it's very similar to what happens on a whitewater river. On a whitewater river, there are things called eddies. They're the spot behind the rock, where the water is racing down the stream, and all the rest of the current is going upstream. Now, kayakers know that you don't just race down a rapid. You pull into the first eddy. You can stop there. The water's racing around. You're stopped. You look downstream; you see where the next eddy is. And then you make your way down to that eddy. And it's a very orderly process through a disorderly environment. So you're in the chaos, but you're not of the chaos.

Knowledge@Wharton: So you're saying that to a limited extent, at least, you can impose some order on the chaos.

Gunther: Yes. And you actually have to. Because the alternative is, if you throw yourself into whitewater and get pushed pell-mell down the stream, all you're going to end up -- you're going to be burned out. You're not going to be good to anybody.

Knowledge@Wharton: Now, that also involves taking a risk for lots of people involved -- certainly for the CEO and the CIO. That gets to my question about your concept of failing quickly and recovering gracefully. Tell me about that and the kind of patience it takes from everybody involved.

Gunther: Well, it's not really an option not to fail in this environment. Things happen too quickly, the world is changing too quickly. But I'll tell you about how kayakers see this. And one of the interesting things I found out that I actually didn't know was that when a paddler uses the term "capsize" it only refers to flipping over and getting out of the boat. Most people see a capsize as a disaster. You've flipped over. That's the end. And on the ocean liner, if you're on the Titanic and you run into an iceberg, that's the end. But we have this little story about an Eskimo on the Titanic. He obviously wouldn't go to sea without his kayak. And for him, this is not an outrageous environment that he can't beat. Because he pops into his kayak, and launches over the side. And he's in his element, because he has the tools and the equipment to deal with this environment that other people can't. But one of the things that you learn as a kayaker is the Eskimo roll. It's very hard to learn, mostly because it's psychological, because your first impulse, when you're deprived of oxygen, is to get air. You may have noticed this in your life. And so when you flip over in your boat and you have a spray skirt on, your first impulse is to get out of the boat and get air as quickly as possible. That impulse is wrong. If you're out of your boat, you can get swept under an undercut rock. You can get into really nasty things. If you're in your boat, you can roll. You can learn a simple series of moves that allow you to right the boat again. And so, during the winter, kayakers practice rolling. They practice failing and recovering from failure. And it does two things. It protects you from dangerous situations. And it allows you to play. Because if you know you can recover from a failure, you can play. You can go into waves, and surf waves, and pop up out of holes. And they will flip you over, and you can recover.

Okay. So, how does this relate to what you do in work and life? Well, when you have a mindset that you're going to experiment with things, you try a lot of different experiments. You try a lot of things that may not be related to exactly what your main work is. But you do them in ways that you can fail, and then recover. And they may be related to what your main work is. They may be experiments that allow you to fail and learn. And then those are the things that may open doors for the next stage of your career in a company, or a career outside the company.

Shea: One way of thinking about the challenge that somebody faces in this environment is that the question is not really, "How do you deal with that form of risk?" The question is, "Which form of risk do you want?" Do you want the form of risk in which you're on an outdated structure? Or do you want the risk that you're going to have to learn how to kayak in permanent whitewater? So it's not a risk-free choice. It's a question of, which one do you want?

Knowledge@Wharton: Still, an organization can still have a low-tolerance for failure. Is that the kind of organization that you want to get away from?

Shea: Well, we'll give you the classic academic and consulting response, which is "it depends." So, you don't want to go to work for a power company and be stationed inside the nuclear division and say, "well, that's close enough." That would not be the kind of tolerance for risk that you'd want to have in the technical part of that operation. It'd be foolish. But the orientation in general -- if you were in a place that had no tolerance for risk, then what it's doing is building a brittle organization. And it makes it more likely that it's going to snap at some point. So obviously you don't want somebody who's risk-foolhardy. You don't want to take risk in those areas that are absolutely essential either to your well-being, or the well-being of the large organization, if we think about the nuclear power plant as an image, right? But at the same time, as Rob was saying, there are clearly places that they should be tolerant of risk. You don't want to get narrowly defined and confined to a particular expertise that gets narrower and narrower and narrower, unless you believe that in fact that's going to have increasing market power for you as an individual actor.

So you want to spend as much time as you can making sure that you have broader, not narrower skills in general, and you want to make sure that you're paying attention to the market -- namely, that what I'm learning is going to have value in the market. And I want to continue to press for those types of assignments that will allow me to try to expand either the depth or breadth of what I know, so that I can carry it out of here if and when either I choose or you choose that I have to do. And that, as we talk about in one chapter about personal flotation devices -- that is up to you, to do the work to construct that. Because the organization and the marketplace, unfortunately, are not going to do that.

Knowledge@Wharton: You also talk about this notion of getting out of the water when you hear the roar of the falls. Which, I guess, is sort of like recognizing that this company that you're with is going to cause damage to itself or to you, personally, and you have to be able to recognize that. But how do you recognize the roar of the falls?

Shea: Well, I think there are at least two forms of roars of the falls that we talk about in the book. One would be that this puts more pressure on the individual to spend time looking up from their desk, metaphorically-speaking, so that they're taking in the larger environment, and trying to make that call from a business perspective. We also talk in the book, though, about paying attention to your own inner voice, about the falls, and what you need. And so we have a story in the book, for example, of an individual who is tired of the way that their boss is handling them. She's at a very senior level, and she decides to make the potentially career-limiting move of going around her boss to talk to her boss's boss about the fact that she started doing her boss's job. Right? And the response that she gets is, "We're so glad that you're doing so much work. Because actually, we don't think this guy's very good," namely your boss, "and we're really glad that you're doing the work for him."

Well, the person talking to her intended that as a compliment. For her, that's the roar of the falls. This is not a place that I want to stay, right? So part one of the story with her is, that's an internal indication that this organization is not being run in the fashion that I would think it should be run, or that will be good for the organization over the long term. A little later in that story, she's very successful -- although she makes a variety of choices, which include her going, for family reasons -- because she needs time to start her family. Once all that's happened, she decides she can't stay where she is, because it's the wrong place for her to be. Not from a job standpoint, necessarily, but rather because of family and personal reasons, that she needs to find a place that she's actually going to raise the family that she's now given birth to. And that's an internal roar of the falls. And she gets out of the river, takes a look around, and ends up actually in a better position. But she had to take that risk that was internally-driven, as opposed to driven from some sort of external -- in this case, reconnaissance about the nature of the organization.

Gunther: And if you think about the ocean liner, how you know when you're headed for trouble. Well, you know, there's the captain up there who's looking. You've got people on watch. And they'll tell you when you're headed into an ocean liner. Well, this is not true in whitewater. In whitewater, you have to -- you can be going down the same rapid as somebody else, and you're a few feet over, and you're in a completely different situation. And so you have to look at your own company, what's going on, and you have to look at the bigger environment. You know, what did the housing -- you know, as the housing market collapses, what does this mean? How is this going to play out in my little part of the world? And what are the opportunities that it creates? And so, instead of waiting for somebody else, instead of waiting for the sirens to go off on the ship, and the horns to go off and wake you up, you've got to be attentive to what's going on in your environment, so you can see when you're headed for trouble.

Knowledge@Wharton: And another roar metaphor that you speak to in the book is communicating above the roar, a skill that one has to have to share ideas, and direction, and to explain what you're doing to the other kayakers. What are some of the skills involved in that?

Shea: One of the key points, I believe, in this environment -- in the permanent whitewater environment -- is that part of what gets shredded is context. We know from a wide range of studies that anywhere from 70 to 80 percent of the meaning of language lies inside of context. So I can say the same words in one setting, and it means something entirely different than if I say them in another setting, perhaps with a different intonation, perhaps with a different affect, or whether I laugh or don't laugh. So, language itself depends a lot, for its meaning, on context. In permanent whitewater, the context is changing all the time, which means it strips language of meaning. So the argument is not to give up language, but to understand that in this context, one needs to look alternatively. So, where are you left, if we stay with the image of permanent whitewater? I have to be able to signal. I have to be able to demonstrate symbolically.

We tell a story in -- this is a made-up example, but captures different experiences of things that I've seen. Imagine that you've got a rapidly-churning workplace. And you have a new boss. And the first thing that boss does is call you into their office, and he tells you how important you are, and how he lives to serve. And your success is his success, and hopefully you'll have a good working partnership. Well, you've probably heard all those words before in some fashion, some way, if you've been in the work force very long. And it's unlikely that made much of a dent or communicated much to you. Imagine that you had a different new boss. And she doesn't say anything to you on day one. However, you can't help but notice that in her first day on the job, she has had removed a large finished oak door that separates her work suite from the rest of the work area. And they've got people in there with chainsaws taking out the entire wall that separates her conference room and her desk area from the rest. No matter how busy you are, no matter how much whitewater you're in, you don't need a lot of explanation of what it is that she's trying to signal. You're gonna pay attention, and you've got it. There's something here about access, there's something here about collaboration. And I've got far more communication that's occurred in that second case, than if James Joyce on a good day had had the first conversation. I'm betting on the symbolic communication, no matter the roar in the office, of that second person.

Knowledge@Wharton: Is it possible that an organization can have too many kayakers? It would seem to me that that might be like trying to herd cats.

Shea: Yes. [LAUGHTER] Part of the challenge is to understand the game that's being played at any given time. We draw heavily on the work of a friend and colleague of mine, Bob Kydel, who talks about the different types of games. He uses both music and sports as images. So if we imagine a game that's like a recital, where what makes it a recital is basically a lot of independent activities -- it's a lot like baseball or track meet or swim meet. There's the type of game that looks a lot more like football, where you have a lot of time-out, time-ins. It's largely about the very scripted plays. It's like orchestral music. You don't walk into an orchestra and say, "I, a second clarinetist, think I'm going to alter Mozart's score here, because I think there are too many notes for the clarinet here." And then there's a third type, which is far more collaborative, like good jazz, where people don't actually know what's going to happen prior to walking in, and start playing off of one another's riffs. It's much more like lacrosse, or basketball.

Depending upon the game that's being played at any given moment, one needs to have the type of teaming that's most appropriate. So even on a kayak trip, if we stay with that metaphor for a moment, most of it is spent playing much more like a recital, or a game of baseball, where as Rob has described, a lot of individual activity. When you're on shore, however, it looks like football. Because what we're doing when we're on shore is, there are certain things that have to happen. We need a fire. We need meals prepared. We need people to handle latrine duty. All that work has to happen. And ideally, the best way to do it is, you go in a very machine-kind of mode to do it. The third thing, when an emergency occurs on the river, you better get interdependent very fast. So although we were playing baseball for much of this, a very independent activity, right now there's something -- maybe a whistle blow that signals we have a problem. You scan for a problem, and you immediately see, "How do I team, in a very interdependent way, to get through this moment?" So there are multiple games. We believe the dominant game is this permanent whitewater or kayaking game. But even inside that, one of the traits of being in this environment is the need to be flexible about the type of teaming that one engages in at any time. And connected to that, you want to make sure you're with people who can engage in different kinds of teaming.

Knowledge@Wharton: Now, in our executive education program here, you're probably dealing with lots of different kinds of corporate executives, Greg. And I wonder how many of those folks do you think either get this, or can do it?

Shea: Well, I just came out of spending a week with a set of executives who were here at the Aresty Institute. And the topic for the week was leadership and change. And what happens much of the time, and certainly fortunately happened, was the dominant experience this week -- at least as they reported it -- was, in terms of the image of permanent whitewater, it helps them create a framework for organizing their own experiences. And then as soon as they've done that, they can start drawing implications for their own leadership. How they want to go back home. So my experience over many years of doing this is, that's the standard response. Is that both they understand it, it speaks to them, it helps them cognitively, but it also helps them normalize it emotionally and then get on with the work of being a leader in that context.

Knowledge@Wharton: So, how do you apply these principles, say, if you're a trader at one of the financial firms on Wall Street that's finding so much difficulty in the current crisis?

Gunther: Well, I think that it's more obvious now that we're in permanent whitewater. So if you didn't realize it -- more people actually realize it. And in a way, that can be a good thing. Because you're not looking to say, "Well, I'm at this investment bank, and this will be my entire career. And it'll be a stable situation." But what's important to realize is, even though it's more apparent now that we're in whitewater -- whitewater is a feature of the environment that goes through good times and bad. And Greg has some statistics on the job hirings and firings. And during the -- from 1998 to 2000, 30 to 50 percent of companies were laying off people. They were hiring people, a lot of them were hiring people at the same time, but they were laying off. So there was this churn and turbulence that's in the environment. And this was during sort of a white-hot period in the economy, before the dot-com bust. And this is still a period where there are a lot of companies doing lay-offs. And it's a very turbulent environment.

So the specific question about, "What do you say to somebody who's in this environment?" I think the principles that we have in the book, the guidelines for how you exist and live in permanent whitewater, are probably what I would say, would be what you want to follow in this environment. But there aren't any -- it's a dangerous environment. This is not a simple, straightforward place. People get hurt in whitewater. People get killed in whitewater. And so nobody's saying, "Oh, if you learn how to paddle a kayak, you're going to be fine." You're not. You're going to be better than you would be if you didn't learn how to paddle a kayak. And you're going to be able to figure out your way to actually meet this environment. Meet this environment, and recognize it for what it is. It's not a stable environment. It's not a steady state. It's not steady state, little bit of change, steady state. It's permanent whitewater.

Knowledge@Wharton: Everybody's going to get wet.

Gunther: Everybody's going to get wet. [LAUGHTER] You're going to be without oxygen. But hey, that's part of the fun of the environment. If you think that your career is uninteresting, or it's going to stay in sort of a narrow path -- it's going to be a lot more work, but a lot more fun. There are a lot more opportunities to play, the bigger the water is. And this is really big water that we're headed into. And what you need to look for is, you need to recognize the environment and then look for the opportunities that it creates.

Shea: Certainly in this, one of the lessons would be that you can't predict the specific manifestation of what we're talking about as permanent whitewater. What you can predict is, we're in permanent whitewater. So this time it's Wall Street. It's gonna be some other time somewhere else. Depending if we're in the '70s, we're talking about consumer electronics entering this world. If we're in the '80s, we're talking about health care, financial services, and the first wave of deregulations. Those are the manifestations in that particular moment of what is an overall gestalt. This is the background. This is what we're all playing in front of, is this kind of dynamic. And it's going to continue to drive, due to changes in the -- as we mention in the book, in globalization and in the financial markets, as well as the escalation of technology. So to your specific question about, "What should that person do now?" That specific advice would be more, "Open your eyes and take a look at the world that you're in." Right now, you're in a choice of whether you're going to confine yourself to what you thought was the world view before, or are you going to move to a world view that says, as Rob has been explicating, that this is a rapidly changing world.

And among other things, besides the skill base that we've talked about a bit, there's also -- it puts particular weight on networking. Not in the sense of some kind of schmooze. It means, who knows that you're good, and who do you know that's good? So when you want to construct the next trip, move to the next river that you're going to try to go down, to stay with that image, where in your network can you go to do that? And these are people who view you as competent, who you view them as competent. These are people you want to re-enter the river with.

I was just going to finish -- we had one story that we talked about, about a female executive who ends up leaving a stable environment. She thinks, for personal reasons, that she doesn't like the direction of the firm. Goes to an entrepreneurial firm, and then eventually comes back in, being requested to rejoin the organization that she left originally, and eventually takes her boss's job. Because that's part of the reason they want her back in. And at the end of that we asked her, "So, how would you sum up your experiences?" And it's not unlike, perhaps, some of the experiences that you're referencing of people who are now in flux in Wall Street. And here's what she said, as a successful senior person who went through these and other changes in a permanent whitewater world. She says, "Work hard, do the right thing, keep your eyes open, and don't be afraid."

Half-a-Million Job Cuts: Is There a Strategy Behind the Layoffs?

2009-03-31T14:43:00.003+05:30

One month into 2009, job cuts by corporations have become a major news story around the world. In one week alone, almost 100,000 jobs were eliminated. These included 20,000 layoffs at NEC, 19,500 at Pfizer, 15,000 at Metro, 10,000 at Boeing and 8,000 at Sprint Nextel. Thousands more from Starbucks, Ericsson, Kodak, Philips, Microsoft, Caterpillar, Home Depot and others added to the total. According to an estimate by outplacement firm Challenger, Gray & Christmas, layoffs in January totaled 241,749, up 45% from December and the highest monthly number in seven years. In response to this situation, U.S. President Barack Obama pushed even harder for passage of an $819 billion economic stimulus plan. "The most important number for this recovery plan is how many jobs it produces," said Rahm Emanuel, Obama's chief of staff, "not how many votes it gets."

Unfortunately, more cuts are probably on the way, according to economists watching the situation. "From what we are seeing, the fourth quarter was breathtakingly weak for companies,' says Christopher Portman, a senior economist at Oxford Economics, which builds macroeconomic models for banks and governments around the world. "In terms of the global economy, 2009 will be the worst year since World War II and even since the 1930s. I don't know that the job losses we have seen so far show the full picture. Unemployment does lag [behind other indicators of economic performance], and even after we hit the bottom of this downturn, the job loss numbers will continue to rise.'

Beyond the individual trauma of lost jobs and wages amid a global economic crisis, the cuts are notable for their depth and breadth. Since September 2008, major companies world-wide have cut some half a million jobs -- and these numbers exclude the financial services firms that have been at the heart of the crisis. Almost every sector has been affected -- autos, airlines, consumer products, retail, chemicals, technology and pharmaceuticals, among others. For some companies, the layoffs are more of a cyclical experience, but others are going through layoffs for the first time. For many firms that have announced or will announce cuts, it is a dramatic turn of events given that they were doing relatively well just a short time ago. It is this all-encompassing aspect that has fueled talk among analysts and strategic planners of a fundamental change in business -- a restructuring of the global economic system.

But is that really the case? Experts at Wharton and elsewhere argue that what companies are experiencing now is neither an indication of a transformation nor a blanket prognosis for the rest of the economy. Instead, they say, the job announcements highlight operational weaknesses and strategic issues that have been lurking under the surface for years. In the past, these were effectively concealed in the same way that weakness and instability in the capital system were hidden by the apparent boom in asset values. Now, the downturn has brought them to the forefront.

What's Going

Peter Cappelli, director of the Center for Human Resources at Wharton, says the problem is that the crisis is forcing many managers to focus only on the short term. "At least in the U.S., companies don't seem to be thinking about much beside the immediate impact. To some extent, this could be because of the pressure to manage operations to conform to quarterly performance expectations. It could also result from the fact that the negative effects of layoffs -- such as the long-term costs associated with hiring again in upturns; delays in getting performance back up; and morale [issues] -- are hard to track. And it also may result from the implicit assumption that the workforce is really a just-in-time resource -- that it will be easy to bring in new workers when business picks up.'

Nevertheless, the track record of companies that have gone through job cuts is terrible. "Virtually all studies show a decline in performance associated with layoffs,' Cappelli notes. "But the caveat is that layoffs are a proxy for the fact that companies which decide to do them are already in trouble. It is hard to sort the effect of the layoffs, per se, from the proxy effect.'

This means that, for many of the companies which have announced or will soon announce layoffs, the current economic crisis is not necessarily the cause of their problems; it is simply what has exposed them. As intuitive as that argument may be, experts say that managers within the companies as well as analysts, investors and policymakers outside the business face the risk of putting too much, or even all, of the blame on the current economic crisis, rather than looking at deeper causes.

Jay Anand, professor of management and human resources at Ohio State University, says challenging times like the present make differences between companies stand out in bold relief. "Looking at the strategic implications, not every company is feeling the impact [of the crisis] in the same way. Some companies have better buffers in place, better capabilities to withstand the pressures, better demand or loyalty for their products, cost structures that are a little more flexible, supply chains that are a little more adaptable, and so on.'

Experts note that job cuts should be recognized as an indication of the change that is happening -- even accelerating -- within some industries. This is clearly the case in financial services and autos, for instance, but it is happening in technology as well. It's part of the reason why some of the IT industry's biggest names like Microsoft, Hewlett-Packard, EMC, Dell, SAP and others have been hit. Each of these companies, in some way, is facing a transition point in its evolution, forcing changes in its business models.

At Microsoft, for instance, its first-ever significant cuts are tied to the sharp decline in demand for traditional PCs, which have long been the company's core market. The company recently announced some 5,000 layoffs. Signs of the shift in Microsoft's market in recent years had already forced the company to begin looking for ways to further diversify its business -- as seen most notably in its failed bid for Yahoo last year. Now Microsoft must accelerate those efforts. According to company reports and analysts, this could happen in at least two ways: First, even as Microsoft sheds jobs in traditional businesses in order to cut costs, it plans to add up to 3,000 jobs in areas such as search, online services and cloud computing. The number of people hired for search will depend on what some analysts describe as a potential "wild card" -- the Yahoo factor. They believe that with Carol Bartz at the helm at Yahoo, a future deal with Microsoft could still happen. In any event, the layoffs -- and hiring plans -- at Microsoft are driven by these strategic considerations rather than just the weak economy.

Similarly, at Caterpillar, the world's largest maker of construction and mining machines, the massive restructuring was primarily attributed to high operating costs in its manufacturing operations. These costs became unsustainable as capacity utilization plunged due to low demand. As a result, Caterpillar announced it would cut 20,000 jobs since the sales volume for construction equipment -- hit hard by the housing market's collapse -- has shrunk by 25%.

For both Microsoft and Caterpillar, and many other companies, the sudden drop in demand exposed inefficiencies in their operations.

As these examples reveal, the problems leading up to announcements being made now have been in motion for a long time. Job cuts, in fact, are trailing indicators, not just for the economy as a whole but also for the specific businesses involved. It takes time for them to be announced and hit the headlines because they are usually among the last steps companies want to take in response to challenging conditions. They also are extremely complex issues to handle, forcing management to make extremely difficult choices.

Looking Ahead

Now comes the hard part. For all the companies that have announced job cuts, operations will become significantly harder to manage in the months ahead, as they work through the process of notifying workers, supporting them and, not the least, finding ways to compensate for staffing changes through existing or new business processes. All these efforts will take a significant amount of management bandwidth, and at the same time many important projects will potentially be either understaffed or delayed. And all of this comes at a time when companies can least afford distraction.

Are any companies or management teams notably "good" at handling situations like this? Wharton's Cappelli says the key is to consider and pursue alternative arrangements first. It is difficult to believe that any company is really good at this process if they aren't also doing some other creative arrangements for cutting labor costs (wage cuts, job sharing, sabbaticals, mandatory vacations, etc.), he notes. "The reason is, it would be remarkable if, after careful analysis, the only option that made sense across a company was layoffs.'

Ohio State's Anand says it is critical, in the end, to maintain perspective. Specifically, he suggests that companies focus on the current crisis but also be prepared for a rebound. "When everybody agrees that times are wonderful, you need to hold on. Similarly, when everybody says times are awful, you should think things through in a balanced way. There will be regression to a mean in time, and it is very important that firms are prepared for that. Even though managers need to act now to respond to the situation, it is important to look ahead and keep open options for growth. You do not want to overreact in a way that causes a substantive reduction in competencies, and in turn fundamentally impinge on your future.'

The turn could come sooner than some expect. Portman at Oxford Economics points out that while previous recessions developed more slowly, and in a less global fashion, businesses are now seeing a fast transition of weakness from the U.S. to the rest of the world. But there is an upside, he says. "This crisis has come about very rapidly, but the converse is that the recovery in time will also come about much quicker than we have seen in the past. Today, the gloom and doom is being extrapolated without taking into account the dynamics that are present. The downturn shouldn't last as long as some people are expecting.

"We have received quite a big setback, and we will continue to be hampered over the next year or so," Portman continues. "But when things can start to move forward again, I don't see any reason to expect huge changes in how business operates -- I don't quite see how that will transpire. Businesses will adapt, and we are already seeing that. We are seeing improved labor productivity, improved competitiveness, and that will underpin and come to the fore when things pick up again. In two years, we will see things improving, and business will be able to focus again on growth.'

The caveat, of course, is deciding which companies will be able to do so. The answers here are unclear. Without a doubt, firms that have approached layoffs -- or alternative solutions to preserving their talent during difficult economic times -- will be better positioned for the recovery than those that have adopted a knee-jerk approach to job cuts as a way of slashing costs for short-term gains. "Today, some companies are being forced to let go of their competencies, while others have not had to cut into any muscle," says Anand. "When the economy improves again, we will start to see the difference."

Steve Jobs's Succession Plan Should Be a Top Priority for Apple

2009-03-31T14:40:00.002+05:30

When Apple announced on December 16 that Philip Schiller, the company's senior vice president of worldwide product marketing, would deliver the keynote speech at this week's Macworld conference instead of CEO Steve Jobs, speculation swirled again about the future of the company -- and Jobs's health. Jobs disclosed in August 2004 that he had a cancerous tumor removed from his pancreas. Observers at recent Apple events reported that the visionary technologist appeared gaunt. Adding fuel to the fire, Apple also announced that it would not be participating in future Macworlds, saying, "Trade shows have become a very minor part of how Apple reaches its customers."

Responding to questions about his health, Jobs said in a January 5 open letter that he was suffering from a hormone imbalance that was "robbing" his body of nutrients. He also noted that he is receiving treatment and will remain CEO of Apple. "I have given more than my all to Apple for the past 11 years now. I will be the first one to step up and tell our board of directors if I can no longer continue to fulfill my duties as Apple's CEO," stated the letter.

Meanwhile, the looming question of who would replace Jobs if he had to leave Apple remains unresolved for shareholders, analysts and customers. While the company maintains it has a succession plan, it has offered no details. Observers are left to question what Apple might look like without Jobs and whether the company can continue pumping out hits like the iPhone, MacBook and iPod.

A succession plan is critical for most companies, but especially so for Apple, according to Wharton faculty. They acknowledge that every company is different, but also point to established best practices for succession planning, including hiring from within, conducting an audition period, easing the successor into a leadership role and providing some level of succession disclosure to shareholders.

Companies with strong corporate cultures can usually count on continued success if they can seamlessly transfer power to an executive from a strong bench of managers. But selecting Jobs's successor will be challenging, given the degree to which he is tied to Apple's identity. As Wharton management professor Michael Useem puts it: "There are few companies where the top person has as much of an impact [as Jobs has had] at Apple."

Apple and Jobs seem almost inseparable in the public mind. Jobs cofounded Apple in 1976, left during a power struggle with corporate investors in 1985 and returned to Apple in 1997 after the struggling company acquired NeXT, another computer firm started by Jobs. Apple ousted CEO Gil Amelio, who had been at the helm a little more than a year. Jobs became interim and then permanent CEO, quickly establishing himself as the voice of Apple and launching a string of consumer electronics hits.

"He really is the face of the company," says Kendall Whitehouse, senior director of IT at Wharton. "When you speak to Apple employees, there is always a lot of talk about Steve and what Steve wants. It's palpable. That has generally been a positive thing for [Apple]. Jobs was the centerpiece for refocusing the company and brand" following his return.

But some Wharton faculty say Apple now seems eager to show that there is more to the company than the vision of Steve Jobs. At an October press event, Jobs appeared on stage with Schiller and chief operating officer Tim Cook, the latter wearing Jobs's trademark black shirt with jeans. "The strategy here appears to be showcasing different members of middle and upper management to illustrate that Apple, as an organization, is more than just a cult figure at the top," says Wharton management professor David Hsu.

Analysts agree. "Apple could have diffused speculation regarding Jobs's health by having him keynote this year's Macworld," Piper Jaffray analyst Gene Munster wrote in a research note. "While we do not believe that this change provides any indication regarding Jobs's health, we do believe that it is a sign we are in the early stages of changing roles in Apple's management structure."

Although Apple's succession plan for Jobs remains unclear, experts at Wharton offer a few tips to help guide the company's succession planning process.

Promote from Within

Apple has a strong bench of executives who could succeed Jobs, but major stakeholders, such as investors, customers and partners, don't know much about them, according to Wharton faculty. The first step in any succession plan may be illustrating that Apple is more than Jobs.

According to Wharton management professors Useem and Peter Cappelli, Apple's effort to highlight executives other than Jobs is a good test for any successor. Why? Part of Apple's mystique revolves around messaging and generating buzz. By putting executives like Cook and Schiller in the limelight, Apple can give other managers some practice introducing products and familiarize them with investors and customers. "It is important for any company to be developing talent internally. And it is also important to be promoting people from within," notes Cappelli. The board "should pay a lot of attention to the abilities and potential of their leadership team -- always."

Wharton management professor Lawrence Hrebiniak also urges Apple to show off executives beyond Jobs. "Apple wants the world to know that it doesn't sink without Jobs. The company is addressing a common concern [that arises] when you have a powerful, well-known leader."

Useem suggests that a board of directors should be responsible for ensuring that a company has the right leader as well as the right leadership team -- especially if there is any hint that the chief executive may step down in three to four years. He cites numerous research studies indicating that internal successors are more effective.

One related challenge is determining whether a company even has the talent to adapt to the new environment. If the decision is made to hire from the inside, then "a CEO and board should be looking at the top contenders" and analyzing what is known about each one, says Useem.

If a company develops its internal talent well, there should be a strong bench of executives who can lead under various scenarios, thus making succession planning easier. "Succession planning per-se is a waste of time," says Cappelli. "It means trying to determine in advance who will take over a top job. But because the needs change so frequently, as often do the players, there is no real ability to plan. These plans take a lot of time and energy, they divert the attention of people in the company and they almost always get tossed aside because they are out of date." The solution: Companies need to develop talent internally so that they have multiple options when a successor is needed.

Useem notes that some companies turn to testing as a way to vet internal candidates. For example, they may hire third parties to interview executives who report directly to the CEO. More often, companies like GlaxoSmithKline pick internal candidates and then ask each of them to take on a CEO-level project and present it to the board. "This approach gives a company a better fix on how executives perform head to head. It can be awkward because these executives work together every day, but it is important to pick the right person."

What remains to be seen at Apple is whether Jobs would stay as a non-executive chairman with a new CEO. While these arrangements are rare in most American industries, says Useem, there are many examples among technology firms. Intel, Microsoft and Dell have all had CEOs become chairmen as day-to-day management was transferred to a new executive. Such an arrangement is more likely if a company founder -- such as Michael Dell or Microsoft's Bill Gates -- is involved, Useem adds.

Meanwhile, a company also has to prepare for the inevitable mop-up duty that follows the appointment of the new CEO. It is unlikely that executives who lost out on the top job will stay. For example, when General Electric transitioned leadership from Jack Welch to Jeff Immelt, the other top candidates for Welch's job -- Robert Nardelli and James McNerney -- departed to become the chief executives of Home Depot and 3M, respectively. Nardelli is now CEO of Chrysler and McNerney is chief executive of Boeing. "Having successors just waiting in the wings is not a good idea," Cappelli says. "If they're good, they won't stay."

Transparency Is Key

Generally speaking, companies in the midst of succession planning need to deliver some kind of transparency to customers and investors. In Apple's case, disclosure -- or lack of it -- about Jobs's health and future plans appears to be a sore point with some analysts. Wharton faculty agree that Apple needs to disclose more about its succession plan, but how much detail is needed is open to debate.

Wall Street is clearly worried about Apple's future post Jobs. Any rumor about Jobs's health can move the stock. Following Apple's announcement that Jobs would not be the keynote speaker at Macworld, Oppenheimer analyst Yair Reiner downgraded Apple shares because the company would not disclose details about the state of Jobs's health or a succession plan.

In general, having a succession plan is a good idea since it minimizes uncertainty, but how much a company discloses depends on culture, says Hrebiniak. If a company is too transparent, "every would-be CEO would leave if he or she was not a finalist," and performance would suffer.

Cappelli agrees. It "isn't obvious" that Apple needs to outline its plans. "Whatever [Apple] outlines today will be irrelevant as soon as circumstances change, and that will happen in months. Apple probably will go through three or four plans before Jobs steps aside, so what's the point?"

Meanwhile, it's unlikely that Apple will fall apart without Jobs, suggests Cappelli. "Investors get worried if they think the future of an entire company depends on a couple of key individuals. In fact, that is almost never the case. This bias -- attributing the success of organizations to individuals -- is pretty common. Several studies have looked to see what happens when CEOs ... die unexpectedly. All the studies show that, rather than collapsing, share prices in fact actually go up. The current leaders are not that crucial. Companies don't collapse when the leader departs and there is some time to fill the job."

Whitehouse, however, says Apple "needs to articulate something." If the company needs a disclosure blueprint, he adds, it doesn't have to look any farther than its long-time rival -- Microsoft.

In January 2000, Bill Gates signaled the beginning of a transition of power at Microsoft. He named Steve Ballmer, who became president of the company in July 1998, as CEO. Gates said he was stepping down to focus on long-term strategy, but he remained chairman and added a new title -- chief software architect. At the time, Gates said making Ballmer CEO was a "very good transition" for Microsoft. Over the next eight years, Microsoft gradually put other executives in the spotlight. In June 2006, Microsoft announced that Gates would transition out of his day-to-day role to focus on the Bill & Melinda Gates Foundation. The biggest change for Microsoft was appointing Ray Ozzie, then chief technology officer, to be the chief software architect working side-by-side with Gates. Gates' last day as an executive was June 27. He remains chairman and advises Microsoft on "key development projects."

"Microsoft had been about Gates for so long. But he scheduled a long, phased wind down. You can see the way that the succession was comfortable for the company, customers and shareholders," Whitehouse notes.

Preserve Corporate Culture

What remains to be seen is whether a post-Jobs Apple will retain the corporate traits that made the company successful with its iconic leader at the helm. The conventional wisdom is that Jobs's control has influenced everything from marketing to design at Apple, says Hsu. After a decade of leading Apple, he argues that it's quite possible Jobs's imprint is permanently etched on the company. "No one could move up in the organization without Jobs's approval. Eventually, management fits the mold Jobs wants."

Hsu says the secret sauce for all successful companies is having a corporate culture that transcends any individual. "You want a culture to be so ingrained in the rest of organization that it [provides a] competitive advantage."

Useem agrees. "You cannot overstate how important corporate culture is -- if it's a good one -- in sustaining and carrying on a company." Some companies, such as Wal-Mart, Mary Kay Cosmetics and Southwest Airlines, support strong cultures that have lasted well beyond their founders' departure, Useem notes. "A strong culture will transcend the exit of leaders. At Wal-Mart, pictures of Sam Walton keep the company thinking about the values that were used to create the company."

The problem for Apple is clear: No one will know until after Jobs leaves how thoroughly his imprint permeated the company. Useem acknowledges that developing a corporate culture is not clear cut. "Culture is one of the great mysterious aspects of company business. It is very important, but poorly understood. You can try to copy a company like Southwest, but rivals can't get their hands around what it is that makes these companies so successful."

