Issue15

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Also including articles from:OXFORD, COLUMBIA & HARVARD

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prestigious business schools.

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Global

September 2014h t t p : / /www. G l o b a l B u s M a g . c o m /i n f o @ g l o b a l b u s m a g . c o mPapegaaistraat 76,9000 GentBelgium

INSIDE this issueCan Creativity Be Taught? 5

Thinking, East and West 9

Adaptive Leadership for the VUCA World: A Tale of Two Managers 11

Will my idea work? 17

Social Media and the Marketing Mix Model 23

The China-EU BIT: The emerging "Global BIT 2.0"? 25

Think you live in globalized world? Think again 27

All Too Human 33

Can Creativity Be Taught?The usual image of how creativity happens: A composer inadvertently hears a melody rising from a babbling brook, or an ad agency creative director crumples page after page of aborted ideas ripped from the typewriter until the right one lands. But creativity, some claim, can come from a far less elusive muse — from a structured process, one that opens up the ranks of the creative to a wider swath than the Steve Jobs, Jonas Salks and Franz Schuberts of the universe.

“I think there are individual differences in our propensity to be creative,” Twitter says Wharton marketing professor Rom Schrift, “but having said that, it’s like a muscle. If you train yourself, and there are different methods for doing this, you can become more creative. There are individual differences in people, but I would argue that it is also something that can be developed, and therefore, taught.”

Wharton marketing professor Jerry (Yoram) Wind has in fact taught a course in creativity at Wharton for years, and says that “in any population, basically the distribution of creativity follows the normal curve. At the absolute extreme you have Einstein and Picasso, and you don’t have to teach them — they are the geniuses. Nearly everyone else in the distribution, and the type of people you would deal with at leading universities and companies, can learn creativity.”

Does creativity need the right conditions to flourish? Jennifer Mueller, a management professor at the University of San Diego and former Wharton professor who has researched creativity, sees evidence that it does. “Every theorist that exists today on the planet will tell you creativity is an ability that ranges in the population, and I think in a given context, creativity can be shut off — or turned on, if the

environment supports creativity.”

John Maeda, former president of Rhode Island School of Design, believes creativity can be taught — though he qualifies that belief. “I wouldn’t say it can be taught in the normal sense of adding knowledge and wisdom to someone. I would say instead it can be re-kindled in people — all children are creative. They just lose their capability to be creative by growing up,” notes Maeda, now a partner at Kleiner Perkins Caufield & Byers and chair of eBay’s design advisory board. Creativity in a child, he adds, “is the ability to diverge. In a productive adult, it’s the ability to diverge and converge, with emphasis on the converging.”

Anyone called upon to tap creativity has his or her own method, but photorealist painter and photographer Chuck Close suggests the matter is actually less mysterious than the muse-chasers might believe. “Inspiration,” he has said, “is for amateurs — the rest of us just show up and get to work.”

Working with Boxes, Inside and Out

In whatever the sector or discipline — product development, exploitation of networks, music or education — creativity shares certain traits, experts say. Jacob Goldenberg, professor of marketing at the Arison School of Business at the IDC Herzliya in Israel, says creativity has more than 200 definitions in the literature. “However, if you ask people to grade ideas, the agreement is very high,” he notes. “This means that even if it is difficult to define creativity, it is easy to identify it. One of the reasons why it is difficult to define is the fact that creativity exists in many different domains.” Still, he says: “Most creative ideas share a common structure of being highly original and at the same time highly useful.”

“If you train yourself, and there are different methods for doing this, you can become more creative.”– Rom Schrift

In Inside the Box: A Proven System of Creativity

for Breakthrough Results, Goldenberg and co-author Drew Boyd make the case that all inventive solutions share certain common patterns. Working within parameters, rather than through free-associative brainstorming, leads to greater creativity, the book says. This method, called Systematic Inventive Thinking, has found application at Procter & Gamble and SAP, among others. “We shouldn’t confuse innovation and creativity,” Goldenberg says. “Creativity refers to the idea, not to the system [product, service, process, etc.] that was built around it. For example, online banking is a great innovation, but the idea [of using the Internet to replace the branch] was not creative. It was expected years before it was implemented.”

Similarly, he adds, “cell phone technology is one of the most innovative developments, but the need was defined years before, and we just waited for the technology. In my view, a creative idea that is still changing our lives is the concept of letting users develop the software they need on a platform [that a particular] firm sells: the apps concept. This means that consumers develop and determine the value of the smartphone and tablets.”

This example, Goldenberg says, fits one of the templates for creativity described in Inside the Box: “Where you subtract one of the resources” — such as engineers and marketers — “and replace them with a resource that exists inside a closure (box), in this case your consumers.”

Schrift has used a different template from Inside the Box in his classes: The idea of building a matrix of characteristics of two unrelated products, and creating new dependencies. Such examples, he says, include an air freshener that changes scent every 10 minutes (remixing the concepts of time and fragrance), or a gym with a fee that is structured to increase if you don’t work out enough (fitness and incentive). “A lot of the time, looking for a new dependency gives you a creative idea,” Schrift notes.

