Are Managers Obsolete?

Open Boundaries: Creating Business Innovation Through Complexity Howard Sherman and Ron Schultz Reading, Mass.: Perseus Books, 1998 There have always been two schools of thought about the rise and fall of corporations. Most of us who read HBR believe that the quality of management has the most to do with a business’s fate. Companies that last do so because the managers who run them are exceptionally good at what they do. They make better decisions and build better organizations than most managers. Through clear thinking and concerted effort, they achieve and maintain competitive advantage despite the vagaries of the marketplace. The decision tree is a good icon for this “management works” school, and Peter Drucker is a leading voice. The opposing view is that, while good management may make a difference for a short time, a company’s fate is determined by forces outside management’s control. Managers cannot predict which business strategies or product platforms will survive. At best, they can try to innovate or scramble to adapt. All companies will die, just at different times. In other words, it’s the system, not management, that dominates. “Creative destruction” is the watchword for this school, and Joseph Schumpeter is its prophet. Many economists, venture capitalists, and Darwinian business thinkers belong to this school. Complexity theory, part of a wave of thinking focused on the “new economy,” is the latest version of the belief that systems dominate. Complexity theory comes to business by way of biology and ecology, where scientists have struggled with a problem familiar to business thinkers: how to understand the behavior of large, complex systems. To put it simply, complex systems are phenomena that can’t be explained by the usual rules of nature. Business strategists, like scientists, have broken down many kinds of complex systems in their efforts to understand the elements and the forces that influence them. The trouble comes in figuring out how all the forces and elements interact to shape an overall system and determine its often surprising outcomes. That is as difficult to do for competitive marketplaces as it is for animal habitats or climate patterns. Seemingly minor events, for example, can have enormous consequences because of the chain of reactions they set off. This difficulty in predicting outcomes is a major problem for advocates of management. If management determines a company’s fate, then why don’t good management, sound strategy, and plenty of resources guarantee strong performance or even survival? Why is it that few public companies outperform the Standard & Poor’s 500 Index for more than a decade or two? And why is it that, as businesses globalize and industry boundaries dissolve, traditional elements of strategy and competitive advantage—distribution systems, production capabilities, even brands—no longer protect established players from talented, radical new entrants? In response to these questions, the advocates of management argue that we should expect some casualties among traditionally strong players. Some managers are better at coping with change than others, and some industries are particularly unstable. Complexity theorists reject that explanation, saying that radical uncertainty is not limited to certain industries—it’s now endemic. Companies that are managed in the traditional way—by executives developing analytically driven strategy and shaping the organization to meet the needs of the business as they see them—are obsolete. Management as we have known it is too cumbersome for today’s fast, unpredictable pace. A new kind of company wins now. The best management models don’t adapt to the new economy; they emerge from it. It’s no longer the survival of the fittest; it’s the arrival of the fittest. Complexity theorists say that radical uncertainty is not limited to certain industries—it’s now endemic. This is the view laid out by Howard Sherman and Ron Schultz in their book Open Boundaries. Both are fellows at the Santa Fe Center for Emergent Strategies in New Mexico. (This center collaborates with but is not formally a part of the Santa Fe Institute, which has done much to develop complexity theory in the sciences.) The book will make readers rethink their assumptions about how competition works and how much managers truly understand the flow of business. Readers may find it fairly abstract, but it does provide an engaging way to think about management. The authors argue that business today is not only faster but also fundamentally different: it moves in a nonlinear fashion. There is no continuity in the flow of competitive events (except perhaps in retrospect), and there is no way to predict which products or companies will succeed. Competitive advantage is fleeting; technology and markets change so frequently and radically that yesterday’s assets become today’s dead weight. Look, for example, at what the CD-ROM did to Encyclopedia Britannica or how deregulation is transforming the electric utility business. This shift to a nonlinear world has two major implications, according to the authors. First, business structures work best when they are self-organized. Rather than impose shape upon the organization, managers should simply allow the organization of people and effort to evolve in response to ongoing messages from customers. Markets, like other complex systems, reflect the intricacies of many low-level interactions. No intelligence from on high can match the quality of solutions to market problems that arise from players who are constantly communicating with one another on the ground level. The invisible hand of the marketplace should displace the visible hand of the manager. The markets can determine where one team or initiative or company ends and another begins. Managers interfere at their peril. Second, strategy should be “emergent.” Companies can’t plan ahead—they must allow their strategies to emerge out of current conditions. If managers try to map out strategies beforehand, they’ll simply end up driving by their rearview mirror. Even scenario building has little value. Since everything in the economy is evolving simultaneously, affecting everything else in unpredictable ways, it’s dangerous to make any assumptions. Sherman and Schultz are right about the direction business