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7-1.Why Innovation Matters

As you approach your office parking garage, the LED lights inside brighten. Prompted by an app on your smartphone, the garage camera matches your license plate to your personnel record, raises the gate, and locates a parking space. Inside the office, the same app finds a desk based on your schedule and preferences (standing desk, sitting desk, work booth, concentration room, or meeting room). Before setting off to your desk, you drop your coat and personal belongings in an empty locker (indicated by a green light), using your ID badge to unlock it. As you arrive at your desk, the temperature and lighting automatically adjust to the personal preferences you set in the app. A central dashboard collects data on everything from energy usage to when the espresso machines—which, naturally, remember how you like your coffee—need to be refilled. The northfacing exterior wall is glass, while the south-facing exterior wall is composed of an alternating pattern of windows and solar panels that generate more electricity than the building uses. And when everyone leaves for the day, small security robots begin their patrol while other robots clean the rooms that were most heavily used that day. Sound futuristic? It’s not. This unbelievable account is routine at the Edge, a smart building in Amsterdam where a complex network of cables and 28,000 sensors connects the building, its mechanical structures (heating, ventilation, plumbing, and electricity), technological systems, and occupants via a smartphone app. *Organizational innovation is the successful implementation of creative ideas, like the construction of the Edge office building in Amsterdam ( http://ovgrealestate.com/project-development/the-edge ).

We can only guess what changes technological innovations will bring in the next 20 years. Will we carry computers in our pockets? Today’s smart-phones are a step in that direction. Will solar power and wind power get cheap and efficient enough so that your home can have a standalone power source off the main electrical grid? Will fully automated, self-driving cars chauffeur you (working in the back seat on a computing tablet via high-speed Internet) to work? Who knows? The only thing we do know about the next 20 years is that innovation will continue to change our lives.

7-1a.Technology Cycles

In Chapter 3, you learned that technology consists of the knowledge, tools, and techniques used to transform inputs (raw materials and information) into outputs (products and services). A technology cycle begins with the birth of a new technology and ends when that technology reaches its limits and dies as it is replaced by a newer, substantially better technology. *  For example, technology cycles occurred when air conditioners supplanted fans, when Henry Ford’s Model T replaced horse-drawn carriages, when planes replaced trains as a means of cross-country travel, when vaccines that prevented diseases replaced medicines designed to treat them, and when battery-powered wristwatches replaced mechanically powered, stem-wound wristwatches.

From Gutenberg’s invention of the printing press in 1448 to the rapid advance of the Internet, studies of hundreds of technological innovations have shown that nearly all technology cycles follow the typical S-curve pattern of innovationshown in Exhibit 7.1. *  Early in a technology cycle, there is still much to learn, so progress is slow, as depicted by point A on the S-curve. The flat slope indicates that increased effort (in terms of money or research and development) brings only small improvements in technological performance.

Fortunately, as the new technology matures, researchers figure out how to get better performance from it. This is represented by point B of the S-curve in Exhibit 7.1. The steeper slope indicates that small amounts of effort will result in significant increases in performance. At point C, the flat slope again indicates that further efforts to develop this particular technology will result in only small increases in performance. More importantly, however, point C indicates that the performance limits of that particular technology are being reached. In other words, additional significant improvements in performance are highly unlikely.

Intel’s technology cycles have followed this pattern. Intel spends billions to develop new computer chips and to build new facilities to produce them. Intel has found that the technology cycle for its integrated circuits is about three years. In each three-year cycle, Intel spends billions to introduce a new chip, improves the chip by making it a little bit faster each year, and then replaces that chip at the end of the cycle with a brand-new, different chip that is substantially faster than the old chip. At first, though (point A), the billions Intel spends typically produce only small improvements in performance. But after six months to a year with a new chip design, Intel’s engineering and production people typically figure out how to make the new chips much faster than they were initially (point B). Yet, despite impressive gains in performance, Intel is unable to make a particular computer chip run any faster because the chip reaches its design limits.

After a technology has reached its limits at the top of the S-curve, significant improvements in performance usually come from radical new designs or new performance-enhancing materials. In Exhibit 7.1, that new technology is represented by the second S-curve. The changeover or discontinuity between the old and new technologies is represented by the dotted line. At first, the old and new technologies will likely coexist. Eventually, however, the new technology will replace the old technology. When that happens, the old technology cycle will be complete, and a new one will have started. The changeover between newer and older computer chip designs typically takes about one year. Over time, improving existing technology (tweaking the performance of the current technology cycle), combined with replacing old technology with new technology cycles (that is, new, faster computer chip designs replacing older ones), has increased the speed of Intel’s computer processors by a factor of 300. Today’s super-powerful Kaby Lake processors, which provide instantaneous processing and results, have 7.2 billion transistors compared to 3.1 million transistors for 1990s 32-bit processors, 275,000 transistors for the earliest 1980s 32-bit processors, or just 4,500 transistors for the 8-bit processors, which began personal computing in the 1970s. *

Though the evolution of Intel’s chips has been used to illustrate S-curves and technology cycles, it’s important to note that technology cycles and technological innovation don’t necessarily involve faster computer chips or cleaner-burning automobile engines. Remember, technology is simply the knowledge, tools, and techniques used to transform inputs into outputs. So a technology cycle occurs whenever there are major advances or changes in the knowledge, tools, and techniques of a field or discipline, whatever it may be.

For example, one of the most important technology cycles in the history of civilization occurred in 1859, when 1,300 miles of central sewer line were constructed throughout London to carry human waste to the sea more than 11 miles away. This extensive sewer system replaced the widespread practice of dumping raw sewage directly into streets, where people walked through it and where it drained into public wells that supplied drinking water. Though the relationship between raw sewage and cholera wasn’t known at the time, preventing waste runoff from contaminating water supplies stopped the spread of that disease, which had killed millions of people for centuries in cities throughout the world.* Safe water supplies immediately translated into better health and longer life expectancies. In fact, the water you drink today is safe thanks to this technological breakthrough. So, when you think about technology cycles, don’t automatically think “high tech.” Instead, broaden your perspective by considering advances or changes in any kind of knowledge, tools, and techniques.

7-1b. Innovation Streams

In Chapter 6, you learned that organizations can create competitive advantage for themselves if they have a distinctive competence that allows them to make, do, or perform something better than their competitors. A competitive advantage becomes sustainable if other companies cannot duplicate the benefits obtained from that distinctive competence. Technological innovation, however, can enable competitors to duplicate the benefits obtained from a company’s distinctive advantage. It can also quickly turn a company’s competitive advantage into a competitive disadvantage.

Twenty-five years ago, digital cameras replaced film-based technology. But with digital camera sales having peaked at 120 million cameras in 2008 and crashed to 24.4 million cameras in 2016, digital camera makers are losing their competitive advantage to smartphones with HD photo and video capabilities far better than basic digital cameras. Shigenobu Nagamori, CEO of Nidec, which makes electric motors used in consumer electronics, says that thanks to smartphones, we should, “assume that the inexpensive cameras are dead, just like PCs.” *   *  Tsugio Tsuchiya, a general manager at Tamron that makes lenses for more advanced DSLRs (digital single-lens reflex cameras), worries that, “Smartphones pose a threat not just to compact cameras but entry-level DSLRs,” which start at $400 and use interchangeable lenses, such as telescoping zooms. *  Indeed, in fall of 2016 Apple’s iPhone 7 Plus incorporated two 12-megapixel sensors to work with two lenses, a 28mm for “normal” pictures and a 56mm 2x optical zoom, which makes objects look twice as big. Both of those lenses can also be zoomed further with a 10x software zoom function. *

Companies that want to sustain a competitive advantage must understand and protect themselves from the strategic threats of innovation. Over the long run, the best way for a company to do that is to create a stream of its own innovative ideas and products year after year. Consequently, we define innovation streams as patterns of innovation over time that can create sustainable competitive advantage. *  Exhibit 7.2 shows a typical innovation consisting of a series of technology cycles. Recall that a technology cycle begins with a new technology and ends when that technology is replaced by a newer, substantially better technology. The innovation stream in Exhibit 7.2 shows three such technology cycles.

An innovation stream begins with a technological discontinuity, in which a scientific advance or a unique combination of existing technologies creates a significant breakthrough in performance or function. Imagine the inefficiency of just one train running on the train track between two cities. It goes to the first, returns to the second, and so on. That, however, is exactly how elevators work, up to the top, down to the bottom, just one car per elevator shaft. ThyssenKrupp, maker of the Multi elevator, hopes to solve that problem by replacing the steel safety cable and pulleys used to move elevators with magnetic levitation (similar to that used on high-speed trains) that allows elevators cars to “float” to their destinations. This not only reduces the space needed for elevators by half, but without cables, multiple cars can use the same shaft, just like a subway line, and they can even move horizontally, from one side of a building to another, all of which will allow the design of wider, uniquely shaped buildings. *

Technological discontinuities are followed by a discontinuous change, which is characterized by technological substitution and design competition. Technological substitution occurs when customers purchase new technologies to replace older technologies. For example, just 20 years ago, nearly all phone calls were made via hardwired landline telephones. But, according to the U.S. National Health Interview Survey, half of U.S. homes don’t have landline phones. * That’s up from 17 percent in 2008. *  However, wireless only rates are much higher among renters (68.8%) and those 25–29 in age (72.6%) and 30–34 in age (69%). *  Finally, with AT&T and Verizon replacing their old cable-based phone systems with wireless IP-based networks, landline phones won’t even be an option within several years. *  Indeed, Verizon’s 10.5 million residential landline customers are already only a small fraction of its 112.1 million individual cellphone connections. Ironically, the growing number of free wifi hotspots may also pose a threat to wireless carriers by making it easy to use a smartphone without a mobile network. Charissa Struble canceled her contract with Verizon and switched to wifi only, saying, “I just got tired of paying an exorbitant bill.” *

Discontinuous change is also characterized by design competition, in which the old technology and several different new technologies compete to establish a new technological standard or dominant design. Because of large investments in old technology and because the new and old technologies are often incompatible with each other, companies and consumers are reluctant to switch to a different technology during a design competition. For example, the telegraph was so widely used as a means of communication in the late 1800s that at first almost no one understood why telephones would be a better way to communicate. It’s hard to envision today, with everyone constantly checking cell phones for email, texts, tweets, and voice mail, but as Edwin Schlossberg explains in his book Interactive Excellence, “People could not imagine why they would want or need to talk immediately to someone who was across town or, even more absurdly, in another town. Although people could write letters to one another, and some could send telegraph messages, the idea of sending one’s voice to another place and then instantly hearing another voice in return was simply not a model that existed in people’s experience. They also did not think it was worth the money to accelerate sending or hearing a message.” *  In addition, during design competition, the older technology usually improves significantly in response to the competitive threat from the new technologies; this response also slows the changeover from older to newer technologies.

Discontinuous change is followed by the emergence of a dominant design, which becomes the new accepted market standard for technology. *  Dominant designs emerge in several ways. One is critical mass, meaning that a particular technology can become the dominant design simply because most people use it, for example, Blu-ray beating out HD-DVD. Critical mass will likely determine the dominant design for wireless device charging, where instead of plugging in your device to recharge, you simply place it on top of a recharging station containing magnetic charging coils. Over the last few years, three different wireless technologies were trying to become the dominant standard: the Power Matters Alliance (PMA) backing Duracell’s Powermat, a Duracell and Procter & Gamble joint venture supported by Google, AT&T, Starbucks, and McDonald’s; the Alliance for Wireless Power (A4WP) and its Rezence charging mats, backed by Samsung, Broadcom, Deutsche Telekom, and Texas Instruments; and the Wireless Power Consortium (WPC) and its Qi charging mats, supported by LG Electronics, Energizer, and Nokia. However, PMA and A4WP joined forces to create a new, combined standard for wireless charging devices. *  Again, why does this matter? It matters because the market for wireless charging, estimated at $785 million, is projected to increase to $12.6 billion by 2020. In other words, becoming the dominant standard is worth billions to the winner. *

The best technology doesn’t always become the dominant design because a number of other factors come into play. For instance, a design can become dominant if it solves a practical problem. The QWERTY keyboard (named for the top left line of letters) became the dominant design for typewriters because it slowed typists who, by typing too fast, caused mechanical typewriter keys to jam. Though computers can easily be switched to the Dvorak keyboard layout, which doubles typing speed and cuts typing errors in half, QWERTY lives on as the standard keyboard. In this instance, the QWERTY keyboard solved a problem that, with computers, is no longer relevant. Yet it remains the dominant design not because it is the best technology, but because most people learned to type that way and continue to use it.

Dominant designs can also emerge through independent standards bodies. The International Telecommunication Union (ITU) ( www.itu.ch ) is an independent organization that establishes standards for the communications industry. The ITU was founded in Paris in 1865 because European countries all had different telegraph systems that could not communicate with each other. Messages crossing borders had to be transcribed from one country’s system before they could be coded and delivered on another. After three months of negotiations, 20 countries signed the International Telegraph Convention, which standardized equipment and instructions, enabling telegraph messages to flow seamlessly from country to country. Today, as in 1865, various standards are proposed, discussed, negotiated, and changed until agreement is reached on a final set of standards that communication industries (Internet, telephony, satellites, radio) will follow worldwide.

For example, the telecommunications industry has yet to agree on standards for 5G, or fifth-generation, service on mobile devices, but the ITU is scheduled to finalize global standards in November 2017. *  Telecom operators are hoping for a 5G standard data-transmission speed of 10–20 gigabits per second, fast enough to download high-def movies within seconds. Another desired 5G standard is for two 5G devices to communicate with each other with a latency (or wait time) of just 4 millisecond, down from 50 milliseconds with 4G. Shorter 5G latencies would allow doctors in remote hospitals to conduct lifesaving robotics-based surgeries on patients in other locations and the operation of driverless cars. It’s estimated that it will take seven years and $275 billion for U.S. wireless providers to make the change from 4G to 5G. *

No matter how it happens, the emergence of a dominant design is a key event in an innovation stream. First, the emergence of a dominant design indicates that there are winners and losers. Technological innovation is both competence enhancing and competence destroying. Companies that bet on the now-dominant design usually prosper. By contrast, when companies bet on the wrong design or the old technology, they may experience technological lockout, which occurs when a new dominant design (that is, a significantly better technology) prevents a company from competitively selling its products or makes it difficult to do so. *  Adobe’s Flash software, which supports animation and video on web pages and ads, was once ubiquitous in website design, including video streaming platforms YouTube and Netflix. In 2010, due to resource intensity and security issues, Apple stopped supporting Flash on iPhones and iPads. By 2015, YouTube, Facebook, and Netflix had removed Flash, opting for the new HTML5 video standard. *  As of 2017, Google’s Chrome Browser will not automatically run Flash (unless users configure it). *  Scott Symonds, managing director at AQKA advertising firm said, “It takes a kick in the pants from a major player like Google to really accelerate a switch over that could have taken years.” *  Today, Flash is now used on just 6 percent of Internet homepages. *  Technological lockout is a serious threat, as more companies are likely to go out of business in a time of discontinuous change and changing standards than in an economic recession or slowdown.

