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CHAPTER 9

Ethics, Corporate Social Responsibility, Environmental Sustainability, and Strategy

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 How the standards of ethical behavior in business are no different from the ethical standards and norms of the larger society and culture in which a company operates.

LO 2 What drives unethical business strategies and behavior.

LO 3 The costs of business ethics failures.

LO 4 The concepts of corporate social responsibility and environmental sustainability and how companies balance these duties with economic responsibilities to shareholders.

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We don’t think of ourselves as do-gooders or altruists. It’s just that somehow we’re trying our best to be run with some sense of moral compass even in a business environment that is growing.

Craig Newmark—Founder of Craigslist

The time is always right to do what is right.

Martin Luther King, Jr.—Civil rights activist and

humanitarian

Sustainability, ensuring the future of life on Earth, is an infinite game, the endless expression of generosity on behalf of all.

Paul Hawken—Founder of Erewhon Trading Co.;

cofounder of Smith & Hawken

CORE CONCEPT

Business ethics deals with the application of general ethical principles to the actions and decisions of businesses and the conduct of their personnel.

Clearly, in capitalistic or market economies, a company has a responsibility to make a profit and grow the business. Managers of public companies have a fiduciary duty to operate the enterprise in a manner that creates value for the company’s shareholders. Just as clearly, a company and its personnel are duty-bound to obey the law and comply with governmental regulations. But does a company also have a duty to go beyond legal requirements and hold all company personnel responsible for conforming to high ethical stan- dards? Does it have an obligation to contribute to the betterment of society, independent of the needs and preferences of the customers it serves? Should a company display a social conscience

by devoting a portion of its resources to better- ing society? Should its strategic initiatives be screened for possible negative effects on future generations of the world’s population?

This chapter focuses on whether a company, in the course of trying to craft and execute a strat- egy that delivers value to both customers and shareholders, also has a duty to (1) act in an ethi- cal manner; (2) be a committed corporate citizen and allocate some of its resources to improving the well-being of employees, the communities in which it operates, and society as a whole; and (3) adopt business practices that conserve natural resources, protect the interests of future generations, and pre- serve the well-being of the planet.

WHAT DO WE MEAN BY BUSINESS ETHICS? Ethics concerns principles of right or wrong conduct. Business ethics is the appli- cation of ethical principles and standards to the actions and decisions of business organizations and the conduct of their personnel.1 Ethical principles in business are not materially different from ethical principles in general. Why? Because business actions have to be judged in the context of society’s standards of right and wrong, not with respect to a special set of ethical standards applicable only to business situ- ations. If dishonesty is considered unethical and immoral, then dishonest behavior in business—whether it relates to customers, suppliers, employees, shareholders,

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competitors, or government—qualifies as equally unethical and immoral. If being ethical entails not deliberately harming others, then businesses are ethically obliged to recall a defective or unsafe product swiftly, regardless of the cost. If society deems bribery unethical, then it is unethical for company personnel to make payoffs to gov- ernment officials to win government contracts or bestow favors to customers to win or retain their business. In short, ethical behavior in business situations requires adhering to generally accepted norms about right or wrong conduct. As a consequence, com- pany managers have an obligation—indeed, a duty—to observe ethical norms when crafting and executing strategy.

LO 1

How the standards of ethical behavior in business are no different from the ethical standards and norms of the larger society and culture in which a company operates.

CORE CONCEPT

The school of ethical universalism holds that the most fundamental conceptions of right and wrong are universal and apply to members of all societies, all companies, and all businesspeople.

WHERE DO ETHICAL STANDARDS COME FROM—ARE THEY UNIVERSAL OR DEPENDENT ON LOCAL NORMS?

Notions of right and wrong, fair and unfair, moral and immoral are present in all societies and cultures. But there are three distinct schools of thought about the extent to which ethical standards travel across cultures and whether multinational companies can apply the same set of ethical standards in any and all locations where they operate.

The School of Ethical Universalism According to the school of ethical universalism, the most fundamental concep- tions of right and wrong are universal and transcend culture, society, and religion.2 For instance, being truthful (not lying and not being deliberately deceitful) strikes a chord of what’s right in the peoples of all nations. Likewise, demonstrating integrity of character, not cheating or harming people, and treating others with decency are concepts that resonate with people of virtually all cultures and religions.

Common moral agreement about right and wrong actions and behaviors across multiple cultures and countries gives rise to universal ethical standards that apply to members of all societies, all companies, and all businesspeople. These univer- sal ethical principles set forth the traits and behaviors that are considered virtuous and that a good person is supposed to believe in and to display. Thus, adherents of the school of ethical universalism maintain that it is entirely appropriate to

expect all members of society (including all personnel of all companies worldwide) to conform to these universal ethical standards.3 For example, people in most societ- ies would concur that it is unethical for companies to knowingly expose workers to toxic chemicals and hazardous materials or to sell products known to be unsafe or harmful to the users.

The strength of ethical universalism is that it draws on the collective views of mul- tiple societies and cultures to put some clear boundaries on what constitutes ethical and unethical business behavior, regardless of the country or culture in which a com- pany’s personnel are conducting activities. This means that with respect to basic moral standards that do not vary significantly according to local cultural beliefs, traditions, or religious convictions, a multinational company can develop a code of ethics that it applies more or less evenly across its worldwide operations. It can avoid the slippery slope that comes from having different ethical standards for different company per- sonnel depending on where in the world they are working.

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The School of Ethical Relativism While undoubtedly there are some universal moral prescriptions (like being truthful and trustworthy), there are also observable variations from one society to another as to what constitutes ethical or unethical behavior. Indeed, differing religious beliefs, social customs, traditions, core values, and behavioral norms frequently give rise to different standards about what is fair or unfair, moral or immoral, and ethically right or wrong. For instance, European and American managers often establish standards of business conduct that protect human rights such as freedom of movement and resi- dence, freedom of speech and political opinion, and the right to privacy. In China, where societal commitment to basic human rights is weak, human rights consider- ations play a small role in determining what is ethically right or wrong in conducting business activities. In Japan, managers believe that showing respect for the collec- tive good of society is a more important ethical consideration. In Muslim coun- tries, managers typically apply ethical standards compatible with the teachings of Muhammad. Consequently, the school of ethical relativism holds that a “one-size- fits-all” template for judging the ethical appropriateness of business actions and the behaviors of company personnel is totally inappropriate. Rather, the underlying thesis of ethical relativism is that whether certain actions or behaviors are ethically right or wrong depends on the ethical norms of the country or culture in which they take place. For businesses, this implies that when there are cross-country or cross- cultural differences in ethical standards, it is appropriate for local ethical standards to take precedence over what the ethical standards may be in a company’s home market.4 In a world of ethical relativism, there are few absolutes when it comes to business ethics, and thus few ethical absolutes for consistently judging the ethical correctness of a company’s conduct in various countries and markets.

This need to contour local ethical standards to fit local customs, local notions of fair and proper individual treatment, and local business practices gives rise to multiple sets of ethical standards. It also poses some challenging ethical dilemmas. Consider the following two examples.

The Use of Underage Labor In industrialized nations, the use of underage workers is considered taboo. Social activists are adamant that child labor is unethical and that companies should nei- ther employ children under the age of 18 as full-time employees nor source any products from foreign suppliers that employ underage workers. Many countries have passed legislation forbidding the use of underage labor or, at a minimum, regulating the employment of people under the age of 18. However, in Eretria, Uzbekistan, Myanmar, Somalia, Zimbabwe, Afghanistan, Sudan, North Korea, Yemen, and more than 50 other countries, it is customary to view children as potential, even necessary, workers. In other countries, like China, India, Russia, and Brazil, child labor laws are often poorly enforced.5 As of 2013, the International Labor Organization estimated that there were about 168 million child laborers age 5 to 17 and that some 85 million of them were engaged in hazardous work.6

While exposing children to hazardous work and long work hours is unquestionably deplorable, the fact remains that poverty-stricken families in many poor countries can- not subsist without the work efforts of young family members; sending their children to school instead of having them work is not a realistic option. If such children are not permitted to work (especially those in the 12-to-17 age group)—due to pressures imposed by activist groups in industrialized nations—they may be forced to go out on

CORE CONCEPT

The school of ethical relativism holds that differing religious beliefs, customs, and behavioral norms across countries and cultures give rise to multiple sets of standards concerning what is ethically right or wrong. These differing standards mean that whether business- related actions are right or wrong depends on the prevailing local ethical standards.

Under ethical relativism, there can be no one-size- fits-all set of authentic ethical norms against which to gauge the conduct of company personnel.

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the streets begging or to seek work in parts of the “underground” economy such as drug trafficking and prostitution.7 So, if all businesses in countries where employing underage workers is common succumb to the pressures to stop employing underage labor, then have they served the best interests of the underage workers, their families, and society in general? Illustration Capsule 9.1 describes IKEA’s approach to dealing with this issue regarding its global supplier network.

The Payment of Bribes and Kickbacks A particularly thorny area facing multinational companies is the degree of cross- country variability in paying bribes.8 In many countries in eastern Europe, Africa, Latin America, and Asia, it is customary to pay bribes to government officials in order to win a government contract, obtain a license or permit, or facilitate an adminis- trative ruling.9 In some developing nations, it is difficult for any company, foreign or domestic, to move goods through customs without paying off low-level officials. Senior managers in China and Russia often use their power to obtain kickbacks when they purchase materials or other products for their companies.10 Likewise, in many countries it is normal to make payments to prospective customers in order to win or retain their business. Some people stretch to justify the payment of bribes and kick- backs on grounds that bribing government officials to get goods through customs or giving kickbacks to customers to retain their business or win new orders is simply a payment for services rendered, in the same way that people tip for service at restau- rants.11 But while this is a clever rationalization, it rests on moral quicksand.

Companies that forbid the payment of bribes and kickbacks in their codes of ethical conduct and that are serious about enforcing this prohibition face a particularly vexing problem in countries where bribery and kickback payments are an entrenched local custom. Complying with the company’s code of ethical conduct in these countries is very often tantamount to losing business to competitors that have no such scruples—an outcome that penalizes ethical companies and ethical company personnel (who may suffer lost sales commissions or bonuses). On the other hand, the payment of bribes or kickbacks not only undercuts the company’s code of ethics but also risks breaking the law. The Foreign Corrupt Practices Act (FCPA) prohibits U.S. companies from paying bribes to government officials, political parties, political candidates, or others in all countries where they do business. The Organization for Economic Cooperation and Development (OECD) has antibribery standards that criminalize the bribery of foreign public officials in international business transactions—all 35 OECD member countries and 7 nonmember countries have adopted these standards.

Despite laws forbidding bribery to secure sales and contracts, the practice persists. As of June 2014, 263 individuals and 164 entities were sanctioned under criminal pro- ceedings for foreign bribery by the OECD. At least 80 of the sanctioned individuals were sentenced to prison. In 2014, Alcoa agreed to pay $384 million to settle charges brought by the Justice Department and the Securities and Exchange Commission (SEC) that it used bribes to lock in lucrative contracts in Bahrain. French oil giant Total settled criminal charges for $398 million the prior year for similar behavior in Iran. Other well- known companies caught up in recent or ongoing bribery cases include Archer Daniels Midland, the global agribusiness trader; Swiss oil-field services firm Weatherford; Avon; and Walmart. In 2013, the Ralph Lauren Corporation struck a non-prosecution agreement with the SEC to forfeit illicit profits made due to bribes paid by a subsidiary in Argentina. When the parent company found the problem, it immediately reported it to the SEC and provided substantial assistance with the investigation. The company paid only $882,000 in penalties (above the forfeited profits) as a result.

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Using the Principle of Ethical Relativism to Create Ethical Standards Is Problematic for Multinational Companies Relying on the principle of ethical relativism to determine what is right or wrong poses major problems for multinational companies trying to decide which ethical stan- dards to enforce companywide. It is a slippery slope indeed to resolve conflicting ethical standards for operating in different countries without any kind of higher- order moral compass. Consider, for example, the ethical inconsistency of a multi- national company that, in the name of ethical relativism, declares it impermissible

ILLUSTRATION CAPSULE 9.1

Known for its stylish ready-to-assemble home furnish- ings, IKEA has long relied on an extensive supplier net- work to manufacture its products and support its rapid global expansion. It has worked hard to develop a suc- cessful approach to encourage high ethical standards among its suppliers, including standards concerning the notoriously difficult issue of child labor.

IKEA’s initial plan to combat the use of child labor by its suppliers involved (1) contracts that threatened immediate cancellation and (2) random audits by a third- party partner. Despite these safeguards, the company discovered that some of its Indian suppliers were still employing children. IKEA realized that this issue would crop up again and again if it continued to use low-cost

suppliers in developing countries—a critical element in its cost-containment strategy.

To address this problem, IKEA developed and intro- duced its new code for suppliers, IWAY, which addresses social, safety, and environmental issues across its pur- chasing model. When faced with a supplier slip-up, IKEA works with the company to figure out and tackle the root cause of violations. Using child labor, for example, can signal bigger problems: production inefficiencies that require the lowest-cost labor, lack of alternative options for children like school or supervised commu- nity centers, family health or income challenges that mean children need to become breadwinners, and so on. IKEA takes action to provide technical expertise to improve working conditions and processes, offer financ- ing help at reasonable rates, run training programs onsite, and help develop resources and infrastructure in areas where its suppliers are based. The IKEA founda- tion also began focusing on these issues through part- nerships with UNICEF and Save the Children aimed at funding long-term community programs that support access to education, health care, and sustainable fam- ily incomes. As of 2016, their efforts have improved the education opportunities of more than 12 million children in 46 different countries.

IKEA’s proactive approach has reduced some of the risks involved in relying on suppliers in developing coun- tries. Through its approach, IKEA has been able to main- tain its core strategic principles even when they seem to be at odds: low costs, great design, adherence to its ethical principles, and a commitment to a better world.

IKEA’s Global Supplier Standards: Maintaining Low Costs While Fighting the Root Causes of Child Labor

Note: Developed with Kiera O’Brien.

Sources: IKEA, “About the Company: This Is IKEA,” www.ikea.com/ms/en_US/this-is-ikea/people-and-planet/people-and-communities/; Elain Cohen, “Banning Child Labor: The Symptom or the Cause?” CSR Newswire, www.csrwire.com/blog/posts/547-banning-child-labor-the- symptom-or-the-cause; UNICEF Press Center, Joint Press Release, www.unicef.org/media/media_89819.html (accessed February 2, 2016).

Codes of conduct based on ethical relativism can be ethically problematic for multinational companies by creating a maze of conflicting ethical standards.

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to engage in kickbacks unless such payments are customary and generally overlooked by legal authorities. It is likewise problematic for a multinational company to declare it ethically acceptable to use underage labor at its plants in those countries where child labor is allowed but ethically inappropriate to employ underage labor at its plants else- where. If a country’s culture is accepting of environmental degradation or practices that expose workers to dangerous conditions (toxic chemicals or bodily harm), should a multinational company lower its ethical bar in that country but rule the very same actions to be ethically wrong in other countries?

Business leaders who rely on the principle of ethical relativism to justify con- flicting ethical standards for operating in different countries have little moral basis for establishing or enforcing ethical standards companywide. Rather, when a com- pany’s ethical standards vary from country to country, the clear message being sent to employees is that the company has no ethical standards or convictions of its own and prefers to let its standards of ethical right and wrong be governed by the customs and practices of the countries in which it operates. Applying multiple sets of ethical stan- dards without some kind of higher-order moral compass is scarcely a basis for holding company personnel to high standards of ethical behavior. And it can lead to prosecu- tions of both companies and individuals alike when there are conflicting sets of laws.

Ethics and Integrative Social Contracts Theory Integrative social contracts theory provides a middle position between the oppos- ing views of ethical universalism and ethical relativism.12 According to this theory, the ethical standards a company should try to uphold are governed by both (1) a limited number of universal ethical principles that are widely recognized as put- ting legitimate ethical boundaries on behaviors in all situations and (2) the cir- cumstances of local cultures, traditions, and values that further prescribe what constitutes ethically permissible behavior. The universal ethical principles are based on the collective views of multiple cultures and societies and combine to form a “social contract” that all individuals, groups, organizations, and businesses in all situations have a duty to observe. Within the boundaries of this social con- tract, local cultures or groups can specify what other actions may or may not be ethically permissible. While this system leaves some “moral free space” for the people in a particular country (or local culture, or profession, or even a company) to make specific interpretations of what other actions may or may not be permissible, universal ethical norms always take precedence. Thus, local ethical standards can be more stringent than the universal ethical standards but never less so. For exam- ple, both the legal and medical professions have standards regarding what kinds of advertising are ethically permissible that extend beyond the universal norm that advertising not be false or misleading. The strength of integrated social contracts theory is that it accommodates the best parts of ethical universalism and ethical relativism. Moreover, integrative social contracts theory offers managers in multinational companies clear guidance in resolving cross-country ethical differences: Those parts of the company’s code of ethics that involve universal ethical norms must be enforced worldwide, but within these boundaries there is room for ethical diversity and the opportunity for host- country cultures to exert some influence over the moral and ethical standards of business units operating in that country.

A good example of the application of integrative social contracts theory to busi- ness involves the payment of bribes and kickbacks. Yes, bribes and kickbacks are

CORE CONCEPT

According to integrated social contracts theory, universal ethical principles based on the collective views of multiple societies form a “social contract” that all individuals and organizations have a duty to observe in all situations. Within the boundaries of this social contract, local cultures or groups can specify what additional actions may or may not be ethically permissible.

According to integrated social contracts theory, adherence to universal or “first-order” ethical norms should always take precedence over local or “second-order” norms.

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common in some countries. But the fact that bribery flourishes in a country does not mean it is an authentic or legitimate ethical norm. Virtually all of the world’s major religions (e.g., Buddhism, Christianity, Confucianism, Hinduism, Islam, Judaism, Sikhism, and Taoism) and all moral schools of thought condemn brib- ery and corruption. Therefore, a multinational company might reasonably conclude that there is a universal ethical principle to be observed here—one of refusing to condone bribery and kickbacks on the part of company personnel no matter what the local custom is and no matter what the sales consequences are.

In instances involving universally applicable ethical norms (like paying bribes), there can be no compromise on what is ethically permissible and what is not.

HOW AND WHY ETHICAL STANDARDS IMPACT THE TASKS OF CRAFTING AND EXECUTING STRATEGY Many companies have acknowledged their ethical obligations in official codes of ethi- cal conduct. In the United States, for example, the Sarbanes–Oxley Act, passed in 2002, requires that companies whose stock is publicly traded have a code of ethics or else explain in writing to the SEC why they do not. But the senior executives of ethi- cally principled companies understand that there’s a big difference between having a code of ethics because it is mandated and having ethical standards that truly provide guidance for a company’s strategy and business conduct.13 They know that the litmus test of whether a company’s code of ethics is cosmetic is the extent to which it is embraced in crafting strategy and in operating the business day to day. Executives committed to high standards make a point of considering three sets of questions when- ever a new strategic initiative or policy or operating practice is under review:

∙ Is what we are proposing to do fully compliant with our code of ethical conduct? Are there any areas of ambiguity that may be of concern?

∙ Is there any aspect of the strategy (or policy or operating practice) that gives the appearance of being ethically questionable?

∙ Is there anything in the proposed action that customers, employees, suppliers, stockholders, competitors, community activists, regulators, or the media might consider ethically objectionable?

Unless questions of this nature are posed—either in open discussion or by force of habit in the minds of company managers—there’s a risk that strategic initiatives and/ or the way daily operations are conducted will become disconnected from the com- pany’s code of ethics. If a company’s executives believe strongly in living up to the company’s ethical standards, they will unhesitatingly reject strategic initiatives and operating approaches that don’t measure up. However, in companies with a cosmetic approach to ethics, any linkage of the professed standards to its strategy and oper- ating practices stems mainly from a desire to avoid the risk of embarrassment and possible disciplinary action for approving actions that are later deemed unethical and perhaps illegal.

While most company managers are careful to ensure that a company’s strategy is within the bounds of what is legal, evidence indicates they are not always so careful to ensure that all elements of their strategies and operating activities are within the bounds of what is considered ethical. In recent years, there have been revelations of ethical misconduct on the part of managers at such companies as Koch Industries, Las Vegas Sands, BP, Halliburton, Hewlett-Packard, GlaxoSmithKline, Marathon Oil

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Corporation, Kraft Foods Inc., Motorola Solutions, Pfizer, several leading investment banking firms, and a host of mortgage lenders. The consequences of crafting strate- gies that cannot pass the test of moral scrutiny are manifested in sizable fines, devas- tating public relations hits, sharp drops in stock prices that cost shareholders billions of dollars, criminal indictments, and convictions of company executives. The fallout from all these scandals has resulted in heightened management attention to legal and ethical considerations in crafting strategy.

LO 2

What drives unethical business strategies and behavior.

CORE CONCEPT

Self-dealing occurs when managers take advantage of their position to further their own private interests rather than those of the firm.

DRIVERS OF UNETHICAL BUSINESS STRATEGIES AND BEHAVIOR

Apart from the “business of business is business, not ethics” kind of thinking apparent in recent high-profile business scandals, three other main drivers of unethical business behavior also stand out:14

∙ Faulty oversight, enabling the unscrupulous pursuit of personal gain and self-interest.

∙ Heavy pressures on company managers to meet or beat short-term performance targets.

∙ A company culture that puts profitability and business performance ahead of ethical behavior.

Faulty Oversight, Enabling the Unscrupulous Pursuit of Personal Gain and Self-Interest People who are obsessed with wealth accumulation, power, status, and their own self-interest often push aside ethical principles in their quest for personal gain. Driven by greed and ambition, they exhibit few qualms in skirting the rules or doing whatever is necessary to achieve their goals. A general dis- regard for business ethics can prompt all kinds of unethical strategic maneuvers and behaviors at companies.

The U.S. government has been conducting a multiyear investigation of insider trad- ing, the illegal practice of exchanging confidential information to gain an advantage in the stock market. Focusing on the hedge fund industry and nicknamed “Operation Perfect Hedge,” the investigation has brought to light scores of violations. The six- year crackdown on insider trading yielded 87 convictions, although 14 were dismissed by prosecutors or lost on appeal by 2015. Among the most prominent of those con- victed was Raj Rajaratnam, the former head of Galleon Group, who was sentenced to 11 years in prison and fined $10 million. At SAC Capital, a $14 billion hedge fund, eight hedge fund managers were convicted of insider trading, in what has been called

the most lucrative insider trading scheme in U.S. history. The company agreed to pay $1.8 billion in penalties and has been forced to stop managing money for out- side investors.15 Since Operation Perfect Hedge began, abnormal jumps in the stock price of target firms (a sign of insider trading) have fallen 45 percent.

Responsible corporate governance and oversight by the company’s corporate board is necessary to guard against self-dealing and the manipulation of informa- tion to disguise such actions by a company’s managers. Self-dealing occurs when managers take advantage of their position to further their own private interests rather than those of the firm. As discussed in Chapter 2, the duty of the corporate board (and its compensation and audit committees in particular) is to guard against

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such actions. A strong, independent board is necessary to have proper oversight of the company’s financial practices and to hold top managers accountable for their actions.

A particularly egregious example of the lack of proper oversight is the scandal over mortgage lending and banking practices that resulted in a crisis for the U.S. residential real estate market and heartrending consequences for many home buyers. This scandal stemmed from consciously unethical strategies at many banks and mortgage compa- nies to boost the fees they earned on home mortgages by deliberately lowering lending standards to approve so-called subprime loans for home buyers whose incomes were insufficient to make their monthly mortgage payments. Once these lenders earned their fees on these loans, they repackaged the loans to hide their true nature and auc- tioned them off to unsuspecting investors, who later suffered huge losses when the high-risk borrowers began to default on their loan payments. (Government authorities later forced some of the firms that auctioned off these packaged loans to repurchase them at the auction price and bear the losses themselves.) A lawsuit by the attorneys general of 49 states charging widespread and systematic fraud ultimately resulted in a $26 billion settlement by the five largest U.S. banks (Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, and Ally Financial). Included in the settlement were new rules designed to increase oversight and reform policies and practices among the mortgage companies. The settlement includes what are believed to be a set of robust monitoring and enforcement mechanisms that should help prevent such abuses in the future.16

Heavy Pressures on Company Managers to Meet Short-Term Performance Targets When key personnel find themselves scrambling to meet the quarterly and annual sales and profit expectations of investors and financial analysts, they often feel enormous pressure to do whatever it takes to protect their reputation for delivering good results. Executives at high-performing companies know that investors will see the slightest sign of a slowdown in earnings growth as a red flag and drive down the company’s stock price. In addition, slowing growth or declining profits could lead to a downgrade of the company’s credit rating if it has used lots of debt to finance its growth. The pressure to “never miss a quarter”—to not upset the expectations of analysts, investors, and creditors—prompts nearsighted managers to engage in short-term maneuvers to make the numbers, regardless of whether these moves are really in the best long-term interests of the company. Sometimes the pres- sure induces company personnel to continue to stretch the rules until the limits of ethi- cal conduct are overlooked.17 Once ethical boundaries are crossed in efforts to “meet or beat their numbers,” the threshold for making more extreme ethical compromises becomes lower.

In 2014, the SEC charged Diamond Foods (maker of Pop Secret and Emerald Nuts) with accounting fraud, alleging that the company falsified costs in order to boost earn- ings and stock prices. The company paid $5 million to the SEC to settle fraud charges, while its (now ousted) CEO paid $125,000 to settle a separate charge of negligence and returned $4 million in bonuses to the company. The company’s now-former CFO initially fought the charges, but eventually settled by paying a $125,000 fine. The real blow for the company was that its pending acquisition of potato chip giant Pringles fell apart as a result of the scandal, thwarting the company’s dreams of becoming the second-largest snack company in the world.18

Company executives often feel pressured to hit financial performance targets because their compensation depends heavily on the company’s performance. Over the last two decades, it has become fashionable for boards of directors to grant lavish

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bonuses, stock option awards, and other compensation benefits to executives for meeting specified performance targets. So outlandishly large were these rewards that executives had strong personal incentives to bend the rules and engage in behaviors that allowed the targets to be met. Much of the accounting manipula- tion at the root of recent corporate scandals has entailed situations in which execu- tives benefited enormously from misleading accounting or other shady activities that allowed them to hit the numbers and receive incentive awards ranging from $10 million to more than $1 billion for hedge fund managers.

The fundamental problem with short-termism—the tendency for managers to focus excessive attention on short-term performance objectives—is that it doesn’t create value for customers or improve the firm’s competitiveness in the market- place; that is, it sacrifices the activities that are the most reliable drivers of higher profits and added shareholder value in the long run. Cutting ethical corners in the name of profits carries exceptionally high risk for shareholders—the steep stock price decline and tarnished brand image that accompany the discovery of scur- rilous behavior leave shareholders with a company worth much less than before—

and the rebuilding task can be arduous, taking both considerable time and resources.

A Company Culture That Puts Profitability and Business Performance Ahead of Ethical Behavior When a company’s culture spawns an ethically corrupt or amoral work climate, people have a company-approved license to ignore “what’s right” and engage in any behavior or strategy they think they can get away with. Such cultural norms as “Everyone else does it” and “It is okay to bend the rules to get the job done” permeate the work environment. At such compa- nies, ethically immoral people are certain to play down observance of ethical stra- tegic actions and business conduct. Moreover, cultural pressures to utilize unethical means if circumstances become challenging can prompt otherwise honorable people to behave unethically. A perfect example of a company culture gone awry on ethics is Enron, a now-defunct but infamous company found guilty of one of the most sprawl- ing business frauds in U.S. history.19

Enron’s leaders pressured company personnel to be innovative and aggressive in figuring out how to grow current earnings—regardless of the methods. Enron’s annual “rank and yank” performance evaluation process, in which the lowest-ranking 15 to 20 percent of employees were let go, made it abundantly clear that bottom-line results were what mattered most. The name of the game at Enron became devising clever ways to boost revenues and earnings, even if this sometimes meant operating outside established policies (and legal limits). In fact, outside-the-lines behavior was celebrated if it generated profitable new business.

A high-performance–high-rewards climate came to pervade the Enron culture, as the best workers (determined by who produced the best bottom-line results) received impressively large incentives and bonuses. On Car Day at Enron, an array of luxury sports cars arrived for presentation to the most successful employees. Understand- ably, employees wanted to be seen as part of Enron’s star team and partake in the benefits granted to Enron’s best and brightest employees. The high monetary rewards, the ambitious and hard-driving people whom the company hired and promoted, and the competitive, results-oriented culture combined to give Enron a reputation not only for trampling competitors but also for internal ruthlessness. The company’s win-at- all-costs mindset nurtured a culture that gradually and then more rapidly fostered the erosion of ethical standards, eventually making a mockery of the company’s stated values of integrity and respect. When it became evident in fall 2001 that Enron was a

CORE CONCEPT

Short-termism is the tendency for managers to focus excessively on short-term performance objectives at the expense of longer-term strategic objectives. It has negative implications for the likelihood of ethical lapses as well as company performance in the longer run.

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house of cards propped up by deceitful accounting and myriad unsavory practices, the company imploded in a matter of weeks—one of the biggest bankruptcies of all time, costing investors $64 billion in losses.

In contrast, when high ethical principles are deeply ingrained in the corporate cul- ture of a company, culture can function as a powerful mechanism for communicating ethical behavioral norms and gaining employee buy-in to the company’s moral stan- dards, business principles, and corporate values. In such cases, the ethical principles embraced in the company’s code of ethics and/or in its statement of corporate values are seen as integral to the company’s identity, self-image, and ways of operating. The message that ethics matters—and matters a lot—resounds loudly and clearly through- out the organization and in its strategy and decisions. Illustration Capsule 9.2 dis- cusses Novo Nordisk’s approach to building an ethical culture and putting its ethical principles into practice.

WHY SHOULD COMPANY STRATEGIES BE ETHICAL? There are two reasons why a company’s strategy should be ethical: (1) because a strat- egy that is unethical is morally wrong and reflects badly on the character of the com- pany and its personnel, and (2) because an ethical strategy can be good business and serve the self-interest of shareholders.

The Moral Case for an Ethical Strategy Managers do not dispassionately assess what strategic course to steer—how strongly committed they are to observing ethical principles and standards definitely comes into play in making strategic choices. Ethical strategy making is generally the product of managers who are of strong moral character (i.e., who are trustworthy, have integrity, and truly care about conducting the company’s business honorably). Managers with high ethical principles are usually advocates of a corporate code of ethics and strong ethics compliance, and they are genuinely committed to upholding corporate values and ethical business principles. They demonstrate their commitment by displaying the company’s stated values and living up to its business principles and ethical standards. They understand the difference between merely adopting value statements and codes of ethics and ensuring that they are followed strictly in a company’s actual strategy and business conduct. As a consequence, ethically strong managers consciously opt for strategic actions that can pass the strictest moral scrutiny—they display no toler- ance for strategies with ethically controversial components.

The Business Case for Ethical Strategies In addition to the moral reasons for adopting ethical strategies, there may be solid business reasons. Pursuing unethical strategies and tolerating unethical conduct not only damages a company’s reputation but also may result in a wide-ranging set of other costly consequences. Figure 9.1 shows the kinds of costs a company can incur when unethical behavior on its part is discovered, the wrongdoings of company per- sonnel are headlined in the media, and it is forced to make amends for its behavior. The more egregious are a company’s ethical violations, the higher the costs and the bigger the damage to its reputation (and to the reputations of the company personnel

LO 3

The costs of business ethics failures.

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Conducting business in an ethical fashion is not only morally right—it is in a company’s enlightened self-interest.

ILLUSTRATION CAPSULE 9.2

Novo Nordisk is a $15.2 billion global pharmaceuti- cal company, known for its innovation and leadership in diabetes treatments. It is also known for its dedica- tion to ethical business practices. In 2012, the com- pany was listed as the global leader in business ethics by Corporate Knights, a corporate social responsibility advisory firm.

Novo Nordisk’s company policies are explicit in their attention to both bioethics and business ethics. In the realm of bioethics, the company is committed to con- ducting its research involving people, animals, and gene technology in accordance with the highest global ethi- cal standards. Moreover, the company requires that all of its suppliers and other external partners also adhere to Novo Nordisk’s bioethical standards. In the realm of business ethics, the policies dictate (1) that high ethical standards be applied consistently across the company’s

value chain, (2) that all ethical dilemmas encountered be addressed transparently, and (3) that company officers and employees be held accountable for complying with all laws, regulations, and company rules.

Novo Nordisk’s strong culture of responsibility helps translate the company’s policies into practice. At Novo Nordisk, every employee pledges to conduct himself or herself according to the Novo Nordisk Way, a set of behavioral norms that has come to define the company’s culture. It’s a culture that promotes teamwork, coopera- tion, respect for others, and fairness. The commitment to business ethics grew out of those values, which are promoted throughout the company by hiring practices, management leadership, and employee mobility to fos- ter a global one-company culture.

As part of this process, Novo Nordisk has set up a business ethics board, composed of senior manage- ment. The board identifies key ethical challenges for the company, drafting guidelines and developing training programs. The training programs are rigorous: All Novo Nordisk employees are trained annually in business eth- ics. The board is also responsible for ensuring compli- ance. It has set up an anonymous hotline and conducts an average of 40 to 50 audits each year. The goal of the audits is to maintain a culture that promotes the prin- ciples of the Novo Nordisk Way.

Implementing a code of ethics across an organiza- tion of 26,000 employees is very difficult and lapses do occur. But such incidents are exceptional and are swiftly addressed by the company. For example, when insider trading allegations came to light against a corporate executive, the company immediately suspended and subsequently fired the employee.

How Novo Nordisk Puts Its Ethical Principles into Practice

Note: Developed with Dennis L. Huggins.

Sources: J. Edwards, “Novo Nordisk Exec Charged with Insider Trading; Cash Stashed in Caribbean,” CBS News, September 2008, www.cbsnews.com (accessed February 19, 2012); company filings and website (accessed April 1, 2014); Corporate Knights, “The 8th Annual Global 100,” global100.org/ (accessed February 20, 2012).

involved). In high-profile instances, the costs of ethical misconduct can easily run into the hundreds of millions and even billions of dollars, especially if they pro- voke widespread public outrage and many people were harmed. The penalties lev- ied on executives caught in wrongdoing can skyrocket as well, as the 150-year prison term sentence of infamous financier and Ponzi scheme perpetrator Bernie Madoff illustrates.

The fallout of a company’s ethical misconduct goes well beyond the costs of making amends for the misdeeds. Customers shun companies caught up in highly

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publicized ethical scandals. Rehabilitating a company’s shattered reputation is time-consuming and costly. Companies with tarnished reputations have difficulty in recruiting and retaining talented employees. Most ethically upstanding people are repulsed by a work environment where unethical behavior is condoned; they don’t want to get entrapped in a compromising situation, nor do they want their personal reputations tarnished by the actions of an unsavory employer. Creditors are unnerved by the unethical actions of a borrower because of the potential busi- ness fallout and subsequent higher risk of default on loans.