is going in. Managers are being cut adrift from many of their traditional moorings. The heightened pace of change is forcing them to rely more on instinct and intuition. And with organization and strategy increasingly set by people on the ground rather than at the top, managers’ roles are changing. But all three of these concepts—nonlinearity, self-organization, and emergent strategy—have important limitations that show the continued primacy of good management. Let’s consider each one in turn. Competing in a Nonlinear World Because companies now operate in a nonlinear world, the value of a business lies increasingly in its ability to capture information and generate new ideas, according to Sherman and Schultz. Analysts have traditionally valued businesses by calculating the net cash flow generated by their assets. But if new entrants can suddenly make a company’s assets obsolete, those assets are no longer useful even in describing how a business works, let alone in valuing a company. This is particularly true of material assets—good information about market demand, for example, can render most inventory unnecessary. But even such intangible assets as brands can lose their competitive strength. This need to capture new information has far-reaching effects. Japan’s banks, for example, are in trouble not just because they made too many bad real estate loans but, more important, because they know how to evaluate only hard assets like buildings and machinery. So they make loans only on the basis of those assets. They don’t have experience with evaluating “soft” credits that have to be managed according to probabilities, as U.S. banks and venture capitalists do. Today’s risk assessments are all about the flow of information. Accordingly, Sherman and Schultz argue that a company should aim to maximize its information and minimize its infrastructure. Information, as they define it, is not just data but “the gathering of patterns, and ways of informing and learning.” Infrastructure is “everything from physical support systems and physical structures to philosophical constraints and preconceptions.” That is, information is everything that helps create new ideas; infrastructure is everything that can get in the way. Their point is typical of the sort of advice coming from other enthusiasts of the new economy. It provokes both interest and skepticism from readers. Yes, it’s good to learn new maps of your world and discard old ways of thinking that slow you down, but how is it that companies with old mind-sets sometimes prevail over au courant competitors? Some U.S. banks didn’t follow their competitors’ “smart money” move into real estate in the 1980s, but they looked smarter in the end. They held back because of an old-fashioned idea about staying with manageable and appropriately sized credits. Similarly, Warren Buffet’s infrastructure of investment guidelines hasn’t changed much in 20 years, and it still brings extraordinary returns. Too much writing on the new economy implies that there is only one way to run a company today—with flat organizations, open work-spaces, and other elements designed to promote maximum flexibility. But ideas can flourish in a variety of settings. Execution is as essential as ideas, and companies that execute exceptionally well often have deep, established infrastructures. At Emerson Electric, a formal, planning-intensive, highly goal-driven style has helped the company achieve 41 consecutive years of annual earnings increases. Lucent Technologies relies on an old-fashioned collegiality and a complicated, multidimensional organization to compete successfully in the complex, fast-moving business of large, customized telecom systems. Even as the writers on the new economy celebrate freshness and flexibility in companies, they undervalue the lessons of experience. Even as the writers on the new economy celebrate freshness and flexibility in companies, they undervalue the lessons of experience. Still, the information-to-infrastructure message has real merit. Companies do become prisoners of their mind-sets and internal systems, causing them to shut off the flow of learning that otherwise might go on naturally. The authors tell a simple story about bottom-up learning at a Supercuts franchise in Corpus Christi, Texas. The new owner wanted to know whether staying open longer hours would be more profitable. Analysis and surveys did not give a clear answer, so the owner decided to allow the staff of stylists to experiment for a while. Each stylist could open the shop during off-hours when he or she had a hunch there would be traffic; the stylist would then receive a percentage of the take during that time. Usually the stylist would spread the word about the odd hours through friends and posters. The owner and staff then observed which times worked and which didn’t and set the hours accordingly. Business improved, and the staff’s morale went up. Marketing efforts grew at little cost to the business. The authors are not arguing for sophisticated information management systems. They emphasize a simple cognitive process: try something and see what happens. This is the watchword of the new economy and the core of its case against hierarchy and analysis. The Limits of Self-Organization But even Sherman and Schultz recognize that companies do not live by experimentation alone; they must also be managed. Just what do the authors want managers to do? Not surprisingly, minimal tasks: finding good people and plugging them into self-organizing teams. As demands on the business change, workers will form teams on their own to take on the most critical problems or the most demanding customers. Management can be flat in structure and decisions can be made collaboratively—some companies might even rotate a few people through the position of chief executive. Both the reporting structure and the incentives can be simple, with little emphasis on supervising. The authors assume that people in this model are standard-issue new economy types—bright, motivated, and able to work well in teams—and thus need less management than the workers in stratified, control-oriented companies. This assumption, unfortunately, is wrong. The combination of fast-growing, entrepreneurial companies and smart, mobile, ambitious workers creates a workplace that is often more