Not on the List? The Truth about Impulse Purchases

2009-03-31T14:36:00.002+05:30

For years, retailers and manufacturers of consumer products have taken for granted the notion that attractive presentation and a bit of whimsy profoundly influence most shoppers' purchasing decisions. In his 1999 book Why We Buy: The Science of Shopping, psychologist and market researcher Paco Underhill described supermarkets "as places of high impulse buying.... Fully 60% to 70% of purchases there were unplanned, grocery industry studies have shown us."

Underhill's book and subsequent studies have since prompted retailers to devote growing resources to in-store promotion -- for example, featuring certain products at the ends of aisles and in checkout lines to encourage impulse buying.

Describing the idea that most supermarket purchases are unplanned as something of an urban legend. In a new research paper, "Unplanned Category Purchase Incidence: Who Does It, How Often and Why," Bell and his co-authors arguethat the amount of unplanned buying is closer to 20%.

Their research does not indicate that in-store marketing is unimportant, but that retailers may need to rethink strategies for it. The researchers found that certain traits of shoppers, including age, income and their particular shopping style, have a greater effect on making unplanned purchases than does the store or environment.

In other words, Bell says, "the differences are based on who they are rather than what they're exposed to. It relates to the issue of nature vs. nurture. Is it demographics or the in-store stimulus? The prevailing view is it's more nurture. We're saying it's more nature."

Bell's co-authors are Daniel Corsten, professor of operations and technology at the Instituto de Empresa Business School in Madrid, and George Knox, professor of marketing at Tilburg University in the Netherlands. Their paper is based on a detailed study of grocery shoppers' behavior in the Netherlands, but the findings can be applied generally to American retailers as well, Bell says.

The researchers began by reviewing a substantial body of academic literature that appears to support Underhill's estimate of unplanned purchasing activity. The authors say that the literature, partially underwritten by the Grocery Marketing Association and the Point of Purchase Advertising Institute, has fueled the substantial growth of in-store marketing budgets in recent years.

"The debate over the extent of unplanned purchasing and the underlying drivers has enormous practical significance," the authors write. "It dictates where marketing dollars are spent (in store or outside the store) and in what amounts."

Looking at Real Purchases

What the researchers found missing in the previous studies was "appropriate and robust" data from actual purchases that would indicate what shoppers' intentions were when they went to a store. The previous studies also did not clearly define "unplanned purchases" to Bell and his colleagues' satisfaction. Does it mean switching brands of detergent from what a shopper usually buys, or buying any product from a category not on a shopping list? And if a shopping list included detergent but not a brand or size, is the final purchase planned or unplanned?

The starting point for Bell's study, which was partially funded by a large European consumer products company, was a review of data from 2,945 supermarket shoppers over a two-week period in July 2006. The consumers shopped at 21 different supermarkets, making 18,000 purchases in 58 categories, such as bread, beer, coffee, produce, detergent, diapers and shampoos and conditioners.

The shoppers completed short questionnaires after each trip, checking off purchases in a category and indicating whether a purchase was "planned in advance of the store visit" or simply "decided in store and purchased." The shoppers attached their store receipts to ensure accuracy. More information on household traits and perceptions of the supermarkets where they shopped was gathered in 90-minute in-home interviews.

The questionnaire and the interviews provided Bell, Corsten and Knox with demographic data, including income bracket and life stage; "shopping style" information, including whether a shopper considered himself "fast and efficient"; and whether the shopper learned about prices from newspaper advertising or in the store. The respondents also were asked about their knowledge of a particular store and its prices, range of offerings and image; if they shopped on weekdays or weekends; and whether shopping trips were long or short.

Bell noted that American shoppers are different from their Dutch counterparts in at least one respect that may merit further study. While most Americans drive to a grocery store, people in the Netherlands are just as likely to walk or ride a bicycle as they are to drive. The researchers found that shoppers who walk to a market are less likely to make unplanned purchases than those who bike or drive.

The most basic information the research revealed is that no unplanned buying was done on slightly more than 60% of all shopping trips. On the rest of the trips, the shoppers made an average of three unplanned purchases -- far fewer than previous research indicated.

The amount of unplanned buying goes up with the total number of categories in which shoppers make purchases, such as bread or milk. But because a smaller percentage of shoppers are doing much of the impulse buying, the average number of unplanned purchases stays low.

More telling data about what makes shoppers behave as they do came from correlating 32 variables with the fact that the majority of all shopping trips include no unplanned purchasing. Here are some of the variables compared with the overall average:

Young, unmarried adult households with higher incomes do 45% more unplanned buying.

Households led by an older person and those that have larger families do 31% to 65% less spontaneous purchasing.

There is 25% less unplanned buying among shoppers who mainly use newspaper ads for price information.

People who consider themselves very "fast and efficient" shoppers are far less likely to make impulse buys -- 82% less than the average.

If the purpose of a shopping trip is "immediate needs or forgotten items," the rate of buying in unplanned categories falls by 53%.

Unplanned purchasing goes up by 23% if the shopping trip itself is unplanned, but it goes down by 13% if it's a major or weekly trip.

If a shopping trip includes stops at multiple stores, there is 9% less unplanned buying at the second or third store.

Unplanned purchasing goes up by 44% if the shopper goes to the store by car instead of on foot.

"The message ... is that the amount of unplanned buying that takes place is more about person-to-person variance than about the store environment itself," Bell says. "Can you really jack up unplanned buying with stimuli, when the greatest amount of variance is in people?"

Two Strategies Emerge

The answer to that question, according to Bell and his fellow researchers, is yes, but it will take sales strategies based on more thinking and market research. The researchers note that their data has enough detail to enable them to offer two possible strategies retailers could use to increase spontaneous purchasing in their stores.

"They can 'do more' with existing customers, or they can make a deliberate attempt to attract ... shoppers who are more likely to make unplanned purchases," they write. "The 'do more' strategy takes the existing mix of shoppers as given and focuses on the in-store environment. The 'attract better customers' strategy involves a broader change to marketing strategy, store image and so on."

The data indicate that the "do more" approach, using, say, better in-store signage or increasing the number of promotions, would be less difficult but perhaps less effective than trying to attract more customers who are inclined to do more unplanned purchasing. The benefits of the two strategies would need to be weighed against the cost.

"Overall, traits [of customers] appear more important than states [of stores] in generating unplanned category purchase incidence," the researchers write. "This raises some important questions for both retailers and their suppliers. Retailers may wonder if their current in-store marketing budgets are too high. Suppliers might want to revisit budget allocations: Should they re-prioritize marketing activities designed to place the brand firmly into the shoppers' [planned purchases]?

"More fundamentally, this research suggests that different consumer segments have different and varying 'receptivity' to different marketing activities. If so, marketers need to develop ... plans with an understanding of these varying levels of receptivity in mind."

Bell suggests that one possible avenue for learning more about how much impulse buying a person might do is to use the data retailers collect through their customer-loyalty programs. "They need to learn more about the shopper from a holistic perspective."

The Financial Crisis: Bad and Getting Worse, but Put Away that D-word

2009-01-28T15:38:00.001+05:30

It began as the "subprime crisis" in 2007, and then mushroomed into a full-blown global recession in 2008. And still, despite mammoth government intervention, the bad news keeps getting worse. Are we now teetering on a precipice, ready to plunge into another Great Depression? Can the latest proposals pull the economy out of its nosedive?

There is plenty to worry about. But while many experts say this crisis is the worst since the Depression, that does not mean it will be as bad.

Unemployment and other economic gauges will continue to worsen, but unless governments make a major misstep, like igniting a worldwide trade war, economies should stabilize and recover on a "very flat path" that could take several years, says Wharton finance professor Marshall E. Blume.

Japan went through a similar bank crisis in the 1990s without tumbling into a full-blown depression, adds Wharton finance professor Jeremy J. Siegel. "Given that we're reacting faster than Japan, I think you can make a good inference that [a depression is] not going to happen here," he says.

Many estimates call for gross domestic product in the U.S. to shrink by 2.6% in the first quarter of 2009, Siegel notes. That's bad, but small compared to the 27% decline from 1929 through 1933. A depression is generally defined as a drop of 10% or more.

Still, there is more bad news than good, and the depth of the problem can be measured by the lack of consensus on what to do about it. Consider this gloomy observation in a January 20 Wall Street Journal story about the British government's abrupt decision to pump billions more into what the writer called the country's "flagging" financial-rescue plan: "Governments on both sides of the Atlantic are struggling to keep up with the deepening economic crisis -- and may be running out of ammunition to battle it."

In the U.S., banks continue to withhold loans despite huge infusions of government cash, and Goldman Sachs estimates that financial institutions will lose $2 trillion on loans, with only half of that realized to date. Banks are even starting to call in loans to borrowers, such as home builders, who have made all their debt payments on time. Troubles are now expanding to commercial real estate firms. The numbers of layoffs, bankruptcies and foreclosures are growing. Household names, such as Circuit City electronics stores, are closing their doors, and problems have worsened at Citigroup and Bank of America despite government help.

There is little consensus on how to remedy the problem. Indeed, the U.S. government is again considering buying up toxic assets held by financial firms, a plan adopted last fall and then immediately scrapped in favor of direct cash infusions to banks.

The tale of woe and confusion is much the same around the world. The economic slowdown is so steep as to cause oil prices to drop to around $40 a barrel, from more than $140 last summer. Trade is so sluggish that shipping rates have plunged to astonishing lows. The European Commission warned on January 20 that the 27 nations of the European Union are likely to experience a "deep and protracted recession."

At the request of then President-elect Barack Obama, the Senate on January 15 voted to release the second half of the $700 billion Troubled Asset Relief Program. (No action by the House is required.) Comments from Obama administration officials suggest much of this $350 billion may be used to buy "bad assets" held by financial institutions. Those include mortgage-backed securities and other holdings that have plunged in value and become all but untradeable. Getting these assets off the financial institutions' books was at the heart of the TARP program when it was proposed in September by Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke.

Paulson and Bernanke say that removing the toxic assets would remove uncertainty about the banks' health, and encourage the banks to resume lending, seen as the key to turning the financial crisis around. But after Congress approved TARP, Paulson instead pumped the money directly into troubled banks, taking some preferred shares and warrants in exchange, arguing the banks needed quicker help because they had turned out to be in worse shape than previously thought. But the banks remain reluctant to lend, and it is not clear the first half of the TARP fund was the good investment Paulson said it was. The Congressional Budget Office estimated in a January 16 report that taxpayers would lose $64 billion of the first $247 billion in TARP spending.

Whether the government should now revive the asset-purchase plan is subject to debate.

Wharton finance professor Richard Marston thinks the direct infusions will restore banks' lending ability faster than asset purchases would, but the government should in return demand a bigger ownership stake than it has. "The Treasury should find a way to inject capital where the taxpayer ends up with large stakes in the banks -- even if they are not formally nationalized. The bank shares are going to soar with recovery, and someone is going to make a fortune." That should be taxpayers if they take on the cost and risk of propping up the banks, Marston argues.

According to Blume, there is so much uncertainty that it is impossible to know which bank-rescue approach is best. Cash infusions can help very quickly, while the asset purchases take longer. But if direct infusions mean toxic assets are left on the banks' books, doubts about the banks' long-term health will remain. Other institutions would then be reluctant to do business with them, and investors would refuse to provide private capital, which ultimately is key to the banks' return to health.

Building a 'Bad Bank'

Also under discussion in Washington is the creation of a "bad bank" to buy the toxic assets. This government-run bank, partly owned by the banks that sell it the assets, would hold those assets, sell them or bundle them into securities for sale to investors. A big question: What should the bad bank pay for those assets if there are no recent sales to show what they are worth? FDIC chairman Sheila C. Bair has said the assets could be purchased at "fair value," which is a price the banks set themselves.

"The idea of setting up a 'bad bank' in which to transfer bad debt may be a good idea," Marston says. But he finds the price dilemma troubling, since paying fair value could cause the government to pay more than it will eventually recover by reselling the assets. "Do we pay market prices for the debt, in which case it does not help the banks? Do we pay above-market prices" and take shares of the banks in exchange?

Under yet another approach, modeled on that used for Citigroup and Bank of America, the government would provide taxpayer-backed insurance against losses in toxic assets that stay on banks' books. But that, too, could leave the public shouldering the banks' losses. Wharton finance professor Franklin Allen argues that the best approach would be "temporary nationalization" of those banks that get public help. That would allow the government to install its own managers, clearing out executives who have presided over so much trouble.

Controlling TARP

"This injection of capital without any [government] control is just not working," says Allen, noting that the banks had not resumed lending after the first TARP infusion. "This [second $350 billion in] TARP money is not going to be used well, and it's going to end up in a black hole. What keeps happening is they give money and then the banks keep coming back for more."

Siegel, too, feels that TARP support should have more strings attached, such as a requirement that banks not call in loans to borrowers who are solvent, creditworthy and up to date on their payments. "I'm not optimistic about this [second half of the] TARP money. Clearly, the first half didn't seem to help."

Obama administration officials also have said they want to use part of the new round of TARP funding -- perhaps as much as $100 billion -- to help homeowners avoid foreclosures. Advocates say this is only fair, since huge sums have gone to rescue corporations, and many argue that stemming foreclosures will help stop the freefall in home prices which has been a major cause of the banks' losses. Hence, attacking the foreclosure problem could lead to more lending by banks, giving the economy the fuel it needs to start growing again.

There are various ways to use government money to put a dent in foreclosures, from providing direct assistance to homeowners to insuring lenders against further losses if they modify loan terms. It is not yet clear what approach the Obama administration favors.

Nor is it a given that reducing the number of foreclosures will have much effect. Allen believes the economic problems are now so widespread that shoring up the housing sector would not help turn things around the way its advocates hope, so that public spending on foreclosures might be wasted. "I think the crisis has moved on from real estate," he says.

Allen and Siegel note that some banks already have expanded programs to renegotiate loan terms to help borrowers stay in their homes. Accepting reduced payments can be less costly for the lenders than foreclosure, especially if there are no buyers for foreclosed properties. J.P. Morgan, for example, recently announced a vastly expanded plan to modify loans on its books as well as those among more than $1 trillion in loans sold to investors.

Too Many Homes

"I think [foreclosures are] a very important problem, but I think it's being worked out by the private sector," Siegel says. The root problem, according to Siegel: There are too many homes and too many were bought at inflated prices. "The price of homes has to fall. There's no way to stop that from happening."

Blume, too, doubts the government can effectively stop the wave of foreclosures. With the economy worsening and unemployment rising, fewer and fewer people can afford the homes they have, and many potential buyers lured by bargain prices can't find banks to give them mortgages. "I have not yet seen a plan to help reduce foreclosures that gets to ... the problem ... that people bought houses they could not afford. If you reduce the interest rate a little bit, they still can't afford them."

He concludes that there may be no alternative but to let the housing market adjust on its own. "Ultimately, all these houses will be off the market," Blume says. "Somebody will buy them and then the market will stabilize."

But there's no telling, he adds, how long that will take, or how far home prices will have to fall.

Lesson One: What Really Lies Behind the Financial Crisis?

2009-01-28T15:35:00.001+05:30

What was the true cause of the worst financial crisis the world has seen since the Great Depression? Was it excessive greed on Wall Street? Was it mark-to-market accounting? The answer is none of the above, says Jermey Siegel, a professor of finance at Wharton. While these factors contributed to the crisis, they do not represent its most significant cause.

Here is the real reason, according to Siegel: Financial firms bought, held and insured large quantities of risky, mortgage-related assets on borrowed money. The irony is that these financial giants had little need to hold these securities; they were already making enormous profits simply from creating, bundling and selling them. "During dot-com IPOs of the early 1990s, the firms that underwrote the stock offerings did not hold on to those stocks," Siegel says. "They flipped them. But in the case of mortgage-backed securities, the financial firms decided these were good assets to hold. That was their fatal flaw."

Speaking in Philadelphia on January 20, Siegel, author of Stocks for the Long Run and The Future for Investors, provided a detailed analysis of the factors that fueled the worldwide financial meltdown. His talk was the inaugural lecture of a 15-session course on the financial crisis that Wharton is offering MBA and undergraduate students. Siegel's mission was to detail the factors that sparked the crisis that has caused the U.S. stock market to lose more than a third of its value in a year, while sending unemployment to its highest level since the 1980s. Siegel's lecture was on the same day that millions of Americans expressed optimism over the inauguration of President Barack Obama, even as the Dow plunged another 300 points.

Explaining his theory further, Siegel pointed out that many troubled banks and insurers continued to prosper in almost every other aspect of their businesses right up to the 2008 meltdown. The exception was the billions of dollars in mortgage-backed securities that they bought and held on to or insured even after U.S. home prices went into a free-fall more than two years ago. American International Group (AIG), the insurer that received an $85 billion federal rescue package last September, is a prime example. Some 95% of its business units were profitable when the company collapsed. "AIG has 125,000 employees," Siegel noted. "Basically, 80 of them tanked the firm. It was the New Products Division, which had an office in London and a small branch office in Connecticut. They came up with the idea of insuring mortgage-backed assets, and nobody at the top decided it wasn't a good idea. So they bet the house -- and the company went under."

Lapse over Lehman

According to Siegel, federal officials -- particularly outgoing Treasury Secretary Henry Paulson -- mishandled initial efforts to intervene in the crisis. For example, Paulson was concerned about the political backlash that might be unleashed by bailing out Lehman Brothers. He allowed the firm to collapse last September but underestimated the impact of Lehman's demise on financial markets. Despite a $700 billion bailout, banks are still unwilling to extend credit, Siegel said.

Siegel told his student audience that in many important measures, the economy is not nearly as battered as it was during the early 1980s, when unemployment, inflation, and interest rates were all considerably higher than they are today. Stocks -- as evaluated by their price-to-earnings ratios -- are undervalued to the point where they could draw enough investors to spark a recovery before the end of 2009. "I'm actually an optimist," said Siegel. "I think by the second half of this year, things might turn around faster than people are now predicting."

While angry investors and taxpayers are anxiously looking to assign blame for the current state of the economy, it's important to know not only which factors led to the meltdown, but which ones did not. He said that government programs encouraging home-buying by low- and middle-income families and short-selling of financial stocks -- which was halted for a time last fall -- have little to do with the crisis on Wall Street.

Instead, Siegel pointed to two interlocking issues: One is a massive failure, not only by traders, but by CEOs of financial firms, their risk management specialists and the major rating agencies to recognize that an unprecedented housing-price bubble began building after 2000. Their faulty reasoning was that the inability of homeowners to pay their mortgages -- and the consequent foreclosures -- would not pose a threat to their mortgage-backed securities. They believed that as long as home prices kept rising, the underlying value of the real estate would provide a hedge against the risk of such defaults. They failed to realize that this reasoning was based on the assumption that home prices would go in just one direction -- up. In fact, these assets became enormously risky once the housing bubble burst and home prices began their inevitable decline.

Siegel also argued that ultimately, the buck stops with corporate CEOs who didn't ask hard enough questions about the risks posed by mortgage-backed assets. He said he and others have wondered why firms like Lehman Brothers, Bear Stearns and Morgan Stanley -- which survived the much more severe Great Depression of the 1930s -- collapsed during 2008. One reason, he suggested, might be that, back then, these firms were organized as partnerships. In such an organizational structure, the partners would have to risk their own capital. When the partnerships were reorganized as widely held public companies, however, they no longer had such constraints. "Back when it was a partnership, you had your life invested in that company," said Siegel, noting that banks also began making higher-return but higher-risk investments in recent years as public ownership increased.

Greenspan's Role

One other key player that Siegel criticized for not heading off the collapse of the mortgage-backed securities is former Federal Reserve chairman Alan Greenspan, who oversaw the government's central bank until 2006. Greenspan was so influential while he oversaw the Fed that he could have easily blown the whistle on the over-accumulation of mortgage-backed assets by the U.S.-based financial giants. He, however, failed to discover that firms were taking such large, risky individual stakes without protecting themselves against a housing market collapse. "[Greenspan was] the greatest central banker in history -- he had access to every piece of data," Siegel said. "He could have looked at the balance sheets of Morgan Stanley or Citigroup and said, 'Oh my God -- they didn't neutralize their risk.'"

Another reason why federal officials and economists failed to detect the perilous economic risks of the 2000s, Siegel said, is the so-called "Great Moderation." This term refers to the fact that since the 1980s, the volatility of the business cycle has declined, thanks to more aggressive fiscal policy and the rise of a service-based economy, among other factors. Siegel noted that a similar flattening of the economic cycles had occurred during the 1920s after the 1913 establishment of the Federal Reserve Bank, a factor that caused stock investors to ignore risks, which eventually led to the stock market crash of 1929 and the Great Depression.

"People asked, 'Are we ever going to have a big recession again?'" Siegel said of today's policy makers. "Everybody thought we were in a new stage and risk premiums didn't need to be so high." But those risks hit home last year. While it would have been difficult for federal regulators to save Lehman Brothers -- which had invested billions of dollars in assets related to subprime mortgages -- even if they had acted six months sooner, the fall of the 158-year-old financial house had a disastrous impact on the wider financial market. Lehman Brothers was connected to 950,000 or so transactions. As a result, bankers became gun-shy about making any type of loan, even to companies with a flawless credit history.

Trouble with TARP

For that reason, Siegel said, the initial phase of the Bush administration's Troubled Asset Relief Program (TARP) was seriously flawed. Paulson's Treasury Department decided to buy equity stakes in troubled banks, assuming they would make more loans with more capital on hand. The amount of capital, though, has little to do with the reluctance of banks to make loans, even as the rate on federal funds is slashed to near zero. John Maynard Keynes, the British economist, called this situation a "liquidity trap," Siegel noted. "The big failure of TARP was that it misunderstood why banks weren't lending. Officials thought it was because they didn't have enough capital. In reality, they were worried about the solvency of all the borrowing that was out there." Siegel suggested that the government rescue plan could be improved with guarantees that recipients demonstrate they are using the federal dollars to extend credit.

According to Siegel, monetary policy has failed to stimulate the U.S. economy. The U.S. faces a situation similar to what happened in Japan during the 1990s when interest rates of zero could not revive the country's moribund financial markets. The only viable solution now open to American policy makers is Keynesian fiscal policy, a stimulus program that lowers taxes or increases government spending or both. Indeed, this is exactly the type of program -- costing at least $825 billion -- that the Obama administration and Senate Democrats are considering. Siegel said that policymakers should not worry about the impact on deficits; it is large, he added, but not dangerously so.

Towards the end of his 90-minute talk, Siegel offered some tongue-in-cheek advice to would-be entrepreneurs. "Start a new bank," he said. "You won't have the problems of existing banks, and the federal loans interest rate is near zero. Demand for loans is high, and you will face no competition from the private market. You could become very profitable."

When the Going Gets Tough, the Tough Don't Skimp on Their Ad Budgets

2008-12-26T12:48:00.002+05:30

With corporate managers under enormous pressure to control costs and maintain liquidity in the current credit crisis, advertising budgets often appear to be a dispensable luxury in the struggle to survive. Executives who succumb to that temptation, however, put the long-term future of their companies at risk, according to Wharton faculty and advertising experts.

"The first reaction is to cut, cut, cut, and advertising is one of the first things to go," As companies slash advertising in a downturn, they leave empty space in consumers' minds for aggressive marketers to make strong inroads. Today's economy "provides an unusual opportunity to differentiate yourself and stand out from the crowd," says Fader, "but it takes a lot of courage and convincing to get senior management on board with that."

emand slack for advertising services, the cost of these services goes down, making advertising expenditures all the more defensible in a bad business climate. "If your company has something to say that is relevant in this environment, it's going to be more efficient to say it now than to say it in better times," says Lodish.

Research shows that companies that consistently advertise even during recessions perform better in the long run. A McGraw-Hill Research study looking at 600 companies from 1980 to 1985 found that those businesses which chose to maintain or raise their level of advertising expenditures during the 1981 and 1982 recession had significantly higher sales after the economy recovered. Specifically, companies that advertised aggressively during the recession had sales 256% higher than those that did not continue to advertise.

For companies that do stay the course and continue to advertise into a recession or increase their promotional activities, the key is to craft messages that reflect the times and describe how their product or service benefits the consumer. For example, companies might be tempted to emphasize price in a recession, but that only works for companies like Costco and Walmart that are built around a core strategy of providing low prices year after year, says Lodish. He points to the current Walmart campaign, "Save Money. Live Better," as a successful approach to the recession.

Dean Jarrett, senior vice president of marketing at The Martin Agency in Richmond, Va., which developed the Walmart ads, acknowledges the campaign began in 2007 before it was clear a harsh recession was building. "We can't claim we knew a recession was coming, but "Save Money. Live Better" is dead on-point with who they are and what they want to be."

Eileen Campbell, chief executive of the Millward Brown Group advertising firm in New York City, says that while companies should probably not dwell on the recession and scare consumers into hoarding their pennies under a mattress, certain products require a straight-up approach -- such as financial services. "If you are in the financial services category, to behave as you did a year ago is silly." At the same time, however, many consumers are weary of negativity generated by the recession and would be receptive to a more upbeat message, she adds. "If you can put a positive spin on how you can genuinely help without invoking doom and gloom, I think that's going to be more compelling."

In Control of Your Pushups

Wharton marketing professor cites Gold's Gym -- the Texas-based gym chain -- as an example of a company that has found a way to navigate the economic slump while promoting a product that might seem discretionary or self-indulgent in hard times. One television spot shows legs working a stair climber as words pop up across the screen changing from "First floor" to "12th floor" to "Kilimanjaro" to "Olympus." Finally the words, "The Corporate Ladder," appear.

"This is about being goal-oriented as opposed to a general fitness or vanity play," she says. "It links to the economy because people are less likely to be spending on flashy things and more likely to be thinking practically and pragmatically. Certainly people are going to be spending less in this downturn, but they will spend something."

Williams agrees that advertisers should approach the 'R-word' (recession) with extreme caution. "Along with this economic downturn comes a lot of emotional response, such as anxiety. It is characterized by a sense that you lack control, that you don't know what's coming and you are at the whim of circumstance. To the extent that advertisers feel their clients or consumers are experiencing anxiety, ads should try to empower consumers and help them think of ways to be in control in a world where they feel out of control."

The Gold's Gym spots address this concern, she suggests. "'You can't control the economy but you can control how many pushups you do, and take control where you can, and we can help you.' That's a powerful message."

Value is another important message to build into marketing campaigns during a downturn, according to Williams. Many marketers design communications aimed at justifying the price they charge for goods and services, either by emphasizing a low price or touting the benefits the company can provide to buyers. "Advertisers will do both," she says. "Some are in a better position to talk about lower costs while others will have to focus on what you get for your money."

Luxury businesses should take a completely different approach, appealing more to emotion, Williams notes, emphasizing the need for some emotional release or comfort in difficult times. High-end advertisers will also attempt to emphasize long-term value -- such as suggesting that a watch is not just a purchase for today, but for years to come. "You can try to remind people that this is, hopefully, a temporary state of things and we should not be focusing on the immediate future but also longer-term."

David Sable, chief operating officer of Wunderman, a brand-building agency that is part of the global marketing firm, The WPP Group, advises advertisers in a downturn to rally to protect and preserve brand equity that has been nurtured for years, with continued investment in and support of branded products. "The worst thing you can do is cheap-out on products -- put less coffee in the cappuccino -- as many have in the past."

According to Sable, while price is important in a recession, the majority of price-driven consumers still factor in the importance of branding. Companies must maintain "good housekeeping" during a recession, such as product quality and good distribution systems, but he suggests that clear brand association and leadership comes through communication. "If you cut the communication, you have a major problem."

He urges marketers to make sure they understand the "elasticity" of their brand, which would be a gauge of how much -- or how little -- advertising is necessary to sustain sales. "It's not a science. There's a lot of art there," he acknowledges, "but you must be supporting your product."

He also warns that in today's networked, digital marketplace, consumer buzz about disappointments with a product can metastasize quickly and widely. "You must give people good things to talk about by continuing to have good products and communication." The biggest lesson is that recessions come and go, but "hopefully your brand is for life. It's forever. So you have to be careful how you react because the downturn is not going to be forever."

If companies cut deeply into advertising and communications in a down period, the cost to regain share of voice in the market once the economy turns around may cost four or five times as much as the cuts saved, he adds. "You must really keep a balance in times like this. Don't go dark when customers and consumers need you because they need you as much as you need them."

Matt Williams, a partner at The Martin Agency, says a downturn is a natural time to focus on core strategy. A recession, he says, can be an "opportunity disguised as a problem.... You can position the brand as an ally to consumers in tough times with product development or sponsorship programs so the consumer can say 'I see by its actions that this brand is on my side.' That will pay dividends not only during the recession but beyond."

When Life's (Not So) Good

Advertisers in all categories must be in tune with consumers in the current climate. For example, he notes that LG Electronics is backing off its "Life's Good" slogan. "That's not the mood people are in. If you do that, it will generate resentment. You need to fine-tune your message to be sensitive." In challenging times, marketers must also work harder to segment consumers with specific messages. "If, in the past, you used mass media, you probably want to be more targeted now to make sure the message gets to the right people."

Research indicates that combative advertising which targets competitors escalates during an economic downturn. "When the marketplace is shrinking, you tend to become a little more competitive in your tone," says Zhang, who cautions that this approach can backfire. "If you say your competitor is bad and your competitor says you are bad, ultimately the customer thinks both are probably good and bad. They tend to be indifferent. Even in a downturn, if you want to create loyal customers, you don't want to be overly competitive. You want to highlight what you do best and be sensitive to the needs of your customers rather than bashing the competition."

An economic slump may be a time to reconfigure the advertising mix between traditional media and digital or other outlets, depending on the product, brand positioning and overall corporate strategy, Zhang continues. "You don't have to put a huge amount of money in the marketplace," he says, adding that lower-cost marketing techniques -- such as banners, street signs or direct mailing -- might merit new attention. When times are flush, it is easy to pay a premium for more expensive established media.

The Ever-elusive Gold Standard

All forms of media can be successful even in a recession, although the impact of digital marketing might be easier to quantify and therefore able to withstand the close scrutiny of senior executives demanding justification for any spending while their operations are under recessionary pressures, says Lodish.

Fader points out that direct marketing and other kinds of interactive communications might be valuable but do not yet deliver easily quantifiable results. "Unfortunately, the industry is still in its early infancy. A lot of people talk about what we are capable of doing in measurability, but no one has established the gold standard yet. Maybe this forthcoming recession will be the chance to catalyze that and make it happen."

The current recession will offer an opportunity for marketers to provide integrated campaigns meshing traditional and digital media. Fader says that in the last downturn, in 2001, digital marketers were operating out of separate agencies, but today marketers are able to construct fully integrated campaigns. "We have been talking about integration for years, but it's been a much slower process" than expected. "I'm not sure the recession will accelerate that integration, but those who are well-integrated will start to see some of the benefits."

Job Cuts vs. Pay Cuts: In a Slowing Economy, What's Better for India?

2008-12-26T12:29:00.000+05:30

One day after Diwali -- the Indian festival of lights -- the Associated Chambers of Commerce and Industry (Assocham), an industry association, published a report on the job market. Titled, "Jobs Scenario Post-Diwali," the end-October survey said that seven key industrial sectors would see nearly 25% layoffs in the next two weeks.

Predictably, there was a huge outcry. Other chambers said the situation was not so dire. "We do not believe any immediate threat exists," noted FICCI (Federation of Indian Chambers of Commerce and Industry) president Rajeev Chandrasekhar. "We should not panic."

The government was not amused either. "[We] have taken serious exception to the Assocham report," said finance minister P. Chidambaram. "The pace of job creation may slow down, but that doesn't mean that jobs are being destroyed." Eventually, Assocham withdrew the report, claiming that the sample size may not have been adequate.

The government was taking no chances, however. On November 3, it called a meeting of senior industrialists in New Delhi. They went there expecting a hearing for their woes in the wake of the global financial meltdown and, possibly, some initiatives to help them get back on track. Instead, they had to settle for the formation of a special crisis panel to consider future action. What the industrial barons -- including Mukesh Ambani, Anand Mahindra, K.V. Kamath, Sunil Bharti Mittal, Deepak Parikh, Shashi Ruia, K.P. Singh and Rajkumar Dhoot -- had to give in exchange was a promise that they would not resort to layoffs.

Yet, according to some, time may be running out for the workers on Main Street as it already has for some on Dalal Street, the Indian equivalent of Wall Street. Says M.K. Pandhe, general secretary of the Center of Indian Trade Unions (CITU): "Layoffs, closures and terminations have begun in a big way."

Trade unions, particularly Left-leaning ones like CITU, see the world through their own prism. But it is true that pink slips are more visible in India these days. The multinationals are leading the charge. U.S. mobile handset maker Motorola is shedding jobs in India as part of its global pruning operation to reduce workforce by 5%. American Express has laid off some 100 employees. IBM has shown several workers the door. For the record, most of these companies deny that there is an orchestrated layoff because of the slowdown; their explanation is that poor performers are being weeded out.

IT Slowdown

Indian information technology (IT) companies, which have been amongst the hardest hit because of the slowdown in tech spending in the U.S., have also brought out the shears. Earlier this year, Tata Consultancy Services (TCS), India's largest software consultancy, let go some 500 people. But a company spokesperson notes that this is not unusual. "Last year, too, we had to dispense with the services of 500 employees," he says. "It is part of our annual performance appraisal."

Others point out that they are still hiring as they were in the past. "This year (2008-09), Wipro has made offers to 14,000 fresh graduates and is likely to take in 5,000 to 6,000 lateral hires," says Pratik Kumar, executive vice-president of human resources at Wipro, a major software firm. Adds Nandita Gurjar, senior vice-president and group head of human resources at Infosys Technologies, the other member of India's IT triumvirate: "For next year (2009-10), we have already made 20,000 offers, the same as we did for this year." The National Association of Software and Service Companies (Nasscom) has ruled out layoffs in the IT arena. It has, however, lowered its 2008-09 job addition target from 270,000 to 200,000. Pay hikes are expected to be moderate the next two years, says Nasscom.

The IT sector is known for its high attrition rates and a certain amount of churn is taken for granted. What made headlines in the newspapers and cover stories of business magazines was aviation joining the pink slip bandwagon. In an unexpected announcement in mid-October, Jet Airways, India's largest carrier, said it was letting go 850 cabin crew. It followed that up with a statement that another 1,000 would have to go. (Jet's total workforce is around 13,000.)

Job losses are not exactly unknown at Jet; when the airline acquired Air Sahara last year, it had pruned some 1,200 jobs. The difference this time was in the way it was done. Employees waiting at home for office transport found that the vehicles never came. When some of them reached the airport on their own, they discovered that their jobs were in jeopardy. "You cannot do such a thing," said Union petroleum minister Murli Deora. "This is not the right time to retrench people, particularly before Diwali."