The Challenges of Climbing the Stack

Why do some companies with seemingly endless resources and brainpower fail when they try to innovate? Venture capitalist Anshu Sharma says that it’s because of the stack fallacy—the tendency of successful companies to overvalue what they know in one area and misjudge what they need to know to innovate in another.

Imagine technology as a layer cake of capabilities. These capabilities stack on top of each other until they ultimately reach the end user. The Minecraft app on your laptop is the top of a technology stack undergirded by layers—from the operating system, to the server, to the microprocessor, to the electricity powering the device. Just because a company is successful in one layer, say, microprocessors, doesn’t mean it can jump up to a higher level, such as the operating system, and have the same success. When Google tried to move from search up to social networking, the result was the failed Google+. IBM saw its revenues shrink four years in a row as it tried to move up from hardware to services. Going down the stack, however, tends to yield positive results. Google moved down the stack by creating its own data farms and servers, which solidified the company’s dominance in search. Why is climbing the technology stack so much harder than descending it? Companies don’t fully understand what customers on the level above theirs actually want. However, because companies often buy products and services at the level below their own, they understand what customers want out of that lower layer of technology. According to Anshu Sharma, the fundamental question of who will win in a given market is, “Who understands the user better?”

Second, the emergence of a dominant design signals a shift from design experimentation and competition to incremental change, a phase in which companies innovate by lowering the cost and improving the functioning and performance of the dominant design. For example, manufacturing efficiencies enable Intel to cut the cost of its chips by one-half to two-thirds during a technology cycle, while doubling or tripling their speed. This focus on improving the dominant design continues until the next technological discontinuity occurs.

Need Innovation? Offer a Prize

Frustrated with the slow pace of innovation, companies and governments are awarding $2 billion a year in 30,000 innovation competitions. Zeniz Tata of XPrize which runs innovation competitions on behalf of major corporations and foundations says, “A prize allows for crazy open innovation to test a new idea, to take a gamble, to take a risk which you cannot do with grant money.” XPrize is currently offering a $20 million prize for turning CO2emissions into a valuable product and $7 million to create a handheld “tricorder” which scans peoples’ health for 13 conditions. Other competitions offer prizes for creating a delivery drone ($50,000) or a new use for canned tuna fish ($5,000 from a French food supplier). So, need innovation fast? Hold a competition and offer prize money!

7-2. Managing Innovation

One consequence of technology cycles and innovation streams is that managers must be equally good at managing innovation in two very different circumstances. First, during discontinuous change, companies must find a way to anticipate and survive the technological changes that can suddenly transform industry leaders into losers and industry unknowns into powerhouses. Companies that can’t manage innovation following technological discontinuities risk quick organizational decline and dissolution. Second, after a new dominant design emerges following discontinuous change, companies must manage the very different process of incremental improvement and innovation. Companies that can’t manage incremental innovation slowly deteriorate as they fall further behind industry leaders.

Unfortunately, what works well when managing innovation during discontinuous change doesn’t work well when managing innovation during periods of incremental change (and vice versa).

Consequently, to successfully manage innovation streams, companies need to be good at three things: 7-2a managing sources of innovation, 7-2b managing innovation during discontinuous change, and 7-2c managing innovation during incremental change.

7-2a. Managing Sources of Innovation

Innovation comes from great ideas. So a starting point for managing innovation is to manage the sources of innovation, that is, where new ideas come from. One place where new ideas originate is with brilliant inventors. But only a few companies have the likes of a Thomas Edison or Alexander Graham Bell. Given that great thinkers and inventors are in short supply, what might companies do to ensure a steady flow of good ideas?

Well, when we say that innovation begins with great ideas, we’re really saying that innovation begins with creativity. As we defined it at the beginning of this chapter, creativity is the production of novel and useful ideas. *  Although companies can’t command employees to be creative (“You will be more creative!”), they can jump-start innovation by building creative work environments in which workers perceive that creative thoughts and ideas are welcomed and valued. As Exhibit 7.3 shows, creative work environments have six components that encourage creativity: challenging work, organizational encouragement, supervisory encouragement, work group encouragement, freedom, and a lack of organizational impediments. *

Work is challenging when it requires effort, demands attention and focus, and is perceived as important to others in the organization. According to researcher Mihaly Csikszentmihalyi (pronounced ME-high-ee CHICK-sent-me-high-ee), challenging work promotes creativity because it creates a rewarding psychological experience known as “flow.” Flow is a psychological state of effortlessness, in which you become completely absorbed in what you’re doing and time seems to fly. When flow occurs, who you are and what you’re doing become one. Csikszentmihalyi first encountered flow when studying artists: “What struck me by looking at artists at work was their tremendous focus on the work, this enormous involvement, this forgetting of time and body. It wasn’t justified by expectation of rewards, like, ‘Aha, I’m going to sell this painting.’” *  Csikszentmihalyi has found that chess players, rock climbers, dancers, surgeons, and athletes regularly experience flow, too. Today, achieving flow is increasingly challenging. A recent study by Professor Gloria Mark at the University of California, Irvine, found that workers focus on their computer screen an average of 1 minute 15 seconds before shifting their attention, down from 2 minutes 18 seconds in 2008. Office furniture maker Steelcase has designed a workstation that, according to designer Mark McKenna, encourages flow by reducing workers’ latent anxiety and distractions from physical surroundings. Mark is skeptical, as her research shows that workers suffer more from digital distractions. Indeed, she found that on a daily basis, workers visited Facebook an average of 21 times and checked email 74 times. *

Removing distractions assists in creating an environment conducive to flow. Another key part of creating flow experiences, and thus creative work environments, is to achieve a balance between skills and task challenge. Workers become bored when they can do more than is required of them. Or, they become anxious when their skills aren’t sufficient to accomplish a task. When skills and task challenges are balanced, however, flow and creativity can occur.

A creative work environment requires three kinds of encouragement: organizational, supervisory, and work group. Organizational encouragement of creativity occurs when management encourages risk taking and new ideas, supports and fairly evaluates new ideas, rewards and recognizes creativity, and encourages the sharing of new ideas throughout different parts of the company. GE Healthcare honors teams who have “dared to try new things and learned from failure.” The idea is not to reward failure but risk taking and the sharing of new ideas. GE spokesperson Laura Paredes says that GE Healthcare employees formalized the sharing process through a short event it called “Failcon,” at which people shared the lessons they learned from failed ideas and efforts. *  Likewise, failure is also celebrated at X, Alphabet’s (Alphabet is Google’s new corporate name) research and development lab, which is also called the “moonshot factory.” Because of the extreme difficult of X’s projects, from self-driving cars to trying to get fuel from seawater, there is a strong expectation that success will be preceded by multiple failures. So like at GE Healthcare, X encourages risk taking by celebrating failure. One way that’s done is by letting employees put stickers of crumpled paper (signifying that it’s time to go back to the proverbial drawing board) on their laptops whenever they abandon ideas or methods that weren’t working. *  Astro Teller, X’s Captain of Moonshots, says, “We keep people brave by rewarding teams that kill their projects. We see killing projects as a normal part of doing business because it means we can go faster and take on ideas that are more promising.” *

Supervisory encouragement of creativity occurs when supervisors provide clear goals, encourage open interaction with subordinates, and actively support development teams’ work and ideas. When it comes to clear goals, MIT’s Andrew McAfee says be specific. He says goals such as, “We need to figure out why so many people are leaving our site before completing a transaction,” or, “How can we increase sales to women in their 30s?” are much better at generating innovations than broad goals such as, “What should our next great idea be?” *  When General Electric launched the Ecomagination initiative to emphasize energy efficiency and ecologically friendly products, the company knew that clear goals were important. According to Lorraine Bolsinger, the GE executive running the program, “At a company full of engineers, a business initiative can’t just be a feel-good plan. Setting hard targets made it an honest GE initiative.” * Bolsinger’s hard targets for this initiative included doubling the $700 million budget for researching clean technology, doubling the $10 million annual revenue from Ecomagination products (such as wind turbines, efficient jet engines, MRI systems, and hybrid locomotives), cutting water usage by 20 percent, and cutting greenhouse-gas emissions by 1 percent—all within five to seven years. Within five years, investment in clean technology research reached $5 billion, annual revenues from Ecomagination products hit an amazing $85 billion, water usage dropped 42 percent, and greenhouse gases dropped 31 percent. *

Work group encouragement occurs when group members have diverse experience, education, and backgrounds, and the group fosters mutual openness to ideas; positive, constructive challenge to ideas; and shared commitment to ideas. Freedom means having autonomy over one’s day-to-day work and a sense of ownership and control over one’s ideas. Numerous studies have indicated that creative ideas thrive under conditions of freedom.

To foster creativity, companies may also have to remove impediments to creativity from their work environments. Internal conflict and power struggles, rigid management structures, and a conservative bias toward the status quo can all discourage creativity. They create the perception that others in the organization will decide which ideas are acceptable and deserve support. Geography was a key impediment to creativity for Levi Strauss. While Levi is headquartered in San Francisco, its research and development facility used to be located 7,000 miles away in Corlu, Turkey (a facility that, incidentally, reported to a regional office in Brussels, Belgium). California-based designers regularly shipped samples back and forth and traveled to Turkey twice a year, staying for just two weeks each trip. Levi’s CEO Chip Bergh said about the arrangement, “We probably spent enough on airfare to buy a 747 just to be managing product back and forth over the ocean.” *  In 2013, Levi’s senior director for technical innovation Bart Sights moved his team from Corlu to San Francisco. The move allowed Sights’s team to work closely with designers to develop a new stretch-denim jean with a more comfortable, flattering fit. The Levi’s 700 line, featuring the new fabric, launched in 2015 to help Levi compete against Lululemon yoga pants, whose surging popularity had led to an 8 percent decline in sales of women’s jeans.

7-2b. Experiential Approach: Managing Innovation during Discontinuous Change

A study of 72 product-development projects (that is, innovation) in 36 computer companies across the United States, Europe, and Asia sheds light on how to manage innovation. Companies that succeeded in periods of discontinuous change (characterized by technological substitution and design competition, as described earlier) typically followed an experiential approach to innovation. *  The experiential approach to innovation assumes that innovation is occurring within a highly uncertain environment and that the key to fast product innovation is to use intuition, flexible options, and hands-on experience to reduce uncertainty and accelerate learning and understanding. The experiential approach to innovation has five aspects: design iterations, testing, milestones, multifunctional teams, and powerful leaders. *

An iteration is a repetition. So a design iteration is a cycle of repetition in which a company tests a prototype of a new product or service, improves on the design, and then builds and tests the improved product or service prototype. A product prototype is a full-scale working model that is being tested for design, function, and reliability. The longtime use of ultrasound to scan lumber for defects inspired dentist Ken Johnson to develop a prototype technology for scanning teeth. Johnson brought his prototype to businessperson Steve Baird, who formed the S-Ray company to develop and test subsequent prototypes. S-Ray’s ClearView Scan combines 3D-modeling software with ultrasound. Besides showing cavities and cracks, the resulting 3D image is used to design perfectly fitting crowns, veneers, braces, and retainers. Dental professor Joerd van der Meer says, “This is the kind of disruptive technology that may really change the dental world.” *

Testing is a systematic comparison of different product designs or design iterations. Companies that want to create a new dominant design following a technological discontinuity quickly build, test, improve, and retest a series of different product prototypes. While many companies are developing driverless cars, prototype testing has occurred in controlled environments (Google’s driverless car always has a driver at the wheel when on public roads—just in case) that often lack the authenticity—and chaos—of daily driving. That changed in 2015 with the opening of M City, a 23-acre mini-metropolis in Ann Arbor, Michigan, with 40 building facades, a bridge, a tunnel, a traffic circle, gravel roads, angled intersections, obstructed views, and even robotic jaywalkers pushing baby carriages. M City allows researchers to test what happens if, say, a red light fails, something they could never do on real city streets. Hideki Hada, an electronics systems manager at Toyota, said, “We would never do any dangerous or risky tests on the open road, so this will be a good place to test some of the next technology.” *

By trying a number of very different designs or making successive improvements and changes in the same design, frequent design iterations reduce uncertainty and improve understanding. Simply put, the more prototypes you build, the more likely you are to learn what works and what doesn’t. Also, when designers and engineers build a number of prototypes, they are less likely to fall in love with a particular prototype. Instead, they’ll be more concerned with improving the product or technology as much as they can. Testing speeds up and improves the innovation process, too. When two very different design prototypes are tested against each other, or the new design iteration is tested against the previous iteration, product design strengths and weaknesses quickly become apparent. Likewise, testing uncovers errors early in the design process when they are easiest to correct. Finally, testing accelerates learning and understanding by forcing engineers and product designers to examine hard data about product performance. When there’s hard evidence that prototypes are testing well, the confidence of the design team grows. Also, personal conflict between design team members is less likely when testing focuses on hard measurements and facts rather than on personal hunches and preferences.

Milestones are formal project review points used to assess progress and performance. For example, a company that has put itself on a 12-month schedule to complete a project might schedule milestones at the three-month, six-month, and nine-month points on the schedule. By making people regularly assess what they’re doing, how well they’re performing, and whether they need to take corrective action, milestones provide structure to the general chaos that follows technological discontinuities. Regularly meeting milestones gives people a sense of accomplishment and can shorten the innovation process by creating a sense of urgency that keeps people on task. At X, Alphabet’s research and development lab known as the “moonshot factory,” project milestones must be achieved before receiving additional funding or staff. One of the key milestones is called Foundry because it requires project engineers to develop business plans for their technologies. X also pays team members “failure bonuses” for shutting down projects that won’t make it to the Foundry milestone. When a team of 30 engineers shut down a two-year-old project, Astro Teller, X’s Captain of Moonshots praised them publicly, saying, “Thank you! By ending their project, this team has done more to speed up innovation at X this month than any other team in this room.” *

Multifunctional teams are work teams composed of people from different departments. Multifunctional teams accelerate learning and understanding by mixing and integrating technical, marketing, and manufacturing activities. By involving all key departments in development from the start, multifunctional teams speed innovation through early identification of new ideas or problems that would typically not have been generated or addressed until much later. Under the code name “Titan,” Apple has a multifunctional project team of 500+ people working to develop the code to control the steering, breaking, safety, and navigation system for self-driving cars. The large project team is composed of software engineers developing apps to link vision sensors to driving systems, regulatory specialists with experience in auto industry rules, and coding specialists hired away from QNX, which develops automotive “infotainment system” software.

Powerful leaders provide the vision, discipline, and motivation to keep the innovation process focused, on time, and on target. Powerful leaders are able to get resources when they are needed, are typically more experienced, have high status in the company, and are held directly responsible for the products’ success or failure. On average, powerful leaders can get innovation-related projects done nine months faster than leaders with little power or influence.