All told, a company’s unethical behavior can do considerable damage to share- holders in the form of lost revenues, higher costs, lower profits, lower stock prices, and a diminished business reputation. To a significant degree, therefore, ethical strategies and ethical conduct are good business. Most companies understand the value of operating in a manner that wins the approval of suppliers, employees, inves- tors, and society at large. Most businesspeople recognize the risks and adverse fallout attached to the discovery of unethical behavior. Hence, companies have an incentive to employ strategies that can pass the test of being ethical. Even if a company’s manag- ers are not personally committed to high ethical standards, they have good reason to operate within ethical bounds, if only to (1) avoid the risk of embarrassment, scandal, disciplinary action, fines, and possible jail time for unethical conduct on their part; and (2) escape being held accountable for lax enforcement of ethical standards and unethical behavior by personnel under their supervision.

Shareholders suffer major damage when a company’s unethical behavior is discovered. Making amends for unethical business conduct is costly, and it takes years to rehabilitate a tarnished company reputation.

FIGURE 9.1 The Costs Companies Incur When Ethical Wrongdoing Is Discovered

Internal Administrative Costs

Visible Costs Intangible or Less Visible

Costs

Government fines and penalties

Civil penalties arising from class-action lawsuits and other litigation aimed at punishing the company for its o�ense and the harm done to others

The costs to shareholders in the form of a lower stock price (and possibly lower dividends)

Legal and investigative costs incurred by the company

The costs of providing remedial education and ethics training to company personnel

The costs of taking corrective actions

Administrative costs associated with ensuring future compliance

Customer defections

Loss of reputation

Lost employee morale and higher degrees of employee cynicism

Higher employee turnover

Higher recruiting costs and di�culty in attracting talented employees

Adverse e�ects on employee productivity

The costs of complying with often harsher government regulations

Source: Adapted from Terry Thomas, John R. Schermerhorn, and John W. Dienhart, “Strategic Leadership of Ethical Behavior,” Academy of Management Executive 18, no. 2 (May 2004), p. 58.

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The idea that businesses have an obligation to foster social betterment, a much-debated topic over the past 50 years, took root in the 19th century when progressive companies in the aftermath of the industrial revolution began to provide workers with housing and other amenities. The notion that corporate executives should balance the interests of all stakeholders—shareholders, employees, customers, suppliers, the communities in which they operate, and society at large—began to blossom in the 1960s. Some years later, a group of chief executives of America’s 200 largest corporations, calling themselves the Business Roundtable, came out in strong support of the concept of corporate social responsibility (CSR):

Balancing the shareholder’s expectations of maximum return against other priorities is one of the fundamental problems confronting corporate management. The shareholder must receive a good return but the legitimate concerns of other constituencies (custom- ers, employees, communities, suppliers and society at large) also must have the appropriate attention. . . . [Leading managers] believe that by giving enlightened consideration to bal- ancing the legitimate claims of all its constituents, a corporation will best serve the interest of its shareholders.

Today, corporate social responsibility is a concept that resonates in western Europe, the United States, Canada, and such developing nations as Brazil and India.

The Concepts of Corporate Social Responsibility and Good Corporate Citizenship The essence of socially responsible business behavior is that a company should balance strategic actions to benefit shareholders against the duty to be a good cor- porate citizen. The underlying thesis is that company managers should display a social conscience in operating the business and specifically take into account how management decisions and company actions affect the well-being of employees, local communities, the environment, and society at large.20 Acting in a socially

responsible manner thus encompasses more than just participating in community ser- vice projects and donating money to charities and other worthy causes. Demonstrating social responsibility also entails undertaking actions that earn trust and respect from all stakeholders— operating in an honorable and ethical manner, striving to make the company a great place to work, demonstrating genuine respect for the environment, and trying to make a difference in bettering society. As depicted in Figure 9.2, corpo- rate responsibility programs commonly include the following elements:

∙ Striving to employ an ethical strategy and observe ethical principles in operating the business. A sincere commitment to observing ethical principles is a necessary component of a CSR strategy simply because unethical conduct is incompatible with the concept of good corporate citizenship and socially responsible business behavior.

∙ Making charitable contributions, supporting community service endeavors, engaging in broader philanthropic initiatives, and reaching out to make a dif- ference in the lives of the disadvantaged. Some companies fulfill their philan- thropic obligations by spreading their efforts over a multitude of charitable and

LO 4

The concepts of corporate social responsibility and environmental sustainability and how companies balance these duties with economic responsibilities to shareholders.

CORE CONCEPT

Corporate social responsibility (CSR) refers to a company’s duty to operate in an honorable manner, provide good working conditions for employees, encourage workforce diversity, be a good steward of the environment, and actively work to better the quality of life in the local communities where it operates and in society at large.

STRATEGY, CORPORATE SOCIAL RESPONSIBILITY, AND ENVIRONMENTAL SUSTAINABILITY

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community activities—for instance, Wells Fargo and Google support a broad variety of community, art, and social welfare programs. Others prefer to focus their energies more narrowly. McDonald’s concentrates on sponsoring the Ronald McDonald House program (which provides a home away from home for the fami- lies of seriously ill children receiving treatment at nearby hospitals). Leading prescription drug maker GlaxoSmithKline and other pharmaceutical companies either donate or heavily discount medicines for distribution in the least developed nations. Companies frequently reinforce their philanthropic efforts by encourag- ing employees to support charitable causes and participate in community affairs, often through programs that match employee contributions.

∙ Taking actions to protect the environment and, in particular, to minimize or elimi- nate any adverse impact on the environment stemming from the company’s own business activities. Corporate social responsibility as it applies to environmental protection entails actively striving to be a good steward of the environment. This means using the best available science and technology to reduce environmen- tally harmful aspects of the company’s operations below the levels required by prevailing environmental regulations. It also means putting time and money into improving the environment in ways that extend beyond a company’s own industry

FIGURE 9.2 The Five Components of a Corporate Social Responsibility Strategy

Actions to promote workforce diversity

Actions to ensure the company operates

honorably and ethically

Actions to support philanthropy,

participate in community service, and better

the quality of life worldwide

Actions to enhance employee well-being

and make the company a great place to work

Actions to protect and sustain the

environment

A Company’s Corporate Social

Responsibility Strategy

Source: Adapted from material in Ronald Paul Hill, Debra Stephens, and Iain Smith, “Corporate Social Responsibility: An Examination of Indi- vidual Firm Behavior,” Business and Society Review 108, no. 3 (September 2003), p. 348.

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boundaries—such as participating in recycling projects, adopting energy conser- vation practices, and supporting efforts to clean up local water supplies. Häagen- Dazs, a maker of all-natural ice creams, started a social media campaign to raise awareness about the dangers associated with the decreasing honeybee popula- tion; it donates a portion of its profits to research on this issue. The Walt Disney Company has created strict environmental targets for themselves and created the “Green Standard” to inspire employees to reduce their environmental impact.

∙ Creating a work environment that enhances the quality of life for employees. Numerous companies exert extra effort to enhance the quality of life for their employees at work and at home. This can include onsite day care, flexible work schedules, workplace exercise facilities, special leaves for employees to care for sick family members, work-at-home opportunities, career development programs and education opportunities, showcase plants and offices, special safety programs, and the like.

∙ Building a diverse workforce with respect to gender, race, national origin, and other aspects that different people bring to the workplace. Most large compa- nies in the United States have established workforce diversity programs, and some go the extra mile to ensure that their workplaces are attractive to ethnic minorities and inclusive of all groups and perspectives. At some companies, the diversity initiative extends to suppliers—sourcing items from small busi- nesses owned by women or members of ethnic minorities, for example. The pursuit of workforce diversity can also be good business. At Coca-Cola, where strategic success depends on getting people all over the world to become loyal consumers of the company’s beverages, efforts to build a public persona of inclusiveness for people of all races, religions, nationalities, interests, and tal- ents have considerable strategic value.

The particular combination of socially responsible endeavors a company elects to pursue defines its corporate social responsibility strategy. The specific compo- nents emphasized in a CSR strategy vary from company to company and are typi- cally linked to a company’s core values. Few companies have managed to integrate CSR as fully and seamlessly throughout their organization as Burt’s Bees; there a special committee is dedicated to leading the organization to attain its CRS goals with respect to three primary areas: natural well-being, humanitarian responsibil- ity, and environmental sustainability. General Mills also centers its CSR strategy around three themes: nourishing lives (via healthier and easier-to-prepare foods), nourishing communities (via charitable donations to community causes and vol- unteerism for community service projects), and nourishing the environment (via efforts to conserve natural resources, reduce energy and water usage, promote recy-

cling, and otherwise support environmental sustainability).21 Starbucks’s CSR strat- egy includes four main elements (ethical sourcing, community service, environmental stewardship, and farmer support), all of which have touch points with the way that the company procures its coffee—a key aspect of its product differentiation strategy. Some companies use other terms, such as corporate citizenship, corporate respon- sibility, or sustainable responsible business (SRB) to characterize their CSR initia- tives. Illustration Capsule 9.3 describes Warby Parker’s approach to corporate social responsibility—an approach that ensures that social responsibility is reflected in all of the company’s actions and endeavors.

Although there is wide variation in how companies devise and implement a CSR strategy, communities of companies concerned with corporate social responsibility

CORE CONCEPT

A company’s CSR strategy is defined by the specific combination of socially beneficial activities the company opts to support with its contributions of time, money, and other resources.

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ILLUSTRATION CAPSULE 9.3

Since its founding in 2010, Warby Parker has succeeded in selling over one million pairs of high-fashion glasses at a discounted price of $95—roughly 80 percent below the average $500 price tag on a comparable pair of eyeglasses from another producer. With more than 25 stores in the United States, the company has built a brand recognized universally as one of the strongest in the world; it consistently posts a net promoter score (a measure of how likely someone would be to recommend the product) of close to 90—higher than companies like Zappos and Apple.

Corporate responsibility is at Warby Parker’s core. For each pair of glasses sold, the company provides international nonprofit partners like VisionSpring with a monthly donation of glasses; with Warby Parker’s support, these partners provide basic eye exams and teach community members how to manufacture and sell glasses at very low prices to amplify beneficial effects in their communities. To date, VisionSpring alone has trained nearly 20,000 people across 35 countries with average impacts of 20 percent increase in income and 35 percent increase in productivity.

Efforts to be a responsible company expand beyond Warby Parker’s international partnerships. The com- pany voluntarily evaluates itself against benchmarks in the fields of “environment,” “workers,” “customers,” “community,” and “governance,” demonstrating a nearly unparalleled dedication to outcomes outside of profit. The company is widely seen as an employer of choice and regularly attracts top talent for all roles across the organization. It holds to an extremely high environ- mental standard, running an entirely carbon neutral operation.

While socially impactful actions matter at Warby Parker, the company is mindful of the critical role of its customers as well. Both founders spent countless hours coordinating partnerships with dedicated suppliers to ensure quality, invested deeply in building a lean man- ufacturing operation to minimize cost, and sought to build an organization that would keep buyers happy. The net effect is a very economically healthy company—they post around $3,000 in sales per square foot, in line with Tiffany & Co.—with financial stability to pursue responsi- bilities outside of customer satisfaction.

The strong fundamentals put in place by the firm’s founders blend responsibility into its DNA and attach each piece of commercial success to positive outcomes in the world. The company was recently recognized as number one on Fast Company’s “Most Innovative Com- panies” list and continues to build loyal followers—both of its products and its CSR efforts—as it expands.

Warby Parker: Combining Corporate Social Responsibility with Affordable Fashion

Note: Developed with Jeremy P. Reich.

Sources: Warby Parker and “B Corp” websites; Max Chafkin, “Warby Parker Sees the Future of Retail,” Fast Company, February 17, 2015 (accessed February 22, 2016); Jenni Avins, “Warby Parker Proves Customers Don’t Have to Care about Your Social Mission,” Quartz, December 29, 2014 (accessed February 14, 2016).

(such as CSR Europe) have emerged to help companies share best CSR practices. Moreover, a number of reporting standards have been developed, including ISO 26000—a new internationally recognized standard for social responsibility set by the International Standards Organization (ISO).22 Companies that exhibit a strong com- mitment to corporate social responsibility are often recognized by being included on lists such as Corporate Responsibility magazine’s “100 Best Corporate Citizens” or Corporate Knights magazine’s “Global 100 Most Sustainable Corporations.”

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Corporate Social Responsibility and the Triple Bottom Line CSR initiatives undertaken by companies are frequently directed at improving the com- pany’s triple bottom line (TBL)—a reference to three types of performance metrics: economic, social, and environmental. The goal is for a company to succeed simulta- neously in all three dimensions, as illustrated in Figure 9.3.23 The three dimensions of performance are often referred to in terms of the “three pillars” of “people, planet, and profit.” The term people refers to the various social initiatives that make up CSR strategies, such as corporate giving, community involvement, and company efforts to improve the lives of its internal and external stakeholders. Planet refers to a firm’s ecological impact and environmental practices. The term profit has a broader mean- ing with respect to the triple bottom line than it does otherwise. It encompasses not only the profit a firm earns for its shareholders but also the economic impact that the company has on society more generally, in terms of the overall value that it creates and the overall costs that it imposes on society. For example, Procter & Gamble’s Swiffer cleaning system, one of the company’s best-selling products, not only offers an earth- friendly design but also outperforms less ecologically friendly alternatives in terms of its broader economic impact: It reduces demands on municipal water sources, saves electricity that would be needed to heat mop water, and doesn’t add to the amount of detergent making its way into waterways and waste treatment facilities. Nike sees itself as bringing people, planet, and profits into balance by producing innovative new products in a more sustainable way, recognizing that sustainability is key to its future profitability. TOMS shoes, which donates a pair of shoes to a child in need in over 50 different countries for every pair purchased, has also built its strategy around main- taining a well-balanced triple bottom line.

Many companies now make a point of citing the beneficial outcomes of their CSR strategies in press releases and issue special reports for consumers and inves- tors to review. Staples, the world’s largest office products company, makes reporting

FIGURE 9. 3 The Triple Bottom Line: Excelling on Three Measures of Company Performance

Economic

Environmental

Social

Goal = Excellence in All Three Performance Dimensions

Source: Developed with help from Amy E. Florentino.

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an important part of its commitment to corporate responsibility; the company posts a “Staples Soul Report” on its website that describes its initiatives and accomplish- ments in the areas of diversity, environment, community, and ethics. Triple-bottom- line reporting is emerging as an increasingly important way for companies to make the results of their CSR strategies apparent to stakeholders and for stakeholders to hold companies accountable for their impact on society. The use of standard reporting frameworks and metrics, such as those developed by the Global Reporting Initiative, promotes greater transparency and facilitates benchmarking CSR efforts across firms and industries.

Investment firms have created mutual funds consisting of companies that are excelling on the basis of the triple bottom line in order to attract funds from environ- mentally and socially aware investors. The Dow Jones Sustainability World Index is made up of the top 10 percent of the 2,500 companies listed in the Dow Jones World Index in terms of economic performance, environmental performance, and social performance. Companies are evaluated in these three performance areas, using indi- cators such as corporate governance, climate change mitigation, and labor practices. Table 9.1 shows a sampling of the companies selected for the Dow Jones Sustainability World Index in 2013.

Name Market Sector Country

Volkswagen AG Automobiles & Components Germany

Australia & New Zealand Banking Group Ltd. Banks Australia

Siemens AG Capital Goods Germany

Adecco SA Commercial & Professional Services Switzerland

Panasonic Corp. Consumer Durables & Apparel Japan

Tabcorp Holdings Ltd. Consumer Services Australia

Citigroup Inc. Diversified Financials United States

BG Group PLC Energy United Kingdom

Woolworths Ltd. Food & Staples Retailing Australia

Nestlé SA Food, Beverage, & Tobacco Switzerland

Abbott Laboratories Health Care Equipment & Services United States

Henkel AG & Co. KGaA Household & Personal Products Germany

Allianz SE Insurance Germany

Akzo Nobel NV Materials Netherlands

Telenet Group Holding NV Media Belgium

Roche Holding AG Pharmaceuticals, Biotechnology, & Life Sciences

Switzerland

Stockland Real Estate Australia

TABLE 9.1 A Selection of Companies Recognized for Their Triple-Bottom-Line Performance in 2013

(continued)

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What Do We Mean by Sustainability and Sustainable Business Practices? The term sustainability is used in a variety of ways. In many firms, it is synony- mous with corporate social responsibility; it is seen by some as a term that is gradu- ally replacing CSR in the business lexicon. Indeed, sustainability reporting and TBL

reporting are often one and the same, as illustrated by the Dow Jones Sustainability World Index, which tracks the same three types of performance measures that con- stitute the triple bottom line.

More often, however, the term takes on a more focused meaning, concerned with the relationship of a company to its environment and its use of natural resources, including land, water, air, plants, animals, minerals, fossil fuels, and biodiversity. It is widely recognized that the world’s natural resources are finite and are being con- sumed and degraded at rates that threaten their capacity for renewal. Since corpora- tions are the biggest users of natural resources, managing and maintaining these resources is critical for the long-term economic interests of corporations.

For some companies, this issue has direct and obvious implications for the con- tinued viability of their business model and strategy. Pacific Gas and Electric has begun measuring the full carbon footprint of its supply chain to become not only a “greener” company but a more efficient energy producer.24 Beverage companies such as Coca-Cola and PepsiCo are having to rethink their business models because of the prospect of future worldwide water shortages. For other companies, the con- nection is less direct, but all companies are part of a business ecosystem whose economic health depends on the availability of natural resources. In response, most major companies have begun to change how they do business, emphasizing the use of sustainable business practices, defined as those capable of meeting the needs of the present without compromising the ability to meet the needs of the future. Many have also begun to incorporate a consideration of environmental sustainabil- ity into their strategy-making activities.

Environmental sustainability strategies entail deliberate and concerted actions to operate businesses in a manner that protects natural resources and eco- logical support systems, guards against outcomes that will ultimately endanger the planet, and is therefore sustainable for centuries.25 One aspect of environmental

CORE CONCEPT

Sustainable business practices are those that meet the needs of the present without compromising the ability to meet the needs of the future.

CORE CONCEPT

A company’s environmental sustainability strategy consists of its deliberate actions to protect the environment, provide for the longevity of natural resources, maintain ecological support systems for future generations, and guard against ultimate endangerment of the planet.

Name Market Sector Country

Lotte Shopping Co. Ltd. Retailing Republic of Korea

Taiwan Semiconductor Manufacturing Co. Ltd. Semiconductors & Semiconductor Equipment Taiwan

SAP AG Software & Services Germany

Alcatel-Lucent Technology Hardware & Equipment France

KT Corp. Telecommunication Services Republic of Korea

Air France-KLM Transportation France

EDP–Energias de Portugal SA Utilities Portugal

Source: Adapted from RobecoSAM AG, www.sustainability-indices.com/review/industry-group-leaders-2013.jsp (accessed February 7, 2014).

TABLE 9.1 (continued)

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sustainability is keeping use of the Earth’s natural resources within levels that can be replenished via the use of sustainable business practices. In the case of some resources (like crude oil, freshwater, and edible fish from the oceans), scientists say that use levels either are already unsustainable or will be soon, given the world’s grow- ing population and propensity to consume additional resources as incomes and liv- ing standards rise. Another aspect of sustainability concerns containing the adverse effects of greenhouse gases and other forms of air pollution to reduce their impact on undesirable climate and atmospheric changes. Other aspects of sustainability include greater reliance on sustainable energy sources; greater use of recyclable materials; the use of sustainable methods of growing foods (to reduce topsoil depletion and the use of pesticides, herbicides, fertilizers, and other chemicals that may be harmful to human health or ecological systems); habitat protection; environmentally sound waste management practices; and increased attempts to decouple environmental degradation and economic growth (according to scientists, economic growth has historically been accompanied by declines in the well-being of the environment).

Unilever, a diversified producer of processed foods, personal care, and home cleaning products, is among the many committed corporations pursuing sustainable business practices. The company tracks 11 sustainable agricultural indicators in its processed-foods business and has launched a variety of programs to improve the envi- ronmental performance of its suppliers. Examples of such programs include special low-rate financing for tomato suppliers choosing to switch to water-conserving irri- gation systems and training programs in India that have allowed contract cucumber growers to reduce pesticide use by 90 percent while improving yields by 78 percent. Unilever has also reengineered many internal processes to improve the company’s overall performance on sustainability measures. For example, the company’s facto- ries have reduced water usage by 63 percent and total waste by 67 percent since 1995 through the implementation of sustainability initiatives. Unilever has also redesigned packaging for many of its products to conserve natural resources and reduce the vol- ume of consumer waste. The company’s Suave shampoo bottles were reshaped to save almost 150 tons of plastic resin per year, which is the equivalent of 15 million fewer empty bottles making it to landfills annually. As the producer of Lipton Tea, Unilever is the world’s largest purchaser of tea leaves; the company committed to sourcing all of its tea from Rainforest Alliance Certified farms, due to its comprehensive triple- bottom-line approach toward sustainable farm management. Illustration Capsule 9.4 sheds more light on Unilever’s focus on sustainability.

Crafting Corporate Social Responsibility and Sustainability Strategies While CSR and environmental sustainability strategies take many forms, those that both provide valuable social benefits and fulfill customer needs in a superior fashion may also contribute to a company’s competitive advantage.26 For example, while car- bon emissions may be a generic social concern for financial institutions such as Wells Fargo, Ford’s sustainability strategy for reducing carbon emissions has produced both competitive advantage and environmental benefits. Its Ford Fusion hybrid automobile not only is among the least polluting automobiles but also now ranks 1 out of 22 in hybrid cars, with exceptional fuel economy, a quiet powertrain, and a spacious cabin. It has gained the attention and loyalty of fuel-conscious buyers and given Ford a new green image. Green Mountain Coffee Roasters’s commitment to protect the welfare of coffee growers and their families (in particular, making sure they receive a fair

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ILLUSTRATION CAPSULE 9.4

With over 53.3 billion euros in revenue in 2015, Unilever is one of the world’s largest companies. The global con- sumer goods giant has products that are used by over 2 billion people on any given day. It manufactures iconic global brands like Dove, Axe, Hellman’s, Heartbrand, and many others. What it is also known for, however, is its commitment to sustainability, leading GlobeScan’s Global Sustainability Survey for sustainable companies with a score 2.5 times higher than its closest competitor.

Unilever implemented its sustainability plan in as transparent and explicit way as possible, evidenced by the Unilever Sustainable Living Plan (USLP). The USLP was released in 2010 by CEO Paul Polman, stating that the company’s goal was to double the size of the busi- ness while halving its environmental footprint by 2020. Importantly, the USLP has remained a guiding force for the company, which dedicates significant resources and time to pursuing its sustainability goals. The plan is updated each year with targets and goals, as well as an annual progress report.

According to Polman, Unilever’s focus on sustain- ability isn’t just charity, but is really an act of self- interest. The company’s most recent annual report states “growth and sustainability are not in conflict. In fact, in our expe- rience, sustainability drives growth.” Polman insists that this is the modern-day way to maximize profits, and that doing so is simply rational business thinking.

To help implement this plan, Unilever has instituted a corporate accountability plan. Each year, Unilever benchmarks its progress against three leading indices: the UN Global Compact, the Global Reporting Initia- tive’s Index, and the UN Millennium Development Goals.

In its annual sustainability report, the company details its progress toward its many sustainability goals. Exam- ples from 2014 include the 397 million people Unilever helped to improve their health and hygiene habits by 2014 as part of the company’s goal of helping 1 billion people do so by 2020.

Unilever has also created new business practices to reach its ambitious targets. Unilever set up a central corporate team dedicated to spreading best sustain- ability practices from one factory or business unit to the rest of the company, a major change from how the siloed manner in which the company previously oper- ated. Moreover, the company set up a “small actions, big differences” fund to invest in innovative ideas that help the company achieve its sustainability goal. To reduce emissions from the overall footprint of its products and extend its sustainability efforts to its entire supply chain, it has worked with its suppliers to source sustainable agricultural products, improving from 14 percent sus- tainable in 2010 to 48 percent in 2014.

Unilever’s Focus on Sustainability

Note: Developed with Byron G. Peyster.

Sources: www.globescan.com/component/edocman/?view=document&id=179&Itemid=591; www.fastcocreate.com/3051498/behind-the- brand/why-unilever-is-betting-big-on-sustainability; www.economist.com/news/business/21611103-second-time-its-120-year-history- unilever-trying-redefine-what-it-means-be; company website (accessed March 13, 2016).

price) also meets its customers’ wants and needs. In its dealings with suppliers at small farmer cooperatives in Peru, Mexico, and Sumatra, Green Mountain pays fair trade prices for coffee beans. Green Mountain also purchases about 29 percent of its coffee directly from farmers to cut out intermediaries and see that farmers realize a higher price for their efforts—coffee is the world’s second most heavily traded commodity after oil, requiring the labor of some 20 million people, most of whom live at the pov- erty level.27 Its consumers are aware of these efforts and purchase Green Mountain coffee, in part, to encourage such practices.

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CSR strategies and environmental sustainability strategies are more likely to contribute to a company’s competitive advantage if they are linked to a company’s competitively important resources and capabilities or value chain activities. Thus, it is common for companies engaged in natural resource extraction, electric power production, forestry and paper products manufacture, motor vehicles production, and chemical production to place more emphasis on addressing environmental con- cerns than, say, software and electronics firms or apparel manufacturers. Companies whose business success is heavily dependent on maintaining high employee morale or attracting and retaining the best and brightest employees are somewhat more prone to stress the well-being of their employees and foster a positive, high-energy workplace environment that elicits the dedication and enthusiastic commitment of employees, thus putting real meaning behind the claim “Our people are our greatest asset.” Ernst & Young, one of the four largest global accounting firms, stresses its “People First” workforce diversity strategy that is all about respecting differences, fostering individuality, and promoting inclusiveness so that its more than 175,000 employees in over 150 countries can feel valued, engaged, and empowered in devel- oping creative ways to serve the firm’s clients. Costco Wholesale, the warehouse club, credits its success to its treatment of its employees, who are paid an average of $20.89 an hour, not including overtime—far above the industry average. Eighty-eight percent of Costco’s employees have company-sponsored insurance; CEO Craig Jelinek is committed to ensuring that his people make a living wage and receive health ben- efits, an approach that he says “also puts more money back into the economy. It’s really that simple.” Between 2009 and 2014, Costco sales grew 39 percent and stock prices doubled—an anomaly in an industry plagued by turmoil and downsizing.

At Whole Foods Market, a $14.2 billion supermarket chain specializing in organic and natural foods, its environmental sustainability strategy is evident in almost every segment of its company value chain and is a big part of its differentiation strategy. The company’s procurement policies encourage stores to purchase fresh fruits and veg- etables from local farmers and screen processed-food items for more than 400 com- mon ingredients that the company considers unhealthy or environmentally unsound. Spoiled food items are sent to regional composting centers rather than landfills, and all cleaning products used in its stores are biodegradable. The company also has cre- ated the Animal Compassion Foundation to develop natural and humane ways of rais- ing farm animals and has converted all of its vehicles to run on biofuels.

Not all companies choose to link their corporate environmental or social agendas to their value chain, their business model, or their industry. For example, the Clorox Company Foundation supports programs that serve youth, focusing its giving on non- profit civic organizations, schools, and colleges. However, unless a company’s social responsibility initiatives become part of the way it operates its business every day, the initiatives are unlikely to catch fire and be fully effective. As an executive at Royal Dutch/Shell put it, corporate social responsibility “is not a cosmetic; it must be rooted in our values. It must make a difference to the way we do business.”28 The same is true for environmental sustainability initiatives.

The Moral Case for Corporate Social Responsibility and Environmentally Sustainable Business Practices The moral case for why businesses should act in a manner that benefits all of the company’s stakeholders—not just shareholders—boils down to “It’s the right thing to do.” Ordinary decency, civic-mindedness, and contributions to society’s

CSR strategies and environmental sustainability strategies that both provide valuable social benefits and fulfill customer needs in a superior fashion can lead to competitive advantage. Corporate social agendas that address only social issues may help boost a company’s reputation for corporate citizenship but are unlikely to improve its competitive strength in the marketplace.

Every action a company takes can be interpreted as a statement of what it stands for.

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well-being should be expected of any business.29 In today’s social and political cli- mate, most business leaders can be expected to acknowledge that socially responsible actions are important and that businesses have a duty to be good corporate citizens. But there is a complementary school of thought that business operates on the basis of an implied social contract with the members of society. According to this contract, society grants a business the right to conduct its business affairs and agrees not to unreasonably restrain its pursuit of a fair profit for the goods or services it sells. In return for this “license to operate,” a business is obligated to act as a responsible citi- zen, do its fair share to promote the general welfare, and avoid doing any harm. Such a view clearly puts a moral burden on a company to operate honorably, provide good working conditions to employees, be a good environmental steward, and display good corporate citizenship.

The Business Case for Corporate Social Responsibility and Environmentally Sustainable Business Practices Whatever the moral arguments for socially responsible business behavior and envi- ronmentally sustainable business practices, there are definitely good business reasons why companies should be public-spirited and devote time and resources to social responsibility initiatives, environmental sustainability, and good corporate citizenship:

∙ Such actions can lead to increased buyer patronage. A strong visible social responsibility or environmental sustainability strategy gives a company an edge in appealing to consumers who prefer to do business with companies that are good corporate citizens. Ben & Jerry’s, Whole Foods Market, Stonyfield Farm, TOMS, Green Mountain Coffee Roasters, and Patagonia have definitely expanded their customer bases because of their visible and well-publicized activities as socially conscious companies. More and more companies are also recognizing the cash register payoff of social responsibility strategies that reach out to people of all cultures and demographics (women, retirees, and ethnic groups).

∙ A strong commitment to socially responsible behavior reduces the risk of reputation-damaging incidents. Companies that place little importance on oper- ating in a socially responsible manner are more prone to scandal and embar- rassment. Consumer, environmental, and human rights activist groups are quick to criticize businesses whose behavior they consider to be out of line, and they are adept at getting their message into the media and onto the Internet. Pressure groups can generate widespread adverse publicity, promote boycotts, and influ- ence like-minded or sympathetic buyers to avoid an offender’s products.

Research has shown that product boycott announcements are associated with a decline in a company’s stock price.30 When a major oil company suffered damage to its reputation on environmental and social grounds, the CEO repeatedly said that the most negative impact the company suffered—and the one that made him fear for the future of the company—was that bright young graduates were no lon- ger attracted to working for the company. For many years, Nike received stinging criticism for not policing sweatshop conditions in the Asian factories that pro- duced Nike footwear, a situation that caused Nike cofounder and chair Phil Knight to observe that “Nike has become synonymous with slave wages, forced overtime, and arbitrary abuse.”31 In response, Nike began an extensive effort to monitor

The higher the public profile of a company or its brand, the greater the scrutiny of its activities and the higher the potential for it to become a target for pressure group action.

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conditions in the 800 factories of the contract manufacturers that produced Nike shoes. As Knight said, “Good shoes come from good factories and good factories have good labor relations.” Nonetheless, Nike has continually been plagued by complaints from human rights activists that its monitoring procedures are flawed and that it is not doing enough to correct the plight of factory workers. As this suggests, a damaged reputation is not easily repaired.

∙ Socially responsible actions and sustainable business practices can lower costs and enhance employee recruiting and workforce retention. Companies with deservedly good reputations for social responsibility and sustainable business practices are better able to attract and retain employees, compared to companies with tarnished reputations. Some employees just feel better about working for a company committed to improving society. This can contribute to lower turn- over and better worker productivity. Other direct and indirect economic benefits include lower costs for staff recruitment and training. For example, Starbucks is said to enjoy much lower rates of employee turnover because of its full-benefits package for both full-time and part-time employees, management efforts to make Starbucks a great place to work, and the company’s socially responsible prac- tices. Sustainable business practices are often concomitant with greater opera- tional efficiencies. For example, when a U.S. manufacturer of recycled paper, taking eco-efficiency to heart, discovered how to increase its fiber recovery rate, it saved the equivalent of 20,000 tons of waste paper—a factor that helped the company become the industry’s lowest-cost producer. By helping two-thirds of its employees to stop smoking and by investing in a number of wellness programs for employees, Johnson & Johnson saved $250 million on its health care costs over a 10-year period.32

∙ Opportunities for revenue enhancement may also come from CSR and environmen- tal sustainability strategies. The drive for sustainability and social responsibility can spur innovative efforts that in turn lead to new products and opportunities for revenue enhancement. Electric cars such as the Chevy Volt and the Nissan Leaf are one example. In many cases, the revenue opportunities are tied to a company’s core products. PepsiCo and Coca-Cola, for example, have expanded into the juice business to offer a healthier alternative to their carbonated beverages. General Electric has created a profitable new business in wind turbines. In other cases, revenue enhancement opportunities come from innovative ways to reduce waste and use the by-products of a company’s production. Tyson Foods now produces jet fuel for B-52 bombers from the vast amount of animal waste resulting from its meat product business. Staples has become one of the largest nonutility corporate producers of renewable energy in the United States due to its installation of solar power panels in all of its outlets (and the sale of what it does not consume in renewable energy credit markets).

∙ Well-conceived CSR strategies and sustainable business practices are in the best long-term interest of shareholders. When CSR and sustainability strategies increase buyer patronage, offer revenue-enhancing opportunities, lower costs, increase productivity, and reduce the risk of reputation-damaging incidents, they contribute to the economic value created by a company and improve its profitabil- ity. A two-year study of leading companies found that improving environmental compliance and developing environmentally friendly products can enhance earn- ings per share, profitability, and the likelihood of winning contracts. The stock prices of companies that rate high on social and environmental performance

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criteria have been found to perform 35 to 45 percent better than the average of the 2,500 companies that constitute the Dow Jones Global Index.33 A review of 135 studies indicated there is a positive, but small, correlation between good cor- porate behavior and good financial performance; only 2 percent of the studies showed that dedicating corporate resources to social responsibility harmed the interests of shareholders.34 Furthermore, socially responsible business behav- ior helps avoid or preempt legal and regulatory actions that could prove costly and otherwise burdensome. In some cases, it is possible to craft corporate social responsibility strategies that contribute to competitive advantage and, at the same time, deliver greater value to society. For instance, Walmart, by working with its suppliers to reduce the use of packaging materials and revamping the routes of its delivery trucks to cut out 100 million miles of travel, saved $200 million in costs (which enhanced its cost-competitiveness vis-à-vis rivals) and lowered car- bon emissions.35 Thus, a social responsibility strategy that packs some punch and is more than rhetorical flourish can produce outcomes that are in the best interest of shareholders.

In sum, companies that take social responsibility and environmental sustain- ability seriously can improve their business reputations and operational efficiency while also reducing their risk exposure and encouraging loyalty and innovation. Overall, companies that take special pains to protect the environment (beyond what is required by law), are active in community affairs, and are generous sup- porters of charitable causes and projects that benefit society are more likely to be seen as good investments and as good companies to work for or do business with. Shareholders are likely to view the business case for social responsibility as a strong one, particularly when it results in the creation of more customer value, greater productivity, lower operating costs, and lower business risk—all of which should increase firm profitability and enhance shareholder value even as the com- pany’s actions address broader stakeholder interests.

