I view that as an enabler rather than a driver. So we couldn’t have these very large decentralized organizations without cheap communication, but the drivers will be the things we want and that we can often get in these more decentralized organizations.
It turns out that when people are making decisions for themselves instead of just following orders, a bunch of good things often happen. They’re often more highly motivated, they’re often more dedicated, they’re often more creative. They’re able to be more flexible and respond to the individual local situation in which they find themselves rather than following some rigid rules set down from on high. And finally, they often just plain like it better.
Now, those benefits of decentralized decision making are not always important. In some cases, like making semiconductor chips, the most important thing by far is the economies of scale. And in cases like those, where there aren’t particular benefits from decentralized decision making, I would expect cheaper communication cost to lead to more centralization rather than more decentralization.
But in our increasingly knowledge-based and innovation-driven economy, the critical factors for success are often precisely the things that are the benefits of decentralized decision making: creativity, innovation, motivation, and so forth.
So, that’s why, in more and more places in our economy, technology would make it possible for — and our desires for flexibility and innovation will drive the change toward — more and more decentralized decision making over the next few decades.
Dresner:
Clearly, there are some industries that you cite and that I think most people would say, “That makes great sense for any decentralized or very loose organization — consulting or retail in some instances.” And then, there are others like certain kinds of discrete manufacturing where that probably wouldn’t make sense.
What are some other examples where it clearly makes sense and others where it absolutely doesn’t make sense? And then, within an existing enterprise that may be somewhat centralized, which units or which functions would it make sense to decentralize?
Malone:
The answer is complex, but in general we should expect to see more decentralized decision making in places where its benefits are important and where its costs can be overcome.
For example, most things we would call knowledge work, most things that depend on innovation and creativity, are places where we should expect to see this kind of decentralized decision making.
You mentioned high-tech consulting. The R&D parts of many companies, even when the manufacturing parts of those companies may be more centralized, are places where I would expect to see these changes happening sooner rather than later. But that doesn’t mean that there are places where it couldn’t possibly happen because, in many situations, you, as a manager have a choice about what strategy you want to follow.
If you’re running a factory, for instance, you could choose to run that in a highly regimented, highly centralized, rigidly controlled way. And you might be successful. But you could also take the very same factory and try to run it in a much more decentralized way — a way that relied on the creativity of individual workers on the factory floor, etc.
In fact, things like quality circles, which were a big deal a decade or two ago, are an example of precisely that — of trying to draw on the creativity and innovation of the first-line factory workers to make the work better. And if you followed that strategy, you might also be very successful.
So, to some degree, the decision of whether one should use decentralized decision making is not just a function of the industry or the business function. It’s also a function of what strategic positioning you want to use to try to capture benefits and advantages in your situation.
Dresner:
So, if we take a look at some of the more extreme models — democracy or the market scenario — what would be the things that would accelerate that process? And what might inhibit it?
Malone:
Well, let me back up a minute and give a perspective before I answer the direct question. One of the things that I did in my book, as you know, is look at the whole sweep of human history and how human societies have been organized. Doing an exercise like that is very sobering. It gives you a much deeper perspective on how non-linear these changes are. It’s not the case that things advance monotonically and steadily in one direction, and that’s the end of it.
If you look at human history and the rise of things like democracy, you see a much more complex pattern. Democracies, for instance, were tried on a small scale in ancient Athens and then died out and weren’t really tried in any serious way again for almost a couple of thousand years. Then, with the American Revolution and the French Revolution, we saw the beginnings of large-scale democracies for the first time. But the trend — which I think most people would agree is at least, in general, a trend toward more democracies — is still going on. It’s been going on for a couple of hundred years. There is a lot of violent conflict in the Middle East right now about whether, when, and how a number of countries are going to move in a more democratic direction.
It’s even been the case that democratic countries have elected leaders who became dictators. So, it’s certainly not a steady progress in one single direction. There’s a lot of back and forth, up and down, false starts, and all kinds of things that happen as these changes are occurring. And I don’t think there’s any reason to think that the changes in business will be any less complex than the equivalent changes in governments have been.
So, we’ll see plenty of ups and downs, back and forth, and false starts over the next few decades as our economy and our society move in the direction that I think is likely, which is toward more and more of these decentralized decision-making structures, including loose hierarchies and democracies and various kinds of markets.
Now, all that being said, what’s likely to accelerate, encourage or facilitate that transition? There are three kinds of things. One is things that increase the desirability of the changes. Another is things that decrease the costs of the changes. And the third is individuals who have the vision to make them happen.
So, things that increase the desirability would be desires for innovation, desires for satisfying work and desires for flexibility in one’s lifestyle. Those are choices that we, as individual people and as workers, make. Our own values will influence the rate at which these changes occur.
Another thing that will affect the rate at which these changes occur is the costs. In some sense, one of the main points of my book is that information technology is reducing one of the most important costs — the cost of communication. But there are also some costs of figuring out how to structure organizations in more decentralized ways. Just because you have the technology to do it doesn’t mean you know who is going to make what decisions, what rules you’ll follow and how responsibilities will be divided. And there are a lot of organizational inventions that we need to make to figure out how to do these things in more situations.
Dresner:
You used a term — “organizational invention.” Can you explain what you mean by this?
Malone:
Well, it’s a term I’ve used before. In fact, you might not remember it, but one of the things that led to the writing of this book was the work I did for the last five years of the 20th century co-leading an initiative called, “Inventing the Organizations of the 21st Century.” So, I think that there really is an opportunity to apply an inventive mindset to not just technologies, but to organizations.
In fact, we often think in the IT industry about a kind of technology stack. At the bottom level, you’ve got hardware. And then you’ve got various levels of system software and application software. I think there’s also a higher level to that stack, which is not the technologies themselves but the organizational structures and processes that use those technologies.
And my opinion is that, while there’s not likely to be any decrease in the inventions at the technological layers of that stack, some of the most important innovations in the coming decades will not be in the technologies, but in the organizations that use those technologies.
So, an example of an organizational invention would be one of the scenarios I talk about in the book, which we developed working with Intel. The problem that we worked on was how Intel decides which products to make in which factories at which times. That decision is today made in a very complex, hierarchical process that involves plant managers, factory schedulers, strategic planners, division managers, product managers and many, many other people.
The possibility we explored was that that same decision might be made much more efficiently and flexibly by a market-like decision-making process. The basic idea is that the plant managers could become sellers. They would sell the rights to have a certain type of product available at a certain time in the future. And the Intel salespeople would be buyers who would buy the rights to have a certain product at a certain time in the future with the expectation that they could then resell those products to external customers.
Then, from the interaction between those internal sellers and those internal buyers, the prices for different products at different times in the future could be continually fluctuating as new information became available. For instance, if Dell decided to postpone a plant order from January to June, then the salesperson dealing with Dell would sell the rights for products in January and buy them for June. This would make the prices for January go down and those for June go up. And through all those decentralized interactions, the prices in this internal futures market, if you will, could be continually varying.
Then, as you approach the time at which the factory needs to start the creation of a given product for a given date, the prices in the internal market would essentially say which products would be (in the collective judgment of everyone participating in this internal marketplace ) the most profitable for the company as a whole. And those are the ones the plant managers should actually make.
Dresner:
That’s a great example. Thanks.
Malone:
It’s an example of an invention. It’s a way of doing things very differently from the way we would usually think of doing them. It requires a fair amount of detailed design and planning. In fact, we’ve done some of that working with Intel so far, but there’s still a significant amount to be done to make things like this usable in the real world. And it’s very much equivalent, I think, to inventing a new kind of technology. But in this case, you’re inventing a new kind of organizational process.
Dresner:
Excellent. Now, there are going to be visionaries out there, or some who think they’re visionaries, who say: “This is a great idea. I’d like to find ways to decentralize my organization to delegate a lot of the authority of decision making.” And some may succeed. I suspect others may fail. What’s the proverbial 12-step program, if you will, to make the transition from centralized to decentralized?
Malone:
I don’t think there’s a simple 12-step program. These processes of organizational change are very complex. They require skill and art as well as vision. In some cases, big, centralized companies will succeed in making these changes. My suspicion is that they’ll be the exceptions rather than the rule, because for this to happen, somebody who has power has to voluntarily give it away.
Lou Gerstner at IBM is an example. He went into an organization that was famous for its hierarchical centralization and changed it in important ways. It’s not the most decentralized company in the world today, that’s for sure. But I think most people who know IBM would agree that it’s less centralized now than it was when Gerstner took over. So he had the vision to see what was possible and the power to make it happen. But people who do that, who spend their lives rising to positions of significant power in highly centralized organizations and then when they get there say, “What the heck. I’m going to give this power away,” will be the exceptions rather than the rule.
Dresner:
You use IBM as an example. And in your book, you suggest that it might have been better off breaking up into multiple independent companies than being centralized, though you give Lou Gerstner credit for having done a pretty good job. My question is, if you’re trying to provide a solution to a customer that draws from these different units or divisions, does it make sense to break those up as independent units? Doesn’t that make it more difficult to coordinate a single solution for the customer?
Malone:
Let me go back and slightly amend something you said. At the time Gerstner took over IBM, the vast majority of analysts and business journals were convinced that he should break up the company. He went against that common wisdom and was very successful in doing so.
I did, in my book, make a comment in passing that even though we know he was successful with what he did, we don’t know what would have happened if he had done the opposite. It’s possible that could also have been successful, maybe even more so. But he certainly was very successful in the path he did choose.
So, the question of how to coordinate things if they’re not all part of the same company is a very important one. And it gets to what I call the centralized mindset that many of us have. Many of us assume that if there’s a problem, the way to solve it is to put someone in charge. If there’s coordination that needs to be done, the only way we can imagine doing it is to have a hierarchy with a boss who does the coordination.
But if you think about it for a minute, there are other situations which we completely take for granted where that’s absolutely not the case. Anywhere there’s a free market, for instance, coordination occurs, but no one is in charge of it.
Consider, for example, the worldwide market for cotton, or for blue men’s dress shirts. There’s no CEO of the worldwide market for cotton. There is no CEO of the worldwide market for blue men’s dress shirts. The decisions about how many bales to produce, how many blue shirts to create and where to sell them are made by the interaction of thousands of independent buyers and sellers all over the world. And yet, most people would agree that those decisions are made pretty well — that, on the whole, we get about as many men’s shirts made as people want to buy and about as much cotton produced as people want to use without any centralized control occurring anywhere.
So, it’s certainly possible to have very effective coordination done in a marketplace without any individual person or company being in charge of it.
One example is what’s happened in the PC marketplace, where you have a whole ecology of vendors creating hardware and software that work quite effectively, more or less, together with a couple of companies playing a leading role — Intel and Microsoft, in this case — in orchestrating this ecosystem of companies. Microsoft and Intel certainly are not the owners or the controllers of all the other companies in the world that make PC software and PC hardware. But they help create the architecture and the ecology in which many other companies and their products can work together.
So, it’s certainly possible that IBM or other companies like it could do something similar.
Dresner:
It’s a great example and a good lead-in to another couple of questions. The reason that the PC industry, or ecosystem, succeeded was due to the de-facto standards which IBM established.