Other political parties got into the act. There were demonstrations and strikes and tearful airline workers crowding prime time on TV. There were threats that no Jet Airways aircraft would be allowed to operate anywhere in India. The next day, Jet chairman Naresh Goyal announced that all the staff would be taken back. "The employees are like family members," said Goyal. "I was mentally disturbed when I saw tears in their eyes." Jet later announced an across-the-board pay cut, which was quietly accepted because the employees had already been given a preview of the alternative.

Jet Airways and Goyal had no supporters for their move. But Manish Sabharwal, chairman of Bangalore-based staffing solutions firm TeamLease, offers a different perspective. "There is no question in my mind that Jet Airways executed what was a right decision the wrong way," he says. "There is also no question in my mind that most of the sacked employees of Jet who have been taken back will not be around a year from now because the company handled them without dignity, respect or listening [to them]."

Moral Obligations

An alternate view is that the layoffs at Jet Airways were "un-Indian." According to Vasanthi Srinivasan, a professor of organizational behavior and human resource management at the Indian Institute of Management, Bangalore (IIMB), "There is this paternalistic culture in our organizations, and therefore a sense of a moral obligation on the part of most managers to care for their employees. Organizations in India prefer to hold on to their people as much as possible. The feeling is that the employees have been with us in good times and contributed to the growth of the organization, so how can we let them go in tough times?"

"Indian organizations have traditionally not had a culture of retrenching employees," says Hema Ravichandar, an HR professional currently offering strategic HR advisory services. She was formerly the global head of HR at Infosys. Adds Sudhakar Balakrishnan, CEO of Adecco India, an HR solutions company: "There is a certain level of obligation that employers in India tend to have towards their workforce. This is more so in the case of family-run firms and the public sector."

The public sector National Aviation Company of India Ltd (Nacil) -- the product of the merger between Air India and Indian Airlines -- has been hit hard by the double whammy of the slowdown and high fuel prices. But the management is handling things in its own fashion. The company has announced that up to 15,000 employees will be offered three-to-five years' leave without pay. Their seniority will be protected. "It is absolutely voluntary," says Nacil executive director of communications, Jitendra Bhargava.

Aviation has flown into an air pocket. So have some other sectors that are driven by bank loans -- real estate and commercial vehicles, for instance. At Jamshedpur, the Tata Motors plant was closed for three days in early November "to match production with demand of vehicles produced [and] avoid build-up of inventory." Explains a company spokesperson: "About 95% of commercial vehicles are purchased through financing.... Unavailability of finance, coupled with high interest rates, is forcing customers to postpone purchases." Consider a headline in the Hindustan Times: "Tata Motors forces unpaid leave on workers."

But things seem to be different abroad, though the company concerned is the same. At the UK plants of Jaguar Land Rover (JLR), meanwhile, there is quite another corporate culture. JLR is now part of Tata Motors after a US$2.3 billion takeover earlier this year. In October, the JLR management had asked for 198 volunteers for a redundancy plan. That has now been increased by another 400. "While regrettable, these are necessary actions to manage our business through a very challenging period," JLR CEO David Smith told the media.

East vs. West

Studies underline the fact that Western and Indian companies have different approaches to managing the crisis. According to a survey by global HR and financial consultancy service Watson Wyatt, 26% of US employers expect to make layoffs in the next 12 months. Some of the other options in this mid-October 2008 survey of 248 companies are: hiring freeze 25%, company-wide restructuring 23%, salary freeze 12%, and salary reduction 4%.

Writing in business daily The Economic Times, Pothen Jacob, head of the human capital group, Watson Wyatt India, points out that the numbers are very different for India. "Watson Wyatt's Strategic Rewards Survey reveals that the most common approach in India is a combination of restructuring (67%), slower rates of salary increase (51%) and a hiring freeze (62%). Only a small percentage of companies have considered options like reduced work week (10%), broad-based base pay reduction (3%) and early retirement (15%)." Pay cuts are limited in India; job cuts are not even on the radar in most places. "In the absence of a structured social net, the implications of a workforce reduction are both economic and emotional," writes Jacob. "Companies should first consider approaches that avoid layoffs."

"In industries like the IT and business process outsourcing (BPO) sectors, where there is close interaction with Western companies, some of the thinking around job cuts has changed," says Srinivasan of IIMB. "But, by and large, job cuts as the way to manage during a slowdown is still a very Western world view. Globalization has not really brought about a change in thinking in Indian organizations. While many multinationals have tried to get this mindset into their employees and there is much greater awareness that that jobs can be terminated at any time, the employees don't really believe it can happen to them. It is still seen as just a clause in their appointment letters. This is true even from the management side. Wherever terminations do take place, there is tremendous discomfort among the managers. We must also recognize that a large percentage of our population is first generation in the workforce from agriculture. There is, therefore, an underlying expectation of loyalty."

Ravichandar, however, believes that change is in the air. "Organizations or employees are no longer subscribers to the covenant of lifetime employment," she says. "The new mantra is really career resilience -- where organizations and individuals work together to ensure that the employee remains relevant and current with the role and organizational requirements.

"One of the biggest challenges organizations face in a downturn is managing employee morale," she continues. "Anxiety and discontent are bound to exist at such times. Strong employee-engagement initiatives including robust communication mechanisms, open channels between managers, their teams and HR, and training programs to keep employees relevant are some of the measures organizations can take to address this. Textbooks don't provide easy answers to managing in these difficult times. A lot depends on experience, prudence and management maturity."

The other big issue in India is the social stigma attached to losing a job. "In India, losing a job has more than just financial implications," says Srinivasan. "Because people work long hours at the workplace and are paid very well, their families tend to believe that they play a crucial role within the organization. If they were to suddenly lose their jobs it is perceived as a reflection on their competence. The social environment does not understand that one can be asked to leave a job because there is an economic downturn."

"Tightening belts is certainly a preferable option to cutting jobs," says Balakrishnan. "Cutting jobs leaves a bitter taste in the mouth. In India, the majority of the households have a single breadwinner, so jobs cuts hit them very hard. Also, in India, a job is not only about money. There is a lot of status attached to it. Unlike in the West, here there is still a stigma attached to losing a job. Indians as a whole are very emotional when it comes to their jobs." Another critical difference is that a laid-off employee in the U.S., even if she or he is the sole breadwinner, can obtain unemployment benefits -- which offers moderate financial assistance at least for a short period. In India, the absence of a social safety net forces jobless workers to fend for themselves, increasing the distress that they and their families face.

So should Indian firms always choose pay cuts over job cuts? "Where you stand on this issue depends on where you sit," notes Sabharwal. "If you are a competent performer, you prefer job cuts. If you are an incompetent performer, you prefer pay cuts. The danger is in believing that everybody thinks about this issue the same way."

The Role of Organizational Culture

Srinivasan sees a certain virtue in cutting salaries rather than jobs. "Wherever there have been across-the-board salary cuts, one finds that the commitment to the organization actually increases," she says. "The fact that the leadership is willing to take a pay cut sends a very positive message to the team."

"If the organizational culture is good, employees will understand that these are difficult times and will be willing to take these cuts," adds Balakrishnan. "There is willingness to fight out the bad times together. Companies will look at rationalizing salaries, lower wage increases and perks like travel and hotel privileges, and try to cut expenses wherever possible."

"The conversation currently is on tightening belts -- be it switching off the lights, closing the facilities when not required or economizing on travel," says Srinivasan. "I am convinced that the way for Indian organizations to manage the slowdown is a combination of different measures: bring down labor costs, relocate different groups of people across the organization [from where they are overstaffed to where they are understaffed] and improve productivity and efficiency."

Srinivasan believes the angst over potential job losses is just a passing phase. "Almost everyone I meet is reasonably confident that things will turn around by mid-2009," she says. But Sabharwal sees a larger problem. "Over the past few years many managers confused luck with skill as the rising tide lifted even the leaky boats," he says. "But the huge inflation in employee numbers and cost over the past few years were accompanied by substantially lower hiring standards and lower productivity expectations. Whether managers like it or not, some cleansing is overdue, necessary and inevitable." He is optimistic, however. "India is going through a classic cycle where five years of high tide should and will be followed by a year or so of low tide. But people should realize that all that is happening in the world makes India much more attractive in an 18-month timeframe."

Some sectors of business are more vulnerable to job losses than others. "Some segments in India like real estate, retail and banking have made strategic errors by way of grossly over-hiring and these will get impacted," says Balakrishnan. The Assocham survey mentions seven sectors -- steel, cement, IT enabled services/BPO, financial and brokerage services, construction, real estate and aviation -- as areas where employers "have no choice." Everyone agrees there will be some impact there.

Winter of Discontent

The numbers being discussed are, however, much larger. In a Cover Story titled Pink Slip Winter, New Delhi-based magazine BusinessWorld talks of "3 million jobs lost in export-oriented and labor-intensive industries such as textiles, leather, gems and handicrafts." When it comes to specific companies, however, at the top of the list is Nacil (where the cut is voluntary and temporary) and Jet (where the employees have been taken back). The next four are IT companies -- Satyam, Wipro, TCS and Patni -- where the numbers laid off are not much higher than in the previous years.

The reality is that the big firms -- in whatever sector -- should be able to ride out the storm. The real damage will be in the unorganized sector, where numbers are hard to come by. It is estimated that small and medium enterprises (SMEs) employ about 150 million people. These SMEs are mainly suppliers to large companies. When the latter catch a cold, the SMEs need hospitalization.

Another vulnerable group -- for which little data is available -- is India's 14 million migrant workers (out of a total of 98 million migrants), according to the 2001 census. The number is estimated to have doubled since then. These workers are employed as casual labor on large projects for large companies. (Almost half of them are in construction.) They get paid on an hourly basis. They can be told when they turn up for work that they are not required any more. They are always the first to be affected.

"Losing a job is a tragedy anywhere," says Sabharwal. "But we must keep things in perspective. All this talk about pink slips only affects 7% of India's labor force; 93% of India's labor force works in the unorganized sector where issues such as job security, workplace safety and social security have no relevance. So, at one level, most Indian workers face the most flexible and unfair labor regime in the world."

My Job Is My Life: The Connection Between Meaningful Work and Personal Identity

2008-12-26T12:27:00.001+05:30

Business researchers have long proposed that when employees find their work meaningful and fulfilling, they are more likely to do that work well, and, as a result, help their companies succeed.

Few have disputed this simple equation. Corley, an assistant professor of management at the W. P. Carey School of Business, does not dispute that meaningful work plays a large role in how well an employee performs. Rather, he believes there's something more that drives an employee to endure an awful commute and put in an honest day's work at the office.

"One of the things that's very important to me is trying to get a better sense of how employees attach themselves to organizations," explains Coley. "What is it, I want to know, that leads an employee to not only get up every morning for that organization, but also be committed enough to do a really good job and really apply their skills and experiences?"

In a recent study, Corley attempted to find an answer.

The resulting paper, "Video Didn't Kill the Radio Star: Exploring the Role of Identity in Meaningful Work through Identification," breaks new ground. It helps establish the connection between an individual's identity and the meaningfulness of his work.

Identification in this context is the extent to which an individual connects his personal identity to his work or employer. Meaningfulness refers to the sense of purpose and significance or value and worth that employees find in their work. Corley's study establishes that identity is a core element in meaningful work, and is one of the first to attempt to bridge the long-standing theoretical gap between meaning of work and personal identity, which until now had only been theorized.

"These two areas -- meaning of work and organizational identification -- are key aspects of how employees attach or do not attach themselves to an organization, but their relationship is not well understood," Corley says. Meaningfulness and identity have been examined independently, he said, and studies about one typically mention the other. But until now researchers have not looked deeply at the dynamic between the two. Corley wanted to know more about the connection.

For his study Corley chose what might appear to be an unlikely place: a college radio station.

Radio days

"We were very interested in an organizational setting that was not molded after your typical Fortune 500 company," Corley explains. "We didn't want a place where employees would be saying, 'I am going to work for this company forever.' We really wanted to capture more of the temporal nature of work that's going on in today's business world -- we wanted a place that relied more on seasonal people, or part-time workers, a place where people come and go."

An attorney at a large law firm may be committed to the firm long-term based on tenure or financial reward, Corley explained, but the workers at this college station would have a much different relationship to their organization. Many of the station's workers would be around for only a short time. Several of them didn't even draw a paycheck.

"In the setting we were looking at, we were talking about mostly students who were always coming and going," Corley said. "It was a much more transient situation. Any sense of 'identity' we found was going to be based in connection to the organization. These folks were there for the excitement of being in radio. It was about having an opportunity to provide something and do something they really wanted to do."

Run almost entirely by students, the station that Corley investigated had just five full-time employees: four sales managers and one operations manager. The 50-year-old station had been a "rock" station since the late 1960s, but during Corley's study it transitioned from a traditional rock format to "college rock."

What Corley sought to do was find out just why these student workers committed themselves to the station. Why get up at 5 a.m., he wondered, to work for such little pay -- or no pay at all?

To find out, Corley and his colleague conducted a series of interviews with 20 employees at the station, observed the organizational dynamics by sitting in on staff meetings and sorted through the station's internal records and other documents.

During the interviews, which lasted up to an a hour each, Corley asked fundamental questions such as, "What makes you get up every day and come to work?" and "What is meaningful to you in your job?"

Corley discovered that the employees found meaningfulness in their work from eight specific sources: self-expression, autonomy, career experience, learning, compensation, internal contribution, external contribution, and social relationships. Going a step further, Corley pulled out those sources of meaningfulness that played directly into professional identification -- self-expression, autonomy, career experience and learning.

The results of the study bore out almost precisely what Corley had expected. The four sources of meaningfulness related to identity, combined with an opportunity to contribute to an organization's success, helped employees develop a sense of professional identification and a deeper connection with the organization.

What does it all mean? Better, happier employees

Corley writes that when employees "find meaningfulness in contributing to their organization and in interacting with people external to the organization, they were more likely to identify with the organization." In other words, employees who are given important jobs within an organization are more likely to identify themselves with that organization, and therefore want to perform well.

"The more that workers find their jobs meaningful, the more satisfied they'll be in their jobs, and the more likely they'll be able to provide good customer service," Corley says.

But there's more. Corley adds that employees who find meaning in their work actually live happier and more balanced lives.

"One of the things that we didn't get very much into in this paper was the fact that the more meaningful you find your job, the better able you are to handle work/life stress," he said. "People who don't find their jobs meaningful, or those who are just focused on the money or because the job will get them where they want to be, tend to have more turnover, more absences."

Though more work must be done to fully explore the connections between meaningful work, identity and workplace performance, Corley says this study does lay valuable theoretical groundwork.

It also provides some guidance for managers.

"Every employee is different, of course, but providing opportunities for employees [to contribute] -- there's a lot of value in that," Corley says. "If managers can provide the opportunity for employees to fulfill those desires, it can go a long way toward helping them find meaningfulness in their work."

Bottom Line:

Business researchers have long proposed that when employees find meaning in their work, they are more likely to perform better. They also believe that when employees identify with their employer, they will do well.
In a new study, management Professor Kevin Corley and his colleague take this one step further -- exploring the role that an employee's identification with an organization plays in meaning of work.
Studying a college radio station, Corley learned that employees who have autonomy at work, who have opportunities to express themselves and learn on the job, and who gain career experience during the day find meaning in their work and identify with their profession.
Corley also found employees are more likely to identify with their organization when they feel as though they are contributing to its success.

Quitters Can Win: Avoiding the Pitfalls of 'The Dip'

2008-12-26T12:25:00.001+05:30

Your phone doesn't ring after your fifth, sixth or tenth job interview.

You're halfway through the marathon, your calves are burning and there's a stitch in your side -- and the finish line is a distant dream.

You've been given steady promotions at a job you've enjoyed for seven years, but your last three have been unchallenging "sideways" moves and you have the distinct feeling your hard work is being taken for granted.

You might be in a Dip -- a temporary setback that you will overcome if you keep pushing. But maybe it's really a Cul-de-Sac, which will never get better no matter how hard you try.

Seth Godin, best-selling author of books and a popular marketing blog, discusses a sticky topic in his small but power-packed "The Dip: A Little Book That Teaches You When to Quit (and When to Stick)."

Vince Lombardi was wrong

The saying "Winners never quit and quitters never win" is a fallacy, according to Godin. In fact, there are times when quitting is the smartest tactic you can employ, as long as your long-term goal remains foremost in your mind. Knowing the difference depends on understanding, and recognizing, what Godin calls the "Dip."

"Almost everything in life worth doing is controlled by the Dip, Godin writes. When you embark on a project, hobby or learning experience, it's usually fun, interesting, and rewarding. Over the first few days, weeks or months, your interest in the endeavor keeps you engaged.

And then you encounter a Dip.

"The Dip is the long slog between starting and mastery. A long slog that's actually a shortcut, because it gets you where you want to go faster than any other path," says the author. Examples:

The combination of bureaucracy and busywork you must deal with before you graduate from college, become certified in scuba diving, or get through a transition period at work.
The difference between the easy "beginner" technique and the more useful "expert" approach in art or athletics.
The long stretch between beginner's luck and real accomplishment

Successful people don't just ride out the Dip, Godin advises. They lean into it, pushing harder and changing the rules as they go." The book illustrates these ideas with graphs and even cartoons. It's an easy read, but don't be fooled. This diminutive book is definitely a case where size doesn't matter. It does not tell the reader what to do. It defines and illustrates case histories, but how you apply them in your own life will depend on how well you absorb the lessons. Godin's message goes down easily enough; however, the best bet is to read the book once, then after catching on to what the author is saying and reflecting on your own life, go back and read it again.

The father of "permission marketing"

Godin's first book to achieve mainstream success was "Permission Marketing: Turning Strangers in to Friends and Friends into Customers." Distinct from "interruption marketing" (TV or radio advertising), permission marketing provides something of value to the consumer then obtains their permission to communicate it. Never employ deceit or spam, Godin wrote, and always keep your promises to the consumer. Generate buzz by being remarkable.

Godin's concept created buzz for itself in the marketing community. Marketing ideas spread as "idea viruses," he preached, and those who employ them are "sneezers."

A graduate of Tufts University with a degree in computer science and philosophy, Godin holds an MBA from Stanford Business School. He founded and worked at successful companies including Yahoo! and Fast Company. In 2005 Godin founded the "recommendation network" Web site Squidoo, and he is the author of a hugely popular marketing blog.

To quit, or not to quit?

All of us have grown up with the idea that quitting is the fast track to Loserville, but recent bestsellers written by successful CEOs have proved otherwise. Failing at an endeavor doesn't have to indicate a failing in character; failing could lead to valuable life lessons and might eventually clear the way along the road to long-term success.

Sadly for many who arrive at middle or old age filled with bitterness and regret, it's possible that societal taboo against quitting led to a lifetime of unhappy, dead-end jobs. Godin prefers to think of quitting (or not quitting) as a "go-up" opportunity, rather than a humiliating experience.

"You can realize that quitting the stuff you don't care about or the stuff you're mediocre at or better yet, quitting the Cul-de-Sacs, frees up your resources to obsess about the Dips that matter," he writes.

Godin spends considerable time describing the ultimate goal as becoming "the best in the world" at what you do. And that may be important to many in the business world. However, for those who are not so driven to perfection, the lesson of the Dip can apply in different ways. An artist, for example, may not care about being "the best"; rather, his or her goal may be simply to pursue art for its own sake, in the face of long years of obscurity and a subsistence income.

Bottom Line:

Here is what Seth Godin has to say about quitting in the chapter "If You're Not Going to Get to #1, You Might as Well Quit Now." Three Questions to Ask Before Quitting:

Am I panicking? Quitting when you're panicked is dangerous and expensive. The best quitters are the ones who decide in advance when they're going to quit. When the pressure is greatest to compromise, to drop out, or to settle, your desire to quit should be at its lowest. The decision to quit is often made in the moment. But that's exactly the wrong time to make such a critical decision.

Who am I trying to influence? Influencing one person is like scaling a wall. If you get over the wall the first few tries, you're in. If you don't, often you'll find the wall gets higher with each attempt. Influencing a market, on the other hand, is more of a hill than a wall. You can make progress, one step at a time, and as you get higher, it actually gets easier. Every step of progress you make is amplified over the last.

What sort of measurable progress am I making? Measurable progress doesn't necessarily have to be a raise or a promotion. It can be more subtle than that. The challenge is to create or recognize new milestones in areas where you have previously expected to find none.

Water Cooler Talk Keeps Organizational Culture Real

2008-12-26T12:22:00.001+05:30

It is a ritual in offices around the country: the morning meet-up. Although employees may have already clocked in and should theoretically be hard at work, they meander over to the coffee pot, fill up a cup and kibitz. Although they may have arrived at 8:30, they don't boot up their computers until 9:00. In many managers' eyes, such behavior is often filed under the heading of wasted time on the company's dime. "You're here to work. If you want to socialize, do it on your own time!" they might say.

Yet, the irony of the situation, says W. P. Carey management Professor Blake Ashforth, is that these social butterflies may very well be adding value to the company. Rather than being grumbled about, such office klatches should be nurtured and encouraged.

The tribe goes to work

It is an idea that Ashforth advances under the banner of "tribalism" in a chapter he authored for the forthcoming SAGE "Handbook of New Approaches in Management and Organization."

After all, says Ashforth, a pack of paralegals or a covey of consultants drinking java or hanging about the proverbial water cooler is not so different from a tribe of Neolithic hunters sitting around a campfire. We as a species have come a long way since the days when the morning commute meant braving saber-tooth tigers but, at our core, people are still very much the same social animals we've always been. We want to feel like we belong and we value our closest connections beyond people we don't know.

In a very real sense, organizations big and small would benefit by seeing themselves framed by a variation of Former U.S. House Speaker Thomas (Tip) O'Neill Jr.'s maxim, "All politics is local." People care about the big issues, but place a very large importance on whether the potholes on their street are fixed and if there are jobs to be had in their town. So it is with organizational culture: The big issues matter but employees are most likely to judge an organization by their most local contacts -- their boss and immediate coworkers.

Ashforth says an organization's success is largely linked to its smallest social units, the tribes who congregate around the coffee maker

"Our argument is that all of that higher order stuff [strategy, mission, etc.] gets translated, made real, by what happens at the local level, so the organization is a distal influence; it's out there, it's important but it is distal," says Ashforth. "It gets the train engine going, but once that engine is in motion, it's what happens in your particular car that makes it real."

Ashforth gives the not-uncommon example of an employee who loves the larger corporate culture and mission of his employer but hates his job because of his tribe (i.e. his manager and/or coworkers) or the employee who loves her job because of those immediately around her despite the organization as a whole being miserable. In these cases, the facets of company health that one might assume would keep people in their jobs -- financial fundamentals and the company's resultant share price, product offerings, sales pipeline and overall mission -- are secondary concerns that don't necessarily trump how employees feel about their situations.

"People construe the organization through how they're treated at the tribal level so if your tribe isn't functioning well, the rest doesn't matter," says Ashforth.

The value of a shared fire

Back in primordial times, a hunter would be more likely to risk his life to save someone from a rampaging mastodon if that imperiled soul were a fellow tribesman and not a stranger. So it is today: People work better together when they know one another on a personal level. It might not be tusks and spears but rather lending an extra hour or two to a coworker who is overwhelmed by home and work pressures.

Of course, to lend that helping hand, one would have to know that a coworker was indeed stretched too thin. Although Ashforth notes that work and home increasingly blend together in an always-on business climate, he notes that there is still organizational pressure to keep one's home life from interfering with one's work life. Yet, knowing coworkers' hobbies and passions, what sports their kids play and if they're caring for a sick parent is precisely what Ashforth says builds bonds that strengthen corporate groups.

"When you come to know people on a personal level, you're far more likely to give them the benefit of the doubt and to have goodwill in your dealings. And that's a tremendous buffer against the itches and pains of everyday life in organizations," he says.

Further, with flextime, telecommuting, extensive business travel and virtual teams, organizations' employees can easily lose their sense of belonging to a small group (and consequently the larger company) because they are not in regular contact with their coworkers. In these cases, managers must work extra hard to make up for the loss in face-time (or coffee breaks) that don't occur because employees are separated by miles if not continents. Ashforth says that some professions in which it is difficult for coworkers to bond during work hours (such as police officers, who often spend the whole day in the company of a single partner) have bridged the tribal gap by building community after-hours -- perhaps at the local watering hole.

Although it is not necessarily a silver bullet, Ashforth says that technology can bolster all-important personal relationships with dispersed teams. A recent survey by Challenger, Gray & Christmas found that nearly one in four companies blocks employees' access to web sites like Facebook and MySpace, believing them to be a productivity killer. However, Ashforth says that social networking sites that transmit personal information and nurture casual and candid rapport can be an important ingredient in building links between coworkers. This is especially true for employees who do not work down the hall from each other.

Becoming a tribal leader

Of course, employees who care about their organization are better for the organization. They are more likely to work harder, be more invested in a company, resolve issues and not look for a new job, taking their skills and know-how elsewhere. Getting managers to be better at the "people part" of the job is easier said than done, but it's not rocket science, says Ashforth.

The recipe for building a tribal culture girded by small-scale social ties is at once easy and difficult. The easy part is adhering to acknowledged managerial practices such as: Setting aside time to encourage personal connections and not focusing entirely on selling more product or making more widgets; Checking in frequently with subordinates rather than just doing an annual retreat or review; Being honest and candid in building a people-centric culture rather than forcing awkward gimmicks on employees. What's difficult is taking a long-term view, which shows that taking time to socialize today may ultimately produce more dollars.

Companies should also put managers in managerial positions as opposed to employees who are particularly skilled in some more specific task. Just because someone is an excellent computer programmer doesn't necessarily mean that he or she will be an excellent manager of other computer programmers. In many cases, employees who are promoted to front-line managerial levels know they are not good managers of people and then once they've been promoted, do not get adequate training to make them good managers. As a result, the project they oversee may be technically sound and completed on time, but the fallout from focusing on the process rather than the people can be so extensive that many of the tribe subsequently leave the company.

"Organizations tend to reward short-term results, so there's always a tendency when times are tough to put the screws to employees to get those short-term numbers up. But, of course, that has terrible long-term consequences," says Ashforth.

As a result, HR training dollars should be used to develop lower-level managers, giving them tools to build rapport, instead of spending those funds exclusively on bigger picture training. Even allocating a few dollars to allow managers to take their subordinates out to lunch can pay dividends in the tribal workplace.

But Ashforth cautions that while departmental lunches are a great venue to build relationships between individuals or the group, a good manager also lets the rest of the tribe operate on its own. It's important to give employees a chance to bond without the boss looking over their shoulder.

Taking a tribal focus places a large burden on lower-level managers versus C-level executives. Figuring out when it's appropriate to go to lunch and when it's best to let the tribe feast on its own can be a challenge, but it is these small moves among small groups that ultimately shape a large organization, says Ashforth.

"If we recognize the importance that these relationships have and the importance the job has at the local level, then a lot of the so-called important macro stuff tends to fall by the wayside. The macro stuff still matters but only in a more distal sense," says Ashforth. "In the day-to-day, everyday sense, what really matters is what you can see, what you can smell, what you can taste, what you can feel, what you're doing."

Bottom Line:

* People are social animals and want to feel a sense of belonging with other people. How they feel about their employer is largely dependent on how they feel about their tribe -- their boss and immediate coworkers -- rather than the organization's larger culture and objectives as dictated by upper management.
* If an organization recognizes the importance of its smallest local groups, or tribes, it places a burden on lower-level managers to make those groups meaningful to their members and to connect the groups to the wider organization.
* Small groups of employees function better if their members feel like they truly know one another. Therefore, it is in the best interest of the organization to encourage employees to develop personal rapport.
* When workgroups do not have the opportunity to socialize they can feel disconnected from their own tribe and thus the larger organization.
* Although it is not a panacea, social networking technologies that encourage personal connections can help connect employees to their coworkers.

. That's because an organization's chances of achieving its big goals and initiatives depends on how these goals are perceived through the lens of the tribe, and how that tribe interprets and acts on them.

As Layoffs Spread, Innovative Alternatives May Soften the Blow

2008-12-26T12:16:00.001+05:30

Just how bad will the economy get? For employers facing tough decisions about layoffs, the question is far from rhetorical. If the current economic turmoil is contained sooner than expected, premature layoffs could be a disaster. If not enough employees are laid off and the recession continues, the company's bottom line could suffer. And in any scenario involving layoffs, morale among those employees remaining at the company is sure to plummet.

Some companies consider alternatives to layoffs, such as voluntary retirements or salary cuts, hiring freezes, reductions in hours, or the cancellation of business trips and/or costly perquisites. Even standard benefit packages and matching contributions to 401(k) plans might come under the microscope.

Executives came to a general consensus that if salaries were cut by 10%, or hours were shaved from the workweek, the company's best people would disappear. The thinking was that the "most mobile" employees would be hired by competitors,.

But that prediction, he adds, doesn't hold up. "It is driven by the executives' view of the way things work, and the executives, frankly, think that everyone thinks like them. They see themselves as the kind of talent that is mobile." They also don't believe that employees would buy into the idea of doing something good on behalf of their colleagues [by accepting reduced wages or hours] because "they themselves wouldn't buy it." Once again, Cappelli adds, that perception "is probably wrong." The act of making sacrifices for fellow employees "might actually build some morale and knit the company together."

Besides, Cappelli says, if the economy stays the way it is or worsens, the concern that a company's top employees will leave is irrelevant, since no one else is hiring either. "If you have a choice between a 10% wage cut and laying off 10% of the work force, why on earth would you choose the latter?" he asks.

Cappelli suggests that it's worth thinking about what kind of problem a company is trying to solve. If there is a concern about what happens when business activity picks back up, for example, companies that hold on to their workers would be in much better shape than companies that have undergone large-scale layoffs.

Spreading the Pain

The costs of layoffs go beyond the morale problems they cause -- both for those laid off and those who keep their jobs. Unemployment insurance premiums spike. Depending on the company, there are severance packages to consider and outplacement services (costly in these days of bigger demand for them). Litigation is a not insignificant risk. Cappelli suggests that if a company can cut back without instituting layoffs, it should do so. "Then you don't have those start-up costs" once things are back on track.

On the other hand, there's nothing like a good economic downturn to get rid of dead wood. A sagging economy can be an opportune time for management to deal with performance problems by using the bluntest instrument possible, Cappelli says. Firing people is often difficult to execute, but an over-arching justification tends to lessen complications.

The subject of alternatives to layoffs is almost always seen from the point of view of the employer, he adds. It would be a rare employee who suggests his or her hours be cut. But executives can share the decision by asking for voluntary pay cuts in exchange for some sort of deferred compensation, such as shares of stock or extra vacation. Some U.S. cities coping with recession-driven budget crises have already opted to reduce salaries and hours. Atlanta Mayor Shirley Franklin recently said 4,600 city employees would see their hours cut by 10% because of a $60 million budget gap.

n the private sector, the conventional wisdom is that the smaller the company, the more apt owners are to work things out personally with workers. "We recently reduced hours in our department," says Ben Atkinson, director of risk management for Edison, N.J.-based Peoplelink Staffing, a provider of staffing, software training, consulting, development and support. "My team proposed the idea, and each [of us] volunteered to reduce [his or her] number of work days. I have asked other managers across our enterprise to consider this approach."

Atkinson says the move has prevented major disruptions to projects, and retains the investment the company has made in training its employees. "This is not to say we won't consider layoffs," he adds. "But it depends on your economic prognosis. If we anticipate a recovery sooner, we are more likely to consider reduced hours. If we expect a long slog, layoffs may seem more appropriate."

"The really small companies are probably more willing to find alternatives," Cappelli suggests. "Relationships are much more personal. It's one thing for the CEO to call the HR person and say, 'Lay off 10% of the staff.' It's another thing for the person at the top to look the [laid-off employee] in the eye" and say he or she no longer has a job.

Small, privately held companies also do not have as much pressure to cut costs if the owner believes it is possible to ride out the storm. Conversely, in a publicly held company, even if a CEO is inclined to seek alternatives to layoffs, pressure from shareholders and Wall Street analysts to cut staff might be too great. "With bigger companies, there is a certain skill to laying people off," notes Cappelli. "It will be interesting to see in this recession how companies do it, because a lot of them have lost that skill."

In the past 20 years, staff cutbacks have more frequently included attractive incentives, according to Daniel O'Meara, a senior fellow at Wharton's Human Resources Center and an employment law attorney with Montgomery, McCracken, Walker & Rhoads in Philadelphia. In the 1990s, O'Meara saw more opportunities for voluntary retirement incentives. "It was more feasible with a defined benefit plan, and very feasible with over-funded pension plans. If [employers] could afford it now, it might be that anyone with 20 years of service and at least 55 [years old] would be treated as [if they have] 30 years [of service] and ... are 65."

These days, such options are less generous, he says, citing a particular hospital where buyout offers are more typical: one or two weeks of pay for each year of service. "No one who is happy in their job and doesn't have something lined up would leave for four or eight weeks of pay. But you might have people who were going to leave anyway, and see it as a great opportunity."

The other side of that coin is that some companies make such offers "only to show employees that they are basically good people, just before the involuntary layoffs come. Since the Depression, all these alternatives have been discussed -- to lay people off or share the pain," O'Meara says, recalling personal experiences as a young man growing up in western Pennsylvania, where he worked summers in a steel mill. "There, when things got slow, we all worked four days a week. That's [a case] where the union had the effect of making sure people held on to their jobs. A lot of this stuff has been around for a long time. These decisions have huge impacts on people and there are no easy solutions."

O'Meara has mixed emotions about unions in general, mentioning "pay compression," where an unskilled broom-sweeper makes perhaps 60% of what a skilled steelworker makes. But that "socialist preference" clearly had a positive impact when the situation went beyond cuts in hours and moved into layoffs. "I have seen people retire and [accept] these fairly modest offers. [They figure] that they are older and their kids are out of college, and they think, 'When I was younger and needed the job, I would have appreciated someone doing that for me,'" O'Meara recalls. "It doesn't happen often, but I saw it in the steel mill."

A new factor on the playing field of labor negotiations is pending legislation called the Employee Free Choice Act, pushed by the AFL-CIO and backed by many Democrats in Congress, including the President-elect. Passed by the U.S. House of Representatives in 2007 and eventually filibustered in the Senate, the act would require a union's certification by the National Labor Relations Board (NLRB) when a majority of employees has signed a card designating a union as its bargaining representative.

"The bill would make it much easier to organize employees," O'Meara says, which might make the case for alternatives to layoffs more pressing. At the same time it could possibly restrict options for employers. "You don't want to lower morale when [Congress] is about to pass a law making it easier to organize. [But] it would make anything innovative a little more difficult."