Companies are, of course, sometimes rewarded for bad behavior—a company that is able to shift environmental and other social costs associated with its activi- ties onto society as a whole can reap large short-term profits. The major cigarette producers for many years were able to earn greatly inflated profits by shifting the health-related costs of smoking onto others and escaping any responsibility for the harm their products caused to consumers and the general public. Only recently

have they been facing the prospect of having to pay high punitive damages for their actions. Unfortunately, the cigarette makers are not alone in trying to evade paying for the social harms of their operations for as long as they can. Calling a halt to such actions usually hinges on (1) the effectiveness of activist social groups in publicizing the adverse consequences of a company’s social irresponsibility and marshaling public opinion for something to be done, (2) the enactment of legislation or regulations to correct the inequity, and (3) decisions on the part of socially conscious buyers to take their business elsewhere.

Socially responsible strategies that create value for customers and lower costs can improve company profits and shareholder value at the same time that they address other stakeholder interests.

There’s little hard evidence indicating shareholders are disadvantaged in any meaningful way by a company’s actions to be socially responsible.

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KEY POINTS

1. Ethics concerns standards of right and wrong. Business ethics concerns the appli- cation of ethical principles to the actions and decisions of business organizations and the conduct of their personnel. Ethical principles in business are not materi- ally different from ethical principles in general.

2. There are three schools of thought about ethical standards for companies with international operations:

∙ According to the school of ethical universalism, common understandings across multiple cultures and countries about what constitutes right and wrong behaviors give rise to universal ethical standards that apply to members of all societies, all companies, and all businesspeople.

∙ According to the school of ethical relativism, different societal cultures and customs have divergent values and standards of right and wrong. Thus, what is ethical or unethical must be judged in the light of local customs and social mores and can vary from one culture or nation to another.

∙ According to the integrated social contracts theory, universal ethical princi- ples based on the collective views of multiple cultures and societies combine to form a “social contract” that all individuals in all situations have a duty to observe. Within the boundaries of this social contract, local cultures or groups can specify what additional actions are not ethically permissible. However, universal norms always take precedence over local ethical norms.

3. Apart from the “business of business is business, not ethics” kind of thinking, three other factors contribute to unethical business behavior: (1) faulty oversight that enables the unscrupulous pursuit of personal gain, (2) heavy pressures on company managers to meet or beat short-term earnings targets, and (3) a company culture that puts profitability and good business performance ahead of ethical behavior. In contrast, culture can function as a powerful mechanism for promoting ethical business conduct when high ethical principles are deeply ingrained in the corporate culture of a company.

4. Business ethics failures can result in three types of costs: (1) visible costs, such as fines, penalties, and lower stock prices; (2) internal administrative costs, such as legal costs and costs of taking corrective action; and (3) intangible costs or less vis- ible costs, such as customer defections and damage to the company’s reputation.

5. The term corporate social responsibility concerns a company’s duty to operate in an honorable manner, provide good working conditions for employees, encourage workforce diversity, be a good steward of the environment, and support philan- thropic endeavors in local communities where it operates and in society at large. The particular combination of socially responsible endeavors a company elects to pursue defines its corporate social responsibility (CSR) strategy.

6. The triple bottom line refers to company performance in three realms: economic, social, and environmental. Increasingly, companies are reporting their perfor- mance with respect to all three performance dimensions.

7. Sustainability is a term that is used in various ways, but most often it concerns a firm’s relationship to the environment and its use of natural resources. Sustainable business practices are those capable of meeting the needs of the present without

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compromising the world’s ability to meet future needs. A company’s environmen- tal sustainability strategy consists of its deliberate actions to protect the environ- ment, provide for the longevity of natural resources, maintain ecological support systems for future generations, and guard against ultimate endangerment of the planet.

8. CSR strategies and environmental sustainability strategies that both provide valu- able social benefits and fulfill customer needs in a superior fashion can lead to competitive advantage.

9. The moral case for corporate social responsibility and environmental sustain- ability boils down to a simple concept: It’s the right thing to do. There are also solid reasons why CSR and environmental sustainability strategies may be good business—they can be conducive to greater buyer patronage, reduce the risk of reputation-damaging incidents, provide opportunities for revenue enhancement, and lower costs. Well-crafted CSR and environmental sustainability strategies are in the best long-term interest of shareholders, for the reasons just mentioned and because they can avoid or preempt costly legal or regulatory actions.

ASSURANCE OF LEARNING EXERCISES

1. Widely known as an ethical company, Dell recently committed itself to becoming a more environmentally sustainable business. After reviewing the About Dell sec- tion of its website (www.dell.com/learn/us/en/uscorp1/about-dell), prepare a list of 10 specific policies and programs that help the company achieve its vision of driving social and environmental change while still remaining innovative and profitable.

2. Prepare a one- to two-page analysis of a recent ethics scandal using your univer- sity library’s access to LexisNexis or other Internet resources. Your report should (1) discuss the conditions that gave rise to unethical business strategies and behav- ior and (2) provide an overview of the costs resulting from the company’s business ethics failure.

3. Based on information provided in Illustration Capsule 9.3, explain how Warby Parker’s CSR strategy has contributed to its success in the marketplace. How are the company’s various stakeholder groups affected by its commitment to social responsibility? How would you evaluate its triple-bottom-line performance?

4. Go to www.google.com/green/ and read about the company’s latest initiatives surrounding sustainability. What are Google’s key policies and actions that help it reduce its environmental footprint? How does the company integrate the idea of creating a “better web that’s better for the environment” with its strategies for cre- ating profit and value. How do these initiatives help build competitive advantage for Google?

LO 1, LO 4

LO 2, LO 3

LO 4

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EXERCISE FOR SIMULATION PARTICIPANTS

1. Is your company’s strategy ethical? Why or why not? Is there anything that your company has done or is now doing that could legitimately be considered “shady” by your competitors?

2. In what ways, if any, is your company exercising corporate social responsibility? What are the elements of your company’s CSR strategy? Are there any changes to this strategy that you would suggest?

3. If some shareholders complained that you and your co-managers have been spend- ing too little or too much on corporate social responsibility, what would you tell them?

4. Is your company striving to conduct its business in an environmentally sustainable manner? What specific additional actions could your company take that would make an even greater contribution to environmental sustainability?

5. In what ways is your company’s environmental sustainability strategy in the best long-term interest of shareholders? Does it contribute to your company’s competi- tive advantage or profitability?

LO 1

LO 4

LO 3, LO 4

LO 4

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Business Review 85, no. 2 (February 2007), pp. 80–90. 30 Wallace N. Davidson, Abuzar El-Jelly, and Dan L. Worrell, “Influencing Managers to Change Unpopular Corporate Behavior through Boycotts and Divestitures: A Stock Market Test,” Business and Society 34, no. 2 (1995), pp. 171–196. 31 Tom McCawley, “Racing to Improve Its Repu- tation: Nike Has Fought to Shed Its Image as an Exploiter of Third-World Labor Yet It Is Still a Target of Activists,” Financial Times, December 2000, p. 14. 32 Michael E. Porter and Mark Kramer, “Creat- ing Shared Value,” Harvard Business Review 89, no. 1–2 (January–February 2011).

Responsibility,” Harvard Business Review 84, no. 12 (December 2006), pp. 78–92. 27 David Hess, Nikolai Rogovsky, and Thomas W. Dunfee, “The Next Wave of Corporate Com- munity Involvement: Corporate Social Initia- tives,” California Management Review 44, no. 2 (Winter 2002), pp. 110–125; Susan Ariel Aar- onson, “Corporate Responsibility in the Global Village: The British Role Model and the Ameri- can Laggard,” Business and Society Review 108, no. 3 (September 2003), p. 323. 28 N. Craig Smith, “Corporate Responsibility: Whether and How,” California Management Review 45, no. 4 (Summer 2003), p. 63. 29 Jeb Brugmann and C. K. Prahalad, “Cocreat- ing Business’s New Social Compact,” Harvard

33 James C. Collins and Jerry I. Porras, Built to Last: Successful Habits of Visionary Compa- nies, 3rd ed. (London: HarperBusiness, 2002). 34 Joshua D. Margolis and Hillary A. Elfenbein, “Doing Well by Doing Good: Don’t Count on It,” Harvard Business Review 86, no. 1 (Janu- ary 2008), pp. 19–20; Lee E. Preston, Douglas P. O’Bannon, Ronald M. Roman, Sefa Hayi- bor, and Bradley R. Agle, “The Relationship between Social and Financial Performance: Repainting a Portrait,” Business and Society 38, no. 1 (March 1999), pp. 109–125. 35 Leonard L. Berry, Ann M. Mirobito, and William B. Baun, “What’s the Hard Return on Employee Wellness Programs?” Harvard Business Review 88, no. 12 (December 2010), p. 105.

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CHAPTER 10

Building an Organization Capable of Good Strategy Execution People, Capabilities, and Structure

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 What managers must do to execute strategy successfully.

LO 2 Why hiring, training, and retaining the right people constitute a key component of the strategy execution process.

LO 3 That good strategy execution requires continuously building and upgrading the organization’s resources and capabilities.

LO 4 What issues to consider in establishing a strategy-supportive organizational structure and organizing the work effort.

LO 5 The pros and cons of centralized and decentralized decision making in implementing the chosen strategy.

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In the end, a strategy is nothing but good intentions unless it’s effectively implemented.

Clayton M. Christensen—Professor and consultant

I try to motivate people and align our individual incen- tives with organizational incentives. And then let people do their best.

John Liu—Director, Whirlpool Corporation

People are not your most important asset. The right people are.

Jim Collins—Professor and author

Once managers have decided on a strategy, the emphasis turns to converting it into actions and good results. Putting the strategy into place and getting the organization to execute it well call for different sets of managerial skills. Whereas crafting strategy is largely an analysis-driven activity focused on market condi- tions and the company’s resources and capabilities, executing strategy is primarily operations-driven, revolving around the management of people, busi- ness processes, and organizational structure. Suc- cessful strategy execution depends on doing a good job of working with and through others; building and strengthening competitive capabilities; creating an appropriate organizational structure; allocating resources; instituting strategy-supportive policies, processes, and systems; and instilling a discipline of getting things done. Executing strategy is an action- oriented task that tests a manager’s ability to direct organizational change, achieve improvements in day-to-day operations, create and nurture a culture that supports good strategy execution, and meet or beat performance targets.

Experienced managers are well aware that it is much easier to develop a sound strategic plan than it is to execute the plan and achieve targeted out- comes. A recent study of 400 CEOs in the United States, Europe, and Asia found that executional excellence was the number-one challenge facing their companies.1 According to one executive, “It’s been rather easy for us to decide where we wanted to go. The hard part is to get the organization to

act on the new priorities.”2 It takes adept manage- rial leadership to convincingly communicate a new strategy and the reasons for it, overcome pockets of doubt, secure the commitment of key personnel, build consensus for how to implement the strategy, and move forward to get all the pieces into place and deliver results. Just because senior manag- ers announce a new strategy doesn’t mean that organization members will embrace it and move forward enthusiastically to implement it. Company personnel must understand—in their heads and hearts—why a new strategic direction is necessary and where the new strategy is taking them.3 Institut- ing change is, of course, easier when the problems with the old strategy have become obvious and/or the company has spiraled into a financial crisis.

But the challenge of successfully implementing new strategic initiatives goes well beyond manage- rial adeptness in overcoming resistance to change. What really makes executing strategy a tougher, more time-consuming management challenge than crafting strategy are the wide array of mana- gerial activities that must be attended to, the many ways to put new strategic initiatives in place and keep things moving, and the number of bedeviling issues that always crop up and have to be resolved. It takes first-rate “managerial smarts” to zero in on what exactly needs to be done and how to get good results in a timely manner. Excellent people- management skills and perseverance are needed to get a variety of initiatives underway and to

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The managerial approach to implementing and executing a strategy always has to be customized to fit the particulars of a company’s situation. Making minor changes in an existing strategy differs from implementing radical strategy changes. The techniques for successfully executing a low-cost provider strategy are different from those for executing a high-end differentiation strategy. Imple- menting a new strategy for a struggling company in the midst of a financial crisis is a different job from improving strategy execution in a company that is doing relatively well. Moreover, some managers are more adept than others at using par- ticular approaches to achieving certain kinds of organizational changes. Hence, there’s no definitive managerial recipe for successful strategy execution that cuts across all company situations and all strategies or that works for all managers. Rather, the specific actions required to execute a strategy—the “to-do list” that

constitutes management’s action agenda—always represent management’s judgment about how best to proceed in light of prevailing circumstances.

The Principal Components of the Strategy Execution Process Despite the need to tailor a company’s strategy-executing approaches to the situation at hand, certain managerial bases must be covered no matter what the circumstances. These include 10 basic managerial tasks (see Figure 10.1):

1. Staffing the organization with managers and employees capable of executing the strategy well.

2. Developing the resources and organizational capabilities required for successful strategy execution.

3. Creating a strategy-supportive organizational structure. 4. Allocating sufficient resources (budgetary and otherwise) to the strategy execu-

tion effort.

LO 1

What managers must do to execute strategy successfully.

CORE CONCEPT

Good strategy execution requires a team effort. All managers have strategy- executing responsibility in their areas of authority, and all employees are active participants in the strategy execution process.

integrate the efforts of many different work groups into a smoothly functioning whole. Depending on how much consensus building and organizational change is involved, the process of implementing strategy changes can take several months to sev- eral years. And executing the strategy with real pro- ficiency takes even longer.

Like crafting strategy, executing strategy is a job for a company’s whole management team—not just a few senior managers. While the chief executive offi- cer and the heads of major units (business divisions, functional departments, and key operating units) are ultimately responsible for seeing that strategy is

executed successfully, the process typically affects every part of the firm—all value chain activities and all work groups. Top-level managers must rely on the active support of middle and lower managers to insti- tute whatever new operating practices are needed in the various operating units to achieve proficient strategy execution. Middle and lower-level manag- ers must ensure that frontline employees perform strategy-critical value chain activities proficiently and produce operating results that allow company- wide performance targets to be met. Consequently, all company personnel are actively involved in the strategy execution process in one way or another.

A FRAMEWORK FOR EXECUTING STRATEGY

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5. Instituting policies and procedures that facilitate strategy execution. 6. Adopting best practices and business processes to drive continuous improvement

in strategy execution activities. 7. Installing information and operating systems that enable company personnel to

carry out their strategic roles proficiently. 8. Tying rewards and incentives directly to the achievement of strategic and

financial targets. 9. Instilling a corporate culture that promotes good strategy execution. 10. Exercising strong leadership to drive the execution process forward and attain

companywide operating excellence as rapidly as feasible.

How well managers perform these 10 tasks has a decisive impact on whether the outcome of the strategy execution effort is a spectacular success, a colossal failure, or something in between.

In devising an action agenda for executing strategy, managers should start by conducting a probing assessment of what the organization must do differently to carry out the strategy successfully. Each manager needs to ask the question “What needs to be done in my area of responsibility to implement our part of the company’s strategy, and what should I do to get these things accomplished in a timely fashion?” It is then incumbent on every manager to determine precisely how to make the necessary internal changes. Successful strategy implementers have a knack for diagnosing what their organizations need to do to execute the chosen strategy well and figuring out how to get these things done efficiently. They are masters in promoting results-oriented behaviors on the part of company personnel and following through on making the right things happen to achieve the target outcomes.4

When strategies fail, it is often because of poor execution. Strategy execution is therefore a critical managerial endeavor. The two best signs of good strategy execution are whether a company is meeting or beating its performance targets and whether it is performing value chain activities in a manner that is conducive to companywide operating excellence. In big organizations with geographically scattered operating units, senior executives’ action agenda mostly involves com- municating the case for change, building consensus for how to proceed, installing strong managers to move the process forward in key organizational units, direct- ing resources to the right places, establishing deadlines and measures of progress, rewarding those who achieve implementation milestones, and personally leading the strategic change process. Thus, the bigger the organization, the more that suc- cessful strategy execution depends on the cooperation and implementation skills of operating managers who can promote needed changes at the lowest organizational levels and deliver results. In small organizations, top managers can deal directly with frontline managers and employees, personally orchestrating the action steps and implementation sequence, observing firsthand how implementation is progress- ing, and deciding how hard and how fast to push the process along. Whether the organization is large or small and whether strategy implementation involves sweep- ing or minor changes, effective leadership requires a keen grasp of what to do and how to do it in light of the organization’s circumstances. Then it remains for com- pany personnel in strategy-critical areas to step up to the plate and produce the desired results.

When strategies fail, it is often because of poor execution. Strategy execution is therefore a critical managerial endeavor.

The two best signs of good strategy execution are whether a company is meeting or beating its performance targets and whether it is performing value chain activities in a manner that is conducive to companywide operating excellence.

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What’s Covered in Chapters 10, 11, and 12 In the remainder of this chapter and in the next two chapters, we discuss what is involved in perform- ing the 10 key managerial tasks that shape the process of executing strategy. This chapter explores the first three of these tasks (highlighted in blue in Figure 10.1): (1) staffing the organization with people capable of executing the strategy well, (2) developing the resources and building the organizational capabilities needed for successful strategy execution, and (3) creating an organizational structure sup- portive of the strategy execution process. Chapter 11 concerns the tasks of allo- cating resources (budgetary and otherwise), instituting strategy-facilitating policies and procedures, employing business process management tools and best practices, installing operating and information systems, and tying rewards to the achievement of good results (highlighted in green in Figure 10.1). Chapter 12 deals with the two remaining tasks: instilling a corporate culture conducive to good strategy execution, and exercising the leadership needed to drive the execution process forward (high- lighted in purple).

FIGURE 10.1 The 10 Basic Tasks of the Strategy Execution Process

Develop the resources and organizational capabilities

required for successful strategy execution

Exercise strong leadership to propel strategy execution

forward

Tie rewards and incentives directly to the achievement of strategic and financial targets

Install information and operating systems that support

strategy execution activities

Adopt best practices and business processes

that drive continuous improvement

Institute policies and procedures that

facilitate strategy execution

Allocate su�cient resources to the

strategy execution e�ort

Instill a corporate culture that promotes

good strategy execution

Sta� the organization with the right people for executing the strategy

Establish a strategy- supportive organizational

structure

The Action Agenda for Executing Strategy

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Proficient strategy execution depends foremost on having in place an organization capable of the tasks demanded of it. Building an execution-capable organization is thus always a top priority. As shown in Figure 10.2, three types of organization- building actions are paramount:

1. Staffing the organization—putting together a strong management team, and recruiting and retaining employees with the needed experience, technical skills, and intellectual capital.

2. Acquiring, developing, and strengthening the resources and capabilities required for good strategy execution—accumulating the required resources, developing

BUILDING AN ORGANIZATION CAPABLE OF GOOD STRATEGY EXECUTION: THREE KEY ACTIONS

FIGURE 10.2 Building an Organization Capable of Proficient Strategy Execution: Three Key Actions

Strategy- Supportive

Resources and Capabilities

Strategy- Supportive

Organizational Structure

Sta�ng the Organization

Acquiring, Developing, and Strengthening Key Resources and Capabilities

Putting together a strong management team Recruiting and retaining talented employees

Developing a set of resources and capabilities suited to the current strategy Updating resources and capabilities as external conditions and the firm’s strategy change Training and retaining company personnel to maintain knowledge-based and skills-based capabilities

Structuring the Organization and Work E�ort Instituting organizational arrangements that facilitate good strategy execution

Deciding how much decision-making authority to delegate

Establishing lines of authority and reporting relationships

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proficiencies in performing strategy-critical value chain activities, and updating the company’s capabilities to match changing market conditions and customer expectations.

3. Structuring the organization and work effort—organizing value chain activities and business processes, establishing lines of authority and reporting relationships, and deciding how much decision-making authority to delegate to lower-level managers and frontline employees.

Implementing a strategy depends critically on ensuring that strategy-supportive resources and capabilities are in place, ready to be deployed. These include the skills, talents, experience, and knowledge of the company’s human resources (managerial and otherwise)—see Figure 10.2. Proficient strategy execution depends heavily on competent personnel of all types, but because of the many managerial tasks involved and the role of leadership in strategy execution, assembling a strong management team is especially important.

If the strategy being implemented is a new strategy, the company may need to add to its resource and capability mix in other respects as well. But renewing, upgrad- ing, and revising the organization’s resources and capabilities is a part of the strategy execution process even if the strategy is fundamentally the same, since strategic assets depreciate and conditions are always changing. Thus, augmenting and strengthening the firm’s core competencies and seeing that they are suited to the current strategy are also top priorities.

Structuring the organization and work effort is another critical aspect of building an organization capable of good strategy execution. An organization structure that is well matched to the strategy can help facilitate its implementation; one that is not well suited can lead to higher bureaucratic costs and communication or coordination breakdowns.

LO 2

Why hiring, training, and retaining the right people constitute a key component of the strategy execution process.

STAFFING THE ORGANIZATION No company can hope to perform the activities required for successful strategy execu- tion without attracting and retaining talented managers and employees with suitable skills and intellectual capital.

Putting Together a Strong Management Team Assembling a capable management team is a cornerstone of the organization- building task.5 While different strategies and company circumstances often call for different mixes of backgrounds, experiences, management styles, and know-how, the most important consideration is to fill key managerial slots with smart people who are clear thinkers, good at figuring out what needs to be done, skilled in managing peo- ple, and accomplished in delivering good results.6 The task of implementing chal- lenging strategic initiatives must be assigned to executives who have the skills and talents to handle them and who can be counted on to get the job done well. Without a capable, results-oriented management team, the implementation process is likely to be hampered by missed deadlines, misdirected or wasteful efforts, and manage- rial ineptness. Weak executives are serious impediments to getting optimal results because they are unable to differentiate between ideas that have merit and those that

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are misguided—the caliber of work done under their supervision suffers.7 In contrast, managers with strong strategy implementation capabilities have a talent for asking tough, incisive questions. They know enough about the details of the business to be able to ensure the soundness of the decisions of the people around them, and they can discern whether the resources people are asking for to put the strategy in place make sense. They are good at getting things done through others, partly by making sure they have the right people under them, assigned to the right jobs. They consistently follow through on issues, monitor progress carefully, make adjustments when needed, and keep important details from slipping through the cracks. In short, they understand how to drive organizational change, and they know how to motivate and lead the com- pany down the path for first-rate strategy execution.

Sometimes a company’s existing management team is up to the task. At other times it may need to be strengthened by promoting qualified people from within or by bringing in outsiders whose experiences, talents, and leadership styles bet- ter suit the situation. In turnaround and rapid-growth situations, and in instances when a company doesn’t have insiders with the requisite know-how, filling key management slots from the outside is a standard organization-building approach. In addition, it is important to identify and replace managers who are incapable, for whatever reason, of making the required changes in a timely and cost-effective manner. For a management team to be truly effective at strategy execution, it must be composed of managers who recognize that organizational changes are needed and who are ready to get on with the process.

The overriding aim in building a management team should be to assemble a criti- cal mass of talented managers who can function as agents of change and further the cause of excellent strategy execution. Every manager’s success is enhanced (or lim- ited) by the quality of his or her managerial colleagues and the degree to which they freely exchange ideas, debate ways to make operating improvements, and join forces to tackle issues and solve problems. When a first-rate manager enjoys the help and support of other first-rate managers, it’s possible to create a managerial whole that is greater than the sum of individual efforts—talented managers who work well together as a team can produce organizational results that are dramatically better than what one or two star managers acting individually can achieve.8

Illustration Capsule 10.1 describes Deloitte’s highly effective approach to develop- ing employee talent and a top-caliber management team.

Recruiting, Training, and Retaining Capable Employees Assembling a capable management team is not enough. Staffing the organization with the right kinds of people must extend to all kinds of company personnel for value chain activities to be performed competently. The quality of an organization’s people is always an essential ingredient of successful strategy execution— knowledgeable, engaged employees are a company’s best source of creative ideas for the nuts-and- bolts operating improvements that lead to operating excellence. Companies like Mercedes-Benz, Alphabet, SAS, Boston Consulting Group, Edward Jones, Quicken Loans, Genentech, Intuit, Salesforce.com, and Goldman Sachs make a concerted effort to recruit the best and brightest people they can find and then retain them with excellent compensation packages, opportunities for rapid advancement and professional growth, and interesting assignments. Having a pool of “A players” with strong skill sets and lots of brainpower is essential to their business.

Putting together a talented management team with the right mix of experiences, skills, and abilities to get things done is one of the first steps to take in launching the strategy- executing process.

In many industries, adding to a company’s talent base and building intellectual capital are more important to good strategy execution than are additional investments in capital projects.

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ILLUSTRATION CAPSULE 10.1

Hiring, retaining, and cultivating talent are critical activi- ties at Deloitte, the world’s largest professional services firm. By offering robust learning and development pro- grams, Deloitte has been able to create a strong talent pipeline to the firm’s partnership. Deloitte’s emphasis on learning and development, across all stages of the employee life cycle, has led to recognitions such as being ranked number-one on Chief Executives’s list of “Best Private Companies for Leaders” and being listed among Fortune’s “100 Best Companies to Work For.” The following programs contribute to Deloitte’s success- ful execution of its talent strategy:

• Clear path to partnership. During the initial recruiting phase and then throughout an employee’s tenure at the firm, Deloitte lays out a clear career path. The path indicates the expected timeline for promotion to each of the firm’s hierarchy levels, along with the competen- cies and experience required. Deloitte’s transparency on career paths, coupled with its in-depth performance

management process, helps employees clearly under- stand their performance. This serves as a motivational tool for top performers, often leading to career acceleration.

• Formal training programs. Like other leading organiza- tions, Deloitte has a program to ensure that recent col- lege graduates are equipped with the necessary training and tools for succeeding on the job. Yet Deloitte’s com- mitment to formal training is evident at all levels within the organization. Each time an employee is promoted, he or she attends “milestone” school, a weeklong simu- lation that replicates true business situations employees would face as they transition to new stages of career development. In addition, Deloitte institutes manda- tory training hours for all of its employees to ensure that individuals continue to further their professional development.

• Special programs for high performers. Deloitte also offers fellowships and programs to help employees acquire new skills and enhance their leadership devel- opment. For example, the Global Fellows program helps top performers work with senior leaders in the organi- zation to focus on the realities of delivering client ser- vice across borders. Deloitte has also established the Emerging Leaders Development program, which utilizes skill building, 360-degree feedback, and one-on-one executive coaching to help top-performing managers and senior managers prepare for partnership.

• Sponsorship, not mentorship. To train the next genera- tion of leaders, Deloitte has implemented formal men- torship programs to provide leadership development support. Deloitte, however, uses the term sponsorship to describe this initiative. A sponsor is tasked with taking a vested interest in an individual and advocating on his or her behalf. Sponsors help rising leaders navigate the firm, develop new competencies, expand their network, and hone the skills needed to accelerate their career.

Management Development at Deloitte Touche Tohmatsu Limited

Note: Developed with Heather Levy.

Sources: Company websites; www.accountingweb.com/article/leadership-development-community-service-integral-deloitte- university/220845 (accessed February 2014).

Facebook makes a point of hiring the very brightest and most talented program- mers it can find and motivating them with both good monetary incentives and the challenge of working on cutting-edge technology projects. McKinsey & Company, one of the world’s premier management consulting firms, recruits only cream-of-the-crop MBAs at the nation’s top-10 business schools; such talent is essential to McKinsey’s strategy of performing high-level consulting for the world’s top corporations. The lead- ing global accounting firms screen candidates not only on the basis of their accounting

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expertise but also on whether they possess the people skills needed to relate well with clients and colleagues. Zappos goes to considerable lengths to hire people who can have fun and be fun on the job; it has done away with traditional job postings and instead asks prospective hires to join a social network, called Zappos Insiders, where they will interact with current employees and have opportunities to demonstrate their passion for joining the company. Zappos is so selective about finding people who fit their culture that only about 1.5 percent of the people who apply are offered jobs.

In high-tech companies, the challenge is to staff work groups with gifted, imag- inative, and energetic people who can bring life to new ideas quickly and inject into the organization what one Dell executive calls “hum.”9 The saying “People are our most important asset” may seem trite, but it fits high-technology companies precisely. Besides checking closely for functional and technical skills, Dell tests applicants for their tolerance of ambiguity and change, their capacity to work in teams, and their ability to learn on the fly. Companies like Zappos, Amazon.com, Google, and Cisco Systems have broken new ground in recruiting, hiring, culti- vating, developing, and retaining talented employees—almost all of whom are in their 20s and 30s. Cisco goes after the top 10 percent, raiding other companies and endeavoring to retain key people at the companies it acquires. Cisco executives believe that a cadre of star engineers, programmers, managers, salespeople, and support personnel is the backbone of the company’s efforts to execute its strategy and remain the world’s leading provider of Internet infrastructure products and technology.

In recognition of the importance of a talented and energetic workforce, companies have instituted a number of practices aimed at staffing jobs with the best people they can find:

1. Spending considerable effort on screening and evaluating job applicants— selecting only those with suitable skill sets, energy, initiative, judgment, aptitude for learning, and personality traits that mesh well with the company’s work envi- ronment and culture.

2. Providing employees with training programs that continue throughout their careers. 3. Offering promising employees challenging, interesting, and skill-stretching

assignments. 4. Rotating people through jobs that span functional and geographic boundaries.

Providing people with opportunities to gain experience in a variety of interna- tional settings is increasingly considered an essential part of career development in multinational companies.

5. Making the work environment stimulating and engaging so that employees will consider the company a great place to work.

6. Encouraging employees to challenge existing ways of doing things, to be creative and innovative in proposing better ways of operating, and to push their ideas for new products or businesses. Progressive companies work hard at creating an envi- ronment in which employees are made to feel that their views and suggestions count.

7. Striving to retain talented, high-performing employees via promotions, salary increases, performance bonuses, stock options and equity ownership, benefit packages including health insurance and retirement packages, and other perks, such as flexible work hours and onsite day care.

8. Coaching average performers to improve their skills and capabilities, while weed- ing out underperformers.

The best companies make a point of recruiting and retaining talented employees—the objective is to make the company’s entire workforce (managers and rank-and- file employees) a genuine competitive asset.

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High among the organization-building priorities in the strategy execution process is the need to build and strengthen the company’s portfolio of resources and capabili- ties with which to perform strategy-critical value chain activities. As explained in Chapter 4, a company’s chances of gaining a sustainable advantage over its market rivals depends on the caliber of its resource portfolio. In the course of crafting strategy, managers may well have well have identified the strategy-critical resources and capa- bilities it needs. But getting the strategy execution process underway requires acquir- ing or developing these resources and capabilities, putting them into place, upgrading them as needed, and then modifying them as market conditions evolve.

If the strategy being implemented has important new elements, company man- agers may have to acquire new resources, significantly broaden or deepen certain capabilities, or even add entirely new competencies in order to put the strategic initia- tives in place and execute them proficiently. But even when a company’s strategy has not changed materially, good strategy execution still involves upgrading the firm’s resources and capabilities to keep them in top form and perform value chain activities ever more proficiently.

Three Approaches to Building and Strengthening Capabilities

Building the right kinds of core competencies and competitive capabilities and keeping them finely honed is a time-consuming, managerially challenging exer- cise. While some assistance can be gotten from discovering how best-in-industry or best-in-world companies perform a particular activity, trying to replicate and then improve on the capabilities of others is easier said than done—for the same reasons that one is unlikely to ever become a world-class halfpipe snowboarder just by studying legendary Olympic gold medalist Shaun White.

With deliberate effort, well-orchestrated organizational actions and contin- ued practice, however, it is possible for a firm to become proficient at capability building despite the difficulty. Indeed, by making capability-building activities

a routine part of their strategy execution endeavors, some firms are able to develop dynamic capabilities that assist them in managing resource and capability change, as discussed in Chapter 4. The most common approaches to capability building include (1) developing and strengthening capabilities internally, (2) acquiring capa- bilities through mergers and acquisitions, and (3) developing new capabilities via collaborative partnerships.

Developing Capabilities Internally Internal efforts to create or upgrade capabilities is an evolutionary process that entails a series of deliberate and well- orchestrated steps as organizations search for solutions to their problems. The process is a complex one, since capabilities are the product of bundles of skills and know-how that are integrated into organizational routines and deployed within activity systems through the combined efforts of teams that are often cross-functional in nature, span- ning a variety of departments and locations. For instance, the capability of speed- ing new products to market involves the collaborative efforts of personnel in R&D,

LO 3

That good strategy execution requires continuously building and upgrading the organization’s resources and capabilities.

Building new competencies and capabilities is a multistage process that occurs over a period of months and years. It is not something that is accomplished overnight.

DEVELOPING AND BUILDING CRITICAL RESOURCES AND CAPABILITIES

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engineering and design, purchasing, production, marketing, and distribution. Simi- larly, the capability to provide superior customer service is a team effort among people in customer call centers (where orders are taken and inquiries are answered), shipping and delivery, billing and accounts receivable, and after-sale support. The process of building a capability begins when managers set an objective of developing a particular capability and organize activity around that objective.10 Managers can ignite the pro- cess by having high aspirations and setting “stretch objectives” for the organization, as described in Chapter 2.11

Because the process is incremental, the first step is to develop the ability to do something, however imperfectly or inefficiently. This entails selecting people with the requisite skills and experience, upgrading or expanding individual abilities as needed, and then molding the efforts of individuals into a joint effort to create an organizational ability. At this stage, progress can be fitful since it depends on experimenting, actively searching for alternative solutions, and learning through trial and error.12

As experience grows and company personnel learn how to perform the activi- ties consistently well and at an acceptable cost, the ability evolves into a tried- and-true competence. Getting to this point requires a continual investment of resources and systematic efforts to improve processes and solve problems creatively as they arise. Improvements in the functioning of a capability come from task repetition and the resulting learning by doing of individuals and teams. But the process can be accelerated by making learning a more deliberate endeavor and providing the incen- tives that will motivate company personnel to achieve the desired ends.13 This can be critical to successful strategy execution when market conditions are changing rapidly.

It is generally much easier and less time-consuming to update and remodel a com- pany’s existing capabilities as external conditions and company strategy change than it is to create them from scratch. Maintaining capabilities in top form may simply require exercising them continually and fine-tuning them as necessary. Similarly, augmenting a capability may require less effort if it involves the recombination of well-established company capabilities and draws on existing company resources. For example, Williams-Sonoma first developed the capability to expand sales beyond its brick-and-mortar location in 1970, when it launched a catalog that was sent to cus- tomers throughout the United States. The company extended its mail-order business with the acquisitions of Hold Everything, a garden products catalog, and Pottery Barn, and entered online retailing in 2000 when it launched e-commerce sites for Pottery Barn and Williams-Sonoma. The ongoing renewal of these capabilities has allowed Williams-Sonoma to generate revenues of nearly $5 billion in 2014 and become the 21st largest online retailer in the United States. Toyota, en route to overtaking General Motors as the global leader in motor vehicles, aggressively upgraded its capabilities in fuel-efficient hybrid engine technology and constantly fine-tuned its famed Toyota Production System to enhance its already proficient capabilities in manufacturing top- quality vehicles at relatively low costs.

