Make Markets inside the firm - The indirect route to improve agility and innovation

An entrepreneurial spirit captures the imagination of employees and serves as an engine of innovation. Hierarchy can lead to bureaucracy and risk aversion and limited innovation. In this intriguing article, Jules Goddard describes a number of ways to redesign hierarchical organisations to release the internal entrepreneur

On a recent business leadership programme at London Business School, a senior executive of one of Britain’s major engineering companies described two different internal cultures in his organisation, each triggered by a different set of circumstances: one (the ‘default’ culture) was rational, structured, process-centric, rule-bound, careful, risk-averse, deferential and compliant; the other, when there was a crisis of some sort, was emotional, spontaneous, problemcentric, improvisational, courageous, communitarian and entrepreneurial.

I am paraphrasing his colourful description of how he and his colleagues would ‘flip’ from one behavioural style to another: ‘When a crisis strikes and the reputation of the firm is at stake, we throw away the rule book; we dispense with procedure; compliance loses its hold on us; and personal fear of failure ceases to cramp our style.

‘We’re no longer “managers” or “bosses” or “process owners” or “function heads”, we’re problem-solvers, team-players, and human beings. We take our lead from the problem in hand, not from the command structure.

‘Anyone who thinks he can contribute weighs in to help. Status, seniority and position lose their meaning. We become natural team players. No one stands on ceremony. We listen to – and build on – the ideas of others, we respect each other’s thinking, and we invite customers and suppliers to join in, on the same terms. ‘We’re just normal people, with our mates, bringing our skills together to solve a shared problem. We do whatever it takes.’

The questions that most exercised this executive were: ‘Why can’t this be our standard way of working? Why can’t we have the spirit of fire-fighting without the need for a fire? Or rather, how can we invent a surrogate fire that has the same heat but without the same collateral damage?’

Similar questions often get asked in advertising agencies and other professional service firms: ‘Why are we at our best pitching for new business? Why can’t we be as creative, as collegial, as effective and as fulfilled as this all the time? What different set of principles directs our activities when we are hunting rather than farming?’

The challenge that this article addresses can be stated in much the same way: ‘What changes to the standard design of an organisation need to be made to release the entrepreneurial talent of its members?’

The secret, it seems, is to make much greater use of internal markets, to bring capitalism inside the business (on a selective basis), to place greater trust in the collective intelligence of employees, and to invite the marketing function to take on the job of redesigning the organisation to enable all this to happen.

 IF HIERARCHY UNDERPERFORMS

Hierarchy makes innovation more difficult than it need be – or should be. For example, hierarchical planning distorts investment decisions in at least three ways. The range of investment alternatives under consideration at any one time is typically drawn from much too narrow a spectrum, mainly because of a strong bias towards overprotection of the legacy business that brought the company its original success.

In the absence of an efficient internal market, companies under-price their own resources, such as their talent, their internal funds available for investment, and their physical assets. These biases give the incumbent managers of the legacy businesses first call on these resources at discounted prices.

Because individual creativity cannot be ‘commanded’ into play, the nature of hierarchy has an intrinsic dampening effect on personal initiative and enthusiasm, with the result that the perseverance necessary to see an idea through to market success is rare. The power of markets is to stimulate entrepreneurship – the activity that is recognised at the macro level of inter-firm rivalry, but less likely to be advocated at the micro-level of the firm itself. The competitive process, if applied within the firm, is usually rejected on the grounds that it would inhibit cooperation, harm coordination and inflict chaos upon the organisation.

Increasingly there is evidence that hybrid organisations, mixing elements of hierarchy and internal market processes, are a viable option. For example, Lloyds TSB has been experimenting with an internal stock market to rebalance the resource allocation process away from a closed, rather secretive and elitist activity and towards a more open, democratic and pluralistic ‘conversation’. Competition, far from fragmenting the organisation, seems to have achieved a level of coordinated decision-making greater than that which typically results from imposing upon the many a small number of key decisions made by the few.

