The catalogue of poor decision practices is immense, but we focus here on three of the most common and, in our experience, most harmful to companies.
There is nothing wrong with learning from others' experience—vicarious learning, as contrasted with direct experience, is an important way for both people and organizations to learn how to navigate a path through the world. After all, it is a lot cheaper and easier to learn from the mistakes, setbacks, and successes of others than to treat every management challenge as something no organization has ever faced before. So benchmarking—using other companies' performance and experience to set standards for your own company—makes a lot of sense. In the end, good or bad performance is defined and measured largely in relation to what others are doing.
The problem lies with the way that benchmarking is usually practiced: It is far too "casual." The logic behind what works at top performers, why it works, and what will work elsewhere is barely unraveled, resulting in mindless imitation. Consider a pair of quick examples. When United Airlines decided in 1994 to compete with Southwest in the intra-California marketplace, the company tried to imitate Southwest. United put its gate staff and flight attendants in casual clothes; it flew only Boeing 737s; it gave the service a different name, "Shuttle by United," and used separate planes and crews; it stopped serving food; it increased the frequency of its flights and reduced the scheduled time planes spent on the ground, copying Southwest's legendary quick turnarounds. Southwest, however, wound up with a higher market share in California than it had before United launched its imitation.7 The Shuttle failed and is now shuttered.
When U.S. automobile companies decided to embrace total quality management and emulate Toyota, the world leader in automobile manufacturing, many copied its factory floor practices. They installed pull-cords that stopped the assembly line if defects were noticed, just-in-time inventory systems, and statistical process control charts. Yet even today, decades later, U.S. automakers for the most part still lag behind Toyota in productivity—the hours required to assemble a car—and many trail in quality and design features as well. Similar failures have plagued retailers' efforts to copy Nordstrom's sales commission system to achieve higher service levels, and the numerous organizations that attempted to mimic General Electric's forced-curve performance-ranking system.
In these and scores of other examples, a pair of fundamental problems render casual benchmarking ineffective. The first is that people copy the most visible, obvious, and frequently least important practices. Southwest's success is based on its culture and management philosophy, the priority it places on its employees (Southwest did not lay off one person following the September 11 meltdown in the aviation industry), not on how it dresses its gate agents and flight attendants, which planes it flies, or how it schedules them. Similarly, the secret to Toyota's success is not a set of techniques but its philosophy—the mindset of total quality management and continuous improvement it has embraced—and the company's relationship with workers that has enabled it to tap their deep knowledge. As a wise executive in one of our classes said about imitating others, "We have been benchmarking the wrong things. Instead of copying what others do, we ought to copy how they think."
This executive was partly right but did not go far enough. The second problem is that companies often have different strategies, different competitive environments, and different business models—all of which make what they need to do to be successful different from what others are doing. Something that helps one organization can damage another. This is true particularly for companies that borrow practices from other industries, but often is true for organizations even within the same industry.
The fundamental problem is that few companies, in their urge to copy—an urge often stimulated by consultants who, much as bees spread pollen across flowers, take ideas from one place to the next—ever ask the basic question of why something might enhance performance. Before you run off to benchmark mindlessly, spending effort and money that results in no payoff, or worse yet, in problems that you never had before, ask yourself:
Doing what (seems to have) worked in the past
Suppose you went to a doctor who said, "I'm going to do an appendectomy on you." When you asked why, the doctor answered, "because I did one on my last patient and it made him better." We suspect you would hightail it out of that office, because you know that the treatment ought to fit the disease, regardless of whether or not the treatment helped the previous patient. Strangely enough, that logical thought process happens less than we might care to admit in most companies.
|Instead of copying what others do, we ought to copy how they think.|
Consider a couple of industry examples. In a compensation committee meeting of a small software company that we worked with, the committee chair, a successful and smart executive, recommended the compensation policies he had employed at his last firm. He even suggested that his former head of human resources call the head of HR at this company to facilitate precise imitation. The fact that the two companies were of dramatically different sizes, used different distribution methods, and sold to different markets and customers somehow didn't faze him or many fellow committee members. This company isn't alone: How many of you are using performance appraisal forms that your executives brought with them from another company? And then there is the case of the same strategy and approach being used regardless of the situation. Al Dunlap—the notorious Chainsaw Al—did layoffs (and it turns out, accounting fraud) in all of his companies, including Scott Paper and Sunbeam. Similarly, executives who believe that any unit that isn't ranked number one or two in its market needs to be sold typically carry that approach to new jobs. The aphorism that nothing predicts future behavior better than past behavior is especially true for executives who develop a template and use it again and again in every situation.