Managerial actions to develop core competencies and competitive capabilities gen- erally take one of two forms: either strengthening the company’s base of skills, knowl- edge, and experience or coordinating and integrating the efforts of the various work groups and departments. Actions of the first sort can be undertaken at all managerial levels, but actions of the second sort are best orchestrated by senior managers who not only appreciate the strategy-executing significance of strong capabilities but also have the clout to enforce the necessary cooperation and coordination among individuals, groups, and departments.14

A company’s capabilities must be continually refreshed and renewed to remain aligned with changing customer expectations, altered competitive conditions, and new strategic initiatives.

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Acquiring Capabilities through Mergers and Acquisitions Sometimes the best way for a company to upgrade its portfolio of capabilities is by acquiring (or merging with) another company with attractive resources and capabili- ties.15 An acquisition aimed at building a stronger portfolio of resources and capabili- ties can be every bit as valuable as an acquisition aimed at adding new products or services to the company’s lineup of offerings. The advantage of this mode of acquiring new capabilities is primarily one of speed, since developing new capabilities internally can, at best, take many years of effort and, at worst, come to naught. Capabilities- motivated acquisitions are essential (1) when the company does not have the ability to create the needed capability internally (perhaps because it is too far afield from its existing capabilities) and (2) when industry conditions, technology, or competitors are moving at such a rapid clip that time is of the essence.

At the same time, acquiring capabilities in this way is not without difficulty. Capa- bilities involve tacit knowledge and complex routines that cannot be transferred read- ily from one organizational unit to another. This may limit the extent to which the new capability can be utilized. For example, Facebook acquired Oculus VR, a com- pany that makes virtual reality headsets, to add capabilities that might enhance the social media experience. Transferring and integrating these capabilities to other parts of the Facebook organization prove easier said than done, however, as many technol- ogy acquisitions fail to yield the hoped-for benefits. Integrating the capabilities of two companies is particularly problematic when there are underlying incompatibilities in their supporting systems or processes. Moreover, since internal fit is important, there is always the risk that under new management the acquired capabilities may not be as productive as they had been. In a worst-case scenario, the acquisition process may end up damaging or destroying the very capabilities that were the object of the acquisition in the first place.

Accessing Capabilities through Collaborative Partnerships A third way of obtaining valuable resources and capabilities is to form collaborative partnerships with suppliers, competitors, or other companies having the cutting-edge expertise. There are three basic ways to pursue this course of action:

1. Outsource the function in which the company’s capabilities are deficient to a key supplier or another provider. Whether this is a wise move depends on what can be safely delegated to outside suppliers or allies and which internal capabilities are key to the company’s long-term success. As discussed in Chapter 6, outsourcing has the advantage of conserving resources so that the firm can focus its energies on those activities most central to its strategy. It may be a good choice for firms that are too small and resource-constrained to execute all the parts of their strategy internally.

2. Collaborate with a firm that has complementary resources and capabilities in a joint venture, strategic alliance, or other type of partnership established for the purpose of achieving a shared strategic objective. This requires launching initiatives to identify the most attractive potential partners and to establish col- laborative working relationships. Since the success of the venture will depend on how well the partners work together, potential partners should be selected as much for their management style, culture, and goals as for their resources and capabilities. In the past 15 years, close collaboration with suppliers to achieve mutually beneficial outcomes has become a common approach to building supply chain capabilities.

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3. Engage in a collaborative partnership for the purpose of learning how the part- ner does things, internalizing its methods and thereby acquiring its capabilities. This may be a viable method when each partner has something to learn from the other and can achieve an outcome beneficial to both partners. For example, firms sometimes enter into collaborative marketing arrangements whereby each partner is granted access to the other’s dealer network for the purpose of expanding sales in geographic areas where the firms lack dealers. But if the intended gains are only one-sided, the arrangement more likely involves an abuse of trust. In con- sequence, it not only puts the cooperative venture at risk but also encourages the firm’s partner to treat the firm similarly or refuse further dealings with the firm.

The Strategic Role of Employee Training Training and retraining are important when a company shifts to a strategy requiring different skills, competitive capabilities, and operating methods. Training is also stra- tegically important in organizational efforts to build skill-based competencies. And it is a key activity in businesses where technical know-how is changing so rapidly that a company loses its ability to compete unless its employees have cutting-edge knowl- edge and expertise. Successful strategy implementers see to it that the training func- tion is both adequately funded and effective. If better execution of the chosen strategy calls for new skills, deeper technological capability, or the building and using of new capabilities, training efforts need to be placed near the top of the action agenda.

The strategic importance of training has not gone unnoticed. Over 4,000 com- panies around the world have established internal “universities” to lead the training effort, facilitate continuous organizational learning, and upgrade their company’s knowledge resources. Many companies conduct orientation sessions for new employ- ees, fund an assortment of competence-building training programs, and reimburse employees for tuition and other expenses associated with obtaining additional college education, attending professional development courses, and earning professional cer- tification of one kind or another. A number of companies offer online training courses that are available to employees around the clock. Increasingly, companies are expect- ing employees at all levels are expected to take an active role in their own professional development and assume responsibility for keeping their skills up to date and in sync with the company’s needs.

Strategy Execution Capabilities and Competitive Advantage As firms get better at executing their strategies, they develop capabilities in the domain of strategy execution much as they build other organizational capabilities. Superior strategy execution capabilities allow companies to get the most from their other organizational resources and competitive capabilities. In this way they contrib- ute to the success of a firm’s business model. But excellence in strategy execution can also be a more direct source of competitive advantage, since more efficient and effec- tive strategy execution can lower costs and permit firms to deliver more value to cus- tomers. Superior strategy execution capabilities may also enable a company to react more quickly to market changes and beat other firms to the market with new prod- ucts and services. This can allow a company to profit from a period of uncontested market dominance. See Illustration Capsule 10.2 for an example of Zara’s route to competitive advantage.

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ILLUSTRATION CAPSULE 10.2

Zara, a major division of Inditex Group, is a leading “fast fashion” retailer. As soon as designs are seen in high-end fashion houses such as Prada, Zara’s design team sets to work altering the clothing designs so that it can produce high fashion at mass-retailing prices. Zara’s strategy is clever, but by no means unique. The company’s com- petitive advantage is in strategy execution. Every step of Zara’s value chain execution is geared toward putting fashionable clothes in stores quickly, realizing high turn- over, and strategically driving traffic.

The first key lever is a quick production process. Zara’s design team uses inspiration from high fashion and nearly real-time feedback from stores to create up-to-the-minute pieces. Manufacturing largely occurs in factories close to headquarters in Spain, northern Africa, and Turkey, all areas considered to have a high

cost of labor. Placing the factories strategically close allows for more flexibility and greater responsive- ness to market needs, thereby outweighing the addi- tional labor costs. The entire production process, from design to arrival at stores, takes only two weeks, while other retailers take six months. Whereas traditional retailers commit up to 80 percent of their lines by the start of the season, Zara commits only 50 to 60 per- cent, meaning that up to half of the merchandise to hit stores is designed and manufactured during the sea- son. Zara purposefully manufactures in small lot sizes to avoid discounting later on and also to encourage impulse shopping, as a particular item could be gone in a few days. From start to finish, Zara has engineered its production process to maximize turnover and turn- around time, creating a true advantage in this step of strategy execution.

Zara also excels at driving traffic to stores. First, the small lot sizes and frequent shipments (up to twice a week per store) drive customers to visit often and pur- chase quickly. Zara shoppers average 17 visits per year, versus 4 to 5 for The Gap. On average, items stay in a Zara store only 11 days. Second, Zara spends no money on advertising, but it occupies some of the most expen- sive retail space in town, always near the high-fashion houses it imitates. Proximity reinforces the high-fashion association, while the busy street drives significant foot traffic. Overall, Zara has managed to create competitive advantage in every level of strategy execution by tightly aligning design, production, advertising, and real estate with the overall strategy of fast fashion: extremely fast and extremely flexible.

Zara’s Strategy Execution Capabilities

Note: Developed with Sara Paccamonti.

Sources: Suzy Hansen, “How Zara Grew into the World’s Largest Fashion Retailer,” The New York Times, November 9, 2012, www.nytimes .com/2012/11/11/magazine/how-zara-grew-into-the-worlds-largest-fashion-retailer.html?pagewanted=all (accessed February 5, 2014); Seth Stevenson, “Polka Dots Are In? Polka Dots It Is!” Slate, June 21, 2012, www.slate.com/articles/arts/operations/2012/06/zara_s_fast_ fashion_how_the_company_gets_new_styles_to_stores_so_quickly.html (accessed February 5, 2014).

Because strategy execution capabilities are socially complex capabilities that develop with experience over long periods of time, they are hard to imitate. And there is no substitute for good strategy execution. (Recall the tests of resource advantage from Chapter 4.) As such, they may be as important a source of sus- tained competitive advantage as the core competencies that drive a firm’s strategy. Indeed, they may be a far more important avenue for securing a competitive edge over rivals in situations where it is relatively easy for rivals to copy promising strat- egies. In such cases, the only way for firms to achieve lasting competitive advan-

tage is to out-execute their competitors.

Superior strategy execution capabilities are the only source of sustainable competitive advantage when strategies are easy for rivals to copy.

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While there are few hard-and-fast rules for organizing the work effort to support good strategy execution, there is one: A firm’s organizational structure should be matched to the particular requirements of implementing the firm’s strategy. Every company’s strategy is grounded in its own set of organizational capabilities and value chain activ- ities. Moreover, every firm’s organizational chart is partly a product of its particu- lar situation, reflecting prior organizational patterns, varying internal circumstances, executive judgments about reporting relationships, and the politics of who gets which assignments. Thus, the determinants of the fine details of each firm’s organizational structure are unique. But some considerations in organizing the work effort are com- mon to all companies. These are summarized in Figure 10.3 and discussed in the following sections.

Deciding Which Value Chain Activities to Perform Internally and Which to Outsource Aside from the fact that an outsider, because of its expertise and specialized know- how, may be able to perform certain value chain activities better or cheaper than a company can perform them internally (as discussed in Chapter 6), outsourcing can also sometimes contribute to better strategy execution. Outsourcing the performance

MATCHING ORGANIZATIONAL STRUCTURE TO THE STRATEGY

FIGURE 10. 3 Structuring the Work Effort to Promote Successful Strategy Execution

An Organizational

Structure Matched

to the Requirements

of Successful Strategy

Execution

Decide which value chain activities to perform internally and which ones to outsource

Align the organizational structure with the strategy

Decide how much authority to centralize at the top and how much to delegate to down-the- line managers and employees

Facilitate collaboration with external partners and strategic allies

LO 4

What issues to consider in establishing a strategy-supportive organizational structure and organizing the work effort.

A company’s organizational structure should be matched to the particular requirements of implementing the firm’s strategy.

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of selected activities to outside vendors enables a company to heighten its strategic focus and concentrate its full energies on performing those value chain activities that are at the core of its strategy, where it can create unique value. For example, E. & J. Gallo Winery outsources 95 percent of its grape production, letting farm- ers take on weather-related and other grape-growing risks while it concentrates its full energies on wine production and sales.16 Broadcom, a global leader in chips for broadband communication systems, outsources the manufacture of its chips to Taiwan Semiconductor, thus freeing company personnel to focus their full energies on R&D, new chip design, and marketing. Nike concentrates on design, marketing, and distribution to retailers, while outsourcing virtually all production of its shoes and sporting apparel. Illustration Capsule 10.3 describes Apple’s decisions about which activities to outsource and which to perform in-house.

Such heightened focus on performing strategy-critical activities can yield three important execution-related benefits:

∙ The company improves its chances for outclassing rivals in the performance of strategy-critical activities and turning a competence into a distinctive compe- tence. At the very least, the heightened focus on performing a select few value chain activities should promote more effective performance of those activities. This could materially enhance competitive capabilities by either lowering costs or improving product or service quality. Whirlpool, ING Insurance, Hugo Boss, Japan Airlines, and Chevron have outsourced their data processing activities to computer service firms, believing that outside specialists can perform the needed services at lower costs and equal or better quality. A relatively large number of companies outsource the operation of their websites to web design and hosting enterprises. Many businesses that get a lot of inquiries from customers or that have to provide 24/7 technical support to users of their products around the world have found that it is considerably less expensive to outsource these functions to specialists (often located in foreign countries where skilled personnel are readily available and worker compensation costs are much lower) than to operate their own call centers. Dialogue Direct is a company that specializes in call center oper- ation, with 14 such centers located in the United States.

∙ The streamlining of internal operations that flows from outsourcing often acts to decrease internal bureaucracies, flatten the organizational structure, speed inter- nal decision making, and shorten the time it takes to respond to changing mar- ket conditions. In consumer electronics, where advancing technology drives new product innovation, organizing the work effort in a manner that expedites getting next-generation products to market ahead of rivals is a critical competitive capa- bility. The world’s motor vehicle manufacturers have found that they can shorten the cycle time for new models by outsourcing the production of many parts and components to independent suppliers. They then work closely with the suppliers to swiftly incorporate new technology and to better integrate individual parts and components to form engine cooling systems, transmission systems, electrical sys- tems, and so on.

∙ Partnerships with outside vendors can add to a company’s arsenal of capabilities and contribute to better strategy execution. Outsourcing activities to vendors with first-rate capabilities can enable a firm to concentrate on strengthening its own complementary capabilities internally; the result will be a more powerful package of organizational capabilities that the firm can draw upon to deliver more value to customers and attain competitive success. Soft-drink and beer manufacturers

Wisely choosing which activities to perform internally and which to outsource can lead to several strategy-executing advantages—lower costs, heightened strategic focus, less internal bureaucracy, speedier decision making, and a better arsenal of organizational capabilities.

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cultivate their relationships with their bottlers and distributors to strengthen access to local markets and build loyalty, support, and commitment for corporate market- ing programs, without which their own sales and growth would be weakened. Similarly, fast-food enterprises like Wendy’s and Burger King find it essential to work hand in hand with franchisees on outlet cleanliness, consistency of product quality, in-store ambience, courtesy and friendliness of store personnel, and other aspects of store operations. Unless franchisees continuously deliver sufficient cus- tomer satisfaction to attract repeat business, a fast-food chain’s sales and competi- tive standing will quickly suffer. Companies like Boeing, Aerospatiale, Verizon Communications, and Dell have learned that their central R&D groups cannot begin to match the innovative capabilities of a well-managed network of supply chain partners.

However, as emphasized in Chapter 6, a company must guard against going overboard on outsourcing and becoming overly dependent on outside suppliers. A company cannot be the master of its own destiny unless it maintains expertise and

ILLUSTRATION CAPSULE 10.3

Innovation and design are core competencies for Apple and the drivers behind the creation of winning products such as the iPod, iPhone, and iPad. In consequence, all activities directly related to new product development and product design are performed internally. For example, Apple’s Industrial Design Group is responsible for creat- ing the look and feel of all Apple products—from the Mac- Book Air to the iPhone, and beyond to future products.

Producing a continuing stream of great new prod- ucts and product versions is key to the success of

Apple’s strategy. But executing this strategy takes more than innovation and design capabilities. Manufacturing flexibility and speed are imperative in the production of Apple products to ensure that the latest ideas are reflected in the products and that the company meets the high demand for its products— especially around launch.

For these capabilities, Apple turns to outsourcing, as do the majority of its competitors in the consumer electronics space. Apple outsources the manufacturing of products like its iPhone to Asia, where contract manu- facturing organizations (CMOs) create value through their vast scale, high flexibility, and low cost. Perhaps no company better epitomizes the Asian CMO value proposition than Foxconn, a company that assembles not only for Apple but for Hewlett-Packard, Motorola, Amazon.com, and Samsung as well. Foxconn’s scale is incredible, with its largest facility (Foxconn City in Shen- zhen, China) employing over 450,000 workers. Such scale offers companies a significant degree of flexibil- ity, as Foxconn has the ability to hire 3,000 employees on practically a moment’s notice. Apple, more so than its competitors, is able to capture CMO value creation by leveraging its immense sales volume and strong cash position to receive preferred treatment.

Which Value Chain Activities Does Apple Outsource and Why?

Note: Developed with Margaret W. Macauley.

Sources: Company website; Charles Duhigg and Keith Bradsher, “How the U.S. Lost Out on iPhone Work,” The New York Times, January 21, 2012, www.nytimes.com/2012/01/22/business/apple-america-and-a-squeezed-middle-class.html?pagewanted=all&_r=0 (accessed March 5, 2012).

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resource depth in performing those value chain activities that underpin its long-term competitive success.17 Thus, with the exception of parts/components supply, the most frequently outsourced activities are those deemed to be strategically less important— like handling customer inquiries and requests for technical support, doing the payroll, administering employee benefit programs, providing corporate security, maintaining fleet vehicles, operating the company’s website, conducting employee training, and performing an assortment of information and data processing functions.

Aligning the Firm’s Organizational Structure with Its Strategy

The design of the firm’s organizational structure is a critical aspect of the strategy execution process. The organizational structure comprises the formal and informal arrangement of tasks, responsibilities, and lines of authority and communication by which the firm is administered.18 It specifies the linkages among parts of the organization, the reporting relationships, the direction of information flows, and the decision-making processes. It is a key factor in strategy implementation since it exerts a strong influence on how well managers can coordinate and control the complex set of activities involved.19

A well-designed organizational structure is one in which the various parts (e.g., decision-making rights, communication patterns) are aligned with one another and also matched to the requirements of the strategy. With the right structure in place, managers can orchestrate the various aspects of the implementation process

with an even hand and a light touch. Without a supportive structure, strategy execution is more likely to become bogged down by administrative confusion, political maneu- vering, and bureaucratic waste.

Good organizational design may even contribute to the firm’s ability to create value for customers and realize a profit. By enabling lower bureaucratic costs and facilitating operational efficiency, it can lower a firm’s operating costs. By facilitating the coordina- tion of activities within the firm, it can improve the capability-building process, leading to greater differentiation and/or lower costs. Moreover, by improving the speed with which information is communicated and activities are coordinated, it can enable the firm to beat rivals to the market and profit from a period of unrivaled advantage.

Making Strategy-Critical Activities the Main Building Blocks of the Organizational Structure In any business, some activities in the value chain are always more critical to successful strategy execution than others. For instance, ski apparel companies like Sport Obermeyer, Arc’teryx, and Spyder must be good at styling and design, low-cost manufacturing, distribution (convincing an attrac- tively large number of dealers to stock and promote the company’s brand), and market- ing and advertising (building a brand image that generates buzz among ski enthusiasts). For discount stockbrokers, like Scottrade and TD Ameritrade, the strategy-critical activi- ties are fast access to information, accurate order execution, efficient record keeping and transaction processing, and full-featured customer service. With respect to such core value chain activities, it is important for management to build its organizational structure around proficient performance of these activities, making them the centerpieces or main building blocks in the enterprise’s organizational structure.

The rationale is compelling: If activities crucial to strategic success are to have the resources, decision-making influence, and organizational impact they need, they must

CORE CONCEPT

A firm’s organizational structure comprises the formal and informal arrangement of tasks, responsibilities, lines of authority, and reporting relationships by which the firm is administered.

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be centerpieces in the enterprise’s organizational scheme. Making them the focus of structuring efforts will also facilitate their coordination and promote good internal fit— an essential attribute of a winning strategy, as summarized in Chapter 1 and elaborated in Chapter 4. To the extent that implementing a new strategy entails new or altered key activities or capabilities, different organizational arrangements may be required.

Matching Type of Organizational Structure to Strategy Execution Requirements Organizational structures can be classified into a limited number of standard types. Which type makes the most sense for a given firm depends largely on the firm’s size and business makeup, but not so much on the specifics of its strategy. As firms grow and their needs for structure evolve, their structural form is likely to evolve from one type to another. The four basic types are the simple structure, the functional structure, the multidivisional structure, and the matrix structure, as described next. 1. Simple Structure A simple structure is one in which a central executive (often the owner-manager) handles all major decisions and oversees the operations of the organization with the help of a small staff.20 Simple structures are also known as line-and-staff structures, since a central administrative staff supervises line employees who conduct the operations of the firm, or flat structures, since there are few levels of hierarchy. The simple structure is characterized by limited task spe- cialization; few rules; informal relationships; minimal use of training, planning, and liaison devices; and a lack of sophisticated support systems. It has all the advantages of simplicity, including low administrative costs, ease of coordination, flexibility, quick decision making, adaptability, and responsiveness to change. Its informality and lack of rules may foster creativity and heightened individual responsibility.

Simple organizational structures are typically employed by small firms and entrepreneurial startups. The simple structure is the most common type of orga- nizational structure since small firms are the most prevalent type of business. As an organization grows, however, this structural form becomes inadequate to the demands that come with size and complexity. In response, growing firms tend to alter their organizational structure from a simple structure to a functional structure.

2. Functional Structure A functional structure is one that is organized along functional lines, where a function represents a major component of the firm’s value chain, such as R&D, engineering and design, manufacturing, sales and marketing, logistics, and customer service. Each functional unit is supervised by functional line managers who report to the chief executive officer and a corporate staff. This arrangement allows functional managers to focus on their area of responsibility, leaving it to the CEO and headquarters to provide direction and ensure that the activities of the functional managers are coordinated and integrated. Functional structures are also known as departmental structures, since the functional units are commonly called departments, and unitary structures or U-forms, since a single unit is responsible for each function.

In large organizations, functional structures lighten the load on top manage- ment, in comparison to simple structures, and enable more efficient use of manage- rial resources. Their primary advantage, however, is greater task specialization, which promotes learning, enables the realization of scale economies, and offers productivity advantages not otherwise available. Their chief disadvantage is that the departmental boundaries can inhibit the flow of information and limit the opportunities for cross-functional cooperation and coordination.

CORE CONCEPT

A simple structure consists of a central executive (often the owner-manager) who handles all major decisions and oversees all operations with the help of a small staff. Simple structures are also called line-and-staff structures or flat structures.

CORE CONCEPT

A functional structure is organized into functional departments, with departmental managers who report to the CEO and small corporate staff. Functional structures are also called departmental structures and unitary structures or U-forms.

The primary advantage of a functional structure is greater task specialization, which promotes learning, enables the realization of scale economies, and offers productivity advantages not otherwise available.

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It is generally agreed that a functional structure is the best organizational arrange- ment when a company is in just one particular business (irrespective of which of the five generic competitive strategies it opts to pursue). For instance, a technical instru- ments manufacturer may be organized around research and development, engineering, supply chain management, assembly, quality control, marketing, and technical ser- vices. A discount retailer, such as Dollar General or Kmart, may organize around such functional units as purchasing, warehousing, distribution logistics, store operations, advertising, merchandising and promotion, and customer service. Functional structures can also be appropriate for firms with high-volume production, products that are closely related, and a limited degree of vertical integration. For example, General Motors now manages all of its brands (Cadillac, GMC, Chevrolet, Buick, etc.) under a common func- tional structure designed to promote technical transfer and capture economies of scale.

As firms continue to grow, they often become more diversified and complex, plac- ing a greater burden on top management. At some point, the centralized control that characterizes the functional structure becomes a liability, and the advantages of func- tional specialization begin to break down. To resolve these problems and address a growing need for coordination across functions, firms generally turn to the multidivi- sional structure.

3. Multidivisional Structure A multidivisional structure is a decentralized structure consisting of a set of operating divisions organized along market, customer, product, or geographic lines, along with a central corporate headquarters, which monitors divisional activities, allocates resources, performs assorted support functions, and exercises overall control. Since each division is essentially a business (often called a single business unit or SBU), the divisions typically operate as independent profit centers (i.e., with profit and loss responsibility) and are organized internally along functional lines. Division managers oversee day-to-day operations and the development of business-level strategy, while corporate executives attend to overall performance and corporate strategy, the ele- ments of which were described in Chapter 8. Multidivisional structures are also called divisional structures or M-forms, in contrast with U-form (functional) structures.

Multidivisional structures are common among companies pursuing some form of diversification strategy or international strategy, with operations in a number of businesses or countries. When the strategy is one of unrelated diversification, as in a conglomerate, the divisions generally represent businesses in separate industries. When the strategy is based on related diversification, the divisions may be organized according to industries, customer groups, product lines, geographic regions, or tech- nologies. In this arrangement, the decision about where to draw the divisional lines depends foremost on the nature of the relatedness and the strategy-critical building blocks, in terms of which businesses have key value chain activities in common. For example, a company selling closely related products to business customers as well as two types of end consumers—online buyers and in-store buyers—may organize its divisions according to customer groups since the value chains involved in serving the three groups differ. Another company may organize by product line due to commonal- ities in product development and production within each product line. Multidivisional structures are also common among vertically integrated firms. There the major build- ing blocks are often divisional units performing one or more of the major processing steps along the value chain (e.g., raw-material production, components manufacture, assembly, wholesale distribution, retail store operations).

Multidivisional structures offer significant advantages over functional structures in terms of facilitating the management of a complex and diverse set of operations.21 Put- ting business-level strategy in the hands of division managers while leaving corporate

CORE CONCEPT

A multidivisional structure is a decentralized structure consisting of a set of operating divisions organized along business, product, customer group, or geographic lines and a central corporate headquarters that allocates resources, provides support functions, and monitors divisional activities. Multidivisional structures are also called divisional structures or M-forms.

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strategy to top executives reduces the potential for information overload and improves the quality of decision making in each domain. This also minimizes the costs of coor- dinating division-wide activities while enhancing top management’s ability to con- trol a diverse and complex operation. Moreover, multidivisional structures can help align individual incentives with the goals of the corporation and spur productivity by encouraging competition for resources among the different divisions.

But a multidivisional structure can also present some problems to a company pur- suing related diversification, because having independent business units—each run- ning its own business in its own way—inhibits cross-business collaboration and the capture of cross-business synergies, which are critical for the success of a related diversification strategy, as Chapter 8 explains. To solve this type of problem, firms turn to more complex structures, such as the matrix structure.

4. Matrix Structure A matrix structure is a combination structure in which the organization is organized along two or more dimensions at once (e.g., busi- ness, geographic area, value chain function) for the purpose of enhancing cross-unit communication, collaboration, and coordination. In essence, it overlays one type of structure onto another type. Matrix structures are managed through multiple report- ing relationships, so a middle manager may report to several bosses. For instance, in a matrix structure based on product line, region, and function, a sales manager for plastic containers in Georgia might report to the manager of the plastics divi- sion, the head of the southeast sales region, and the head of marketing.

Matrix organizational structures have evolved from the complex, over- formalized structures that were popular in the 1960s, 70s, and 80s but often pro- duced inefficient, unwieldy bureaucracies. The modern incarnation of the matrix structure is generally a more flexible arrangement, with a single primary reporting relationship that can be overlaid with a temporary secondary reporting relationship as need arises. For example, a software company that is organized into functional departments (software design, quality control, customer relations) may assign employ- ees from those departments to different projects on a temporary basis, so an employee reports to a project manager as well as to his or her primary boss (the functional department head) for the duration of a project.

Matrix structures are also called composite structures or combination structures. They are often used for project-based, process-based, or team-based management. Such approaches are common in businesses involving projects of limited duration, such as consulting, architecture, and engineering services. The type of close cross-unit collaboration that a flexible matrix structure supports is also needed to build com- petitive capabilities in strategically important activities, such as speeding new prod- ucts to market, that involve employees scattered across several organizational units.22 Capabilities-based matrix structures that combine process departments (like new product development) with more traditional functional departments provide a solution.

An advantage of matrix structures is that they facilitate the sharing of plant and equipment, specialized knowledge, and other key resources. Thus, they lower costs by enabling the realization of economies of scope. They also have the advantage of flex- ibility in form and may allow for better oversight since supervision is provided from more than one perspective. A disadvantage is that they add another layer of manage- ment, thereby increasing bureaucratic costs and possibly decreasing response time to new situations.23 In addition, there is a potential for confusion among employees due to dual reporting relationships and divided loyalties. While there is some controversy over the utility of matrix structures, the modern approach to matrix structures does much to minimize their disadvantages.24

CORE CONCEPT

A matrix structure is a combination structure that overlays one type of structure onto another type, with multiple reporting relationships. It is used to foster cross- unit collaboration. Matrix structures are also called composite structures or combination structures.

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Determining How Much Authority to Delegate Under any organizational structure, there is room for considerable variation in how much authority top-level executives retain and how much is delegated to down-the- line managers and employees. In executing strategy and conducting daily operations, companies must decide how much authority to delegate to the managers of each orga- nizational unit—especially the heads of divisions, functional departments, plants, and other operating units—and how much decision-making latitude to give individual employees in performing their jobs. The two extremes are to centralize decision mak- ing at the top or to decentralize decision making by giving managers and employees at all levels considerable decision-making latitude in their areas of responsibility. As shown in Table 10.1, the two approaches are based on sharply different underlying principles and beliefs, with each having its pros and cons.

Centralized Decision Making: Pros and Cons In a highly central- ized organizational structure, top executives retain authority for most strategic and

LO 5

The pros and cons of centralized and decentralized decision making in implementing the chosen strategy.

Centralized Organizational Structures Decentralized Organizational Structures

Basic tenets

• Decisions on most matters of importance should be in the hands of top-level managers who have the experience, expertise, and judgment to decide what is the best course of action.

• Lower-level personnel have neither the knowledge, time, nor inclination to properly manage the tasks they are performing.

• Strong control from the top is a more effective means for coordinating company actions.

Basic tenets

• Decision-making authority should be put in the hands of the people closest to, and most familiar with, the situation.

• Those with decision-making authority should be trained to exercise good judgment.

• A company that draws on the combined intellectual capital of all its employees can outperform a command-and-control company.

Chief advantages

• Fixes accountability through tight control from the top.

• Eliminates potential for conflicting goals and actions on the part of lower-level managers.

• Facilitates quick decision making and strong leadership under crisis situations.

Chief advantages

• Encourages company employees to exercise initiative and act responsibly.

• Promotes greater motivation and involvement in the business on the part of more company personnel.

• Spurs new ideas and creative thinking.

• Allows for fast response to market change.

• Entails fewer layers of management.

Primary disadvantages

• Lengthens response times by those closest to the market conditions because they must seek approval for their actions.

• Does not encourage responsibility among lower-level managers and rank-and-file employees.

• Discourages lower-level managers and rank-and-file employees from exercising any initiative.

Primary disadvantages

• May result in higher-level managers being unaware of actions taken by empowered personnel under their supervision.

• Can lead to inconsistent or conflicting approaches by different managers and employees.

• Can impair cross-unit collaboration.

TABLE 10.1 Advantages and Disadvantages of Centralized versus Decentralized Decision Making

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operating decisions and keep a tight rein on business unit heads, department heads, and the managers of key operating units. Comparatively little discretionary authority is granted to frontline supervisors and rank-and-file employees. The command-and- control paradigm of centralized decision making is based on the underlying assump- tions that frontline personnel have neither the time nor the inclination to direct and properly control the work they are performing and that they lack the knowledge and judgment to make wise decisions about how best to do it—hence the need for pre- scribed policies and procedures for a wide range of activities, close supervision, and tight control by top executives. The thesis underlying centralized structures is that strict enforcement of detailed procedures backed by rigorous managerial oversight is the most reliable way to keep the daily execution of strategy on track.

One advantage of a centralized structure, with tight control by the manager in charge, is that it is easy to know who is accountable when things do not go well. This structure can also reduce the potential for conflicting decisions and actions among lower-level managers who may have differing perspectives and ideas about how to tackle certain tasks or resolve particular issues. For example, a manager in charge of an engineering department may be more interested in pursuing a new technology than is a marketing manager who doubts that customers will value the technology as highly. Another advantage of a command-and-control structure is that it can facilitate strong leadership from the top in a crisis situation that affects the organization as a whole and can enable a more uniform and swift response.

But there are some serious disadvantages as well. Hierarchical command-and- control structures do not encourage responsibility and initiative on the part of lower- level managers and employees. They can make a large organization with a complex structure sluggish in responding to changing market conditions because of the time it takes for the review-and-approval process to run up all the layers of the management bureaucracy. Furthermore, to work well, centralized decision making requires top- level managers to gather and process whatever information is relevant to the decision. When the relevant knowledge resides at lower organizational levels (or is technical, detailed, or hard to express in words), it is difficult and time-consuming to get all the facts in front of a high-level executive located far from the scene of the action—full understanding of the situation cannot be readily copied from one mind to another. Hence, centralized decision making is often impractical—the larger the company and the more scattered its operations, the more that decision-making authority must be delegated to managers closer to the scene of the action.

Decentralized Decision Making: Pros and Cons In a highly decentralized organization, decision-making authority is pushed down to the low- est organizational level capable of making timely, informed, competent decisions. The objective is to put adequate decision-making authority in the hands of the people closest to and most familiar with the situation and train them to weigh all the factors and exercise good judgment. At Starbucks, for example, employees are encouraged to exercise initiative in promoting customer satisfaction—there’s the oft-repeated story of a store employee who, when the computerized cash register system went offline, offered free coffee to waiting customers, thereby avoiding customer displeasure and damage to Starbucks’s reputation.25

The case for empowering down-the-line managers and employees to make deci- sions related to daily operations and strategy execution is based on the belief that a company that draws on the combined intellectual capital of all its employees can out- perform a command-and-control company.26 The challenge in a decentralized system

The ultimate goal of decentralized decision making is to put authority in the hands of those persons closest to and most knowledgeable about the situation.

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is maintaining adequate control. With decentralized decision making, top manage- ment maintains control by placing limits on the authority granted to company person- nel, installing companywide strategic control systems, holding people accountable for their decisions, instituting compensation incentives that reward people for doing their jobs well, and creating a corporate culture where there’s strong peer pressure on indi- viduals to act responsibly.27

Decentralized organizational structures have much to recommend them. Delegat- ing authority to subordinate managers and rank-and-file employees encourages them to take responsibility and exercise initiative. It shortens organizational response times to market changes and spurs new ideas, creative thinking, innovation, and greater involvement on the part of all company personnel. At TJX Companies Inc., parent company of T.J.Maxx, Marshalls, and five other fashion and home decor retail store chains, buyers are encouraged to be intelligent risk takers in deciding what items to purchase for TJX stores—there’s the story of a buyer for a seasonal product category who cut her own budget to have dollars allocated to other categories where sales were expected to be stronger. In worker-empowered structures, jobs can be defined more broadly, several tasks can be integrated into a single job, and people can direct their own work. Fewer managers are needed because deciding how to do things becomes part of each person’s or team’s job. Further, today’s online communication systems and smartphones make it easy and relatively inexpensive for people at all organiza- tional levels to have direct access to data, other employees, managers, suppliers, and customers. They can access information quickly (via the Internet or company net- work), readily check with superiors or whomever else as needed, and take responsible action. Typically, there are genuine gains in morale and productivity when people are provided with the tools and information they need to operate in a self-directed way.

But decentralization also has some disadvantages. Top managers lose an element of control over what goes on and may thus be unaware of actions being taken by per- sonnel under their supervision. Such lack of control can be problematic in the event that empowered employees make decisions that conflict with those of others or that serve their unit’s interests at the expense of other parts of the company. Moreover, because decentralization gives organizational units the authority to act independently, there is risk of too little collaboration and coordination between different units.

