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Lean start-up thinking for all

My Financial Times Column 10/25/10

Not so long ago, management theorists and manufacturing scientists drooled over Toyota. Its production system represented scientific management at its best, the climax of a century that began with Frederick Taylor’s time-and-motion studies, passed through Henry Ford’s River Rouge plant, Alfred Sloan’s General Motors and finally reached perfection in Toyota City, the vast complex of manufacturing and assembly plants east of Nagoya.

A spate of recalls has recently dented Toyota’s reputation. But its management principles are finding new life in a very different corner of business: technology start-ups.

At the core of Toyota’s philosophy is the idea of “lean” processes. The term is often misunderstood to mean cheap. In fact, a lean production system is one in which every step of every process is transparent and considered ripe for improvement. Thinking lean is about constantly measuring all you do, and being able to change quickly as fresh evidence emerges.

Apply this to starting a company or launching a new product within an existing company. The classic method is to look at the market for an opportunity, establish a business case, develop your product, test, validate and finally launch. At each stage, you gather resources, establish criteria for the next step and try to adjust as you go. The challenge these days, though, is that technology and customer tastes are moving so fast that the classic method is no longer adequate.

Eric Ries, a Silicon Valley entrepreneur who has coined the phrase “lean start-ups”, happens to drive a new Toyota. While he’s delighted with the car, he says its GPS system encapsulates the problem. Here you have a car packed with technology, but the GPS system is primitive compared with what he could download to his phone. The reason is that the innovation cycle time for car manufacturing is much slower than that for GPS software. So one part of the car will seem dated long before the rest of it.

Mr Ries hit on the idea of lean start-ups after suffering one failed technology start-up and enjoying one success, the 3D instant messaging company IMVU, as well as observing the peculiar fortunes of many others as an investor and adviser. The classic start-up methods, built on linear management and innovation processes, he found, were not working for him or his peers. “They kept blowing up in my face,” he says.

Such methods offered too little flexibility to deal with changes in available technology and in customer needs. Imagine that today you decide to launch a new product. You size the opportunity, talk to potential customers, gather the resources and set to work. By the time you’re ready to launch, what are the chances your product is still relevant?

Mr Ries and other new management thinkers – notably Steve Blank, a former entrepreneur who now teaches classes at Stanford and the Haas Business School at Berkeley – say the risks in any start-up can be reduced by constant interaction with potential customers during product development.

Rather than waiting until you have all your ducks in a row, you iterate early and often by finding customers willing to help you refine your product and even buy it in its most primitive form. You don’t waste your money by investing in an unproven product, but rely on customer feedback to tell you where to spend.

The ideas owe much to “agile software development”, an adaptive process that values customer collaboration, responsiveness and individual input over strict product road maps, tools and marketing plans. For the traditionalists, agile development may smack of ill- discipline, when in fact it is just a different kind of discipline.

Technology companies are the most obvious seeding ground for these ideas. Facebook began with profile pages and a basic messaging service and has been adding features over time based on feedback from users. But Mr Ries says his ideas are equally applicable to larger companies. He recently returned from a trip to the UK and Ireland, during which he says he advised multinationals on their innovation processes. “My own definition of a start-up is an institution asked to create something new under conditions of high uncertainty,” he says. “This has nothing to do with company size.”

One counter-argument to this is that some risks are better taken than minimised. Customer development may increase your chances of certain revenue, but not your chances of maximum revenue. Great product innovators, like great film-makers or novelists, can develop in isolation, deposit their products on an unsuspecting market and still triumph. But that is a high-risk route. Not everyone can be Steve Jobs or James Cameron. For the more ordinary among us – who have not founded Apple or had a 3D movie hit – lean is a far better way to go.

 

The value of hardship

My Financial Times column 10/18/10

These are rotten times to be graduating from school, undergraduate or graduate school and trying to find work. All that education, all those high-minded speeches about pursuing your dreams and inheriting the future and boom, smack into the worst economy since Tom Joad chewed the grapes of wrath.