7-2c. Compression Approach: Managing Innovation during Incremental Change

Whereas the experiential approach is used to manage innovation in highly uncertain environments during periods of discontinuous change, the compression approach is used to manage innovation in more certain environments during periods of incremental change. Whereas the goals of the experiential approach are significant improvements in performance and the establishment of a new dominant design, the goals of the compression approach are lower costs and incremental improvements in the performance and function of the existing dominant design.

The general strategies in each approach are different, too. With the experiential approach, the general strategy is to build something new, different, and substantially better. Because there’s so much uncertainty—no one knows which technology will become the market leader—companies adopt a winner-take-all approach by trying to create the market-leading, dominant design. With the compression approach, the general strategy is to compress the time and steps needed to bring about small, consistent improvements in performance and functionality. Because a dominant technology design already exists, the general strategy is to continue improving the existing technology as rapidly as possible. For example, after using an experiential approach and investing $50 billion to develop its groundbreaking 787 Dreamliner passenger jet, Boeing is now switching to a compression approach to innovation. Chief Operating Officer Dennis Muilenburg said, “In the past, we may have said our best engineers are working on the new thing. Now we want our best engineers working on innovative reuse.” *  Likewise, Ray Conner, CEO of Boeing’s commercial airplane unit said, “It’s not to say you don’t innovate [but] how do you innovate to make it more producible? How do you innovate to make it more reliable?” *

In short, a compression approach to innovation assumes that innovation is a predictable process, that incremental innovation can be planned using a series of steps, and that compressing the time it takes to complete those steps can speed up innovation. The compression approach to innovation has five aspects: planning, supplier involvement, shortening the time of individual steps, overlapping steps, and multifunctional teams. *

In Chapter 5, planning was defined as choosing a goal and a method or strategy to achieve that goal. When planning for incremental innovation, the goal is to squeeze or compress development time as much as possible, and the general strategy is to create a series of planned steps to accomplish that goal. Planning for incremental innovation helps avoid unnecessary steps and enables developers to sequence steps in the right order to avoid wasted time and delays between steps. Planning also reduces misunderstandings and improves coordination.

Most planning for incremental innovation is based on the idea of generational change. Generational change occurs when incremental improvements are made to a dominant technological design such that the improved version of the technology is fully backward compatible with the older version. *  Most computers, for instance, have USB (universal serial bus) input slots to connect and power USB thumb drives, monitors, or external hard drives used for backup storage. USB 3.1 (Gen 2), the latest USB standard, can transfer more than 10 Gbps (gigabytes per second), compared to USB 3.0 devices, which operate at 5 Gbps, or USB 2.0 devices, which operate at roughly 1/2 Gbps. *  What happens if you buy a new computer with USB 3.1 slots, but still own a USB 3.0 external hard drive and a USB 2.0 thumb drive? Both will work, but at slower speeds, because they are backward compatible with USB 3.1.

Because the compression approach assumes that innovation can follow a series of preplanned steps, one of the ways to shorten development time is supplier involvement. Delegating some of the preplanned steps in the innovation process to outside suppliers reduces the amount of work that internal development teams must do. Plus, suppliers provide an alternative source of ideas and expertise that can lead to better designs. Even though Apple develops most of its innovations in house, it does rely on suppliers for innovation as well. The prospect of landing a large contract and supplying a crucial component to a company like Apple drives suppliers to build out their own research and development capabilities. Professor Ram Mudambi believes that Apple’s size and component budget ($29.5 billion in 2016) motivate suppliers to pitch their biggest breakthroughs to the company: “Suppliers are racing with each other to get Apple’s business, and part of the racing they are doing is spending more on R&D.” *

Another way to shorten development time is simply to shorten the time of individual steps in the innovation process. Indian cellphone manufacturer Micromax Informatics does this by customizing off-the-shelf hardware rather than developing it from scratch. This allows the company to keep up with consumer trends by unveiling a new model every few weeks. In fact, while Apple typically releases two new phones a year and China’s Xiaomi releases four, Micromax releases more than 30 new models every year. Because it uses existing hardware imported from China, Micromax only needs three to four months to take a phone from concept to store shelves. Indeed, only four months after deciding it wanted to launch a handset that could function seamlessly across India’s 20 official languages, Micromax released the Unite. Priced at just $110, the 2017 model, the Unite 4 Plus, allows users to communicate using 21 different scripts, including Gujarati, Marathi, and Tamil, as well as English and Hindi. The Unite 4 Plus, which has a fingerprint sensor, a 5-inch HD screen, 4G LTE upload and download speeds, and an 8MP rear camera and a 5MP front camera, is just one of dozens of Micromax cellphones designated for release in 2017. Others include models built on Windows, models with six-inch screens for doodling, models that boast long battery life, no-frills models, and more. According to Micromax CEO Vineet Taneja, “We turn around faster than any other company.” *

In a sequential design process, each step must be completed before the next step begins. But sometimes multiple development steps can be performed at the same time. Overlapping steps shorten the development process by reducing delays or waiting time between steps.

7-3. Organizational Decline: The Risk of not Changing

Founded in 1921 in Boston as a store for ham radio enthusiasts, RadioShack grew to more than 7,000 stores by stocking a wide range of components used to build or repair various electronic devices. In fact, before starting Apple, co-founders Steve Jobs and Steve Wozniak bought parts at RadioShack to make a “blue box” device that illegally switched on free long distance calling (which mattered when long distance calls were 40 cents a minute). *  RadioShack’s growth was first propelled by hobbyists (nerds like Jobs and Wozniak), then by battery sales, computers, and cell phones. The TRS-80, introduced in 1977, was one of the first broadly popular PCs. Following computers, which it stopped making in 1993, its next growth cycle came from cell phones. The phone companies at first relied on RadioShack to sign up and service customers, but this changed as they eventually established their own retail stores. RadioShack moved away from its focus on serving technology power users and hobbyists by opening unsuccessful big-box electronics and appliance stores, such as Computer City and Incredible Universe, on which it lost hundreds of millions of dollars in the 1990s. Outmaneuvered by BestBuy in brick-and-mortar retailing, and never really competitive on the Web, RadioShack filed for bankruptcy in spring 2015 after losing $936 million since 2011, the last year it was profitable. *

Businesses operate in a constantly changing environment. Recognizing and adapting to internal and external changes can mean the difference between continued success and going out of business. Companies that fail to change run the risk of organizational decline. *  Organizational decline occurs when companies don’t anticipate, recognize, neutralize, or adapt to the internal or external pressures that threaten their survival. CEO of Netflix Reed Hastings, whose company successfully bridged from its DVD-by-mail business to Internet streaming, said, “Most companies that are great at something—AOL dial-up or Borders bookstores—do not become great at new things people want (streaming for us) because they are afraid to hurt their initial business. Eventually, these companies realize their error of not focusing enough on the new thing, and then the company fights desperately and hopelessly to recover. Companies rarely die from moving too fast, and they frequently die from moving too slowly.” *  In other words, decline occurs when organizations don’t recognize the need for change. There are five stages of organizational decline: blinded, inaction, faulty action, crisis, and dissolution.

In the blinded stage, decline begins because key managers fail to recognize the internal or external changes that will harm their organizations. This blindness may be due to a simple lack of awareness about changes or an inability to understand their significance. It may also come from the overconfidence that can develop when a company has been successful.

In the inaction stage, as organizational performance problems become more visible, management may recognize the need to change but still take no action. The managers may be waiting to see if the problems will correct themselves. Or, they may find it difficult to change the practices and policies that previously led to success. Possibly, too, they wrongly assume that they can easily correct the problems, so they don’t feel the situation is urgent.

In the faulty action stage, faced with rising costs and decreasing profits and market share, management will announce belt-tightening plans designed to cut costs, increase efficiency, and restore profits. In other words, rather than recognizing the need for fundamental changes, managers assume that if they just run a tighter ship, company performance will return to previous levels.

In the crisis stage, bankruptcy or dissolution (breaking up the company and selling its parts) is likely to occur unless the company completely reorganizes the way it does business. At this point, however, companies typically lack the resources to fully change how they run their businesses. Cutbacks and layoffs will have reduced the level of talent among employees. Furthermore, talented managers who were savvy enough to see the crisis coming will have found jobs with other companies, often with competitors. At this stage, hoping to generate enough cash to fund a much-needed redesign of its remaining stores, RadioShack took out $835 million in loans and closed 1,100 stores, However, during the 2014 holiday season, its corporate finances amounted to the equivalent of just $15,000 cash per store. *

In the dissolution stage, after failing to make the changes needed to sustain the organization, the company is dissolved through bankruptcy proceedings or by selling assets to pay suppliers, banks, and creditors. At this point, a new CEO may be brought in to oversee the closing of stores, offices, and manufacturing facilities; the final layoff of managers and employees; and the sale of assets. It is important to note that decline is reversible at each of the first four stages and that not all companies in decline reach final dissolution. RadioShack declared bankruptcy in February 2015, and was acquired by its largest lender, hedge fund Standard General. Initially, 1,700 stores remained open, with 1,400 featuring Sprint/ RadioShack signage and branding. Sprint used one-third of each store to sell and display Sprint mobile phones and related products. *  By 2017, Radio Shack filed for bankruptcy again, laying off headquarters staff, closing 200 stores, and “evaluating options” on the remaining stores. *

7-4. Managing Change

According to social psychologist Kurt Lewin, change is a function of the forces that promote change and the opposing forces that slow or resist change. *  Change forces lead to differences in the form, quality, or condition of an organization over time. In contrast to change forces, resistance forces support the status quo, that is, the existing conditions in an organization. Change is difficult under any circumstances. Production schedules on movie sets have changed dramatically as a result of directors having switched from film to digital recordings. When shooting with film, a new film reel has to be loaded every ten minutes, creating frequent breaks when stars would return to their trailers to read, rehearse, or rest. Because there are no film reels with digital recording, shooting can occur continuously, significantly reducing film production time and costs. A number of famous actors, however, don’t like the change. Actor Robert Downey Jr. complained, “I can’t work like this. I never get to go to my trailer … I’m on my feet 14 hours a day. I’m shooting all the time.” *

Resistance to change is caused by self-interest, misunderstanding and distrust, and a general intolerance for change. * People resist change out of self-interest because they fear that change will cost or deprive them of something they value. Resistance might stem from a fear that the changes will result in a loss of pay, power, responsibility, or even perhaps one’s job.

People also resist change because of misunderstanding and distrust; they don’t understand the change or the reasons for it, or they distrust the people—typically management—behind the change. Resistance isn’t always visible at first. In fact, some of the strongest resisters may initially support the changes in public, nodding and smiling their agreement, but then ignore the changes in private and do their jobs as they always have. Management consultant Michael Hammer calls this deadly form of resistance the “Kiss of Yes.” *

Resistance may also come from a generally low tolerance for change. Some people are simply less capable of handling change than others. People with a low tolerance for change feel threatened by the uncertainty associated with change and worry that they won’t be able to learn the new skills and behaviors needed to successfully negotiate change in their companies.

Because resistance to change is inevitable, successful change efforts require careful management.

In this section, you will learn about 7-4a managing resistance to change, 7-4b what not to do when leading organizational change, and 7-4c different change tools and techniques.

7-4a. Managing Resistance to Change

According to psychologist Kurt Lewin, managing organizational change is a basic process of unfreezing, change intervention, and refreezing. Unfreezing is getting the people affected by change to believe that change is needed. During the change intervention itself, workers and managers change their behavior and work practices. Refreezing is supporting and reinforcing the new changes so that they stick.

Resistance to change is an example of frozen behavior. Given the choice between changing and not changing, most people would rather not change. Because resistance to change is natural and inevitable, managers need to unfreeze resistance to change to create successful change programs. The following methods can be used to manage resistance to change: education and communication, participation, negotiation, top-management support, and coercion. *

When resistance to change is based on insufficient, incorrect, or misleading information, managers should educateemployees about the need for change and communicate change-related information to them. Managers must also supply the information, funding, or other support employees need to make changes. For example, resistance to change can be particularly strong when one company buys another company. This is because one company in the merger usually has a higher status due to its size or its higher profitability or the fact that it is the acquiring company. These status differences are important to managers and employees, particularly if they’re in the lower-status company, who worry about retaining their jobs or influence after the merger. That fear or concern can greatly increase resistance to change. *  When PMA Companies, an insurance risk management firm, was acquired by Old Republic International, an insurance company, PMA’s CEO Vince Donnelly communicated frequently with PMA’s employees about the merger. Four months before the acquisition became official, he traveled to each of the company’s 20 offices and gave employees a detailed description of how their day-to-day operations would change and why the acquisition was good for everyone involved. He also held quarterly updates with employees via videoconference. Said Donnelly, “It’s not just one and done. Communication needs to be continual. You need to continue to reinforce the messages that you want people to internalize. So you need to understand that communication is a continuous process and not something that you do just once.” He went on to say, “What you are asking people to do is trust you, [trust] that you have the best interest of everybody in mind, and [trust that] when there is news to tell, you’re going to hear it directly from the CEO—good, bad, or indifferent.” *

Another way to reduce resistance to change is to have those affected by the change participate in planning and implementing the change process. Employees who participate have a better understanding of the change and the need for it. Furthermore, employee concerns about change can be addressed as they occur if employees participate in the planning and implementation process. It took Kaiser Permanente, a large healthcare provider, five years to transition from paper records to digital medical records and telemedicine services (for patients in remote locations). CEO Bernard Tyson said, “The biggest problem was our physicians had a bond with the patient. It was the personal touch, the personal voice, the personal phone call. The physician is the advocate of the patient. Then you have the nurses and others. And they had a way of working. There was a lot of concern about breaking that trusted relationship, a lot of questions as to whether it would really work in the health-care industry. It took a lot of buy-in, and conversations and engaging the physicians in particular but the other health-care workers, too. So, ultimately, it wasn’t done to them. They were a part of it. But I would not kid you. It was extremely difficult.” *

Employees are also less likely to resist change if they are allowed to discuss and agree on who will do what after change occurs. Craig Durosko, founder of Sun Design Home Remodeling Specialists in Burke, Virginia, says, “Unfortunately, the way most employees find out when a company isn’t doing well is when their paychecks bounce or when they show up and the front doors are locked. When changes go down and they don’t know about it, they can’t do anything about it.” So, when Sun Design’s business shrank dramatically during the recession, Durosko explained the problem, sharing detailed financial information, and then asked his employees what could be done to minimize losses. He says, “No less than 20 employees gave line-by-line specific things they could do to make a difference. *

Resistance to change also decreases when change efforts receive significant managerial support. Managers must do more than talk about the importance of change, though. They must provide the training, resources, and autonomy needed to make change happen. Finally, resistance to change can be managed through coercion, or the use of formal power and authority to force others to change. Because of the intense negative reactions it can create (for example, fear, stress, resentment, sabotage of company products), coercion should be used only when a crisis exists or when all other attempts to reduce resistance to change have failed.