fragile than its industrial predecessors. It demands more, not less, management of people. The new workplace is different because it is both high-stakes and collaborative. People think they can get rich, but they know it will take a lot of working together. If research shows anything about the origins of superior ideas, it’s that they come from collaboration. But any one of several difficulties can undermine collaborative efforts: conflict between individuals that goes unresolved, nonperformers who want too much credit, or strong performers who want too much of a reward and threaten to leave. People often clash over where and how fast the business is changing. And the going gets especially tough when competitors’ ideas are closing in and the company’s stock price is dropping. When an entrepreneurial company is new, it is typically led by energetic founders who have a clear, unique vision. It comes as close to self-organization as a company ever will. But as it grows, the founders’ vision often blurs, providing less of a focus for people’s efforts. The company’s effectiveness will diminish unless it is actively managed. If a high-performance group is going to stick together as it grows, its senior people need to pay attention to selecting and nurturing the best talent, setting the right rules for the organization, wiring people into the right networks, distributing the rewards properly, resolving conflicts, and ushering out the wrong people. And whether you call this the work of managers or leaders, it’s the same work. Like other revolutionaries, Sherman and Schultz tend to idealize the organizations they celebrate. Power struggles are as likely at virtual companies as they are at traditional ones like Citigroup. The new companies most likely to succeed are made up of strong-willed, talented people—the very people most likely to leave if the group goes off course. Complexity theorists can argue that when that happens companies are still self-organizing—they divide into more enterprises with more ideas. Let the best enterprises prevail! But managers know better. There is a huge difference between companies and value chains reorganizing into smaller, focused, more effective pieces and companies losing critical mass before fully exploiting their promising ideas. Some people in the business world have never worked with a great manager, while others have. This great divide may help explain why some people believe in good management and others do not; you have to see good management up close to know how it makes a difference. Mediocre managers may be the least likely to believe in great management because they can’t imagine what it involves. Good managers care about their people, talk to many different sources to find out what’s going on, and see further ahead than others about how courses of action might play out. They then use this acuity to develop practices that are well suited to the situation they are trying to improve. It takes good managers doing this every day to keep a company effective as it grows larger and more complex. Good managers can also lead the way in rescuing an ailing company before the “system” recycles it. Sherman and Schultz seem to believe that companies have only one chance at success: either a company’s approach works with the emerging system, or it falls apart and its pieces reassemble into better combinations. Maybe that’s because complexity theory began as a way to describe phenomena like the weather or an ecosystem. Clouds and animals aren’t reflective; they just react to whatever the system throws at them. But in business, people consciously seek value. Even in the fastest-paced industries, companies such as Dell have been able to recover from big mistakes and go on to great success. Complexity theorists probably downplay managerial initiative because they think companies are always self-organizing. But consider Thermo Electron and Chrysler, two very different companies whose success can be traced in large part to great management creativity. Thermo Electron, a maker of industrial and biomedical instruments, was a successful high-tech start-up that began in the late 1950s. Its founder, former MIT professor George Hatsopoulos, favored a close-to-the-action, entrepreneurial management style. He probably saw the world much like the complexity theorists do. But in the 1980s, as the company kept spawning more high-potential businesses and became a billion-dollar company, he faced two problems: how to motivate managers to take appropriate risks and how to raise capital to fund new ventures. Simply decentralizing management or taking the entire company to the new equity markets looked inadequate. So he began to spin off core businesses one at a time, with the parent company retaining a majority interest in each. The parent retained the role of chief financial officer for all the companies and has continued to do so. Hatsopoulos’s solution relied a good deal on self-organization. Each subsidiary’s management team now owns a part of the company it leads and is rewarded directly by the market, thus avoiding the politics of corporate compensation setting. By handling its own stock issues and acquisitions, each subsidiary takes over the task of capital allocation from the corporation and speeds up the acquisition process. Employees can apply for positions anywhere within the Thermo Electron group, which helps talent go where it’s most needed. The solution harnesses the power of bottom-up value creation in the modern economy. Yet it retains the advantages of a large company—leveraging research and development; keeping restless, bright managers in the group by offering them alternatives; and trading on the corporation’s financial experience. This unusual combination of the strengths of both the self-organized and the corporate models was a management idea; it did not just emerge. Teams didn’t come up with it on their own. They needed great managers to develop it—and at the right time. Chrysler’s success in the 1990s also depended on timely management ideas, though it faced the opposite problem from Thermo Electron. Unlike the industrial and biomedical instruments business, there are no successful small automobile companies. The business demands both large scale and a high degree of coordination, and that was Chrysler’s problem. As Chrysler