What sort of standards would we need at a business level to do that for businesses to easily interoperate and become more centralized?
Malone:
Excellent question. In fact, it speaks to one of the two paradoxes I have in my book. The first of those paradoxes we’ve already talked about, which I didn’t label it as such in our conversation today, but it’s what I call the Paradox of Power: sometimes the best way to gain power is to give it away.
The other paradox is what I call the Paradox of Standards, which says that even though you may assume that rigid standards and flexibility are opposed to each other, sometimes rigid standards at one level of a system promote more freedom and flexibility at other levels of the system.
The best example of that is the Internet itself, where the protocol called IP, the Internet Protocol, is an extremely rigid standard. It is absolutely the same everywhere in the world, anywhere anyone connects to the Internet. And in part, it’s precisely because of the rigidity of the definition of that standard that all the other flexibility and all the other decentralization that we associate with the Internet are possible.
So, you’re absolutely right that one of the key things to make decentralized coordination possible is standards. And in particular, there is a very interesting and not yet widely recognized opportunity for developing a new set of standards — not at the level of the technologies, but at the level of the business processes that are involved in using those technologies.
We’ve done some work over the last almost-decade and a half now in a project at MIT that we call the Process Handbook. It’s an online repository of knowledge about business activities and business processes organized in powerful ways that take advantage of the ideas of specialization and inheritance as we know them in object-oriented programming, but applied here not to objects, but to actions.
So, in a sense, we are not inheriting down a hierarchy of nouns; we’re inheriting down a hierarchy of verbs. And we think there are some very interesting possibilities for that approach in helping to define new standards for business processes and business activities in a way that gives both the benefits of commonality and the possibilities of variation at the more specialized levels of this inheritance hierarchy. One sense of the vision for what’s possible there is that we could have plug-and-play businesses, not just plug-and-play technologies, and that any of a wide number of businesses could be able to easily interoperate with any of the other businesses in those groups.
In some ways, this is the vision underlying Web services. But the perspective on it I’m suggesting here focuses not just on the technologies, but on the businesses themselves – the business processes themselves.
Dresner:
Precisely. And I know that things like XBRL [Extensible Business Reporting Language] as sort of an early example of how this could work. And that’s merely the tip of the iceberg. I suspect a tremendous amount of work still needs to be done so that we have a common language business, which is, I think, what you’re talking about with your Process Handbook.
Malone:
Absolutely.
Dresner:
OK. Let’s talk a little bit more about technology, and in particular IT. What becomes of IT in the new world? Certainly, we still need people to create systems, implement systems, manage systems, administer them, etc.? What will IT look like in the future? Probably different, but how?
Malone:
One of the thought experiments I often do when I’m thinking about the future of organizations is to imagine that communication is free, instant and unlimited. It’s certainly not literally true and will probably never be. But it’s the asymptote that we’re approaching and getting closer and closer to every year.
I like to use that as a thought experiment because that makes it easier to think about how you would organize work, how you would structure organizations and how you would design business processes if communication were not a factor, if it were free and unlimited. But I think that thought experiment also gives us a way of imagining the progress of technological development over the next few decades — that at least one important aspect of what will happen in IT over the coming decades is that we’ll see wave after wave of technology that gets us closer and closer to that asymptote.
So, we’re already not too far from that for text-based communication. You can send pretty large – not unlimited, but pretty large – amounts of text anywhere in the world, almost instantly and almost for free once you’ve paid a basic charge for your e-mail.
The same is beginning — it is not quite true, but will probably be true pretty soon — with voice. That is, with voice over IP, we’re getting pretty close to the point where you can have essentially unlimited amounts of voice anywhere in the world almost instantly, for free, almost.
We’re still quite a ways from that for video. So, one important dimension of progress will be to develop videoconferencing that is almost free, almost unlimited, almost instant, anywhere in the world. And in the case of videoconferencing, there are a few other technical problems we’ll need to solve to make the video interaction as effective and as satisfying as a real face-to-face interaction.
For instance, we need to get gaze awareness to work. With most of today’s videoconferencing systems, the cameras are not aligned with the screen, so that when you’re looking at the eyes of the person you’re talking to, it doesn’t look to them like you’re looking straight at their eyes. So, there are a few other things like that that we need to get right.
But I think it’s pretty easy to predict that some time in the next few decades — possibly sooner rather than later in that period, and probably within the working lifetimes of many people who are reading this interview — there will be videoconferencing facilities that will be so good in quality that it will be hard to tell the difference between whether you’re talking to someone who is three feet away from you or someone who is 3,000 miles away from you interacting electronically.
Every year until that happens, we’ll get closer and closer to it. And as we do that, more and more of the interactions that we now have through face-to-face conversations will not be worth the time or the effort or the cost of physically traveling to have face-to-face. So, more and more of those interactions will occur remotely.
I want to be very clear that we’re not there yet. And I’m certainly not someone who says there is no need for face-to-face meetings today because we’re still quite a way from equivalence of a face-to-face interaction. But over the years, we’ll get closer and closer. Many people haven’t yet thought hard about how the world will change as that happens. So, that’s one vision for technology focused on human-to-human communication — text, voice, and video.
Another vision for technology is that all kinds of data will also become available for free — almost free, almost instantly, and in almost unlimited volume anywhere in the world.
I’m quite taken by the idea of ubiquitous computing, where at least the manufactured world becomes perceptive and active. In other words, you’ll be able to sit anywhere you want and see anywhere else on the world you want. You’ll be able to see any street corner, any public room, any factory in the world that your company is working with. You’ll be able to see all kinds of data about all kinds of business processes and all kinds of other things.
And when that happens, you’ll need tools far more advanced than what we have today — not just to transport the information, but also to analyze it – to make pictures of it, to give you some sense of it so you’ll know what to do about it. So, there are lots of opportunities for technologies to reduce the costs of communicating in all kinds of modalities and to help human beings analyze, understand and make sense of the huge volumes of information that will then be available.
So, in some sense, that’s a complete theme of a vision for technology. Notice that I haven’t said a thing about intelligence. I’ve focused on a vision of technology based on communication rather than on thinking or computing. There’s also, of course, another path for technological development, which is the path toward greater and greater artificial intelligence.
That, as you know, is a technological vision that is notorious for the unfulfilled optimism of its proponents. And I don’t want to be someone who yet again naively predicts artificial intelligence long before it will actually occur.
On the other hand, the relentless improvement in cost performance of computing technology is going to lead our machines to be able to do some really interesting and surprising things for us in the coming decades, even if it’s not what we used to think of as intelligent robots — humanoid robots. Whatever it is, is going to be pretty interesting.
Dresner:
Oh, I think if one could look back to the comic strips or movies of decades before, we would see much of that vision of the science fiction vision realized today. And much of today’s science fiction has to do with artificial intelligence with humanoid robots. So, one has to wonder if 20 years from now that might be realized.
Malone:
It might be. But I have to say, my intuition is that long before we get really humanoid robots we’re going to have some other form of something you might loosely call intelligence. But it will be very surprising.
Here’s an example that illustrates the point: Google is an amazing thing. It can give you in less than a second links to often incredibly surprisingly relevant pieces of information from a vast pool of billions of sources all over the globe. Is that a humanoid robot? Certainly, not. Is it something amazingly interesting and useful and sort of intelligent? Certainly, yes.
So, Google-like intelligence in many new variations is likely to surprise us long before boring old humanoid robots come along. Does that make sense?
Dresner:
It does make sense. And there’s a whole other discussion we could have around embedded intelligence and things like RFID. But I think we’ll have that some other time, perhaps.
I do want to take up the notion of outsourcing as the future of technology. If communication was instantaneous and free, in theory, that would encourage a high degree of specialization. And, obviously, there are economies of scale associated with that specialization. So, it would encourage, in theory, businesses to outsource a tremendous amount of what they do today internally. There’s probably a down side to that, too; maybe you could expand on that a little bit. Where do you see that headed?
Malone:
Well, you say that free communication encourages specialization, and that’s true. But the more specialists you have, the more need you also have for generalists who coordinate the work of the specialists. So, both things would be needed in greater degree in a world where outsourcing has come.
I’ve predicted for some time that the reduced costs of communication enabled by information technology will lead to more outsourcing of non-critical or non-core functions in a company. And I think we’ve seen quite a bit of that over the last almost-two decades — since I first started predicting that.
The most recent version of that that’s been a big deal in the past year is outsourcing to other countries — off-shoring, not just outsourcing. That’s almost inevitable. The forces leading toward it are pretty compelling as long as there are huge inequalities in labor rates in different parts of the world — but that’s a big if, a big qualification, because those huge inequalities in labor rates are getting smaller every week. And it won’t be too long — certainly no more than a generation, and maybe quite a bit less than a generation, probably — before the global labor market has more or less come into equilibrium.
Now, even in the United States, where you could say that national labor market is in equilibrium, there are still different wage rates in different cities having to do with things like the cost of living in those places, maybe even the desirability of living in those places. So, I don’t think that wages will ever become identical all over the globe. But I think that the global labor market will come into equilibrium more rapidly than many people probably assume. There will no longer be easy opportunities for what you might call labor rate arbitrage (moving something to a lower wage place).
When that happens, we’ll see a continuing of the trend that’s already happening within our society, which is that outsourcing leads to the possibility of greater specialization, greater focus and greater efficiencies in many cases. But we’ll need to learn how to find and coordinate the increasingly specialized suppliers for whatever it is we need to do in a given business.
Dresner:
And along those lines, one of the things you talk about is the re-emergence of guilds, which is interesting because we as human beings need to identify with something. We need to somehow align ourselves with some sort of organizing construct.
But as you start to organize around guilds based on profession or skills, doesn’t that impact business because the guild’s goals may, in fact, not be aligned with your goals? How do you, as a business, deal with that?
Malone:
Well, let me say a little bit about what I mean by “guild” and then try to answer your question. In today’s world – or in the traditional world, the world of the recent past – many people got a lot of benefits from being part of large, stable organizations. They got financial security. They got a place to socialize. They got a place to learn, even a sense of identity.
In a world of increasingly independent workers — what we call e-lance workers, meaning electronically connected freelancers — there are a lot of benefits in terms of flexibility and efficiency. Companies don’t have to hire workers except when they actually need the skill those workers have. And then, they can find the best ones available in the world. Workers have a lot more choice about what they work on, when they work, where they work. So, there are a lot of potential benefits of flexibility and efficiency on both sides of the transaction.
But there are some potential disadvantages for workers — an independent contractor, an e-lance worker, in a pure e-lance economy doesn’t have any obvious place to get many of those benefits that workers used to get from being employees.
So, as we thought about this problem, it occurred to us that there was a fairly obvious but not widely appreciated possibility for solving the problem, and that is to have a set of independent organizations whose job it was to fulfill the needs of their members who were independent workers.
You could call these things societies or networks or clubs or associations. But the word that we liked best was guilds — harking back to the medieval craft guilds. The basic idea is that, as an independent worker, you could join a guild which would give you a kind of home – a stable home as you moved from job to job, company to company, employer to employer.