7-4b. What Not to Do when Leading Change

So far, you’ve learned about the basic change process (unfreezing, change intervention, refreezing) and managing resistance to change. Harvard Business School professor John Kotter argues that knowing what not to do is just as important as knowing what to do when it comes to achieving successful organizational change. *

Managers commonly make predictable errors when they lead change. The first two errors occur during the unfreezing phase, when managers try to get the people affected by change to believe that change is really needed. The first and potentially most serious error is not establishing a great enough sense of urgency. In fact, Kotter estimates that more than half of all change efforts fail because the people affected are not convinced that change is necessary. People will feel a greater sense of urgency if a leader in the company makes a public, candid assessment of the company’s problems and weaknesses.

In 1973, Nordstrom launched Nordstrom Rack, a lower-cost outlet version of its nameplate store. Neiman Marcus Last Call, Filene’s Basement, and Saks Off Fifth quickly followed. *  While Macy’s currently accounts for 40 percent of U.S. department store sales, it made a critical mistake by debating what to do about off-price stores for six years before finally opening its own version, Macy’s Backstage, in 2015. While the company deliberated, off-price behemoth TJX—parent company of T.J.Maxx, Marshalls, and Homegoods—shot past it on three key financial metrics. TJX has been more profitable than Macy’s since 2008 and has had higher sales revenue since 2014. Since 2005, Macy’s market capitalization has shrunk by $5 billion, while TJX’s has risen by $35 billion, making it three times larger than Macy’s. According to researcher Craig Johnson, “Macy’s has been so successful for so long with its core format that it blinded them to the ways that consumer shopping behaviors were changing . . . The fix isn’t going to happen overnight.” *

The second mistake that occurs in the unfreezing process is not creating a powerful enough coalition. Change often starts with one or two people. But change has to be supported by a critical and growing group of people to build enough momentum to change an entire department, division, or company. Besides top management, Kotter recommends that key employees, managers, board members, customers, and even union leaders be members of a core change coalition that guides and supports organizational change. For GE’s Ecomagination initiative, that core change coalition included a group of engineers who were responsible for finding ways to achieve the company’s overall goals of reducing emissions and water usage while increasing energy efficiency. Initiative leader Lorraine Bolsinger said, “We started doing what we called ‘treasure hunts’ [to] see if there were ways to use our own products at our own facilities to improve efficiency.” *  Many of these treasure hunts paid off. For example, one team at a jet engine testing facility figured out how to save 3 million gallons of jet fuel per year by moving engine tests indoors, reducing the run times needed for accurate testing, and better calculating the placement of weights used to balance the hundreds of fans on jet engines, resulting in a smoother, easier-turning, more efficient jet engine. *

The next four errors that managers make occur during the change phase, when a change intervention is used to try to get workers and managers to change their behavior and work practices. Lacking a vision for change is a significant error at this point. As you learned in Chapter 5, a vision (defined as a purpose statement in Chapter 5) is a statement of a company’s purpose or reason for existing. A vision for change makes clear where a company or department is headed and why the change is occurring. Change efforts that lack vision tend to be confused, chaotic, and contradictory. By contrast, change efforts guided by visions are clear, are easy to understand, and can be effectively explained in five minutes or less.

Undercommunicating the vision by a factor of ten is another mistake in the change phase. According to Kotter, companies mistakenly hold just one meeting to announce the vision. Or, if the new vision receives heavy emphasis in executive speeches or company newsletters, senior management then undercuts the vision by behaving in ways contrary to it. Successful communication of the vision requires that top managers link everything the company does to the new vision and that they “walk the talk” by behaving in ways consistent with the vision. Furthermore, even companies that begin change with a clear vision sometimes make the mistake of not removing obstacles to the new vision. They leave formidable barriers to change in place by failing to redesign jobs, pay plans, and technology to support the new way of doing things. Chapter 1 discussed how CEO Mark Fields was moving Ford Motor Company toward its new “Smart Mobility” vision as an “auto and mobility” company. *  “Smart Mobility,” said Fields, “is our plan to use innovation to take Ford to the next level in connectivity, mobility, autonomous vehicles, the customer experience, and big data.” *  Ford, however, is clearly avoiding the mistake of undercommunicating and undercutting this vision. Indeed, Ford’s commitment to “Smart Mobility” is evident in the 25 mobility experiments it’s conducting, such as in London and Shanghai, where plug-in devices used to track live parking and traffic data are linked to smartphone apps helping drivers find and pay for the nearest available parking space. *  Likewise, Ford spent $1 billion to become the majority owner in Argo AI, a startup founded by executives who formerly managed self-driving car teams at Uber and Google. Ford will combine its software engineers with Argo AI’s to develop the virtual driver system for Ford’s self-driving cars. Finally, Ford’s board of director’s changed CEO Field’s financial incentives to reward him for eventually creating a new division, Ford Smart Mobility LLC.

Another error in the change phase is not systematically planning for and creating short-term wins. Most people don’t have the discipline and patience to wait two years to see if the new change effort works. Change is threatening and uncomfortable, so people need to see an immediate payoff if they are to continue to support it. Kotter recommends that managers create short-term wins by actively picking people and projects that are likely to work extremely well early in the change process.

The last two errors that managers make occur during the refreezing phase, when attempts are made to support and reinforce changes so that they stick. Declaring victory too soon is a tempting mistake in the refreezing phase. Managers typically declare victory right after the first large-scale success in the change process. Declaring success too early has the same effect as draining the gasoline out of a car: It stops change efforts dead in their tracks. With success declared, supporters of the change process stop pushing to make change happen. After all, why push when success has been achieved? Rather than declaring victory, managers should use the momentum from short-term wins to push for even bigger or faster changes. This maintains urgency and prevents change supporters from slacking off before the changes are frozen into the company’s culture.

The last mistake that managers make is not anchoring changes in the corporation’s culture. An organization’s culture is the set of key values, beliefs, and attitudes shared by organizational members that determines the accepted way of doing things in a company. As you learned in Chapter 3, changing cultures is extremely difficult and slow. According to Kotter, two things help anchor changes in a corporation’s culture. The first is directly showing people that the changes have actually improved performance. The second is to make sure that the people who get promoted fit the new culture. If they don’t, it’s a clear sign that the changes were only temporary.

7-4c. Change Tools and Techniques

Imagine that your boss came to you and said, “All right, genius, you wanted it. You’re in charge of turning around the division.” Where would you begin? How would you encourage change-resistant managers to change? What would you do to include others in the change process? How would you get the change process off to a quick start? Finally, what approach would you use to promote long-term effectiveness and performance? Results-driven change, the General Electric fastworks approach and organizational development are different change tools and techniques that can be used to address these issues.

One of the reasons that organizational change efforts fail is that they are activity oriented rather than results oriented. In other words, they focus primarily on changing company procedures, management philosophy, or employee behavior. Typically, there is much buildup and preparation as consultants are brought in, presentations are made, books are read, and employees and managers are trained. There’s a tremendous emphasis on doing things the new way. But, with all the focus on “doing,” almost no attention is paid to results, to seeing if all this activity has actually made a difference.

By contrast, results-driven change supplants the emphasis on activity with a laser-like focus on quickly measuring and improving results. *  At Zara, the Spain-based retailer known for “fast fashion,” 350 designers send brand new styles to stores and  Zara.com  twice a week. Because designers get daily data on what’s selling, they can react to fashion trends by going from concept to ready-for-sale clothing in just three weeks. If daily reports show surging demand for particular products, Zara airlifts them (the most expensive way to ship) to get them in stores as fast as possible. *  Furthermore, retailers don’t need anyone’s approval to make changes. They decide on the spot. Ann Critchlow, an analyst at Société Générale, says, “The root of Inditex’s success [Inditex own’s Zara] is its predominantly short lead time, which gives a greater level of newness to its collections.” *

Another advantage of results-driven change is that managers introduce changes in procedures, philosophy, or behavior only if they are likely to improve measured performance. In other words, managers and workers actually test to see if changes make a difference. A third advantage of results-driven change is that quick, visible improvements motivate employees to continue to make additional changes to improve measured performance. Exhibit 7.4 describes the basic steps of results-driven change.

Exhibit7.4.How to Create a Results-Driven Change Program

1.	Set measurable, short-term goals to improve performance.
2.	Make sure your action steps are likely to improve measured performance.
3.	Stress the importance of immediate improvements.
4.	Solicit help from consultants and staffers to achieve quick improvements in performance.
5.	Test action steps to see if they actually yield improvements. If they don’t, discard them and establish new ones.
6.	Use resources you have or that can be easily acquired. It doesn’t take much.

General Electric fastworks approach is a special kind of results-driven change. With fastworks, companies improve results in an uncertain business environment by quickly experimenting with new ideas to solve customer problems and learn from repeated tests and improvements. Because things change quickly in uncertain business environments, the idea is to move as fast, if not faster than competitors. For example, it normally takes GE Healthcare two to four years to bring a new PET/CT scanner to market. But because of customer feedback under fastworks, it cut development time in half. *

Fastworks also focuses on solving customer problems. Viv Goldstein, director of innovation acceleration at GE Corporate, says, “We don’t assume that we know what features create the best solution. We start speaking to customers much earlier in the cycle so we can test solutions quickly and inexpensively… It’s about achieving customer outcomes, as opposed to selling products.” *

Finally, repeated testing and improvements depend on putting a minimum viable product in front of customers. When GE Appliances was redesigning its high-end Monogram refrigerators, it listened to feedback from home designers and then built a new refrigerator (that is, a minimum viable product). Customers disliked it because the stainless steel was too dark. They fixed that. Next, customers disliked the lighting. GE fixed that. After 6 prototypes, GE built 75 versions for broader testing and feedback. Five versions later, it was ready to begin manufacturing. Fast-works resulted in a refrigerator developed in half the time, for half the cost, and which is selling twice as fast as the typical new model. *

Organizational development is a philosophy and collection of planned change interventions designed to improve an organization’s long-term health and performance. Organizational development takes a long-range approach to change; assumes that top-management support is necessary for change to succeed; creates change by educating workers and managers to change ideas, beliefs, and behaviors so that problems can be solved in new ways; and emphasizes employee participation in diagnosing, solving, and evaluating problems. *  As shown in Exhibit 7.5, organizational development interventions begin with the recognition of a problem. Then, the company designates a change agent to be formally in charge of guiding the change effort. This person can be someone from within the company or a professional consultant. The change agent clarifies the problem, gathers information, works with decision makers to create and implement an action plan, helps to evaluate the plan’s effectiveness, implements the plan throughout the company, and then leaves (if from outside the company) after making sure the change intervention will continue to work.

Exhibit7.5.General Steps for Organizational Development Interventions

1. Entry	A problem is discovered, and the need for change becomes apparent. A search begins for someone to deal with the problem and facilitate change.
2. Startup	A change agent enters the picture and works to clarify the problem and gain commitment to a change effort.
3. Assessment & feedback	The change agent gathers information about the problem and provides feedback about it to decision makers and those affected by it.
4. Action planning	The change agent works with decision makers to develop an action plan.
5. Intervention	The action plan, or organizational development intervention, is carried out.
6. Evaluation	The change agent helps decision makers assess the effectiveness of the intervention.
7. Adoption	Organizational members accept ownership and responsibility for the change, which is then carried out through the entire organization.
8. Separation	The change agent leaves the organization after first ensuring that the change intervention will continue to work.

Exhibit7.6.Different Kinds of Organizational Development Interventions

Large-System Interventions
Sociotechnical systems	An intervention designed to improve how well employees use and adjust to the work technology used in an organization.
Survey feedback	An intervention that uses surveys to collect information from the members of the system, reports the results of that survey to the members, and then uses those results to develop action plans for improvement.
Small-Group Interventions
Team building	An intervention designed to increase the cohesion and cooperation of work group members.
Unit goal setting	An intervention designed to help a work group establish short- and long-term goals.
Person-Focused Interventions
Counseling/coaching	An intervention designed so that a formal helper or coach listens to managers or employees and advises them on how to deal with work or interpersonal problems.
Training	An intervention designed to provide individuals with the knowledge, skills, or attitudes they need to become more effective at their jobs.

8-1. Global Business, Trade Rules, and Trade Agreements

Business is buying and selling of the goods or services. Buying this textbook was a business transaction. So was selling your first car and getting paid for babysitting or for mowing lawns. Global business is the buying and selling of goods and services by people from different countries. The Apple iPhone sitting on my desk while writing this chapter was purchased from an Apple Store in Indiana. The components of that iPhone, the touch screen, camera lenses, microphone, and the hard drive for storage, were made by 200 suppliers around the world. Once assembled in China, my iPhone was flown by UPS or FedEx to Anchorage, Alaska (for refueling), before arriving in Louisville, Kentucky, where it was sorted for truck delivery to the Apple Store. *

Global business presents its own set of challenges for managers. How can you be sure that the way you run your business in one country is the right way to run that business in another? This chapter discusses how organizations answer that question. We will start by examining global business in two ways: first exploring its impact on U.S. businesses and then reviewing the basic rules and agreements that govern global trade. Next, we will examine how and when companies go global by examining the trade-off between consistency and adaptation and discussing how to organize a global company. Finally, we will look at how companies decide where to expand globally, including finding the best business climate, adapting to cultural differences, and better preparing employees for international assignments.

Beyond the earlier iPhone example, if you want other demonstrations of the impact of global business, look at the tag on your shirt, the inside of your shoes, and the inside of your digital camera (take out your battery). Chances are, all of these items were made in different places around the world. As I write this, my shirt, shoes, and digital camera were made in Thailand, China, and Korea. Where were yours made?

Let’s learn more about 8-1a the impact of global business, 8-1b how tariff and nontariff trade barriers have historically restricted global business, 8-1c how today global and regional trade agreements are reducing those trade barriers worldwide, and 8-1d how consumers are responding to those changes in trade rules and agreements.

8-1a. The Impact of Global Business

Multinational corporations (MNCs) are corporations that own businesses in two or more countries. Motorcycle maker Harley-Davidson is headquartered in Milwaukee, Wisconsin, and has U.S. assembly plants in York, Pennsylvania, and Kansas City, Missouri. But with manufacturing plants in Brazil and India and regional headquarters in England and Singapore, Harley-Davidson, a brand considered to be quintessentially American, is a multinational corporation. While 38 percent of its 2017 sales are outside the United States, up from 22 percent in 2007, Harley-Davidson’s goal is to have international sales account for half of its revenues. *  Harley-Davidson isn’t unique. There are 30,000-plus MNCs around the world. The 100 largest MNCs, on average, have 500 foreign facilities/offices located in 50 different countries! *

Another way to appreciate the impact of global business is by considering direct foreign investment. Direct foreign investment occurs when a company builds a new business or buys an existing business in a foreign country. Luxembourg conglomerate JAB Holding Company made a direct foreign investment in the United States when it paid $7.5 billion for Panera restaurants. *

Of course, companies from many other countries also own businesses in the United States. As Exhibit 8.1 shows, companies from the United Kingdom, Japan, the Netherlands, Canada, Luxembourg, Switzerland, Germany, and France have the largest direct foreign investment in the United States. Overall, foreign companies invest more than $2.9 trillion a year to do business in the United States.