Avoiding Layoffs 'At All Costs'

"The economy has got us all watching very closely. Like anyone, we are trying to figure out where the bottom is," says Tim Roth, president of Megavolt, an agricultural machine re-manufacturer based in Springfield, Mo. "Agriculture has been relatively strong compared to other industries, but in June, we saw that in future months we would have some problems. We tried to figure out how to keep people and avoid layoffs at all costs."

Megavolt has two advantages over many other private companies. First, it is a joint venture with two other firms descended from International Harvester after a buyout 25 years ago. In some cases, this allows employees who get additional training and certification to temporarily move to other work places, as needed.

Second, the company moved in October to a "shared work program" of three 10-hour days a week as a way to cope with the downturn. While workers keep their jobs, the lost 10 hours each week is nonetheless enough for them to be eligible for state unemployment benefits in Missouri, where Megavolt is located. The Missouri program also does not restrict unemployment benefits for people who take on part-time jobs, Roth says. And within the shared work program, companies can soften the blow to people who are laid off. In that situation, the state stipulates that the employer give the volunteers a specific recall date -- generally, anywhere from one to six months out, according to Roth. The company also maintains health benefits for employees and defers their contribution to the premiums.

"It's one thing to have lost a job completely, but it's quite another to be able to look for work and know you have got something else behind you," Roth says. "It's a good program."

Cappelli says Missouri's program sounds promising as a model for other states. But it might be a moot point in the short term. Indiana officials just announced that they are running out of unemployment dollars and might have to increase the state tax that generates those funds. Currently, the first $7,000 of earned income is taxed for unemployment insurance, something Indiana may need to increase to offset its own residents' needs.

Other states, such as New York, have shared work programs similar to Missouri's, but the gap in flexibility from one state to another can be wide. At the moment, most state unemployment offices are passing on the news to out-of-work residents who have exhausted their benefits that recently passed legislation provides up to seven additional weeks of compensation, funded by the federal government.

In the end, companies need to balance what's best for their employees while making sure the company remains viable in tough times. Small companies might be able to maneuver more nimbly, Cappelli says, but innovation will suit the times and circumstances no matter what the size of the firm, public or private.

He cites Cisco Systems in 2001, after the tech bubble and before 9/11, as an example. Cisco allowed employees to take sabbaticals while they were paid one-third their salary. "The reason was that at one-third pay, you couldn't survive forever, but it was enough money that you wouldn't necessarily be looking for another job" in the meantime. Cisco saved both money and talent.

Roth maintains that solutions like the ones his company have come up with work well only if state and federal agencies leave the innovation to the companies. "We can have the greatest idea to do something, and if the state doesn't support us, we can't do it," Roth says. "We have to save jobs. We cannot let this country lose more jobs."

CEOs and Market Woes: Is Poor Corporate Governance to Blame?

2008-12-26T11:55:00.001+05:30

From Wall Street to Detroit, chief executives are losing their bonuses, agreeing to work for a dollar a year and in many cases losing their jobs. Congress is invading the executive suite, demanding veto power over management decisions as a price for tax-funded rescues.

And, of course, stock prices have plummeted.

It all looks like a sweeping vote of no confidence, as if the world thinks America's executives and boards of directors are beset with an epidemic of incompetence, self-dealing or both. Many shareholder advocates see the financial collapse and economic woes as stunning proof of their long-held claim that too often the wrong people are in charge -- and that attacking this problem demands an overhaul in corporate governance regulations.

They propose a range of measures to encourage chief executives to focus on the long term rather than the next quarter, to give shareholders a "say on pay" and to make it easier for them to field their own candidates for directorships.

"The recent volatility we have seen shows that the need for better corporate governance has never been clearer or more pressing," writes Nell Minow, editor and co-founder of The Corporate Library, a research firm that presses for better governance practices. She adds that "this latest mess is so pervasive and so -- apparently -- legal that it has called into question the most fundamental notions of trust in Wall Street and in the American economy."

Not everyone sees governance as the culprit, and some warn that a kneejerk attack on established corporate practices could backfire. But many experts expect that regulators, Congress and the incoming Obama administration will take a hard look at whether rule changes could improve the management of public companies.

"The failure of so many firms can partly be attributed to structural factors beyond anyone's control, but not entirely," says Wharton management professor Michael Useem. "One has to infer that we also have a combination of leadership and governance problems that can explain why so many companies went south so quickly." With hindsight, he notes, it is clear that many corporate directors and executives failed to appreciate the "risks lurking in what they were doing, and the risks lurking in the economy at large."

The main exhibits for reform advocates: First, the near collapse of the three U.S. automakers, while foreign competitors thrived in the same market conditions; and, second, the extraordinary level of borrowing and risk-taking that sank major investment banks.

The Madness of Crowds

For many experts, the common thread was a focus on short-term results that endangered firms' long-term health. The car makers promoted profitable SUVs and trucks, failing to develop enough fuel-efficient vehicles or upgrade plants so they could swiftly produce different vehicles as consumer demand changed. Investment banks and mortgage lenders soaked up profits on high-risk loans and securities tied to mortgages, ignoring the damage that must eventually come when the home-price bubble burst.

General Motors executives and directors, for example, can be faulted for misunderstanding the implications of a gasoline-starved and environmentally threatened world, Useem says, while Wall Street is "dominated and driven by investors and equity analysts" with a short-term outlook. Wharton management professor Thomas P. Gerrity describes the run up to the collapse as "a classic delusion, a madness of crowds. We've lived through it over and over again."

Washington is already addressing governance issues, and most experts think more will come. Banks that take federal rescue money have to agree to executive-pay restrictions, such as a loss of tax deduction on pay exceeding $500,000 a year and a ban on big paydays for departing executives, called "golden parachutes."

For the moment, pay restrictions may be necessary to get support for rescue measures from an angry public and Congress who resent big pay for those who presided over disaster, says Wayne R. Guay, a Wharton accounting professor. But he questions whether making such restrictions permanent would be wise, arguing that big firms "are not going to survive long-term by paying their executives $500,000. They're just not going to attract the talent."

Even severance payments can make sense, he says, citing cases of CEOs faced with losing their jobs by selling their firms, which is often the best move for shareholders. "A severance package is going to provide that CEO with some incentive to say, 'I am willing to sell out the firm and get fired, because there is a golden parachute that I will get,'" he suggests.

To critics, however, this reasoning underscores the corporate culture's hazardous fixation on self-interest. A top executive who is already wealthy by any ordinary standard should not need to be paid extra to do right by his shareholders, according to this view.

Minow says Corporate Library studies show that executives receive outsized pay because they exert excessive influence over their boards of directors -- influence that also can help a poor-performing executive hold on to his job. She says her organization's proprietary studies, which are sold to subscribers, show a correlation between excessive pay and poor shareholder returns.

While Minow argues that the widespread failures among financial firms show how pervasive bad management has become, others say the breadth of the problems shows the crisis was unpredictable, noting that not many regulators or academics saw it coming either. "This was not something that was missed by a bunch of dummies. They just didn't get it," says Gerrity. "The few voices that were expressing skepticism were drowned out by the fact that the market was booming." Executives felt compelled to jump into the subprime mortgage and other risky markets to compete. "Everyone was playing the roulette wheel."

Guay, too, feels it is too easy to blame corporate governance for the whole mess. "It is just hard to tell a story about why these firms would choose executives who weren't trying to maximize shareholder value," he says. Hence, executives striving to match competitors' use of lucrative mortgage securities were doing what their shareholders wanted -- and shareholders were not complaining at the time. "Most of these executives held a vast majority of their own wealth in their companies' stock or stock options, so they had the greatest possible incentives to maximize profits," he says, noting that many Wall Street executives not only lost their jobs after the business soured but much of their fortunes as well. "It's hard to say that all the banks hired bad executives."

Some critics argue that stock and stock options give top executives an incentive to manipulate results or take excessive risks to boost stock prices over the short term, and they suggest that executive performance should be judged according to different gauges, such as revenue growth, earnings measures or other data calculated by corporate accountants. But Guay notes that many types of data produced in-house are more easily manipulated than share price, which is governed by the market's judgment.

Shareholder groups have been pushing "say on pay" initiatives that would require companies to put executive-pay issues to shareholder votes. While such votes probably would be non-binding, the idea is that the prospect of an embarrassing "no" vote would prod directors out of paying too much and compel them to justify pay packages publicly. But Guay and Gerrity question whether many shareholders are equipped to make such decisions. "These [decisions] are complex," Guay says. "They require a lot of detailed information.... If we move the decision-making that has traditionally been in the hands of the boards back to shareholders, we sort of move away from the reason we have boards of directors in the first place."

That begs another question raised by the crisis: If directors are there to make tough decisions and oversee executives, why did they allow so much risk taking?

Minow and other critics say directors are too cozy with the executives to oversee them adequately. In many cases, the CEO is the chairman of the board, giving him significant say over who is offered a board seat, which can be worth hundreds of thousands of dollars a year at a major corporation. Although directors must be elected by shareholders, critics note that traditionally a candidate needs only a plurality of votes to win an election. Reformers want to require that candidates receive at least 50% of votes cast to win. Indeed, this requirement has been adopted fairly widely in the past few years. "More and more firms are starting to move in that direction and I don't think it's a bad idea," Guay says.

Back in the USSR

The effect of such "majority voting" is dampened, however, by the fact that there typically is only one candidate on the ballot for each board opening -- a candidate nominated by the board itself. Critics liken this to elections in the Soviet Union, complaining it is just too hard for challengers to get board approval to be placed on ballots, and they seek regulatory reform to open up the process. Most proposals would require candidates to be listed if they produce petitions representing a significant portion of shareholders, such as 3% or 5%. Business groups oppose the idea, arguing it would allow unions, environmentalists or minority shareholders to foment destructive turmoil.

But Lucian A. Bebchuck, a law professor at Harvard who specializes in governance, says such reforms would strengthen U.S. corporations, arguing they would serve shareholders better if they adopted some of the United Kingdom's governance rules. In addition to opening the ballots to challengers and shareholder-sponsored issues, reform should include requiring all directors to face election every year, he says. In the "staggered" system common in the U.S., only a fraction of directors face election in any given year. Advocates say this promotes stability, while critics say it helps entrench weak directors and managers. Bebchuk's studies have concluded that staggered boards weaken corporate performance. He says the range of reforms he advocates could be swiftly enacted by amending the Delaware General Corporation Law, since most U.S. companies are incorporated in that state.

Obama has supported say on pay and other governance reforms, and most experts expect the Democratic-controlled Congress to push these issues next year.

Eric. W. Orts, professor of legal studies and business ethics at Wharton, warns against putting too much emphasis on governance reform, believing other regulatory changes are more promising, including improved public disclosures about new securities such as credit default swaps. Firms were not ignoring risks; they did not have the data needed to see how risk was spreading through the system. Consolidating regulatory functions now scattered among different agencies would help, he says. "This is the ideal moment."

Useem, too, cautions against a quick resort to a handful of politically popular remedies. "The great danger is [you] screw up free enterprise," he says, arguing that Obama should establish a blue chip task force to consider governance issues in depth. "The way in which regulation is going to be effective here is if it [comes from] a lot of smart people [looking at] what happened at Lehman, Merrill and General Motors and saying, 'we can't let it ever happen again.'"

Any analysis of successful companies shows there is no single governance style that guarantees success, Useem says. Nonetheless, he believes that moves to make directors more responsive to shareholders and to open board elections to challengers could be helpful. It also can be useful to better tie executive compensation to long-term results by parceling out compensation over a number of years, with provisions for withholding portions if performance fades.

Having been so badly stung, many firms are already moving to address risk taking, Gerrity notes. "We have a healthy new thrust in corporate governance called enterprise risk management" to establish standing operations to take a more sophisticated and comprehensive look at a firm's risks. Depending on the business, that can entail everything from the risk of hurricane damage or terrorist attacks to the risk inherent in portfolios of mortgage securities, or factors that could threaten access to cash and credit.

Because these evaluations are so complex, they could be hampered if too much authority shifts from management and employees to shareholders, Gerrity adds. "You're not going to improve [risk management] from a thousand miles away, with no real knowledge of the needs of the firm. The only solution to this is more intensity and more courageous questioning. People didn't look at the systemic risk, which is more obvious now than it ever has been in our history, because markets are more interconnected."

More important than regulatory change is the need for a cultural shift to better emphasize long-term issues, Useem says. Ultimately, he notes, Americans may adopt a disdain for short-term risk taking similar to the disgust they have developed for smokers who light up in crowded rooms. A new risk-consciousness held by the public should work its way into the boardroom and executive suite, he says. "Rebuilding the national culture becomes absolutely vital."

Brain Drain

2008-11-07T12:20:00.000+05:30

Emerging markets can win in the global war for talent by leveraging the talents of their expats.

"To study a banyan tree, you not only must know its main stem in its own soil, but also must trace the growth of its greatness in the further soil, for then you can know the true nature of its vitality".
—Rabindranath Tagore

Consider a few statistics. In the 1990s, roughly 650,000 people from emerging markets migrated to the United States on professional-employment visas. Over 40 percent of the foreign-born adults in the United States have at least some college education, thereby making that country the epicenter of the global talent drain (Exhibit 1). Foreign-born workers now make up 20 percent of all employees in the US information technology sector. About 30 percent of the 1998 graduating class of the famed Indian Institute of Technology—and a staggering 80 percent of the graduates in computer science—headed for graduate schools or jobs in the United States. Some 80 percent of foreign doctoral students in science and engineering plan to stay there after graduation—up from 50 percent in 1985 (Exhibit 2). Roughly a third of the R&D professionals of developing countries have left them to work in the United States, the members of the European
Union, or Japan.

View the pdf..........

China and India: The race to growth Part - 3

2008-11-07T12:07:00.000+05:30

Sector by sector

The strength of the Chinese and Indian economies will actually be decided at the industry level.

The answer to the question, "Which is the better approach to economic development?" is not to be found at the national level. You have to look at what's going on in individual industries. And when you do, you find that supportive government policies that encourage competition drive good performance. Both China and India have some sluggish, inefficient industries that are heavily regulated and lack competitive dynamism. But both countries also have successful industries that thrive unfettered by poor regulation.

The McKinsey Global Institute has long argued that the key to high economic growth is productivity and that the main barrier to productivity gains is the raft of microlevel government regulations that hinder competition. This idea is well illustrated in the case of India.

At the high end of India's productivity spectrum is the information technology, software, and business-process-outsourcing sector. It's a big success story, having created hundreds of thousands of jobs and billions of dollars' worth of exports. As a new sector—and one whose potential the government, in my view, failed to recognize early on—it has avoided stifling regulation. IT, software, and outsourcing companies are exempt from the labor regulations that govern working hours and overtime in other sectors, and they have been allowed to receive foreign direct investment, which is prohibited in retailing, for example. Without this foreign money, it is debatable whether the sector could have taken off. By 2002 it already accounted for 15 percent of all foreign direct investment in India.

In the middle of the spectrum is the auto industry, which has seen dramatic change since the government began to liberalize it in the 1980s. By 1992 most of the barriers to foreign investment had been lifted, and this made it possible for output and labor productivity to soar. Prices have fallen and, even as the industry has consolidated, employment levels have held steady thanks to robust demand. Nonetheless, with tariffs on finished cars still relatively high, automakers remain sheltered from global competition and the sector is less efficient than it could be.

At the low end of the spectrum is the consumer electronics sector, which, despite the lifting of foreign-investment restrictions in the early 1990s, is still burdened by tariffs, taxes, and regulations. As a result, Indian consumer electronics goods can't compete internationally and prices for local consumers are unnecessarily high. The performance of India's food-retailing industry is even worse. Partly as a result of a total ban on foreign investment, labor productivity is just 6 percent of US levels.

Now look at China, which also has some reasonably liberalized and highly competitive industries, including consumer electronics, in which labor productivity is double that of its Indian counterpart. Over the past 20 years, the industry has become globally competitive through a combination of foreign direct investment and intense competition among domestic companies. It is also remarkable for the relatively liberal approach the government has taken to regulation—probably because of a failure to see its growth potential. Today China makes $60 billion worth of consumer electronics goods a year.

The performance of China's auto industry—which was considered a strategic one and remains tightly regulated because of the government's desire to bring in technology and investment—is less clear-cut. The market has been opened up to foreign automakers, consumer demand has grown enormously, and prices have dropped. Yet the sector shows how government intervention can thwart the potential of foreign direct investment. Foreign automakers can invest only in joint ventures, they have to buy components from local suppliers, and tariffs shield the market from imports. Competition is beginning to increase as private companies grow stronger. But for the time being, the productivity of foreign joint ventures in China is low compared with that of plants in Japan or the United States—astounding given China's low labor costs.

Since there are such big differences in the performance of different sectors within the same country, it makes sense to compare the performance of India and China at the sector rather than the national level. In IT and business-process outsourcing, India is so far ahead of the game that China can't do anything during the next 10 or 15 years that would bring it close to catching up. In consumer electronics, however, China dominates, and India won't provide serious competition during the next 10 years.

The auto sector is a toss-up. India's competitive forces have driven an enormous amount of innovation in the sector. Low-cost labor has been used instead of expensive automation, and local engineering talent has developed innovative new products such as the Scorpio—a sport utility vehicle that sells for a fraction of the price of an equivalent car in the United States. In China, large amounts of foreign direct investment have built a big industry, but regulation has so far limited its competitive potential.

It is far from clear which economy will emerge as the stronger one. The foundations of robust, sustainable economic growth must be built at the industry level, on the back of high productivity, which is achieved when governments ensure a level playing field through sound regulation and remove the barriers that stifle competition. Both China and India still have ample opportunity to help their industries and economies thrive.

China and India: The race to growth Part - 2

2008-11-07T12:05:00.000+05:30

China: The best of all possible models

In an efficient market, the private sector is better than governments at allocating investment funds. But China isn't an efficient market, and India has relatively little investment funding.
Finding fault with China's approach to economic development is easy: cyclical overcapacity, state-influenced resource allocation, and growing social inequalities are just a few of its shortcomings. But it's hard to see how any other model could have given the economy such a powerful kick start.

The Chinese government manages the development of enterprises with a view to driving economic growth. You can be a small entrepreneur in China, but if you want to be big you will have to get money from a government-affiliated source at some point. Government officials essentially have the power to decide which companies grow.

In achieving the objective of growth, this policy has been tremendously successful. China has quickly built industries large enough to drive its economy. Take the auto industry, now an important contributor to the manufacturing sector. Only 20 years ago, China had no auto industry to speak of; there were a few manufacturers of trucks but none of passenger cars. To get started, the government decided that in a high-scale, high-tech industry, some foreign company—in this case, Volkswagen—had to come in and show local ones what to do. Because most local companies were state-owned 20 years ago, Volkswagen was hooked up with a state-owned company.

You might argue that this development model has thwarted entrepreneurship. But there weren't any entrepreneurs in the industry at the time. There were no private companies that could partner with Volkswagen, let alone compete with it. The government simply said, "We want China to modernize. We want the Chinese economy to grow. We don't have the companies we need to make that happen, so we're prepared to do what it takes to create them."

The capital-intensive auto plants built with foreign partners in China as a result of its development policy may have no particular productivity advantage over the plants they might have built at home. But all of the spending by the big car companies has paid off.
Moreover, local, privately owned automakers such as Chery Automotive and Geely Automotive are beginning to thrive. A generation of entrepreneurs has put to good advantage the skills and training that the foreigners provided, so that Chinese companies now put together cars of reasonable quality much more cheaply than foreign automakers can. At present, domestic players benefit from the price umbrella that the foreign ones provide. But these smaller fry are now making cars for $2,000, which means that any company that has high cost structures will eventually suffer. With lower tariffs on the way because of China's accession to the World Trade Organization, and with new competitors proliferating, the automotive industry is heading into a classic price war that only the fittest will survive. This is precisely what happened in the consumer electronics industry, where competition led to the emergence of successful Chinese companies that operate globally. I think that in five or ten years' time, at least a third of the Chinese auto industry will be completely private—nothing to do with the current state players. And this will all have started with the state saying, "We want to build a car industry."

Looking at industry more broadly, inefficiencies and cyclicality have resulted from the fact that many funding decisions are driven at the local-government level. Local officials have GDP growth as a political-performance target, so many of them look for the biggest investments they can make to push along the regional economy. Like stock market investors pursuing the latest speculative fad, they have created a lemming effect, with lots of unsound investments, whether in aluminum smelters, residential real estate, or TV factories. The outcome tends to be waves of overcapacity as investments are made right up to—and sometimes way beyond—the point where it is patently obvious that the economics cannot justify them.

But remember that the essential mechanism of economic reform in China has been the encouragement of competition among provinces and municipalities. Until the 1980s there was no such thing in China as a national company. Everything was local. There was no single legal entity that operated more than five kilometers (about 3.1 miles) from its headquarters. With the removal of internal trade barriers, local entrepreneurs and their government backers invested to build scale and attack neighboring markets. Yes, this does lead to overcapacity and price wars. But over time—and relatively short periods of time, too—all that cyclicality also leads to shakeouts that the most competitive enterprises survive. These enterprises, thanks to their national scale and real competitive advantages, no longer depend on local-government funding and can now start to compete for the long term, both domestically and internationally.

That has certainly been the story in consumer electronics, where the top three players in personal computers control 50 percent of the domestic market, and in beer, where the top ten own 30 percent. It is starting to be the story in heavy industries, where companies such as China Qianjiang own 40 percent of the motorcycle market and Wanxiang dominates its niche in automotive components . Interestingly, it is not the foreign companies but the locals that tend to be the winners of the consolidation wars. The beer industry is a case in point: most foreign brewers, unprepared for tough domestic competition and rapid consolidation, entered and exited in the 1990s.

The government is fixing the banks through tough higher reserve margins, branch-level changes, and more flexible risk-based pricing

Moreover, I don't believe that foreign direct investment is linked to the development of China's capital markets or to a reform of the banking system. Multinationals account for only 15 percent of fixed-asset investment, so they don't drive the economy to a very great extent. China must rely on its own domestic financial resources to finance growth. As a result, the country's capital markets are being developed. And the government is fixing the banks through tough higher reserve margins, branch-level changes in performance management and incentives, and more flexible risk-based pricing.

As for the oft-stated view that China is trying to create global state-owned champions, it is at least partly a myth. The government does want to develop strong Chinese companies, but it does not expect them to be state enterprises, which are inefficient by definition. Indeed, it is now telling them that if they want to grow, they will have to get listed on the stock market. The government's policy for the first 20 years of its reform program was, "Let's do what's needed to establish markets." Its policy for the next 20 years will be, "Let's get out of those markets." The global Chinese companies of tomorrow will be competitive, mostly listed, and entirely commercial in their aims and purposes.

Ultimately, you have to ask whether the inefficiencies of the Chinese approach outweigh what it has achieved for the economy overall. The answer, I think, is no. The government still controls most of the country's financial resources and has been reasonably good at allocating them—that's why the economy has grown so fast. Compared with the private sector in an efficient market, the government is no doubt worse at allocating funds. But China is not an efficient market, and the Indian model—essentially one with relatively little investment funding, whether by the government or the private sector—could not have achieved as much growth for the Chinese economy as the approach China's government actually took. The Indian model might not be adequate for India's economy either: the country's family-owned businesses and other private investors may be good at deciding what makes a sound investment for them, but they have not spent enough money to drive the kind of growth seen in China. It would not surprise me at all to see investment in India rise dramatically as foreign and domestic investors alike begin to recognize its potential going forward.

China and India: The race to growth Part - 1

2008-11-07T11:59:00.002+05:30

The world’s two biggest developing countries are taking different paths to economic prosperity. Which is the better one?

First it was China. The rest of the world looked on in disbelief, then awe, as the Chinese economy began to take off in the 1980s at what seemed like lightning speed and the country positioned itself as a global economic power. GDP growth, driven largely by manufacturing, rose to 9 percent in 2003 after reaching 8 percent in 2002. China used its vast reservoirs of domestic savings to build an impressive infrastructure and sucked in huge amounts of foreign money to build factories and to acquire the expertise it needed. In 2003 it received $53 billion in foreign direct investment, or 8.2 percent¹ of the world's total—more than any other country.

India began its economic transformation almost a decade after China did but has recently grabbed just as much attention, prompted largely by the number of jobs transferred to it from the West. At the same time, the country is rapidly creating world-class businesses in knowledge-based industries such as software, IT services, and pharmaceuticals. These companies, which emerged with little government assistance, have helped propel the economy: GDP growth stood at 8.3 percent in 2003, up from 4.3 percent in 2002. But India's level of foreign direct investment—$4.7 billion in 2003, up from $3 billion in 2002—is a fraction of China's.

Both countries still have serious problems: India has poor roads and insufficient water and electricity supplies, all of which could thwart its development; China has massive bad bank loans that will have to be accounted for. The contrasting ways in which China and India are developing, and the particular difficulties each still faces, prompt debate about whether one country has a better approach to economic development and will eventually emerge as the stronger.

India's entrepreneurial advantage

China has shackled its independent businesspeople. India has empowered them.

China and India have followed radically different approaches to economic development. China's resulted from a conscious decision; India more or less happened upon its course. Is one way better than the other? There is no gainsaying the fact that China's growth has rocketed ahead of India's, but the conventional view that the Chinese model is unambiguously the better of the two is wrong in many ways; each has its advantages. And it is far from clear which will deliver the more sustainable growth.

Together with Yasheng Huang, of the Sloan School of Management, at the Massachusetts Institute of Technology (MIT), I have argued that these approaches differ on two dimensions. First, the Chinese government nurtures and directs economic activity more than the Indian government does. It invests heavily in physical infrastructure and often decides which companies—not necessarily the best—receive government resources and listings on local stock markets. By contrast, since the mid-1980s the Indian government has become less and less interventionist. The second dimension is foreign direct investment. China has embraced it; India remains cautious.

These differences have an impact on the types of companies that succeed and, I would argue, on entrepreneurialism. Let's look first at what kinds of companies thrive. China trumps India when it comes to industries that rely on "hard" infrastructure (roads, ports, power) and will do so for the foreseeable future. But when it comes to "soft" infrastructure businesses—those in which intangible assets matter more—India tends to come out ahead, be it in software, biotechnology, or creative industries such as advertising.

Thus manufacturing companies whose just-in-time production processes rely on efficient road and transport networks fare poorly in India. But businesses that are unconstrained by shortages of generators and roads flourish. Soft assets underpin even the Indian car industry. Unlike China's car sector, which has expanded as a result of big capital investments from multinational companies, India's has succeeded on the back of clever designs that make it possible to produce cheap indigenous models. India actually sends China high-value-added mechanized and electronic components whose production depends more on know-how than on infrastructure.

Moreover, many hard-asset companies in China exist because the government funnels money to them. The government can do this because it intervenes in domestic capital markets. In India there is no such government intervention. Hence successful companies tend to cluster in industries where capital constraints are less of an issue. You don't need a deep reservoir of capital to start a software company; you do for a big steel plant.

The Indian government's lower level of intervention in capital markets and its decision not to regulate industries that lack tangible assets (software, biotech, media) have created room for entrepreneurs. Entrepreneurial activity is fueled both by incumbent (often family-owned) enterprises and by new entrants. The former use cash flows from diverse existing businesses to invest in newer ventures. In biotechnology, however, Biocon emerged from pure entrepreneurial effort, as did Infosys Technologies in software. Similarly, hundreds of smaller versions of companies such as Infosys and Wipro Technologies have no government links, unlike so many of China's successful companies.

Although India's stock and bond markets are hardly perfect, they do on the whole support private enterprise. Here too, entrepreneurialism has played a part, even improving India's institutional framework. Take the Bombay Stock Exchange (BSE), founded about 130 years ago and until recently the most inefficient entity imaginable. It has become radically more efficient in the past decade as a result of the competing efforts of an enterprising former bureaucrat named R. H. Patil. With technological inputs from around the world and some fancy footwork to dodge entrenched interests at the BSE, in 1994 he started a rival institution, the state-of-the-art National Stock Exchange of India, which now has more business. In China, by contrast, the government tries to make stock markets successful by command, with predictably little to show for its efforts. There has been little competition indeed between the Shanghai and Shenzhen exchanges.

Good hard infrastructure and the Chinese government's decision to welcome foreign investment make it reasonably easy for multinationals to do business in China, and since they bring their own capital and senior talent, they do not have to rely heavily on local institutions. China has no shortage of homegrown entrepreneurial talent. But indigenous companies have a much tougher time, hindered as they are by inefficient capital markets, a banking system notorious for bad loans, and the fact that local officials rather than market forces largely decide who receives funding.

The pros and cons of these two models should be studied, and it is fair to ask whether China's will hamper its economic development

China and India both have the ability to keep growing in their own very different ways for a decade or so. The Chinese government's intervention in the economy—including the decision to welcome foreign direct investment—has brought a material improvement in the standard of living that India hasn't enjoyed. It may also be that each country has chosen the path best suited to its own historical circumstances. But the pros and cons of these two development models should be studied, and it is fair to ask whether China's approach will hamper its future economic development.

Huang and I believe that the presence of so many self-reliant multi-national companies has partly relieved the Chinese government of pressure to develop or reform the institutions that support free enterprise and economic growth. And the fact that many domestic investments still are not allocated through sensible pricing mechanisms means that China wastes many of its resources. Productivity and long-term economic growth, as we all know, thrive on competition, which is all too often stifled by government intervention.

When the two countries are compared, it is easy to forget that India began its economic reforms more than a decade later than China did. As India opens up further to foreign direct investment, we might well discover that the country's more laissez-faire approach has nurtured the conditions that will enable free enterprise and economic growth to flourish more easily in the long run.

Nurturing entrepreneurship in India’s villages

2008-11-07T11:57:00.000+05:30

The world’s great cities and the professionals who live in them are linked more tightly to one another than they are with their own rural hinterlands. Yet true prosperity starts in the countryside.

It’s not surprising that well-travelled professionals living in global cities, such as New Delhi, New York, Paris, Rio, and Shanghai, have more in common with one another, in lifestyle and values, than they do with rural citizens in their respective nations. In general, villagers, particularly in the emerging world, have benefitted less from globalization than urbanites have. Seventy percent of India’s citizens, for instance, live in rural isolation, largely disconnected from the benefits of their nation’s fast-paced economic growth.

These are globalization’s forgotten frontiers, where more must be done to connect urban markets with rural ones in order to speed their development. How this happens will vary from nation to nation. In China, for instance, the government actively spurred the village economy, largely through agricultural-reform measures implemented during the 1980s. By contrast, India’s government has only a limited ability to bring about real change in the country’s villages. Private entrepreneurs might well be more effective.

Recently, I trudged through the mire of a government-run food auction yard, or mandi, in Bangalore, the global economy’s offshoring capital. Piles of supposedly fresh produce lay everywhere, rotting in the sun and competing with mangy dogs and scampering mice for my attention. Huddles of impecunious farmers, wearing the traditional dhoti, looked on with resignation. A government agent, pen tucked behind ear, offered a pittance for the produce on display.

The farmers’ day had started before dawn. Chugging along on narrow so-called highways, they came to the auction yard in ramshackle public buses, bullock carts, trucks, and even tractors. Their produce unloaded, they accepted whatever they got. After snatching a few hours’ sleep in a shady corner, they retraced their steps home.

In India, agricultural mandates have long required farmers to sell their produce through such wholesale yards. Although meant to free poor farmers from the clutches of local moneylenders, the mandi has become a monopoly. The farmer remains exploited, but now by local political interests.

But let’s change the scene from a city market in India to a rural village in China. Not long after I visited Bangalore, I crisscrossed parts of Henan—the name means “south of the Yellow River” (Huanghe). The province, one of China’s most populous, is home to more than a hundred million people. I started in Zhengzhou, the capital, a major industrial center and railway junction, and traveled to Chengguan, a county seat with 100,000 inhabitants. Chengguan was scrupulously clean; municipal services were apparent even in the predawn hours. The city bustled, but there was no squalor in the streets. I then headed to the very small village of Qiu, with a population of no more than a few thousand. The paved roads, in better condition than the Massachusetts Turnpike and other highways I know at home, led right up to the cornfields on the edge of the village. Qiu itself, if not quite prosperous, had none of the desperation so obvious in many Indian villages.

Rural development is crucial for the overall development of a nation’s economy. China’s economic revolution started with the reform of its village enterprises; foreign direct investment followed. Agricultural development in rural areas generated economic surpluses that in turn fed light manufacturing in rural and semiurban areas and, ultimately, industrialization in urban ones. A virtuous cycle ensued. The economic surplus promoted reinvestment in new technology and released human capital for broader development. This was China’s path, as it was Indonesia’s, and Vietnam has taken it since 1989.

India, however, has not. The nation’s government has failed to invest in its villages. The farmers who sold their produce in a mandi in Bangalore live a daily struggle for existence in their home villages. Today, 89 percent of all rural households do not own a telephone, and 52 percent have no domestic power connection. The average village is two kilometers away from an all-weather road, and 20 percent of rural habitations must walk for miles to obtain safe drinking water, have access to it for only a few hours a day for much of the year, or have no access at all.

Where India’s government has failed, social and business entrepreneurs are accumulating a better track record. The Self-Employed Women’s Association (SEWA), for example, centered in Gujarat, has economically empowered hundreds of thousands of women, helping them to become economically self-sufficient by providing small loans to start myriad businesses catering to health care, elementary education, and the like. Companies such as Hindustan Unilever and Indian Tobacco Company (ITC) have long had distribution networks that provide some investment, goods, and services to Indian villages beyond the government’s reach.

India should take a page from China’s playbook and fix its villages, but not in the way China has. China’s strong government was able to force the rapid dissemination of rural agricultural reforms. India’s weak one cannot accomplish anything remotely comparable. Instead, India should seek to empower its villagers and nurture entrepreneurial activity, while also taking advantage of its strengths in the private sector. Corporations need a seat at the table of village reform—even multinationals, because the task of reform is so enormous. Outright foreign direct investment, by Düsseldorf-based Metro AG, for example, should be welcome, as should joint ventures, like the one between Bharti Enterprises and Wal-Mart Stores. Such businesses, together with local ones, can lay the foundations for a modern agricultural supply chain linking the village farmer with the urban market.

Only then will India, and not just its global cities, rise.

Hidden flaws in strategy

2008-11-06T15:38:00.000+05:30

After nearly 40 years, the theory of business strategy is well developed and widely disseminated. Pioneering work by academics such as Michael E. Porter and Henry Mintzberg has established a rich literature on good strategy. Most senior executives have been trained in its principles, and large corporations have their own skilled strategy departments.