These guilds, for instance, could provide financial security. They could take some percentage of your income in the good times in return for guaranteeing you at least a minimum income in the bad times. They could train and educate you, developing your skills to keep you continually productive and economically attractive in the ever-changing economy. They could give you a place to socialize — physically and virtually. And they could even give you a sense of identity. Some people might get their sense of identity from being a member of the Electrical Engineers’ Guild or the MIT Alumni Guild. So, that possibility has the potential to make a lot of things better.
Now, you raised the question of whether the interests of these guilds would be opposed to the interests of companies that were employing them. Let me give you two examples of where I think that’s not necessarily the case at all.
These guilds could come from professional societies, from college alumni associations, from temporary-help agencies and a variety of other ways. But one of the interesting possibilities is that they could come from unions. In today’s world, many unions and many union members define the role — and in some sense, even the main reason for existence — of a union as being collective bargaining, that is, to provide a kind of monolithic — you might almost say monopolistic — voice on the side of the table representing workers to counter the power of the monolithic/monopolistic employer company on the other side. But in an e-lance economy, there wouldn’t, in many cases, be anyone on the other side of the table to collectively bargain with because there’d be a different combination of companies and people every week. Who would you be bargaining with?
So, one of the very interesting possibilities is that the role of unions might change. As unions become more and more like what we call guilds, they might come to see their primary role not as one of collective bargaining, but as one of providing other kinds of services to their members — services like insurance, financial security, education, job training and so forth.
In that case, the basic dialogue between companies and unions might change., You might caricature the traditional version of this dialogue as something like this: The unions say, “You owe our members good jobs.” And the companies say “But we have to make a profit.” And there’s a contradiction there.
But in a world of ever-shifting companies, and stable guilds, you might imagine that the dialogue would evolve to something like this: The unions say, “Our job is to help our members remain economically productive,” and the companies say, “Our job is to use your economically productive members to make a profit.” So, there’s at least a potential that the interests between guilds and companies could be more closely aligned than the interests of unions and companies have been in the past,. That’s one possibility that illustrates the lack of conflict.
Another possibility — one that I mentioned in passing at the end of this section in my book — is that companies might come to see themselves as what we have called guilds. That is, in today’s world, the management of a company often sees its role as one of directing the work of its employees to satisfy its customers and to make a profit in doing so.
You could imagine a company that said, “It’s our employees’ responsibility to satisfy the customers and to make a profit in doing so. And our job, as a company, is just to provide a good home and infrastructure to help our employees do that.” In that case, the role of a company becomes one of providing benefits to its members, and helping them to be economically productive.
You talked a little bit about corporate social responsibility. I think it’s something that companies should aspire to, but most don’t. And also, you have to take into account that most shareholders are driven by greed and not some higher goal. There are examples, like CALpers, for instance — a tremendous investor in the market that invests carefully, based on certain social goals. But the majority do not.
What do you see as changing that, so that companies will be more focused on society and the benefits, or the well-being of their employees, as opposed to where they are today, which is a singular focus on profitability.?
I think it’s important to make a distinction between the ideas I was suggesting and a conventional view of corporate social responsibility.
There are certainly some responsibilities corporations have to their societies. But what I did in the last chapter of my book was to talk about what I think is, in some sense, a broader concept of what I call the Marketplace for Values. This says that there are a lot of values that are important — or in which businesses could play an important role — about which different people have different opinions about what’s good.
So most advocates of corporate social responsibility assume that they know what’s right. And the only question is how to convince companies to do it.
There are many cases where different people have legitimate differences of opinion about what’s right. But that doesn’t mean that companies shouldn’t be able to do anything or shouldn’t want to do anything about those things. What it means is that we can let the market – the decentralized, decision-making processes and markets – help direct our societal resources to the different social values that different groups of people think are important.
Some people, for instance, think that making any kind of weapons is a bad thing. Other people think making weapons is fine. People have very different views about abortion, birth control, tobacco, alcohol, pornography and things like that. A desirable thing is to make it easier for people to know what social values are represented by and embodied by different companies in making their choices about which companies to do business with — as customers, as employees, as suppliers and even as investors.
One example that is very telling is socially responsible investing. Many people would say that the only legitimate purpose of a company is to maximize the financial return for its shareholders. And many people would also believe, as you said, that most investors care only about maximizing their financial return. I don’t have a strong opinion about what percentage of investors care about that. But it’s very interesting to observe that over 10 percent of all the funds under professional management in the United States today use some form of socially responsible investing.
So, 10 percent is not a majority, but it’s a pretty significant minority. And it’s up from almost nothing about 20 years ago. So, I suspect there’s even more potential for socially responsible investing than is currently captured by the funds that do that today.
In fact, if you think about who investors are, they ultimately are all people. And people care about money and the things you can buy with money. But every person I know cares about some other things, too. So, it’s a misleading simplification to assume that all or even most investors care only about maximizing their financial return.
For some people in some situations, that absolutely is the most important thing. But I have a feeling that there’s a huge untapped potential for companies to say, “We’re going to pursue these social values, these human values, in the context of a for-profit activity or a profit-making company. And if you want to participate in that, feel free to invest in us. And if you don’t, that’s fine, too.”
An interesting example of this is Google. In Google’s IPO, it made a big deal about doing no evil. And Google did a number of things that were countercultural to Wall Street. It said it was not going to give frequent guidance about what it thought its earnings are going to be. It said it was not going to do a bunch of things that most companies do. And plenty of people were happy to invest in Google. Some of those people probably did it purely for financial reasons. Others may have done it in part for other reasons, too. So I think that’s interesting proof that it’s possible.
For that to become more common and to work better in the future, we need much better transparency – not just for financial things, but also for non-financial things about the company’s operations.
There’s another example I mentioned in my book about a company called IdealsWork. It’s a Web site that helps you pick among different products that you might buy as a consumer, like clothing, appliances and so forth. So, if you want to buy an athletic shoe, for instance, you can go to the IdealsWork Web site. And you can check off which of a number of different social values are important to you – environmental issues, worker rights, safety, rights of women, animal rights.
Most of the ones that are there now are what you would think of as traditionally liberal concerns. But there’s no reason in principle why you couldn’t have a site that had a bunch of traditionally conservative concerns or concerns that were important to Catholics or gun owners or Buddhists or practically any interest group you can think of.
So the idea is that you can go to this Web site, select which social values are important to you and then it will give you a rating of the different companies that supply whatever product category you’re interested in, like athletic shoes or TVs, in terms of the values that you said were important to you. And they say they base these ratings on objective data available to the public.
So whether this particular company succeeds in its efforts or not, it seems to me almost inevitable that things like that will happen more and more, and that it will become increasingly easy for you to find out about what companies are really doing — not just financially as reflected in their financial statements, but in terms of what they’re doing to the environment, what they’re doing to the workers, what kind of place it is to work — all kinds of things that may be important to you. You can find that out and use that in making your decisions about whether to buy from those companies, about whether to work for those companies, about whether to invest in those companies.
And I think if that information were widely, easily and reliably available, it would have a big effect on the degree to which companies explicitly try to do things that satisfy a wider range of human values than the purely financial ones.
In a sense, what I’m saying is that information technology, coupled with the right kinds of information, has the potential to make markets much more transparent and efficient, not just in terms of economic values, but also in terms of a much wider range of human values as well.
Dresner:
Excellent.
Thank you very much for your time. You were very generous with it.
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Computerworld – Can the same laws of supply and demand that fuel world economies work within a company to help it staff projects, share information and even schedule manufacturing? In April’s Harvard Business Review, Thomas W. Malone, the Patrick J. McGovern Professor of Management at MIT’s Sloan School of Management, tells how a team at MIT has been experimenting with the use of internal markets to demonstrate that what works in the global economy may work inside your business as well. In an interview with Computerworld’s Kathleen Melymuka, he explains what internal markets are all about.
What is an internal market? An arrangement where people inside a single company buy and sell things to each other for money or some kind of internal points or “funny money.”
What are the broader implications of internal markets for the way we work? Internal markets are one intriguing way that people throughout a company can exchange information much more rapidly and widely in a way that lets lots more people make decisions for themselves instead of just relying on people above them to tell them what to do.
What role does IT play in the internal-market scenario? IT greatly reduces the cost and difficulties of having broad internal markets and therefore makes them more feasible in many more situations than they would have been in the past.
Talk about the way Hewlett-Packard uses internal markets to fund and staff projects. HP used a “VC cafe,” inspired by how venture capitalist funding works. Anyone in the division could propose a project, and that proposal would be reviewed by a board of senior managers. If those managers thought the project worth doing, they would fund it, and then a description of the project would be posted in an internal system where everyone could see it. People could indicate interest to the project manager. In this way, projects could be proposed and individuals could find projects they wanted to do even if their managers didn’t know about their interests.
Thomas W. Malone of MIT’s Sloan School of Management
How else has HP used internal markets? In one case, they let marketing and sales people in one part of the company buy and sell “futures” contracts for predictions about what the sales of a particular product would be. For instance, people who believed sales would be 10,000 to 20,000 units would buy a contract for that prediction. If the prediction was correct, their contract would be worth a dollar; if incorrect, worth nothing. So over time, people bought and sold their futures contracts on sales predictions, and prices varied according to the collective opinions of everyone participating in the market. It turned out that this market made more accurate predictions of actual sales than HP’s own market research.
Why do you think that happened? Because the people participating in the market had a clear incentive to bet on the things they actually believed would happen rather than the things they hoped would happen or would make them look good. Another reason is they were able to combine the opinions of everyone participating more efficiently than a single survey or forecast would usually be able to do.
Can you briefly explain the internal market experiment MIT is doing with Intel? We’ve worked on a project with Intel to develop a scenario for how they could use an internal market to allocate their manufacturing capacity. Plant managers would sell futures contracts for a certain number of products to be delivered at a certain time in the future, and salespeople would buy those contracts in order to resell those products to their own external customers.
Through the process of supply and demand, prices for different products at different times would vary, and at the last moment before manufacturing needed to begin, the most highly valued products would actually be scheduled in the factories. In this way, the collective knowledge of all the plant managers and all the salesmen about manufacturing costs, customer demand and other factors could be efficiently taken into account in deciding exactly which products to make when.
How well do internal markets respond to change? They can respond very rapidly to changing conditions. Imagine that an earthquake disrupted an Intel factory in Singapore. If they were using an internal market, the response would be determined by rapid exchanges throughout the whole company. Other plant managers who had available capacity could quickly bid on performing the highest-value jobs that had been previously scheduled for the disrupted plant. Salespeople could negotiate to be sure the most important customer needs were met, and hundreds of people throughout the company could be simultaneously working on different parts of the problem without any bottleneck in the process.
Are there situations in which internal markets wouldn’t work well? Certainly. In some cases, the best decision for the company is something that internal buyers and sellers would never agree on because it would never be in their own individual interests. In other cases, like when a company is shrinking, it might be possible to make decisions with internal markets, but it’s likely to be faster and more effective to do so with centralized managers.
Why haven’t internal markets been used much up to now? The most important reason they haven’t been used is that the cost of communications and information processing needed for them to work has been prohibitive. Now those costs are falling dramatically with new information technologies.