grew rapidly after the introduction of its minivan, key people were losing touch with one another. Different organizational units were working at cross-purposes, and old management systems were strained. Chrysler’s leaders decided to address these problems not by changing the organization or incentive structures—the tack that auto companies usually take—but by changing the roles of senior managers. They put most senior people in charge of both a functional organization and a product group. The vice president of procurement and supply, for example, might also be in charge of the large-car platform. After all, the classic tension in auto companies is between functions and vehicle groups, so why not bring them together? Complexity theorists might have preferred to let the tensions drift down to self-managing, cross-organizational teams below. Chrysler’s solution managed the big conflicts and trade-offs more effectively, and it created a group of more capable managers and role models. The Challenges of Emergent Strategy One of the primary roles of managers has always been to set a course for the enterprise. The definition of strategy has been in flux for a long time, but complexity theory provides perhaps the most thoroughgoing critique of traditional analytically based strategy development. If the only reliable strategy is an emergent one, then most of the goal-oriented thinking currently at the heart of strategy development is counterproductive. Complexity theory elegantly reminds us of something we know but don’t always remember—that we can’t depend on any analytic construction of the future. As soon as we and other players act on the future, we alter it in unpredictable ways. Sherman and Schultz, like some other new-economy thinkers, believe that emergent strategy is the solution. It is strategy finally rid of its self-deception, they contend. But emergent strategy is not the solution, it is the problem. Managers know that the world shifts beneath their feet every day, but they also know that their company’s evolving, improvised responses may not be enough. Most businesses do not move so fast that foresight, commitment, preemption, deterrence, and other traditional elements of strategy have lost their ability to build value. So management groups press on, periodically pulling together what they and the people to whom they listen have learned in order to update their plans. The emergent nature of their business doesn’t keep them from planning. It just makes the process harder and results more uncertain. Industries actually have widely varying degrees of stability. At one extreme are those such as the mainframe computer industry, where new players must confront the barriers of an entrenched set of standards and the high cost of switching. Here, such traditional concepts as market segmentation, economies of scale, and preemptive investment still matter a lot. Mainframe computers are not immune to change—witness the minicomputer and PC revolutions—but there are periods of considerable stability. In the middle of the spectrum are businesses like branded consumer goods and health care. Substitution risks range from modest to high, and new players can displace established enterprises—but not overnight. Competitive advantage increasingly depends on capabilities, network relationships, and other factors subject to discontinuity. But established frameworks based on such ideas as core competency, game theory, building competitive barriers, discovery of customer needs through analysis, and value-chain management are still useful within limits. Most industries are here in this middle ground and may well remain here for a long time. At the other extreme lies turbulence—a constant risk of substitution, and networks of players whose positions and prospects change suddenly and unpredictably. Complexity theory’s concepts of fluid boundaries and self-organization are the right way to understand what’s going on. Many Internet businesses are located at this end of the spectrum. Strategy must indeed be emergent in these industries. Managers have neither the time nor the knowledge to analyze market positioning, build capabilities, or make financial projections. What, then, do companies caught in such turbulence use as their strategic levers? The answer is surprisingly familiar—they look for ways to influence the performance of their people in order to distinguish their enterprise from others. Competition is all about new ideas, as it is in these turbulent businesses, so the strategic imperative becomes creating the right conditions for thinking and learning. As I said before, select and nurture the best talent, set the right rules for the organization, wire people into appropriate networks, distribute rewards properly, resolve conflicts, and usher out the wrong people. Do these better than competitors do. Even if the future is unpredictable, strategists aren’t helpless. As Alan Kay, head of R&D at Disney Imagineering, says, “The best way to predict the future is to invent it.” Inventing the future involves imagining a set of possibilities and going after them. Of course, other companies in the same general area, or groups soon to be companies, will be doing the same thing. The game will once again come down to which management group has done the best job of pursuing the targeted possibility—even while knowing that the possibility may be a mirage. If you do that better than your rivals, your chances of winning are greater. Emergent competition favors the prepared company just as science favors the prepared mind, though there are no guarantees in either case. In the end, turbulent businesses are a lot like those operating in the old economy: better managers and strategists will win more often. Their victories may not last as long as before, but the games will involve contests of will and brains between one company’s leaders and another’s. Even amid complexity, companies will have to make hard choices that commit them in a particular direction. They will try to prevail over changing forces. They will push the data and their intuitions as hard as they can and then make their uncomfortably large investments. And if I had to bet, I’d bet on the group who believes in the importance of management.

Are Managers Obsolete?

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