There is nothing wrong with learning from experience and developing proficiency at certain strategies and tactics. We ought to learn from experience—and use that experience to get better at what we do and develop specialties and talents that we can execute with consummate skill. The problems come when the new situation is different from the past and when what we "learned" was right in the past may have been wrong, or incomplete, in the first place.
In the software company example, the chair's recommended system—individual incentive pay with big rewards for making sales—would have undermined the consultative sales process that was essential for selling this company's particular product. The layoffs used routinely by Al Dunlap and so many other executives often don't work. Blindly copying the same approach without considering the underlying business problems is just plain dumb.8 And lots of companies have gotten into trouble by importing, without sufficient thought, performance management and other measurement practices from past experience at other companies.
As in benchmarking, asking some simple questions and acting on their answers can help avoid the bad results that come from mindlessly repeating the past:
Following deeply held yet unexamined ideologies
The third flawed and widespread basis for decisions often does the most damage because it is the most difficult to change. It happens when people are overly influenced by deeply held ideologies or beliefs—causing their organization to adopt some management practice not because it is based on sound logic or hard facts but because managers "believe" it works, or it matches their (sometimes flawed) assumptions about what propels people and organizations to be successful.
|The logic behind the use of options as managerial incentive is flawed once you consider what behaviors are actually rewarded.|
The use and defense of stock options as a compensation strategy is a great example of belief trumping evidence, to the detriment of organizations. In the early years of the new millennium, there was an unprecedented wave of corporate bankruptcies and financial scandals. Senior executives lied about their company's performance, even as they sold stock and left pension funds and other investors holding worthless paper. Experts and evidence now place a large part of the blame for financial scandals on the excessive use of stock options and stock-based compensation.
Carol Bowie, director of governance research services at the Investor Responsibility Research Center, concluded, "At the very least, options tended to promote a short-term focus . . . and at worst they promoted fraudulent activity to manipulate earnings."9 Roy Satterthwaite, a beneficiary of the options craze while a vice president at Commerce One, noted that options not only fueled long work weeks but they skewed people's decision priorities, leading to an excessive focus on cutting deals and growing revenues, the numbers the market seemed to focus on.10 Satterthwaite confessed that options "motivated us to a selfish, short-term view" and did not create long-term value. Nor is the evidence about stock options and their effects just anecdotal. One study comparing 435 companies that had to restate their financial statements with companies that did not found that the higher the proportion of the senior executives' pay in stock options, the more likely the company was to have restated its earnings.11 A study by Moody's, the bond rating service, concluded that incentive pay packages can "create an environment that ultimately leads to fraud."12
Even the logic behind the use of options as managerial incentive is flawed once you consider what behaviors are actually rewarded. Roger Martin, Dean of the University of Toronto's business school and one of the co-founders of the strategy consulting firm Monitor, noted the problems of mixing the measuring and rewarding of performance in an expectations market—the stock market—with the measuring and rewarding of performance in the real market of sales, earnings, and productivity. As he noted, in the National Football League, players would never be permitted to profit from beating the point spread—the expectations market—because it would encourage all kinds of nefarious activity. Martin argued that, "stock-based compensation is an incentive to increase expectations, not performance. The easiest way to do that is to hype the stock."13
There is, in fact, little evidence that equity incentives of any kind, including stock options, enhance organizational performance. One review of more than 220 studies concluded that equity ownership had no consistent effects on financial performance.14 Another massive study and review of research on executive compensation published by the National Bureau of Economic Research reported that most schemes designed to align managerial and shareholder interests failed to do so; instead, executive compensation practices just operated as devices to enrich senior managers, who usually received most of the stock options.15
Yet executives, particularly those in high technology, remain uninterested in and unconvinced by the logic and the evidence, waging political battles to avoid expensing stock options on their income statements and maintaining that stock options are not only helpful but essential for building their companies. The evidence notwithstanding, many executives maintain that options create an ownership culture that encourages eighty-hour workweeks, frugality with the company's money, and a host of personal sacrifices designed to make the options more valuable. T. J. Rodgers, Chief Executive of Cypress Semiconductor, is typical. He has maintained that without options, "I would no longer have employee shareholders, I would just have employees."16
Stock options are more crucial to success, and perhaps less likely to produce false hype, in small, privately held start-up companies. The entrepreneurship fueled by options helps new companies get off the ground. Cash is at a premium in most start-ups, and the chance to strike it rich attracts talent that otherwise would remain out of reach. Yet, despite such virtues, unwavering belief in stock options that is so pervasive among the leaders of high technology companies is not based on sound evidence or logic.