Many companies have concluded that the advantages of decentralization outweigh the disadvantages. Over the past several decades, there’s been a decided shift from centralized, hierarchical structures to flatter, more decentralized structures that stress employee empowerment. This shift reflects a strong and growing consensus that authoritarian, hierarchical organizational structures are not well suited to implement- ing and executing strategies in an era when extensive information and instant com- munication are the norm and when a big fraction of the organization’s most valuable assets consists of intellectual capital that resides in its employees’ capabilities.

Capturing Cross-Business Strategic Fit in a Decentralized Structure Diversified companies striving to capture the benefits of synergy between separate businesses must beware of giving business unit heads full rein to operate independently. Cross-business strategic fit typically must be captured either by enforcing close cross-business collaboration or by centralizing the perfor- mance of functions requiring close coordination at the corporate level.28 For exam- ple, if businesses with overlapping process and product technologies have their own independent R&D departments—each pursuing its own priorities, projects, and strategic agendas—it’s hard for the corporate parent to prevent duplication of

Efforts to decentralize decision making and give company personnel some leeway in conducting operations must be tempered with the need to maintain adequate control and cross-unit coordination.

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effort, capture either economies of scale or economies of scope, or encourage more collaborative R&D efforts. Where cross-business strategic fit with respect to R&D is important, one solution is to centralize the R&D function and have a coordinated corporate R&D effort that serves the interests of both the individual businesses and the company as a whole. Likewise, centralizing the related activities of separate busi- nesses makes sense when there are opportunities to share a common sales force, use common distribution channels, rely on a common field service organization, use com- mon e-commerce systems, and so on. Another structural solution to realizing the ben- efits of strategic fit is to create business groups consisting of those business units with common strategic-fit opportunities

Facilitating Collaboration with External Partners and Strategic Allies Organizational mechanisms—whether formal or informal—are also required to ensure effective working relationships with each major outside constituency involved in strategy execution. Strategic alliances, outsourcing arrangements, joint ventures, and cooperative partnerships can contribute little of value without active manage- ment of the relationship. Unless top management sees that constructive organizational bridge building with external partners occurs and that productive working relation- ships emerge, the potential value of cooperative relationships is lost and the company’s power to execute its strategy is weakened. For example, if close working relationships with suppliers are crucial, then supply chain management must enter into consider- ations of how to create an effective organizational structure. If distributor, dealer, or franchisee relationships are important, then someone must be assigned the task of nurturing the relationships with such forward-channel allies.

Building organizational bridges with external partners and strategic allies can be accomplished by appointing “relationship managers” with responsibility for making particular strategic partnerships generate the intended benefits. Relationship managers have many roles and functions: getting the right people together, promoting good rap- port, facilitating the flow of information, nurturing interpersonal communication and cooperation, and ensuring effective coordination.29 Multiple cross-organization ties have to be established and kept open to ensure proper communication and coordi- nation. There has to be enough information sharing to make the relationship work and periodic frank discussions of conflicts, trouble spots, and changing situations.

Organizing and managing a network structure provides a mechanism for encouraging more effective collaboration and cooperation among external partners. A network structure is the arrangement linking a number of independent orga- nizations involved in some common undertaking. A well-managed network struc- ture typically includes one firm in a more central role, with the responsibility of ensuring that the right partners are included and the activities across the network are coordinated. The high-end Italian motorcycle company Ducati operates in this manner, assembling its motorcycles from parts obtained from a handpicked inte- grated network of parts suppliers.

Further Perspectives on Structuring the Work Effort All organizational designs have their strategy-related strengths and weaknesses. To do a good job of matching structure to strategy, strategy implementers first have to pick a basic organizational design and modify it as needed to fit the company’s particular

CORE CONCEPT

A network structure is a configuration composed of a number of independent organizations engaged in some common undertaking, with one firm typically taking on a more central role.

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KEY POINTS

1. Executing strategy is an action-oriented, operations-driven activity revolving around the management of people, business processes, and organizational struc- ture. In devising an action agenda for executing strategy, managers should start by conducting a probing assessment of what the organization must do differently to carry out the strategy successfully. They should then consider precisely how to make the necessary internal changes.

2. Good strategy execution requires a team effort. All managers have strategy- executing responsibility in their areas of authority, and all employees are active participants in the strategy execution process.

3. Ten managerial tasks are part of every company effort to execute strategy: (1) staffing the organization with the right people, (2) developing the resources and building the necessary organizational capabilities, (3) creating a supportive organizational structure, (4) allocating sufficient resources (budgetary and other- wise), (5) instituting supportive policies and procedures, (6) adopting processes for continuous improvement, (7) installing systems that enable proficient com- pany operations, (8) tying incentives to the achievement of desired targets, (9) instilling the right corporate culture, and (10) exercising internal leadership to propel strategy execution forward.

4. The two best signs of good strategy execution are that a company is meeting or beating its performance targets and is performing value chain activities in a man- ner that is conducive to companywide operating excellence. Shortfalls in perfor- mance signal weak strategy, weak execution, or both.

5. Building an organization capable of good strategy execution entails three types of actions: (1) staffing the organization—assembling a talented management team and recruiting and retaining employees with the needed experience, technical skills,

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business lineup. They must then (1) supplement the design with appropriate coordinat- ing mechanisms (cross-functional task forces, special project teams, self-contained work teams, etc.) and (2) institute whatever networking and communications arrange- ments are necessary to support effective execution of the firm’s strategy. Some com- panies may avoid setting up “ideal” organizational arrangements because they do not want to disturb existing reporting relationships or because they need to accommodate other situational idiosyncrasies, yet they must still work toward the goal of building a competitively capable organization.

What can be said unequivocally is that building a capable organization entails a process of consciously knitting together the efforts of individuals and groups. Orga- nizational capabilities emerge from establishing and nurturing cooperative working relationships among people and groups to perform activities in a more efficient, value- creating fashion. While an appropriate organizational structure can facilitate this, organization building is a task in which senior management must be deeply involved. Indeed, effectively managing both internal organizational processes and external col- laboration to create and develop competitively valuable organizational capabilities remains a top challenge for senior executives in today’s companies.

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and intellectual capital; (2) acquiring, developing, and strengthening strategy- sup- portive resources and capabilities—accumulating the required resources, develop- ing proficiencies in performing strategy-critical value chain activities, and updating the company’s capabilities to match changing market conditions and customer expectations; and (3) structuring the organization and work effort—instituting organizational arrangements that facilitate good strategy execution, deciding how much decision-making authority to delegate, and managing external relationships.

6. Building core competencies and competitive capabilities is a time-consuming, managerially challenging exercise that can be approached in three ways: (1) devel- oping capabilities internally, (2) acquiring capabilities through mergers and acqui- sitions, and (3) accessing capabilities via collaborative partnerships.

7. In building capabilities internally, the first step is to develop the ability to do something, through experimenting, actively searching for alternative solutions, and learning by trial and error. As experience grows and company personnel learn how to perform the activities consistently well and at an acceptable cost, the abil- ity evolves into a tried-and-true capability. The process can be accelerated by making learning a more deliberate endeavor and providing the incentives that will motivate company personnel to achieve the desired ends.

8. As firms get better at executing their strategies, they develop capabilities in the domain of strategy execution. Superior strategy execution capabilities allow com- panies to get the most from their organizational resources and capabilities. But excellence in strategy execution can also be a more direct source of competitive advantage, since more efficient and effective strategy execution can lower costs and permit firms to deliver more value to customers. Because they are socially complex capabilities, superior strategy execution capabilities are hard to imitate and have no good substitutes. As such, they can be an important source of sus- tainable competitive advantage. Anytime rivals can readily duplicate successful strategies, making it impossible to out-strategize rivals, the chief way to achieve lasting competitive advantage is to out-execute them.

9. Structuring the organization and organizing the work effort in a strategy- supportive fashion has four aspects: (1) deciding which value chain activities to perform internally and which ones to outsource, (2) aligning the firm’s organiza- tional structure with its strategy, (3) deciding how much authority to centralize at the top and how much to delegate to down-the-line managers and employees, and (4) facilitating the necessary collaboration and coordination with external partners and strategic allies.

10. To align the firm’s organizational structure with its strategy, it is important to make strategy-critical activities the main building blocks. There are four basic types of organizational structures: the simple structure, the functional structure, the multidivisional structure, and the matrix structure. Which is most appropriate depends on the firm’s size, complexity, and strategy.

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ASSURANCE OF LEARNING EXERCISES

1. The foundation of Nike’s global sports apparel dominance lies in the company’s continual ability to outcompete rivals by aligning its superior design, innovation, and marketing capabilities with outsourced manufacturing. Such a strategy neces- sitates a complex marriage of innovative product designs with fresh marketing techniques and a global chain of suppliers and manufacturers. Explore Nike’s most recent strategic management changes (news.nike.com/leadership). How well do these changes reflect the company’s focus on innovative design and marketing strat- egies? Has the company’s relentless focus on apparel innovation affected its supply chain management? Do these changes—or Nike’s strategy, more broadly—reflect the company’s ubiquitous Swoosh logo and “Just Do It” slogan? Visit Nike’s corpo- rate website for more in-depth information: nikeinc.com/pages/about-nike-inc.

2. Search online to read about Jeff Bezos’s management of his new executives. Spe- cifically, explore Amazon.com’s “S-Team” meetings (management.fortune.cnn. com/2012/11/16/jeff-bezos-amazon/). Why does Bezos begin meetings of senior executives with 30 minutes of silent reading? How does this focus the group? Why does Bezos insist new ideas must be written and presented in memo form? How does this reflect the founder’s insistence on clear, concise, and innovative think- ing in his company? And does this exercise work as a de facto crash course for new Amazon executives? Explain why this small but crucial management strategy reflects Bezos’s overriding goal of cohesive and clear idea presentation.

3. Review Facebook’s Careers page (www.Facebook.com/careers/). The page emphasizes Facebook’s core values and explains how potential employees could fit that mold. Bold and decisive thinking and a commitment to transpar- ency and social connectivity drive the page and the company as a whole. Then research Facebook’s internal management training programs, called “employee boot camps,” using a search engine like Google or Bing. How do these programs integrate the traits and stated goals on the Careers page into specific and tan- gible construction of employee capabilities? Boot camps are open to all Facebook employees, not just engineers. How does this internal training prepare Facebook employees of all types to “move fast and break things”?

4. Review Valve Corporation’s company handbook online: www.valvesoftware.com/ company/Valve_Handbook_LowRes.pdf. Specifically, focus on Valve’s corporate structure. Valve has hundreds of employees but no managers or bosses at all. Valve’s gaming success hinges on innovative and completely original experiences like Portal and Half-Life. Does it seem that Valve’s corporate structure uniquely promotes this type of gaming innovation? Why or why not? How would you characterize Valve’s organizational structure? Is it completely unique, or could it be characterized as a multidivisional, matrix, or functional structure? Explain your answer.

5. Johnson & Johnson, a multinational health care company responsible for man- ufacturing medical, pharmaceutical, and consumer goods, has been a leader in promoting a decentralized management structure. Perform an Internet search to gain some background information on the company’s products, value chain activi- ties, and leadership. How does Johnson & Johnson exemplify (or not exemplify) a decentralized management strategy? Describe the advantages and disadvantages of a decentralized system of management in the case of Johnson & Johnson. Why was it established in the first place? Has it been an effective means of decision making for the company?

LO 1

LO 2

LO 2, LO 3

LO 4

LO 5

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EXERCISE FOR SIMULATION PARTICIPANTS

1. How would you describe the organization of your company’s top-management team? Is some decision making decentralized and delegated to individual manag- ers? If so, explain how the decentralization works. Or are decisions made more by consensus, with all co-managers having input? What do you see as the advantages and disadvantages of the decision-making approach your company is employing?

2. What specific actions have you and your co-managers taken to develop core com- petencies or competitive capabilities that can contribute to good strategy execu- tion and potential competitive advantage? If no actions have been taken, explain your rationale for doing nothing.

3. What value chain activities are most crucial to good execution of your company’s strategy? Does your company have the ability to outsource any value chain activities? If so, have you and your co-managers opted to engage in outsourcing? Why or why not?

LO 5

LO 3

LO 1, LO 4

ENDNOTES 981–996; M. Zollo and S. Winter, “Deliberate Learning and the Evolution of Dynamic Capa- bilities,” Organization Science 13, no. 3 (May– June 2002), pp. 339–351. 14 Robert H. Hayes, Gary P. Pisano, and David M. Upton, Strategic Operations: Competing through Capabilities (New York: Free Press, 1996); Jonas Ridderstrale, “Cashing In on Corporate Competencies,” Business Strategy Review 14, no. 1 (Spring 2003), pp. 27–38; Danny Miller, Russell Eisenstat, and Nathaniel Foote, “Strategy from the Inside Out: Building Capability-Creating Organizations,” California Management Review 44, no. 3 (Spring 2002), pp. 37–55. 15 S. Karim and W. Mitchell, “Path-Dependent and Path-Breaking Change: Reconfiguring Business Resources Following Acquisitions in the US Medical Sector, 1978–1995,” Strategic Manage- ment Journal 21, no. 10–11 (October–November 2000), pp. 1061–1082; L. Capron, P. Dussauge, and W. Mitchell, “Resource Redeployment Fol- lowing Horizontal Acquisitions in Europe and North America, 1988–1992,” Strategic Manage- ment Journal 19, no. 7 (July 1998), pp. 631–662. 16 J. B. Quinn, Intelligent Enterprise (New York: Free Press, 1992). 17 Gary P. Pisano and Willy C. Shih, “Restoring American Competitiveness,” Harvard Business Review 87, no. 7–8 (July–August 2009), pp. 114–125. 18 A. Chandler, Strategy and Structure (Cam- bridge, MA: MIT Press, 1962). 19 E. Olsen, S. Slater, and G. Hult, “The Impor- tance of Structure and Process to Strategy Implementation,” Business Horizons 48, no. 1 (2005), pp. 47–54; H. Barkema, J. Baum, and E. Mannix, “Management Challenges in a New Time,” Academy of Management Journal 45, no. 5 (October 2002), pp. 916–930. 21 H. Mintzberg, The Structuring of Organiza- tions (Englewood Cliffs, NJ: Prentice Hall,

1 Donald Sull, Rebecca Homkes, and Charles Sull, “Why Strategy Execution Unravels—and What to Do About It,” Harvard Business Review 93, no. 3 (March 2015), p. 60. 2 Steven W. Floyd and Bill Wooldridge, “Manag- ing Strategic Consensus: The Foundation of Effective Implementation,” Academy of Manage- ment Executive 6, no. 4 (November 1992), p. 27. 3 Jack Welch with Suzy Welch, Winning (New York: HarperBusiness, 2005). 4 Larry Bossidy and Ram Charan, Execution: The Discipline of Getting Things Done (New York: Crown Business, 2002). 5 Christopher A. Bartlett and Sumantra Ghoshal, “Building Competitive Advantage through People,” MIT Sloan Management Review 43, no. 2 (Winter 2002), pp. 34–41. 6 Justin Menkes, “Hiring for Smarts,” Harvard Business Review 83, no. 11 (November 2005), pp. 100–109; Justin Menkes, Executive Intel- ligence (New York: HarperCollins, 2005). 7 Menkes, Executive Intelligence, pp. 68, 76. 8 Jim Collins, Good to Great (New York: Harp- erBusiness, 2001). 9 John Byrne, “The Search for the Young and Gifted,” Businessweek, October 4, 1999, p. 108. 10 C. Helfat and M. Peteraf, “The Dynamic Resource-Based View: Capability Lifecycles,” Strategic Management Journal 24, no. 10 (October 2003), pp. 997–1010. 11 G. Hamel and C. K. Prahalad, “Strategy as Stretch and Leverage,” Harvard Business Review 71, no. 2 (March–April 1993), pp. 75–84. 12 G. Dosi, R. Nelson, and S. Winter (eds.), The Nature and Dynamics of Organizational Capa- bilities (Oxford, England: Oxford University Press, 2001). 13 S. Winter, “The Satisficing Principle in Capa- bility Learning,” Strategic Management Journal 21, no. 10–11 (October–November 2000), pp.

1979); C. Levicki, The Interactive Strategy Workout, 2nd ed. (London: Prentice Hall, 1999). 22 O. Williamson, Market and Hierarchies (New York: Free Press, 1975); R. M. Burton and B. Obel, “A Computer Simulation Test of the M-Form Hypothesis,” Administrative Science Quarterly 25 (1980), pp. 457–476. 23 J. Baum and S. Wally, “Strategic Decision Speed and Firm Performance,” Strategic Man- agement Journal 24 (2003), pp. 1107–1129. 24 C. Bartlett and S. Ghoshal, “Matrix Manage- ment: Not a Structure, a Frame of Mind,” Harvard Business Review, July–August 1990, pp. 138–145. 25 M. Goold and A. Campbell, “Structured Net- works: Towards the Well Designed Matrix,” Long Range Planning 36, no. 5 (2003), pp. 427–439. 26 Iain Somerville and John Edward Mroz, “New Competencies for a New World,” in Frances Hesselbein, Marshall Goldsmith, and Richard Beckard (eds.), The Organization of the Future (San Francisco: Jossey-Bass, 1997), p. 70. 26 Stanley E. Fawcett, Gary K. Rhoads, and Phillip Burnah, “People as the Bridge to Com- petitiveness: Benchmarking the ‘ABCs’ of an Empowered Workforce,” Benchmarking: An International Journal 11, no. 4 (2004), pp. 346–360. 27 Robert Simons, “Control in an Age of Empowerment,” Harvard Business Review 73 (March–April 1995), pp. 80–88. 28 Jeanne M. Liedtka, “Collaboration across Lines of Business for Competitive Advantage,” Academy of Management Executive 10, no. 2 (May 1996), pp. 20–34. 29 Rosabeth Moss Kanter, “Collaborative Advan- tage: The Art of the Alliance,” Harvard Business Review 72, no. 4 (July–August 1994), pp. 96–108.

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CHAPTER 11

Managing Internal Operations Actions That Promote Good Strategy Execution

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 Why resource allocation should always be based on strategic priorities.

LO 2 How well-designed policies and procedures can facilitate good strategy execution.

LO 3 How best practices and process management tools drive continuous improvement in the performance of value chain activities and promote superior strategy execution.

LO 4 The role of information and operating systems in enabling company personnel to carry out their strategic roles proficiently.

LO 5 How and why the use of well-designed incentives and rewards can be management’s single most powerful tool for promoting adept strategy execution.

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Apple is a very disciplined company, and we have great processes. But that’s not what it’s about. Process makes you more efficient.

Steve Jobs—Cofounder of Apple, Inc.

Motivation is the art of getting people to do what you want them to do because they want to do it.

Dwight D. Eisenhower—Thirty-fourth president of the

United States

I don’t pay good wages because I have a lot of money; I have a lot of money because I pay good wages.

Robert Bosch—Founder of engineering company Robert

Bosch GmbH

LO 1

Why resource allocation should always be based on strategic priorities.

In Chapter 10, we emphasized that proficient strat- egy execution begins with three types of manage- rial actions: staffing the organization with the right people; acquiring, developing, and strengthening the firm’s resources and capabilities; and structur- ing the organization in a manner supportive of the strategy execution effort.

In this chapter, we discuss five additional mana- gerial actions that advance the cause of good strat- egy execution:

• Allocating ample resources to execution-critical value chain activities.

• Instituting policies and procedures that facilitate good strategy execution.

• Employing process management tools to drive continuous improvement in how value chain activities are performed.

• Installing information and operating systems that enable company personnel to carry out their strategic roles proficiently.

• Using rewards and incentives to promote better strategy execution and the achievement of stra- tegic and financial targets.

Early in the strategy implementation process, managers must determine what resources (in terms of funding, people, and so on) will be required and how they should be dis- tributed across the company’s various organizational units. This includes carefully screening requests for more people and new facilities and equipment, approving those that will contribute to the strategy execution effort, and turning down those that don’t. Should internal cash flows prove insufficient to fund the planned strategic initiatives, then management must raise additional funds through borrowing or selling additional shares of stock to investors.

ALLOCATING RESOURCES TO THE STRATEGY EXECUTION EFFORT

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A company’s ability to marshal the resources needed to support new strategic ini- tiatives has a major impact on the strategy execution process. Too little funding and an insufficiency of other types of resources slow progress and impede the efforts of orga- nizational units to execute their pieces of the strategic plan competently. Too much funding of particular organizational units and value chain activities wastes organiza- tional resources and reduces financial performance. Both of these scenarios argue for managers to become deeply involved in reviewing budget proposals and directing the

proper kinds and amounts of resources to strategy-critical organizational units. A change in strategy nearly always calls for budget reallocations and resource

shifting. Previously important units with a lesser role in the new strategy may need downsizing. Units that now have a bigger strategic role may need more people, new equipment, additional facilities, and above-average increases in their operating budgets. Implementing new strategy initiatives requires managers to take an active and some- times forceful role in shifting resources, not only to better support activities now having a higher priority but also to capture opportunities to operate more cost-effectively. This requires putting enough resources behind new strategic initiatives to fuel their success and making the tough decisions to kill projects and activities that are no longer justified.

Google’s strong support of R&D activities helped it grow to a $527 billion giant in just 18 years. In 2013, however, Google decided to kill its 20 percent time policy, which allowed its staff to work on side projects of their choice one day a week. While this side project program gave rise to many innovations, such as Gmail and AdSense (a big contributor to Google’s revenues), it also meant that fewer resources were avail- able for projects that were deemed closer to the core of Google’s mission. In the years since Google killed the 20 percent policy, the company has consistently topped For- tune, Forbes, and Fast Company magazines’ “most innovative companies” lists for ideas such as Google Glass, self-driving automobiles, and Chromebooks.

Visible actions to reallocate operating funds and move people into new organi- zational units signal a determined commitment to strategic change. Such actions can catalyze the implementation process and give it credibility. Microsoft has made a practice of regularly shifting hundreds of programmers to new high-priority program- ming initiatives within a matter of weeks or even days. Fast-moving developments in many markets are prompting companies to abandon traditional annual budgeting and resource allocation cycles in favor of resource allocation processes supportive of more rapid adjustments in strategy. In response to rapid technological change in the com- munications industry, AT&T has prioritized investments and acquisitions that have allowed it to offer its enterprise customers faster, more flexible networks and provide innovative new customer services, such as its Sponsored Data plan.

Merely fine-tuning the execution of a company’s existing strategy seldom requires big shifts of resources from one area to another. In contrast, new strategic initiatives gen- erally require not only big shifts in resources but a larger allocation of resources to the effort as well. However, there are times when strategy changes or new execution initia- tives need to be made without adding to total company expenses. In such circumstances, managers have to work their way through the existing budget line by line and activity by activity, looking for ways to trim costs and shift resources to activities that are higher- priority in the strategy execution effort. In the event that a company needs to make sig- nificant cost cuts during the course of launching new strategic initiatives, managers must be especially creative in finding ways to do more with less. Indeed, it is common for strategy changes and the drive for good strategy execution to be aimed at achieving considerably higher levels of operating efficiency and, at the same time, making sure the most important value chain activities are performed as effectively as possible.

A company’s strategic priorities must drive how capital allocations are made and the size of each unit’s operating budgets.

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A company’s policies and procedures can either support or hinder good strategy exe- cution. Anytime a company moves to put new strategy elements in place or improve its strategy execution capabilities, some changes in work practices are usually needed. Managers are thus well advised to carefully consider whether existing policies and procedures fully support such changes and to revise or discard those that do not.

As shown in Figure 11.1, well-conceived policies and operating procedures facili- tate strategy execution in three ways:

1. By providing top-down guidance regarding how things need to be done. Poli- cies and procedures provide company personnel with a set of guidelines for how to perform organizational activities, conduct various aspects of operations, solve problems as they arise, and accomplish particular tasks. In essence, they represent a store of organizational or managerial knowledge about efficient and effective ways of doing things—a set of well-honed routines for running the company. They clarify uncertainty about how to proceed in executing strategy and align the actions and behavior of company personnel with the

LO 2

How well-designed policies and procedures can facilitate good strategy execution.

A company’s policies and procedures provide a set of well-honed routines for running the company and executing the strategy.

INSTITUTING POLICIES AND PROCEDURES THAT FACILITATE STRATEGY EXECUTION

FIGURE 11.1 How Policies and Procedures Facilitate Good Strategy Execution

Provide top-down guidance about how certain things need to be done

Channel individual and group e�orts along a strategy-supportive path

Align the actions and behavior of company personnel with the requirements for good strategy execution

Place limits on independent action and help overcome resistance to change

Help enforce consistency in how strategy-critical activities are performed

Improve the quality and reliability of strategy execution

Help coordinate the strategy execution e�orts of individuals and groups throughout the organization

Promote the creation of a work climate that facilitates good strategy execution

Well-Conceived Policies

and Procedures

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requirements for good strategy execution. Moreover, they place limits on ineffec- tive independent action. When they are well matched with the requirements of the strategy implementation plan, they channel the efforts of individuals along a path that supports the plan. When existing ways of doing things pose a barrier to strat- egy execution initiatives, actions and behaviors have to be changed. Under these conditions, the managerial role is to establish and enforce new policies and oper- ating practices that are more conducive to executing the strategy appropriately. Policies are a particularly useful way to counteract tendencies for some people to resist change. People generally refrain from violating company policy or going against recommended practices and procedures without gaining clearance or hav- ing strong justification.

2. By helping ensure consistency in how execution-critical activities are per- formed. Policies and procedures serve to standardize the way that activities are performed. This can be important for ensuring the quality and reliability of the strategy execution process. It helps align and coordinate the strategy execution efforts of individuals and groups throughout the organization—a feature that is particularly beneficial when there are geographically scattered operating units. For example, eliminating significant differences in the operating practices of dif- ferent plants, sales regions, or customer service centers or in the individual outlets in a chain operation helps a company deliver consistent product quality and ser- vice to customers. Good strategy execution nearly always entails an ability to rep- licate product quality and the caliber of customer service at every location where the company does business—anything less blurs the company’s image and lowers customer satisfaction.

3. By promoting the creation of a work climate that facilitates good strategy execu- tion. A company’s policies and procedures help set the tone of a company’s work climate and contribute to a common understanding of “how we do things around here.” Because abandoning old policies and procedures in favor of new ones invariably alters the internal work climate, managers can use the policy-changing process as a powerful lever for changing the corporate culture in ways that better support new strategic initiatives. The trick here, obviously, is to come up with new policies or procedures that catch the immediate attention of company personnel and prompt them to quickly shift their actions and behaviors in the desired ways.

To ensure consistency in product quality and service behavior patterns, McDonald’s policy manual spells out detailed procedures that personnel in each McDonald’s unit are expected to observe. For example, “Cooks must turn, never flip, hamburgers. If they haven’t been purchased, Big Macs must be discarded in 10 minutes after being cooked and French fries in 7 minutes. Cashiers must make eye contact with and smile at every customer.” Retail chain stores and other organi- zational chains (e.g., hotels, hospitals, child care centers) similarly rely on detailed policies and procedures to ensure consistency in their operations and reliable service to their customers. Video game developer Valve Corporation prides itself on a lack of rigid policies and procedures; its 37-page handbook for new employees details how things get done in such an environment—an ironic tribute to the fact that all types of companies need policies.

One of the big policy-making issues concerns what activities need to be strictly prescribed and what activities ought to allow room for independent action on the part of personnel. Few companies need thick policy manuals to prescribe exactly how daily operations are to be conducted. Too much policy can be as obstructive as wrong policy

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and as confusing as no policy. There is wisdom in a middle approach: Prescribe enough policies to give organization members clear direction and to place reason- able boundaries on their actions; then empower them to act within these bound- aries in pursuit of company goals. Allowing company personnel to act with some degree of freedom is especially appropriate when individual creativity and initia- tive are more essential to good strategy execution than are standardization and strict conformity. Instituting policies that facilitate strategy execution can therefore mean policies more policies, fewer policies, or different policies. It can mean poli- cies that require things be done according to a precisely defined standard or poli- cies that give employees substantial leeway to do activities the way they think best.

There is wisdom in a middle-ground approach: Prescribe enough policies to give organization members clear direction and to place reasonable boundaries on their actions; then empower them to act within these boundaries in pursuit of company goals.

LO 3

How best practices and process management tools drive continuous improvement in the performance of value chain activities and promote superior strategy execution.

ADOPTING BEST PRACTICES AND EMPLOYING PROCESS MANAGEMENT TOOLS Company managers can significantly advance the cause of competent strategy exe- cution by adopting best practices and using process management tools to drive con- tinuous improvement in how internal operations are conducted. One of the most widely used methods for gauging how well a company is executing its strategy entails benchmarking the company’s performance of particular activities and busi- ness processes against “best-in-industry” and “best-in-world” performers.1 It can also be useful to look at “best-in-company” performers of an activity if a company has a number of different organizational units performing much the same function at different locations. Identifying, analyzing, and understanding how top- performing companies or organizational units conduct particular value chain activities and busi- ness processes provide useful yardsticks for judging the effectiveness and efficiency of internal operations and setting performance standards for organizational units to meet or beat.

How the Process of Identifying and Incorporating Best Practices Works As discussed in Chapter 4, benchmarking is the backbone of the process of identify- ing, studying, and implementing best practices. The role of benchmarking is to look outward to find best practices and then to develop the data for measuring how well a company’s own performance of an activity stacks up against the best-practice stan- dard. However, benchmarking is more complicated than simply identifying which companies are the best performers of an activity and then trying to imitate their approaches—especially if these companies are in other industries. Normally, the best practices of other organizations must be adapted to fit the specific circumstances of a company’s own business, strategy, and operating requirements. Since each organiza- tion is unique, the telling part of any best-practice initiative is how well the company puts its own version of the best practice into place and makes it work. Indeed, a best practice remains little more than another company’s interesting success story unless company personnel buy into the task of translating what can be learned from other companies into real action and results. The agents of change must be frontline employ- ees who are convinced of the need to abandon the old ways of doing things and switch to a best-practice mindset.

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As shown in Figure 11.2, to the extent that a company is able to successfully adapt a best practice pioneered elsewhere to fit its circumstances, it is likely to improve its performance of the activity, perhaps dramatically—an outcome that promotes better strategy execution. It follows that a company can make giant strides toward excellent strategy execution by adopting a best-practice mindset and successfully implementing the use of best practices across more of its value chain activities. The more that organizational units use best practices in performing their work, the closer a company moves toward performing its value chain activi-

ties more effectively and efficiently. This is what operational excellence is all about. Employing best practices to improve internal operations and strategy execution has powerful appeal—legions of companies across the world are now making concerted efforts to employ best practices in performing many value chain activities, and they regularly benchmark their performance of these activities against best-in-industry or best-in-world performers.

Business Process Reengineering, Total Quality Management, and Six Sigma Quality Programs: Tools for Promoting Operating Excellence Three other powerful management tools for promoting operating excellence and bet- ter strategy execution are business process reengineering, total quality management (TQM) programs, and Six Sigma quality control programs. Each of these merits dis- cussion since many companies around the world use these tools to help execute strate- gies tied to cost reduction, defect-free manufacture, superior product quality, superior customer service, and total customer satisfaction.

Business Process Reengineering Companies searching for ways to improve their operations have sometimes discovered that the execution of strategy- critical activities is hampered by a disconnected organizational arrangement whereby pieces of an activity are performed in several different functional departments, with no one manager or group being accountable for optimal performance of the entire

Wide-scale use of best practices across a company’s entire value chain promotes operating excellence and good strategy execution.

FIGURE 11.2 From Benchmarking and Best-Practice Implementation to Operational Excellence in Strategy Execution

Engage in benchmarking to identify the best

practice for performing an

activity

Continue to benchmark company

performance of the activity

against best-in-industry or best-in-world

performers

Adapt the best practice to fit

the company’s situation; then implement it (and further improve it over time)

Move closer to operating excellence in performing the activity

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activity. This can easily occur in such inherently cross-functional activities as cus- tomer service (which can involve personnel in order filling, warehousing and shipping, invoicing, accounts receivable, after-sale repair, and technical support), particularly for companies with a functional organizational structure.

To address the suboptimal performance problems that can arise from this type of situation, a company can reengineer the work effort, pulling the pieces of an activity out of different departments and creating a cross-functional work group or single department (often called a process department) to take charge of the whole process. The use of cross-functional teams has been popularized by the practice of business process reengineering, which involves radically redesigning and stream- lining the workflow (typically enabled by cutting-edge use of online technology and information systems), with the goal of achieving quantum gains in performance of the activity.2

The reengineering of value chain activities has been undertaken at many com- panies in many industries all over the world, with excellent results being achieved at some firms.3 Hallmark reengineered its process for developing new greeting cards, creating teams of mixed-occupation personnel (artists, writers, lithographers, merchandisers, and administrators) to work on a single holiday or greeting card theme. The reengineered process speeded development times for new lines of greeting cards by up to 24 months, was more cost-efficient, and increased customer satisfaction.4 In the order-processing section of General Electric’s circuit breaker division, elapsed time from order receipt to delivery was cut from three weeks to three days by consoli- dating six production units into one, reducing a variety of former inventory and han- dling steps, automating the design system to replace a human custom-design process, and cutting the organizational layers between managers and workers from three to one. Productivity rose 20 percent in one year, and unit manufacturing costs dropped 30 percent. Northwest Water, a British utility, used process reengineering to eliminate 45 work depots that served as home bases to crews who installed and repaired water and sewage lines and equipment. Under the reengineered arrangement, crews worked directly from their vehicles, receiving assignments and reporting work completion from computer terminals in their trucks. Crew members became contractors to North- west Water rather than employees, a move that not only eliminated the need for the work depots but also allowed Northwest Water to eliminate a big percentage of the bureaucratic personnel and supervisory organization that managed the crews.5

While business process reengineering has been criticized as an excuse for down- sizing, it has nonetheless proved itself a useful tool for streamlining a company’s work effort and moving closer to operational excellence. It has also inspired more techno- logically based approaches to integrating and streamlining business processes, such as enterprise resource planning, a software-based system implemented with the help of consulting companies such as SAP (the leading provider of business software).

Total Quality Management Programs Total quality management (TQM) is a management approach that emphasizes continuous improvement in all phases of operations, 100 percent accuracy in performing tasks, involvement and empowerment of employees at all levels, team-based work design, benchmarking, and total customer satisfaction.6 While TQM concentrates on producing quality goods and fully satisfying customer expectations, it achieves its biggest successes when it is extended to employee efforts in all departments—human resources, bill- ing, accounting, and information systems—that may lack pressing, customer-driven incentives to improve. It involves reforming the corporate culture and shifting to

CORE CONCEPT

Business process reengineering involves radically redesigning and streamlining how an activity is performed, with the intent of achieving quantum improvements in performance.

CORE CONCEPT

Total quality management (TQM) entails creating a total quality culture, involving managers and employees at all levels, bent on continuously improving the performance of every value chain activity.