What solace is there for students going through this particular agony, and their anxious parents? Well, some of the greatest businesses in the world were founded during dark economic times. Microsoft and FedEx were started in the depths of the mid-1970s recession. Thomas Edison founded General Electric during the slump of the late 1870s.

In some ways, recessions are ideal times to start a business. Rents are cheap, suppliers are biddable and hiring should be a cinch. Unfortunately, if what you have in mind is a more conventional career the news is not so good.

Antoinette Schoar, a professor at MIT’s Sloan School of Management, has studied the careers of managers who start working at different points in the business cycle. She found that chief executives who began their careers during a recession took longer to become CEO and were more likely to have risen through the ranks within one organisation than to have moved over from other industries or companies.

They also tend to be CEOs of smaller businesses and to have more conservative management styles, using less leverage and investing more in internal operations than on acquisitions.

Prof Schoar also found that CEOs who start their careers during a recession have more graduate degrees, likely a consequence of delaying their entry into the labour market in the hope of escaping the worst of it.

It may seem unfair that the economic climate that greets you in your early to mid-20s affects where you end up 25 years later. But Prof Schoar isn’t the only one saying it. Lisa Kahn, an economist at the Yale School of Management, wrote a paper last year that concluded that “graduating from college in a bad economy has a long-run, negative impact on wages”.

Why exactly isn’t entirely clear. One reason may be that people hired in a recession tend to start in lower positions and at lower wages than those who start in a boom. Even over the course of a career, that initial gap can be hard to eliminate. Another reason may be that by starting lower down, you waste time investing in skills that may be of no use later on, rather than quickly acquiring senior management abilities. Starting at the bottom may give you a good view of a company’s operations, but it also means you have a lot further to climb than someone in the boomtime rotational programme.

Warren Buffett’s snowball theory is also relevant here. The earlier you can define your skills, talents and ambitions, the longer you have to let them roll downhill, accumulating size and power. Spending those early, precious years groping for work and then rolling down snowless ground is a waste that compounds over time.

Prof Schoar has recommendations for both those starting work now and the companies that hire them. To recent graduates, she says, don’t let the job you’ve been given or the bad economic times limit you. Part of the reason that those starting out now will take longer to become CEO is that they don’t receive the broad set of experiences easily available to those who start their careers in good times. The cure for this is actively to pursue those different experiences, to demand them even in companies that are in retrenching mode. Ask to be moved to different departments, territories or functions. Don’t be inhibited by the conservatism that naturally affects companies in times like these. Your career will long outlast the gloom.

For companies, Prof Schoar warns against misattributing success. People who have thrived in good times may have glittering CVs, awash with surging numbers and promotions. But were they really any good? Or were they just lifted by a rising tide? It is important for companies to look for and reward the managers who started their careers in, say, the dotcom bust of 2001 and then helped stabilise failing businesses in 2008 or 2009. They may seem less glamorous on paper, but they will be good hires and deserve greater recognition.

In my own experience, a dose of hardship is useful for anyone. It’s the wild-eyed, boomtime gunslingers who cause the trouble, levering up, building models that misprice risk, persuading themselves and investors that the good times will never end.

It can’t be any fun starting a career today. But for those of us hoping the managers of the future behave sensibly, it’s good to know they are starting out with a large inoculation against economic madness.

 

The winning tactic of cultural continuity

Published in the Financial Times 10/11/2010

The winning tactic of cultural continuity

Philip Delves Broughton

Assuming that Liverpool Football Club is sold to John Henry and his team from New England Sports Ventures, and that current owners, Tom Hicks and George Gillett quietly walk away from the club they have grievously mismanaged, what then? How does an American group with experience in baseball, ice hockey, hedge funds and sitcoms manage a club like Liverpool?

I grew up in Northampton, an English town with a lamentable football team. Supporting the Cobblers was a weekly dose of woe. But peering up from the bowels of the Fourth Division as it was then, there was always Liverpool to watch. It experienced the highest highs – European Cups and a record number of domestic championships – and the lowest lows – hooliganism and the Heysel and Hillsborough stadium disasters in which scores of fans lost their lives. One of the club’s great managers, Bill Shankly, summed up life at Liverpool when he said “some people think football is a matter of life and death. I assure you, it’s much more serious than that.”