And stock options are just one case where vehement beliefs rather than logic and evidence guide management ideas and actions. A series of studies demonstrates that people, especially those who write for and read the business press, believe in the first-mover advantage—that the first company to enter an industry or market will have an edge over competitors. Existing empirical evidence is actually mixed and unclear as to whether such an advantage exists, and many of the "success stories" purported to support the first-mover advantage turn out to be false—Amazon.com, for example, was not the first company to start selling books on the Web. The more that people read the business press, the more strongly they believe in first-mover advantage. But nonbusinesspeople usually believe in it as well, apparently because of cultural beliefs that favor being first, and giving either group—experienced or naÃ¯ve—contradictory evidence does not cause them to lose their faith in the first-mover advantage. Beliefs rooted in ideology or in cultural values are quite "sticky"—they resist disconfirming evidence and persist in affecting judgments and choice, regardless of whether or not they are true.17
To avoid succumbing to using belief or ideology over evidence, ask yourself:
by Jeffrey Pfeffer and Robert I. Sutton
Michael Schrage is right: "A collaboration of incompetents, no matter how diligent or well-meaning, cannot be successful."21 But not being in the top 10 percent isn't the same as being incompetent—90 percent of the people in every organization simply fail to qualify. It is a mathematical fact that only 10 percent of the people are going to be in the top 10 percent. And despite claims in The War for Talent, Topgrading, and numerous other books on hiring the best people, the talent mind-set is rooted in a set of assumptions and empirical evidence that are incomplete, misleading, and downright wrong. A moment's consideration will reveal that the war for talent idea rests on three crucial assumptions:
Talent isn't so easy to perfectly identify
What do Steve Young, Kurt Warner, and Jake Delhomme have in common? All eventually became starting National Football League quarterbacks, but only after long stints sitting on the bench or playing in obscure football leagues because they weren't considered good enough for the NFL. All three played in Super Bowls, and Young and Warner won Most Valuable Player awards. Talent management "errors" like these "point out how . . . luck plays a much greater role than anyone would have you believe and sometimes, key players emerge from the most unlikely circumstances."22 In fact, just about all professional sports teams—a domain where we might expect individual talent to be crucial and readily discerned—have numerous top players who were not deemed as such early in their careers.
Talent is not easy to identify for a number of reasons. First, even the best predictors don't do a very good job of selecting the best people. Take IQ. Intelligence is the most powerful predictor of job performance across studies, but IQ still seldom correlates more than 0.4 with performance. Since the amount of variation explained by a predictor is the correlation squared, intelligence accounts for no more than 16 percent of the variation in performance, leaving some 84 percent unexplained. Other alleged predictors have even lower correlations. This doesn't mean that companies should spurn valid indicators of ability when selecting people. But it does mean we all ought to be more circumspect about our ability to discern talent.
Second, performance naturally varies over time. Even the best athletes, the best musicians, and yes, the best professors, have off days. A study of output rates among foundry employees (machine molders, hand molders, and chippers and grinders) found week-to-week consistency in individual employee output that would leave about 50 percent of the variation unexplained. A review of other studies of variation in individual output in industrial settings where output could be precisely measured and both incentives and skills were constant reported that "individual output varied over a fairly large range from week to week."23 This means that, depending on when you happened to look, A players would appear to be B players, or vice versa. An obvious implication is that you get better measures of performance or ability if you take more than one sample. Unfortunately, this simple insight is routinely ignored: Hiring decisions are often based on a single test, work sample, or interview. Similarly, student achievement tests—used to measure whether schools are failing or succeeding—are administered once a year, at most.