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a continuous-improvement business philosophy that permeates every facet of the organization.7 TQM aims at instilling enthusiasm and commitment to doing things right from the top to the bottom of the organization. Management’s job is to kindle an organizationwide search for ways to improve that involves all company personnel exercising initiative and using their ingenuity. TQM doctrine preaches that there’s no such thing as “good enough” and that everyone has a responsibility to participate in continuous improvement. TQM is thus a race without a finish. Success comes from making little steps forward each day, a process that the Japanese call kaizen.

TQM takes a fairly long time to show significant results—very little benefit emerges within the first six months. The long-term payoff of TQM, if it comes, depends heavily on management’s success in implanting a culture within which the TQM philosophy and practices can thrive. But it is a management tool that has attracted numerous users and advocates over several decades, and it can deliver good results when used properly.

Six Sigma Quality Control Programs Six Sigma programs offer another way to drive continuous improvement in quality and strategy execution. This approach entails the use of advanced statistical methods to identify and remove the causes of defects (errors) and undesirable variability in performing an activ- ity or business process. When performance of an activity or process reaches “Six Sigma quality,” there are no more than 3.4 defects per million iterations (equal to 99.9997 percent accuracy).8

There are two important types of Six Sigma programs. The Six Sigma process of define, measure, analyze, improve, and control (DMAIC, pronounced “de-may- ic”) is an improvement system for existing processes falling below specification and needing incremental improvement. The Six Sigma process of define, measure, ana-

lyze, design, and verify (DMADV, pronounced “de-mad-vee”) is used to develop new processes or products at Six Sigma quality levels. DMADV is sometimes referred to as Design for Six Sigma, or DFSS. Both Six Sigma programs are overseen by personnel who have completed Six Sigma “master black belt” training, and they are executed by personnel who have earned Six Sigma “green belts” and Six Sigma “black belts.” According to the Six Sigma Academy, personnel with black belts can save companies approximately $230,000 per project and can complete four to six projects a year.9

The statistical thinking underlying Six Sigma is based on the following three prin- ciples: (1) All work is a process, (2) all processes have variability, and (3) all processes create data that explain variability.10 Six Sigma’s DMAIC process is a particularly good vehicle for improving performance when there are wide variations in how well an activity is performed. For instance, airlines striving to improve the on-time perfor- mance of their flights have more to gain from actions to curtail the number of flights that are late by more than 30 minutes than from actions to reduce the number of flights that are late by less than 5 minutes. Six Sigma quality control programs are of particu- lar interest for large companies, which are better able to shoulder the cost of the large investment required in employee training, organizational infrastructure, and consult- ing services. For example, to realize a cost savings of $4.4 billion from rolling out its Six Sigma program, GE had to invest $1.6 billion and suffer losses from the program during its first year.11

Since the programs were first introduced, thousands of companies and nonprofit organizations around the world have used Six Sigma to promote operating excellence. For companies at the forefront of this movement, such as Motorola, General Electric (GE), Ford, and Honeywell (Allied Signal), the cost savings as a percentage of revenue

CORE CONCEPT

Six Sigma programs utilize advanced statistical methods to improve quality by reducing defects and variability in the performance of business processes.

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varied from 1.2 to 4.5 percent, according to data analysis conducted by iSixSigma (an organization that provides free articles, tools, and resources concerning Six Sigma). More recently, there has been a resurgence of interest in Six Sigma practices, with companies such as Siemens, Coca-Cola, Ocean Spray, GEICO, and Merrill Lynch turning to Six Sigma as a vehicle to improve their bottom lines. In the first five years of its adoption, Six Sigma at Bank of America helped the bank reap about $2 billion in revenue gains and cost savings; the bank holds an annual “Best of Six Sigma Expo” to celebrate the teams and the projects with the greatest contribution to the company’s bottom line. GE, one of the most successful companies implementing Six Sigma train- ing and pursuing Six Sigma perfection across the company’s entire operations, esti- mated benefits of some $10 billion during the first five years of implementation—its Lighting division, for example, cut invoice defects and disputes by 98 percent.12

Six Sigma has also been used to improve processes in health care. Froedtert Hospi- tal in Milwaukee, Wisconsin, used Six Sigma to improve the accuracy of administer- ing the proper drug doses to patients. DMAIC analysis of the three-stage process by which prescriptions were written by doctors, filled by the hospital pharmacy, and then administered to patients by nurses revealed that most mistakes came from misreading the doctors’ handwriting. The hospital implemented a program requiring doctors to enter the prescription on the hospital’s computers, which slashed the number of errors dramatically. In recent years, Pfizer embarked on 85 Six Sigma projects to streamline its R&D process and lower the cost of delivering medicines to patients in its pharma- ceutical sciences division.

Illustration Capsule 11.1 describes Charleston Area Medical Center’s use of Six Sigma as a health care provider coping with the current challenges facing this industry.

Despite its potential benefits, Six Sigma is not without its problems. There is evi- dence, for example, that Six Sigma techniques can stifle innovation and creativity. The essence of Six Sigma is to reduce variability in processes, but creative processes, by nature, include quite a bit of variability. In many instances, breakthrough innova- tions occur only after thousands of ideas have been abandoned and promising ideas have gone through multiple iterations and extensive prototyping. Google’s chair, Eric Schmidt, has declared that applying Six Sigma measurement and control principles to creative activities at Google would choke off innovation altogether.13

A blended approach to Six Sigma implementation that is gaining in popularity pursues incremental improvements in operating efficiency, while R&D and other processes that allow the company to develop new ways of offering value to custom- ers are given freer rein. Managers of these ambidextrous organizations are adept at employing continuous improvement in operating processes but allowing R&D to operate under a set of rules that allows for exploration and the development of breakthrough innovations. However, the two distinctly different approaches to man- aging employees must be carried out by tightly integrated senior managers to ensure that the separate and diversely oriented units operate with a common purpose. Ciba Vision, now part of eye care multinational Alcon, dramatically reduced operating expenses through the use of continuous-improvement programs, while simultane- ously and harmoniously developing a new series of contact lens products that have allowed its revenues to increase by 300 percent over a 10-year period.14 An enterprise that systematically and wisely applies Six Sigma methods to its value chain, activity by activity, can make major strides in improving the proficiency with which its strategy is executed without sacrificing innovation. As is the case with TQM, obtaining manage- rial commitment, establishing a quality culture, and fully involving employees are all of critical importance to the successful implementation of Six Sigma quality programs.15

Ambidextrous organizations are adept at employing continuous improvement in operating processes but allowing R&D to operate under a set of rules that allows for exploration and the development of breakthrough innovations.

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The Difference between Business Process Reengineering and Continuous-Improvement Programs Like Six Sigma and TQM Whereas business process reengineering aims at quantum gains on the order of 30 to 50 percent or more, total quality programs like TQM and Six Sigma stress ongoing incremental progress, striving for inch-by-inch gains again and again in a never-ending stream. The two approaches to improved performance of value chain activities and operating excellence are not mutually exclusive; it makes sense to use them in tandem. Reengineering can be used first to produce a good

ILLUSTRATION CAPSULE 11.1

Established in 1972, Charleston Area Medical Center (CAMC) is West Virginia’s largest health care provider in terms of beds, admissions, and revenues. In 2000, CAMC implemented a Six Sigma program to examine quality problems and standardize care processes. Per- formance improvement was important to CAMC’s man- agement for a variety of strategic reasons, including competitive positioning and cost control.

The United States has been evolving toward a pay- for-performance structure, which rewards hospitals for providing quality care. CAMC has utilized its Six Sigma program to take advantage of these changes in the health care environment. For example, to improve its performance in acute myocardial infarction (AMI), CAMC applied a Six Sigma DMAIC (define-measure- analyze-improve-control) approach. Nursing staff mem- bers were educated on AMI care processes, performance

targets were posted in nursing units, and adherence to the eight Hospital Quality Alliance (HQA) indicators of quality care for AMI patients was tracked. As a result of the program, CAMC improved its compliance with HQA- recommended treatment for AMI from 50 to 95 percent. Harvard researchers identified CAMC as one of the top- performing hospitals reporting comparable data.

Controlling cost has also been an important aspect of CAMC’s performance improvement initiatives due to local regulations. West Virginia is one of two states where medical services rates are set by state regulators. This forces CAMC to limit expenditures because the hospi- tal cannot raise prices. CAMC first applied Six Sigma in an effort to control costs by managing the supply chain more effectively. The effort created a one-time $150,000 savings by working with vendors to remove outdated inventory. As a result of continuous improvement, a 2015 report stated that CAMC had achieved supply chain management savings of $12 million in the past four years.

Since CAMC introduced Six Sigma, over 100 qual- ity improvement projects have been initiated. A key to CAMC’s success has been instilling a continuous improvement mindset into the organization’s culture. Dale Wood, chief quality officer at CAMC, stated: “If you have people at the top who completely support and want these changes to occur, you can still fall flat on your face. . . . You need a group of networkers who can carry change across an organization." Due to CAMC’s performance improvement culture, the hospital ranks high nationally in ratings for quality of care and patient safety, as reported on the Centers for Medicare and Medicaid Services (CMS) website.

Charleston Area Medical Center’s Six Sigma Program

Note: Developed with Robin A. Daley

Sources: CAMC website; Martha Hostetter, “Case Study: Improving Performance at Charleston Area Medical Center,” The Commonwealth Fund, November–December 2007, www.commonwealthfund.org/publications/newsletters/quality-matters/2007/november-december/ case-study-improving-performance-at-charleston-area-medical-center (accessed January 2016); J. C. Simmons, “Using Six Sigma to Make a Difference in Health Care Quality,” The Quality Letter, April 2002.

Business process reengineering aims at one- time quantum improvement, while continuous- improvement programs like TQM and Six Sigma aim at ongoing incremental improvements.

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basic design that yields quick, dramatic improvements in performing a business pro- cess. TQM or Six Sigma programs can then be used as a follow-on to reengineer- ing and/or best-practice implementation to deliver incremental improvements over a longer period of time.

Capturing the Benefits of Initiatives to Improve Operations The biggest beneficiaries of benchmarking and best-practice initiatives, reengineer- ing, TQM, and Six Sigma are companies that view such programs not as ends in themselves but as tools for implementing company strategy more effectively. The least rewarding payoffs occur when company managers seize on the programs as novel ideas that might be worth a try. In most such instances, they result in strategy-blind efforts to simply manage better.

There’s an important lesson here. Business process management tools all need to be linked to a company’s strategic priorities to contribute effectively to improving the strategy’s execution. Only strategy can point to which value chain activities matter and what performance targets make the most sense. Without a strategic framework, managers lack the context in which to fix things that really matter to business unit performance and competitive success.

To get the most from initiatives to execute strategy more proficiently, managers must have a clear idea of what specific outcomes really matter. Is it high on-time delivery, lower overall costs, fewer customer complaints, shorter cycle times, a higher percentage of revenues coming from recently introduced products, or something else? Benchmark- ing best-in-industry and best-in-world performance of targeted value chain activities provides a realistic basis for setting internal performance milestones and longer-range targets. Once initiatives to improve operations are linked to the company’s strategic pri- orities, then comes the managerial task of building a total quality culture that is genu- inely committed to achieving the performance outcomes that strategic success requires.16

Managers can take the following action steps to realize full value from TQM or Six Sigma initiatives and promote a culture of operating excellence:17

1. Demonstrating visible, unequivocal, and unyielding commitment to total quality and continuous improvement, including specifying measurable objectives for increasing quality and making continual progress.

2. Nudging people toward quality-supportive behaviors by: a. Screening job applicants rigorously and hiring only those with attitudes and

aptitudes that are right for quality-based performance. b. Providing quality training for employees. c. Using teams and team-building exercises to reinforce and nurture individual

effort. (The creation of a quality culture is facilitated when teams become more cross-functional, multitask-oriented, and increasingly self-managed.)

d. Recognizing and rewarding individual and team efforts to improve quality regularly and systematically.

e. Stressing prevention (doing it right the first time), not correction (instituting ways to undo or overcome mistakes).

3. Empowering employees so that authority for delivering great service or improving products is in the hands of the doers rather than the overseers—improving quality has to be seen as part of everyone’s job.

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4. Using online systems to provide all relevant parties with the latest best practices, thereby speeding the diffusion and adoption of best practices throughout the orga- nization. Online systems can also allow company personnel to exchange data and opinions about how to upgrade the prevailing best-in-company practices.

5. Emphasizing that performance can and must be improved, because competitors are not resting on their laurels and customers are always looking for something better.

In sum, benchmarking, the adoption of best practices, business process reen- gineering, TQM, and Six Sigma techniques all need to be seen and used as part of a bigger-picture effort to execute strategy proficiently. Used properly, all of these tools are capable of improving the proficiency with which an organization performs its value chain activities. Not only do improvements from such initia- tives add up over time and strengthen organizational capabilities, but they also help build a culture of operating excellence. All this lays the groundwork for gaining a competitive advantage.18 While it is relatively easy for rivals to also implement process management tools, it is much more difficult and time-consuming for them to instill a deeply ingrained culture of operating excellence (as occurs when such techniques are religiously employed and top management exhibits lasting commit- ment to operational excellence throughout the organization).

The purpose of using benchmarking, best practices, business process reengineering, TQM, and Six Sigma programs is to improve the performance of strategy-critical activities and thereby enhance strategy execution.

LO 4

The role of information and operating systems in enabling company personnel to carry out their strategic roles proficiently.

INSTALLING INFORMATION AND OPERATING SYSTEMS Company strategies can’t be executed well without a number of internal systems for business operations. Qantas Airways, JetBlue, Ryanair, British Airways, and other successful airlines cannot hope to provide passenger-pleasing service without a user- friendly online reservation system, an accurate and speedy baggage-handling sys- tem, and a strict aircraft maintenance program that minimizes problems requiring at-the-gate service that delay departures. FedEx has internal communication systems that allow it to coordinate its over 100,000 vehicles in handling a daily average of 10.5 million shipments to more than 220 countries and territories. Its leading-edge flight operations systems allow a single controller to direct as many as 200 of FedEx’s 650 aircraft simultaneously, overriding their flight plans should weather problems or other special circumstances arise. FedEx also has created a series of e-business tools for customers that allow them to ship and track packages online, create address books, review shipping history, generate custom reports, simplify customer billing, reduce internal warehousing and inventory management costs, purchase goods and services from suppliers, and respond to their own quickly changing customer demands. All of FedEx’s systems support the company’s strategy of providing businesses and individu- als with a broad array of package delivery services and enhancing its competitiveness against United Parcel Service, DHL, and the U.S. Postal Service.

Amazon.com ships customer orders of books, CDs, and myriad other items from a global network of more than 120 warehouses in locations including the United States, China, and Germany. The warehouses are so technologically sophisticated that they require about as many lines of code to run as Amazon’s website does. Using complex picking algorithms, computers initiate the order-picking process by sending signals to workers’ wireless receivers, telling them which items to pick off the shelves in which order. Computers also generate data on mix-boxed items, chute backup times, line speed, worker productivity, and shipping weights on orders. Systems are upgraded regularly, and productivity improvements are aggressively pursued. Two new things that Amazon is trying out are drone delivery and a crowdsourcing app called On My

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Way that would allow drivers to deliver part-time for Amazon in the same way that Uber drivers provide rides for people.

Otis Elevator, the world’s largest manufacturer of elevators, with more than 2.5 million elevators and escalators installed worldwide, has a 24/7 remote electronic monitoring system that can detect when an elevator or escalator installed on a cus- tomer’s site has any of 325 problems.19 If the monitoring system detects a problem, it analyzes and diagnoses the cause and location, then makes the service call to an Otis mechanic at the nearest location, and helps the mechanic (who is equipped with a web-enabled cell phone) identify the component causing the problem. The company’s maintenance system helps keep outage times under three hours—the elevators are often back in service before people even realize there was a problem. All trouble-call data are relayed to design and manufacturing personnel, allowing them to quickly alter design specifications or manufacturing procedures when needed to correct recurring problems. All customers have online access to performance data on each of their Otis elevators and escalators.

Well-conceived state-of-the-art operating systems not only enable better strategy exe- cution but also strengthen organizational capabilities—enough at times to provide a com- petitive edge over rivals. For example, a company with a differentiation strategy based on superior quality has added capability if it has systems for training personnel in quality techniques, tracking product quality at each production step, and ensuring that all goods shipped meet quality standards. If these quality control systems are better than those employed by rivals, they provide the company with a competitive advantage. Similarly, a company striving to be a low-cost provider is competitively stronger if it has an unrivaled benchmarking system that identifies opportunities to implement best practices and drive costs out of the business faster than rivals. Fast-growing companies get an important assist from having capabilities in place to recruit and train new employees in large num- bers and from investing in infrastructure that gives them the capability to handle rapid growth as it occurs, rather than having to scramble to catch up to customer demand.

Instituting Adequate Information Systems, Performance Tracking, and Controls Accurate and timely information about daily operations is essential if managers are to gauge how well the strategy execution process is proceeding. Companies everywhere are capitalizing on today’s technology to install real-time data-generating capability. Most retail companies now have automated online systems that generate daily sales reports for each store and maintain up-to-the-minute inventory and sales records on each item. Manufacturing plants typically generate daily production reports and track labor productivity on every shift. Transportation companies have elaborate informa- tion systems to provide real-time arrival information for buses and trains that is auto- matically sent to digital message signs and platform audio address systems.

Siemens Healthcare, one of the largest suppliers to the health care industry, uses a cloud-based business activity monitoring (BAM) system to continuously monitor and improve the company’s processes across more than 190 countries. Customer satisfac- tion is one of Siemens’s most important business objectives, so the reliability of its order management and services is crucial. Caesars Entertainment, owner of casinos and hotels, uses a sophisticated customer relationship database that records detailed information about its customers’ gambling habits. When a member of Caesars’s Total Rewards program calls to make a reservation, the representative can review previous spending, including average bet size, to offer an upgrade or complimentary stay at Cae- sars Palace or one of the company’s other properties. At Uber, the popular ridesharing

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service, there are systems for locating vehicles near a customer and real-time demand monitoring to price fares during high-demand periods.

Information systems need to cover five broad areas: (1) customer data, (2) opera- tions data, (3) employee data, (4) supplier and/or strategic partner data, and (5) finan- cial performance data. All key strategic performance indicators must be tracked and reported in real time whenever possible. Real-time information systems permit com- pany managers to stay on top of implementation initiatives and daily operations and to intervene if things seem to be drifting off course. Tracking key performance indica- tors, gathering information from operating personnel, quickly identifying and diag- nosing problems, and taking corrective actions are all integral pieces of the process of managing strategy execution and overseeing operations.

Statistical information gives managers a feel for the numbers, briefings and meet- ings provide a feel for the latest developments and emerging issues, and personal contacts add a feel for the people dimension. All are good barometers of how well things are going and what operating aspects need management attention. Managers must identify problem areas and deviations from plans before they can take action to get the organization back on course, by either improving the approaches to strategy execution or fine-tuning the strategy. Jeff Bezos, Amazon.com’s CEO, is an ardent proponent of managing by the numbers. As he puts it, “Math-based decisions always trump opinion and judgment. The trouble with most corporations is that they make

judgment-based decisions when data-based decisions could be made.”20

Monitoring Employee Performance Information systems also provide managers with a means for monitoring the performance of empowered workers to see that they are acting within the specified limits.21 Leaving empowered employees to their own devices in meeting performance standards without appropriate checks and balances can expose an organization to excessive risk.22 Instances abound of employ- ees’ decisions or behavior going awry, sometimes costing a company huge sums or producing lawsuits and reputation-damaging publicity.

Scrutinizing daily and weekly operating statistics is one of the ways in which manag- ers can monitor the results that flow from the actions of subordinates without resorting to constant over-the-shoulder supervision; if the operating results look good, then it is reasonable to assume that empowerment is working. But close monitoring of operating performance is only one of the control tools at management’s disposal. Another valuable lever of control in companies that rely on empowered employees, especially in those that use self-managed work groups or other such teams, is peer-based control. Because peer evaluation is such a powerful control device, companies organized into teams can remove some layers of the management hierarchy and rely on strong peer pressure to keep team members operating between the white lines. This is especially true when a company has the information systems capability to monitor team performance daily or in real time.

Having state-of-the- art operating systems, information systems, and real-time data is integral to superior strategy execution and operating excellence.

USING REWARDS AND INCENTIVES TO PROMOTE BETTER STRATEGY EXECUTION

It is essential that company personnel be enthusiastically committed to executing strategy successfully and achieving performance targets. Enlisting such commit- ment typically requires use of an assortment of motivational techniques and rewards. Indeed, an effectively designed reward structure is the single most powerful tool

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management has for mobilizing employee commitment to successful strategy execu- tion. But incentives and rewards do more than just strengthen the resolve of company personnel to succeed—they also focus employees’ attention on the accomplishment of specific strategy execution objectives. Not only do they spur the efforts of indi- viduals to achieve those aims, but they also help coordinate the activities of individ- uals throughout the organization by aligning their personal motives with the goals of the organization. In this manner, reward systems serve as an indirect type of control mechanism that conserves on the more costly control mechanism of supervisory oversight.

To win employees’ sustained, energetic commitment to the strategy execu- tion process, management must be resourceful in designing and using motivational incentives—both monetary and nonmonetary. The more a manager understands what motivates subordinates and the more he or she relies on motivational incentives as a tool for achieving the targeted strategic and financial results, the greater will be employees’ commitment to good day-in, day-out strategy execution and the achieve- ment of performance targets.23

Incentives and Motivational Practices That Facilitate Good Strategy Execution Financial incentives generally head the list of motivating tools for gaining whole- hearted employee commitment to good strategy execution and focusing attention on strategic priorities. Generous financial rewards always catch employees’ atten- tion and produce high-powered incentives for individuals to exert their best efforts. A company’s package of monetary rewards typically includes some combination of base-pay increases, performance bonuses, profit-sharing plans, stock awards, company contributions to employee 401(k) or retirement plans, and piecework incentives (in the case of production workers). But most successful companies and managers also make extensive use of nonmonetary incentives. Some of the most important nonmonetary approaches companies can use to enhance employee moti- vation include the following:24

∙ Providing attractive perks and fringe benefits. The various options include coverage of health insurance premiums, wellness programs, college tuition reimbursement, generous paid vacation time, onsite child care, onsite fitness centers and massage services, opportunities for getaways at company-owned recreational facilities, personal concierge services, subsidized cafeterias and free lunches, casual dress every day, personal travel services, paid sabbaticals, maternity and paternity leaves, paid leaves to care for ill family members, tele- commuting, compressed workweeks (four 10-hour days instead of five 8-hour days), flextime (variable work schedules that accommodate individual needs), college scholarships for children, and relocation services.

∙ Giving awards and public recognition to high performers and showcasing com- pany successes. Many companies hold award ceremonies to honor top-performing individuals, teams, and organizational units and to celebrate important company milestones and achievements. Others make a special point of recognizing the outstanding accomplishments of individuals, teams, and organizational units at informal company gatherings or in the company newsletter. Such actions foster a positive esprit de corps within the organization and may also act to spur healthy competition among units and teams within the company.

LO 5

How and why the use of well-designed incentives and rewards can be management’s single most powerful tool for promoting adept strategy execution.

A properly designed reward structure is management’s single most powerful tool for mobilizing employee commitment to successful strategy execution and aligning efforts throughout the organization with strategic priorities.

CORE CONCEPT

Financial rewards provide high-powered incentives when rewards are tied to specific outcome objectives.

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∙ Relying on promotion from within whenever possible. This practice helps bind workers to their employer, and employers to their workers. Moreover, it provides strong incentives for good performance. Promoting from within also helps ensure that people in positions of responsibility have knowledge specific to the business, technology, and operations they are managing.

∙ Inviting and acting on ideas and suggestions from employees. Many companies find that their best ideas for nuts-and-bolts operating improvements come from the sug- gestions of employees. Moreover, research indicates that giving decision-making power to down-the-line employees increases their motivation and satisfaction as well as their productivity. The use of self-managed teams has much the same effect.

∙ Creating a work atmosphere in which there is genuine caring and mutual respect among workers and between management and employees. A “family” work envi- ronment where people are on a first-name basis and there is strong camaraderie promotes teamwork and cross-unit collaboration.

∙ Stating the strategic vision in inspirational terms that make employees feel they are a part of something worthwhile in a larger social sense. There’s strong moti- vating power associated with giving people a chance to be part of something excit- ing and personally satisfying. Jobs with a noble purpose tend to inspire employees to give their all. As described in Chapter 9, this not only increases productivity but reduces turnover and lowers costs for staff recruitment and training as well.

∙ Sharing information with employees about financial performance, strategy, opera- tional measures, market conditions, and competitors’ actions. Broad disclosure and prompt communication send the message that managers trust their workers and regard them as valued partners in the enterprise. Keeping employees in the dark denies them information useful to performing their jobs, prevents them from being intellectually engaged, saps their motivation, and detracts from performance.

∙ Providing an appealing working environment. An appealing workplace environ- ment can have decidedly positive effects on employee morale and productivity. Providing a comfortable work environment, designed with ergonomics in mind, is particularly important when workers are expected to spend long hours at work. But some companies go beyond the mundane to design exceptionally attractive work settings. Google management built the company’s Googleplex headquarters campus to be “a dream workplace” and a showcase for environmentally correct building design and construction. Employees have access to dozens of cafés with healthy foods, break rooms with snacks and drinks, multiple fitness centers, heated swimming pools, ping-pong and pool tables, sand volleyball courts, and commu- nity bicycles and scooters to go from building to building. Apple and Facebook also have dramatic and futuristic headquarters projects underway.

For specific examples of the motivational tactics employed by several prominent companies (many of which appear on Fortune’s list of the 100 best companies to work for in America), see Illustration Capsule 11.2.

Striking the Right Balance between Rewards and Punishment While most approaches to motivation, compensation, and people management accentuate the positive, companies also make it clear that lackadaisical or indiffer- ent effort and subpar performance can result in negative consequences. At General

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Electric, McKinsey & Company, several global public accounting firms, and other companies that look for and expect top-notch individual performance, there’s an “up-or-out” policy—managers and professionals whose performance is not good enough to warrant promotion are first denied bonuses and stock awards and eventu- ally weeded out. At most companies, senior executives and key personnel in under- performing units are pressured to raise performance to acceptable levels and keep it there or risk being replaced.

ILLUSTRATION CAPSULE 11.2

Companies design a variety of motivational and reward practices to create a work environment that energizes employees and promotes better strategy execution. Other benefits of a successful recognition system include high job satisfaction, high retention rates, and increased output. Here’s a sampling of what some of the best companies to work for in America are doing to motivate their employees:

• Software developer SAS prioritizes work–life balance and mental health for its workforce of almost 7,000. The onsite health center it hosts for families of all employees maintains a staff of 53 medical and support personnel, including nurses, registered dietitians, lab technicians, and clinical psychologists. The sprawling headquarters also has a Frisbee golf course, indoor swimming pool, and walking and biking trails decorated with sculptures from the company’s 4,000-item art collection. With such an environment, it should come as no surprise that 95 percent of employees report looking forward to heading to the office every day.

• Salesforce.com, a global cloud-computing company based in San Francisco, has been listed by Forbes maga- zine as the most innovative company in America. With its workforce more than tripling from 5,000 employees in 2012, Salesforce.com has worked hard to integrate new hires into existing teams. The company’s recogni- tion programs include rewards for achievement both in the office and in the larger community. For example, in 2013, top sellers were awarded two-week trips to Bhutan for their dedication and results.

• DPR Construction is one of the nation’s top-50 general contractors, serving clients like Facebook, Pixar, and Genentech. The company fosters teamwork and equal- ity across levels with features like open-office floor

plans, business cards with no titles, and a bonus plan for employees. DPR also prioritizes safety for its employees. In 1999, a craftsperson who reached 30,000 consecutive safe work hours was rewarded with a new Ford F-150 truck. Management created a new safety award in his name that includes a plaque, a $2,000 trip, a 40-hour week off with pay, and a safety jacket with hours printed on it. In 2016, twenty-eight craftspeople received this generous award for their dedication to safety.

• Hilcorp, an oil and gas exploration company, made head- lines in 2011 for its shocking generosity. After reach- ing its five-year goal to double in size, the company gave every employee a $50,000 dream car voucher (or $35,000 in cash). Building on this success, Hilcorp announced an incentive program that promised to award every employee $100,000 in 2015 if certain goals are met. Hilcorp met its targets in April 2015 and distrib- uted checks to its employees in June of that same year.

How the Best Companies to Work for Motivate and Reward Employees

Note: Developed with Meghan L. Cooney.

Sources: “100 Best Companies to Work For, 2014,” Fortune, money.cnn.com/magazines/fortune/best-companies/ (accessed February 15, 2014); company profiles, GreatRated!, us.greatrated.com/sas (accessed February 24, 2014).

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As a general rule, it is unwise to take off the pressure for good performance or play down the adverse consequences of shortfalls in performance. There is scant evidence that a no-pressure, no-adverse-consequences work environment leads to superior strat- egy execution or operating excellence. As the CEO of a major bank put it, “There’s a deliberate policy here to create a level of anxiety. Winners usually play like they’re one touchdown behind.”25 A number of companies deliberately give employees heavy workloads and tight deadlines to test their mettle—personnel are pushed hard to achieve “stretch” objectives and are expected to put in long hours (nights and weekends if need be). High-performing organizations nearly always have a cadre of ambitious people who relish the opportunity to climb the ladder of success, love a challenge, thrive in a performance-oriented environment, and find some competition and pressure useful to satisfy their own drives for personal recognition, accomplishment, and self-satisfaction.

However, if an organization’s motivational approaches and reward structure induce too much stress, internal competitiveness, job insecurity, and fear of unpleasant con- sequences, the impact on workforce morale and strategy execution can be counter- productive. Evidence shows that managerial initiatives to improve strategy execution should incorporate more positive than negative motivational elements because when cooperation is positively enlisted and rewarded, rather than coerced by orders and threats (implicit or explicit), people tend to respond with more enthusiasm, dedication, creativity, and initiative.26

Linking Rewards to Achieving the Right Outcomes To create a strategy-supportive system of rewards and incentives, a company must reward people for accomplishing results, not for just dutifully performing assigned tasks. Showing up for work and performing assignments do not, by themselves, guar- antee results. To make the work environment results-oriented, managers need to focus jobholders’ attention and energy on what to achieve as opposed to what to do.27 Employee productivity among employees at Best Buy’s corporate headquarters rose by 35 percent after the company began to focus on the results of each employee’s work

rather than on employees’ willingness to come to work early and stay late. Ideally, every organizational unit, every manager, every team or work group,

and every employee should be held accountable for achieving outcomes that con- tribute to good strategy execution and business performance. If the company’s strategy is to be a low-cost provider, the incentive system must reward actions and achievements that result in lower costs. If the company has a differentiation strat- egy focused on delivering superior quality and service, the incentive system must reward such outcomes as Six Sigma defect rates, infrequent customer complaints, speedy order processing and delivery, and high levels of customer satisfaction. If a company’s growth is predicated on a strategy of new product innovation, incentives should be tied to such metrics as the percentages of revenues and profits coming from newly introduced products.

Incentive compensation for top executives is typically tied to such financial measures as revenue and earnings growth, stock price performance, return on investment, and creditworthiness or to strategic measures such as market share growth. However, incentives for department heads, teams, and individual workers tend to be tied to performance outcomes more closely related to their specific area of responsibility. For instance, in manufacturing, it makes sense to tie incentive compensation to such outcomes as unit manufacturing costs, on-time production

Incentives must be based on accomplishing the right results, not on dutifully performing assigned tasks.

The key to creating a reward system that promotes good strategy execution is to make measures of good business performance and good strategy execution the dominating basis for designing incentives, evaluating individual and group efforts, and handing out rewards.

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and shipping, defect rates, the number and extent of work stoppages due to equip- ment breakdowns, and so on. In sales and marketing, incentives tend to be based on achieving dollar sales or unit volume targets, market share, sales penetration of each target customer group, the fate of newly introduced products, the frequency of cus- tomer complaints, the number of new accounts acquired, and measures of customer satisfaction. Which performance measures to base incentive compensation on depends on the situation—the priority placed on various financial and strategic objectives, the requirements for strategic and competitive success, and the specific results needed to keep strategy execution on track.

Illustration Capsule 11.3 provides a vivid example of how one company has designed incentives linked directly to outcomes reflecting good execution.

Additional Guidelines for Designing Incentive Compensation Systems It is not enough to link incentives to the right kinds of results— performance outcomes that signal that the company’s strategy and its execution are on track. For a company’s reward system to truly motivate organization members, inspire their best efforts, and sustain high levels of productivity, it is also important to observe the following additional guidelines in designing and administering the reward system:

∙ Make the performance payoff a major, not minor, piece of the total compensa- tion package. Performance bonuses must be at least 10 to 12 percent of base salary to have much impact. Incentives that amount to 20 percent or more of total compensation are big attention-getters, likely to really drive individual or team efforts. Incentives amounting to less than 5 percent of total compensation have a comparatively weak motivational impact. Moreover, the payoff for high- performing individuals and teams must be meaningfully greater than the payoff for average performers, and the payoff for average performers meaningfully big- ger than that for below-average performers.

∙ Have incentives that extend to all managers and all workers, not just top manage- ment. It is a gross miscalculation to expect that lower-level managers and employ- ees will work their hardest to hit performance targets if only a senior executives qualify for lucrative rewards.

∙ Administer the reward system with scrupulous objectivity and fairness. If perfor- mance standards are set unrealistically high or if individual and group perfor- mance evaluations are not accurate and well documented, dissatisfaction with the system will overcome any positive benefits.

∙ Ensure that the performance targets set for each individual or team involve out- comes that the individual or team can personally affect. The role of incentives is to enhance individual commitment and channel behavior in beneficial directions. This role is not well served when the performance measures by which company personnel are judged are outside their arena of influence.

∙ Keep the time between achieving the performance target and receiving the reward as short as possible. Nucor, a leading producer of steel products, has achieved high labor productivity by paying its workers weekly bonuses based on prior-week production levels. Annual bonus payouts work best for higher-level managers and for situations where the outcome target relates to overall company profitability.

∙ Avoid rewarding effort rather than results. While it is tempting to reward people who have tried hard, gone the extra mile, and yet fallen short of achieving perfor- mance targets because of circumstances beyond their control, it is ill advised to

The first principle in designing an effective incentive compensation system is to tie rewards to performance outcomes directly linked to good strategy execution and the achievement of financial and strategic objectives.

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do so. The problem with making exceptions for unknowable, uncontrollable, or unforeseeable circumstances is that once “good excuses” start to creep into justi- fying rewards for subpar results, the door opens to all kinds of reasons why actual performance has failed to match targeted performance. A “no excuses” standard is more evenhanded, easier to administer, and more conducive to creating a results- oriented work climate.