How do internal markets facilitate individualized service? Internal markets let individual salespeople bid as much as they think it’s worth to provide expedited delivery or other kinds of specialized service for their own individual customers instead of having to do this by calling in favors or pulling strings throughout the company. The individual salespeople can see immediately what the actual cost would be and decide whether it’s worth it in each case.
And internal markets tend to keep people honest, right? Internal markets provide the right incentives for people to buy and sell according to what they actually think will happen. It is, of course, possible that people might try to manipulate the market, [but] I think it will be easier to enforce trading rules because the senior managers will still have the power to punish those who abuse the internal market.
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“People seem to have strong attachments to centralized ways of thinking: they assume that a pattern can exist only if someone (or something) creates and orchestrates the pattern,” Resnick wrote in a 1998 article in Complexity 3. “When we see a flock of birds, they generally assume the bird in front is leading the others – when in fact it is not. And when people design new organizational structures, they tend to impose centralized control even when it is not needed.”
Only if we can overcome that rigid mind-set, Malone says, can we open ourselves to the enormous opportunities for rethinking the way organizations work that have been created by the wave of information technology that has surged through the business world in the past decade or so. Advances in IT have generated once-in-a-lifetime opportunities to rethink the way the organization is working, and severely undermined the old mode of centralized authority. The Internet is now so ubiquitous that small, loosely tied groups of “e-lancers” can take on large, hierarchical corporations. The technologies are pretty well there now, Malone says; it is just that the continuing post-dotcom-boom hangover is hampering organizations from realizing their genuine potential.
Malone has drawn on 20 years of groundbreaking research to foreshadow a workplace revolution that is set to dramatically change organizational structures and the roles employees play in them. To succeed, managers must grasp these changes, he says.
Malone, renowned for his forward thinking, is the Patrick J McGovern professor of management at the MIT Sloan School of Management and the founder and director of the MIT Centre for Coordination Science in Cambridge, Massachusetts. In a 1987 article he predicted many of the major e-business developments of the past decade, including electronic buying and selling, e-markets, organizational outsourcing of non-core functions and the use of intelligent agents for commerce
In his just released Future of Work, How the New Order of Business Will Shape Your Organization, Your Management Style, and Your Life, published by Harvard Business School Press, Malone provides the first credible model for actually designing the company of the future. The logic of that model, combined with the “amazing pattern” that has seen societies and business organizations move increasingly towards decentralized decision-making, provides compelling evidence that we are in the midst of a fundamental and predictable change – “one that may be as important to business as the shift to democracy has been to government”. Equally importantly, he explores the skills that managers will need in a workplace in which the power to decide belongs to everyone.
“I think the key difference that I see between the organizations of the future and the organizations of today is that there will be, I believe, more freedom, more decentralization of decision-making in the organizations of the future,” Malone told CIO magazine. “One of the most important things is decentralization. People have talked about this before, but now changes are happening much more radically.
In fact Malone’s findings support the conclusion of other researchers that greater use of IT can lead either to centralization or to decentralization, depending on the situation. For instance, the model shows how IT can support more centralization when economies of scale are important and less where the emphasis is on motivation and flexibility. But Malone’s model goes further than others in revealing that in many cases the benefits of centralization are the benefits of “bigness”, not the benefits of centralization per se. And it shows that when communication costs are low enough it is often possible to decentralize in a way that provides those self-same benefits of “bigness” – scale economies for instance – as well as the benefits of “smallness” such as motivation and flexibility.
“Decentralized business organizations represent a new world of work, with new rules and new demands,” Malone writes.
Loosening the Hierarchy
When search engine technology company Google starts a major project, it does not create a huge venture with lots of management layers. Instead it sets up a few, autonomous engineering teams – often of only about three members each – and sets them loose, giving them wide latitude on how they do their work. When the teams need to communicate, they usually do so directly, either face-to-face or electronically.
This is an example of a loose hierarchy, one of the numbers of ways organizations are choosing to decentralize.
In loose hierarchies, Malone says, there are still hierarchical structures and bosses, but a huge amount of decision-making authority is delegated to very low levels of the organization. Also epitomized by the group of people that developed Linux, “one of the best operating systems available”, loose hierarchies are a new, highly decentralized way of organizing knowledge work.
Loose hierarchies have dense communication; no matter how widely dispersed their members are, their members need to stay in touch with each other. They lack central control, with relatively few decisions being centralized. And the members of the hierarchy have the freedom to participate: they can join in or drop out of the effort whenever they feel like it.
Loose hierarchies are no longer the exclusive domain of universities, consulting firms and software development groups. AES Corporation, one of the largest suppliers of electric power in the world, with revenue of $US8.6 billion and 36,000 employees in 2002, runs on the notion that every employee should be a businessperson – “a well-rounded generalist, a mini-CEO responsible for important decisions in the company”, as Malone puts it.
Then there are the organizations that have harnessed a second way of making decentralized decisions: democracy. In democracies, Malone says, individual workers get to vote on key corporate decisions, and in many cases even on “who their managers are going to be”. For instance, when the managers of any of the 143 Whole Foods supermarkets in North America decide to hire someone, they know their decision is really only a recommendation. Before becoming a permanent employee, every candidate works for a three-day trial period and then the entire departmental team votes on whether to keep them.
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There have been experiments in workplace democracy before, Malone points out, but most have proved successful only in limited situations, if at all. “As communication costs continue their dramatic fall, however,” he says, “the democratic form of decentralized decision-making is becoming feasible in far more places than ever before.”
Over recent times organizations have experimented with opinion polling their employees (such as when Hewlett-Packard proposed to buy Compaq Computer in late 2001); participative decision-making (no one at US clothing giant Gore-Tex bar the president and secretary have a position title – they are all called an associate and becoming a manager means going out on your own initiative to find fellow employees who will agree to work for you); and cross-organizational democracy (epitomized by Bank of America and the other banks BoA had licensed to use the BankAmerica credit card, which were in fact competitors, as they set up a for-profit membership corporation to deal with major operational problems).
Malone says democracies give those involved a greater sense of autonomy (and thus creativity and motivation) than hierarchies but less than in a market structure, which is the other way organizations are choosing to decentralize.
“The third and fourth ways I see decentralizing happening are two separate forms of markets,” Malone says. “The simplest to understand is what I call external markets – that is markets as we know them where more things are outsourced to other companies or freelance contractors, including things performed inside a single company.
“The fourth possibility is what I call internal markets, where you have employees of a single company buying and selling things among themselves inside the company’s boundaries, as a way of allocating resources or making other decisions.
“We usually think of a market as something where separate companies or at least legally separate individuals buy and sell things to each other with contracts, exchange of money and so on,” he says. “Most people have heard about the advantages – at least in principle – that come from that market way of organizing things. So most people are familiar with those benefits in efficiency and flexibility and motivation that come from the market. But most people don’t realize that it’s possible – at least in principle – to get many of those same benefits inside a single company, if you let people inside the company buy and sell things to each other, as if they were operating in a market.”
The way many IT organizations have been set up to handle transfer costs can be seen as a precursor to the kind of internal markets Malone is talking about.
Those early forms of internal markets are usually done at a fairly high level. For instance a vice president might make deals with other vice presidents about the internal charge rate for work to be done at a fairly high level of the organization and at a fairly gross grouping. That is a fairly large-scale transaction. “I think one of the most interesting possibilities of these new information technologies is that it makes it easier to do that same kind of thing on a much smaller scale, much finer grained transactions, and at much lower levels of the organization,” Malone says.
His book provides an extensive example of how a large semiconductor manufacturing company might use such a structure to allocate manufacturing resources to their products. In the scenario outlined, each of the salespeople in the company would essentially be buyers of products in the internal marketplace, and each of the manufacturing plants would be sellers of product or manufacturing capacity to make those products. Both parties would then turn to an internal futures market to buy and sell products for not only current but also future needs. For instance the price for 100 integrated circuit chips might be $60 right now, but $30 in six weeks due to a drop-off in anticipated demand.
There are ways any one of these models could bring negatives to an organization, Malone says, but they also offer scope to make organizations not only more economically efficient, but also better places for people to work. And at any rate, they are certainly, if not inevitably, likely to hold sway in the future, he says. “I believe there are powerful forces that are leading us in this direction, powerful economic forces especially, that have to do with the decreasing cost of communication and the possibilities that creates.
“I don’t think that it is preordained that this is all going to happen quickly or even necessarily in ways that are the best for us. In other words I think we do have choices. We have choices about how quickly we embrace these underlying trends, and we have choices about how we actually implement them. And I think the ways we make those choices may in fact make a big difference in whether the organization we create, that in some sense the world we create, is a better one than what we have today.”
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Outsourcing, Malone says, is not only one of the forces causing the trend to decentralization; it is also in some ways a result of those same trends. One way to achieve decentralized decision-making is outsourcing in search of economic benefits, flexibility and efficiency. But the same trends are giving organizations more flexibility in terms of where they outsource work to, and outsourcers more flexibility about who they work for.
And while outsourcing in the short term is potentially a huge problem for those people who find their jobs displaced by lower earners elsewhere in the world, in the long term, global outsourcing is both more or less inevitable and more or less desirable. “I think it’s also important to remember that as the economy becomes more efficient through outsourcing some jobs to places where they can be done more economically, more jobs are created and often better jobs are created in the high-wage countries,” he says.
Generation Apps
Choosing the right decentralized model for the organization begins with realizing the choices are there to be made. CIOs should be thinking carefully now about the likely impact on their organizations of the trends predicted in his book, Malone says. “For instance, if the predictions and observations I make in the book are correct, then I think it means there will be increased emphasis on some applications that hardly exist at all today, and on others that exist but that are not used as heavily or regularly as they will be in the future.”
The first and probably most important is communication applications in general.
“When we use the term ‘computing’, it implies a technology that computes things, but in fact I think it’s important to realize that the vast majority of ways that computers are actually useful in business are not so much to compute things, in the sense of doing arithmetic, but to help communicate things. I believe there is a whole class of communication applications that is likely to become more and more important in the world of the future.”
One set of these communication applications is what used to be called groupware, with some parts now being called social software – the tools for collaborative work. E-mail and instant messaging are going to become ever more important to organizations, as is a class of applications that is not always a part of the CIO’s domain but which can be vitally important: the pure communication applications like videoconferencing and audio conferencing. These will all increasingly run on the same infrastructure, and managing them effectively and making them easily and cheaply available to people throughout an organization will be an important part of a CIO’s job. Another set of applications that hardly exists at all today, but will become more important, is the application software necessary to those internal markets.
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The Center Cannot Hold MIT’s Tom Malone discusses his new book The Future of Work: How the New Order of Business Will Shape Your Organization, Your Management Style, and Your Life.
From the development of Linux to the outsourcing of data to Bangalore, and from the Screen Actors Guild to the “loose hierarchy” at AES Corp. (the leading global producer of electrical power), MIT Sloan School Professor of Management Tom Malone has studied all sorts of distributed work organizations. His conclusion: Thanks in no small measure to IT, these decentralized networks, guilds and associations represent the business future. For the first time in history, Malone contends, we’re in a position to enjoy the economic benefits of large corporations without compromising the human benefits of small ones. In a recent interview with CIO Insight Editor Edward Baker, he talked about outsourcing, the advent of a decentralized 21st-century organization and the prospects for “a marketplace for values.”