Yet another problem with assessing ability or talent is that human judgments are clouded by invariable, potent, and largely inescapable psychological biases. A few years ago, one of us talked to an oil company executive who claimed he could identify top managerial talent at an early age. We asked how he could be so confident in his ability. He responded that the people he identified, who then were tapped for a fast track program, invariably turned out to be successful. This executive never considered that their success could stem mostly from being tapped, not from his ability to spot talent. Consider a more systematic study of managerial bias. Managers provided performance evaluations for two types of employees—subordinates they were involved in hiring versus subordinates they were not involved in hiring. As you might expect, managers gave higher performance evaluations to subordinates they had a voice in hiring, independently of other employee performance measures.24 This is what happens when people expend effort and make a public commitment to a course of action—they think they have done a good job. If you help chose someone for a position, you will think more highly of that person's abilities compared to someone you didn't help select, in part to justify the decision you have made.
These uncertainties and human frailties mean that for most jobs in most organizations, assessing talent and ability is fraught with error and bias. Most dimensions of work performance are not as objective as how well someone can pitch, hit a ball, or throw a discus. In ambiguous, interdependent, subjective situations, all sorts of biases—including the commitment effect just described, as well as biases from similarity and liking—will intrude and affect how talent is assessed. These biases cloud how talent is judged even when objective performance indicators are present, such as how fast a person can type or how many points a basketball player has scored.25
21. Michael Schrage, "The Rules of Collaboration," Forbes ASAP, June 5, 1995, 88.
22. Ira Miller, "Dark Horses Become WorkHorses," The San Francisco Chronicle, October 22, 2001.
23. Harold F. Rothe, "Output Rates Among Industrial Employees," Journal of Applied Psychology 63 (1978): 40-46.
24. F. D. Schoorman, "Escalation Bias in Performance Appraisals: An Unintended Consequence of Supervisor Participation in Hiring Decisions," Journal of Applied Psychology 73 (1988): 58-62.
25. Robert L. Cardy and Gregory H. Dobbins, "Affect and Appraisal Accuracy: Liking as an Integral Dimension in Evaluating Performance," Journal of Applied Psychology 71 (1986): 672-678; Barry M. Staw and Ha Haong, "Sunk Costs in the NBA: Why Draft Order Affects Playing Time and Survival in Professional Basketball," Administrative Science Quarterly 40 (1995): 474-494.
Excerpted by permission of Harvard Business School Press from Hard Facts, Dangerous Half-Truths, and Total Nonsense: Profiting from Evidence-Based Management. Copyright 2006 Jeffrey Pfeffer and Robert I. Sutton. All rights reserved.
7. Scott McCartney and Michael J. McCarthy, "Southwest Flies Circles Around United's Shuttle," Wall Street Journal, February 20, 1996.
8. For a review of the evidence on the ineffectiveness of most layoffs, see Wayne E. Cascio, Responsible Restructuring: Creative and Profitable Alternatives to Layoffs (San Francisco: Berrett Koehler, 2002).
9. Gretchen Morgenson, "When Options Rise to Top, Guess Who Pays," The New York Times, November 10, 2002.
10. Matt Murray, "Option Frenzy: What Went Wrong?" Wall Street Journal, December 17, 2002.
11. Floyd Norris, "Stock Options: Do They Make Bosses Cheat?" The New York Times, August 8, 2005.
13. Roger Martin, "The Wrong Incentive," Barron's, December 22, 2003, 30 31.
14. Dan R. Dalton et al., "Meta Analyses of Financial Performance and Equity: Fusion and Confusion?" Academy of Management Journal 46 (2003):13 27.
15. Lucian Arye Bebchuk, Jesse M. Fried, and David I. Walker, "Managerial Power and Rent Extraction in the Design of Executive Compensation," The University of Chicago Law Review 69 (Summer 2002): 751 846.
16. David R. Baker, "Silicon Valley Fights Fiercely for Options," San Francisco Chronicle, November 10, 2002.
17. Lisa E. Bolton and Chip Heath, "Believing in First-Mover Advantage" (Palo Alto, CA: Stanford Graduate School of Business), 2005.