For an organization’s incentive system to work well, the details of the reward struc- ture must be communicated and explained. Everybody needs to understand how his

ILLUSTRATION CAPSULE 11.3

The strategy at Nucor Corporation, one of the three largest steel producers in the United States, is to be the low-cost producer of steel products. Because labor costs are a significant fraction of total cost in the steel business, successful implementation of Nucor’s low-cost leadership strategy entails achieving lower labor costs per ton of steel than competitors’ costs. Nucor manage- ment uses an incentive system to promote high worker productivity and drive labor costs per ton below those of rivals. Each plant’s workforce is organized into pro- duction teams (each assigned to perform particular functions), and weekly production targets are estab- lished for each team. Base-pay scales are set at levels comparable to wages for similar manufacturing jobs in the local areas where Nucor has plants, but workers can earn a 1 percent bonus for each 1 percent that their out- put exceeds target levels. If a production team exceeds its weekly production target by 10 percent, team mem- bers receive a 10 percent bonus in their next paycheck; if a team exceeds its quota by 20 percent, team mem- bers earn a 20 percent bonus. Bonuses, paid every two weeks, are based on the prior two weeks’ actual produc- tion levels measured against the targets.

Nucor’s piece-rate incentive plan has produced impressive results. The production teams put forth exceptional effort; it is not uncommon for most teams to beat their weekly production targets by 20 to 50 percent. When added to employees’ base pay, the bonuses earned by Nucor workers make Nucor’s workforce among the highest paid in the U.S. steel industry. From a manage- ment perspective, the incentive system has resulted in Nucor having labor productivity levels 10 to 20 percent above the average of the unionized workforces at several of its largest rivals, which in turn has given Nucor a sig- nificant labor cost advantage over most rivals.

After years of record-setting profits, Nucor struggled in the economic downturn of 2008–2010, along with the manufacturers and builders who buy its steel. But while bonuses have dwindled, Nucor showed remarkable loy- alty to its production workers, avoiding layoffs by having employees get ahead on maintenance, perform work for- merly done by contractors, and search for cost savings. Morale at the company remained high, and Nucor’s CEO at the time, Daniel DiMicco, was inducted into Industry- Week magazine’s Manufacturing Hall of Fame because of his no-layoff policies. As industry growth has resumed, Nucor has retained a well-trained workforce, more com- mitted than ever to achieving the kind of productivity for which Nucor is justifiably famous. DiMicco had good reason to expect Nucor to be “first out of the box” follow- ing the crisis, and although he has since stepped aside, the company’s culture of making its employees think like owners has not changed.

Nucor Corporation: Tying Incentives Directly to Strategy Execution

Sources: Company website (accessed March 2012); N. Byrnes, “Pain, but No Layoffs at Nucor,” BusinessWeek, March 26, 2009; J. McGregor, “Nucor’s CEO Is Stepping Aside, but Its Culture Likely Won’t,” The Washington Post Online, November 20, 2012 (accessed April 3, 2014).

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or her incentive compensation is calculated and how individual and group per- formance targets contribute to organizational performance targets. The pressure to achieve the targeted financial and strategic performance objectives and con- tinuously improve on strategy execution should be unrelenting. People at all levels must be held accountable for carrying out their assigned parts of the strategic plan, and they must understand that their rewards are based on the caliber of results achieved. But with the pressure to perform should come meaningful rewards. With- out an attractive payoff, the system breaks down, and managers are left with the less workable options of issuing orders, trying to enforce compliance, and depend- ing on the goodwill of employees.

The unwavering standard for judging whether individuals, teams, and organizational units have done a good job must be whether they meet or beat performance targets that reflect good strategy execution.

KEY POINTS

1. Implementing a new or different strategy calls for managers to identify the resource requirements of each new strategic initiative and then consider whether the current pattern of resource allocation and the budgets of the various subunits are suitable.

2. Company policies and procedures facilitate strategy execution when they are designed to fit the strategy and its objectives. Anytime a company alters its strat- egy, managers should review existing policies and operating procedures and replace those that are out of sync. Well-conceived policies and procedures aid the task of strategy execution by (1) providing top-down guidance to company personnel regarding how things need to be done and what the limits are on inde- pendent actions; (2) enforcing consistency in the performance of strategy-critical activities, thereby improving the quality of the strategy execution effort and coor- dinating the efforts of company personnel, however widely dispersed; and (3) pro- moting the creation of a work climate conducive to good strategy execution.

3. Competent strategy execution entails visible unyielding managerial commitment to best practices and continuous improvement. Benchmarking, best-practice adop- tion, business process reengineering, total quality management (TQM), and Six Sigma programs are important process management tools for promoting better strategy execution.

4. Company strategies can’t be implemented or executed well without well- conceived internal systems to support daily operations. Real-time information systems and control systems further aid the cause of good strategy execution. In some cases, state-of-the-art operating and information systems strengthen a company’s strat- egy execution capabilities enough to provide a competitive edge over rivals.

5. Strategy-supportive motivational practices and reward systems are powerful man- agement tools for gaining employee commitment and focusing their attention on the strategy execution goals. The key to creating a reward system that pro- motes good strategy execution is to make measures of good business performance and good strategy execution the dominating basis for designing incentives, eval- uating individual and group efforts, and handing out rewards. Positive motiva- tional practices generally work better than negative ones, but there is a place for both. While financial rewards provide high-powered incentives, nonmonetary

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incentives are also important. For an incentive compensation system to work well, (1) the performance payoff should be a major percentage of the compensation package, (2) the use of incentives should extend to all managers and workers, (3) the system should be administered with objectivity and fairness, (4) each individual’s performance targets should involve outcomes the person can person- ally affect, (5) rewards should promptly follow the achievement of performance targets, and (6) rewards should be given for results and not just effort.

ASSURANCE OF LEARNING EXERCISES

1. Implementing a new or different strategy calls for new resource allocations. Using your university’s access to LexisNexis or EBSCO, search for recent articles that discuss how a company has revised its pattern of resource allocation and divi- sional budgets to support new strategic initiatives.

2. Policies and procedures facilitate strategy execution when they are designed to fit the company’s strategy and objectives. Using your university’s access to LexisNexis or EBSCO, search for recent articles that discuss how a company has revised its policies and procedures to provide better top-down guidance to com- pany personnel on how to conduct their daily activities and responsibilities.

3. Illustration Capsule 11.1 discusses Charleston Area Medical Center’s use of Six Sigma practices. List three tangible benefits provided by the program. Explain why a commitment to quality control is particularly important in the hospital industry. How can the use of a Six Sigma program help medical providers survive and thrive in the current industry climate?

4. Read some of the recent Six Sigma articles posted at www.isixsigma.com. Pre- pare a one-page report to your instructor detailing how Six Sigma is being used in two companies and what benefits the companies are reaping as a result. Fur- ther, discuss two to three criticisms of, or potential difficulties with, Six Sigma implementation.

5. Company strategies can’t be executed well without a number of support systems to carry on business operations. Using your university’s access to LexisNexis or EBSCO, search for recent articles that discuss how a company has used real- time information systems and control systems to aid the cause of good strategy execution.

6. Illustration Capsule 11.2 provides a sampling of motivational tactics employed by several prominent companies (many of which appear on Fortune’s list of the 100 best companies to work for in America). Discuss how rewards at SAS, Salesforce.com, DPR Construction, and Hilcorp aid in the strategy execution efforts of each company.

LO 1

LO 2

LO 3

LO 4

LO 5

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EXERCISE FOR SIMULATION PARTICIPANTS

1. Have you and your co-managers allocated ample resources to strategy-critical areas? If so, explain how these investments have contributed to good strategy exe- cution and improved company performance.

2. What actions, if any, is your company taking to pursue continuous improvement in how it performs certain value chain activities?

3. Are benchmarking data available in the simulation exercise in which you are par- ticipating? If so, do you and your co-managers regularly study the benchmarking data to see how well your company is doing? Do you consider the benchmarking information provided to be valuable? Why or why not? Cite three recent instances in which your examination of the benchmarking statistics has caused you and your co-managers to take corrective actions to boost company performance.

4. What hard evidence can you cite that indicates your company’s management team is doing a better or worse job of achieving operating excellence and executing strategy than are the management teams at rival companies?

5. Are you and your co-managers consciously trying to achieve operating excel- lence? Explain how you are doing this and how you will track the progress you are making.

6. Does your company have opportunities to use incentive compensation techniques? If so, explain your company’s approach to incentive compensation. Is there any hard evidence you can cite that indicates your company’s use of incentive com- pensation techniques has worked? For example, have your company’s compensa- tion incentives actually increased productivity? Can you cite evidence indicating that the productivity gains have resulted in lower labor costs? If the productivity gains have not translated into lower labor costs, is it fair to say that your com- pany’s use of incentive compensation is a failure?

LO 1

LO 2, LO 3, LO 4 LO 3

LO 3

LO 2, LO 3, LO 4

LO 5

ENDNOTES 1996), pp. 93–99; Stephen L. Walston, Law- ton R. Burns, and John R. Kimberly, “Does Reengineering Really Work? An Examination of the Context and Outcomes of Hospital Reengi- neering Initiatives,” Health Services Research 34, no. 6 (February 2000), pp. 1363–1388; Allessio Ascari, Melinda Rock, and Soumitra Dutta, “Reengineering and Organizational Change: Lessons from a Comparative Analysis of Company Experiences,” European Manage- ment Journal 13, no. 1 (March 1995), pp. 1–13; Ronald J. Burke, “Process Reengineering: Who Embraces It and Why?” The TQM Magazine 16, no. 2 (2004), pp. 114–119. 4 www.answers.com (accessed July 8, 2009); “Reengineering: Beyond the Buzzword,” Busi- nessweek, May 24, 1993, www.businessweek .com (accessed July 8, 2009). 5 Gene Hall, Jim Rosenthal, and Judy Wade, “How to Make Reengineering Really Work,” Harvard Business Review 71, no. 6 ( November–December 1993), pp. 119–131.

1 Christopher E. Bogan and Michael J. English, Benchmarking for Best Practices: Winning through Innovative Adaptation (New York: McGraw-Hill, 1994); Mustafa Ungan, “Factors Affecting the Adoption of Manufacturing Best Practices,” Benchmarking: An International Journal 11, no. 5 (2004), pp. 504–520; Paul Hyland and Ron Beckett, “Learning to Com- pete: The Value of Internal Benchmarking,” Benchmarking: An International Journal 9, no. 3 (2002), pp. 293–304; Yoshinobu Ohinata, “Benchmarking: The Japanese Experience,” Long-Range Planning 27, no. 4 (August 1994), pp. 48–53. 2 M. Hammer and J. Champy, Reengineering the Corporation: A Manifesto for Business Revolution (New York: HarperCollins, 1993). 3 James Brian Quinn, Intelligent Enterprise (New York: Free Press, 1992); Ann Majchrzak and Qianwei Wang, “Breaking the Functional Mind- Set in Process Organizations,” Harvard Business Review 74, no. 5 (September–October

6 M. Walton, The Deming Management Method (New York: Pedigree, 1986); J. Juran, Juran on Quality by Design (New York: Free Press, 1992); Philip Crosby, Quality Is Free: The Act of Making Quality Certain (New York: McGraw-Hill, 1979); S. George, The Baldrige Quality System (New York: Wiley, 1992); Mark J. Zbaracki, “The Rhetoric and Reality of Total Quality Management,” Administrative Science Quarterly 43, no. 3 (September 1998), pp. 602–636. 7 Robert T. Amsden, Thomas W. Ferratt, and Davida M. Amsden, “TQM: Core Paradigm Changes,” Business Horizons 39, no. 6 (November–December 1996), pp. 6–14. 8 Peter S. Pande and Larry Holpp, What Is Six Sigma? (New York: McGraw-Hill, 2002); Jiju Antony, “Some Pros and Cons of Six Sigma: An Academic Perspective,” TQM Magazine 16, no. 4 (2004), pp. 303–306; Peter S. Pande, Robert P. Neuman, and Roland R. Cavanagh, The Six Sigma Way: How GE, Motorola and

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16 Milan Ambroé, “Total Quality System as a Product of the Empowered Corporate Culture,” TQM Magazine 16, no. 2 (2004), pp. 93–104; Nick A. Dayton, “The Demise of Total Quality Management,” TQM Magazine 15, no. 6 (2003), pp. 391–396. 17 Judy D. Olian and Sara L. Rynes, “Making Total Quality Work: Aligning Organizational Processes, Performance Measures, and Stake- holders,” Human Resource Management 30, no. 3 (Fall 1991), pp. 310–311; Paul S. Goodman and Eric D. Darr, “Exchanging Best Practices Information through Computer-Aided Sys- tems,” Academy of Management Executive 10, no. 2 (May 1996), p. 7. 18 Thomas C. Powell, “Total Quality Manage- ment as Competitive Advantage,” Strategic Management Journal 16 (1995), pp. 15–37; Richard M. Hodgetts, “Quality Lessons from America’s Baldrige Winners,” Business Hori- zons 37, no. 4 (July–August 1994), pp. 74–79; Richard Reed, David J. Lemak, and Joseph C. Montgomery, “Beyond Process: TQM Content and Firm Performance,” Academy of Man- agement Review 21, no. 1 (January 1996), pp. 173–202. 19 www.otiselevator.com (accessed February 16, 2012). 20 Fred Vogelstein, “Winning the Amazon Way,” Fortune 147, no. 10 (May 26, 2003), pp. 60–69. 21 Robert Simons, “Control in an Age of Empowerment,” Harvard Business Review 73 (March–April 1995), pp. 80–88.

Other Top Companies Are Honing Their Performance (New York: McGraw-Hill, 2000); Joseph Gordon and M. Joseph Gordon, Jr., Six Sigma Quality for Business and Manufacture (New York: Elsevier, 2002); Godecke Wessel and Peter Burcher, “Six Sigma for Small and Medium-Sized Enterprises,” TQM Magazine 16, no. 4 (2004), pp. 264–272. 9 www.isixsigma.com (accessed November 4, 2002); www.villanovau.com/certificate- programs/six-sigma-training.aspx (accessed February 16, 2012). 10 Kennedy Smith, “Six Sigma for the Service Sector,” Quality Digest Magazine, May 2003; www.qualitydigest.com (accessed September 28, 2003). 11 www.isixsigma.com/implementation/ financial-analysis/six-sigma-costs-and- savings/ (accessed February 23, 2012). 12 Pande, Neuman, and Cavanagh, The Six Sigma Way, pp. 5–6. 13 “A Dark Art No More,” The Economist 385, no. 8550 (October 13, 2007), p. 10; Brian Hindo, “At 3M, a Struggle between Efficiency and Creativ- ity,” Businessweek, June 11, 2007, pp. 8–16. 14 Charles A. O’Reilly and Michael L. Tushman, “The Ambidextrous Organization,” Harvard Busi- ness Review 82, no. 4 (April 2004), pp. 74–81. 15 Terry Nels Lee, Stanley E. Fawcett, and Jason Briscoe, “Benchmarking the Challenge to Quality Program Implementation,” Benchmark- ing: An International Journal 9, no. 4 (2002), pp. 374–387.

22 David C. Band and Gerald Scanlan, “Stra- tegic Control through Core Competencies,” Long Range Planning 28, no. 2 (April 1995), pp. 102–114. 23 Stanley E. Fawcett, Gary K. Rhoads, and Phillip Burnah, “People as the Bridge to Com- petitiveness: Benchmarking the ‘ABCs’ of an Empowered Workforce,” Benchmarking: An International Journal 11, no. 4 (2004), pp. 346–360. 24 Jeffrey Pfeffer and John F. Veiga, “Putting People First for Organizational Success,” Acad- emy of Management Executive 13, no. 2 (May 1999), pp. 37–45; Linda K. Stroh and Paula M. Caliguiri, “Increasing Global Competitiveness through Effective People Management,” Jour- nal of World Business 33, no. 1 (Spring 1998), pp. 1–16; articles in Fortune on the 100 best companies to work for (various issues). 25 As quoted in John P. Kotter and James L. Heskett, Corporate Culture and Performance (New York: Free Press, 1992), p. 91. 26 Clayton M. Christensen, Matt Marx, and Howard Stevenson, “The Tools of Cooperation and Change,” Harvard Business Review 84, no. 10 (October 2006), pp. 73–80. 27 Steven Kerr, “On the Folly of Rewarding A While Hoping for B,” Academy of Management Executive 9, no. 1 (February 1995), pp. 7–14; Doran Twer, “Linking Pay to Business Objec- tives,” Journal of Business Strategy 15, no. 4 (July–August 1994), pp. 15–18.

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CHAPTER 12

Corporate Culture and Leadership Keys to Good Strategy Execution

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 The key features of a company’s corporate culture and the role of a company’s core values and ethical standards in building corporate culture.

LO 2 How and why a company’s culture can aid the drive for proficient strategy execution.

LO 3 The kinds of actions management can take to change a problem corporate culture.

LO 4 What constitutes effective managerial leadership in achieving superior strategy execution.

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Success goes to those with a corporate culture that assures the ability to anticipate and meet customer demand.

Tadashi Okamura—Former president and CEO of Toshiba

As we look ahead into the next century, leaders will be those who empower others.

Bill Gates—Cofounder and former CEO and chair of

Microsoft

Leadership is practiced, not so much in words as in attitude and in actions.

Harold S. Geneen—Former CEO and chair of ITT

CORE CONCEPT

Corporate culture refers to the shared values, ingrained attitudes, core beliefs, and company traditions that determine norms of behavior, accepted work practices, and styles of operating.

Every company has its own unique corporate culture—the shared values, ingrained attitudes, and company traditions that determine norms of behavior, accepted work practices, and styles of operating.1 The character of a company’s culture is a product of the core values and beliefs that executives espouse, the standards of what is ethically acceptable and what is not, the “chemistry” and the “personality” that permeate the work environment, the company’s traditions, and the stories that get told over and over to illustrate and reinforce the company’s shared values, business practices, and traditions. In a very real sense, the culture is the company’s automatic, self-replicating “operating system” that defines “how we do things around here.”2 It can be thought of as the company’s psyche or organizational DNA.3 A company’s culture is important because it influences the

In the previous two chapters, we examined eight of the managerial tasks that drive good strategy execution: staffing the organization, acquiring the needed resources and capabilities, designing the organizational structure, allocating resources, establishing policies and procedures, employing process management tools, installing operating

systems, and providing the right incentives. In this chapter, we explore the two remaining managerial tasks that contribute to good strategy execution: creating a corporate culture that supports good strategy execution and leading the strategy execu- tion process.

INSTILLING A CORPORATE CULTURE CONDUCIVE TO GOOD STRATEGY EXECUTION

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organization’s actions and approaches to conducting business. As such, it plays an important role in strategy execution and may have an appreciable effect on business performance as well.

Corporate cultures vary widely. For instance, the bedrock of Walmart’s culture is zealous pursuit of low costs and frugal operating practices, a strong work ethic, ritu- alistic headquarters meetings to exchange ideas and review problems, and company executives’ commitment to visiting stores, listening to customers, and soliciting sug- gestions from employees. The culture at Apple is customer-centered, secretive, and highly protective of company-developed technology. To spur innovation and creativity, the company fosters extensive collaboration and cross-pollination among differ- ent work groups. But it does so in a manner that demands secrecy—employees are expected not to reveal anything relevant about what new project they are working on, not to employees outside their immediate work group and especially not to fam- ily members or other outsiders; it is common for different employees working on the same project to be assigned different project code names. The different pieces of a new product launch often come together like a puzzle at the last minute.4 W. L. Gore & Associates, best known for GORE-TEX, credits its unique culture for allowing the company to pursue multiple end-market applications simultaneously, enabling rapid growth from a niche business into a diversified multinational company. The compa- ny’s culture is team-based and designed to foster personal initiative, with no tradi- tional organizational charts, no chains of command, no predetermined channels of communication. The culture encourages multidiscipline teams to organize around opportunities and in the process leaders emerge. At Nordstrom, the corporate cul- ture is centered on delivering exceptional service to customers, where the company’s motto is “Respond to unreasonable customer requests,” and each out-of-the-ordinary request is seen as an opportunity for a “heroic” act by an employee that can further the company’s reputation for unparalleled customer service. Nordstrom makes a point of promoting employees noted for their heroic acts and dedication to outstanding service.

Illustration Capsule 12.1 describes the corporate culture of another exemplar company—Epic Systems, well known by health care providers.

Identifying the Key Features of a Company’s Corporate Culture A company’s corporate culture is mirrored in the character or “personality” of its work environment—the features that describe how the company goes about its busi- ness and the workplace behaviors that are held in high esteem. Some of these fea- tures are readily apparent, and others operate quite subtly. The chief things to look for include:

∙ The values, business principles, and ethical standards that management preaches and practices—these are the key to a company’s culture, but actions speak much louder than words here.

∙ The company’s approach to people management and the official policies, proce- dures, and operating practices that provide guidelines for the behavior of company personnel.

∙ The atmosphere and spirit that pervades the work climate—whether the work- place is competitive or cooperative, innovative or resistant to change, collegial or politicized, all business or fun-loving, and the like.

LO 1

The key features of a company’s corporate culture and the role of a company’s core values and ethical standards in building corporate culture.

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ILLUSTRATION CAPSULE 12.1

Epic Systems Corporation creates software to support record keeping for mid- to large-sized health care orga- nizations, such as hospitals and managed care organi- zations. Founded in 1979 by CEO Judith Faulkner, the company claims that its software is “quick to implement, easy to use and highly interoperable through industry standards.” Widely recognized for superior products and high levels of customer satisfaction, Epic won the Best Overall Software Suite award for the sixth consec- utive year—a ranking determined by health care profes- sionals and compiled by KLAS, a provider of company performance reviews. Part of this success has been attributed to Epic’s strong corporate culture—one based on the slogan “Do good, have fun, make money.” By remaining true to its 10 commandments and principles, its homegrown version of core values, Epic has nurtured a work climate where employees are on the same page and all have an overarching standard to guide their actions.

Epic’s 10 Commandments:

1. Do not go public. 2. Do not be acquired. 3. Software must work. 4. Expectations = reality.

5. Keep commitments. 6. Focus on competency. Do not tolerate mediocrity. 7. Have standards. Be fair to all. 8. Have courage. What you put up with is what you stand

for. 9. Teach philosophy and culture. 10. Be frugal. Do not take on debt for operations.

Epic’s Principles:

1. Make our products a joy to use. 2. Have fun with customers. 3. Design in collaboration with users. 4. Make it easy for users to do the right thing. 5. Improve the patient’s health and healthcare experience. 6. Generalize to benefit more. 7. Follow processes. Find root causes. Fix processes. 8. Dissent when you disagree; once decided, support. 9. Do what is difficult for us if it makes things easier for

our users. 10. Escalate problems at the start, not when all hell breaks

loose.

Epic fosters this high-performance culture from the get-go. It targets top-tier universities to hire entry-level talent, focusing on skills rather than personality. A rig- orous training and orientation program indoctrinates each new employee. In 2002, Faulkner claimed that someone coming straight from college could become an “Epic person” in three years, whereas it takes six years for someone coming from another company. This culture positively affects Epic’s strategy execution because employees are focused on the most important actions, there is peer pressure to contribute to Epic’s success, and employees are genuinely excited to be involved. Epic’s faith in its ability to acculturate new team members and stick true to its core values has allowed it to sustain its status as a premier provider of health care IT systems.

Strong Guiding Principles Drive the High-Performance Culture at Epic

Note: Developed with Margo Cox.

Sources: Company website; communications with an Epic insider; “Epic Takes Back ‘Best in KLAS’ title,” Healthcare IT News, January 29, 2015, www.healthcareitnews.com/news/epic-takes-back-best-klas; “Epic Systems’ Headquarters Reflect Its Creativity, Growth,” Boston Globe, July 28, 2015, www.bostonglobe.com/business/2015/07/28/epic-systems-success-like-its-headquarters-blend-creativity-and- diligence/LpdQ5m0DDS4UVilCVooRUJ/story.html (accessed December 5, 2015).

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∙ How managers and employees interact and relate to one another—whether people tend to work independently or collaboratively, whether communications among employees are free-flowing or infrequent, whether people are called by their first names, whether co-workers spend little or lots of time together outside the work- place, and so on.

∙ The strength of peer pressure to do things in particular ways and conform to expected norms.

∙ The actions and behaviors that management explicitly encourages and rewards and those that are frowned upon.

∙ The company’s revered traditions and oft-repeated stories about “heroic acts” and “how we do things around here.”

∙ The manner in which the company deals with external stakeholders—whether it treats suppliers as business partners or prefers hard-nosed, arm’s-length business arrangements and whether its commitment to corporate citizenship and environ- mental sustainability is strong and genuine.

The values, beliefs, and practices that undergird a company’s culture can come from anywhere in the organizational hierarchy. Typically, key elements of the culture originate with a founder or certain strong leaders who articulated them as a set of business principles, company policies, operating approaches, and ways of dealing with employees, customers, vendors, shareholders, and local communities where the com- pany has operations. They also stem from exemplary actions on the part of company personnel and evolving consensus about “how we ought to do things around here.”5 Over time, these cultural underpinnings take root, come to be accepted by company managers and employees alike, and become ingrained in the way the company con- ducts its business.

The Role of Core Values and Ethics The foundation of a company’s corporate culture nearly always resides in its dedication to certain core values and the bar it sets for ethical behavior. The culture-shaping significance of core values and ethical behaviors accounts for why so many companies have developed a formal value statement and a code of ethics. Of course, sometimes a company’s stated core values and code of ethics are cosmetic, existing mainly to impress outsiders and help create a positive company image. But usually they have been developed to purposely mold

the culture and communicate the kinds of actions and behavior that are expected of all company personnel. Many executives want the work climate at their companies to mirror certain values and ethical standards, partly because of personal convic- tions but mainly because they are convinced that adherence to such principles will promote better strategy execution, make the company a better performer, and posi- tively impact its reputation.6 Not incidentally, strongly ingrained values and ethical standards reduce the likelihood of lapses in ethical and socially approved behavior that mar a company’s public image and put its financial performance and market standing at risk.

As depicted in Figure 12.1, a company’s stated core values and ethical prin- ciples have two roles in the culture-building process. First, a company that works hard at putting its stated core values and ethical principles into practice fosters a work climate in which company personnel share strongly held convictions about how the company’s business is to be conducted. Second, the stated values and ethical principles provide company personnel with guidance about the manner in which they are to do their jobs—which behaviors and ways of doing things are

A company’s culture is grounded in and shaped by its core values and ethical standards.

A company’s value statement and code of ethics communicate expectations of how employees should conduct themselves in the workplace.

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approved (and expected) and which are out-of-bounds. These value-based and ethics- based cultural norms serve as yardsticks for gauging the appropriateness of particular actions, decisions, and behaviors, thus helping steer company personnel toward both doing things right and doing the right thing.

Embedding Behavioral Norms in the Organization and Perpetuating the Culture Once values and ethical standards have been for- mally adopted, they must be institutionalized in the company’s policies and practices and embedded in the conduct of company personnel. This can be done in a number of different ways.7 Tradition-steeped companies with a rich folklore rely heavily on word-of-mouth indoctrination and the power of tradition to instill values and enforce ethical conduct. But most companies employ a variety of techniques, drawing on some or all of the following:

1. Screening applicants and hiring those who will mesh well with the culture. 2. Incorporating discussions of the company’s culture and behavioral norms into

orientation programs for new employees and training courses for managers and employees.

3. Having senior executives frequently reiterate the importance and role of company values and ethical principles at company events and in internal communications to employees.

4. Expecting managers at all levels to be cultural role models and exhibit the advo- cated cultural norms in their own behavior.

5. Making the display of cultural norms a factor in evaluating each person’s job per- formance, granting compensation increases, and deciding who to promote.

6. Stressing that line managers all the way down to first-level supervisors give ongo- ing attention to explaining the desired cultural traits and behaviors in their areas and clarifying why they are important.

FIGURE 12.1 The Two Culture-Building Roles of a Company’s Core Values and Ethical Standards

Foster a work climate where company personnel share common and strongly held convictions about how the company’s business is to be conducted.

Provide company personnel with guidance about how to do their jobs—steering them toward both doing things right and doing the right thing.

A company’s stated core values and

ethical principles

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7. Encouraging company personnel to exert strong peer pressure on co-workers to conform to expected cultural norms.

8. Holding periodic ceremonies to honor people who excel in displaying the com- pany values and ethical principles.

To deeply ingrain the stated core values and high ethical standards, companies must turn them into strictly enforced cultural norms. They must make it unequivo- cally clear that living up to the company’s values and ethical standards has to be “a way of life” at the company and that there will be little toleration for errant behavior.

The Role of Stories Frequently, a significant part of a company’s culture is captured in the stories that get told over and over again to illustrate to newcomers the importance of certain values and the depth of commitment that various company person- nel have displayed. One of the folktales at Zappos, known for its outstanding customer service, is about a customer who ordered shoes for her ill mother from Zappos, hoping the company would remedy her mother’s foot pain and numbness. When the shoes didn’t work, the mother called the company to ask how to return them and explain why she was returning them. Two days later, she received a large bouquet of flowers from the com- pany, along with well wishes and a customer upgrade giving her free expedited service on all future orders. Specialty food market Trader Joe’s is similarly known for its culture of going beyond the call of duty for its customers. When a World War II veteran was snowed in without any food for meals, his daughter called several supermarkets to see if they offered grocery delivery. Although Trader Joe’s technically doesn’t offer deliv- ery, it graciously helped the veteran, even recommending items for his low-sodium diet. When the store delivered the groceries, the veteran wasn’t charged for either the grocer- ies or the delivery. When Apple’s iPad 2 was launched, one was returned to the company almost immediately, with a note attached that said “Wife said No!”8 Apple sent the cus- tomer a refund, but it also sent back the device with a note reading “Apple says Yes!” Such stories serve the valuable purpose of illustrating the kinds of behavior the company reveres and inspiring company personnel to perform similarly. Moreover, each retelling of a legendary story puts a bit more peer pressure on company personnel to display core values and do their part in keeping the company’s traditions alive.

Forces That Cause a Company’s Culture to Evolve Despite the role of time-honored stories and long-standing traditions in perpetuating a company’s culture, cultures are far from static—just like strategy and organizational structure, they evolve. New challenges in the marketplace, revolutionary technologies, and shift- ing internal conditions—especially an internal crisis, a change in company direction, or top-executive turnover—tend to breed new ways of doing things and, in turn, drive cultural evolution. An incoming CEO who decides to shake up the existing business and take it in new directions often triggers a cultural shift, perhaps one of major pro- portions. Likewise, diversification into new businesses, expansion into foreign coun- tries, rapid growth that brings an influx of new employees, and the merger with or acquisition of another company can all precipitate significant cultural change.

Strong versus Weak Cultures Company cultures vary widely in strength and influence. Some are strongly embed- ded and have a big influence on a company’s operating practices and the behavior of company personnel. Others are weakly ingrained and have little effect on behaviors and how company activities are conducted.

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Strong-Culture Companies The hallmark of a strong-culture company is the dominating presence of certain deeply rooted values, business principles, and behavioral norms that “regulate” the conduct of company personnel and determine the climate of the workplace.9 In strong-culture companies, senior managers make a point of explaining and reiterating why these values, principles, norms, and oper- ating approaches need to govern how the company conducts its business and how they ultimately lead to better business performance. Furthermore, they make a con- scious effort to display these values, principles, and behavioral norms in their own actions—they walk the talk. An unequivocal expectation that company personnel will act and behave in accordance with the adopted values and ways of doing busi- ness leads to two important outcomes: (1) Over time, the professed values come to be widely shared by rank-and-file employees—people who dislike the culture tend to leave—and (2) individuals encounter strong peer pressure from co-workers to observe the culturally approved norms and behaviors. Hence, a strongly implanted corporate culture ends up having a powerful influence on behavior because so many company personnel are accepting of the company’s culturally approved traditions and because this acceptance is reinforced by both management expectations and co-worker peer pressure to conform to cultural norms.

Strong cultures emerge only after a period of deliberate and rather intensive cul- ture building that generally takes years (sometimes decades). Two factors contribute to the development of strong cultures: (1) a founder or strong leader who established core values, principles, and practices that are viewed as having contributed to the success of the company; and (2) a sincere, long-standing company commitment to operating the business according to these established traditions and values. Continuity of leadership, low workforce turnover, geographic concentration, and considerable organizational success all contribute to the emergence and sustainability of a strong culture.10

In strong-culture companies, values and behavioral norms are so ingrained that they can endure leadership changes at the top—although their strength can erode over time if new CEOs cease to nurture them or move aggressively to institute cultural adjustments. The cultural norms in a strong-culture company typically do not change much as strategy evolves, either because the culture constrains the choice of new strategies or because the dominant traits of the culture are somewhat strategy-neutral and compatible with evolving versions of the company’s strategy. As a consequence, strongly implanted cultures provide a huge assist in executing strategy because com- pany managers can use the traditions, beliefs, values, common bonds, or behavioral norms as levers to mobilize commitment to executing the chosen strategy.

Weak-Culture Companies In direct contrast to strong-culture companies, weak-culture companies lack widely shared and strongly held values, principles, and behavioral norms. As a result, they also lack cultural mechanisms for aligning, constraining, and regulating the actions, decisions, and behaviors of company person- nel. In the absence of any long-standing top management commitment to particular values, beliefs, operating practices, and behavioral norms, individuals encounter little pressure to do things in particular ways. Such a dearth of companywide cultural influ- ences and revered traditions produces a work climate where there is no strong employee allegiance to what the company stands for or to operating the business in well-defined ways. While individual employees may well have some bonds of identification with and loyalty toward their department, their colleagues, their union, or their immediate boss, there’s neither passion about the company nor emotional commitment to what it is trying to accomplish—a condition that often results in many employees’ viewing their company as just a place to work and their job as just a way to make a living.

CORE CONCEPT

In a strong-culture company, deeply rooted values and norms of behavior are widely shared and regulate the conduct of the company’s business.

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As a consequence, weak cultures provide little or no assistance in executing strategy because there are no traditions, beliefs, values, common bonds, or behav- ioral norms that management can use as levers to mobilize commitment to executing the chosen strategy. Without a work climate that channels organizational energy in the direction of good strategy execution, managers are left with the options of either using compensation incentives and other motivational devices to mobilize employee commitment, supervising and monitoring employee actions more closely, or trying to establish cultural roots that will in time start to nurture the strategy execution process.

Why Corporate Cultures Matter to the Strategy Execution Process Even if a company has a strong culture, the culture and work climate may or may not be compatible with what is needed for effective implementation of the chosen strat- egy. When a company’s present culture promotes attitudes, behaviors, and ways of doing things that are in sync with the chosen strategy and conducive to first-rate strat- egy execution, the culture functions as a valuable ally in the strategy execution pro- cess. For example, a corporate culture characterized by frugality and thrift prompts employee actions to identify cost-saving opportunities—the very behavior needed for successful execution of a low-cost leadership strategy. A culture that celebrates taking initiative, exhibiting creativity, taking risks, and embracing change is conducive to successful execution of product innovation and technological leadership strategies.11

A culture that is grounded in actions, behaviors, and work practices that are conducive to good strategy implementation supports the strategy execution effort in three ways:

1. A culture that is well matched to the chosen strategy and the requirements of the strategy execution effort focuses the attention of employees on what is most important to this effort. Moreover, it directs their behavior and serves as a guide to their decision making. In this manner, it can align the efforts and decisions of employees throughout the firm and minimize the need for direct supervision.