CIO Insight: Are there changes going on today that support your theory of a decentralized future?
Malone: I think most things that happen in organizations and human societies happen by fits and starts. There are ups and downs, booms and busts. And I think we’ve just been through a boom-and-bust cycle in the year 2000, and after the year 2000, when there was a great deal of overly optimistic enthusiasm about how much-and especially how fast-information technology would change business. [But] I think many of the ideas people had about what changes would happen were basically right. They just aren’t going to happen nearly as fast as some were assuming.
Does the kind of decentralization that you write about-for example, an increasingly remote, mobile, “free agent” workforce-does that tend to be held up during periods of economic contraction?
I think it’s often the case that decentralization works better in times of growth rather than in times of contraction. Not always, but that’s often the case.
Let’s talk about outsourcing. How do you see that in the context of the trend toward decentralization?
Outsourcing is one of the important ways that decentralization will continue to occur. When you outsource work to other companies or to independent contractors-work that used to be done inside a company by its own employees-that’s a major driver of decentralization, obviously. It’s also clear that, through outsourcing, much of business is increasingly turning to a global market, rather than to a local or regional one. That has potential risks for the individuals whose jobs are moving around, but I think that in the long run it makes all of us better off.
All of us, or just the ones with the work?
Well, let me say a little bit more about that. First, I think that the global labor market today is still very unequal. There are still differences in wages of factors of five, or ten, or sometimes more between the highest-wage countries and the lowest-wage countries. We are in for at least a generation or so during which that global wage market will equalize out. That will never happen exactly, but for the most part the labor market will come into equilibrium. So in the short term that means people with skills or jobs that can easily be exported because of the technology are at risk of having their jobs exported to low-wage countries. People in the low-wage countries stand to benefit from that. But it doesn’t mean the world is getting worse off; it just means that some individuals have hard times. I think that there are two things we need to do as a country about that. We need to provide as many opportunities as we can for people whose jobs are being moved to other places. Second, I think we need to invest in education and innovation so that we will keep creating new high value-added jobs in this country while the older, less value-added jobs are done more cheaply elsewhere.
But aren’t a lot of those new jobs taken by younger people coming into the job market?
Well, yeah. But the point I was making is that in the long term new jobs are created. In the short term, there definitely are dislocations for individuals whose jobs are moved.
Obviously, in very hierarchical organizations, power resides at the top. As corporations decentralize, will decision-making power get decentralized, too?
Yes, I think it does. I think that the broad historical theme that runs throughout my book is a theme of how information technology, by reducing the costs of communication, is making it possible for many more people in organizations to have enough information to make decisions for themselves instead of just following orders from someone else.
How do you lead such an organization so that all those independent decision-makers work toward a common good-especially when the “common good,” at least at this point, is shareholder value?
Well, let me take two parts of that question. The first part is: How do you organize a decentralized system so that everyone is working toward the common good? You can use loose hierarchies where a great deal of authority and decision-making power is delegated, but there still are centralized managers who, if they do nothing else, at least decide how to reward people for the results of the decisions they’ve made. Another way of doing this is by using various kinds of democratic decision-making where people vote on various kinds of decisions. And then, finally, you have markets with their balancing of supply and demand, and individual buyers and sellers making their own individual decisions about when to have a transaction. Markets also provide a way of aligning, in some sense, the independent decisions of lots of individuals, and pairs of buyers and sellers, with some overall common good. The second part of your question is the goal of maximizing shareholder value. In the last chapter of the book I talk quite a bit about this question of values. It is widely believed that the primary goal of business is, or at least should be, to maximize the return to the owners of the business, to the shareholders of the business. But if you think about who the shareholders are, they’re people, and people care about a lot of things. They care about economic and financial things certainly, but they also care about relationships, they care about challenge and achievement for themselves. They care about finding meaning in their lives. And I think one of the best examples of how, even in investment decisions, other human values can play an important role is the rise in so-called socially responsible investing. Socially responsible investing now accounts for over 10 percent of all the funds under professional management in the United States.
And yet plenty of people would describe the last 30 years of business history as the rise of market values-not social ones.
I think you’re right that much of the last 30 years or so has seen an increase in concern for purely economic values in business, but I see a lot of signs that that trend is reversing.
Ultimately, how do you reconcile the inevitable conflicts of interest that would arise when you have to focus decentralized, socially responsible managers on the bottom line?
Well, that’s an excellent question. What we need is some way of reconciling or balancing among all those different ideas of what’s important. In the last chapter of my book, I talk about one way of doing that, which I think is more promising than many people realize, which is what I call a marketplace for values. A marketplace for values is a market in which people make their individual decisions with other buyers and sellers on the basis of whatever is most important to them. So economic factors certainly play a role there, but if it is, for instance, more important to you to spend time with your family on weekends rather than to add 10 percent to your income, then, as an independent contractor, you have arguably more freedom to make those decisions and to make those tradeoffs in whatever way is most important to you. At the same time, if it’s important to you to save the environment by reducing environmental pollution, then you can chose to buy from and work for companies that you think are doing a good job of that, and not to buy from and work for companies that you think are doing a bad job of that. And out of all that very complex, decentralized set of decisions-all the different decisions of who’s going to buy from, or work for, or sell to, or invest in whom-will emerge a kind of decentralized consensus about what values are important to us as a society or as an economy.
Okay, but don’t markets have the unfortunate habit of picking winners and losers?
Markets have winners and losers, but so do all other ways of making decisions. Democracies have winners and losers. Hierarchies have winners and losers. So I think the fact that some people get more of what they want than others in a market is by no means unique to markets. And I don’t think, by the way, that markets should rule all. There are clearly times when markets should be, and need to be constrained by other kinds of institutions, such as democratically chosen laws and hierarchical enforcement mechanisms. The right answer in nearly every economy is some combination of centralized and decentralized. The art of the future will be to know which things to centralize and which things to decentralize.
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Author Thomas Malone, a professor at MIT Sloan School of Management, says that the cheap cost of communication—e-mail, instant messaging, the Internet—is making possible a new type of organizational structure. This organization of the future will be decentralized, the term defined as “participation of people in making the decisions that matter to them.” Decentralization brings with it increased productivity and quality of life. But decentralization isn’t right in every situation. In this chapter from Malone’s new book, he asks: When should you decentralize?—Ed.
Soon after Lou Gerstner became CEO of IBM in 1993, he made what he calls probably the biggest decision of his entire career.1 At the time, many people in IBM and the business press were convinced that the best course for the “lumbering dinosaur” was to break itself up into smaller companies. By decentralizing in this way, they said, IBM would obtain the benefits of smallness that it sorely needed—things like flexibility, speed, and entrepreneurial motivation. And the market would be able to coordinate the interactions of the resulting companies better than IBM’s corporate executives could.
But Gerstner became convinced that the best choice was to do exactly the opposite: keep IBM as a single large company and use its unique size and capabilities to help customers integrate the diverse components of their information technology (IT) systems. In other words, he wanted to use the hierarchical decision-making structures of an integrated IBM to help coordinate all the IT decisions that customers would otherwise have to make on their own (or hire someone else to make for them).
We now know, of course, what happened. Gerstner loosened up IBM’s organization but did not break it apart. And his plan worked. IBM’s stock price increased by almost a factor of ten during Gerstner’s tenure, and many people credit him with pulling off a stunningly successful turnaround against very steep odds.
Of course, we don’t know what would have happened if a different CEO had gone ahead with the breakup plan. The spin-off companies might have been even more successful collectively than the integrated IBM was. But we do know that Gerstner’s choice to keep the company centralized was extremely successful.
You might think that Gerstner would be a zealous advocate of centralization since it served him so well in this situation. But even within IBM, he advocated substantial decentralization: “Let’s decentralize decision making wherever possible, but . . . we must balance decentralized decision making with central strategy and common customer focus.”2 Even more surprising, he believes that the success of centralization at IBM was unusual: “CEOs should not go to [the level of integration IBM did] unless it is absolutely necessary” [Gerstner's italics].3 This level of integration, he believes, is a “bet-the-company proposition.” It is often tried, he observes, but almost never succeeds.
You may never face choices about centralizing or decentralizing on the scale Gerstner did, but if you’re like most managers, you face such decisions on a smaller scale all the time. How should you make them? How can you tell whether your situation is one for which decentralization makes sense? And if you’re going to decentralize, how can you know which kind of decentralization will work best?
In many cases the best solution is to create a custom system that combines elements of more than one basic structure.
As Table 8-1 shows, centralized hierarchies and the three basic types of decentralization—loose hierarchies, democracies, and markets—each have strengths and weaknesses. When you need to economize on communication costs or when resolving difficult conflicts of interest is critical, centralized hierarchies may be best. When you need to maximize employee motivation and creativity or tap into many minds simultaneously, markets are especially attractive. When aspects of all four dimensions are important, the two intermediate structures (loose hierarchies and democracies) may work well.
In many cases, however, the best solution is to create a custom system that combines elements of more than one basic structure. You can, for instance, use different structures for different types of decisions. That’s what often happens in internal markets: The basic operational decisions are made through the decentralized market, but hierarchical managers choose the participants, set the ground rules, and intervene when the market would otherwise fail to do what is best for the organization overall.
Assigning different decisions to different structures isn’t easy; it requires a detailed understanding of your own specific situation and goals. But…there is a systematic way to think about the problem.4 For each major kind of decision your company makes, you can ask yourself the following three questions: (1) Are the potential benefits of decentralizing important? (2) Can you compensate for the potential costs of decentralizing? (3) Do the benefits of decentralizing outweigh the costs? Let’s look at each of these questions in turn.
Are the potential benefits of decentralizing important?
As we saw earlier, decentralization has three general benefits: (1) It encourages motivation and creativity; (2) it allows many minds to work simultaneously on the same problem; and (3) it accommodates flexibility and individualization. The importance of these benefits varies greatly, but they are often especially important in certain industries and business functions. For example, the success of most professional services organizations (such as consulting, software development, and law) hinges on the motivation and creativity of their professionals. Consequently, these organizations are especially good candidates for decentralized decision making. Creativity and innovation are also often particularly important in functions like engineering, sales, product design, and information technology. Here, too, decentralization will often pay off.
But as more work in our economy becomes knowledge work, and as innovation becomes increasingly critical to business success in many industries, the benefits of decentralization are likely to become important in more and more places.5 In fact, in principle, almost any business activity could benefit from having highly motivated, creative people performing it. Much of the early work in the Total Quality Movement, for example, was about encouraging assembly line workers to look for ways to innovate and improve the routine processes they performed.
So the question of whether the benefits of decentralization are important in your situation is not a purely objective one. It is also a matter of your strategic choices. Different people in the same situation can make different choices about how much they want to rely on the advantages of decentralization. Mrs. Fields Cookies tries to systematize and centrally control almost all the decisions needed to operate its local stores, while Wal-Mart tries to give significant autonomy to its local workers.6 Either strategy can work well, but you have to pick one and use it consistently.
Can you compensate for the potential costs of decentralizing?