But direct foreign investment in the United States is only half the picture. U.S. companies also have made large direct foreign investments in countries throughout the world. San Diego-based Qualcomm, which designs and manufacturers smartphone computer chips, is paying $38.5 billion to buy NXP Semiconductors, a Netherlands-based manufacturer of chips used in cars, smartwatches, secure credit cards and appliances. Analyst Mark Hung commented that Qualcomm “is trying to diversify away from smartphones.” *  Qualcomm CEO Steve Mollenkopf said, “It’s no secret that we’ve been looking around. If you look at our growth strategy, it’s to grow into adjacent markets at the time that they are being disrupted by the technology of mobile.” *

As Exhibit 8.2 shows, U.S. companies have made their largest direct foreign investments in the Netherlands, the United Kingdom, Luxembourg, Canada, and Ireland. Overall, U.S. companies invest more than $4.9 trillion a year to do business in other countries.

8-1b. Trade Barriers

Although today’s consumers usually don’t care where the products they buy come from (more on this in Section 8-1d), national governments have traditionally preferred that consumers buy domestically made products in hopes that such purchases would increase the number of domestic businesses and workers. In fact, governments have done much more than hope that you will buy from domestic companies. Historically, governments have actively used trade barriers to make it much more expensive or difficult (or sometimes impossible) for consumers to buy or consume imported goods. The Chinese government adds a 25 percent tariff to automobiles imported to China. Imports make up just 4 percent of the 24.4 million cars sold annually in China, a percentage that hasn’t changed in 15 years. Consultant Michael Dunne says, “There might as well be a sign saying: Imports not welcome.” *  By establishing these restrictions and taxes, the Chinese government is engaging in protectionism, which is the use of trade barriers to protect local companies and their workers from foreign competition. According to trade monitoring group Global Trade Alert, almost 7,000 protectionist measures have been put in place by governments since 2009. *

 

Countries place tariffs on exports to discourage manufacturers from sending domestically produced goods overseas.

 

Governments have used two general kinds of trade barriers: tariff and nontariff barriers. A tariff is a direct tax on imported goods. Tariffs increase the cost of imported goods relative to that of domestic goods. The Argentinian import tax on electronic products is 35 percent, for example. *  Countries also place tariffs on exports to discourage manufacturers from sending domestically produced goods overseas. For example, under former president Cristina Fernandez de Kirchner, Argentina placed heavy export tariffs on its agricultural products, including a 35 percent tax on soy exports, 23 percent tax on wheat, and 20 percent tax on corn. This resulted in a stockpile of crops valued at $11.4 billion. *  When Mauricio Mauri became president in 2015, he eliminated all export tariffs on crops, saying, “We must stop being the world’s barn to become the world’s supermarket.” *

Nontariff barriers are nontax methods of increasing the cost or reducing the volume of imported goods. There are five types of nontariff barriers: quotas, voluntary export restraints, government import standards, government subsidies, and customs valuation/classification. Because there are so many different kinds of nontariff barriers, they can be an even more potent method of shielding domestic industries from foreign competition.

Quotas are specific limits on the number or volume of imported products. For example, the Chinese government only allows 34 imported movies each year. China also limits the amount of foreign content available on video-streaming websites to no more than 30 percent. To get around the quota, films must be at least partially shot in China, co-financed by a Chinese firm, and have some Chinese cultural elements. *

Like quotas, voluntary export restraints limit the amount of a product that can be imported annually. The difference is that the exporting country rather than the importing country imposes restraints. Usually, however, the “voluntary” offer to limit exports occurs because the importing country has implicitly threatened to impose quotas. For example, to protect Brazilian auto manufacturers from less expensive Mexican-made cars, the Brazilian government convinced Mexico to “voluntarily” restrict auto exports to Brazil to no more than $1.55 billion a year for three years. *  According to the World Trade Organization (see the discussion in Section 8-1c), however, voluntary export restraints are illegal and should not be used to restrict imports. *

In theory, government import standards are established to protect the health and safety of citizens. In reality, such standards are often used to restrict or ban imported goods. Europe bans imports of hormone-treated U.S.-raised beef due to alleged health risks to European Union citizens. However, the World Trade Organization (WTO) ruled that the EU’s ban is not based on scientific evidence, and that the European Union should open its markets to American beef imports. Because the EU has not lived up to the WTO ruling, the United States is threatening re-taliation with 100 per-cent tariffs on select EU imports, such as Perrier mineral water, Roquefort cheese, and Vespa scooters. Tracy Brunner, president of the National Cattlemen’s Beef Associa-tion, said, “While this is not our preferred choice, retaliation is the only way cattle producers are going to secure our rights for the losses we have incurred over the years due to the EU’s hormone ban.” *

Many nations also use subsidies, such as long-term, low-interest loans, cash grants, and tax deferments, to develop and protect companies in special industries. In 2016, the WTO ruled that the European Union illegally provided billions in subsidies to Airbus Group SE, a European conglomerate that designs and manufactures passenger jets. The office of the U.S. Trade Representative said, “The EU did not come into compliance with respect to the subsidies previously found, and it further breached WTO rules by granting more than $4 billion in new subsidized financing for the A350XWB [Airbus’s long-haul plane].” *  U.S. Trade Representative Micheal Froman said, “EU aircraft subsidies have cost American companies tens of billions of dollars in lost revenue.” *  The United States indicated that Airbus received EU subsidies totaling $22 billion and that it would seek $10 billion a year in retaliatory tariffs. *  The European Union is appealing the fine.

The last type of non-tariff barrier is customs classification. As products are imported into a country, they are examined by customs agents, who must decide which of nearly 9,000 categories they should be classified into (see the Official Harmonized Tariff Schedule of the United States at  www.usitc.gov  for more information). The category assigned by customs agents can greatly affect the size of the tariff and whether the item is subject to import quotas. For example, the U.S. Customs Service classifies the various parts of a Santa Claus costume differently. The beard, wig, and hat are classified as “festive articles,” which are defined as “flimsy, nondurable, and not normal articles of wearing apparel.” Festive articles are exempt from import duties. The jacket, pants, gloves, and toy sacks, however, are considered apparel. They carry tariffs from 10 to 32 percent. *

8-1c. Trade Agreements

Thanks to the trade barriers described previously, buying imported goods has often been much more expensive and difficult than buying domestic goods. During the 1990s, however, the regulations governing global trade were transformed. The most significant change was that 124 countries agreed to adopt the General Agreement on Tariffs and Trade (GATT). GATT, which existed from 1947 to 1995, was an agreement to regulate trade among (eventually) more than 120 countries, the purpose of which was “substantial reduction of tariffs and other trade barriers and the elimination of preferences.” *  GATT members engaged in eight rounds of trade negotiations, with the Uruguay Round signed in 1994 and going into effect in 1995. Although GATT itself was replaced by the World Trade Organization (WTO) in 1995, the changes that it made continue to encourage international trade. Today, the WTO and its member countries are negotiating what’s known as the Doha Round, which seeks to advance trade opportunities for developing countries in areas ranging from agriculture to services to intellectual property rights. The WTO, headquartered in Geneva, Switzerland, administers trade agreements, provides a forum for trade negotiations, handles trade disputes, monitors national trade policies, and offers technical assistance and training for developing countries for its 164 member countries.

Through tremendous decreases in tariff and nontariff barriers, the Uruguay round of GATT made it much easier and cheaper for consumers in all countries to buy foreign products. First, tariffs were cut 40 percent on average worldwide by 2005. Second, tariffs were eliminated in 10 specific industries: beer, alcohol, construction equipment, farm machinery, furniture, medical equipment, paper, pharmaceuticals, steel, and toys. Third, stricter limits were put on government subsidies (see the discussion of subsidies in Section 8-1b). Fourth, the Uruguay round of GATT established protections for intellectual property, such as trademarks, patents, and copyrights. In 2017, the WTO’s Trade Facilitation Agreement (TFA), which simplifies and standardizes customs procedures around the world, went into effect. The WTO estimates the TFA may cut trade costs by 14 percent. *

Protection of intellectual property has become an increasingly important issue in global trade because of widespread product piracy. For example, the International Federation of the Phonographic Industry estimates that 20 percent of “fixed-line Internet users worldwide regularly access services offering copyright infringing music.” *  Likewise, according to BSA The Software Alliance, 39 percent of all software used in the world is pirated, costing companies $52.2 billion in lost sales. *

Product piracy is also costly to the movie industry, as movie studios and theaters, as well as video/DVD distributors, lose $18 billion each year to pirates. In fact, digital sales of movies rose 6–10 percent for two movie studios after Megaupload, an illegal site for downloading movies, was closed. *

Finally, trade disputes between countries now are fully settled by arbitration panels from the WTO. In the past, countries could use their veto power to cancel a panel’s decision. For instance, the French government routinely vetoed rulings that its large cash grants to French farmers constituted unfair subsidies. Now, however, countries that are members of the WTO no longer have veto power. Thus, WTO rulings are complete and final. Exhibit 8.3 provides a brief overview of the WTO and its functions.

The second major development that has reduced trade barriers has been the creation of regional trading zones, or zones in which tariff and nontariff barriers are reduced or eliminated for countries within the trading zone. The largest and most important trading zones are:

• Africa: African Free Trade Zone Agreement (AFTZ) and Tripartite Free Trade Area (TFTA)

• Asia: Association of Southeast Asian Nations (ASEAN), Asia-Pacific Economic Cooperation (APEC), and Trans-Pacific Partnership (TPP)

• Central America: Dominican Republic-Central America Free Trade Agreement (CAFTA-DR)

• Europe: The Maastricht Treaty

• North America: North American Free Trade Agreement (NAFTA)

• South America: Union of South American Nations (USAN)

In 1992, Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, and the United Kingdom adopted the Maastricht Treaty of Europe. The purpose of this treaty was to transform their 12 different economies and 12 currencies into one common economic market, called the European Union (EU), with onecommon currency. On January 1, 2002, a single common currency, the euro, went into circulation in 12 of the EU’s members (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain). Austria, Finland, and Sweden joined the EU in 1995, followed by Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia in 2004; Bulgaria and Romania in 2007; and Croatia in 2013, bringing the total membership to 28 countries. *  Albania, Macedonia, Montenegro, Serbia and Turkey have applied and are being considered for membership. In June 2016, the United Kingdom voted to leave the EU. On March 30, 2017, UK prime minister triggered “Article 50,” which provides exactly two years to negotiate the UK’s exit from the EU. *

Prior to the treaty, trucks carrying products were stopped and inspected by customs agents at each border. Furthermore, because the required paperwork, tariffs, and government product specifications could be radically different in each country, companies often had to file 12 different sets of paperwork, pay 12 different tariffs, produce 12 different versions of their basic product to meet various government specifications, and exchange money in 12 different currencies. Likewise, open business travel, which we take for granted in the United States, was complicated by inspections at each border crossing. If you lived in Germany but worked in Luxembourg, your car was stopped and your passport was inspected twice every day as you traveled to and from work. Also, every business transaction required a currency exchange, for example, from German deutsche marks to Italian lira, or from French francs to Dutch guilders. Imagine all of this happening to millions of trucks, cars, and workers each day, and you can begin to appreciate the difficulty and cost of conducting business across Europe before the Maastricht Treaty. For more information about the Maastricht Treaty, the EU, and the euro, see  http://europa.eu

NAFTA, the North American Free Trade Agreement among the United States, Canada, and Mexico, went into effect on January 1, 1994. More than any other regional trade agreement, NAFTA has liberalized trade between countries so that businesses can plan for one market (North America) rather than for three separate markets. One of NAFTA’s most important achievements was to eliminate most product tariffs and prevent the three countries from increasing existing tariffs or introducing new ones. Overall, Mexican and Canadian exports to the United States are up 637 percent and 151 percent, respectively, since NAFTA went into effect. U.S. exports to Mexico and Canada are up 455 percent and 166 percent, growing twice as fast as U.S. exports to any other part of the world. In fact, Mexico and Canada now account for 34 percent of all U.S. exports. *

CAFTA-DR, the Dominican Republic-Central America Free Trade Agreement among the United States, the Dominican Republic, and the Central American countries of Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua, went into effect in August 2005. With a combined population of 52 million, the CAFTA-DR countries together are the sixteenth-largest U.S. export market in the world. U.S. companies export nearly $29 billion in goods each year to the CAFTA-DR countries. *

On May 23, 2008, 12 South American countries signed the Union of South American Nations (UNASUR) Constitutive Treaty, which united the countries of the Mercosur trade group (Argentina, Brazil, Paraguay, Uruguay, and Venezuela) and the countries of the Andean Community (Bolivia, Colombia, Ecuador, and Peru) with Guyana, Suriname, and Chile. UNASUR aims to create a unified South America by permitting free movement between nations, creating a common infrastructure that includes an interoceanic highway, and establishing the region as a single market by eliminating all tariffs by 2019. UNASUR is one of the largest trading zones in the world, encompassing 418 million people in South America with a combined gross domestic product (GDP) of nearly $4.2 trillion. *

ASEAN, the Association of Southeast Asian Nations, and APEC, the Asia-Pacific Economic Cooperation, are the two largest and most important regional trading groups in Asia. ASEAN is a trade agreement among Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam, which form a market of more than 629 million people with a combined GDP of $2.4 trillion. U.S. trade with ASEAN countries exceeds $234 billion a year. *

In fact, the United States is ASEAN’s third-largest trading partner (China is its largest), and ASEAN’s member nations constitute the fourth-largest trading partner of the United States. An ASEAN free-trade area was established in 2015 for the six original countries (Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore, and Thailand), and in 2018 for the newer member countries (Cambodia, Lao PDR, Myanmar, and Vietnam). All 10 nations have committed to develop a “deeply integrated and highly cohesive ASEAN economy” by 2025. *

APEC is a broad agreement that includes Australia, Canada, Chile, the People’s Republic of China, Hong Kong, Japan, Mexico, New Zealand, Papua New Guinea, Peru, Russia, South Korea, Taiwan, the United States, and all the members of ASEAN except Cambodia, Lao PDR, and Myanmar. APEC’s 21 member countries have a total population of 2.8 billion people and combined GDP of more than $43.4 trillion. *

APEC countries began reducing trade barriers in 2000, though all the reductions will not be completely phased in until 2020. *

The Tripartite Free Trade Agreement (TFTA) is an African trade agreement proposed in 2015. Currently signed by 27 member states and awaiting ratification, the TFTA’s ultimate goal is to create a free trade area across all 54 African Union states by 2017. *

8-1d. Consumers, Trade Barriers, and Trade Agreements

The average worker earns nearly $46,550 in Finland, $57,920 in Sweden, $93,740 in Norway, and $55,980 in the United States. *  Yet after adjusting these incomes for how much they can buy, the Finnish income is worth just $42,600, the Swedish $48,700, the Norwegian 65,430, and the American $57,540. *  This is the same as saying $1 of income can buy only $0.92 worth of goods in Finland, $0.84 in Sweden, $0.70 in Norway and $1.03 in the United States. *  In other words, Americans can buy much more with their incomes than those in many other countries.