2. Culture-induced peer pressure further induces company personnel to do things in a manner that aids the cause of good strategy execution. The stronger the cul- ture (the more widely shared and deeply held the values), the more effective peer pressure is in shaping and supporting the strategy execution effort. Research has shown that strong group norms can shape employee behavior even more power- fully than can financial incentives.

3. A company culture that is consistent with the requirements for good strategy exe- cution can energize employees, deepen their commitment to execute the strategy flawlessly, and enhance worker productivity in the process. When a company’s culture is grounded in many of the needed strategy-executing behaviors, employ- ees feel genuinely better about their jobs, the company they work for, and the merits of what the company is trying to accomplish. Greater employee buy-in for what the company is trying to accomplish boosts motivation and marshals organizational energy behind the drive for good strategy execution. An energized workforce enhances the chances of achieving execution-critical performance tar- gets and good strategy execution.

In sharp contrast, when a culture is in conflict with the chosen strategy or what is required to execute the company’s strategy well, the culture becomes a

LO 2

How and why a company’s culture can aid the drive for proficient strategy execution.

A strong culture that encourages actions, behaviors, and work practices that are in sync with the chosen strategy and conducive to good strategy execution is a valuable ally in the strategy execution process.

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stumbling block.12 Some of the very behaviors needed to execute the strategy suc- cessfully run contrary to the attitudes, behaviors, and operating practices embedded in the prevailing culture. Such a clash poses a real dilemma for company personnel. Should they be loyal to the culture and company traditions (to which they are likely to be emotionally attached) and thus resist or be indifferent to actions that will promote better strategy execution—a choice that will certainly weaken the drive for good strat- egy execution? Alternatively, should they go along with management’s strategy execu- tion effort and engage in actions that run counter to the culture—a choice that will likely impair morale and lead to a less-than-enthusiastic commitment to good strategy execution? Neither choice leads to desirable outcomes. Culture-bred resistance to the actions and behaviors needed for good strategy execution, particularly if strong and widespread, poses a formidable hurdle that must be cleared for a strategy’s execution to be successful.

The consequences of having—or not having—an execution-supportive corporate culture says something important about the task of managing the strategy exe- cution process: Closely aligning corporate culture with the requirements for proficient strategy execution merits the full attention of senior executives. The culture-building objective is to create a work climate and style of operating that mobilize the energy of company personnel squarely behind efforts to execute strat- egy competently. The more deeply management can embed execution-supportive ways of doing things, the more management can rely on the culture to automati- cally steer company personnel toward behaviors and work practices that aid good strategy execution and veer from doing things that impede it. Moreover, culturally astute managers understand that nourishing the right cultural environment not only adds power to their push for proficient strategy execution but also promotes strong employee identification with, and commitment to, the company’s vision, performance targets, and strategy.

Healthy Cultures That Aid Good Strategy Execution A strong culture, provided it fits the chosen strategy and embraces execution- supportive attitudes, behaviors, and work practices, is definitely a healthy culture. Two other types of cultures exist that tend to be healthy and largely supportive of good strategy execution: high-performance cultures and adaptive cultures.

High-Performance Cultures Some companies have so-called high- performance cultures where the standout traits are a “can-do” spirit, pride in doing things right, no- excuses accountability, and a pervasive results-oriented work climate in which people go all out to meet or beat stretch objectives.13 In high-performance cultures, there’s a strong sense of involvement on the part of company personnel and emphasis on individual initiative and effort. Performance expectations are clearly delineated for the company as a whole, for each organizational unit, and for each individual. Issues and problems are promptly addressed; there’s a razor-sharp focus on what needs to be done. The clear and unyielding expectation is that all company personnel, from senior executives to frontline employees, will display high-performance behaviors and a passion for making the company successful. Such a culture— permeated by a spirit of achievement and constructive pressure to achieve good results—is a valuable con- tributor to good strategy execution and operating excellence.14

The challenge in creating a high-performance culture is to inspire high loyalty and dedication on the part of employees, such that they are energized to put forth their very

It is in management’s best interest to dedicate considerable effort to establishing a corporate culture that encourages behaviors and work practices conducive to good strategy execution.

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best efforts. Managers have to take pains to reinforce constructive behavior, reward top performers, and purge habits and behaviors that stand in the way of high produc- tivity and good results. They must work at knowing the strengths and weaknesses of their subordinates to better match talent with task and enable people to make mean- ingful contributions by doing what they do best. They have to stress learning from mistakes and must put an unrelenting emphasis on moving forward and making good progress—in effect, there has to be a disciplined, performance-focused approach to managing the organization.

Adaptive Cultures The hallmark of adaptive corporate cultures is willingness on the part of organization members to accept change and take on the challenge of introducing and executing new strategies. Company personnel share a feeling of con- fidence that the organization can deal with whatever threats and opportunities arise; they are receptive to risk taking, experimentation, innovation, and changing strate- gies and practices. The work climate is supportive of managers and employees who propose or initiate useful change. Internal entrepreneurship (often called intrapre- neurship) on the part of individuals and groups is encouraged and rewarded. Senior executives seek out, support, and promote individuals who exercise initiative, spot opportunities for improvement, and display the skills to implement them. Managers

openly evaluate ideas and suggestions, fund initiatives to develop new or better products, and take prudent risks to pursue emerging market opportunities. As in high-performance cultures, the company exhibits a proactive approach to identify- ing issues, evaluating the implications and options, and moving ahead quickly with workable solutions. Strategies and traditional operating practices are modified as needed to adjust to, or take advantage of, changes in the business environment.

But why is change so willingly embraced in an adaptive culture? Why are organization members not fearful of how change will affect them? Why does an adaptive culture not break down from the force of ongoing changes in strategy, operating practices, and behavioral norms? The answers lie in two distinctive and dominant traits of an adaptive culture: (1) Changes in operating practices and

behaviors must not compromise core values and long-standing business principles (since they are at the root of the culture), and (2) changes that are instituted must satisfy the legitimate interests of key constituencies—customers, employees, share- holders, suppliers, and the communities where the company operates. In other words, what sustains an adaptive culture is that organization members perceive the changes that management is trying to institute as legitimate, in keeping with the core val- ues, and in the overall best interests of stakeholders.15 Not surprisingly, company per- sonnel are usually more receptive to change when their employment security is not threatened and when they view new duties or job assignments as part of the process of adapting to new conditions. Should workforce downsizing be necessary, it is impor- tant that layoffs be handled humanely and employee departures be made as painless as possible.

Technology companies, software companies, and Internet-based companies are good illustrations of organizations with adaptive cultures. Such companies thrive on change—driving it, leading it, and capitalizing on it. Companies like Amazon, Google, Apple, Facebook, Adobe, Groupon, Intel, and Yelp cultivate the capability to act and react rapidly. They are avid practitioners of entrepreneurship and innovation, with a demonstrated willingness to take bold risks to create altogether new products, new businesses, and new industries. To create and nurture a culture that can adapt rap- idly to shifting business conditions, they make a point of staffing their organizations

As a company’s strategy evolves, an adaptive culture is a definite ally in the strategy-implementing, strategy-executing process as compared to cultures that are resistant to change.

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with people who are flexible, who rise to the challenge of change, and who have an aptitude for adapting well to new circumstances.

In fast-changing business environments, a corporate culture that is receptive to altering organizational practices and behaviors is a virtual necessity. However, adap- tive cultures work to the advantage of all companies, not just those in rapid-change environments. Every company operates in a market and business climate that is chang- ing to one degree or another and that, in turn, requires internal operating responses and new behaviors on the part of organization members.

Unhealthy Cultures That Impede Good Strategy Execution The distinctive characteristic of an unhealthy corporate culture is the presence of counterproductive cultural traits that adversely impact the work climate and company performance. Five particularly unhealthy cultural traits are hostility to change, heavily politicized decision making, insular thinking, unethical and greed-driven behaviors, and the presence of incompatible, clashing subcultures.

Change-Resistant Cultures Change-resistant cultures—where fear of change and skepticism about the importance of new developments are the norm— place a premium on not making mistakes, prompting managers to lean toward safe, conservative options intended to maintain the status quo, protect their power base, and guard their immediate interests. When such companies encounter business envi- ronments with accelerating change, going slow on altering traditional ways of doing things can be a serious liability. Under these conditions, change-resistant cultures encourage a number of unhealthy behaviors—avoiding risks, not capitalizing on emerging opportunities, taking a lax approach to both product innovation and continu- ous improvement in performing value chain activities, and responding more slowly than is warranted to market change. In change-resistant cultures, word quickly gets around that proposals to do things differently face an uphill battle and that people who champion them may be seen as something of a nuisance or a troublemaker. Executives who don’t value managers or employees with initiative and new ideas put a damper on product innovation, experimentation, and efforts to improve.

Hostility to change is most often found in companies with stodgy bureaucracies that have enjoyed considerable market success in years past and that are wedded to the “We have done it this way for years” syndrome. General Motors, IBM, Sears, Borders, and Eastman Kodak are classic examples of companies whose change-resistant bureau- cracies have damaged their market standings and financial performance; clinging to what made them successful, they were reluctant to alter operating practices and modify their business approaches when signals of market change first sounded. As strategies of gradual change won out over bold innovation, all four lost market share to rivals that quickly moved to institute changes more in tune with evolving market conditions and buyer preferences. While IBM and GM have made strides in building a culture needed for market success, Sears and Kodak are still struggling to recoup lost ground.

Politicized Cultures What makes a politicized internal environment so unhealthy is that political infighting consumes a great deal of organizational energy, often with the result that what’s best for the company takes a backseat to politi- cal maneuvering. In companies where internal politics pervades the work climate,

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empire-building managers pursue their own agendas and operate the work units under their supervision as autonomous “fiefdoms.” The positions they take on issues are usu- ally aimed at protecting or expanding their own turf. Collaboration with other organi- zational units is viewed with suspicion, and cross-unit cooperation occurs grudgingly. The support or opposition of politically influential executives and/or coalitions among departments with vested interests in a particular outcome tends to shape what actions the company takes. All this political maneuvering takes away from efforts to execute strategy with real proficiency and frustrates company personnel who are less political and more inclined to do what is in the company’s best interests.

Insular, Inwardly Focused Cultures Sometimes a company reigns as an industry leader or enjoys great market success for so long that its personnel start to believe they have all the answers or can develop them on their own. There is a strong tendency to neglect what customers are saying and how their needs and expectations are changing. Such confidence in the correctness of how the company does things and an unflinching belief in its competitive superiority breed arrogance, prompting company personnel to discount the merits of what outsiders are doing and to see little payoff from studying best-in-class performers. Insular thinking, internally driven solu- tions, and a must-be-invented-here mindset come to permeate the corporate culture. An inwardly focused corporate culture gives rise to managerial inbreeding and a fail- ure to recruit people who can offer fresh thinking and outside perspectives. The big risk of insular cultural thinking is that the company can underestimate the capabilities of rival companies while overestimating its own—all of which diminishes a compa- ny’s competitiveness over time.

Unethical and Greed-Driven Cultures Companies that have little regard for ethical standards or are run by executives driven by greed and ego gratifi- cation are scandals waiting to happen. Executives exude the negatives of arrogance, ego, greed, and an “ends-justify-the-means” mentality in pursuing overambitious rev- enue and profitability targets.16 Senior managers wink at unethical behavior and may cross over the line to unethical (and sometimes criminal) behavior themselves. They are prone to adopt accounting principles that make financial performance look bet- ter than it really is. Legions of companies have fallen prey to unethical behavior and greed, most notably Turing Pharmaceuticals, Enron, Three Ocean Shipping, BP, AIG, Countrywide Financial, and JPMorgan Chase, with executives being indicted and/or convicted of criminal behavior.

Incompatible, Clashing Subcultures Although it is common to speak about corporate culture in the singular, it is not unusual for companies to have multiple cultures (or subcultures). Values, beliefs, and practices within a company sometimes vary significantly by department, geographic location, division, or business unit. As long as the subcultures are compatible with the overarching corporate culture and are supportive of the strategy execution efforts, this is not problematic. Multiple cultures pose an unhealthy situation when they are composed of incompatible subcultures that embrace conflicting business philosophies, support inconsistent approaches to strat- egy execution, and encourage incompatible methods of people management. Clashing subcultures can prevent a company from coordinating its efforts to craft and execute strategy and can distract company personnel from the business of business. Internal jockeying among the subcultures for cultural dominance impedes teamwork among the company’s various organizational units and blocks the emergence of a collaborative

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approach to strategy execution. Such a lack of consensus about how to proceed is likely to result in fragmented or inconsistent approaches to implementing new strate- gic initiatives and in limited success in executing the company’s overall strategy.

Changing a Problem Culture When a strong culture is unhealthy or otherwise out of sync with the actions and behaviors needed to execute the strategy successfully, the culture must be changed as rapidly as can be managed. This means eliminating any unhealthy or dysfunctional cultural traits as fast as possible and aggressively striving to ingrain new behaviors and work practices that will enable first-rate strategy execution. The more entrenched the unhealthy or mismatched aspects of a company culture, the more likely the culture will impede strategy execution and the greater the need for change.

Changing a problem culture is among the toughest management tasks because of the heavy anchor of ingrained behaviors and attitudes. It is natural for company per- sonnel to cling to familiar practices and to be wary of change, if not hostile to new approaches concerning how things are to be done. Consequently, it takes concerted management action over a period of time to root out unwanted behaviors and replace an unsupportive culture with more effective ways of doing things. The single most vis- ible factor that distinguishes successful culture-change efforts from failed attempts is competent leadership at the top. Great power is needed to force major cultural change and overcome the stubborn resistance of entrenched cultures—and great power is possessed only by the most senior executives, especially the CEO. However, while top management must lead the change effort, the tasks of marshaling support for a new culture and instilling the desired cultural behaviors must involve a company’s whole management team. Middle managers and frontline supervisors play a key role in implementing the new work practices and operating approaches, helping win rank-and- file acceptance of and support for changes, and instilling the desired behavioral norms.

As shown in Figure 12.2, the first step in fixing a problem culture is for top man- agement to identify those facets of the present culture that are dysfunctional and pose obstacles to executing strategic initiatives. Second, managers must clearly define the desired new behaviors and features of the culture they want to create. Third, they must convince company personnel of why the present culture poses problems and why and how new behaviors and operating approaches will improve company performance— the case for cultural reform has to be persuasive. Finally, and most important, all the talk about remodeling the present culture must be followed swiftly by visible, forceful actions to promote the desired new behaviors and work practices—actions that com- pany personnel will interpret as a determined top-management commitment to bring- ing about a different work climate and new ways of operating. The actions to implant the new culture must be both substantive and symbolic.

Making a Compelling Case for Culture Change The way for man- agement to begin a major remodeling of the corporate culture is by selling company personnel on the need for new-style behaviors and work practices. This means mak- ing a compelling case for why the culture-remodeling efforts are in the organization’s best interests and why company personnel should wholeheartedly join the effort to do things somewhat differently. This can be done by:

∙ Explaining why and how certain behaviors and work practices in the current cul- ture pose obstacles to good strategy execution.

LO 3

The kinds of actions management can take to change a problem corporate culture.

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∙ Explaining how new behaviors and work practices will be more advantageous and produce better results. Effective culture-change leaders are good at telling stories to describe the new values and desired behaviors and connect them to everyday practices.

∙ Citing reasons why the current strategy has to be modified, if the need for cultural change is due to a change in strategy. This includes explaining why the new stra- tegic initiatives will bolster the company’s competitiveness and performance and how a change in culture can help in executing the new strategy.

It is essential for the CEO and other top executives to talk personally to per- sonnel all across the company about the reasons for modifying work practices and culture-related behaviors. For the culture-change effort to be successful, frontline supervisors and employee opinion leaders must be won over to the cause, which means convincing them of the merits of practicing and enforcing cultural norms at every level of the organization, from the highest to the lowest. Arguments for new ways of doing things and new work practices tend to be embraced more readily if employees understand how they will benefit company stakeholders (particularly customers, employees, and shareholders). Until a large majority of employees accept the need for a new culture and agree that different work practices and behaviors are called for, there’s more work to be done in selling company personnel on the whys and wherefores of culture change. Building widespread organizational support requires taking every opportunity to repeat the message of why the new work prac- tices, operating approaches, and behaviors are good for company stakeholders and essential for the company’s future success.

FIGURE 12.2 Changing a Problem Culture

Step 1

Step 2

Step 3

Step 4

Identify facets of the present culture that are dysfunctional and impede good

strategy execution

Follow with visible, forceful actions—both substantive and symbolic—to ingrain a new

set of behaviors, practices, and norms

Talk openly about problems with the current culture and make a persuasive case for cultural

reform

Specify clearly what new actions, behaviors, and work practices should characterize the new

culture

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Substantive Culture-Changing Actions No culture-change effort can get very far when leaders merely talk about the need for different actions, behaviors, and work practices. Company executives must give the culture-change effort some teeth by initiating a series of actions that company personnel will see as unmistak- ably indicative of the seriousness of management’s commitment to cultural change. The strongest signs that management is truly committed to instilling a new culture include:

∙ Replacing key executives who are resisting or obstructing needed organizational and cultural changes.

∙ Promoting individuals who have stepped forward to spearhead the shift to a differ- ent culture and who can serve as role models for the desired cultural behavior.

∙ Appointing outsiders with the desired cultural attributes to high-profile positions— bringing in new-breed managers sends an unambiguous message that a new era is dawning.

∙ Screening all candidates for new positions carefully, hiring only those who appear to fit in with the new culture.

∙ Mandating that all company personnel attend culture-training programs to better understand the new culture-related actions and behaviors that are expected.

∙ Designing compensation incentives that boost the pay of teams and individuals who display the desired cultural behaviors. Company personnel are much more inclined to exhibit the desired kinds of actions and behaviors when it is in their financial best interest to do so.

∙ Letting word leak out that generous pay raises have been awarded to individuals who have stepped out front, led the adoption of the desired work practices, dis- played the new-style behaviors, and achieved pace-setting results.

∙ Revising policies and procedures in ways that will help drive cultural change.

Executives must launch enough companywide culture-change actions at the outset to leave no room for doubt that management is dead serious about changing the pres- ent culture and that a cultural transformation is inevitable. Management’s commit- ment to cultural change in the company must be made credible. The series of actions initiated by top management must command attention, get the change process off to a fast start, and be followed by unrelenting efforts to firmly establish the new work practices, desired behaviors, and style of operating as “standard.”

Symbolic Culture-Changing Actions There’s also an important place for symbolic managerial actions to alter a problem culture and tighten the strategy– culture fit. The most important symbolic actions are those that top executives take to lead by example. For instance, if the organization’s strategy involves a drive to become the industry’s low-cost producer, senior managers must display frugality in their own actions and decisions. Examples include inexpensive decorations in the executive suite, conservative expense accounts and entertainment allowances, a lean staff in the corporate office, scrutiny of budget requests, few executive perks, and so on. At Walmart, all the executive offices are simply decorated; executives are habitually frugal in their own actions, and they are zealous in their efforts to control costs and promote greater efficiency. At Nucor, one of the world’s low-cost produc- ers of steel products, executives fly coach class and use taxis at airports rather than limousines. Top executives must be alert to the fact that company personnel will be watching their behavior to see if their actions match their rhetoric. Hence, they need

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to make sure their current decisions and actions will be construed as consistent with the new cultural values and norms.17

Another category of symbolic actions includes holding ceremonial events to single out and honor people whose actions and performance exemplify what is called for in the new culture. Such events also provide an opportunity to celebrate each culture- change success. Executives sensitive to their role in promoting strategy–culture fit make a habit of appearing at ceremonial functions to praise individuals and groups that exemplify the desired behaviors. They show up at employee training programs to stress strategic priorities, values, ethical principles, and cultural norms. Every group gathering is seen as an opportunity to repeat and ingrain values, praise good deeds, expound on the merits of the new culture, and cite instances of how the new work practices and operating approaches have produced good results.

The use of symbols in culture building is widespread. Numerous businesses have employee-of-the-month awards. The military has a long-standing custom of award- ing ribbons and medals for exemplary actions. Mary Kay Cosmetics awards an array of prizes ceremoniously to its beauty consultants for reaching various sales plateaus, including the iconic pink Cadillac.

How Long Does It Take to Change a Problem Culture? Planting the seeds of a new culture and helping the culture grow strong roots require a deter- mined, sustained effort by the chief executive and other senior managers. Changing a problem culture is never a short-term exercise; it takes time for a new culture to emerge and take root. And it takes even longer for a new culture to become deeply embedded. The bigger the organization and the greater the cultural shift needed to produce an execution-supportive fit, the longer it takes. In large companies, fixing a problem culture and instilling a new set of attitudes and behaviors can take two to five years. In fact, it is usually tougher to reform an entrenched problematic culture than it is to instill a strategy-supportive culture from scratch in a brand-new organization.

Illustration Capsule 12.2 discusses the approaches used at América Latina Logística (ALL) to change a culture that was grounded in antiquated practices and bureaucratic management.

LO 4

What constitutes effective managerial leadership in achieving superior strategy execution.

For an enterprise to execute its strategy in truly proficient fashion, top executives must take the lead in the strategy implementation process and personally drive the pace of progress. They have to be out in the field, seeing for themselves how well operations are going, gathering information firsthand, and gauging the progress being made. Pro- ficient strategy execution requires company managers to be diligent and adept in spot- ting problems, learning what obstacles lay in the path of good execution, and then clearing the way for progress—the goal must be to produce better results speedily and productively. There must be constructive, but unrelenting, pressure on organizational units to (1) demonstrate excellence in all dimensions of strategy execution and (2) do so on a consistent basis—ultimately, that’s what will enable a well-crafted strategy to achieve the desired performance results.

The specifics of how to implement a strategy and deliver the intended results must start with understanding the requirements for good strategy execution. After- ward comes a diagnosis of the organization’s preparedness to execute the strategic initiatives and decisions on how to move forward and achieve the targeted results.18

LEADING THE STRATEGY EXECUTION PROCESS

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ILLUSTRATION CAPSULE 12.2

For many, a steam-engine locomotive’s stocky profile, bil- lowing exhaust, and hiss evoke nostalgia for a bygone era. For the managers at América Latina Logística (ALL), which had just acquired the southern freight lines of the Brazilian Rail Network (RFFSA), such antiquated locomo- tives represented the difficulties they faced in fixing their ailing railroad system, of which RFFSA was just a piece.

At the time of this acquisition, ALL was losing money, struggling from decades of underinvestment, and encumbered by bureaucratic management. Half the network’s bridges required repairs, over three-quarters of its rails were undersized for supporting standard- sized loads, and the system still relied on 20 steam- engine locomotives to move industrial customers’ cargo.

CEO Alexandre Behring’s priority was to trans- form ALL into a performance-oriented organization with the strong cost discipline necessary to support an overdue modernization program. He decided that this would require a complete cultural transformation for the

company. His first step was to recruit a new management team and fire the dozens of political appointees previ- ously administering the railroad. In his first 10 days, he and his COO interviewed the top-150 managers to evaluate their suitability. They selected 30 for additional respon- sibility and removed those who did not embrace the new direction. The company established a trainee program, and in four years hired 500 recent college graduates. In Behring’s first year, he introduced a performance-based bonus program; in his second year, the company began comparing performance on operational indicators like car utilization and on-time delivery between divisions.

The top managers also took symbolic steps to demonstrate their commitment to the new culture and to reinforce the personnel and process changes they implemented. They sold cars previously reserved for officers’ use and fired the chauffeurs retained to drive them. Behring became certified as a train conductor and spent a week each month working in the field, wearing the conductor uniform. For the first time, managers vis- ited injured workers at home. The company created the “Diesel Cup” to recognize conductors who most effec- tively reduced fuel consumption.

Behring’s new direction energized the company’s middle managers and line employees, who had been demoralized after years of political interference and inef- fectual leadership. In three years Behring transformed a company that hadn’t made a hire in over a decade into one of the most desirable employers in Brazil, attracting 9,000 applications for 18 trainee positions. In 2000 ALL finally achieved profitability, enabled by the company’s cultural transformation. ALL merged with Rumo Logistics in 2014 to create Latin America’s largest railway and logistics company.

Culture Transformation at América Latina Logística

Note: Developed with Peter Jacobson.

Sources: Company website, pt.all-logistica.com; www.strategy-business.com/article/ac00012?pg=1; blogs.hbr.org/2012/09/shape- strategy-with-simple-rul/; Donald N. Sull, Fernando Martins, and Andre Delbin Silva, “America Latina Logistica,” Harvard Business School case 9-804-139, January 14, 2004.

In general, leading the drive for good strategy execution and operating excellence calls for three actions on the part of the managers in charge:

∙ Staying on top of what is happening and closely monitoring progress. ∙ Putting constructive pressure on the organization to execute the strategy well and

achieve operating excellence. ∙ Initiating corrective actions to improve strategy execution and achieve the targeted

performance results.

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Staying on Top of How Well Things Are Going To stay on top of how well the strategy execution process is going, senior executives have to tap into information from a wide range of sources. In addition to commu- nicating regularly with key subordinates and reviewing the latest operating results, watching the competitive reactions of rival firms, and visiting with key customers and suppliers to get their perspectives, they usually visit various company facilities and talk with many different company personnel at many different organizational levels—a technique often labeled management by walking around (MBWA). Most managers attach great importance to spending time with people at company facilities, asking questions, listening to their opinions and concerns, and gathering firsthand information about how well aspects of the strategy execution process are going. Facili- ties tours and face-to-face contacts with operating-level employees give executives a good grasp of what progress is being made, what problems are being encountered, and whether additional resources or different approaches may be needed. Just as impor- tant, MBWA provides opportunities to give encouragement, lift spirits, focus attention on key priorities, and create some excitement—all of which generate positive energy and help boost strategy execution efforts.

The late Steve Jobs, famed cofounder of Apple, was noted for his practice of MBWA as CEO, spending a considerable amount of time on the floor with his employ- ees every day. Walmart executives have had a long-standing practice of spending two to three days every week visiting Walmart’s stores and talking with store managers and employees. Sam Walton, Walmart’s founder, insisted, “The key is to get out into the store and listen to what the associates have to say.” Jack Welch, the highly effective former CEO of General Electric, not only spent several days each month personally visiting GE operations and talking with major customers but also arranged his sched- ule so that he could spend time exchanging information and ideas with GE managers from all over the world who were attending classes at the company’s leadership devel- opment center near GE’s headquarters.

Many manufacturing executives make a point of strolling the factory floor to talk with workers and meeting regularly with union officials. Some managers operate out of open cubicles in big spaces filled with open cubicles for other personnel so that they can interact easily and frequently with co-workers. Managers at some companies host weekly get-togethers (often on Friday afternoons) to create a regular opportunity for information to flow freely between down-the-line employees and executives.

Mobilizing the Effort for Excellence in Strategy Execution Part of the leadership task in mobilizing organizational energy behind the drive for good strategy execution entails nurturing a results-oriented work climate, where per- formance standards are high and a spirit of achievement is pervasive. Successfully leading the effort is typically characterized by such leadership actions and managerial practices as:

∙ Treating employees as valued partners. Some companies symbolize the value of individual employees and the importance of their contributions by referring to them as cast members (Disney), crew members (McDonald’s), job owners ( Graniterock), partners (Starbucks), or associates (Walmart, LensCrafters, W. L. Gore, Edward Jones, Publix Supermarkets, and Marriott International). Very often,

CORE CONCEPT

Management by walking around (MBWA) is one of the techniques that effective leaders use to stay informed about how well the strategy execution process is progressing.

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there is a strong company commitment to training each employee thoroughly, offering attractive compensation and benefits, emphasizing promotion from within and promising career opportunities, providing a high degree of job security, and otherwise making employees feel well treated and valued.

∙ Fostering an esprit de corps that energizes organization members. The task here is to skillfully use people-management practices calculated to build morale, foster pride in working for the company, promote teamwork and collaborative group effort, win the emotional commitment of individuals and organizational units to what the company is trying to accomplish, and inspire company personnel to do their best in achieving good results.19

∙ Using empowerment to help create a fully engaged workforce. Top executives— and, to some degree, the enterprise’s entire management team—must seek to engage the full organization in the strategy execution effort. A fully engaged workforce, where individuals bring their best to work every day, is necessary to produce great results.20 So is having a group of dedicated managers committed to making a difference in their organization. The two best things top-level execu- tives can do to create a fully engaged organization are (1) delegate authority to middle and lower-level managers to get the strategy execution process moving and (2) empower rank-and-file employees to act on their own initiative. Operating excellence requires that everybody contribute ideas, exercise initiative and cre- ativity in performing his or her work, and have a desire to do things in the best possible manner.

∙ Setting stretch objectives and clearly communicating an expectation that com- pany personnel are to give their best in achieving performance targets. Stretch objectives—those beyond an organization’s current capacities—can sometimes spur organization members to increase their resolve and redouble their efforts to execute the strategy flawlessly and ultimately reach the stretch objectives. When stretch objectives are met, the resulting pride of accomplishment boosts employee morale and acts to spur continued drive to “overachieve” and perform at an excep- tionally high level.

∙ Using the tools of benchmarking, best practices, business process reengineering, TQM, and Six Sigma to focus attention on continuous improvement. These are proven approaches to getting better operating results and facilitating better strat- egy execution.

∙ Using the full range of motivational techniques and compensation incentives to inspire company personnel, nurture a results-oriented work climate, and reward high performance. Managers cannot mandate innovative improvements by simply exhorting people to “be creative,” nor can they make continuous progress toward operating excellence with directives to “try harder.” Rather, they must foster a cul- ture where innovative ideas and experimentation with new ways of doing things can blossom and thrive. Individuals and groups should be strongly encouraged to brainstorm, let their imaginations fly in all directions, and come up with pro- posals for improving the way that things are done. This means giving company personnel enough autonomy to stand out, excel, and contribute. And it means that the rewards for successful champions of new ideas and operating improvements should be large and visible. It is particularly important that people who champion an unsuccessful idea are not punished or sidelined but, rather, encouraged to try again. Finding great ideas requires taking risks and recognizing that many ideas won’t pan out.

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∙ Celebrating individual, group, and company successes. Top management should miss no opportunity to express respect for individual employees and apprecia- tion of extraordinary individual and group effort.21 Companies like Google, Mary Kay, Tupperware, and McDonald’s actively seek out reasons and opportunities to give pins, ribbons, buttons, badges, and medals for good showings by average performers—the idea being to express appreciation and give a motivational boost to people who stand out in doing ordinary jobs. At Kimpton Hotels, employees who create special moments for guests are rewarded with “Kimpton Moment” tokens that can be redeemed for paid days off, gift certificates to restaurants, flat-screen TVs, and other prizes. Cisco Systems and 3M Corporation make a point of ceremo- niously honoring individuals who believe so strongly in their ideas that they take it on themselves to hurdle the bureaucracy, maneuver their projects through the sys- tem, and turn them into improved services, new products, or even new businesses.

While leadership efforts to instill a results-oriented, high-performance culture usu- ally accentuate the positive, negative consequences for poor performance must be in play as well. Managers whose units consistently perform poorly must be replaced. Low- performing employees must be weeded out or at least employed in ways better suited to their aptitudes. Average performers should be candidly counseled that they have limited career potential unless they show more progress in the form of additional effort, better skills, and improved ability to execute the strategy well and deliver good results.

Leading the Process of Making Corrective Adjustments There comes a time at every company when managers have to fine-tune or overhaul the approaches to strategy execution since no action plan for executing strategy can foresee all the problems that will arise. Clearly, when a company’s strategy execution effort is not delivering good results, it is the leader’s responsibility to step forward and initiate corrective actions, although sometimes it must be recognized that unsatisfactory perfor- mance may be due as much or more to flawed strategy as to weak strategy execution.22

Success in making corrective actions hinges on (1) a thorough analysis of the situ- ation, (2) the exercise of good business judgment in deciding what actions to take, and (3) good implementation of the corrective actions that are initiated. Successful manag- ers are skilled in getting an organization back on track rather quickly. They (and their staffs) are good at discerning what actions to take and in bringing them to a successful conclusion. Managers who struggle to show measurable progress in implementing cor- rective actions in a timely fashion are candidates for being replaced.

The process of making corrective adjustments in strategy execution varies accord- ing to the situation. In a crisis, taking remedial action quickly is of the essence. But it still takes time to review the situation, examine the available data, identify and eval- uate options (crunching whatever numbers may be appropriate to determine which options are likely to generate the best outcomes), and decide what to do. When the situation allows managers to proceed more deliberately in deciding when to make changes and what changes to make, most managers seem to prefer a process of incre- mentally solidifying commitment to a particular course of action.23 The process that managers go through in deciding on corrective adjustments is essentially the same for both proactive and reactive changes: They sense needs, gather information, broaden and deepen their understanding of the situation, develop options and explore their pros and cons, put forth action proposals, strive for a consensus, and finally formally adopt

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an agreed-on course of action. The time frame for deciding what corrective changes to initiate can be a few hours, a few days, a few weeks, or even a few months if the situa- tion is particularly complicated.

The challenges of making the right corrective adjustments and leading a successful strategy execution effort are, without question, substantial.24 There’s no generic, by-the- books procedure to follow. Because each instance of executing strategy occurs under different organizational circumstances, the managerial agenda for executing strategy always needs to be situation-specific. But the job is definitely doable. Although there is no prescriptive answer to the question of exactly what to do, any of several courses of action may produce good results. As we said at the beginning of Chapter 10, execut- ing strategy is an action-oriented, make-the-right-things-happen task that challenges a manager’s ability to lead and direct organizational change, create or reinvent business processes, manage and motivate people, and achieve performance targets. If you now better understand what the challenges are, what tasks are involved, what tools can be used to aid the managerial process of executing strategy, and why the action agenda for implementing and executing strategy sweeps across so many aspects of managerial work, then the discussions in Chapters 10, 11, and 12 have been a success.

A FINAL WORD ON LEADING THE PROCESS OF CRAFTING AND EXECUTING STRATEGY In practice, it is hard to separate leading the process of executing strategy from lead- ing the other pieces of the strategy process. As we emphasized in Chapter 2, the job of crafting and executing strategy consists of five interrelated and linked stages, with much looping and recycling to fine-tune and adjust the strategic vision, objectives, strategy, and implementation approaches to fit one another and to fit changing circumstances. The process is continuous, and the conceptually separate acts of crafting and executing strategy blur together in real-world situations. The best tests of good strategic leadership are whether the company has a good strategy and business model, whether the strategy is being competently executed, and whether the enterprise is meeting or beating its per- formance targets. If these three conditions exist, then there is every reason to conclude that the company has good strategic leadership and is a well-managed enterprise.

KEY POINTS

1. Corporate culture is the character of a company’s internal work climate—the shared values, ingrained attitudes, core beliefs and company traditions that deter- mine norms of behavior, accepted work practices, and styles of operating. A com- pany’s culture is important because it influences the organization’s actions, its approaches to conducting business, and ultimately its performance in the market- place. It can be thought of as the company’s organizational DNA.

2. The key features of a company’s culture include the company’s values and eth- ical standards, its approach to people management, its work atmosphere and

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