Yet the business world remains littered with examples of bad strategies. Why? What makes chief executives back them when so much know-how is available? Flawed analysis, excessive ambition, greed, and other corporate vices are possible causes, but this article doesn’t attempt to explore all of them. Rather, it looks at one contributing factor that affects every strategist: the human brain.

The brain is a wondrous organ. As scientists uncover more of its inner workings through brain-mapping techniques,¹ our understanding of its astonishing abilities increases. But the brain isn’t the rational calculating machine we sometimes imagine. Over the millennia of its evolution, it has developed shortcuts, simplifications, biases, and basic bad habits. Some of them may have helped early humans survive on the savannas of Africa ("if it looks like a wildebeest and everyone else is chasing it, it must be lunch"), but they create problems for us today. Equally, some of the brain’s flaws may result from education and socialization rather than nature. But whatever the root cause, the brain can be a deceptive guide for rational decision making.

The basic assumption of modern economics—rationality—does not stack up against the evidence

These implications of the brain’s inadequacies have been rigorously studied by social scientists and particularly by behavioral economists, who have found that the underlying assumption behind modern economics—human beings as purely rational economic decision makers—doesn’t stack up against the evidence. As most of the theory underpinning business strategy is derived from the rational world of microeconomics, all strategists should be interested in behavioral economics.

Insights from behavioral economics have been used to explain bad decision making in the business world,² and bad investment decision making in particular. Some private equity firms have successfully remodeled their investment processes to counteract the biases predicted by behavioral economics. Likewise, behavioral economics has been applied to personal finance,³ thereby providing an easier route to making money than any hot stock tip. However, the field hasn’t permeated the day-to-day world of strategy formulation.

This article aims to help rectify that omission by highlighting eight⁴ insights from behavioral economics that best explain some examples of bad strategy. Each insight illustrates a common flaw that can draw us to the wrong conclusions and increase the risk of betting on bad strategy. All the examples come from a field with which I am familiar—European financial services—but equally good ones could be culled from any industry.

Several examples come from the dot-com era, a particularly rich period for students of bad strategy. But don’t make the mistake of thinking that this was an era of unrepeatable strategic madness. Behavioral economics tells us that the mistakes made in the late 1990s were exactly the sorts of errors our brains are programmed to make—and will probably make again.

Flaw 1: Overconfidence

Our brains are programmed to make us feel overconfident. This can be a good thing; for instance, it requires great confidence to launch a new business. Only a few start-ups will become highly successful. The world would be duller and poorer if our brains didn’t inspire great confidence in our own abilities. But there is a downside when it comes to formulating and judging strategy.

The brain is particularly overconfident of its ability to make accurate estimates. Behavioral economists often illustrate this point with simple quizzes: guess the weight of a fully laden jumbo jet or the length of the River Nile, say. Participants are asked to offer not a precise figure but rather a range in which they feel 90 percent confidence—for example, the Nile is between 2,000 and 10,000 miles long. Time and again, participants walk into the same trap: rather than playing safe with a wide range, they give a narrow one and miss the right answer. (I scored 0 out of 15 on such a test, which was one of the triggers of my interest in this field!) Most of us are unwilling and, in fact, unable to reveal our ignorance by specifying a very wide range. Unlike John Maynard Keynes, most of us prefer being precisely wrong rather than vaguely right.

We also tend to be overconfident of our own abilities.⁵ This is a particular problem for strategies based on assessments of core capabilities. Almost all financial institutions, for instance, believe their brands to be of "above-average" value.

Related to overconfidence is the problem of overoptimism. Other than professional pessimists such as financial regulators, we all tend to be optimistic, and our forecasts tend toward the rosier end of the spectrum. The twin problems of overconfidence and overoptimism can have dangerous consequences when it comes to developing strategies, as most of them are based on estimates of what may happen—too often on unrealistically precise and overoptimistic estimates of uncertainties.

One leading investment bank sensibly tested its strategy against a pessimistic scenario—the market conditions of 1994, when a downturn lasted about nine months—and built in some extra downturn. But this wasn’t enough. The 1994 scenario looks rosy compared with current conditions, and the bank, along with its peers, is struggling to make dramatic cuts to its cost base. Other sectors, such as banking services for the affluent and on-line brokerages, are grappling with the same problem.

There are ways to counter the brain’s overconfidence:

Test strategies under a much wider range of scenarios. But don’t give managers a choice of three, as they are likely to play safe and pick the central one. For this reason, the pioneers of scenario planning at Royal Dutch/Shell always insisted on a final choice of two or four options.⁶
Add 20 to 25 percent more downside to the most pessimistic scenario.⁷ Given our optimism, the risk of getting pessimistic scenarios wrong is greater than that of getting the upside wrong. The Lloyd’s of London insurance market—which has learned these lessons the hard, expensive way—makes a point of testing the market’s solvency under a series of extreme disasters, such as two 747 aircraft colliding over central London. Testing the resilience of Lloyd’s to these conditions helped it build its reserves and reinsurance to cope with the September 11 disaster.
Build more flexibility and options into your strategy to allow the company to scale up or retrench as uncertainties are resolved. Be skeptical of strategies premised on certainty.

Flaw 2: Mental accounting

Richard Thaler, a pioneer of behavioral economics, coined the term "mental accounting," defined as "the inclination to categorize and treat money differently depending on where it comes from, where it is kept, and how it is spent."⁸ Gamblers who lose their winnings, for example, typically feel that they haven’t really lost anything, though they would have been richer had they stopped while they were ahead.

Mental accounting pervades the boardrooms of even the most conservative and otherwise rational corporations. Some examples of this flaw include the following:

being less concerned with value for money on expenses booked against a restructuring charge than on those taken through the P&L
imposing cost caps on a core business while spending freely on a start-up
creating new categories of spending, such as "revenue-investment spend" or "strategic investment"

All are examples of spending that tends to be less scrutinized because of the way it is categorized, but all represent real costs.

These delusions can have serious strategic implications. Take cost caps. In some UK financial institutions during the dot-com era, core retail businesses faced stringent constraints on their ability to invest, however sound the proposal, while start-up Internet businesses spent with abandon. These banks have now written off much of their loss from dot-com investment and must reverse their underinvestment in core businesses.

Make sure that all investments are judged on consistent criteria, and be wary of spending that has been reclassified to make it acceptable

Avoiding mental accounting traps should be easier if you adhere to a basic rule: that every pound (or dollar or euro) is worth exactly that, whatever the category. In this way, you will make sure that all investments are judged on consistent criteria and be wary of spending that has been reclassified. Be particularly skeptical of any investment labeled "strategic."

Flaw 3: The status quo bias

In one classic experiment,⁹ students were asked how they would invest a hypothetical inheritance. Some received several million dollars in low-risk, low-return bonds and typically chose to leave most of the money alone. The rest received higher-risk securities—and also left most of the money alone. What determined the students’ allocation in this experiment was the initial allocation, not their risk preference. People would rather leave things as they are. One explanation for the status quo bias is aversion to loss—people are more concerned about the risk of loss than they are excited by the prospect of gain. The students’ fear of switching into securities that might end up losing value prevented them from making the rational choice: rebalancing their portfolios.

A similar bias, the endowment effect, gives people a strong desire to hang on to what they own; the very fact of owning something makes it more valuable to the owner. Richard Thaler tested this effect with coffee mugs imprinted with the Cornell University logo. Students given one of them wouldn’t part with it for less than $5.25, on average, but students without a mug wouldn’t pay more than $2.75 to acquire it. The gap implies an incremental value of $2.50 from owning the mug.

The status quo bias, the aversion to loss, and the endowment effect contribute to poor strategy decisions in several ways. First, they make CEOs reluctant to sell businesses. McKinsey research shows that divestments are a major potential source of value creation but a largely neglected one.¹⁰ CEOs are prone to ask, "What if we sell for too little—how stupid will we look when this turns out to be a great buy for the acquirer?" Yet successful turnarounds, such as the one at Bankers Trust in the 1980s, often require a determined break with the status quo and an extensive reshaping of the portfolio—in that case, selling all of the bank’s New York retail branches.

These phenomena also make it hard for companies to shift their asset allocations. Before the recent market downturn, the UK insurer Prudential decided that equities were overvalued and made the bold decision to rebalance its fund toward bonds. Many other UK life insurers, unwilling to break with the status quo, stuck with their high equity weightings and have suffered more severe reductions in their solvency ratios.

This isn’t to say that the status quo is always wrong. Many investment advisers would argue that the best long-term strategy is to buy and hold equities (and, behavioral economists would add, not to check their value for many years, to avoid feeling bad when prices fall). In financial services, too, caution and conservatism can be strategic assets. The challenge for strategists is to distinguish between a status quo option that is genuinely the right course and one that feels deceptively safe because of an innate bias.

To make this distinction, strategists should take two approaches:

Adopt a radical view of all portfolio decisions. View all businesses as "up for sale." Is the company the natural parent, capable of extracting the most value from a subsidiary? View divestment not as a failure but as a healthy renewal of the corporate portfolio.
Subject status quo options to a risk analysis as rigorous as change options receive. Most strategists are good at identifying the risks of new strategies but less good at seeing the risks of failing to change.

Flaw 4: Anchoring

One of the more peculiar wiring flaws in the brain is called anchoring. Present the brain with a number and then ask it to make an estimate of something completely unrelated, and it will anchor its estimate on that first number. The classic illustration is the Genghis Khan date test. Ask a group of people to write down the last three digits of their phone numbers, and then ask them to estimate the date of Genghis Khan’s death. Time and again, the results show a correlation between the two numbers; people assume that he lived in the first millennium, when in fact he lived from 1162 to 1227.

Anchoring can be a powerful tool for strategists. In negotiations, naming a high sale price for a business can help secure an attractive outcome for the seller, as the buyer’s offer will be anchored around that figure. Anchoring works well in advertising too. Most retail-fund managers advertise their funds on the basis of past performance. Repeated studies have failed to show any statistical correlation between good past performance and future performance. By citing the past-performance record, though, the manager anchors the notion of future top-quartile performance to it in the consumer’s mind.

Anchoring can be dangerous—particularly when it is a question of becoming anchored to the past

However, anchoring—particularly becoming anchored to the past—can be dangerous. Most of us have long believed that equities offer high real returns over the long term, an idea anchored in the experience of the past two decades. But in the 1960s and 1970s, UK equities achieved real annual returns of only 3.3 and 0.4 percent, respectively. Indeed, they achieved double-digit real annual returns during only 4 of the past 13 decades. Our expectations about equity returns have been seriously distorted by recent experience.

In the insurance industry, changes in interest rates have caused major problems due to anchoring. The United Kingdom’s Equitable Life Assurance Society assumed that high nominal interest rates would prevail for decades and sold guaranteed annuities accordingly. That assumption had severe financial consequences for the company and its policyholders. The banking industry may now be entering a period of much higher credit losses than it experienced during the past decade. Some banks may be caught out by the speed of change.

Besides remaining unswayed by the anchoring tactics of others, strategists should take a long historical perspective. Put trends in the context of the past 20 or 30 years, not the past 2 or 3; for certain economic indicators, such as equity returns or interest rates, use a very long time series of 50 or 75 years. Some commentators who spotted the dot-com bubble early did so by drawing comparisons with previous technology bubbles—for example, the uncannily close parallels between radio stocks in the 1920s and Internet stocks in the 1990s.

Flaw 5: The sunk-cost effect

A familiar problem with investments is called the sunk-cost effect, otherwise known as "throwing good money after bad." When large projects overrun their schedules and budgets, the original economic case no longer holds, but companies still keep investing to complete them.

Financial institutions often face this dilemma over large-scale IT projects. There are numerous examples, most of which remain private. One of the more public cases was the London Stock Exchange’s automated-settlement system, Taurus. It took the intervention of the Bank of England to force a cancellation, write off the expenses, and take control of building a replacement.

Executives making strategic-investment decisions can also fall into the sunk-cost trap. Certain European banks spent fortunes building up large equities businesses to compete with the global investment-banking firms. It then proved extraordinarily hard for some of these banks to face up to the strategic reality that they had no prospect of ever competing successfully against the likes of Goldman Sachs, Merrill Lynch, and Morgan Stanley in the equities business. Some banks in the United Kingdom took the agonizing decision to write off their investments; other European institutions are still caught in the trap.

Why is it so hard to avoid? One explanation is based on loss aversion: we would rather spend an additional $10 million completing an uneconomic $110 million project than write off $100 million. Another explanation relies on anchoring: once the brain has been anchored at $100 million, an additional $10 million doesn’t seem so bad.

What should strategists do to avoid the trap?

Apply the full rigor of investment analysis to incremental investments, looking only at incremental prospective costs and revenues. This is the textbook response to the sunk-cost fallacy, and it is right.
Be prepared to kill strategic experiments early. In an increasingly uncertain world, companies will often pursue several strategic options.¹¹ Successfully managing a portfolio of them entails jettisoning the losers. The more quickly you get out, the lower the sunk costs and the easier the exit.
Use "gated funding" for strategic investments, much as pharmaceutical companies do for drug development: release follow-on funding only once strategic experiments have met previously agreed targets.

Flaw 6: The herding instinct

The banking industry, like many others, shows a strong herding instinct. It tends to lend too much money to the same kinds of borrowers at the same time—to UK property developers in the 1970s, less-developed countries in the 1980s, and technology, media, and telecommunications companies more recently. And banks tend to pursue the same strategies, be it creating Internet banks with strange-sounding names during the dot-com boom or building integrated investment banks at the time of the "big bang," when the London stock market was liberalized.

This desire to conform to the behavior and opinions of others is a fundamental human trait and an accepted principle of psychology.¹² Warren Buffett put his finger on this flaw when he wrote, "Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press."¹³ For most CEOs, only one thing is worse than making a huge strategic mistake: being the only person in the industry to make it.

We all felt the tug of the herd during the dot-com era. It was lonely being a Luddite, arguing the case against setting up a stand-alone Internet bank or an on-line brokerage. At times of mass enthusiasm for a strategic trend, pressure to follow the herd rather than rely on one’s own information and analysis is almost irresistible. Yet the best strategies break away from the trend. Some actions may be necessary to match the competition—imagine a bank without ATMs or a good on-line banking offer. But these are not unique sources of strategic advantage, and finding such sources is what strategy is all about. "Me-too" strategies are often simply bad ones.¹⁴ Seeking out the new and the unusual should therefore be the strategist’s aim. Rather than copying what your most established competitors are doing, look to the periphery¹⁵ for innovative ideas, and look outside your own industry.

Initially, an innovative strategy might draw skepticism from industry experts. They may be right, but as long as you kill a failing strategy early, your losses will be limited, and when they are wrong, the rewards will be great.

Flaw 7: Misestimating future hedonic states

What does it mean, in plain English, to misestimate future hedonic states? Simply that people are bad at estimating how much pleasure or pain they will feel if their circumstances change dramatically. Social scientists have shown that when people undergo major changes in circumstances, their lives typically are neither as bad nor as good as they had expected—another case of how bad we are at estimating. People adjust surprisingly quickly, and their level of pleasure (hedonic state) ends up, broadly, where it was before.

This research strikes a chord with anyone who has studied compensation trends in the investment-banking industry. Ever-higher compensation during the 1990s led only to ever-higher expectations—not to a marked change in the general level of happiness on the Street. According to Tom Wolfe’s Sherman McCoy, in Bonfire of the Vanities, it was hard to make ends meet in New York on $1 million a year in 1987. Back then, that was shocking hubris from a (fictional) top bond salesman. By 2000, even adjusted for inflation, it would have seemed a perfectly reasonable lament from a relatively junior managing director.

Another illustration of our poor ability to judge future hedonic states in the business world is the way we deal with a loss of independence. More often than not, takeovers are seen as the corporate equivalent of death, to be avoided at all costs. Yet sometimes they are the right move. Two once great British banks—Midland and National Westminster—both struggled to maintain their independence. Midland gave in to HSBC’s advances in 1992; NatWest was taken over by the Royal Bank of Scotland in 2000. At both institutions, the consequences were positive for customers, shareholders, and most employees on any test of the "greatest good of the greatest number." The employees ended up being part of better-managed, stronger, more respected institutions. Morale at NatWest has gone up. Midland has achieved what was, for an independent bank, an unrealistic goal: to become part of a great global bank.

Often, top management is blamed for resisting any loss of independence. Certainly part of the problem is the desire of managements and boards to hang on to the status quo. That said, frontline staff members often resist a takeover or merger however much they are frustrated with the existing top management. Some deeper psychological factor appears to be at work. We do seem very bad at estimating how we would feel if our circumstances changed dramatically—changes in corporate control, like changes in our personal health or wealth.

How can the strategist avoid this pitfall?

In takeovers, adopt a dispassionate and unemotional view. Easier said than done—especially for a management team with years of committed service to an institution and a personal stake in the status quo. Nonexecutives, however, should find it easier to maintain a detached view.
Keep things in perspective. Don’t overreact to apparently deadly strategic threats or get too excited by good news. During the high and low points of the crisis at Lloyd’s of London in the mid-1990s, the chairman used to quote Field Marshall Slim—"In battle nothing is ever as good or as bad as the first reports of excited men would have it." This is a good guide for every strategist trying to navigate a crisis, with the inevitable swings in emotion and morale.

Flaw 8: False consensus

People tend to overestimate the extent to which others share their views, beliefs, and experiences—the false-consensus effect. Research shows many causes, including these:

confirmation bias, the tendency to seek out opinions and facts that support our own beliefs and hypotheses
selective recall, the habit of remembering only facts and experiences that reinforce our assumptions
biased evaluation, the quick acceptance of evidence that supports our hypotheses, while contradictory evidence is subjected to rigorous evaluation and almost certain rejection; we often, for example, impute hostile motives to critics or question their competence
groupthink,¹⁶ the pressure to agree with others in team-based cultures

Consider how many times you may have heard a CEO say something like, "the executive team is 100 percent behind the new strategy" (groupthink); "the chairman and the board are fully supportive and they all agree with our strategy" (false consensus); "I’ve heard only good things from dealers and customers about our new product range" (selective recall); "OK, so some analysts are still negative, but those ’teenage scribblers’ don’t understand our business—their latest reports were superficial and full of errors" (biased evaluation). This hypothetical CEO might be right but more likely is heading for trouble. The role of any strategic adviser should be to provide a counterbalance to this tendency toward false consensus. CEOs should welcome the challenge.

False consensus often leads strategists to overlook important threats to their companies and to persist with doomed strategies

False consensus, which ranks among the brain’s most pernicious flaws, can lead strategists to miss important threats to their companies and to persist with doomed strategies. But it can be extremely difficult to uncover—especially if those proposing a strategy are strong role models. We are easily influenced by dominant individuals and seek to emulate them. This can be a force for good if the role models are positive. But negative ones can prove an irresistible source of strategic error.

Many of the worst financial-services strategies can be attributed to over-dominant individuals. The failure of several Lloyd’s syndicates in the 1980s and 1990s was due to powerful underwriters who controlled their own agencies. And overdominant individuals are associated with several more recent insurance failures. In banking, one European institution struggled to impose effective risk disciplines because its seemingly most successful employees were, in the eyes of junior staff, cavalier in their approach to compliance. Their behavior set the tone and created a culture of noncompliance.

The dangers of false consensus can be minimized in several ways:

Create a culture of challenge. As part of the strategic debate, management teams should value open and constructive criticism. Criticizing a fellow director’s strategy should be seen as a helpful, not a hostile, act. CEOs and strategic advisers should understand criticisms of their strategies, seek contrary views on industry trends, and, if in doubt, take steps to assure themselves that opposing views have been well researched. They shouldn’t automatically ascribe to critics bad intentions or a lack of understanding.
Ensure that strong checks and balances control the dominant role models. A CEO should be particularly wary of dominant individuals who dismiss challenges to their own strategic proposals; the CEO should insist that these proposals undergo an independent review by respected experts. The board should be equally wary of a domineering CEO.
Don’t "lead the witness." Instead of asking for a validation of your strategy, ask for a detailed refutation. When setting up hypotheses at the start of a strategic analysis, impose contrarian hypotheses or require the team to set up equal and opposite hypotheses for each key analysis. Establish a "challenger team" to identify the flaws in the strategy being proposed by the strategy team.

An awareness of the brain’s flaws can help strategists steer around them. All strategists should understand the insights of behavioral economics just as much as they understand those of other fields of the "dismal science." Such an understanding won’t put an end to bad strategy; greed, arrogance, and sloppy analysis will continue to provide plenty of textbook cases of it. Understanding some of the flaws built into our thinking processes, however, may help reduce the chances of good executives backing bad strategies.

The demographic deficit: How aging will reduce global wealth

2008-11-06T14:50:00.001+05:30

To fill the coming gap in global savings and financial wealth, households and governments will need to increase their savings rates and earn higher returns on the assets they already have.

The world's population is aging, and as it gets even grayer, bank balances will stop
growing and living standards, which have improved steadily since the industrial
revolution, could stagnate. The reason is that the populations of Japan, the United States,
and Western Europe, where the vast majority of the world's wealth is created and held,
are aging rapidly (Exhibit 1). During the next two decades, the median age in Italy will
rise to 51, from 42, and in Japan to 50, from 43. Since people save less after they retire
and younger generations in their prime earning years are less frugal than their elders
were, savings rates are set to fall dramatically.

Using branding to attract talent

2008-11-06T14:36:00.000+05:30

To win the best recruits, a company must know how they perceive its brand.

Competition for talent is heating up in many industries and will probably intensify, since demographic trends make it increasingly difficult for companies to replace valued employees when they retire. In response, many companies are trying to sharpen the way they market themselves to recruits, by applying branding techniques to recruitment.

Our analysis indicates that few companies are as rigorous or precise at branding themselves as employers as they are at branding their products and services. Experience therefore suggests to us that many of these initiatives could fail. For a company to exploit its brand effectively when it fishes for talent, it must think of recruits as customers, use sophisticated marketing analysis to identify its key rivals, determine which corporate attributes matter most to specific types of recruits, and understand how best to reach them.

Surveys that rank favorite employers by industry are common; so too are surveys based on the recruits' academic focus, such as business, engineering, or science. But these surveys don't provide employers with the knowledge they really need: information on which companies are the most formidable competitors for the recruits they want and how to become more effective during the various stages of the recruitment process. Such areas of focus include increasing their name recognition among applicants to making potential recruits more familiar with what they do to persuading those recruits to consider them actively, apply for their jobs, and, finally, accept their offers

Best practice does not equal best strategy

2008-10-31T15:18:00.001+05:30

Best practice doesn’t always equal best strategy. Best-practice benchmarking, rightly viewed as one of the most important tools for improving operational efficiency, can be a double-edged sword. Managers must guard against transforming what is a purely process-related technique into the overriding goal of strategic decision making. When industry competitors begin to herd around a single strategy, declining margins are bound to follow

Benchmarking is an important way to improve operational efficiency, but it is not a tool for strategic decision making. When competitors all try to play exactly the same game, declining margins are bound to follow.

Steve Ballmer Speaks Passionately about Microsoft, Leadership ... and Passion

2008-10-31T14:52:00.000+05:30

Microsoft CEO Steve Ballmer's job: Convince customers that Microsoft's latest products are ground-breaking enough to purchase, transform a company with $44 billion in sales into an agile innovator, compete against new business models that challenge Microsoft's traditional approach to software development and recruit enough talent to keep the software giant relevant 25 years from now.

Ballmer joined Microsoft in 1980, five years after its inception. He has witnessed the company grow from 30 employees to almost 80,000. In 1998, he was named president of Microsoft, responsible for day-to-day operations, and two years later was named CEO. With a management style that he characterizes as "more bubbly" than most, Ballmer says leadership "requires a heavy degree of personalization" and the ability to adapt to new conditions.

The day before Microsoft's Vista launch for business customers in New York City, Ballmer spoke at Wharton as part of the school's Leadership Lecture series. During his talk, Ballmer emphasized that Microsoft's style is to focus on the long term: His troops target a market and work until their products are competitive -- an ethos that has been apparent in nearly every Microsoft product from Windows to Xbox and, most recently, Zune.

"We're going to bet on our long term. We don't do things for the short term. And if we don't at first succeed, we keep trying," he says. "If we don't get what the customers really want, we keep going. It took us three attempts to get Windows right and if we had given up after attempt one or attempt two, Microsoft wouldn't look anything like" it does today. "Leaders have to set the tone that says, 'We'll be patient.'"

Leaders Must Continuously Adapt

Ballmer's patience will be crucial as Microsoft targets new growth areas. The company has two primary cash cows -- its Windows and Office franchises -- and has been spending heavily to expand into new markets. Microsoft's Zune is designed to compete with Apple's hugely successful iPod. Despite a third-place market share in search (behind Google and Yahoo), Microsoft is trying to close the gap. In addition, the company is facing the rise of entirely new ways of developing and distributing software that, according to Ballmer, present a challenge greater than that posed by any individual company.

To make a dent in these new markets, Microsoft has to instill the agility typically associated with startups into a massive company with $32 billion in cash and equivalents. Ballmer's challenge is to adapt to the different markets that Microsoft is targeting. "I believe that good leaders will ... adapt themselves to whatever the situation is that they face," says Ballmer, adding that there is no single blueprint for leadership. "Leadership requires a heavy degree of personalization. A lot of lessons are valuable, but what's probably more valuable is hearing people talk about their experiences and then developing your own model," he says. The one characteristic, however, that he believes is "universally applicable to anybody who wants to be a leader" is passion. "You've got to love what you are doing."

Ballmer readily admits that when he joined Microsoft he was not a computer expert, but he developed a passion about Bill Gates' vision to put a computer on every desk and in every home. The company "spoke to this notion [that] most people [want] to have some kind of grander purpose about what they are doing," Ballmer says. "And, yes, it's about a career and, yes, it's about taking care of family, and, yes, it's about winning.... But, generally, people want to know that there is some bigger, more important thing out there [worth] really striving for. Leaders must set the tone about what the real purpose of any organization is. If you really want to inspire people and inspire their passions, you have to appeal to them in some way that is a little less generic than, 'Hey, it's good for the company. The company can earn a lot of money.'"

Developing passion is particularly critical in the markets where innovation is essential. "Because our business is software and software doesn't wear out, we have to be about innovation," says Ballmer. "If our new release isn't any good, people will not upgrade to it." He disputes the notion that Microsoft doesn't innovate, adding that the company's overall culture is about innovation. "No matter how you will judge ... [what] ... we have done or will do in the future, the culture, the leadership tone has got to be about innovation."

According to Ballmer, Microsoft has maintained a position of leadership throughout a number of transformations in its business. The company helped to create the PC industry, transitioned from text-based interfaces to the era of graphical computing and evolved again when the Internet transformed information technology. "Unless you are really committed to building a culture of continuous change and innovation and transformation, you are not in good shape," says Ballmer, who makes a distinction between personal adaptability and adaptability in response to evolving competitive threats. Indeed, Ballmer sees his job as assuring that Microsoft adapts to these new ways of doing business.

Competing Against New Business Models

"You know, everybody likes to have someone, a competitor, who is more interesting," stated Ballmer. "We have many competitors. We have had very good competitors for years. We competed with IBM when nobody gave us a chance of succeeding -- and we did [succeed] with Windows. We competed with guys like Lotus and WordPerfect and Novell, who started out ahead of us."

Today Ballmer sees two major competitors for Microsoft -- the open source software movement and advertising-supported software. According to Ballmer, the threat comes not from specific companies, but from the business models represented by these two trends. "Right now, the emblem of the first one is Linux and the emblem of the second one is Google. But it's not the companies, it's the phenomena" that present the greatest challenge to Microsoft.

The question surrounding open source software like Linux is whether this approach to software development can surpass that of commercial companies. "Will open source do a better job than a proprietary software company -- any software company?" asks Ballmer. "It's an interesting question -- not just for us, but for anybody who is interested in business. The question is, can paid, commercial people do a better job than unpaid volunteers? The answer, I think, will be yes, but we're going to have to push ourselves."

The other threat facing Microsoft is what Ballmer characterizes as "ad funding" --software, such as that provided by Google, which is delivered for free over the web and monetized through advertising. Ballmer's take on the rise of Google is that "getting search right was actually not the hardest part of the issue. They got ad funding -- they really figured that out. And now the rest of us are going to have to learn that game." Advertising is a new model for software and the question is, "Will we be as good at ad-funded software as we were at paid software?"

Squaring off against Google and figuring out an advertising-funded model for Microsoft software excites Ballmer more than other competitive challenges because it requires the software giant to be "extra agile, extra clever. I get extra fired up about that possibility. And yet, I'm confident in how we'll do in that game. Certainly I'm confident in the long run."

Why Innovation and Agility Matter

Microsoft's confidence largely comes from a history of entering markets where it wasn't top dog and yet eventually becoming a strong competitor. For example, Ballmer says that Microsoft is up to the challenge of being a late comer to a market like digital music players. "When you are not the first guy in the market, you have two choices at the beginning of the day: Get in or don't get in. You just have to decide. Are you a company that is afraid to get into something where there is a clear market leader? We put our hands up and said, 'No, we're not going to be afraid of that.'"

To Ballmer, these new markets are marathons. "It's going to take ... patience and long-term innovation to win. It's what it took us with Windows and, frankly, what it has taken most companies in our business." Google, for example, "didn't invent search. They weren't the first guy to the party." Ballmer points out that Google spent "six, seven, eight years before it established a position [in search] and beat AltaVista and Yahoo. It took Apple a while to come in on top of MP3 and music Players. SAP was at it for almost 20 years before they really got to critical mass with the SAP R/3 product." For Ballmer, the issue is simple: "If you're not the first with an innovation, do you shy away or not?"

And search is an area that Ballmer believes is ripe for innovation. Realizing that the company is playing catch-up to Google, Ballmer says Microsoft had to get in the game, but he also acknowledges that advancing search will be a long-term project. "We're getting the basics right. We think that we have some clever ideas coming, but you know we're going to be in there battling for years and years and years."

Meanwhile, Microsoft is betting that there is opportunity for additional players to improve search. "Fifty percent of all searches still don't ever result in an answer that answers the person's question. And of the other 50%, most people will tell you that it took them longer than they thought it should have. That's got to be a world where innovation matters."

Innovating is one thing. Being agile enough to turn on a dime and take advantage of innovation is quite another. Ballmer acknowledges the challenge. "It's not easy to change cultures.... We have almost 80,000 people working for us these days.... [What we] are working hardest on now is agility. What does it mean to be agile in the marketplace? Agility means that you are able to turn things around, that you can invent new things and yet you can still do things that require scale, discipline and execution."

For a company the size of Microsoft, Ballmer says he's trying to cultivate pockets of agile groups, some of which are "incredibly fast, but shallow," and others that are slower, but "incredibly deep." "How you knit [together] and enable people to get the best of all the cultural aspects in the organization is a challenge right now." He insists that Microsoft can become more agile. While there is one overall Microsoft culture, beneath that is a wide range of sub-cultures which operate at different paces.

For instance, the Windows group, which is responsible for creating an operating system that needs to satisfy multiple requirements, will move slower than the Zune unit, which is targeting a specific niche. "What it means to be agile in the Windows product is quite different than what it will mean to be agile in delivering Zune. Windows shouldn't update itself every three months.... Windows needs to be more things to more people than any other product I can name on the planet ... so Windows has to try to be more encompassing." Zune, on the other hand, is in a very different position, according to Ballmer. "Zune is nowhere in the market. So hit, run, work, find your niche -- go, go, go, go! This is a whole different agility profile than what you need in Windows."

The key "isn't trying to put everybody on the same treadmill. The key is to strike the theme, set the tone, set the priorities among all of the leaders and then let them interpret what makes sense relative to what we are trying to get done in a given context," says Ballmer.

Breaking with the Past to Compete in the Future

Sustaining this level of agility often involves making difficult choices. With the launch of Zune, for example, Microsoft introduced a product that was incompatible with the "PlaysForSure" digital rights management (DRM) scheme the company had been previously encouraging all its partners to use. Following the model that made Microsoft's Windows so successful, Microsoft licensed PlaysForSure to multiple hardware vendors of digital music players. "We thought that was a brilliant strategy -- [develop] an open ecosystem, get a lot of people [to support it]." What happened? As Ballmer puts it, "In this particular case, the whole was not bigger than the sum of the parts." And, as a result, "Apple -- with one model that was simple and consistent -- wound up taking 75%-80% of the market."

Microsoft believed it needed to move quickly to change its strategy. "So we said, 'Okay, what do we have to do here?'.... We had to make the market, not just let our partners make the market.... We needed to get an absolutely consistent...user experience [and] retailer experience.... We said, 'Look, we've got to take a different approach, build a new ecosystem and, by the way, we better do something that Apple hasn't done.'"

Microsoft saw an opportunity in music sharing. "We believe in community; community means sharing.... How do I share my music with you? I want to be able to do that legally. So we said, 'We'll go out and negotiate for the rights.' If I share a song with you, you can listen to it three times, or for three days, whichever comes first, then you can mark it and buy. That's one of the features of Zune. But, as soon as you say that, it is inconsistent with PlaysForSure. The DRM information doesn't know anything about that."

The change in strategy was, in Ballmer's words, a "very hard call." But his conclusion was: "We could be consistent with what is out there, which hasn't succeeded. Or, we can try a new approach, which we think has ... merit and can succeed."

As for the impact on Microsoft's partners as a result of this change of strategy, Ballmer states, "Some of our partners will say 'This wasn't partner-friendly.' But having our partners only have 20% of a market share between them is also not very partner-friendly. One of the key things ... that I have learned about business partners is that business partners are your partners because they make money with you, they succeed with you. And if you don't succeed, eventually you don't have any partners."

Attracting, Retaining Talent

Ballmer believes that the key to all of these goals is talent. Can Microsoft effectively recruit and retain the brainpower to expand its traditional markets while also tackling the challenges of the new business models introduced by the growth of the web? The task is even more crucial as rivals like Yahoo and Google are increasingly competing for talent.

Throughout Microsoft's evolution during his tenure, Ballmer says the "number-one thing that has consumed my time is attracting great people, retaining great people and enabling people." In the end, Ballmer says he's recruiting for Microsoft's next generation, trying to find people willing to continually reinvent the company. "If I were to do surveys with Microsoft right now [asking], 'How many of our folks were around before Windows was a success?' [The answer would be] it's a low percentage. As a leader, then, my job has got to be to connect the dots for people who have had all different kinds of experiences."

Ballmer recalls a question once posed to him by an intern: Where will Microsoft be 25 years from now? After some thought, Ballmer says, the only thing he could predict is that "we're going to have great people.... And if we have great people and we have a leadership position today, then everything will take care of itself," says Ballmer. "We'll be driving the leading edge of technology. We'll be making good money. We'll be earning good returns for shareholders and all of that kind of stuff. But at the end of the day, the only thing that could be the magnetic north compass for the place over the next 25 years has got to be this notion of prioritization of people."