And then, last month, the impossible happened. My poor, shabby Cobblers, still a minnow of the sport, confronted Liverpool and beat them. For an investor such as Mr Henry, it must have confirmed that here was one of the great turnround opportunities in sport.

He comes at Liverpool’s problem with an astonishing bench. His fellow investors are Jeffrey Vinik, former manager of Fidelity’s gargantuan Magellan Fund turned successful hedge fund manager; Michael Gordon, Mr Vinik’s former partner; David Ginsberg, one of Mr Henry’s former fund managers, and Tom Werner, the producer of television mega-series such as The Cosby Show and Roseanne. Mr Henry can also deploy Michael Porter, his strategy adviser at the Boston Red Sox and the world’s most influential business academic.

Applying his widely taught Five Forces analysis to measure the attractiveness of English football, Prof Porter would find that its competitive rivalry is intense, measured week after week by results on the pitch as well as on income statements. The threat of new entrants is low, as the same handful of clubs tend to dominate European football year after year. The threat of substitutes is equally small, as football fans are not easily swayed to other sports. The bargaining power of customers is low as fans rarely switch allegiance, and sponsors and broadcasters are desperate to tap into the sport’s popularity.

Unfortunately, the bargaining power of suppliers, the players, is where football’s economic attractiveness breaks down. Wage inflation has made it hard for even the most successful clubs to turn a large profit. As Deloitte said in its latest Review on Football Finance: “We [are] seeing a continuing shift from a sustainable ‘not for profit’ model towards one with potentially calamitous, consistent and significant lossmaking characteristics.”

Three business models have surfaced in English football in recent years.

The open cheque book model at Chelsea and Manchester City, where a multibillionaire owner decides to spend whatever it takes to buy success. The leveraged buy-out model, at Manchester United and Liverpool, where foreign owners hobble their clubs with debt and find themselves loathed by fans. And finally the Arsenal model, where a steady management focuses on cash flow from player transfers and property, as well as the usual tickets, merchandise and broadcast rights, and remains competitive without straining to win at all costs.

Mr Henry could get Liverpool for a bargain price. The club still has devoted fans and extraordinary players. But he does not have the billions of Roman Abramovich at Chelsea and, after Liverpool’s near bankruptcy, is unlikely to find fresh lines of easy credit. As another American buying a British team, his leash with the fans will be short.

His first move, then, should be to show he is a worthy owner of the club by reviving its unique management system. From the 1960s to the 1990s, Liverpool’s glory years, the heart of this system was “the boot room”. Conjuring up images of muddy tracksuits and stewing tea, it was the room where managers, coaches and senior players would gather and talk. After matches, opposing managers were invited as well. The boot room was where winning habits were set and future managers trained. It created cultural continuity, and just as at General Electric, Liverpool’s boot room was about promoting from within.

But in the late 1990s, after some mediocre years, Liverpool abandoned the boot room. It hired outside managers who failed to restore the club’s edge. If Mr Henry’s first act were to restore the boot room, it would show respect for Liverpool’s traditions, the fans would love it, and it would buy him time while he ponders what to do with his cheque book.

 

Kerviel and Dreyfus

Jerome Kerviel’s sentencing may be just, but it is also reveals a cruel unfairness in how the leaders of the financial system are protected. Kerviel evidently shouldn’t have done what he did. But what’s absurd is that he alone is punished. I wrote about Kerviel in The Sunday Times of London a couple of years ago. I felt then, and now, that he did what he did because he was allowed to by a trading culture which encouraged high risks and was willing to ignore excesses. This label “rogue trader” would only make sense if what he was doing was actually “rogue”, rather than the norm. The idea that he is jailed for ignoring the risk limits imposed by SocGen while so many banks, and so many eminent bankers, set risk limits which exposed the entire financial system to collapse and put at risk the lives and livelihoods and millions is evidently wrong. One set of bankers bring their banks to the edge of collapse and receive a taxpayer bailout and continued compensation. Another, younger, more disposable banker does so and goes to jail. The Dreyfus affair exposed institutional anti-Semitism in France at the turn of the 20th century. The Kerviel case proves yet again that there is one set of rules for those who run the financial system, and another for everyone else. If Kerviel was a folk hero before this sentencing, he will be even more of one now.