You may be thinking, “Sure, sure, all this decentralization stuff sounds great in theory, but how often could it actually work? How can you make decisions effectively when no one is really in control? How can you guarantee quality or protect your company against catastrophic losses if no one is watching over things? How can you take advantage of economies of scale or knowledge sharing, if everything is so fragmented?”
These concerns are important—sometimes so important that they’ll lead you to reject decentralized structures and stick with rigid hierarchies. Often, though, there are creative ways to deal with the potential downsides. Let’s look at the four main problems with decentralization and the possible solutions.
How can you make decisions quickly and efficiently when no one is in control?
Sometimes, it just takes a long time to involve everyone in joint decisions and resolve all their conflicting desires. Cheaper and faster communication, through e-mail, for example, helps temper this problem. But even when the transmission of information is free and instantaneous, it still takes time for people to send and comprehend the information. And no matter how much people communicate, they still won’t all agree on every question. Each of the decentralized structures offers different ways to make decision making more efficient.
In loose hierarchies, you, as a manager, can sometimes force decisions on people, even when not everyone agrees. In an economic downturn, for instance, you might decide for yourself which groups to cut, instead of waiting for the groups themselves to make such a difficult decision.
If you’re a good manager in a loose hierarchy, you probably won’t force decisions very often. Sometimes, you’ll have to force a decision, such as when a decision is taking too long, when it looks as if there will never be enough agreement, or when people are spending so much time arguing they’re not doing their other work. But the rest of the time, you should let people work things out for themselves.
In democracies, you can make decisions more efficiently in two ways. You can let the employees elect managers to make decisions on their behalf, as the partners of many law firms and consulting firms do in electing managing partners. Or you can let people vote directly (or via opinion polls) on the most important decisions, as the Mondragon cooperatives sometimes do.
In markets, decisions are often made efficiently because only two parties—a buyer and seller—need to agree for a transaction to occur. If an earthquake disables one of your factories, for instance, and your company has an internal market, then pairs of buyers and sellers can start trading with each other right away to solve the problem. They don’t need anyone else to agree about what to do.
But for a market to work well, everyone who participates has to agree on the rules of the game. Markets need legal frameworks to resolve disputes between buyers and sellers, and they need regulatory systems to prevent activities (like pollution, price fixing, misleading accounting, or deceptive advertising) that make the whole market less efficient. In external markets, governments usually provide the rules. But, as we saw with Visa International and eBay, other organizations like trade associations, market makers, or standards bodies can also set rules. In internal markets, the rules are established and enforced by the managers of the company.
How can you guarantee quality or protect against catastrophic losses if no one is in control?
Many people assume that quality assurance and risk management require someone to be in control. But that isn’t always true. When the right incentives are in place, just sharing information can be enough to maintain quality and temper risk. Suppose that in your company, the bonuses for everyone who deals with customers depend partly on customer satisfaction ratings. And suppose that everyone in the company can easily call up a page on the company intranet to see the customer satisfaction ratings for each store and salesperson. Just by setting up a system like this, many service-quality problems are likely to take care of themselves without any centralized intervention. Social and other pressures will push people to excel.
Sharing information can work in loose hierarchies, democracies, and markets. But each decentralized decision-making structure also offers other ways to manage risk and quality. If you’re a manager in a loose hierarchy, you don’t have to watch over or sign off on every action your subordinates take. This freedom allows you to focus on controlling the quality of people and measuring results. For instance, you can devote more attention to whom to hire and promote and how to reward them for the results you want.7
In democracies, you can elect managers to watch quality and risk. Or you can let the members of a group vote—taking into account quality and risk, as well as other factors—on whom to hire and promote and how to allocate rewards. Many consulting and law firms, for instance, elect their new partners by a vote of all the existing partners.
In markets, you can control quality in two ways. First, you can use online reputation systems (e.g., those used by eBay, Elance, and Asynchrony) to help people pick high-quality providers in the first place.8 When online reputation systems become widely used, the traditional signifiers of quality, like brand names, are likely to become less important. Actual user ratings give buyers a much more accurate and efficient way of judging quality than relying on their general knowledge of a brand. Which would you rather buy: (a) a television with a well-known brand (e.g., Sony), even though previous buyers and objective raters like Consumer Reports rate the set poorly, or (b) an unknown-brand television (e.g., from Joe’s No-Name Appliances) that gets wildly enthusiastic ratings from most previous buyers and objective raters?
In addition to reputation systems, the other primary way to manage quality and risk in markets is with various financial instruments: insurance, performance bonds, pools of risk capital, and other kinds of collateral. One of my former students, for instance, used to work in the credit card area of CapitalOne, a large financial services company with a decentralized, entrepreneurial culture. This student really appreciated the freedom that individual analysts had there to make pricing and credit policy decisions for massive mailings of credit card offers. But in 2002, government regulators forced CapitalOne to institute numerous centralized controls and approval processes designed to reduce the risk of huge credit card losses.9 In my student’s view, this involuntary centralization seriously damaged the unique entrepreneurial culture and strengths of the bank.
Could CapitalOne have managed this risk in other—more decentralized—ways? I think so. Here is one possibility: Instead of having a centralized manager sign off on the terms of every mailing, each analyst could have a pool of risk capital. If you were an analyst and wanted to make a mailing in which the total credit offered was below your risk capital limit, you could proceed with no other approvals. And you could still exceed your own limit without centralized approval by assembling a syndicate of peers who together were willing to contribute enough of their own risk capital to cover the mailing. In undertaking a huge risk, you might still have to get approval from a higher-level manager, but you and your peers could manage most of your own risks in a decentralized way.
How can you take advantage of economies of scale if everything is decentralized?
Many times, people assume that just because there are economies of scale in one part of a process, the whole process has to be centralized. But you can often get the benefits of both bigness and smallness by centralizing only those decisions involving important economies of scale and decentralizing everything else. In semiconductor manufacturing, for example, there are major economies of scale—Intel now spends about $2.5 billion to build a fabrication plant.10 But this doesn’t necessarily mean that similar economies of scale apply in everything else Intel does. There’s no reason, for instance, why the design of semi-conductor chips couldn’t be much more decentralized. In fact, some of Intel’s competitors, like the Taiwan Semiconductor Manufacturing Company (TSMC), take this idea to an extreme by providing only semiconductor-manufacturing services. Its customers, ranging from tiny start-ups to huge multinationals, design their own chips and then pay TSMC to manufacture them.
Even when economies of scale apply, you can sometimes achieve them with very little centralized control if you follow two key practices: Share information widely, and provide incentives that encourage scale economies. Many companies assume, for instance, that to achieve economies of scale in purchasing, they need to centralize purchasing decisions. By forcing all the different parts of their company to buy from the same vendors, they get much bigger volume discounts.
But what if, instead of forcing everyone to buy from the same vendors, you just provide incentives for people to form voluntary purchasing groups? If I don’t much care, for instance, what kind of personal computer I have, I could just delegate my personal computer purchasing decision to a PC purchasing specialist and automatically get whatever volume discounts that person can negotiate. If I do care, I could look at an online database of the different PC purchasing plans available in my company and decide which one is best for me. In this scenario, the central purchasing people could still have a job organizing voluntary coalitions of buyers, maintaining a database of available purchasing plans, and negotiating volume discounts for the people who choose to participate.
Of course, if the incentives aren’t right, this arrangement won’t work well. I might, for instance, choose my own favorite PC vendor, even when this is really not the best choice from the company’s point of view. But if I am measured and rewarded on the basis of my contributions to corporate profit, then I can balance the potential cost savings for the company with all the other factors that are important to me.
In general, the three decentralized structures allow individuals to make their own decisions about economies of scale. But, in each structure, you sometimes need to restrict individual decisions to encourage economies of scale (e.g., with utilities) or to prevent abuses of power (e.g., with monopolies). In loose hierarchies, the managers do this. In democracies, it’s done by elected managers or popular vote. In markets, some kind of regulatory infrastructure does it. For instance, in an internal production-capacity market with only a single factory, the corporation might regulate the factory like a public utility rather than letting its managers charge whatever price the internal market would bear.
How can you enjoy the benefits of knowledge sharing without centralized control?
One of the most important advantages of being in a big organization is having ready access to many sources of knowledge. If you’re the owner of an isolated hamburger stand in a small town in New Mexico, you have only your own ideas and experience to guide you in running your restaurant. But if you’re the manager of a McDonald’s in the same town, then—at least theoretically—you have access to the best burger-selling knowledge available anywhere in the world.
Of course, big companies don’t always take advantage of their full potential for knowledge sharing. And even when they do, gaining the benefit of knowledge sharing doesn’t require centralized control at all. It just requires the widespread sharing of knowledge. When communication is difficult and expensive, the best way to share knowledge may be to have centralized managers find and spread the best ideas from different parts of their organizations. But when communication is cheap and easy, it’s often better to have people share knowledge directly through many different channels. For example, independent restaurant managers can share knowledge with each other through trade association meetings, online discussion groups, best-practice databases, and so forth.
In each decision-making structure, you have different ways of encouraging broad knowledge sharing. In loose hierarchies and democracies, one of your most important roles as a manager is often to provide the channels and incentives for sharing knowledge. For instance, when some consulting firms do their annual employee performance evaluations, they take account of individuals’ contributions to corporate knowledge bases.
To share knowledge in markets, you need effective ways to buy and sell it. The effective sharing of knowledge is the purpose of intellectual property laws, like patents and copyrights. Some people are surprised to hear that intellectual property laws are meant to help share knowledge. They think, for instance, that if you can’t share music for free over the Internet, the laws are decreasing your opportunities for knowledge sharing. But when designed well, legal infrastructures like copyright laws give people much stronger economic incentives to create knowledge and package it for sharing.
Do the benefits of decentralizing outweigh the costs?
Once you’ve worked out the benefits and costs, you need to weigh them to decide whether decentralization will pay off. Here, again, however, there are no simple answers—much depends on your particular situation. But some simple rules of thumb can help you think through the choice.
Decentralize when the motivation and creativity of many people is critical. We’ve already seen examples of this principle in action in AES, consulting firms, internal markets for allocating semiconductor manufacturing, and so on. This principle becomes especially important in certain situations. When your company is growing rapidly, for instance, it is often a good idea to encourage people to creatively explore new possibilities. When your industry is in the midst of rapid change, the best way to figure out how to respond is often to let many highly motivated people try many experiments. And when small groups in your company work independently from other groups (e.g., in a consulting firm or a research university), it’s often a good idea to decentralize most decisions to these small groups to spur their innovativeness.
To share knowledge in markets, you need effective ways to buy and sell it.
Centralize when resolving conflicts is critical. When the key issue for your organization is not encouraging creativity, but resolving conflicts, then centralizing may be the better choice. For instance, Goran Lindahl, former CEO of highly decentralized ABB, says that you often need to centralize when an organization is shrinking.11 In times of contraction, hard choices need to be made about where to cut and what to change. Although it’s not impossible to make these decisions in a decentralized way, getting people to agree to give up things—including their jobs—is usually much harder than handing down orders from on top. AES, for example, appears to be moving to more centralized decision making now that its whole industry is shrinking.12
Centralize when it’s critical to have lots of detail—down to a very low level—united by a single vision. Even though sometimes thousands of people are involved in filming and editing a movie, the director usually needs to make many very detailed decisions to be sure that the final film embodies a single artistic vision. Sometimes, this principle applies in decisions about business strategy as well. For example, you could argue that Microsoft’s successful strategic shift to embrace the Internet in the mid-1990s was possible because Bill Gates both understood the details of his business and had significant centralized power.