Secrets of Leadership Success

2008-10-31T14:32:00.000+05:30

Several years ago, while visiting a regional branch of Lee Hecht Harrison, a global career management services company, then-president Stephen Harrison was stopped short by "Ray," his chief operating officer. "You didn't greet the receptionist," said Ray, who proceeded to show Harrison how to do what he called the "two minute schmooze." Introducing himself, Ray inquired about the receptionist's commute and impressions of the company.

Ray explained to Harrison: "A receptionist is a corporate concierge. They will talk to more important people in a day -- suppliers, customers, even CEOs -- than you will talk to all year."

Enron-level scandals are not averted by talking to the receptionist alone, but Harrison, contended that small acts like this are part of what makes for an ethical corporate culture. And culture, not "heavy handed legislation" like the 2002 Sarbanes-Oxley Act, is a key safeguard against moral lapses, he said in his talk.

Harrison, who is now chairman of Lee Hecht Harrison, pointed to the failure of Sarbanes-Oxley to stop incidences of corporate fraud and misconduct. He quoted a 2005 PricewaterhouseCoopers survey that reported a 22% increase in global fraud over the last two years. When the Federal Sentencing Commission discovered this gap between intention and results, said Harrison, it held a year of hearings and then added one line to the Federal Sentencing Guidelines stating that public companies must "promote an organizational culture that encourages ethical conduct."

Shortly after this addition was made, Harrison was appointed Worldwide Chief Ethics and Compliance Officer of Lee Hecht Harrison's parent company, Adecco, a position he held for two years and one that is mandated for publicly traded companies complying with Sarbanes-Oxley. He, along with other newly appointed ethics and compliance officers, wanted to know: What does "ethical culture" mean to the Federal Reserve Board? Harrison spoke with Federal Reserve Board officials and attended conferences where board members addressed the issue.

"All of us had pens in hand, waiting for the answer. They couldn't give it to us," Harrison recalled. "So I decided I would dig into this myself." What he concluded mirrors the words of former SEC Commissioner Cynthia Glassman, who said that while the government can mandate ethical compliance, "we cannot legislate ethical behavior." For Harrison, even the word "ethics" itself seems too abstract; he replaces it with what he sees as a more intuitive, common-sense word: decency.

"Decency is not just about being nice," noted Harrison, author of The Manager's Book of Decencies. Rather, it is about creating a "bubble wrap" of good deeds that will protect a company in hard times. "Our willingness to be decent at work cannot depend on whether business is up or whether we're in a bad mood or whether it's raining. Decencies don't amount to anything unless we take the trouble to make them come alive through concrete acts in all kinds of weather."

For those at the top, this can mean such actions as being the first to volunteer for ethics training; honoring those with unglamorous jobs, like office cleaning; and listening to people at all levels of the organization. He pointed to the example of Herb Baum, former CEO of Dial, who used to host "Hot Dogs with Herb" on the factory floor, where he invited employees to talk with him about anything on their minds.

Being accessible is as important as being humble, said Harrison. "Remember Ed Koch?" The former mayor of New York, in his second year in office, drove from borough to borough, asking people, "How am I doing?" "He went from being well-liked to well-loved." Harrison also recalled meeting up one night with a long-lost college roommate, Ruben Mark, chairman and CEO of Colgate Palmolive. Over a Japanese dinner, Harrison asked him how he explained his success. "He leaned across the table and said, 'That's easy. I make absolutely sure nothing creative or important is ever identified as my idea,'" said Harrison. "Now that's humility."

He also counseled executives to avoid the trap of "executive pomposity." He first heard that term in a 1967 speech from the CEO of Technico, who spoke specifically about executive "telephone pomposity." Said Harrison: "I have answered my own phone since then."

Being generous with praise and recognition will earn leaders what Harrison calls "psychic income." He gave the example of the chairman and CEO of Campbell Soup who "at the end of every day gathers his people to hear about neat stuff done that day and then handwrites thank-you notes to the people who did it. If you go around Campbell Soup, all over the world, you will find those notes framed."

A key test of a leader's sensitivity comes at layoff time. While Western companies, and particularly American companies, have come to accept the reality of the need for layoffs, "what they should not come to terms with is a downsizing episode that is anything but sensitive, well thought out and has preserving personal dignity as the highest priority," Harrison said.

Immediately after layoffs take place, for example, a leader should be "very visible and accessible," ready to answer questions, reduce anxieties and even assuage the guilt of those who survive the layoffs. "It takes courage to put your chest out, shoulders back, and be there to deal with this. It's a decency, and people will appreciate it."

At the end of the day, said Harrison, the words of poet Maya Angelou ring true: "People will forget what you said, they will even forget what you did, but they will never forget what you made them feel."

Leading with Your Voice

As public speaking coach Richard Greene knows, however, a few unique individuals are able to combine words and feelings in stirring, almost miraculous ways. "I would rather hear Martin Luther King read the Philadelphia White Pages out loud than hear almost anyone in corporate America deliver the 'I have a dream' speech," said Greene during his presentation.

While King had natural gifts that only a chosen few possess, Greene argued that most people have never been trained in public speaking, in part because the subject is not usually taught in schools. "It's a mechanical process and every single employee, with a little bit of intention, focus and time spent, can learn a new skill set. They haven't had a chance to see how good they can be," said Greene.

The first task of a speaker is to realize his or her purpose in speaking, whether it involves addressing several prospective customers across a boardroom table or a convention of thousands. "Public speaking is nothing more than having a conversation about something you're passionate about with two or more people, while you just happen to be standing up, or not," said Greene, who has advised CEOs of Fortune 500 companies and coached presidents, prime ministers, and, in 1996, Diana, Princess of Wales.

One of the biggest pitfalls for speakers in a corporate communication setting is perceiving a speech or presentation as a performance. "It's easy to get nervous and think, 'I want them to know how smart I am and how much I know,'" said Greene. "But if it's just about downloading data, then stay home, hit the send button and save everyone's time and expense."

The best communicators have understood that public speaking is not a performance; it's about making a connection with others, said Greene. "What did Franklin Roosevelt call his weekly radio addresses? Not 'fireside speeches' but 'fireside chats.' He understood that this new technology -- radio -- could be a way to connect with people."

Greene, who began his career as a lawyer, became intrigued by public speaking after watching motivational speaker Tony Robbins. "His ability to work a crowd is unparalleled and I learned a lot from him. I also decided it would be much more fun to do what he was doing, rather than what I was doing, which was being his lawyer."

During the 2000 presidential election, Greene advised Al Gore's campaign to let the then-Democratic nominee speak about environmental issues, but his advice was brushed off by the vice president's campaign on the basis that "no one cares about the environment." "What was missing from Gore in 2000 was a sense of human passion and authenticity. It doesn't matter what you think of global warming: What matters is you see that he believes in something passionately," he said.

Authenticity can help convince an audience that you are bringing something unique to the table, said Greene. "When you're trying to market an idea or product or service, you have to answer two questions the customer has, which are: 'What makes you unique, as compared to your competitors? And how can your uniqueness benefit me?'"

Greene offered some practical tips, including the observation that "the difference between a good speaker and a great speaker is the pause." He recited a piece of the famous King speech: "He said, 'I have a dream' -- pause, pause, pause -- 'that one day' -- pause, pause, pause -- 'this nation will rise up….' He didn't just run it all together, one word after another."

Other simple tools of the trade include making eye contact with audience members even in a large room, establishing a casual relationship by walking in front of a podium rather than standing behind it, and varying voice tone and rhythm. "This is all low-hanging fruit," said Greene, meaning that with a little training, most speakers can improve in these areas.

Of course some public speaking skills are the result of natural gifts, Greene acknowledged, and voice resonance is one of those gifts. Former CBS News anchorman Walter Cronkite won the nation's trust in part because of his deep, full voice, said Greene; on the flip side, Democratic presidential nominee Hubert Humphrey lost the 1968 election in part because his voice was high-pitched and even grating.

As for the current presidential race, Greene predicted that Mitt Romney would win the Republican nomination and Barack Obama the Democratic because both are strong communicators. "There is a continuum of great speakers. Where you are on this continuum is pretty much where you are in terms of overall effectiveness."

He attributes Obama's rapid political rise to the skill of his keynote address at the 2004 Democratic National Convention. "It didn't sound like a normal political speech. He spoke from a place of pure nakedness, as if he were saying, 'I'm not even giving a speech; let's just connect.'"

While disparaging an older generation of public speaking advice that recommended viewing audience members in their underwear, Greene offered a different kind of advice that can be summed up in four words: "It's not about you." Referring again to Martin Luther King, Greene said, "He had this ability to reach inside his heart and soul and just bring out what was there. What he cared about at every moment was just getting his message across. He wasn't worrying about how he looked."

Colgate-Palmolive's Reuben Mark: On Leadership and 'Moving the Bell Curve'

2008-10-31T14:30:00.001+05:30

After an unusually long 23-year tenure as chief executive, Reuben Mark, who is still chairman of Colgate-Palmolive, sees corporate leadership like a baseball game that is won, not by spectacular homeruns, but by singles and doubles.

In a recent Wharton leadership lecture titled, "The Essence of Colgate's Leadership Training," Mark said effective leadership at the $12.2 billion consumer products company pays off in incremental and consistent gains. "The essence of leadership is the idea of continuous improvement. No matter what, you can always coach people to do a little better, and if everyone does that, the whole organization moves up."

Colgate-Palmolive, headquartered in New York City, is the world's leader in oral care products with its flagship Colgate toothpaste, but it also sells soaps (including dish soap), pet food and household cleaners such as Ajax. The company's stable of consumer brands has delivered steady growth throughout the past two decades. Since the end of 1983, total return for the Standard & Poor's 500 Index was 1555% while Colgate-Palmolive's peer group of companies returned 2932%. Total return for Colgate-Palmolive during the same period was 4204%. Its after-tax return on capital from 2002 to 2007 was 33% compared to 18.5% at peer companies.

Mark said business leaders should look at their company's performance like a bell curve. The left side of the curve represents very bad results, and the right side, excellence. The bulk of a company's activities will fall in the thickest part of the bell curve in the middle. Management's job is to gradually implement and nurture improvements that will move the entire curve toward the right, Mark suggested: "It's not romantic and not revolutionary or headline-getting, but over time, that's what generates success."

On a First-name Basis

For example, Colgate management worked for several years to get all 35,000 Colgate-Palmolive employees to wear identification badges with their first names in large, highly visible type. The nametags, he said, make it easier for top executives visiting plants and offices around the world to connect more quickly with employees by using first names. "All these efforts at cultural change help to get people to believe and move the curve. The job of the major leaders in the organization centers around culture."

Colgate-Palmolive was founded in New York in 1806 as a candle and soap company. One of its early innovations was packaging dental cream -- at that time sold in jars -- into squeezable tubes. Today, the company operates in 223 countries and is the leading toothpaste brand in most of the world. (In the U.S., it faces heavy competition from Crest.) Mark, 68, joined the company in 1963 and went on to serve as its vice president for Far East operations, president, and then chief executive in 1984. This summer, in keeping with Colgate-Palmolive's succession plan, Ian Cook, Colgate's chief operating officer, took over as chief executive. Mark will continue as chairman through 2008.

He stressed that focus is an important element of leadership at Colgate-Palmolive. The company has limited the number of product lines in its portfolio to focus only on those in which the company can maintain a strong position. For example, the company never followed competitors into pharmaceuticals. "In our case, we decided 25 years ago we couldn't compete with some organizations, like Procter & Gamble, on all fronts. We had to select a limited number of product areas where we could compete."

Indeed, he said, Colgate-Palmolive would have liked to add the Listerine brand to its oral care division in 2006, when Pfizer announced it was selling the mouthwash along with its consumer healthcare division. However, the deal would have included products that did not fit into Colgate-Palmolive's core groups, including Nicorette, the stop-smoking patch, and over-the-counter drugs like Sudafed, Neosporin, Zantac and Benadryl. Colgate-Palmolive walked away from the acquisition and Johnson & Johnson went on to buy the Pfizer brands for $16.6 billion. Mark said that while it was difficult not to buy a strong brand like Listerine, it was more important to remain focused on the company's guiding strategy. "When somebody says this is the deal of a lifetime and you can't pass it up, you almost have to run in the other direction," he added.

Financial discipline is another simple strategy that has led to constant improvement at Colgate-Palmolive, according to Mark. Company managers at Colgate-Palmolive constantly look to reduce overhead and plow savings back into marketing and new product development. As a result, the company's margins have grown from 37.9% in 1984 to 56.4% in 2006, he said.

Mark then went on to describe personal characteristics that are important in successful leaders. "In leadership, some traits come naturally [while others] must be learned," he noted. He emphasized integrity first. "That goes without saying. However, in recent years -- especially in business -- taking integrity for granted has been a mistake. A lot of people got into a lot of trouble because the people at the top of the organization did not demonstrate integrity."

He pointed to former Tyco chief executive Dennis Kozlowski, who agreed to pay restitution for tax evasion after he was caught in a scheme to avoid paying taxes on artwork purchased in Manhattan. Empty cartons supposedly holding the art were shipped to a Tyco facility in New Hampshire for tax purposes, but the paintings were actually sent to Kozlowski's New York apartment.

Mark asked his audience to think about the impact on a worker in the New Hampshire plant, earning $22 an hour, seeing the crates coming to his plant. "He knows that the boss is cheating on taxes. How can you really expect that warehouseman to be honest in his job when the example he's getting is just the opposite? With everything you do as a leader, you've got to think not only, 'Is it the right thing for me to do?' but, 'Is it right for the organization?'"

Coping with Ambiguity

Common sense is another critical trait of good leaders. "That's what business pays big bucks for. That's what makes a success -- seeing the situation and simplifying it so everyone can understand and come up with a common-sense solution that will move the business forward." Strong leaders are able to cope with ambiguity, he added. "If everything were black and white, everyone could do it, but most things in business at any level are gray. The ability to parse out what is on one side and what is on another -- and present those sides well and come to a conclusion -- is important."

Clarity in communications is also vital, said Mark. "You can't expect people to do what you want them to do and to get better each day unless there is clarity." He is often amazed to find himself sitting in a meeting, listening carefully as misunderstandings develop. To prevent this, the top 500 people at Colgate-Palmolive gather twice a year to hear presentations about initiatives within the company. They then must return to their divisions and facilities to make sure the information they received from the very top cascades throughout the rest of the company.

Mark then discussed the use of power by corporate leaders. "The more power you have, the less you need to use it." If top management has fostered the right culture, everyone is aligned and voluntarily moving toward the same goals. In that kind of company, bosses don't need to wield their power. He also emphasized the "human touch." First, he said, leaders must create a caring environment. "Love is a better motivator than fear, I believe, and our company believes." Finally, he added, strong leaders value the contributions of everyone in the organization, manage with respect and often use humor as a powerful tool to get around problems and disarm people who may be inclined to hamper progress.

He was then asked which of the personal traits of good leaders come naturally and which need to be developed. Many of the "human touch" characteristics, he said, can be learned, if necessary -- "It comes down to manifesting an interest in people" -- while the ability to handle ambiguity is something that must be learned with experience. Integrity, however, cannot be learned. Even if a leader has integrity, that is not enough. "It's manifesting integrity to set the example. Even when something comes intuitively, you still have to work to develop it, to move your own personal curve in the right direction."

He told of visiting a new bank headquarters in the Midwest on a rainy day. The building was constructed in such a way that employees and visitors were soaked by the time they entered the bank. Mark was certain the chief executive had used another entrance and thus avoided arriving in the office dripping wet. It was a sign, he suspected, that management did not care much for its employees and investors. Indeed, a short time later, the chief executive was fired and the stock plummeted. "You see it time after time," said Mark. "It's all about how you treat your 'family.'"

Finally, Mark stressed that despite the importance of focus in business, it is also crucial to maintain balance. "You will be a far better professional in all respects if your life is balanced." When asked about his unusually long time as a chief executive, he said his case was not typical. Younger executives need to find a way to the top at companies, he said, and added that he was surprised to learn that he likes retirement. "I was probably in the job too long."

'The Art of Woo': Selling Your Ideas to the Entire Organization, One Person at a Time

2008-10-31T14:28:00.001+05:30

Former Chrysler chairman Lee Iacocca once noted, "You can have brilliant ideas; but if you can't get them across, your ideas won't get you anywhere."

As an example of effective persuasion, the story of rock star Bono's visit to then-Senator Jesse Helms' Capitol Hill office to enlist his help in the global war against AIDS.

Bono had all the facts and figures at his fingertips, and launched into a detailed appeal based on this data. He was, in essence, speaking to Helms the same way he had recently spoken to executives and technical experts at the many foundations and corporations he had approached about this issue. But within a few minutes, Bono sensed that he was losing Helms' attention, and he instinctively changed his pitch. Knowing that Helms was a deeply religious man (and drawing on his own born-again Christian values), Bono began speaking of Jesus Christ's concern for the sick and poor. He argued that AIDS should be considered the 21^stcentury equivalent of leprosy, an affliction cited in many Bible stories of the New Testament. Helms immediately sat up and began listening, and before the meeting was over had promised to be the Senate champion for Bono's cause.

Examples such as this one illustrate what you mean by "woo": It's the ability to "win others over" to your ideas without coercion, using relationship-based, emotionally intelligent persuasion. The rock star Bono is superb at the art of woo because he understands what it takes to be a super-salesman, in the best sense of that term. Here you have a rock star with tinted glasses and an elderly, conservative Southern senator. But when Bono had the good sense to switch from public policy talk about debt relief -- what we call in our book the 'rationality' channel -- to religious talk about poverty and disease -- what we call the 'vision' channel -- he touched Helms' heart. He sold his idea and, in the process, created trust."

Using persuasion rather than force -- is one of the most important skills that everyone from CEOs and entrepreneurs to team leaders and mid-level managers need to learn if they want to be effective in their organizations.

The Art of Woo presents a simple, four-step approach to the idea-selling process.

Firstly Persuaders need to polish their ideas and survey the social networks that will lead them to decision makers. Example : How an unknown mail pilot named Charles Lindbergh turned his dream of being the first person to fly nonstop across the Atlantic into a reality. His idea was radical: He would make the crossing in a single-engine plane flying without a co-pilot or even a life raft. The idea was followed by his campaign to overcome people's disbelief that such a venture could ever work and to win over supporters in his hometown of St. Louis. Lindbergh started with contacts at the local airport who could see why his plan made sense and eventually worked his way up to the most influential businessmen in the city, using each person along the way to leverage an interview with the next.

The second stage of the Woo process is confronting "the five barriers" -- the five most common obstacles that can sink ideas before they get started. These include unreceptive beliefs, conflicting interests, negative relationships, a lack of credibility and failing to adjust one's communication mode to suit a particular audience or situation. Great persuaders throughout history have shared with Bono an instinct for overcoming this last barrier. For example, when Napoleon was a young officer at the siege of Toulon, he set up an artillery battery in such a dangerous location that his superiors thought he would never get troops to man it. They would have been right had Napoleon relied on the conventional "authority channel" and issued threats and orders to get his way. Instead, he demonstrated his social intelligence by switching to the visionary channel and creating a large placard that was placed next to the cannons. It read: "The Battery of the Men without Fear." The position was manned night and day.

Similarly, when Nelson Mandela was incarcerated on the notorious Robben Island in South Africa, he managed to obtain blankets and other necessities for his fellow prisoners by foregoing the expected high-minded appeals to politics and human rights. He worked instead on the relationship persuasion channel. By learning the guards' Afrikaans language and reading their literature, Mandela earned their respect and won them over to his idea of fair treatment -- even as he continued to face hostility from the officials who ran the prison.

The third stage is to pitch your idea in a compelling way. At Google, employees selling ideas to upper management are given a challenge: to distill their business concepts into short, punchy presentations that get right to the essence of what they are proposing. This discipline forces them to figure out exactly what problem their idea addresses, how their idea will solve it and why their idea is better than both the status quo and available alternatives. The authors offer a template for pitching ideas in this format and give examples of distinct ways one can personalize an idea to make it memorable and distinctive.

The final stage of Woo is to secure both individual and organizational commitments. "is to think that their job is finished once they succeed in getting someone to say 'yes' to their proposal. That's only the beginning. Research shows that in most organizations, a minimum of eight people will need to sign off on even simple ideas. The number goes up from there. So after you move the individual, you also have to move the organization."

For example the story of Charles F. Kettering, a brilliant inventor and engineer from the 1930s whom many consider an equal of Thomas Edison. Kettering invented such things as the automatic transmission and safety plate glass, but one of his best ideas -- the air-cooled automobile engine -- sat on the shelf for decades until the Volkswagen Beetle incorporated it. Kettering convinced Alfred Sloan, GM's top executive, that producing the air-cooled engine was a good idea, and the company's executive committee gave the go-ahead to make a limited number of cars with the prototype. But instead of following the idea through, Kettering went back to his lab to concentrate on the technical aspects of the project. The committee handed the production assignment to the Chevrolet division, whose top managers had never been brought into the persuasion process. They let the idea languish and it was eventually abandoned. "Kettering made a fundamental mistake: He didn't follow up and keep the pressure on," Shell notes. "He didn't do the political coalition-building needed to implement his idea."

Andy Grove's 'Constructive Confrontation'

Individual personality plays a key role in how you influence others, For example,The "Driver" style (a highly assertive type who gives only limited attention to the social environment) by examining how Intel CEO Andy Grove managed the persuasion process at Intel during his years as that company's leader. Labeled the "screamer," Grove could be intimidating to people who didn't know him well. But he was also willing to listen if people stood up to him and matched his passion. To facilitate communication, Grove instituted what he called a culture of "constructive confrontation" that freed everyone to be as blunt and assertive as he was. The result was a high-stress environment, but one in which everyone could speak their minds.

The Art of Woo goes on to describe four other distinctive styles with examples drawn from business history. Banker J. P. Morgan is given as the model for the Commander (a Grove-like person who has a quieter demeanor), John D. Rockefeller exemplifies the Chess Player (a quieter person who attends strategically to the social environment), Andrew Carnegie's life provides the example for the Promoter style (a gregarious type who uses high levels of social intelligence), and Sam Walton is the model for the style that strikes the balance among all the others -- the Advocate.

Three Typical Mistakes

The top three mistakes are that people make in selling ideas, Shell notes that the number one-error is "egocentric bias," or "focusing on yourself instead of your audience. People assume that the person they are trying to sell on their idea is just like them, that he or she has the same primary goals and frame of reference, and that what they are talking about is important to the other side. But other people may not care at all about what is important to you.... It's a killer assumption."

A second mistake is the belief that there are no systematic ways to persuade people to accept an idea. "A lot of people just wing it, thinking they can count on their own experience and instinctive powers of persuasion to carry the day," says Shell. "But in fact, you do need a strategy. That is what this book is about."

The third most common error is to forget about organizational politics, as Charles Kettering did at General Motors. "Whenever a new idea might affect resources, power, control or turf," Shell says, "politics will be part of the problem at the implementation stage. You need to prepare an idea-selling campaign, not just a presentation."

The authors suggest that people working in any group -- from the largest Fortune 500 company to an entrepreneurial startup -- can benefit from improving their skills at the art of persuasion. As Shell notes: "Influencing others in an organization to accept and act on your ideas is a challenge that never goes away."

What is the business of business?

2008-10-29T12:31:00.001+05:30

By building social issues into strategy, big companies can recast the debate about their role in society.

The great, long-running debate about business's role in society is currently caught between two contrasting, and tired, ideological positions. On one side of the current debate are those who argue that, to borrow Milton Friedman's phrase, "the business of business is business." This belief, most established in Anglo-Saxon economies, implies that social issues are peripheral to the challenges of corporate management. The sole legitimate purpose of business is to create shareholder value. On the other side are the proponents of corporate social responsibility, a rapidly growing, rather fuzzy movement encompassing companies that claim that they already practice the principles of CSR and skeptical advocacy groups arguing that they must go further in mitigating their social impact. As other regions of the world—parts of continental Europe, for example—move toward the Anglo-Saxon shareholder value model, the debate between these points of view has increasingly taken on global significance.

Both perspectives obscure, in different ways, the significance of social issues to business success. They also unhelpfully caricature the contribution of business to social welfare. It is time for CEOs of big companies to recast this debate and recapture the intellectual and moral high ground from their critics.

Large companies must build social issues into strategy in a way that reflects their actual business importance. Such companies need to articulate their social contribution and to define their ultimate purpose in a way that is more subtle than "the business of business is business" and less defensive than most current CSR approaches. It can help to view the relationship between big business and society as an implicit social contract—Rousseau adapted to the corporate world, you might say. This contract has obligations, opportunities, and advantages for both sides.

To explain the basis for such an approach, it may help first to pinpoint the limitations of the two current ideological poles. Start with "the business of business is business." The issue here is not primarily legal: in many countries, such as Germany, companies have a legal obligation to stakeholders, and even in the United States the legal primacy of shareholders is open to very broad interpretation.

The problem with the "business of business is business" mind-set is rather that it can obscure two important realities. The first is that social issues are not so much tangential to the business of business as fundamental to it. From a defensive point of view, companies that ignore public sentiment make themselves vulnerable to attack. Social pressures can also serve as early indicators of factors essential to corporate profitability: for example, the regulations and public-policy environment in which companies must operate, the appetite of consumers for certain goods above others, and the motivation of employees—and their willingness to be hired in the first place.

Companies that treat social issues as either irritating distractions or simply unjustified vehicles for attacks on business are turning a blind eye to impending forces that have the potential to alter the strategic future in fundamental ways. Although the effects of social pressures on these forces may not be immediate, that is not a reason for companies to delay preparing for or tackling them. Even from a strict shareholder perspective, most stock market value—typically, more than 80 percent in US and Western European public markets—depends on expectations of corporate cash flows beyond the next three years.

Examples abound of the long-term business impact of social issues. That impact is growing fast. In the pharmaceutical sector, the past decade's storm of social pressures—stemming from issues such as public perceptions of excessive prices charged for HIV/AIDS drugs in developing countries—are now translating into a general (and sometimes seemingly indiscriminate) toughening of the regulatory environment. In the food and restaurant sector, meanwhile, the long-escalating debate about obesity is now resulting in calls for further controls on the marketing of unhealthy foods. In the case of big financial institutions, concerns about conflicts of interest and the mis-selling of products have recently led to changes in core business practices and industry structure. For some big retailers, public and planning resistance to new stores is constraining growth opportunities. And all this is to say nothing of the way social and political pressures have reshaped and redefined the tobacco and the oil and mining industries, among others, over the decades.

In all such cases, billions of dollars of shareholder value have been put at stake as a result of social issues that ultimately feed into the fundamental drivers of corporate performance. In many instances, a "business of business is business" outlook has blinded companies to outcomes, or to shifts in the implicit social contract, that often could have been anticipated.

Just as important, these outcomes have not just posed risks to companies but also generated value creation opportunities: in the case of the pharmaceutical sector, for example, the growing market for generic drugs; in the case of fast-food restaurants, providing healthier meals; and in the case of the energy industry, meeting fast-growing demand (as well as regulatory pressure) for cleaner fuels such as natural gas. Social pressures often indicate the existence of unmet social needs or consumer preferences. Businesses can gain advantage by spotting and supplying these before their competitors do.

Paradoxically, therefore, the language of shareholder value may in this respect hinder companies from maximizing their shareholder value. Practiced as an unthinking mantra, "the business of business is business" can lead managers to focus excessively on improving the short-term performance of their businesses, thus neglecting important longer-term opportunities and issues, including societal pressures, the trust of customers, and investments in innovation and other growth prospects.

The second point that the "business of business is business" outlook obscures for many companies—the need to address questions about their ethics and legitimacy—is related to the first. For reasons of integrity and enlightened self-interest, big companies need to tackle such issues, with both words and actions. It is neither sufficient nor wise to say that it is for governments to set laws and for companies simply to operate within them. Nor is it enough simply to point out that many criticisms of businesses are unmerited or that those throwing the mud ought also to examine their own practices and social responsibility. Irrespective of whether the criticisms are valid, their cumulative effect can shape the strategic context for companies. It is imperative that businesses seek to lead rather than merely react to these debates.

Moreover, in certain parts of the world—particularly some poor developing countries—the rule of law and basic public services are notable by their absence. This reality can render the "business of business is business" mind-set positively unhelpful as a guide for corporate action. If companies operating in such an environment focus too narrowly on ill-defined local legislation or shy away from broad debates about their alleged behavior, they are likely to face mounting criticism over their activities as well as a greater risk of becoming embroiled in local political tensions.

Is CSR the answer? If only it were. The point is not to criticize the many laudable CSR initiatives undertaken by individual companies or to dispute the obvious need for businesses (as for any other social entity) to act responsibly. It is rather to examine the broad prescriptions proposed by groups and activists involved with CSR. These prescriptions commonly include stakeholder dialogue, social and environmental reports, and corporate policies on ethical issues. This approach is too limited, too defensive, and too disconnected from corporate strategy.

The defensive posture of CSR springs from its origins. Its popularity as a set of corporate tactics was driven, in large part, by a series of anticorporate campaigns in the late 1990s. These campaigns were in turn given impetus by the antiglobalization protests mounted around the same time. Since then, companies have been drawn to CSR by nice-sounding if vague notions such as the "triple bottom line": the idea that companies can simultaneously serve social and environmental goals as well as earn profits. Companies have seen CSR as a way to avoid nongovernmental-organization (NGO) and reputational flak and to mitigate the rougher edges and consequences of capitalism.

This defensiveness starts the argument on the wrong foot—certainly as far as business leaders should be concerned. Big business provides huge and critical contributions to modern society. These are insufficiently articulated, acknowledged, or understood. Among them are productivity gains, innovation and research, employment, large-scale investments, human-capital development, and organization. All of them are, and will be, essential for future national and global economic welfare. Big business also supplies investment vehicles that are likely to be central to the provision of pensions in the aging countries of the Organisation for Economic Co-operation and Development (OECD). In developing countries, meanwhile, the entry of multinational companies through foreign direct investment has often contributed critical capital, technology, skills, and other poverty-reducing economic spillovers. It is no coincidence that developing countries place such emphasis on attracting big business and the investment it can bring to their economies.

CSR is limited as an agenda for corporate action because it fails to capture the potential importance of social issues for corporate strategy. Admittedly, companies undertaking a stakeholder dialogue with NGOs will be more aware, in advance, of potential issues. But tracking NGO opinion is only part of the process of understanding the range of social pressures that can ultimately affect core business drivers such as regulations and consumption patterns.

An obvious next step for companies, having understood the possible evolution of these broad social pressures, is to map long-term options and responses. This process clearly needs to be rooted in the development of strategy. Yet typical CSR initiatives—a new ethical policy here, for example, or a glossy sustainability report there—are often tangential to it. It is perfectly possible for a company to follow many prescriptions of CSR and still be caught short by seismic shifts in the socially driven business environment. One of the compounding problems is the fact that many companies have chosen to root their CSR functions too narrowly, within their public- or corporate-affairs departments. Although such departments play an important tactical role, they are often geared toward rebutting criticism and tend to operate at a distance from strategic decision making within the company.

A contract has two sides, and business must acknowledge that in return for the ability to function, it is subject to rules and constraints

In the limitations of both CSR and of the "business of business is business" thinking lie the outlines of a new approach—as relevant for Chinese, German, and Indian companies as for US and British ones. Three main strands stand out. The first is a helpfully simple prescription: businesses should introduce explicit processes to make sure that social issues and emerging social forces are discussed at the highest levels as part of overall strategic planning. This point means that executives must educate and engage their boards of directors. It also means that they need to develop broad metrics or summaries that usefully describe the relevant issues, in much the same way that most companies analyze customer trends today. The risk that stakeholders—including governments, consumer groups, lawyers, and the media—will mobilize around particular issues can be roughly estimated by studying the known agendas and interests of these parties. For example, the likelihood that the obesity debate would rebound on food companies was partly predictable from the growing expenditures of governments on obesity-related health problems, the inevitable media focus on the issue, plus the interest of some lawyers in finding fresh corporate targets for litigation. By the time businesses seriously engaged with the question, they were in a defensive posture, merely struggling to catch up with the public debate. In the future, companies will need to be much better at understanding and anticipating such issues.

Both the second and third strands of the new approach reflect the idea that there is an implicit contract between big business and society or indeed between whole economic sectors and society—the contract that is the subject of this article. Detractors have often successfully portrayed the contract as a one-way bargain that benefits business at society's expense. The reality is much more complex. The activities undertaken by business have clearly brought social benefits as well as costs. Similarly, however, there are two sides to a contract, and business must acknowledge that in return for the ability to function, it is subject to rules and constraints. At times, the contract can come under obvious strain. The recent backlash against big business in the United States can be seen as society seeking to shift the terms of the contract as a result of popular perceptions that business has abused its power. Similarly, in Germany at present, business is struggling to defend itself against charges that its contract with society is fundamentally unbalanced.

The second strand requires companies not just to understand their individual contracts but also to manage those contracts actively. To do so, companies can choose from a range of potential tactics, such as more transparent reporting, shifts in R&D or asset reorganization to capture expected future opportunities or to shed perceived liabilities, changes in approaches to regulation, and, at an industry level, the development and deployment of voluntary standards of behavior.

Some companies and sectors are already experimenting with such approaches. Nonetheless, there is scope for much more activity, provided it is aligned with corporate strategic goals. Reshaping conduct on an industry-wide and increasingly global basis may be particularly important, given that the perceived misdeeds of one company can rebound on its sector as a whole.

An important point to remember is that companies, depending on their circumstances, will have quite different tactical responses, so off-the-shelf or simply nice-sounding solutions may not always be appropriate. Transparency offers a good example. It is easy, but wrong, to say that there can never be enough of it. What might be good for a pharmaceutical company trying to restore the consumers' trust could be damaging for a hedge fund manager. A voluntary code of practice for a retailer naturally would be very different from that of a copper-mining company.

This observation leads me to the third strand of the new approach for business leaders: they need to shape the debate on social issues much more consciously by establishing ever higher (but appropriate) standards of integrity and transparency within their own companies and by becoming much more actively involved in external debates (such as those in the media) on issues that shape the social context of business.

A starting point may be for CEOs to articulate publicly the purpose of business in terms less dry than shareholder value, although that should continue to be seen as the critical measure of business success. However, it may be more accurate, more motivating—and indeed more beneficial to shareholder value over the long term—to describe the ultimate purpose of business as the efficient provision of goods and services that society wants.