The charge that markets introduce chaos into organisational life is itself a form of hierarchical bias. In other words, the perception of chaos and confusion may well be subjective. From the vantage point of those in command, hierarchy typically feels like an ordered society, but to those under their command, hierarchy can seem arbitrary, unpredictable, impulsive, incoherent and disordered.

The two great virtues of the competitive process – as embodied in the market principle and as compared with hierarchical solutions – are as follows. First, it radically expands the range of options under consideration – by bringing a far greater number and diversity of people into the process. Second, it adjudicates between these ideas in a fairer, more democratic manner – by drawing upon the collective wisdom of the crowd rather than the judgment of an elite.

 Experimenting with internal Markets

How does one begin the process of dismantling the more deleterious aspects of hierarchy and bureaucracy and in their place start to construct an alternative set of organisational principles? In particular, what is the best way of systematically and creatively testing the potential of internal markets to better solve the perennial problems facing all organisations?

There are many experiments that companies could conduct in the pursuit of viable alternatives to the reigning managerial paradigm. I shall give a sketch of three experiments in each of the three markets in which all firms compete – the market for talent, for customers, and for capital.

In each of these markets, the internal market solution should address a particular problem where hierarchical failure is rife, respectively: organising in teams around market opportunities; generating imaginative strategic ideas; and predicting competitive market response.

Task Twinning Consider giving employees the right to share their responsibilities and accountabilities. In effect, managers (typically peers) could pool their talents by mutual agreement and combine their individual jobs into a jointly held, more broadly based work package. Both managers would now be jointly and severally responsible for what previously had been separate activities. They would have to feel that, as a team, they could create more value for the company than as separate jobholders.

One qualifying condition might be that any twinning of tasks would have to cross functional, departmental or divisional boundaries. For example, sales people would not be permitted simply to combine territories, whereas, for example, the combination of a finance specialist or a manufacturing engineer and a customer-account manager would be welcomed.

The hypothesis being tested is that most jobs are sized to a single person, creating the ultimate silo, and that only by rescoping work packages to cross critical organisational boundaries is it possible to break down myopic thinking. In combination, managers could not only learn from one another and actively seek out synergies but, more importantly, they could give each other the confidence and courage to act in a more decisive and less risk-averse manner.

 Performance Transparency

People manage what they see. If they see waste, they eliminate it. If they see success, they imitate it. If they see opportunity, they exploit it. Part of the skill of management, therefore, is making things more visible, particularly things from which learning is possible.

Lean manufacturing makes inventory as visible to as many people as possible. Instead of being just a line on a set of financial accounts published at the end of the year and only for the eyes of senior management, it becomes something tangible to all and therefore an object of attention.

The experiment would explore the repercussions of making many things more visible to more people – not just salaries, bonuses, travel expenses, and 360° feedback, for example, but especially the links between personal actions and corporate results. If the traces that managers left behind them were made visible, people would infer the causes of success and failure, and learn from the experiences of others.

Extended Networks

In a world where the outsourcing of non-core activities has become a global industry, how about experimenting with the insourcing of the capability at the very core of any enterprise – namely the solving of problems critical to the future performance of the firm?

The hypothesis is that companies are missing a trick by limiting their creative resourcefulness to their own employees and failing to draw upon the voluntary skills and efforts of many experts around the world who are prepared to chip in and offer their ideas, motivated by the chance of winning big if their ideas are chosen.

New companies such as Incentive enable companies to post difficult problems on the web and to invite thousands of volunteers (especially scientists, entrepreneurs and engineers) to come up with possible answers.

At root, the idea is that organisations, particularly in the future, will be much bigger and broader than the legal entity that currently defines the boundaries of the corporation.

Organisations that succeed will be those that redefine themselves to include their customers, business partners, and many others as co-creators of wealth. The internet is making it much more feasible to tap into the collective knowledge of this larger, more extended, more virtual organisation.

Personal Budgets If every budget holder in a company had the right to invest, say, 5% of their budget in any opportunity of their own personal choosing, provided that the returns on this investment were published as openly as on the remaining 95%, would it not be interesting to know where managers chose to place their investments and whether or not the 5% outperformed the 95%?