One reason that Americans get more for their money is that the U.S. marketplace is the third most competitive in the world (behind Switzerland and Singapore). The U.S. economy has historically been one of the easiest for foreign companies to enter. *  Although some U.S. industries, such as textiles, have been heavily protected from foreign competition by trade barriers, for the most part, American consumers (and businesses) have had plentiful choices among American-made and foreign-made products. More important, the high level of competition between foreign and domestic companies that creates these choices helps keep prices low in the United States. Furthermore, it is precisely the lack of choice and the low level of competition that keep prices higher in countries that have not been as open to foreign companies and products. For example, Japanese trade barriers on agricultural products are high. In fact, over 45 percent of the value of Japan’s agricultural industry comes from trade barriers or subsidies. The tariffs on rice alone amount to $8.4 billion in additional costs to Japanese consumers and taxpayers. *

So why do trade barriers and free-trade agreements matter to consumers? They’re important because free-trade agreements increase choices, competition, and purchasing power and thus decrease what people pay for food, clothing, necessities, and luxuries. Indeed, in the US trade lowers prices 29% for middle income consumers and 62% for the poorest consumers. *  Accordingly, today’s consumers rarely care where their products and services come from. From seafood to diamonds, people don’t care where products are from—they just want to know which brand or kind is cheaper. * And why do trade barriers and free-trade agreements matter to managers? The reason, as you’re about to read, is that while free-trade agreements create new business opportunities, they also intensify competition, and addressing that competition is a manager’s job.

Global Tastes Include Soggy Corn Flakes

Cereal sales have been declining for years in the United States, but they have been exploding in many developing nations. While this overall growth is good news for cereal manufacturer Kellogg’s, it has also brought a new set of challenges. Yogurt is more widely available than milk in Colombia, so Kellogg’s sells cereal attached to packets of yogurt. Kellogg’s found that consumers in South Africa were boiling their Corn Flakes to give the cereal a more porridge-like consistency, so it developed Corn Flakes Instant Porridge for that market. Kara Timperley, Kellogg’s marketing director for sub-Saharan Africa, said that once they realized consumer differences, reconceiving Corn Flakes as porridge was a “no-brainer.” Today, nearly a third of Kellogg’s $14.6 billion annual revenue comes from sales of cereal and related products in emerging markets.

8-2. Consistency or Adaptation?

After a company has decided that it will go global, it must decide how to go global. For example, if you decide to sell in Singapore, should you try to find a local business partner who speaks the language, knows the laws, and understands the customs and norms of Singapore’s culture? Or should you simply export your products from your home country? What do you do if you are also entering Eastern Europe, perhaps starting in Hungary? Should you use the same approach in Hungary that you use in Singapore?

In this section, we return to a key issue: How can you be sure that the way you run your business in one country is the right way to run that business in another? In other words, how can you strike the right balance between global consistency and local adaptation?

Global consistency means that a multinational company with offices, manufacturing plants, and distribution facilities in different countries uses the same rules, guidelines, policies, and procedures to run all of those offices, plants, and facilities. Managers at company headquarters value global consistency because it simplifies decisions. For example, rather than stock its new São Paulo, Brazil, store with apparel according to South American seasonality, Ralph Laurenfollowed the North American seasons, putting winter apparel on the shelves during the Brazilian summer. *  By contrast, a company following a policy of local adaptation modifies its standard operating procedures to adapt to differences in foreign customers, governments, and regulatory agencies. Amazon chose local adaptation to grow its video services in India by developing new shows specifically for Indian viewers. Roy Price, chief of Amazon Studios, said, “You can have a global service, but there are no global customers. There are only local customers.” *  Amazon is developing a dozen original Indian shows. For example, the animated series “Baahubali: The Lost Legends,” based on a popular Indian movie, will be produced in Hindi and English, as well as Tamil and Telugu, two regional languages. *  Local adaptation is typically preferred by local managers who are charged with making the international business successful in their countries.

 

Walmart became the world’s largest retailer by building hypermarkets with a full-sized grocery and a full-sized discount department store, but the strategy has struggled overseas.

 

If companies lean too much toward global consistency, they run the risk of using management procedures poorly suited to particular countries’ markets, cultures, and employees (that is, a lack of local adaptation). Walmart became the world’s largest retailer by building hypermarkets with a full-sized grocery and a full-sized discount department store. But that strategy has struggled overseas. Professor Flavio Tayra said, “Ever since it entered Brazil, Wal-Mart has found it difficult to integrate itself into the market. It occupies a modest space here given all the potential it has.” *  Traffic is notoriously bad in Brazil’s large cities, so getting to Walmart stores located in city outskirts (because of their large size) is frustrating. Also, bargain-hunting Brazilians prefer “cash and carries” retailers selling heavily discounted goods in bulk. While they might visit cash and carries once a month, Brazilians shop for groceries several times a week at smaller, neighborhood grocers. This makes Walmart’s current plans to spend $320 million to upgrade its hypermarkets, and convert two regional chains it bought to hypermarkets with Walmart’s name, surprising. Analyst Bruna Pezzin said, “Focusing on a format that is clearly losing market share and is no longer very attractive to Brazilians doesn’t seem appropriate.” *

If, however, companies focus too much on local adaptation, they run the risk of losing the cost effectiveness and productivity that result from using standardized rules and procedures throughout the world. *  While Amazon’s video services relies on local adaptation to grow in India, Netflix’s concerns for productivity drive its use of global consistency as it slowly expands in India. For now, CEO Reed Hastings said that Netflix’s target customers are, “iPhone owners,” or “Western-oriented elites” capable of paying $8 a month (500 rupees) for a Netflix subscription. And rather than develop new shows for India, Netflix uses its massive set of viewer data preferences for making local programming decisions. Hastings said, “There’s no point in us trying to out-Bollywood Bollywood at this point.” *

8-3. Forms for Global Business

Besides determining whether to adapt organizational policies and procedures, a company must also determine how to organize itself for successful entry into foreign markets.

Historically, companies have generally followed the phase model of globalization, in which a company makes the transition from a domestic company to a global company in the following sequential phases: 8-3a exporting, 8-3b cooperative contracts, 8-3c strategic alliances, and 8-3d wholly owned affiliates. At each step, the company grows much larger, uses those resources to enter more global markets, is less dependent on home-country sales, and is more committed in its orientation to global business. Some companies, however, do not follow the phase model of globalization. Some skip phases on their way to becoming more global and less domestic. Others don’t follow the phase model at all. These are known as 8-3e global new ventures. This section reviews these forms of global business. *

8-3a. Exporting

When companies produce products in their home countries and sell those products to customers in foreign countries, they are exporting. Exporting as a form of global business offers many advantages. It makes the company less dependent on sales in its home market and provides a greater degree of control over research, design, and production decisions. The largest auto manufacturing plant in the world in Spartanburg, South Carolina, is owned by Germany-based BMW. Opened in 1994, BMW’s Spartanburg plant produced 411,000 cars in 2016. Seventy percent of the X3, X4, X5, and X6 BMWs produced there are exported outside the United States, with China being the largest market. Sherry McCraw, vice president of finance at the Spartanburg plant, said that factory workers know when they’re producing “Chinese cars,” because they’re ordered with every possible option. *

Though advantageous in a number of ways, exporting also has its disadvantages. The primary disadvantage is that many exported goods are subject to tariff and nontariff barriers that can substantially increase their final cost to consumers. The second disadvantage is that transportation costs can significantly increase the price of an exported product. Chinese regulations require live imported animals to be slaughtered within 55 miles of their point of entry. To meet China’s growing demand for fresh beef, Australian ranchers have begun flying cattle on 747 jumbo jets to ports of entry thousands of miles inland. By switching from ships to jets, exporters have been able to expand the market for fresh beef in inland China.*  The final disadvantage of exporting is that exporters depend on foreign importers for product distribution. If, for example, the foreign importer makes a mistake on the paperwork that accompanies a shipment of imported goods, those goods can be returned to the foreign manufacturer at the manufacturer’s expense.

8-3b. Cooperative Contracts

When an organization wants to expand its business globally without making a large financial commitment to do so, it may sign a cooperative contract with a foreign business owner who pays the company a fee for the right to conduct that business in his or her country. There are two kinds of cooperative contracts: licensing and franchising.

Under a licensing agreement, a domestic company, the licensor, receives royalty payments for allowing another company, the licensee, to produce its product, sell its service, or use its brand name in a particular foreign market. It costs more than $4 million to produce a single episode of a television series like Blacklist, CSI, or Gotham. Payments from U.S. television networks generally only cover 50–65 percent of that, so foreign licensing agreements are critical to covering the remaining production costs. For example, in order to air these shows in the United Kingdom, Britain’s Channel 5 (the licensee) pays Warner Bros. (the licensor) a $780,000-per-episode fee. *  Forty percent of the revenue generated by popular television shows comes from foreign broadcast licenses. *

One of the most important advantages of licensing is that it allows companies to earn additional profits without investing more money. As foreign sales increase, the royalties paid to the licensor by the foreign licensee increase. Moreover, the licensee, not the licensor, invests in production equipment and facilities to produce the product. Licensing also helps companies avoid tariff and nontariff barriers. Because the licensee manufactures the product within the foreign country, tariff and non-tariff barriers don’t apply.

The biggest disadvantage associated with licensing is that the licensor gives up control over the quality of the product or service sold by the foreign licensee. Unless the licensing agreement contains specific restrictions, the licensee controls the entire business from production to marketing to final sales. Many licensors include inspection clauses in their license contracts, but closely monitoring product or service quality from thousands of miles away can be difficult.

An overeager licensor can dilute the value of a brand or damage the brand’s reputation through overexposure. Luxury fashion brands like Louis Vuitton, Celine, Gucci, Yves Saint Laurent, and Burberry recently ended long-term licensing agreements, citing a lack of control over the products sold under their brand names. Burberry ended a 45-year agreement with its Japanese licensee, Sanyo Shokai, because the company opened hundreds of stores and flooded Japan with too many moderately-priced items. After canceling the contract, Burberry reduced the number of Japanese stores from more than 400 to two dozen and replaced Sanyo Shokai’s mid-tier products with ones costing up to 10 times more. According to CEO for Burberry in Asia, Pascal Perrier, “The license has been suffering from overexposure. We will never do that again.” *  An additional disadvantage is that licensees can eventually become competitors, especially when a licensing agreement includes access to important technology or proprietary business knowledge.

A franchise is a collection of networked firms in which the manufacturer or marketer of a product or service, the franchisor, licenses the entire business to another person or organization, the franchisee. For the price of an initial franchise fee plus royalties, franchisors provide franchisees with training, assistance with marketing and advertising, and an exclusive right to conduct business in a particular location. Most franchise fees run between $5,000 and $35,000. Franchisees pay McDonald’s, one of the largest franchisors in the world, an initial franchise fee of $45,000. Another $1,003,000 to $2,228,000 is needed beyond that to pay for food inventory, kitchen equipment, construction, landscaping, and other expenses (the cost varies by location). While franchisees typically borrow part of this cost from a bank, McDonald’s requires applicants to have over $500,000 in nonborrowed assets and requires a 25–40 percent down payment in cash for the initial investment. *  Typical royalties run from 4 percent of gross sales (plus rent at 8.5%) to 15 percent based on location and revenue. *  So franchisors are well rewarded for the help they provide to franchisees. More than 400 U.S. companies franchise their businesses to foreign franchise partners.

Despite franchising’s many advantages, franchisors face a loss of control when they sell businesses to franchisees who are thousands of miles away. Franchising specialist Cheryl Scott says, “One franchisor I know was wondering why the royalties coming from India were so small when he knew the shop was always packed. It was because the franchisee wasn’t putting all of the sales through the cash register. *

Although there are exceptions, franchising success may be somewhat culture-bound. Because most global franchisors begin by franchising their businesses in similar countries or regions (Canada is by far the first choice for U.S. companies taking their first step into global franchising), and because 65 percent of franchisors make absolutely no change in their business for overseas franchisees, that success may not generalize to cultures with different lifestyles, values, preferences, and technological infrastructures. In Hong Kong Pizza Hut’s “flying fish roe salmon cream cheese pizza” is topped with shrimp, crayfish, clams, and scallops. In Australia it serves a hot dog stuffed crust pizza. And in South Korea its serves a dessert stuffed crust (cream cheese, cranberry or cinnamon apple nut) pizza with sausage, steak, bacon and calamari toppings. Burger King offers the “SufganiKing” whopper with two fried donut halves for the bun in Israel, the “Meatatarian” burger with bacon, chicken, beef, cheese and barbecue sauce in New Zealand, and the “Kuro” (black) burger with a black charred bun, black cheese made from charcoaled bamboo, and black sauce from black squid ink in Japan. *

8-3c. Strategic Alliances

Companies forming strategic alliances combine key resources, costs, risks, technology, and people. Airbnb, the reservation site for people renting rooms, apartments and homes to travelers, makes it easy for Chinese customers to pay for reservations by partnering with Alipay, the Chinese version of PayPal, and with Tencent, the owner of WeChat, the dominant messaging and social group app in China that can also be used to pay bills and make online purchases via TenPay (Tencent’s version of PayPal). *  The most common strategic alliance is a joint venture, which occurs when two existing companies collaborate to form a third company. The two founding companies remain intact and unchanged, except that together they now own the newly created joint venture.

One of the advantages of global joint ventures is that, like licensing and franchising, they help companies avoid tariff and nontariff barriers to entry. Another advantage is that companies participating in a joint venture bear only part of the costs and the risks of that business. Many companies find this attractive because of the expense of entering foreign markets or developing new products.

Global joint ventures can be especially advantageous to smaller local partners who link up with larger, more experienced foreign firms that can bring advanced management, resources, and business skills to the joint venture.

Global joint ventures are not without problems, though. Because companies share costs and risks with their joint venture partners, they must also share profits. Managing global joint ventures can also be difficult because they represent a merging of four cultures: the country and the organizational culture of the first partner, and the country and the organizational culture of the second partner. Often, to be fair to all involved, each partner in the global joint venture will have equal ownership and power. But this can result in power struggles and a lack of leadership. Because of these problems, companies forming global joint ventures should carefully develop detailed contracts that specify the obligations of each party. U.S.-based Simon Property, the world’s largest shopping mall developer, has had two unsuccessful joint ventures in China. Its first joint venture with U.S.-based investment firm Morgan Stanley and a state-owned Chinese company to build shopping malls in China ended with Simon selling its shares in the business back to its partners. Two years later Simon agreed to form a joint venture with a China-based developer, Bailian Group, to build high end outlet centers in China. But nothing resulted from that agreement, either. *

8-3d. Wholly Owned Affiliates (Build or Buy)

Approximately one-third of multinational companies enter foreign markets through wholly owned affiliates. In 2015, Chinese firms spent a record $15.7 billion to acquire companies or build new facilities as a way of entering the U.S. market. One of these firms, Golden Dragon Precise Copper Tube Group, entered the U.S. market by building a $120 million pipe factory in Wilcox, Alabama. The company’s U.S. subsidiary, GD Copper, is completely owned by the Chinese parentcompany. *  Unlike licensing arrangements, franchises, or joint ventures, wholly owned affiliates, such as American Standard Brands and GROHE, are 100 percent owned by their parent company, in this case, Lixil.