This is a hugely valuable, even noble, purpose. It is the basis of the contract between business and society and the basis of most people's real interactions with business. CEOs could point out that profits are not an end in themselves but a signal from society that a company is succeeding in its mission of providing something people want—and doing so in a way that uses resources efficiently relative to other possible uses. From this perspective, the creation of shareholder value or profits is the measure, and the reward, of success in delivering to society the goods and services we desire, which is the more fundamental business objective. The measures and rewards reflect the predominant values of the relevant society.

CEOs could point out that profits are not an end in themselves but a signal from society that a company is providing things people want

By moving away from a rigid focus on the term shareholder value, big business can also make clear to broad audiences that it understands the trade-offs inherent in its social contract. The debate between business and society is essentially one about how to manage (and reach agreement on) those trade-offs. What might this point mean specifically? There is no shortage of big social issues today that directly affect many big businesses and require new debate. These issues include ensuring that aid organizations and trade regimes successfully promote the development of Africa and other poor regions, whose economic liftoff would present a major potential boon to global markets as well as to international security; promoting a more sophisticated and sensitive approach, by both companies and governments, to balancing the societal risks and rewards from new technologies; spearheading dialogue on the health care and pension challenges in many developed countries; and supporting efforts to resolve regional conflicts.

Obviously, the relevant issue must be matched to the specific business. Some companies and business organizations have taken strong public stances on these and similar issues. But in general, high-level, concerted corporate activism is more notable by its absence. Business leaders shouldn't fear taking a more forward role advocating the idea of a contract between business and society. Public receptiveness to active business leadership on issues such as these may be a lot greater than some might be inclined to think. Despite the poor image and bad press of big business in recent times, polls suggest that people retain a belief in its ability to provide a positive contribution to society.

More than two centuries ago, Rousseau's social contract helped to seed the idea among political leaders that they must serve the public good, lest their own legitimacy be threatened. The CEOs of today's big corporations should take the opportunity to restate and reinforce their own social contracts in order to help secure, for the long term, the invested billions of their shareholders.

Seven ways China might surprise us in 2009

2008-10-29T12:24:00.002+05:30

The country could yet again change the way the world sees it. Here’s a shortlist of realistic possibilities.

How will China surprise us next? Shocks, tipping points, and revelations have become basic staples of the world’s daily news diet. But with so many eyes now on this emerging Asian giant, what happens there continues to have an exceptional ability to draw attention and to shift perceptions drastically and suddenly.

Will the surprise be planned, like the magnificent Beijing Olympics Games, whose nearly flawless execution set a counterpoint to China’s image as an economic laggard buoyed mainly by cheap labor? Will it repel, like the tainted-milk scandal? Or will it send a message, as Lenovo’s takeover of IBM’s personal-computer business did in serving notice that Chinese companies were ready to enter the global fray?

Here’s a list of some realistic possibilities for the next year. Will all of them come to pass? I doubt it. But any one of them could, and each might make us see China and its future in a new light. What do you think?

China announces that by 2020, half of the cars in the country will be electric. It invests tens of billions of dollars in R&D toward achieving that goal.

Such a move could make China the leader in the automotive technology of the future, with other countries struggling to keep pace. Shanghai Automotive Industry Corporation (SAIC) or newcomer BYD Auto could become the Ford Motor of the 21st century, propelled by a new technology—much as Ford capitalized on the internal-combustion engine at the start of the 20th century.

The Chinese government buys a 50-year lease on an entire geographic region of Mexico, enabling Chinese companies to build factories there to supply the North American market more easily.

Chinese companies would then become the undisputed leaders in outsourced production. No longer constrained by geography, they could bring their expertise in low-cost manufacturing to Mexico (or Poland or Turkey), greatly expanding their reach and overcoming obstacles—such as maintaining supply chains across the Pacific—that still hinder their growth.

A major office block collapses in Chaoyang, Beijing’s central business district.

Although officials would scramble to rewrite construction regulations, a disaster in the capital or another large city would change the relationship between the country’s growing middle class and the government and might threaten its ability to keep social unrest in check. True, construction standards came under fire after the May 2008 Sichuan earthquake felled many school buildings. But the reaction to that tragedy would pale beside the response to a similar one in a rich urban area with immediate media access.

A leading Chinese company tries to buy an iconic US technology firm (or two).

A major deal could be worth 10 or 100 times Lenovo’s $1.35 billion purchase of IBM’s PC division. If the US government blocked the sale, the acquisition’s failure could herald an era of renewed corporate nationalism in China, just as its companies were becoming more global. You could expect an aggressive increase in domestic R&D spending as the country focused on homegrown technology, as well as a chillier climate for multinationals with research operations in China.

A successful deal, by contrast, could create a truly global company, unlike anything seen before, with a multinational culture superseding any sense of national origins.

A restructuring of China’s telecommunications industry turns into a complete consolidation.

Regulatory failure and competitive imbalances have already reduced competition down to three major players, from four, and telecom companies are now being encouraged to share infrastructure. If stock prices continue their freefall and these imbalances remain, the inability of the second- and third-ranked players to chart a path to success could bring a full reconsolidation of the domestic industry.

The English Premier League football association buys its Chinese counterpart, the Chinese Super League.

What better way to signal a coming of age for China’s urban middle class? The takeover would be a major bet that this growing socioeconomic group is ready to spend heavily on sports and entertainment—a bet that could open the floodgates for investment in other consumer sectors. Wallets are already opening up: witness the Olympics and the US National Basketball Association’s exploration of franchise and stadium deals in China. Such a purchase would also show that the country is willing to bring outside expertise and professionalism into a challenged domestic industry.

Warming cross-strait relationships lead to a merger between the mainland’s Industrial and Commercial Bank of China and Taiwan’s Chinatrust Commercial Bank.

The reaction in Taiwan would probably be ambivalent—just another large business deal. But in China, a cross-strait merger of powerhouses like these, in banking or some other sector, would be applauded as an affirmation of its One China worldview.

Just-in-time strategy for a turbulent world

2008-10-28T11:07:00.003+05:30

Uncertainty and rising levels of risk make it impossible for companies to determine the future. But a portfolio-of-initiatives approach to strategy can help ensure that companies take full advantage of their best opportunities without taking unnecessary risks.

The classic approach to corporate strategy starts with a presumption: that with sufficient analytical rigor and an adequate assessment of the probabilities, strategists can pave a predictable path to the future from the matter of the past. In this world, they make reasonable assumptions about the evolution of product markets, capital markets, technology, and government regulation and, in effect, "assume away" most risk. Chief executive officers articulate strategy every few years, often in the context of a change in top management.

Such traditional strategy formulation often pays lip service to the perspectives of the capital markets, to changing industry structures, and to the forces at work in the environment. But in reality, a "visionary" corporate strategy is often an internally driven reflection of what the company wants the world to look like.

But suppose we no longer believe that the future is foreseeable. What if defining and achieving an enduring competitive advantage is really just a conceit that must be abandoned? What if the outstanding fact of business, as John Maynard Keynes once described it, is the "extreme precariousness of the basis of knowledge"? What if it is no longer possible to block out the "noise" of the world's messy reality in order to rationalize a plan to achieve predetermined outcomes?

In fact, this is the confusing, complex, and uncertain environment that corporate leaders now face. Globalization and technology are sweeping away the market and industry structures that have historically defined the nature of competition. Although the pace of change continues to accelerate, the fundamental transformations under way in the global economy have only just started.1 The variables that can profoundly influence success and failure are too numerous to count. That makes it impossible to predict, with any confidence, which markets a company will be serving or how its industry will be structured—even a few years hence.

The result is an economic environment that is rich in opportunity but also marked by a substantial increase in awareness of risk and aversion to it— a phenomenon reflected in the rise of risk premiums throughout the world even while the risk-free cost of capital remains low.

A new approach

Strategy today has to align itself to the fluid nature of this external environment. It must be flexible enough to change constantly and to adapt to outside and internal conditions even as the aspiration to deliver favorable outcomes for shareholders remains constant.

An analogy may help. Consider the management problem of moving supplies and ships across the Pacific Ocean during World War II. The starting point for the strategist was to recognize that controlling the environment—the weather in the Pacific—was beyond anyone's power but that risks could be minimized and schedules roughly set through the study of weather patterns and the use of navigational aids. But the real challenge was to consider factors beyond natural forces—factors such as enemy submarines, other enemy ships, and air attacks, analogous to corporate competitors with unknown capabilities and plans.

The strategist's answer was to deploy whole convoys with a mix of aircraft carriers, battleships, destroyers, escort ships, troop ships, and supply ships. Convoys improved the ability of each ship to cross the ocean and, crucially, helped to ensure, through "portfolio effects," that sufficient supplies made it across the ocean even when some ships didn't. The strategist couldn't know where battles might occur or which ships would be lost to enemy action. Yet the probability of success for individual vessels and the mission as a whole could be increased.

A CEO can think about corporate strategy as a 'portfolio of initiatives' intended to achieve favorable outcomes for the entire enterprise

Likewise, a CEO can think about corporate strategy not as a "portfolio of businesses" but as a "portfolio of initiatives" aimed at achieving favorable outcomes for the entire enterprise. Usually, these initiatives will be organized around themes—"convoys" if you please—focused on achieving particular aspirations, such as increasing the global reach of the enterprise, entering a new but related industry, or achieving the industry's lowest marginal cost of production. Portfolio effects increase the likelihood that some of these aspirations will be achieved even if many others fail.

Like a more traditional strategy, such an effort is best led by the corporate center and an activist CEO, making use of his or her command over talent and resources. Beyond that, however, most executives will find this approach more deductive, adaptive, and fluid than any they have used before.

Familiarity breeds opportunity

An approach that enables a corporation to mobilize convoys of initiatives now offers extraordinary payoffs. In the post-September 11 business environment, risk premiums have risen for all manner of investments. Consider the rise of risk premiums in the bond markets: in early 2002, for example, US Treasury bonds commanded nothing less than an 8 to 9 percent premium over B-rated corporate debt, compared with a spread of only 4 percent just ten years ago.

Risk premiums rise not only because the absolute level of risk increases but also because lenders require higher rates of return when they are unsure about how companies will perform—that is, when they lack deep famili-arity with the specific risks individual companies face. An investor who can acquire distinctive knowledge about particular B-rated credits and discern where the risk premiums are "too high" can create a bond portfolio with superior returns relative to the risks taken. Strategy thus becomes increasingly about gaining competitive advantage through deep familiarity (in other words, distinctive knowledge), which can transform the rise in risk premiums into increased rewards.

Consider another analogy. Of two runners, one is faster than the other and can be expected to win on a level track no matter how many times the race is run. But what if the race were held at night on a path strewn with rocks and fallen trees? Suppose that the slower runner practiced both in daylight and at night, while the faster one didn't bother to see the course in advance. The runner with the superior knowledge—the greater familiarity—would probably win even if the other were intrinsically faster. If the prize money were to rise, the value of familiarity would rise as well.

In today's increasingly global economic environment, confusion about risk is like the obstacles in this analogy. Familiarity makes them less dangerous. As the global economy evolves, and as geographic markets and industry structures aggregate, par-ticipants will enjoy a variety of advantages from familiarity and a variety of disadvantages from unfamiliarity. The strategic idea is constantly to adapt the corporation to this fluid environment and to take risks primarily where it enjoys the former, while shedding the latter.

A company that builds a portfolio of initiatives in areas in which it enjoys advantages of familiarity can prosper even amid uncertainty

Statisticians call this approach a search for "asymmetric" risk. Oddsmakers might call it "loading the dice," and it is the opportunity to capture this effect that makes a portfolio-of-initiatives approach so appealing today. If companies scanning the range of new opportunities choose to compete only where they have significant advantages of familiarity, and if they can build a portfolio of such initiatives, they make it highly probable that they can prosper even amid a high level of complexity and uncertainty.

A portfolio in action

Consider the hypothetical case of a financial company. Bank Multistate, a multiregional institution with $250 billion in assets and $2 billion in profits, was formed from a series of regional bank mergers. Its strengths lie in lending to small and midsize businesses, branch-based retail banking, credit cards, and mortgage banking. It also has special strengths in commercial finance and leasing.

Bank Multistate enjoys a number of familiarity advantages in many of its core businesses and geographic locations. It is particularly familiar with the use of technology to improve the productivity and underwriting results of lending to small businesses. The bank wants to explore whether it could use this skill to become an "outsourcing" intermediary for other banks. To load the dice in this initiative, Bank Multistate might begin by making a small bet ($1 million to $2 million) to assess the opportunity and design a value proposition. Its objective would be, first, to acquire distinctive knowledge by exploring market acceptance of its proposed offering and by "reverse-engineering" possible competing offerings. It would also work to acquire skills such as hiring experienced talent. During this exploratory phase, a full-time team of one senior manager and three or four junior managers and analysts would probably be deployed for four to six months.

Diagnosis and design can take a company only so far, however. Much of the needed familiarity can come only through experimentation, which in this case might include testing the new value proposition. At this point, Bank Multistate might need to make a medium-bet investment of $20 million to $30 million to undertake a pilot with two or three customers.

If the customer pilots proved successful, Bank Multistate might then be willing to make a large bet of $200 million or more so that the company could leapfrog potential competition. In any case, the decision on whether or not to scale up the business would be made "just in time," when further information had been gained from the pilots. By staging the investments, Bank Multistate would be using the passage of time to acquire deep familiarity and the option to expand, while still limiting its downside risk until the value proposition became clearer.

The hallmark of this approach is a willingness to change direction contin-ually as more and more distinctive knowledge is acquired. The approach implies an expectation that major midcourse corrections will be required, not that everything will go according to plan. It calls for a willingness to shut down initiatives if it becomes clear that they are headed nowhere.

Certain companies already use this approach in at least some of their strategic decision-making processes. The pharmaceutical industry has long used such disciplined processes to develop new drugs and medical devices, and so have venture capital firms, with their portfolios of companies. But most businesses are much less disciplined: far too often, large-scale decisions to build new businesses, to acquire or divest others, and even to adapt core businesses to changing conditions are made under extreme time pressure. In turn, these big, spur-of-the-moment decisions often come about because the company squandered its available lead time.

In particular, most companies put too little energy into adapting core businesses to changing markets. Indeed, they often unintentionally harvest their core businesses by pushing for short-term performance while neglecting the investments needed to stay ahead of the game. Often, companies move only when competitors start investing aggressively. When these companies do act, they usually make insufficient small-bet investments in diagnosis and design and skip the medium-bet prototyping and piloting steps entirely because they are trying to play catch-up. As a result, these initiatives are often exposed to entirely avoidable risks in execution, or, even worse, sometimes businesses panic and make bet-the-company investments based upon leaps of faith.

In a portfolio-of-initiatives approach, every major strategic action is subject to a disciplined process. Bank Multistate might, for example, have 10 to 20 such initiatives, at various stages of exploration, in order to build new businesses, to adapt its core businesses, and to acquire or divest businesses. The bank might have pursued some of these initiatives in the ordinary course of events. What makes a portfolio-of-initiatives approach different is the quantity of initiatives explored, the rigor of the analysis behind them, the discipline of the process, the willingness to make midcourse corrections, the staging of investments, the high degree of hands-on involvement by executives, the open discussion of issues, and the care taken before deciding whether to forge ahead.

Rigorous monitoring is crucial. The group for reviewing initiatives could consist of a strategy oversight team of the company's 20 or so top managers, chaired by the CEO, which would review initiatives perhaps monthly. Each initiative might well be reviewed several times before the final large-scale decision is made.

Increasing the visibility and transparency of these processes helps ensure that the best decisions are made and raises the stakes so that managers don't approach the group's work in a halfhearted way. The intent, of course, is to improve performance. In Bank Multistate's case, a favorable outcome for the shareholders might be financing five or six big-bet initiatives annually. In all, these might provide an extra 5 percent a year of growth in earnings and an extra 3 percent increase in the bank's return on equity—without involving big risks.

Three distinct elements are central to a portfolio-of-initiatives approach. First, it entails a disciplined search, based on familiarity, to discover and create initiatives that provide disproportionately high rewards for the risks taken. Second, it involves a dynamic, continuous effort to manage the portfolio of initiatives resulting from this search process and the use of time-management and portfolio theory to overcome unavoidable risks due to complexity and uncertainty. Finally, it calls for a flexible and evolutionary approach that lets "natural selection" rather than vision determine where, how, and when to compete. It may be useful to examine each of these elements in greater detail.

A disciplined search

CEOs might find it difficult to believe that there can be an abundance of "no-regrets" and "low-regrets" opportunities in these uncertain times. Yet the same global forces that create confusion, complexity, and uncertainty also create opportunities for companies to innovate in their core businesses. The world's markets and industry structures are in flux because the global forces at work are lowering the barriers to interaction.2 As interaction costs fall around the world, new economies of specialization, scale, and scope are being created—economies that can provide innovative companies with an abundance of opportunities to earn high rewards for the risks taken. Some companies, for example, are discovering that they can save up to a third of their labor costs in overhead or customer service functions by moving them to, say, Scotland or India.

Most large incumbents have dozens of high-potential opportunities to use their familiarity advantages to adapt their core businesses or to build closely related ones that could capture the new economies of scale, scope, or specialization. Many of these seemingly mundane opportunities will prove upon close examination to have higher returns, relative to the risks taken, than some other activities on which the company may already be investing its focus, talent, and discretionary spending. A daylong brainstorming session can usually generate dozens of ideas about potential opportunities.

The challenge is to convert these raw ideas into real investment opportunities. A company must organize a disciplined search to identify, enhance, and nurture its best ideas—and deploy some of its most talented people to pursue them—if it wants to create real opportunities to earn high returns relative to the risks taken. One of the hallmarks of a portfolio-of-initiatives approach is the overinvestment of scarce resources, such as discretionary spending, talent, and focus, on acquiring advantages of familiarity. No less important, senior management must "just say no" to making big bets in situations in which it lacks familiarity or is exposed to uncertain outcomes, even when competitors are making big strategic moves. As a rule of thumb, a company is familiar with opportunities when it doesn't have to take any large leaps of faith to understand where it expects to make returns from its investments.

Managing a portfolio of initiatives

Corporate-level involvement is essential because hard decisions must be made about allocating scarce resources to nurture the initiatives. Only the company's top-management team can balance the risks, rewards, and timing of each of the initiatives and make decisions about which to start, scale up, or terminate.

The challenge for a chief executive and the top-management team is to create enough initiatives to be reasonably sure that the company will be able to outperform the market's expectations. While it is essential always to have opportunities with large current returns, numerous small-bet initiatives can hold out the promise of large potential future returns once familiarity has been achieved. Much of the challenge of undertaking a portfolio-of-initiatives approach to strategy is the need to keep many balls in the air at the same time.

Executives employing a portfolio-of-initiatives approach should make the passage of time an ally. Checkpoint reviews, milestones, and staged investments enable managers to make maximum progress while minimizing risk. Pilot programs build familiarity before investments are scaled up. Risks arising from complexity and uncertainty fade as time passes, because the range of outcomes is reduced . Competitive advantage comes in the form of the progress a company makes while its competitors, paralyzed by confusion, complexity, and uncertainty, sit on the sidelines. The key is to be ready to act as soon as it becomes possible to estimate, in a reasonable way, the risks and rewards of an investment. The advantage lies not with the first mover but with the first mover that can scale up activities once the way forward has become clear and it is possible to see returns from larger bets.

A flexible and evolutionary approach

A successful portfolio-of-initiatives strategy involves creating enough initiatives offering high returns relative to the risks taken to enable a company to meet its aspirations and outperform the expectations of the capital markets. The process requires the CEO and the management team to keep an open mind about where the company might be headed. Inherent in this approach is the understanding that future decisions and future outcomes are likely to vary enormously from initial hypotheses. The whole process resembles art more than science. Most of the critical decisions involve subjective judgments that, unlike those generated by more deterministic strategies, will be informed by not just the highest-quality staff work but also the knowledge gained as time passes.

There is, of course, no substitute for the talent of a top-management team. But the advantage of the portfolio-of-initiatives approach is that it is far better at getting the most out of a company's top talent than are traditional approaches to strategy.

The Anatomy of Financial Crises: Understanding Their Causes and Consequences

2008-10-24T12:25:00.000+05:30

Crises have been a feature of the financial landscape for hundreds of years. They often appear with little warning, as the sub-prime mortgage crisis of 2007 and the Asian crisis of 1997-1998 illustrate. It's not always clear what causes crises, whether they can be avoided and how their impact can be reduced. A recent book, titled Understanding Financial Crises (Oxford University Press), by Wharton finance professor Franklin Allen and Douglas Gale, a professor of economics at New York University, tackles this subject from a number of different angles. The authors review the history of financial crises in addition to offering their own approach to examining the underlying causes. Allen and Gale also discuss asset price volatility, the interaction between banks and markets, bubbles and financial contagion, among other topics. Below is an excerpt from the book.
What happened in Asia in 1997? Countries such as South Korea, Thailand, Indonesia, Singapore and Hong Kong whose economies had previously been the envy of the world experienced crises. Banks and other financial intermediaries were put under great strain and in many cases collapsed. Stock markets and currencies plunged. Their real economies were severely affected and their GDPs fell significantly. What were the causes of these dramatic events?
To many people these crises were a new phenomenon. There had been crises in other countries such as Mexico and Brazil but these could be attributed to inconsistent government macroeconomic policies. In those cases taxes were too small relative to government expenditures to maintain a fixed exchange rate. This was not the case for the Asian crisis. Other causes were looked for and found. The institutions in these countries were quite different from those in the U.S. Many had bank-based financial systems. There was little transparency either for banks or corporations. Corporate governance operated in a quite different way. In many cases it did not seem that managers' interests were aligned with those of shareholders. In some countries, such as Indonesia, corruption was rife. These factors were seen by many as the cause of the crises. However, they had all been present during the time that these countries were so successful.
Others blamed guarantees to banks and firms by governments or implicit promises of "bail-outs" by organizations such as the International Monetary Fund (IMF). Rather than inconsistent macroeconomic policies being the problem, bad microeconomic policies were the problem. Either way it was governments and international organizations that were to blame.
In this book we argue that it is important not to take too narrow a view of crises. They are nothing new. They have not been restricted to emerging economies even in recent times. The Scandinavian crises of the early 1990s are examples of this. Despite having sophisticated economies and institutions, Norway, Sweden and Finland all had severe crises. These were similar in many ways to what happened in the Asian crises of 1997. Banks collapsed, asset prices plunged, currencies came under attack and their value fell. Output was severely affected.
Taking an historical view, the period from 1945 to 1971 was exceptional. There were no banking crises anywhere in the world, apart from one in Brazil in 1962. There were currency crises when exchange rates were pegged at the wrong levels but that was all. Going back to the first half of the twentieth century and before, there were many examples of financial crises. The stock market crash of 1929, the banking crises of the early 1930s and the Great Depression was one of the most dramatic episodes. There were many others, particularly in the U.S. in the last half of the nineteenth century when it had no central bank. In Europe, crises were much less frequent. The Bank of England had learned to prevent crises and the last one there (prior to the recent Northern Rock episode) was the Overend & Gurney crisis of 1866. Other central banks also learned to prevent crises and their incidence was significantly reduced. Prior to that, crises were endemic in Europe as well.
Particularly after the experience of the Great Depression in the period prior to 1945-1971, crises were perceived as a market failure. It was widely agreed they must be avoided at all costs. The reform of the Federal Reserve System in the early 1930s and the extensive regulation of the financial system that was put in place in the U.S. were part of this mindset. In other countries financial regulation went even farther. Governments controlled the allocation of funds to different industries through state-owned banks or heavily regulated banks. This extensive regulation was the cause of the virtual disappearance of banking crises from 1945 to 1971.
However, the elimination of crises came at a cost. Because of the extensive regulation and government intervention, the financial system ceased to perform its basic function of allocating investment. There were many inefficiencies as a result. This led to calls for deregulation and the return of market forces to the allocation of investment. As a result, crises have returned.
Crises in Different Eras
Bordo [and others] have addressed the question of how recent crises such as the European Monetary System Crisis of 1992-93, the Mexican crisis of 1994-5, the Asian crisis of 1997-98, the Brazilian crisis of 1998, the Russian crisis of 1998, and the Argentinian crisis of 2001 compare with earlier crises. They identify four periods.
1. Gold Standard Era 1880-1913
2. The Interwar Years 1919-1939
3. Bretton Woods Period 1945-1971
4. Recent Period 1973-1997
As we shall see, there are a number of similarities between the periods but also some important differences. They consider 21 countries for the first three periods and then, for the recent period, give data for the original 21 as well as an expanded group of 56.
The first issue is how to define a crisis. They define a banking crisis as financial distress that is severe enough to result in the erosion of most or all of the capital in the banking system. A currency crisis is defined as a forced change in parity, abandonment of a pegged exchange rate or an international rescue. The second issue is how to measure the duration of a crisis. To do this, they compute the trend rate of GDP growth for five years before. The duration of the crisis is the amount of time before GDP growth returns to its trend rate. Finally, the depth of the crisis is measured by summing the output loss relative to trend for the duration of the crisis.
With regard to the frequency of crises in the four periods, comparing the data with the original 21 countries, the interwar years are the worst. This is perhaps not surprising given that this was when the Great Depression occurred. Banking crises were particularly prevalent during this period relative to the other periods.
The Bretton Woods period is very different from the other periods. After the Great Depression, policymakers in most countries were so determined not to allow such an event to happen again that they imposed severe regulations or brought the banks under state control to prevent them from taking much risk. As a result banking crises were almost completely eliminated. There was one twin crisis in Brazil in 1962, but apart from that, there were no other banking crises during the entire period. There were frequent currency crises but as we have seen, these were mostly situations where macroeconomic policies were inconsistent with the level of the fixed exchange rates set in the Bretton Woods system.
Interestingly the most benign period was the Gold Standard Era from 1880-1913. Here banking crises did occur but were fairly limited, and currency and twin crises were limited compared to subsequent periods. Since the global financial system was fairly open at this time, the implication is that globalization does not inevitably lead to crises.
The recent period is not as bad as the interwar period but is nevertheless fairly bad. Banking and twin crises with both banking and currency crises are more frequent than in every period except the interwar years, and currency crises are much more frequent. This is especially true if the sample of 56 countries is used as the basis of comparison rather than the 21 countries used in the other periods. The countries that are added to create the larger sample are mostly emerging countries. This suggests that emerging countries are more prone to crises and particularly to currency crises.
In recent years, emerging countries have been particularly prone to currency crises and twin crises. During the Interwar period, it was the industrial countries that were particularly hard hit by crises. They were actually more prone to currency and twin crises than the emerging countries. Recessions with crises have a much higher loss of GDP than recessions without crises. This was particularly true in the interwar period. Also the average recovery time is somewhat higher in recessions with crises rather than recessions without crises.
Some Recent Crises
Now that we have seen a comparison of recent crises with crises in other eras, it is perhaps helpful to consider some of the more recent ones in greater detail. We start with those that occurred in Scandinavia in the early 1990s.
The Scandinavian Crises
Norway, Finland and Sweden experienced a classic boom-bust cycle that led to twin crises. In Norway, lending increased by 40 percent in 1985 and 1986. Asset prices soared while investment and consumption also increased significantly. The collapse in oil prices helped burst the bubble and caused the most severe banking crisis and recession since the war. In Finland an expansionary budget in 1987 resulted in massive credit expansion. Housing prices rose by a total of 68 percent in 1987 and 1988. In 1989, the central bank increased interest rates and imposed reserve requirements to moderate credit expansion. In 1990 and 1991, the economic situation was exacerbated by a fall in trade with the Soviet Union. Asset prices collapsed, banks had to be supported by the government and GDP shrank by 7 percent. In Sweden, a steady credit expansion through the late 1980s led to a property boom. In the fall of 1990, credit was tightened and interest rates rose. In 1991, a number of banks had severe difficulties because of lending based on inflated asset values. The government had to intervene and a severe recession followed.
Japan
In the 1980s, the Japanese real estate and stock markets were affected by a bubble. Financial liberalization throughout the 1980s and the desire to support the United States dollar in the latter part of the decade led to an expansion in credit. During most of the 1980s, asset prices rose steadily, eventually reaching very high levels. For example, the Nikkei 225 index was around 10,000 in 1985. On December 19, 1989, it reached a peak of 38,916. A new Governor of the Bank of Japan, less concerned with supporting the U.S. dollar and more concerned with fighting inflation, tightened monetary policy, which led to a sharp increase in interest rates in early 1990. The bubble burst. The Nikkei 225 fell sharply during the first part of the year and by October 1, 1990, it had sunk to 20,222. Real estate prices followed a similar pattern. The next few years were marked by defaults and retrenchment in the financial system. Three big banks and one of the largest four securities firms failed. The real economy was adversely affected by the aftermath of the bubble and growth rates during the 1990s and 2000's have mostly been slightly positive or negative, in contrast to most of the post war period when they were much higher. Using the average growth rate of GDP of 4 percent from 1976-1991, the difference between trend GDP and actual GDP from 1992-1998 is around ¥340 trillion or about 68 percent of GDP.
The Asian Crisis
From the early 1950s until the eve of the crisis in 1997, the `Dragons' (Hong Kong, Singapore, South Korea, and Taiwan) and the `Tigers' (Indonesia, Malaysia, the Philippines, and Thailand) were held up as models of successful economic development. Their economies grew at high rates for many years. After sustained pressure, the Thai central bank stopped defending the baht on July 2, 1997, and it fell 14 percent in the onshore market and 19 percent in the offshore market. This marked the start of the Asian financial crisis.
The next currencies to come under pressure were the Philippine peso and the Malaysian ringitt. The Philippine central bank tried to defend the peso by raising interest rates, but it nevertheless lost $1.5 billion of foreign reserves. On July 11, it let the peso float and it promptly fell 11.5 percent. The Malaysian central bank also defended the ringitt until July 11 before letting it float. The Indonesian central bank defended the rupee until August 14.
The Dragons were also affected. At the beginning of August, Singapore decided not to defend its currency and by the end of September it had fallen 8 percent. Taiwan also decided to let their currency depreciate and was not much affected. Hong Kong's exchange rate, which was pegged to the dollar, came under attack. However, it was able to maintain the peg. Initially, the South Korean won appreciated against the other South East Asian currencies. However, in November it lost 25 percent of its value. By the end of December 1997, which marked the end of the crisis, the dollar had appreciated by 52, 52, 78, 107, and 151 percent against the Malaysian, Philippine, Thai, South Korean, and Indonesian currencies, respectively.
Although the turbulence in the currency markets was over by the end of 1997, the real effects of the crisis continued to be felt throughout the region. Many financial institutions and industrial and commercial firms went bankrupt and output fell sharply. Overall, the crisis was extremely painful for the economies involved.
The Russian Crisis and Long Term Capital Management (LTCM)
In 1994, John Meriwether, who had previously worked for Salomon Brothers and had been a very successful bond trader, founded LTCM. In addition to Meriwether, the other partners included two Nobel-prize winning economists, Myron Scholes and Robert Merton, and a former vice-chairman of the Federal Reserve Board, David Mullins. The fund had no problem raising $1.3 billion initially.
The fund's main strategy was to make convergence trades. These involved finding securities whose returns were highly correlated but whose prices were slightly different. The fund would then short (i.e. borrow) the one with the high price and use the proceeds to go long in the one with the low price. The convergence trades that were taken included the sovereign bonds of European countries that were moving towards European Monetary Union, and on-the-run and off-the-run U.S. government bonds. Since the price differences were small, the strategy involved a large amount of borrowing. For example, at the beginning of 1998, the firm had equity of about $5 billion and had borrowed over $125 billion.
In the first two years the fund was extremely successful and earned returns for its investors of around 40 percent. However, 1997 was not as successful, with a return of 27 percent, which was about the same as the return on equities that year. By this time, LTCM had about $7 billion under management. Meriwether decided to return about $2.7 billion to investors as they were not able to earn high returns with so much money under management.
On August 17, 1998, Russia devalued the rouble and declared a moratorium on about 281 billion roubles ($13.5 billion) of government debt. Despite the small scale of the default, this triggered a global crisis with extreme volatility in many financial markets. Many of the convergence trades that LTCM had made started to lose money as the flight to quality caused prices to move in unexpected directions. By September 22, 1998, the value of LTCM's capital had fallen to $600 million. Goldman Sachs, AIG, and Warren Buffett offered to pay $250 million to buy out the partners and to inject $4 billion into the business so that it would not be forced to sell out its positions. Eventually, the Federal Reserve Bank of New York coordinated a rescue whereby the banks that had lent significant amounts to LTCM would put $3.5 million for 90 percent of the equity of the fund and take over the management of the portfolio. The reason the Fed did this was to avoid the possibility of a meltdown in global asset markets and the systemic crisis that would follow.
The Argentina Crisis of 2001-2002
During the 1970s and 1980s, Argentina's economy did poorly. It had a number of inflationary episodes and crises. In 1991, it introduced a currency board that pegged the Argentinian peso at a one-to-one exchange rate with the dollar. This ushered in a period of low inflation and economic growth. Despite these favorable developments, a number of weaknesses developed during this period, including an increase in public sector debt and a low share of exports in output and a high concentration of these in a limited number of sectors.
In the last half of 1998, a number of events, including the crisis in Brazil and the resulting devaluation and the Russian crisis, triggered a sharp downturn in Argentina's economy. The public debt the government had accumulated limited the amount of fiscal stimulation that the government could undertake. Also the currency board meant that monetary policy could not be used to stimulate the economy. The recession continued to deepen. At the end of 2001, it began to become clearer that Argentina's situation was not sustainable. The government tried to take a number of measures to improve the situation, such as modifying the way that the currency board operated. Exporters were subject to an exchange rate that was subsidized and importers paid a tax. The effect of these kinds of measures was to lower confidence rather than raise it. Despite an agreement with the IMF in September 2001 to inject funds of $5 billion immediately and the prospect of another $3 billion subsequently, the situation continued to worsen. There were a number of attempts to restructure the public debt but again, this did not restore confidence.
During November 28 to 30, there was a run on private sector deposits. The government then suspended convertibility in the sense that it imposed a number of controls, including a weekly limit of 250 pesos on the amount that could be withdrawn from banks. In December 2001, the economy collapsed. Industrial production fell 18 percent year-on-year. Imports fell by 50 percent and construction fell 36 percent. In January 2002, the fifth president in three weeks introduced a new currency system. This involved multiple exchange rates depending on the type of transaction. In February, the peso was allowed to float and it soon fell to 1.8 pesos to the dollar.
Overall, the crisis was devastating. Real GDP fell by about 11 percent in 2002 and inflation in April 2002 went to 10 per cent a month. The government defaulted on its debt. The economy started to recover in 2003 and has done well since then.
Theories of Crises
The contrast between the majority view concerning the cause of crises in the 1930s and the view of many today is striking. In the 1930s, the market was the problem and government intervention through regulation or direct ownership of banks was the solution. Today many argue that inconsistent government macroeconomic policies or moral hazard in the financial system caused by government guarantees is at the root of recent crises. Here the view is that government is the cause of crises and not the solution. Market forces are the solution.
The aim of this book is to provide some perspective on this debate by developing a theoretical approach to analyze financial crises. In each chapter we develop the basic ideas and then provide a brief account of the theoretical and empirical literature on the topic.
We start in Chapter 2 with some background material. Chapter 3 considers intermediation. Chapter 4 investigates the operation of asset markets where asset price volatility is driven by liquidity shocks. Rather than just focusing on banks as in Chapter 3, or on markets as in Chapter 4, in Chapter 5 the interaction of banks and markets is considered. It is shown that small events can trigger a large effect so there is financial fragility as in the Russian Crisis of 1998. While in Chapters 3-5 the focus is on understanding the positive aspects of how various types of crisis can arise, in Chapter 6 we develop a general framework for understanding the normative aspects of crises. The model is a benchmark for investigating the welfare properties of financial systems. Having identified when there is a market failure, the natural question that follows is whether there exist policies that can correct the undesirable effects of such failures. This is the topic of Chapter 7. Chapter 8 considers the effect of allowing for money and the denomination of debt and other contracts in nominal terms. The final two chapters in the book consider two forms of crisis that appear to be particularly important. In many instances, financial crises occur after a bubble in asset prices collapses. How these bubbles form and collapse and their effect on the financial system is the subject of Chapter 9. Contagion through interbank markets is the subject matter of Chapter 10.