This, of course, is a version of ‘skunk works’ made famous by 3M many years ago. Here was a pioneering process that encouraged employees, particularly scientists, to invest company time in their own ideas and initiatives. More recently, Google has adopted a similar philosophy with the aim of bringing out the entrepreneur in each of its employees.

The difference with this experiment is that managers are allowed, indeed encouraged, to invest corporate funds, not simply company time, in their own entrepreneurial initiatives.

 Ideas Tournaments

Tournaments are a type of incentive mechanism. They are particularly valuable when innovation is needed but is not forthcoming and when therefore the organisation needs to be jolted out of its lethargy, arrogance or complacency.

A tournament is a contest where the rewards of winning are based on relative performance rather than on an absolute benchmark of quality.

Economists have shown that tournaments are more effective than traditional contracts under three organisational conditions: the motivation of employees to make an effort and generate ideas is either weak or difficult to measure; the quality of the ideas being proposed is easier to rank against each other than measure on an absolute scale; and there are many uncontrollable, extraneous factors interfering with performance.

The hypothesis being tested is that if employees are placed in competition with one another to come up with breakthrough ideas, as judged by their peers, or the entire workforce, they will find this challenge both motivating and fun. They will want to excel. They will go the extra mile to invent and ‘sell’ their ideas to their colleagues. They will find that it brings out their latent creativity.

 Employee Patents

Tournaments and their like are strengthened further if the authors of the winning ideas have a stake in the success of their ideas.

have (at least partial) property rights in the intellectual ideas they develop at work and make available to their employer, they will be motivated to have more – and better – ideas. Ownership of IP could belong entirely to the inventor(s) or be shared in some proportion with the company itself. Tests could be conducted to see whether money or recognition is the more powerful incentive.

Monetary returns could take the form of licence fees on the patent or trade mark, or commission on sales of products and services based on the idea, or dividends from ownership of an equity share in the idea.

 Spread Betting

One simple way of tapping into the collective intelligence of the workforce would be to make a prediction market in business performance. Every employee would be invited to bet on the future performance of each business unit, or each corporate project, or each new product.

By making a spread betting market in business outcomes, where employees could make money betting against the ‘official’ line (as defined by the strategic plan), the executive board would discover where the organisation as a whole believed individual businesses were being too ambitious or too timid – and therefore, implicitly, where resources were being misallocated.

Effectively, such a market would pit the collective wisdom of the workforce against the technical expertise of the strategic planners. From this experiment the firm would discover whose predictions to trust more – those of the generalist (the mass of employees) or those of the specialist (the elite group of strategists).

 Angel Investors Rather than betting on outcomes, what about investing in assets? Imagine making a stock market in the firm’s core assets, such as its established businesses, its new ventures and its research projects, and issuing to employees fixed amounts of either real funds or ‘wooden dollars’ to invest in a portfolio of in-company equities. It would be interesting to compare the value that this ‘artificial’ market placed on the key ingredients of the company’s strategy with the value that the ‘real’ stock exchange placed on them.

If employees were allowed to play the internal stock market only if they invested their own money, would the result be any different? And of the two markets, which would be the more efficient?

 Employee Syndicates

A related privilege could be that managers have the right to pool their personal funds to create larger pools of cash to invest either in fewer, bigger opportunities or in a more diverse portfolio. Valuable information from this experiment would include knowing who teamed with whom to create the best results. How large and diverse are the best performing teams? What were the assumptions underlying the membership of syndicates?

Conclusion We recognise the power of markets outside the organisation to allocate resources efficiently and inspire entrepreneurialism. Introducing markets into the rigid hierarchies of traditional companies has the power to reap the same kinds of rewards.

Dr Jules Goddard is Research Fellow of the Management Lab at London Business School. [email protected]

 

Ownership of IP could belong entirely to the inventor(s) or it could be shared in some proportion with the company itself. Tests could be conducted to see whether money or recognition is the more powerful incentive

 Tournaments are a type of incentive mechanism. They are particularly valuable when innovation is needed but is not forthcoming and when the organisation needs to be jolted out of its lethargy