The primary advantage of wholly owned businesses is that the parent company receives all of the profits and has complete control over the foreign facilities. The biggest disadvantage is the expense of building new operations or buying existing businesses. Although the payoff can be enormous if wholly owned affiliates succeed, the losses can be immense if they fail because the parent company assumes all of the risk. After Hong-Kong apparel maker TAL Group opened a pants factory in Dongguan, China, employee wages and benefits skyrocketed 31 percent the first year, 28 percent the second year, and then rose 10–12 percent annually thereafter. After nine years, TAL Group closed the pants factory and laid off 2,400 employees. After the shutdown, CEO Roger Lee said that because of the higher labor costs there was no way the Chinese factory could ever be as profitable as factories in Southeast Asia. “We’ve done the calculation quite a few times,” said Lee. *

 

Purchasing power is growing in countries such as India and China, which have low average levels of income.

8-3e. Global New Ventures

Companies used to evolve slowly from small operations selling in their home markets to large businesses selling to foreign markets. Furthermore, as companies went global, they usually followed the phase model of globalization. Recently, however, three trends have combined to allow companies to skip the phase model when going global. First, quick, reliable air travel can transport people to nearly any point in the world within one day. Second, low-cost communication technologies such as email, teleconferencing and phone conferencing via the Internet, and cloud computing make it easier to communicate with global customers, suppliers, managers, and employees. Third, there is now a critical mass of businesspeople with extensive personal experience in all aspects of global business. *  This combination of developments has made it possible to start companies that are global from inception. With sales, employees, and financing in different countries, global new ventures are companies that are founded with an active strategy. *

Although there are several different kinds of global new ventures, all share two common factors. First, the company founders successfully develop and communicate the company’s global vision from inception. Second, rather than going global one country at a time, new global ventures bring a product or service to market in several foreign markets at the same time. U.S.-based Trov sells “on-demand insurance for the things you love.” Just two years old, Trov’s smartphone app allows consumers to insure cameras and lenses, smartphones and tablets, laptop computers and computer monitors, smartwatches and headphones. Coverage can be bought by the day, month, or year. Everything is handled via Trov’s smartphone app. CEO Scott Walcheck says, “From binding a policy to making a claim, the consumer doesn’t have to speak to anybody.” *  Trov began offering insurance for Australian and UK customers, will expand coverage to the US in 2017, and has immediate plans to enter Japan and France

8-4. Finding the Best Business Climate

When deciding where to go global, companies try to find countries or regions with promising business climates.

An attractive global business climate 8-4a positions the company for easy access to growing markets, 8-4b is an effective but cost-efficient place to build an office or manufacturing facility, and 8-4c minimizes the political risk to the company.

8-4a. Growing Markets

The most important factor in an attractive business climate is access to a growing market. Two factors help companies determine the growth potential of foreign markets: purchasing power and foreign competitors.

Purchasing power is measured by comparing the relative cost of a standard set of goods and services in different countries. For example, a Starbucks’ grande latte costs $6.96 in Zürich, Switzerland. Because that same grande latte costs $5.08 in the United States, the average American has more purchasing power than the average Swiss. *  Purchasing power is growing in countries such as India and China, which have low average levels of income. This is because basic living expenses such as food and shelter are very inexpensive in those countries, so consumers still have money to spend after paying for necessities, especially as salaries increase thanks to demand from international trade (see box “Paying for a ‘Mac Attack’”).

Consequently, countries with high and growing levels of purchasing power are good choices for companies looking for attractive global markets. As Exhibit 8.5 shows, the number of cars per 1,000 people in a country rises directly with purchasing power. For example, in India, China, Israel, and Germany, where the average person earns, respectively $6,030, $14,390, $36,040, and $49,090 per year, the number of cars per 1,000 people increases, respectively, from 32 to 205 to 383 to 572. The more purchasing power people have, the more likely they are to buy cars for themselves and family members. Is purchasing power a perfect predictor of an attractive global market? No. Other factors, such as government regulations, or the cost and convenience of public transportation, also influence car sales. For instance, while China’s car sales have grown from 4 million cars a year in 2005 to 24.3 million cars in 2016 as purchasing power doubled, it’s unlikely that additional increases in Chinese purchasing power will lead to similar growth in car sales. Terrible pollution and traffic have prompted city governments in locations like Beijing and Shanghai to strongly limit the number of cars on their roads. So while car sales will continue to grow in China along with purchasing power, the increase will be much slower than before. *

The second part of assessing the growth potential of global markets involves analyzing the degree of global competition, which is determined by the number and quality of companies that already compete in a foreign market. Coffee consumption in China is growing 7 percent a year, compared to just 0.9 percent in North America. With this in mind, Starbucks decided to double its Chinese stores to 3,400 by 2019. Likewise, the UK’s Costa Coffee plans to grow from 344 Chinese stores to 900 by 2020. Californian Jim Lee, who moved to Shanghai four years ago to start the Ocean Grounds coffee shop, believes that this incredible growth means that there should be plenty of business for new and old coffee houses alike. “This market is exploding,” says Lee. *

Paying for a “Mac Attack”

Every year, The Economist magazine produces the Big Mac Index to illustrate differences in purchasing power across countries. By comparing the price of a single item, in this case, a Big Mac from McDonald’s, the index shows how much (or how little) consumers in each country get for their money. According to the latest index, a Big Mac costs an average of $5.06 in the United States. The average cost jumps to $6.35 in Switzerland, $5.67 in Norway, and $5.26 in Sweden, meaning that residents of these countries get less for their money than U.S. residents do. Conversely, the average cost of a Big Mac is $2.30 in Poland, $2.49 in India, $2.15 in Russia, and just $1.46 in Egypt.

8-4b. Choosing an Office/Manufacturing Location

Companies do not have to establish an office or manufacturing location in each country they enter. They can license, franchise, or export to foreign markets, or they can serve a larger region from one country. But there are many reasons why a company might choose to establish a location in a foreign country. Some foreign offices are established through global mergers and acquisitions, and some are established because of a commitment to grow in a new market. South Korea-owned LG Electronics is building a $250 million factory in Tennessee to speed time to market, and, to avoid exchange rate fluctuations, which affect products imported into the United States, and tariffs on LG’s Chinese manufactured washing machines. William Cho, chief executive of LG North America, explained that the new factory provides, “increased speed to the market[, which] makes us more nimble.” LG’s share of the U.S. washing machine market grew from 13.2 percent in 2012 to 16.5 percent in 2016. *

Other companies choose locations by seeking a tax haven (although this is more difficult for U.S. companies due to legal concerns) or as part of creating a global brand. Ireland is a popular location to establish a company headquarters because of its corporate tax rate of 12.5 percent, which is much lower than the United Kingdom (25%), Germany (30.2%), or the United States (35%), which has the second highest corporate tax rate in the world. *

The criteria for choosing an office/manufacturing location are different from the criteria for entering a foreign market. Rather than focusing on costs alone, companies should consider both qualitative and quantitative factors. Two key qualitative factors are workforce quality and company strategy. Workforce quality is important because it is often difficult to find workers with the specific skills, abilities, and experience that a company needs to run its business. Workforce quality is one reason that many companies doing business in Europe locate their customer call centers in the Netherlands. Workers in the Netherlands are the most linguistically gifted in Europe, with 77 percent trilingual (speaking Dutch, English, and a third language) and 90 percent bilingual (Dutch and English). Comparable numbers across Europe are 25 percent and 54 percent. *  Furthermore, compared to 60 countries worldwide, the Netherlands ranks fourth in terms of the supply of skilled labor, tenth for workers with financial skills, and second for competent managers (the United States ranks fifteenth, seventh, and fifth. *

A company’s strategy is also important when choosing a location. For example, a company pursuing a low-cost strategy may need plentiful raw materials, low-cost transportation, and low-cost labor. A company pursuing a differentiation strategy (typically a higher-priced, better product or service) may need access to high-quality materials and a highly skilled and educated workforce.

Quantitative factors such as the kind of facility being built, tariff and nontariff barriers, exchange rates, and transportation and labor costs should also be considered when choosing an office/manufacturing location. In the apparel industry, low costs and short distances from field to factory are critical success factors for every manufacturer. That’s why VF Corporation, owner of brands such as Wrangler, North Face, and Timberland, is sourcing products from Ethiopia. In addition to having the ability to go from fiber to factory in one country, Ethiopia also boasts a low average salary for garment workers ($21 per month versus up to $297 per month in China), low energy costs, and a free-trade agreement with the United States. The Ethiopian government built a $250 million industrial park exclusively for foreign investors in the apparel industry and is building a railroad through neighboring Djibouti to give its landlocked country access to a sea port. M. Raghuraman, CEO of Brandix, Sri Lanka’s largest clothing exporter, is interested in Ethiopia as a manufacturing location because “Ethiopia seems to be the best location from a government, labor, and power point of view.*  Companies rely on studies such as FM Global’s annually published “Resilience Index” to compare business climates throughout the world.*  Exhibit 8.6 offers a quick overview of the best cities for business based on a variety of criteria. This information is a good starting point if your company is trying to decide where to put an international office or manufacturing plant.

8-4c. Minimizing Political Risk

When managers think about political risk in global business, they envision burning factories and riots in the streets. Although political events such as these receive dramatic and extended coverage in the media, the political risks that most companies face usually are not covered as breaking stories on Fox News or CNN. Nonetheless, the negative consequences of ordinary political risk can be just as devastating to companies that fail to identify and minimize that risk. *

When conducting global business, companies should attempt to identify two types of political risk: political uncertainty and policy uncertainty. *  Political uncertainty is associated with the risk of major changes in political regimes that can result from war, revolution, death of political leaders, social unrest, or other influential events. Policy uncertainty refers to the risk associated with changes in laws and government policies that directly affect the way foreign companies conduct business.

Policy uncertainty is the most common—and perhaps most frustrating—form of political risk in global business, especially when changes in laws and government policies directly undercut sizable investments made by foreign companies. The British exit (Brexit) from the European Union, effective March 29, 2019, has created tremendous uncertainty for British-based firms who don’t know how much post-Brexit access, if any, they will have to EU markets. As a result, banks like JP Morgan Chase, which has 16,000 British employees, are studying where to establish sizable offices in Europe. Chase staff have spent nine months studying and visiting 8 European cities, such as Paris, Frankfurt, Luxembourg, and Dublin. CEO Jamie Dimon estimates that 25 percent of Chase’s staff may need to move to Europe to maintain Chase’s access to EU markets. *  Likewise, British-based EasyJet would be required by EU law to set up a separate European operating company and have more than half of its publicly held stock be owned by Europeans. The difficulty is that businesses don’t know what rules will or won’t apply. Companies that wait until specific terms are negotiated for their businesses may not leave themselves enough time to set up operations and relocate staff to Europe. Companies that move staff and operations before Brexit terms are finalized risk incurring unnecessary costs should the EU and UK agree to relatively open access to each others’ markets. *

Several strategies can be used to minimize or adapt to the political risk inherent in global business. An avoidance strategyis used when the political risks associated with a foreign country or region are viewed as too great. If firms are already invested in high-risk areas, they may divest or sell their businesses. If they have not yet invested, they will likely postpone their investment until the risk shrinks. Russia is an attractive market for automakers because it has a growing middle class but ranks fifty-seventh worldwide in terms of the number of cars per 1,000 people (just 300). With the potential of a growing market, General Motors opened a manufacturing facility in St. Petersburg in 2008 to produce 98,000 cars a year. Four years later, GM was hoping to double production capacity. But by 2015, the Russian car market was shrinking and amid increasingly business-unfriendly regulations, GM closed the plant, taking a $600 million writeoff. *  GM’s president, Daniel Ammann, said, “This decision avoids significant investment into a market that has very challenging long-term prospects.” *

Exhibit 8.7 shows the long-term political stability of various countries in the Middle East (higher scores indicate less political risk). The following factors, which were used to compile these ratings, indicate greater political risk: government instability, poor socioeconomic conditions, internal or external conflict, military involvement in politics, religious and ethnic tensions, high foreign debt as a percentage of GDP, exchange rate instability, and high inflation. *  An avoidance strategy would likely be used for the riskiest countries shown in Exhibit 8.7, such as Iran, Lebanon, and Saudi Arabia but might not be needed for the less risky countries, such as Israel or United Arab Emirates. Risk conditions and factors change, so be sure to make risk decisions with the latest available information from resources such as the PRS Group ( www.prsgroup.com ), which supplies information about political risk to 80 percent of Fortune 500 companies.

Control is an active strategy to prevent or reduce political risks. Firms using a control strategy lobby foreign governments or international trade agencies to change laws, regulations, or trade barriers that hurt their business in that country. Uber’s low-cost European ride-sharing service, UberPop, has faced a number of setbacks in recent years, including massive protests from professional taxi drivers and restrictive government regulations. UberPop has even been banned outright in France, Germany, and Spain. *  To deal with these setbacks, Uber hired veteran lobbyist Mark MacGann. MacGann appealed to European Union officials in Belgium, saying, “This is supposed to be a single market [but] what we’re finding is that we’re getting treated in completely different ways in different countries, and even within individual countries.” *  Thus far, Uber has made little progress controlling the political risks in these countries.

Another method for dealing with political risk is cooperation, which involves using joint ventures and collaborative contracts, such as franchising and licensing. Although cooperation does not eliminate the political risk of doing business in a country, it can limit the risk associated with foreign ownership of a business. For example, a German company forming a joint venture with a Chinese company to do business in China may structure the joint venture contract so that the Chinese company owns 51 percent or more of the joint venture. Doing so qualifies the joint venture as a Chinese company and exempts it from Chinese laws that apply to foreign-owned businesses. However, cooperation cannot always protect against policy risk if a foreign government changes its laws and policies to directly affect the way foreign companies conduct business.