Centralize when only a few people are capable of making good decisions. Sometimes people think decentralization means automatically pushing all decisions lower in an organization, whether or not the people at the bottom have the skills to make the decisions wisely. But such an approach is not decentralization; it’s just stupidity. With some decisions, no matter how much information you have, you still need special skills or knowledge to make the right choice. Most hospital patients, for instance, want well-trained physicians to make the key decisions about their medical care, even though the nurses on the floor may have much more detailed patient information. Similarly, some business decisions benefit from the kind of judgment that comes only from years of experience. Such decisions often need to be centralized. Even in such cases, however, a business may benefit from developing good decision-making capabilities in more people. You might be surprised at what some people can do when given the right opportunities to develop their skills.
Excerpted with permission from The Future of Work: How the New Order of Business Will Shape Your Organization, Your Management Style, and Your Life, by Thomas W. Malone. Harvard Business School Press, 2004.
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Thomas W. Malone is the Patrick J. McGovern Professor of Management at the MIT Sloan School of Management and the Founder and Director of the MIT Center for Coordination Science.
Evaluating Decision-Making Structures
by Thomas W. Malone
Excerpted with permission from The Future of Work: How the New Order of Business Will Shape Your Organization, Your Management Style, and Your Life, by Thomas W. Malone. Harvard Business School Press, 2004.
Notes:
1. Louis V. Gerstner Jr., Who Says Elephants Can’t Dance? Inside IBM’s Historic Turnaround (New York: HarperBusiness, 2002), 12-13, 57-62, 68-70.
2. Ibid., 22.
3. Ibid., 248-252.
4. For related work that contributed to the development of this approach, see Jay R. Galbraith, Designing Organizations: An Executive Guide to Strategy, Structure, and Process, 2nd ed. (San Francisco: Jossey-Bass, 2002); K. A. Merchant, “The Control Function of Management,” Sloan Management Review 23, no. 4 (spring 1982): 43-55.
5. On the growing importance of knowledge work, see, for example, Peter F. Drucker, Post-Capitalist Society (New York: HarperBusiness, 1993).
6. Thomas W. Malone, “Is ‘Empowerment’ Just a Fad? Control, Decision-Making, and Information Technology,” Sloan Management Review 23: 38, no. 2 (1997): 23-35; M. Stevenson, “The Store to End All Stores,” Canadian Business Review, May 1994; B. Fox, “Staying on Top at Wal-Mart,” Chain Store Age Executive 70, no. 4 (1994): 47; Thomas Richman, “Mrs. Fields’ Secret Ingredient,” INC. Magazine, October 1987, 65-72.
7. Merchant, “The Control Function of Management.”
8. See, for example, Chrysanthos Dellarocas, “The Digitization of Word-of-Mouth: Promise and Challenges of Online Reputation Mechanisms,” working paper, MIT Sloan School of Management, Cambridge, MA, 2002; Paul Resnick et al., “Reputation Systems,” Communications of the ACM 43, no. 12 (2000): 45-48.
9. Capital One Financial Corporation, “Securities and Exchange Commission Form 8-K,” 16 July 2002, available at (accessed 2 June 2003).
10. Brent Schlender, “Intel’s $10 Billion Gamble,” Fortune, 11 November 2002, 90.
11. Goran Lindahl, conversation with author, Carmel, CA, 24 June 2001.
12. Rebecca Smith, “AES, Calpine Post Losses for the Quarter: Results Reflect Electric-Power Industry’s Tight Credit, Instability, Declining Margins,” Wall Street Journal, 14 February 2003.
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Options for growth
For all but the biggest brands, success will depend on specialisation and innovation. This is a bitter pill for many to swallow. Mid-sized firms have to admit that they will probably never have the scale and status of their larger rivals; smaller firms have to relinquish new markets. Yet the opportunity here remains enormous: even the most cash-strapped clients want genuinely world-class expertise. Tier One consulting firms have been able to grow through diversification: strategy firms have stepped into operational work, operational firms have moved into strategy and technology – the list goes on. This remains a viable strategy but consulting firms will over time find themselves over-stretching their price points as much as their brands.
The volume of work done by standalone consulting firms is shrinking as niche firms are absorbed by larger ones, so cross-selling between consulting and non-consulting practices in a single business may be an important source of growth. Yet a long list of failed acquisitions is testimony to how difficult this is in practice. Equally challenging from an internal perspective is being able to respond to the consulting opportunities in globalisation and, in particular, to tap into client demand for integrated international teams. Astute firms won’t simply reconfigure their organisations to make knowledge-sharing and multinational teams easier, but will look at how they can change their business model, redefining consulting
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There’s a growing consensus amongst consulting firms that the pyramid model, around which their industry has so far shaped itself, might have had its day. Geared towards the idea of a nice shiny partner selling in his formidable knowledge before deploying legions of fresh-faced young guns with intellects the size of Massachusetts to mop up margin, clients are starting to question whose interests the model serves best. Few are concluding that it’s theirs.
Anticipating, if not already experiencing, a rebellion, many consulting firms are starting to look to a future beyond the pyramid. In the course of researching a recently-launched report – A new front in the war for talent, produced in partnership with Penna – we heard consultants talking about thinner pyramids, coffins, mushrooms, barrels and, most commonly, diamonds. Diamonds have a number of advantages. Firstly they recognise the idea that client demand for consulting services (as opposed to interim resources) no longer favours firms with…ahem…wide bottoms. Secondly they accept that lovely as it might be, moving to a top-heavy model (stop it) is neither easy (because the most senior people tend to be the hardest to recruit) nor without risk (because these are people you can’t afford to have on the bench). And lastly diamonds just sound nicer than mushrooms and barrels, and infinitely more optomistic than coffins.
We’re not completely convinced by any of these shapes, but then we’d be the first to accept that our latest suggestion – the hourglass – isn’t exactly without fault either. What we are convinced about is that something needs to change. A new front in the war for talent found evidence of a growing competitive interface between clients and consulting firms to sit alongside the existing front between consulting firms and their competitors where talent is concerned. Fuelled by a growing desire amongst clients to recruit consultants, this front is both different – consulting firms don’t want to beat clients, they want to work with them – and one in which the battle (friendly though it may be) is over something far more significant than talent: the future of consulting itself. The competition is increasing, too: the average consulting firm we surveyed said they had lost 8% of their full-time consultants to industry in the last year. Against a backdrop of attrition rates running at about 11%, that’s quite a chunk. And many – as the chart below shows – expect it to continue growing over the next three years.
What consulting is, and, just as importantly, what it isn’t, are matters about which clients are becoming increasingly clear. Demand is moving to the extremes of the pyramid: at the top end, clients are looking for solutions from the most experienced consultants and are willing to pay top dollar for them. At the bottom, they’re buying contingent labour and – while they may be happy to buy that from consulting firms – they’re not willing to pay consulting rates for it. Threatening though that may feel to many consultants, the reality, at a time when consulting has become a dirty word, is that change can’t come soon enough.
There’s still time for consulting firms to figure out what shape suits them best, but figure it out they must, and doing so will start with one question above all else: what business do we want to be in?
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Brand in a recession
Most people would agree that the recession has so far produced a flight to brand in the consulting market. But will this continue to be the case?
There are two forces acting here.
The first, pulling clients towards familiar firms, is security. Of course, this has always been important to some extent, especially where high-profile, critically important projects were concerned. But it is unquestionably more acute now. With limited money to spend, clients are reluctant to bet it on a horse their colleagues may not have heard of. Brands have been backed by two other advantages (which have helped reinforce the brands in their turn). Big brand firms have had the resources to invest in account management over recent years, continually walking the corridors of their clients in a way their smaller rivals couldn’t afford to. They are also the firms to have benefited most from the relentless shift towards preferred supplier lists. If you only have space for five firms on your list, who would you choose?
But pulling against this is something quite different. One of the reasons why clients choose a firm with a brand is to overcome internal uncertainty or even dissension. Hire a well-known firm, the argument goes, and its credibility will rub off on our strategy or business case. Worried that your colleagues won’t agree with your analysis? Hire a big brand firm to validate your thinking. There’s nothing wrong with this: we all need support and encouragement from time to time. You might think you need more of it during a recession – but I’d question that assumption. With fewer initiatives possible and the financial crisis making it clear what organisations need to focus on, the level of internal debate on how to deploy their resources has to be muted. Clients won’t need expensive, big brand consulting firms telling them whether project A is better than project B, because they can’t afford to do either. And they don’t need a firm to tell them what to do (cut costs, conserve cash) – and that could leave the big brands higher and drier than they expect.
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Fees in a recession
As part of our research on consulting in Europe, the Middle East, India and Africa, we inevitably asked consulting firms how much they’d seen prices fall during the recession.
Overall, we estimate that fee rates among multinational corporations have dropped by between 10% and 15%, and those among large regional or national companies by as much as 50%. The most precipitous declines have now levelled off and in some highly specialised and sought-after areas there are even indications that prices are edging up.
But will they recover more generally? History and logic says no. We see six main factors which we expect will keep rates low for the foreseeable future:
1.The blurring of boundaries between client segments: Consulting fee rates are – very broadly – dictated by the size of the client and the scale/brand of the consulting firm. The bigger and better-known the consulting firm, and the larger the client it serves, the higher its average fee rates will be. However, this simple model starts to change the more permeable the boundaries between client segments become. During the 2004-2008 boom, the premium rates of the Big Four firms drove up fee rates for mid-sized consulting firms. However, now that those firms have graduated to be among the biggest consultancies, their fee rates are being compared with the big strategy firms, against which they look low. The result: strategy firms’ rates are falling.
2.The involvement of centralised purchasing: The increasingly active role played by procurement in multinational corporations will not only keep consulting rates low in these organisations but promises to bring down prices elsewhere as regional and national corporations increasingly adopt this approach.
3.The fight for market share: Many consulting firms plan to grow faster than the market creating a situation in which they are quite transparently fighting to take market share from their competitors – something that is as true in established consulting markets as it is in emerging ones.
4.The shift towards implementation: Implementing tends to mean sticking around for a lot longer, which in turn means greater scrutiny on price. Implementation also means working with different layers of an organisation, against which the difference in the cost of doing something internally set against bringing in external consultants, can look alarming to clients.
5.The continuing barriers to articulating and measuring value: None of the above issues would matter if it weren’t for the fact that clients question the return on investment they earn from consulting.
6.The low penetration of performance-based payment: Risk-reward and other, more innovative payment structures might raise effective fee rates for some types of work. However, all the evidence points to a small increase in the consulting work done on this basis, but no substantial shift.
There are two problems here: that, as explained above, fee rates have not just fallen but are likely to carry on falling and that they’re not falling across all areas at the same rate.