Break the model on employee behavior

My Financial Times column 10/4/10

Break the model on employee behaviour

Philip Delves Broughton

If ever there were a moment for companies to be experimenting with how they organise and motivate their employees, now would seem to be it. Businesses are being yanked in every direction by the forces of recession, emerging markets and new technology. Psychologists and economists are collaborating as never before to expand the field of behavioural economics, to tell us why we behave the way we do when it comes to work and money.

So why are more companies not using the crisis to rethink how they manage their people? Why are they so much more innovative when it comes to jiggering with their balance sheet or product line than human resources?

It is a question that is dumbfounding Dan Ariely, a professor of behavioural economics at Duke University and author of two books, Predictably Irrational and The Upside of Irrationality. Prof Ariely is one of management’s most widely cited behavioural economists, and he told me that while companies harried him for insights into customer behaviour, they were loath to try out anything new on their employees. “There is no worse place to try to do experiments than human resources,” he said. “The first thing on their mind when they hear the word ‘experiment’ is lawsuits.”

Some of Prof Ariely’s most interesting research has been in the area of compensation. He has concluded, for example, that large bonuses have little effect on the performance of bankers. He suggests that banks would be better off firing all but their most talented employees and hiring thousands of new workers with none of the salary and bonus expectations of the old ones. They would be able to do the same work for much less money, unburdened by outlandish expectations. I would love to hear Jamie Dimon and Lloyd Blankfein debate that one.

Prof Ariely argues that financial rewards are only one piece of a complex web of motivations which affect each of us differently. These include a sense of purpose, status, altruism, ego and control, all of which a clever manager should take into account. And yet how many do this in anything but the most informal way?

“I went to a lot of companies and said, ‘Let’s do studies of bonuses,’ ” he says. “One hundred per cent of the time, people would tell us that bonus season is so miserable, they didn’t want to prolong the agony by studying it any further – even though we know that productivity goes down during bonus season and that bonuses are not the most efficient motivator.”

He added that “the biggest curse in compensation are compensation consulting firms” that do nothing but benchmark compensation against companies, which may or may not be useful comparisons. “They know nothing about the science,” says Prof Ariely. “They’re just perpetuating the misery.”

It may be that companies don’t have Prof Ariely’s urgency. Managers who have survived the recession intact are probably feeling confident in their existing model. Now may not seem the time to go redrafting the rewards structure and instituting flexi-time for all.

Prof Ariely says he still receives plenty of calls from start-ups, brimming with enthusiasm for new organisational forms. They crave new ideas about compensation and how to improve employee morale and creativity. They are eager to use unconventional methods to motivate individuals who spend their days working away from the main office on unusual schedules, and may only ever see parts rather than the whole of a business.

But once these companies reach any kind of scale, the experimental mindset hardens into a procedural one. The enthusiasm to get the most out of every individual becomes a desire to settle on a one-size-fits-all motivational template, regardless of the irrational behaviours it might cause.

The only way Prof Ariely has found through this inertia is to get the chief executive on side. He began working with Scott Cook of Intuit, the financial software company, on experiments to understand the behaviour of his customers. Why, for example, do people pay down their smallest loans before those that carry the highest interest rates? He suggested creating a software tool to help customers behave more rationally.

But now he says his behavioural economics research is seeping into Intuit’s internal organisation. Instead of offering purely financial incentives for great work, Intuit now offers high-performing employees half a year’s sabbatical.

Mr Cook is also encouraging a culture of experimentation, telling employees that a failed experiment is no failure if it produces evidence. This is vital to employees’ feelings of control.

Innovative management that takes the complexity of human behaviour into account can be a competitive advantage – especially now, when so few are ready to practice it.

 

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