8-5. Becoming Aware of Cultural Differences

National culture is the set of shared values and beliefs that affects the perceptions, decisions, and behavior of the people from a particular country. The first step in dealing with culture is to recognize that there are meaningful differences. In recent years, Indian companies have targeted a group of mid-sized, independent, often family-owned, German companies (called Mittlestand) for acquisition. When Rail.One GmbH was acquired by PCM Group, an Indian conglomerate, the new owners didn’t change the Bavarian management because, says PCM Chairman Kamal Mittal, “We didn’t want to disturb the business.” *  Professor Geert Hofstede spent 20 years studying cultural differences in 53 different countries. His research shows that there are six consistent cultural dimensions across countries: power distance, individualism, masculinity, uncertainty avoidance, short-term versus long-term orientation, and indulgence versus restraint. *

Power distance is the extent to which people in a country accept that power is distributed unequally in society and organizations. In countries where power distance is weak, such as Denmark and Sweden, employees don’t like their organization or their boss to have power over them or tell them what to do. They want to have a say in decisions that affect them. As Exhibit 8.8 shows, Russia, China and Nigeria, with scores of 93, 80, and 80, respectively, are much stronger in power distance than Germany (35), the Netherlands (38), and the United States (40).

ndividualism is the degree to which societies believe that individuals should be self-sufficient. In individualistic societies, employees put loyalty to themselves first and loyalty to their company and work group second. In Exhibit 8.8, the United States (91), the Netherlands (80), France (71), and Germany (67) are the strongest in individualism, while Indonesia (14), China (20), and Hong Kong (25) are the weakest.

Masculinity and femininity capture the difference between highly assertive and highly nurturing cultures. Masculine cultures emphasize assertiveness, competition, material success, and achievement, whereas feminine cultures emphasize the importance of relationships, modesty, caring for the weak, and quality of life. In Exhibit 8.8, Japan (95), Germany (66), and China (66) have the most masculine orientations, while the Netherlands (14) has the most feminine orientation. Manu Parpia, the CEO of Geometric, Ltd., the Indian company that acquired German engineering company 3Cap, noted that, compared to India, “German culture is more precise, very process oriented [and] quite blunt. The emphasis on process in India is much lower, because if you focused on process, nothing would get done.” *

The cultural difference of uncertainty avoidance is the degree to which people in a country are uncomfortable with unstructured, ambiguous, unpredictable situations. In countries with strong uncertainty avoidance, such as Greece and Portugal, people tend to be aggressive and emotional and seek security rather than uncertainty. In Exhibit 8.8, Russia (95), Japan (92), and France (86) are strongest in uncertainty avoidance, while Hong Kong (29) and China (30) are the weakest. Rail.One CEO Jochen Riepl has noticed this dimension playing itself out during meetings with PCM officials. “In India, a ‘no’ is a kind of invitation to start a discussion. In Germany, a ‘no’ is a ‘no,’” he says. *

The cultural dimension of short-term/long-term orientation addresses whether cultures are oriented to the present and seek immediate gratification or to the future and defer gratification. Not surprisingly, countries with short-term orientations are consumer-driven, whereas countries with long-term orientations are savings-driven. In Exhibit 8.8, Japan (88) and China (87) have very strong long-term orientations, while Nigeria (13) and the United States (26), have very strong short-term orientations. The cultural dimension of indulgence versus restraint addresses the degree to which a society allows relatively free gratification of basic drives related to enjoying life and having fun versus strict social norms that regulate and suppress gratification of needs and wants. Nigeria (81), the United States (68), and the Netherlands (68) are strongest in indulgence, while Hong Kong (17), Russia (20), and China (24) practice the most restraint. Part of what makes Mittelstand companies comfortable with new Indian owners is that Indian bidders usually offer long-term commitments. Attorney Christopher Wright says of Indian investors, “They tend to have a long-term vision and [that] gives German companies some assurance. *

To generate a graphical comparison of two different countries’ cultures, go to  http://geert-hofstede.com/countries.html . Select a “Country” from the dropdown list, and then select a “Comparison Country.” A graph comparing the countries on each of Hofstede’s six cultural differences will be generated automatically.

Cultural differences affect perceptions, understanding, and behavior. Recognizing cultural differences is critical to succeeding in global business. Nevertheless, as Hofstede pointed out, descriptions of cultural differences are based on averages—the average level of uncertainty avoidance in Portugal, the average level of power distance in Argentina, and so forth. Accordingly, says Hofstede, “If you are going to spend time with a Japanese colleague, you shouldn’t assume that overall cultural statements about Japanese society automatically apply to this person.” *  Similarly, cultural beliefs may differ significantly from one part of a country to another. *

After becoming aware of cultural differences, the second step is deciding how to adapt your company to those differences. Unfortunately, studies investigating the effects of cultural differences on management practices point more to difficulties than to easy solutions.

Another difficulty is that cultural values are changing, albeit slowly, in many parts of the world. The fall of communism in Eastern Europe and the former Soviet Union and the broad economic reforms in China have produced sweeping changes on two continents in the past four decades. Thanks to increased global trade resulting from free-trade agreements, major economic transformations are also under way in India, China, Central America, and South America. Consequently, when trying to adapt management practices to cultural differences, companies must ensure that they are not basing their adaptations on outdated and incorrect assumptions about a country’s culture.

8-6. Preparing for an International Assignment

When Atlanta native Joanna Maddox was first in Argentina, she was invited to an asado, or Argentinian barbecue, scheduled for 8 p.m. Not wanting to be late, she arrived at 7:30 p.m. The catering chef explained that in Argentina, “you never arrive early to an asado.” *  When Argentinian guests arrived after 9 p.m., Maddox said, “Not a single apology was given for arriving late.” *  And because drinks and appetizers weren’t served until 9:30 p.m., Maddox, who usually ate much earlier, said she was so hungry she could, “eat the tablecloth.” Dinner was eventually served at 10:30 p.m. Now, however, Maddox has adjusted to Argentina’s cultural expectations regarding time. Today, she says, “when I make plans to meet my Argentine friends for coffee or lunch, all I have to do is add an hour to our meeting time and voila, I will be on time.” *

If you become an expatriate, someone who lives and works outside his or her native country, chances are you’ll run into cultural surprises just like Joanna Maddox did in Argentina. The difficulty of adjusting to language, cultural, and social differences is the primary reason for expatriate failure in overseas assignments. For example, although there have recently been disagreements among researchers about these numbers, it is probably safe to say that 5–20 percent of American expatriates sent abroad by their companies will return to the United States before they have successfully completed their assignments. *  Of those who do complete their international assignments, about one-third are judged by their companies to be no better than marginally effective. *  Because even well-planned international assignments can cost as much as three to five times an employee’s annual salary, failure in those assignments can be extraordinarily expensive. *  Furthermore, while it is difficult to find reliable indicators, studies typically show that 8–25 percent of expatriate managers leave their companies following an international assignment. *

The chances for a successful international assignment can be increased through 8-6a language and cross-cultural trainingand 8-6b consideration of spouse, family, and dual-career issues.

8-6a. Language and Cross-Cultural Training

Predeparture language and cross-cultural training can reduce the uncertainty that expatriates feel, the misunderstandings that take place between expatriates and natives, and the inappropriate behaviors that expatriates unknowingly commit when they travel to a foreign country. In fact, simple things such as using a phone, locating a public toilet, asking for directions, finding out how much things cost, exchanging greetings, or understanding what people want can become tremendously complex when expatriates don’t know a foreign language or a country’s customs and cultures. Even after spending years in China planning for the opening of Shanghai Disneyland, it was still challenging to clearly translate names, concepts, and ideas from English into Chinese. For example, when Qi Zhu visited Shanghai Disneyland, the slogan “Ignite the magical dream within your heart” translated as “strange dream.” Qi said, “What is a strange dream? [And] Why would I want a strange dream in a park?” *  Fangxing Pitcher, who is part of the park design group for Disney Imagineering, said, “Every time we come up with a name, we had to make sure it has a whimsical Disney feel, it resonates with Chinese people, and it conveys what the experience is. If you just do a straight translation, all of that gets lost.” *

Expatriates who receive predeparture language and cross-cultural training make faster adjustments to foreign cultures and perform better on their international assignments. *  Unfortunately, only a third of the managers who go on international assignments are offered any kind of predeparture training, and only half of those actually participate in the training! * Suzanne Bernard, director of international mobility at Bombardier Aerospace in Canada, says, “We always offer cross-cultural training, but it’s very seldom used by executives leaving in a rush at the last minute.” *  This is somewhat surprising given the failure rates for expatriates and the high cost of those failures. Furthermore, with the exception of some language courses, predeparture training is not particularly expensive or difficult to provide. Three methods can be used to prepare workers for international assignments: documentary training, cultural simulations, and field experiences.

Expats Leave as Squares, Try to Fit in as Circles, and Come Back as Triangles

Working and living abroad changes expatriates. First is the challenge of leaving home, family, and friends, moving from one culture (squares) to fit into a new culture (circles). And that challenge can be harder for the so-called “trailing spouse.” Petra Trudell, who gave up her job as a reporter to move with her husband to Japan says, “My own turning point came when I first met the wife of my husband’s boss. They are fellow Americans who hadn’t been in Japan much longer than us, and we met for dinner while my husband and I were still in temporary housing. She looked at me and asked how I was doing. When I gave the polite answer, dancing around my own insecurities, she did something I didn’t expect: She congratulated me. She told me not to feel badly about wanting to stay inside and feeling overwhelmed.”

Most expats and their families do adjust to their new cultures. Many thrive and learn to love their new homes and neighbors, eventually taking as their own some of the customs and norms of those new cultures. In that process, they become triangles, a hybrid between their original culture (squares) and their new culture (circles). And that becomes most apparent to them when they return home. Relocation specialist Naomi Hattaway, who moved with her family to India and then Singapore and back to the United States, says, “During my time abroad, my horizons were expanded, but when we returned home to the U.S., I found myself struggling with fitting in. I felt like a misfit.” So she took to blogging to share her thoughts and feelings, forming the “I am a Triangle” group on Facebook, which grew from 30 to 6,300 members. One Facebook participant wrote, “Being home and near family has been great, but outside of that, everything is a challenge. I feel completely foreign to the local culture, and have a hard time connecting with people…[But] I have been reading posts and comments and I already feel better, seeing the community and support here in this group.”

Becoming an expat changes you. As Petra Trudell eventually learned in Japan, “it’s not always an easy life, but there’s no disputing it’s a good life.” Even when you’re a triangle returning home to squares.

Documentary training focuses on identifying specific critical differences between cultures. France-based fashion company L’Oreal values direct communication so much that it offers a “Managing Confrontation” course for global employees who come from cultures with different communication norms. One Chinese employee said, “We don’t do this type of debate traditionally in China, but these trainings have taught us a method of expressing diverging opinions, which we have all come to practice and appreciate, even in meetings made up of only Chinese.” *

After learning specific critical differences through documentary training, trainees can participate in cultural simulations, in which they practice adapting to cultural differences. EMC, a global provider of information storage solutions, uses cultural simulations to train its people. In its early days, EMC was largely based in the United States, but with research labs, offices, and customers on every continent, cross-cultural interactions are a daily part of business. EMC’s cultural simulations use photos and audio and video clips to present real-world situations. EMC employees must decide what to do and then learn what happened as a result of their choices. Whether it’s interacting with customers or dealing with EMC employees from other countries, at every step they have the opportunity to learn good and bad methods of responding to cultural differences. EMC requires its worldwide workforce of 40,500 people to regularly use the cultural simulations. Louise Korver-Swanson, EMC’s global head of executive development, said, “This is about ensuring that we’re truly a global company. We need everyone in the organization to be tuned in.” *

Finally, field simulation training, a technique made popular by the U.S. Peace Corps, places trainees in an ethnic neighborhood for three to four hours to talk to residents about cultural differences. For example, a U.S. electronics manufacturer prepared workers for assignments in South Korea by having trainees explore a nearby South Korean neighborhood and talk to shopkeepers and people on the street about South Korean politics, family orientation, and day-to-day living.

8-6b. Spouse, Family, and Dual-Career Issues

Not all international assignments are difficult for expatriates and their families, but the evidence clearly shows that how well an expatriate’s spouse and family adjust to the foreign culture is the most important factor in determining the success or failure of an international assignment. *  In fact, a Harvard Business Review study found that 32 percent of those offered international assignments turned them down because they did not want their families to have to relocate, while 28 percent turned them down “to protect their marriages.” *  Unfortunately, despite its importance, there has been little systematic research on what does and does not help expatriates’ families successfully adapt. A number of companies, however, have found that adaptability screening and intercultural training for families can lead to more successful overseas adjustment.

Adaptability screening is used to assess how well managers and their families are likely to adjust to foreign cultures. For example, Prudential Relocation Management’s international division has developed an “Overseas Assignment Inventory” (OAI) to assess a spouse and family’s open-mindedness, respect for others’ beliefs, sense of humor, and marital communication. The OAI was initially used to help the U.S. Peace Corps, the U.S. Navy, and the Canadian International Development Agency select people who could adapt well in foreign cultures. Success there led to its use in helping companies assess whether managers and their spouses were good candidates for international assignments. *  Likewise, Pennsylvania-based AMP, a worldwide producer of electrical connectors, conducts extensive psychological screening of expatriates and their spouses when making international assignments. But adaptability screening does not just involve a company assessing an employee; it can also involve an employee screening international assignments for desirability. Because more employees are becoming aware of the costs of international assignments (spouses having to give up or change jobs, children having to change schools, everyone having to learn a new language), some companies are willing to pay for a preassignment trip so the employee and his or her spouse can investigate the country before accepting the international assignment. *

Only 40 percent of expatriates’ families receive language and cross-cultural training, yet such training is just as important for the families of expatriates as for the expatriates themselves. *  In fact, it may be more important because, unlike expatriates, whose professional jobs often shield them from the full force of a country’s culture, spouses and children are fully immersed in foreign neighborhoods and schools. Households must be run, shopping must be done, and bills must be paid. When Judy Holland’s husband was transferred to Shanghai, his company sent the family to a two-day cultural immersion class in the United Kingdom, where the family learned about business etiquette, the cultural importance of the number 8, the Chinese zodiac, and how to eat with chopsticks. The class even prepared the Hollands for differences they might not have anticipated, such as, in China, it’s uncommon to find men’s shoes in sizes larger than a U.S. 9.5 (Holland’s husband wore a U.S. 11.5). Holland was grateful for the instruction, saying, “Nothing can fully prepare you for China, but it certainly took the shock out of arriving.” Soon after arriving, however, her sense of confidence eroded. “I remember standing in a house with no furniture, not knowing anyone, and wishing they had buddied me up with someone from my husband’s company.” *  In addition to helping families prepare for the cultural differences they will encounter, language and cross-cultural training can help reduce uncertainty about how to act and decrease misunderstandings between expatriates and their families and locals. For example, in the West, people enjoy a fairly large circle of personal space and are only comfortable with family and intimate friends being within inches of their bodies. But in China, where personal space is measured in inches and not feet, the constant jostling by strangers can be perceived as an encroachment and unhinge many Westerners. New Zealander Marita Light, who spent five years in China, found that recalibrating her expectations and being intentionally open helped. “Letting go of my judgments and consciously being more open enabled more creativity in how I dealt with awkward situations. It was a much more rewarding way to live in China.