Of the two, the first is the more familiar scenario: as each successive recession has reduced fee rates, consulting firms have had time to adapt their business models to accommodate them. Thus, considerable effort in the last two years has gone into raising utilisation levels and cutting back-office costs in order to shore up threatened margins. Challenges remain – recruiting and retaining high-quality staff when there’s less money to pay for them – but they’re well-understood.
As long as a firm offers services at one price or the other, the situation is manageable, but the pyramid structure around which most larger consulting firms are built combines both price points. In the past, that wouldn’t have been an issue as both sets of prices were moving in the same direction, making it possible, for example, for firms to raise their fees by the same proportion. But where the already high prices at the apex of the pyramid are rising and those already low ones at its base are falling, the distance between the two business models may be stretched beyond endurance. Clients may query why the experts are so expensive when the junior consultants are so cheap. The resulting salary differentials may be so great that the profile of recruits and even the firm’s culture may start to diverge, to a point where we end up with two quite clear segments of consulting firms: the cheap and the expensive
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Disscounting
Discounting isn’t just confined to the high street. Consulting firms are already cutting their fee rates, even though all the indications are that the consulting industry grew slightly in 2008 and most firms are not in a position where they are desperate for business. Indeed, compared to the last downturn in the consulting industry, firms seem to be offering price cuts at an earlier point in the economic cycle.
So what’s going on? I think there are two factors at work here. The first is that an industry is only as strong as its weakest link. That means that in any segment of the consulting industry, if one firm starts to discount, the others find it hard not to follow suit. They’re concerned that they’ll lose market share and open the doors to new competitors just at a time when they want to hunker down with their long-term clients. The second is uncertainty: the consulting industry is just as much in the dark as the rest of the economy as to how the recession will affect it and for how long. Discounting has the advantage of making you feel you’re doing something, even while you try to work out what the long-term game plan is.
But is discounting good for clients? We’ve all made snap decisions to buy something in a sale that we’ve regretted later (but can’t take back) and consulting isn’t any different. Price should never just be the only deciding factor and what looks like a great deal on paper may result in your buying a service your organisation doesn’t really want or need.
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Commodisation
Consulting is always being commoditised but has yet to become a commodity.
Commoditisation has always snapped at the heels of the industry, but emerging challenges and new technologies has historically allowed the industry, on balance, to stay ahead. And that’s what consultants do: they keep on running.
But just occasionally it’s worth looking back over our shoulders to understand exactly how and why consulting services become commoditised. After all, if we could slow down that process, perhaps we wouldn’t be so breathless.
The first and most familiar stage of commoditisation is when clients believe that many firms are capable of offering the same service. All are equally well-qualified and are therefore interchangeable, allowing clients to substitute one firm for another. Price competition and falling margins are the obvious results. The frontline of defence here is innovation and differentiation: if firms have something unique to say or do, then clients have no choice but to hire them to do it. For the moment, however, this strategy appears to have all the resilience of the Maginot Line: the consulting landscape is dotted with concrete fortifications, each claiming to a new idea or service, which clients have simply gone round.
And that brings us to the second stage of commoditisation – and the second line of defence. It’s a small practical step, but a huge conceptual leap, for clients who believe that every consulting firm offers the same service to decide to do it themselves. If the skills required are abundant externally, then they can be found internally or recruited. Consulting firms have to respond by saying that it’s not what they do, but how they do it, that’s different. Clients work too slowly, the argument goes; they get bogged down in internal politics and distracted by the workaday issues. And this is actually where the battle is being fought at the moment: you just need to see how much consulting firms stress how the “experience” of working with them is different to understand that.
It’s a difficult thing to articulate in general terms and it poses some genuine challenges for consulting firms in terms of consistency of delivery. And it’s not clear that the battle is being won: during the recession, many big client organisations, motivated by spare capacity and a need to cut consulting budgets, are doing more for themselves.
And the third stage of commoditisation? It’s when what started out as a consulting project and then became an internal initiative evolves into something people do without thinking. It’s when something ceases to be special. Thus, you could argue that change management, which was the preserve of consultants before being taken over by internal staff, is now regarded as a skill everyone should have. We don’t need projects to manage change, because it’s just what we do. This is, of course, the big battle and the last battle – and I’m not sure the consulting industry has any defence for this. It’s when “consulting” isn’t something we bring in people to do from the outside, or do internally, it’s the way we all work, all of the time.
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Consulting in Spain
The Spanish consulting market is a long way from the current engines of growth in Europe, the German and Swedish markets. Its immediate past may be troubled, but it can still teach us important lessons about future success.
We estimate the Spanish market for “big” consulting (work done by consulting firms with more than 50 consultants for clients whose turnover is in excess of €500 million, the focus of our European Market Report) was worth around €1.1 billion in 2010. The debt crisis made this one of the toughest consulting markets of all last year; smaller budgets have inevitably resulted in greater competition and steeply falling prices. The financial services sector remains the biggest market for consultants (it accounts for around 23% of the total); manufacturing is slightly smaller (18%), but telecoms is relatively large (12%). The public sector, excluding healthcare, represents around 13% of the market. Much management consulting in Spain is really IT consulting: we estimate it accounts for 45% of the market. That squeezes demand for other services, with only 13% going on operational improvement, 10% on managing people and 9% on strategy.
But there are still success stories: with Spanish clients keen to tap into faster-growing consumer markets, most obviously in South America, there’s money to invest with consultants who can offer insights into those emerging markets and guidance on how best to expand there. Two distinct categories of consulting firms are starting to emerge as a result. The first are those which have, and are able to exploit, experience of South American markets. Their combination of mature consulting skills (from Spain) with knowledge of emerging markets is a comparative scarce resource: established Spanish firms will have the former, but perhaps not the latter; new firms in South America clearly boast the latter, but perhaps not the former. Demand for firms that can do both will be high. By contrast, the second group of firms are those unable to compete in this increasingly global market and which find themselves relegated to slow growth at best.
The other implication of this shift is even more fundamental. Over time the faster-growing, more international firms will outpace their local rivals. Instead of being a “normal” consulting market, Spain will, in effect, become a centre of excellence for advice on how best to exploit the opportunities in South America. We’re accustomed to the idea of consulting firms becoming more specialised, but perhaps countries will become so as well.
I wrote recently about how Spanish consulting firms have responded to collapsing domestic demand by working with local companies expanding into the South American market and with South American markets looking to build a presence in Spain. The Dutch consulting industry hasn’t had anything like such a difficult time, but it’s been tough nevertheless. The response, however, of Dutch firms has been quite different.
Two factors make the Netherlands a peculiarly challenging market. The first is the shape of the Dutch economy. Although the financial services industry, like manufacturing, accounts for around a quarter of the market, this is a slightly lower percentage than elsewhere. The banking sector in particular is 15% smaller than the average across Europe, 30% less than in the UK (which has the biggest financial services consulting market). This means that Dutch consultants have had fewer opportunities than their colleagues in the UK, France and Germany to work on the regulatory and restructuring projects which are the continuing aftershocks of the financial crisis. To compound the problem, the Dutch market has a higher-than-average dependence on the public sector and, within that, on programme management – a combination that, our research suggests, makes it particularly vulnerable to cutbacks.
But the other thing that makes the Dutch market peculiarly hard is that the consulting business model appears to be changing faster here than anywhere else, fuelled by a strong market for freelance consultants. Some firms have a hybrid model combining consulting with interim management: Turner is a good example, but Bakkenist has recently entered into an alliance with an interim management company and others will no doubt follow suit. Twynstra Gudde, which also boasts a large network of associates working alongside its full-time consultants, has taken a new tack, setting up a practice that takes ten people a year straight from university and provides a combination of business education (five days a month) and practical consulting experience. At the end of a standard three-year contract, these people may be invited to join Twynstra Gudde or they may choose to work for a client or even a competitor. The approach has benefits all round: new graduates gain business experience; Twynstra Gudde can test their mettle, securing a pipeline of good recruits in an increasing tight labour market; those who leave may well think of themselves as alumni, building an important network for the future.
But perhaps the most significant thing about all these examples is that they offer clients a choice; they acknowledge, quite explicitly, that different consulting projects require different types of people. Small strategy projects might need a couple of experts, but no juniors; consultants-turned-client may not need expert advice, but bright, energetic graduates to help them implement.
The Dutch consulting market may be lagging its larger neighbours in terms of growth, but it’s leading the way in redefining what we mean by consulting.
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Globalization
Over the last three months, we’ve interviewed around 250 people in 150 consulting firms across 35 different countries, asking them how their local market is performing, how and why that may change in the future, and what the key challenges are that they face.
From the massive amount of data we collected, summarised in our new report, launched on Thursday, one message stands out: the ability of a consulting firm to provide an integrated global perspective will determine its success over the next five years. You might think there’s nothing new in this, especially if you work for a strategy firm that’s accustomed to fielding multinational teams, but there are three reasons why even the most global firm should pause to consider.
The first is about clients. One of the lessons they’ve learnt from the last three years is that economic sustainability depends on having a presence in emerging markets: companies that have, have emerged more quickly and strongly from the recession than those that don’t. This recognition isn’t confined to big business – sizeable companies which are still primarily national in focus now understand globalisation is both a threat and opportunity for them, too.
The second reason relates to competition. These organisations have tended to buy consulting services from local, mid-sized consulting firms in the past (ones that, in effect, are a bit like them). But what will they do in the future? Potentially this represents a new market for bigger consulting firms and leaves mid-sized consulting firms stuck on the slow lane with small, domestic clients.
But the third, and most important question, is what we mean by global. It turns out that clients mean two, quite distinct things. First there’s footprint, the extent to which a firm has a physical presence around the world which is important for projects that entail global roll-out, consistency and standardisation, particularly IT, regulation and some types of operational improvement. But being everywhere isn’t everything. The second thing clients are looking for is people and/or firms that can make global connections, helping them understand what it is for a Belgium manufacturer to move to Vietnam or a Spanish firm to target consumers in South America. This is mindset not an office network, so it’s not limited to the very biggest consulting firms. Indeed, it could reshape the consulting industry. It’s heresy to say it in the current climate, when most firms have ambitious plans for growth, so I’ll just whisper it: size may not matter.
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Consulting firms spend a lot of time on the corporate equivalent of the psychiatrist’s couch. Are they specialists or generalists, advisors or implementers? They agonise about their DNA; they blame their parent companies. Like Harry, they worry about who they are.
If you want an example of this introspection, you only need to look at the networks of offices maintained by all the big consulting firms. Having – the equivalent of being born with – such a network doesn’t necessarily make you a multinational firm. Indeed, research we recently carried out in the financial services sector showed that clients buy consulting services from Big Four firms for many reasons, but getting global teams, made up of people who come from different countries but feel at home wherever they are (something strategy firms do as a matter of course), is not one of them. The size of your global footprint matters less than what you choose to do with it: you can have people liberally distributed across the world, but if they never work together, how different are they to a local consulting firm? By contrast, a firm that has just one office, but a globally-recognised depth of expertise in a particular field, is more likely to have consultants who feel comfortable in any international environment.
Yes, of course, a firm with multiple offices may be the only one capable of offering the same service across the world, but it can do so only because it reduces global differentiation. It’s rolling out a standardised process across the world and there’s unquestionably a market among clients for that. But a global firm doesn’t necessarily equal a global mindset.