Siemens CEO Peter Löscher: A Company Is Only as Good as Its Values

2008-10-24T12:16:00.001+05:30

It would be hard enough under any circumstances to become the first outsider named to lead a 161-year-old global conglomerate, but Peter Löscher faced a unique challenge last summer when he assumed the reins at Siemens AG -- the German-based engineering and healthcare giant.

Löscher said he has moved aggressively to change the firm's culture and standards.

"Corruption exists in the whole world; but it's not our marketing plan," Löscher told. "It is not the business we are interested in, and it's not a sustainable business model, either." The Siemens CEO described his first-year mission as making sure that "the organization, from a cultural perspective, understands that this is a zero tolerance policy, that we stand for the highest performance with the highest ethical standards -- and [that the goal is] to put all the control systems in place and to travel the world and spread the word that there's absolutely no compromise whatsoever."

Löscher's international resume and personal history suggest he may be the right person to serve as a kind of worldwide ethics ambassador for Siemens, which currently does business in 190 different countries. Born on the side of Austria that borders Italy -- his parents are Austrian and his grandmother is Italian -- Löscher worked for a number of years in Japan, Spain and, most recently, the United States, before assuming the top job at Siemens. Two of his children were born in the U.S. and one in Spain, and the youngest is already speaking four languages -- at age three.

Valuing diversity as a path to success both in life and in the business world was a steady theme running throughout Löscher's presentation. At Siemens, which has about $110 billion in annual revenues and roughly 400,000 employees worldwide, one of "the key elements is diversity," he noted, "because the connectivity of our world has never been greater than today."

Coca-Cola and the Catholic Church

Although much of his talk was focused on personal leadership advice, he also provided a broad overview of where Siemens has been as a company over more than a century and a half, and where the giant firm is headed now.

The current path begins with corporate ethics. Löscher has shaken up the management structure, reduced a middle layer of bureaucracy and imposed new executive principles. As part of his effort to rebuild the company, Löscher launched his tenure with a 100-day listening tour that took him around the world to key Siemens locations, where he met with employees and clients.

But Löscher -- who was president of global human health for Merck in New Jersey before he was tapped by Siemens -- has also reorganized the business model at his new employer. Since arriving, he has divided the German-based company into three broad divisions -- industrial, energy and healthcare -- in order to capitalize on the company's broad strength in those areas.

In a brief history of Siemens, he noted that the company is seeking to re-emphasize the two qualities that have always defined it: a global approach to sales and a drive to innovate. Within five years of the founding of Siemens in Berlin in 1847 by telegraph technologist Werner von Siemens, one of his brothers had set up shop in Russia -- a first at that time -- and another was operating in London. The firm's emphasis on global communications gave Siemens an early start in a number of key nations; Siemens was doing business in China in 1872, India in 1868 and Japan in 1875.

That tradition has continued. "We like to say only a few organizations are more global than we are -- among them probably the Catholic Church, the world soccer organization and Coke," Löscher said. "Coca-Cola is one of our customers, by the way, so the global footprint obviously is a key element."

But he noted that the company would not have achieved that kind of global success without the right products. Some of these were on the cutting edge of their time, like the first trans-Atlantic cable from Ireland to New York in 1875, while at least one was ahead of its time -- a prototype for an electric car that Siemens unveiled in 1904. Quipped Löscher: "We underestimated all the issues around storage and power life, but at least in terms of long-term innovation, it was in our sights."

Today, he said, Siemens is combining that spirit of innovation and its know-how in the area of information technology to revolutionize healthcare, which is an increasingly important sector of the company. Ironically, Siemens came perilously close to shedding its medical unit about a decade ago.

"In the 1990s, all the investment analysts were proclaiming that Siemens is too complex, that the healthcare business is not in tune with the rest of the businesses, that the healthcare business should be sold off," Löscher said. But instead, information technology has become a much greater factor in healthcare products -- especially in diagnostics, where Siemens is now the No. 1 player. The lesson from that experience, he added, is that when corporate leaders develop a long-term strategy, it's important that they stick to it, in spite of the short-term obstacles.

The key to Siemens' success in diagnostics is understanding that the company's selling point is getting the best information to the clinicians, regardless of whether that comes from an electronic scanner or from an in-vitro test tube kit. "I would say that information is the critical element, that any organization has to move away from products and think about total solution packages. The information element is a part of it."

The Importance of Disruptive Technology

Increasingly, Löscher said, those key scientific ideas will be coming from collaboration outside the corporate walls. "I have found out that disruptive technology is happening anywhere in the world -- big and small but usually fast, creative and innovative. Consider that 90% of the innovation agenda is happening outside of any organization. So you have to make sure that your business is truly connected."

He said his experiences working in Japan, where he was an executive in the 1990s for two firms, including the pharmaceutical company Aventis, taught him the business advantages of cultural diversity and understanding. For one thing, he learned that the word "no" is not a part of the vocabulary in Japan. "So many misunderstandings happen when you negotiate in the Asian context with an inexperienced team. It's because the signals are not received in the right context. [Inexperienced non-Japanese negotiators] don't fully understand that a certain expression that is not the word 'no' is actually a 'no.'"

Löscher was also surprised to learn when he worked on some major mergers and acquisitions in Japan that the CEO not only steps back from the talks, but that the most junior members of the negotiating team are expected to play the critical role. "As CEO, I am the face of the organization, so if I take a position and I lose my position, I have lost face. My organization tries at all times to protect me."

Löscher's advice to his audience included his own experience in the job market -- and the importance of finding a career that is, above all, challenging and rewarding. He had studied economics at Vienna University and in Hong Kong, earned an MBA in Vienna as well as an advanced degree from Harvard Business School, and worked as a senior management consultant before joining a German chemical company. His mentor became the firm's CEO and so Löscher presented him with an ambitious plan.

"I laid out my career path -- what I would like to do -- and I started to discuss it with him. As [my presentation] ended, he looked at it and turned it around and put it down and said, 'You know, this actually doesn't matter. The thing that matters is whatever you do, you have to enjoy.'"

Returning to the major challenge confronting him -- instituting an ethics overhaul at a company as large as Siemens -- Löscher encouraged anyone thinking about joining a particular organization "to look at its values, and at how the senior leadership team is actually living the values." Companies all around the globe, he added, "have all the rules in the world. They live in a rules-based environment. But the rules are only as good as how they fit the culture and organization."

Obama and McCain: Different -- and Evolving -- Visions for the U.S. Economy

2008-10-24T12:02:00.001+05:30

With Americans facing gasoline prices of $4 a gallon, record home foreclosures and fears about unemployment, presidential candidates John McCain and Barack Obama are increasing their focus on economic policy in their campaigns for the presidency.

For the most part, the positions of the presumptive nominees, Republican McCain and Democrat Obama, fall along traditional party lines: Obama leans more toward government involvement in the economy, while McCain's proposals rely on private sector solutions. Both plans, however, would certainly add to already troubling deficits, according to Wharton faculty and economic policy analysts who point to worrisome elements of both candidates' plans.

"It's early in the election cycle. Both candidates have an opportunity to refine -- and rethink -- their economic policies," says Richard Marston. "Both had better do more rethinking before one of them becomes president."

Voters are growing increasingly concerned about the nation's financial situation. More than half of Americans, 56%, describe the country's economic condition as poor, while 33% say the economy is only fair, according to The Pew Research Center for the People & the Press.

"People are very attuned to the economy. In the polls, it has taken precedence over the Iraq war, which has perhaps faded to a dull roar in people's consciousness," says Brooks Jackson, director of Annenberg Political Fact Check, a group based at Penn's Annenberg Public Policy Center that monitors the accuracy of statements by major U.S. political players. "We're going through an unprecedented and very scary period with home prices and an unprecedented increase in energy prices. Nobody knows where it's going to stop."

The divide between the two major candidates is clear in tax policy. Obama wants to let the Bush Administration's tax cuts expire, as scheduled, at the end of 2010 and provide new tax breaks for low-income workers, senior citizens, students and start-up companies. When McCain launched his campaign, he opposed the tax cuts because he said they favored the wealthy and reduced the availability of government resources during wartime. Now he says the cuts should remain in place because allowing them to expire would amount to a tax increase at a time when the economy is already weak.

McCain also wants to reduce the corporate tax rate from 35% to 25%. Obama supports a corporate tax rate cut as well, but has not specified exactly how large. In addition, Obama would raise capital gains taxes on Americans earning more than $250,000 a year, while McCain would maintain current tax rates on capital gains and dividends.

On the campaign trail, Obama has called Bush "fiscally irresponsible" and said McCain is running to serve George W. Bush's third term -- only more irresponsibly. "When it comes to taxes," Obama has added, comparing McCain to the incumbent president is "not being fair to George Bush." McCain's camp has fired back with charges that Obama's ideas are unrealistic and will result in government intervention that will slow economic growth. Douglas Holtz-Eakin, chief economic aide to John McCain, said Obama's proposals are "like being for kittens, puppies and sunshine."

Voters Need a Clearer Vision

According to Marston, McCain's proposal to extend the Bush tax credits amounts to campaign rhetoric in the current climate. "There is no way all of the cuts will be extended now that the political winds have shifted," he says, adding that McCain has not been able to articulate which of his proposed tax cuts is most important. "Voters need a clearer economic vision."

Obama's tax policy, he suggests, is more refined than those presented by the Democratic candidates in the last two elections. For example, his plan explicitly aims taxes at Americans making more than $250,000 a year. "The thought appears to be that those making less than that will readily approve such tax increases. It remains to be seen whether this is the case, but it's a definite change in strategy." Marston says Obama and his advisors have not addressed the issue of whether higher taxes will have an impact on incentives for businesses to reinvest and create new growth. "Will this affect risk-taking by entrepreneurs who provide the innovation that the country thrives on?" Marston asks. "If so, would other tax increases, say on dividends, be preferable?"

McCain's support for the Bush tax cuts is a mistake because they will continue to deepen the U.S. budget deficit. "The deficit and the trade deficit -- which are related -- are hurting us and are going to hurt us a lot more in the future."

As for Obama, Pack says his tax and spending policies are more complicated than McCain's, making it more difficult to gauge their impact. "While I like the idea of undoing the Bush tax cuts, Obama's plan is not that simple and it's not exactly clear what the net effect would be." For example, Obama has outlined plans to spend $15 billion a year for 10 years on energy technology funded by revenue collected through a system of trading pollution permits. He also would create an "infrastructure reinvestment bank" that would finance $60 billion in high-speed railways, energy grids and other projects over 10 years.

According to the Tax Policy Center, a joint venture between the Urban Institute and the Brookings Institution, the two candidates' specific non-health tax proposals would reduce tax revenues by $3.6 trillion (McCain) and $2.7 trillion (Obama) over the next 10 years, or approximately 10% and 7% of the revenues scheduled for collection under current law.

"Both sets of policies are bad in that they don't balance the federal budget and they would each run up deficits," says Roberton Williams, principal research associate at the Tax Policy Center. "Those are deep holes to fill back in with spending cuts. If we run deficits like that somewhere down the road we will have to worry about paying back those costs." He says the need to raise taxes in the future may outstrip the gains made by cutting taxes now. "Both plans would impose costs on our children and grandchildren at a time when Baby Boomers in retirement will be demanding more and more resources as well."

Touching the 'Third Rail'

Each candidate has already made some statements about Social Security, which is sometimes called the "third rail" of politics because addressing the issue of solvency is likely to rile beneficiaries. Obama wants to eliminate the payroll tax limit, but give an exemption for people making between $102,000 and $250,000 a year. He would also eliminate the income tax on Social Security benefits for people making less than $50,000 a year. He notes that McCain wants to appoint a bipartisan commission to explore changes to the system. Unlike Bush's previous commission, which was handpicked by the White House, McCain will let Democrats pick their own representatives, says Smetters, adding that McCain's commission will likely be composed of members of Congress in order to force the issue on them.

Obama's proposed tax increase on people making above $250,000, who already pay the majority of the nation's taxes, will mean a marginal tax rate on wages of around 65% in high tax states such as California and New York, up from about 45% today, Smetters adds. "Even then, Social Security and Medicare will be quite broken and so more revenue will be needed from them. So we are talking about a very sharp increase in taxes. While most everyone agrees that the rich should pay a larger proportion of their income in taxes, even John Kennedy thought it was a bad idea to hit the job creators that hard."

He also points out that Obama's tax reduction on those making below $50,000 essentially defeats the purpose of the Earned Income Tax Credit, which already offsets taxes on the poor.

"However, Obama, being a Democrat, is more likely to be trusted by the public to control the growth rate of benefits, and so he might be more effective at creating overall reform," says Smetters. "McCain will need the commission for cover."

Smetters argues that the best approach to Social Security is to control the growth rate of benefits for richer people at a rate no higher than inflation, while getting some additional revenue by removing the preferential tax treatment on employee benefits that he says encourages over-utilization.

Medicare, he notes, is a much bigger problem and harder to solve equitably. "To McCain's credit, he voted against Bush's disastrous Part D Medicare expansion even though McCain represents one of the most aged population states in the country. That obviously took a lot of guts. I don't see Obama ever taking that type of risk."

McCain and Obama have at least begun to discuss Social Security fairly early in this campaign, perhaps for two reasons, says Smetters. One is that this is the first presidential election in which the Baby Boom generation is entering retirement. The other is that McCain has used the "privatization" label in the past to describe a proposal to allow young workers to earmark Social Security savings in private plans. McCain is polling well with people above age 65 and needs to reassure them that Social Security will be there for them, Smetters says, adding that Obama will probably use the "privatization" label on McCain's plan because that term polls poorly. The candidates are not likely to put forth more extensive plans before the election, because that might require tough medicine for beneficiaries or "gimmicks. Either way you open yourself up to criticism."

Cracking Down on 'Reckless Behavior'

The candidates' economic proposals come against a background of financial instability linked to the subprime credit meltdown and call for greater regulation of credit companies. In a speech before the National Small Business Summit, McCain said Americans "are right to be offended" by the "extravagant salaries and severance deals" of corporate officers who have engaged in "reckless corporate behavior." He vowed that federal prosecutors will go after wrong-doers.

Meanwhile, Obama has come out in support of measures to help homeowners protect themselves against foreclosure and additional oversight of the credit industry. Pack says the current mortgage meltdown is the predictable result of policies created during the Bush and Clinton administrations encouraging homeownership for people who should not have been qualified for mortgages. "It was crazy at the time and the results could have been foretold, but it was a popular policy among certain people."

Marston predicts financial sector regulation will be a major issue after the election, especially following the rescue of Bear Stearns. "The precedent has been set for the Fed to help rescue an investment bank -- not a commercial bank as it has in the past -- so the new president will have to figure out what that means for regulation," he says. "It's a big issue, but we have no idea what Obama or McCain will do about that."

According to Marston, trade is another area of concern. In the Ohio Democratic primary debate, Obama suggested he might renegotiate the North American Free Trade Act (NAFTA). "I think that is just campaign rhetoric. But it remains to be seen whether he is as much of a free trader as Bill Clinton was," says Marston, who adds that NAFTA would never have been approved without strong support from Clinton.

"Obama probably won't reverse previous advances, but we don't know whether his heart will be in new initiatives. McCain will back free trade just as Reagan and every president since then has done, but Obama is a question mark."

Pack says that to pull back on current trade policies would be a mistake. "There's hardly an economist in the world who would argue that expanding free trade is not a good thing. [A pullback] may be popular with unions or some employees, but it is not the way to go. It's really sad to see that after President Clinton pressed for NAFTA and a reduction in tariffs, this is such a big issue. It's pandering." Pack argues that low-income consumers in the United State benefit from free trade which allows them to buy goods cheaper from developing nations that, in turn, need access to markets to help their populations emerge from poverty. "The major animus is directed at China and there are many reasons for that besides trade. A lot of people are buying things from China they could not otherwise buy. "

Overseas Views

The trade debate is of interest overseas -- but many economic analysts in key trading-partner nations such as China and India and in Latin America consider the campaign-related comments on trade to be mostly pre-election bluster.

Yuan Zheng, associate director of the U.S. Diplomacy Research Center of the China Social Science Academy, has suggested that U.S. trade policies with China are based on U.S. national interest rather than on the personal views of the president. Some people will send strong signals on certain topics to get elected, he adds, but after being in office for a while, the president will then get back to further boosting the Sino-U.S. relationship.

"You hardly see any Chinese intellectuals with a strong preference [for either of] these two candidates," says Xiao Geng, Director of the Brookings-Tsinghua Center in Beijing. "No matter who wins, things will come back to the expected policies.... [the] China-U.S. relationship is way too important."

Still, some researchers expect the dollar to get stronger after the election, which could have an impact on trade; a weaker dollar makes Chinese products more expensive in the U.S. and U.S. products more expensive in China. As the dollar strengthens, the U.S. trade deficit with China could become a bigger political issue. Jian Feng, director of the structural finance research center at the China Social Science Academy, said in a speech in early April that "if you look at what happened in the past, the dollar generally depreciates pre-election and then appreciates post-election. I think [after] this year, you will mostly see the dollar get stronger."

In the Indian business magazine Business Today, V.K. Kaul, professor of business economics at Delhi University, said that rating the most favorable candidate from India's perspective is a futile exercise. "Any U.S. president will look to promote only that country's interests. Who comes to power is, therefore, immaterial."

"If one was to look purely from a trade and outsourcing perspective ... McCain seems to be a better choice for India," says Ravi Bapna, a professor at the India School of Business. "But when push comes to shove, even the Democrats, despite all their rhetoric during campaigning, will not be able to walk away from globalization. No U.S. president can walk away from market-based mechanisms which are now so deeply embedded.

"What are perhaps more important issues are geopolitical stability, the war in Iraq and how to get America back to the intellectual standards that it once had and which have been eroded in recent years," Bapna adds. "In that sense, Obama is much more of a dynamic personality who can really bring back America's intellectual place in the world. And if that happens, then other good things will follow naturally."

Yogen Lal, chief operating officer (COO) of the Mumbai-based Unity Infraprojects, one of India’s leading players in infrastructure development, sticks to conventional wisdom. “Democrats have traditionally supported India,” he says. “In my opinion, Obama will be better for India.”

Pradeep Mukherjee, who previously worked for Citibank for several years in the U.S and now is CEO of Mumbai-based HR consultancy Potential Unlimited, says that if he had to choose, he would opt for Obama, but not for any business or economic reasons. “I expect Obama to ask the question: ‘Why does the world hate America so much these days?’ He may not have an easy solution, but he will at least be looking for the answers. Secondly, I respect Obama for what he has achieved at his age and against all the odds.”

McCain, he asserts, “is an unknown quantity” in India. “Nobody knows what he stands for. But because he belongs to the same party as Bush, he starts off with several strikes against him.”

Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB), says that the Bush presidency was quite favorable for India. Chakrabarti spent nearly a decade at the Georgia Tech College of Management and is thus keenly aware of both the U.S. and the Indian political process and sensitivities.

“The Clinton presidency was very good for India too,” Chakrabarti adds. “Of course it is difficult to estimate as to how much of that was because of the presidency or because of world events. If one looks back, since the collapse of the Soviet Union, the relationship between India and the U.S. has warmed and improved almost continuously during both Republican and Democratic presidencies. There was some freeze because of the nuclear testing but that was a one-time event and any president in power would have acted the same. The way in which the Republicans and the Democrats handle the world affairs, especially in the Middle East, could have an indirect impact on India. But here also I don’t see any major difference between the two in terms of new developments.”

Still, Chakrabarti says, he worries about the Democratic Party’s trade stance. “In their election campaigns, the Democrats have been making noises about being more protectionist, less trade oriented, reducing the flow of outsourcing, etc.,” he notes. “Whether it is rhetoric or whether they will actually implement it if they come to power is not very clear. I don’t really believe that they will in fact do any of this if they come to power. However, it seems on the face of it that the Republicans are better for India because of their open trade approach. McCain is probably a safer bet for India in that not much is likely to change in terms of economic policies.”

“Traditionally the Republicans have been more open and less restrictive in terms of trade agreements,” says Ashok Soota, executive chairman of the Bangalore-based software consultancy MindTree Ltd. “Obama, on the other hand, has made some remarks which could be construed as somewhat negative, but that’s more restricted to the NAFTA. My belief is that the forces of globalization are so strong that I don’t think anything fundamental will change with either of them... [However], I believe that we will not see the strong positive thrust that we got with Bush with either McCain or Obama.”

For Latin Americans, says Fausto Hernández Trillo, an economist and researcher at CIDE, the center for research and teaching in Mexico, "the only thing that you need to pay attention to [in campaign speeches] is a certain flirtation with the Hispanic population in the U.S., for purely electoral goals." No matter who wins the next election. "I don't think that the close economic relationship between Mexico and the U.S. will suffer."

Latin America is not a priority for the United States nowadays, Trillo adds, beyond making sure that the relationship between the U.S. and the region does not deteriorate. "Interest [in the region] is more about drug trafficking."

Still, Hugo Macías Cardona, a professor at the University of Medellín in Colombia, worries about the future of the bilateral U.S.-Colombia free trade agreement. Macías says he believes it would help Colombia if McCain won the presidency. However, if Obama wins, the U.S. will have to continue to maintain a close relationship with Colombia.

Colombia is one of the principal allies of the U.S. on the continent, and one of its partners when dealing with regional problems, especially when it comes to neutralizing the impact of Venezuelan President Hugo Chávez, who has been very critical of the U.S. and the role that it plays in the region, he states. "This relationship has become stronger under the Republican Party, which is much closer from a philosophical view to the approach of the right-wing and center-right groups that have been in power in Colombia."

As Macías notes, a fragmented form of integration is emerging in the region, in which Central America and the Caribbean are strengthening their ties with the U.S. whereas South America -- except for Colombia -- is coming together and strengthening its relationships with Europe more than with the U.S. In this context, "Colombia will continue to be a strategic ally of the U.S., even under a Democratic-controlled government and Congress."

Gayle Allard, a professor at the IE business school, points out that McCain has declared his support for the free-trade pact with Colombia. In contrast, Obama has said nothing specifically about the treaty -- which, according to her, is an unfortunate omission. "If you want to know what economic policy the new president is going to pursue, you have to look at the Congress, which might be more in tune with Obama," Allard notes. She believes that the bilateral treaty will eventually be approved by the U.S. Congress.

Outmoded Cuba Policy?

On the other hand, Allard notes that American policy toward Cuba, which has been the target of a trade embargo by the U.S. for decades, "is a bit outmoded; you have to recognize that fact and change the policy. Obama could very well lead such a change because he can count on a great deal of support from the Congress on this issue." Obama said recently that he favors removing restrictions on traveling to Cuba and sending money to that country.

Beyond such concrete differences, Allard believes that for the world at large, the impact of a victory by one candidate or the other will mostly be on the image of the U.S. "McCain projects more of the traditional image of the American conservative while Obama's image is radically new and more attractive for Europeans," she states. The image of the U.S., which has deteriorated a great deal under Bush, would improve if Obama wins because his "rhetoric about people fighting for global causes extends beyond the U.S." She expressed approval of the effort to elect a president who reflects the country's diversity so well. "This, more than any economic policy that the U.S. might undertake, would be the most positive thing if Obama winds up winning." Finally, Allard predicts that Obama, if elected, would have a greater potential for creating a dialogue with Europeans because he is the son of an immigrant and has an international background.

Now that the long primary campaigns have finally ended, Pack says it seems likely both major party candidates will have to sharpen their positions. "We're not really into the season quite yet although [the candidates] started so early it seems like we've been in it for the last five years," says Pack. "They will probably flesh things out more after the conventions, which is too bad because it gives them a long time to speak vaguely."

Leadership Lapses That Fueled Wall Street's Fall

2008-10-24T11:56:00.001+05:30

Eyes on the Wrong Prize

AIG, Bear Stearns, Fannie Mae and Freddie Mac needed government bailouts or takeovers to survive. Lehman Brothers is in bankruptcy. Merrill Lynch has been sold. The shocking succession of corporate meltdowns signals a massive leadership failure across the financial services landscape, according to Wharton faculty. Executives at these troubled firms may have ignored or failed to see the level of risk their companies were taking on in a crusade to enhance results and their own compensation. When markets turned against them, their firms -- big as they were -- crumbled.

This type of lapse in leadership dates to the 1980s when companies began to focus on aligning executive incentives with shareholder interests. He believes an excessive focus on individual financial goals, at the expense of managing in the best interests of the company overall, is at the root of the leadership debacle that has rocked the financial services sector.

"We ought to start thinking about whether this idea is really working," says Cappelli. "It seems to work for the people in charge, but is it really working for the company? It's certainly not working in the broader society. The shareholders and the executives who have shares in the company are in trouble, but this is spilling over into the economy in a way that I haven't seen before."

Harsh Managers, Narrow Focus

Cappelli says too many managers simply choose not to lead. He says managers believe that if they hire smart people and provide huge financial incentives for individual results, management of the firm will take care of itself.

Surveys of incoming MBA students who had worked in finance, and particularly in investment banking, according to Cappelli, indicate that managers in these fields are particularly harsh and ineffective. These managers provide little feedback, expect long hours in the office even if they are not productive and destroy an employee's work-life balance. The long hours make up for management's lack of discipline and planning. "All the problems were smoothed over by bonus money, lots and lots of it, based on individual performance," Cappelli writes in a column published this week by HR Executive. "Taking risks to achieve one's individual targets, even if it puts others or the organization as a whole in danger, seems acceptable. Covering up failures becomes the norm."

Top level managers too often focus narrowly on issues that concern their organizations and do not pay enough attention to what is going on across their industry. "These problems are so tightly connected to broader problems in the overall financial services and banking industries. Everybody in those industries needs to be better attuned to slowly percolating [crises] and ethical issues," he says.

From the outside, it was perhaps easy to see that home prices were inflated even though complex securitization made it difficult to determine the true value of assets. "Alarm bells should have gone off," Donaldson notes. "But in many major industries, problems grow slowly and come to be accepted by members of the industry, only to explode later." He points to the conflict inherent in allowing brokerage houses to provide research into equities they market as an earlier example of a problem waiting to happen.

Donaldson says companies continually underestimate what they have to lose by allowing their reputations to be tarnished through "corporate Watergates." Every year, companies lose more through damaged reputations than they do from regulatory fines or legal actions, he adds -- although some firms in recent years have become more aware of the threat.

"One thing you can say with confidence is that the next big ethical disaster to befall Corporation X is going to be one that will blindside most of the people on the board of directors and the top management, too," he predicts. "That's all the more reason for being more vigilant and for setting up processes, especially at the top levels of leadership, to allow people to talk about some of these things that are hard to talk about."

Change: A Leadership Challenge

In today's business climate, it often takes the board of directors to make a course correction when a company is on an illegal or irresponsible heading, according to Cappelli. But that happens rarely, he notes, and typically only if some of the board members are veterans of the period before executive compensation was tied to stock price. They are more likely to recognize and point out "that what's going on now is peculiar." But he's hopeful about the new generation of business leaders who entered the workforce over the past 10 years and are more oriented toward working in groups. They are not likely to let extreme individualistic behavior push entire markets into taking ever bigger risks just because their competitors are doing so. Cappelli attributes this mind-set to changes in the educational system initiated at the request of business, which needed more people who were able to attack complex problems in a team structure. "It's not so weird [now] to talk about a team-based, effort-and-reward system in which a group takes responsibility rather than just an individual."

Donaldson says regulatory efforts in the United Kingdom are now focusing on industry-wide cooperation that may prevent a rogue individual or company from doing something that could be ruinous for competitive markets, such as mortgage securitization. "The UK has a track record of having key people in industries create blueprints for themselves and then let the government participate. In [the U.S.], we have more of a tendency to want the government off our back and to resist any reform." He notes that the head of British Petroleum took the unprecedented step of joining with other leaders in the oil and gas industry to encourage government to take uniform steps to reduce climate change. "It keeps the playing field even so you don't have the virtuous paying more," Donaldson adds.

Following the demise of Enron and other scandals, the accounting industry began to take some initiative at reining in ethical problems. Many firms created an anonymous hotline for employees to report such matters. However, Donaldson notes, the problems that really trip up companies are so obvious they don't lend themselves to a tip line. For example, the entire accounting industry was at one time participating in ways to shelter income from taxes that either broke the law, or came close to it -- until regulators finally cracked down. "These are the kinds of things that people sitting around at a top management meeting have a queasy feeling in their stomach about, yet don't really want to talk about it," he says. "Usually a lot of money is being made."

Donaldson has helped companies develop a system in which a trusted senior executive is designated as a sounding board for employees who don't want to put their careers at risk with a public campaign, but are concerned about broad-based unethical behavior. Many firms have ombudsmen, but they are usually lower down in the corporate hierarchy. He suggests that companies should designate a senior manager to be open to these types of conversations in order to assess and protect against potentially damaging reputational risk.

U.S. businesses need to be aware of what a tribe in New Guinea called "mokita," or the truth that everybody knows but agrees not to speak about, Donaldson advises. "When it came to subprime and many of the other problems that have tripped up Fannie and Freddie and so many others, there was mokita."

Moral Hazard

The so-called "moral hazard" created when financial services companies get a government bailout to stave off widespread economic disaster. Such rescues may contribute to weak leadership, because "markets for efficient organizations work only when they are allowed to correct and punish mistakes and mismanagement. ... Some of the current examples of very large government bailouts are setting bad precedents for the future." He concedes some bailouts may be necessary to prevent a broad collapse of the financial system, but the need to take such extreme measures is a clear indication that a regulatory overhaul is necessary to reduce the long-term economic risk to taxpayers.

Donaldson suggests better regulation is only one solution. "Unfortunately, regulation typically lags behind awareness in an industry," he says, predicting that the unregulated hedge fund industry may pose the next big challenge to the economic system. "We're maybe one or two big hedge fund failures away from Congress stepping in with regulations." However, the Sarbanes-Oxley legislation passed in the wake of massive accounting scandals has not solved those problems entirely and has introduced new challenges. "The solutions lie with the hedge fund industry policing its own house." How would that happen? "It means asking the questions people in polite conversation don't want to ask," says Donaldson.

The combined public and private missions of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp. may have contributed to special leadership problems at those companies. "A quasi-public private organization, such as Fannie Mae or Freddie Mac, has difficulties in terms of playing a dual role [of] enhancing the ability of private individuals to gain mortgage financing to purchase their own homes ... and maximizing shareholder value in a highly competitive environment," says Orts.

Meanwhile, pressure within the mortgage industry intensified the disconnect between the dual roles within both Fannie and Freddie. "Mortgage securitization seems to have been allowed to spiral out of control with insufficient regulatory oversight. Pressure to increase profits at Fannie Mae and Freddie Mac led to excessive financial risk-taking rather than prudent banking." In retrospect, he adds, regulatory efforts to encourage competition between Fannie Mae and Freddie Mac were misguided because they intensified the pressure on entities that were not completely free-market vehicles. Leaders either did not understand or were unable to balance the goals of a "public-private hybrid" Orts notes. "It might be more sensible to have a clear division between 'public' and 'private' organizations in order for them to focus on a clear mission."

Donaldson points out that Fannie Mae and Freddie Mac spent more than $150 million on lobbyists over the past decade, illustrating another leadership problem stemming from the organizations' structures. "That's wholly inappropriate for a government agency and yet, given the way the business model was set up, lobbying had to be an attractive option for the leaders -- though perhaps not to that extent," he says.

Gary Gordon, who follows Fannie Mae for Portales Partners, an independent equity research firm in New York, says the leadership failures at Fannie and Freddie were aggravated by the recent housing price bubble that has led to problems across the financial services sector. While asset bubbles are common, from tulips to Internet stocks, the housing bubble was even more difficult to prick because the price inflation benefited so many Americans across the income spectrum. "I'm not sure you can come up with a system that could fix it," he says. "You would have to create a system where some human being would blow the whistle as everyone else is benefiting."

Moshe Orenbuch, a Credit Suisse analyst who follows the mortgage industry, says Fannie and Freddie came under the same pressures that led private mortgage firms and companies in other industries to restate income related to derivatives. Fannie and Freddie continued to write loans after the credit markets seized up in 2007 in order to fulfill their public mission, leaving them with a greater share of the market and more problem loans. "If you take market share without tightening criteria, you effectively loosen," notes Orenbuch.

In recent years, regulators did raise questions about management at the government-sponsored housing lenders. In 2006, the Office of Federal Housing Enterprise Oversight (OFHEO), which monitors the financial health of Fannie Mae and Freddie Mac, released a report describing an arrogant and unethical culture at Fannie Mae where employees manipulated earnings to generate higher bonuses for executives between 1998 and 2004. "Our examination found an environment where the ends justified the means. Senior management manipulated accounting; reaped maximum, undeserved bonuses; and prevented the rest of the world from knowing. They co-opted their internal auditors. They stonewalled OFHEO," said James Lockhart, the director of OFHEO when the report was released.

Companies can get into dire straits when they ignore early signals of problems like those at Fannie Mae and Freddie Mac, says Robert Mittelstaedt, a former Wharton dean who now leads the W. P. Carey School of Business at Arizona State University. "These warnings kept popping up. At some point in time there had to be somebody somewhere in these organizations that said, 'This just doesn't feel right.' It's a common mistake."