Wind says that in whatever discipline, creativity is primarily “an ability to challenge the status quo and come up with new and better solutions. In art, the most creative figures are those who came up with new perspectives — Brancusi, who broke away from Rodin; Picasso, who broke away from the Impressionists; Duchamp, who took readymades [ordinary manufactured objects, a porcelain urinal being the most infamous] and said, ‘this is art.’ Anyone who primarily breaks the current status quo and creates a new dimension — the first person to think about understanding medicine in terms of a person’s DNA; in advertising it is [William] Bernbach, who came up with the slogan for Volkswagen, [or] Frank Gehry, who basically broke the tradition of the four-wall museum and came up with a dramatically different structure in Bilbao.”

Making Space for the Troublemakers

Corporate culture is no less hungry for creative leaders. Or is it? Any company would eagerly embrace the next iPhone, but it is far from clear that companies tolerate the cost of doing business when it comes to generating creativity. In an IBM survey of 1,500 CEOs from 60 countries in 33 industries released in 2010, creativity was cited as the most important organization-wide trait required for navigating the business environment. And yet, as Mueller found in a 2010 study published in Psychological Science, people often espouse creativity as an abstract goal, but then, when presented with it, spurn it. In The Bias Against Creativity: Why People Desire But Reject Creative Ideas, co-authored by Mueller with Shimul Melwani and Jack A. Goncalo, experiments suggest that the desire for creativity is often overshadowed by a need to reduce uncertainty — even as subjects rate their attitudes toward creativity as positive. Moreover, this bias contributes toward people being less able to even recognize creativity.

Additional research underway by Mueller suggests that creative personalities are often dismissed as trouble. “They are seen as difficult,

not as efficient or able to present their ideas with focus, and are also seen as naïve,” she says. “People, either rightly or wrongly, have this stereotype that creative people are high maintenance and emotionally volatile. Twitter And where it gets problematic, the moment the organization suffers, is when creative people are discounted for not being seen as team players. And that is the dark side of being tagged as a creative type.” And yet: “Why would you want somebody who doesn’t produce creative work [just because] they are less trouble to manage?”

“The stereotype is that creativity just has to be unleashed, and it’s not true. It has to be tightly managed. You have to know how to foster it.” –Jennifer Mueller

The bias against creativity even extends to the classroom, Mueller says. “There is the reality that any teacher needs a rubric in order to give a good grade, and creativity in being new or different creates uncertainty in the mind of the students about whether it fits the answer the teacher is looking for,” she notes. “Teachers think of creative students as disobedient. There is lots of focus on reducing ambiguity, especially in college where the student is your customer. You now have to answer to what the customer wants, and what the customer wants is to get a good grade — and the best way to get a good grade is to reduce ambiguity.”

Americans are not showing the kind of creative expression that might otherwise be bubbling away — in college, but also grade school. Scores from the widely administered Torrance Tests of Creative Thinking have been declining since 1990 among the nation’s youngest students, according to a study by College of William & Mary assistant professor Kyung-Hee Kim of nearly 300,000 test scores between 1968 and 2008. “The decline is steady and persistent, from 1990 to present, and ranges across the various components tested by the TTCT,” the study finds. “The decline begins in young children, which is especially concerning as it stunts

abilities which are supposed to mature over a lifetime.”

“There is an understanding that this is happening in China and India as well,” Mueller adds, “and the fact that it is happening in the U.S. is troubling people, but I don’t think they know what to do about it. I, myself, have tried to do stuff students don’t like, and they will hate you. If student ratings aren’t high, then you’re not going to get tenure.”

One environment Mueller admires for its healthy creative process is IDEO, the multinational design consulting firm. Creativity is begun in brainstorming sessions — which is certainly not novel — but it is then shepherded through a more structured route. “They have their initial session, called ‘deep dive,’ and that session is very short. Then they break the problem apart by assigning people specific pieces. Then there is a focus session, so there is chaos and focus, and interplay between these two things is always going on. There is a person whose full responsibility is to structure it, and I think in that process you learn, you ask the customer certain things, you tweak it some more,” Mueller notes. “The stereotype is that creativity just has to be unleashed, and it’s not true. It has to be tightly managed. You have to know how to foster it.”

Creative Safe Haven

The willingness to “foster it” is a challenge in many corporate environments. According to Schrift, one way to manage creative forces is to manage talent wisely. “Maybe we don’t want creative people in certain positions,” he says. “One of the obstacles for innovation is not necessarily the process of coming up with the idea, but is more cultural — a lot of companies do not incentivize employees to do things differently.” Sometimes, workers are evaluated on a relatively short cycle, and “when you are innovating, that involves a lot of failure.”

“Mind-wandering seems to be essential to the

creative process, and I don’t think a lot of businesses are aware of that fact.”– Scott Barry Kaufman

Changes in corporate culture, such as giving workers permission to question authority, can be efficacious, says Scott Barry Kaufman, scientific director of the Imagination Institute at Penn’s Positive Psychology Center. The salient question isn’t whether creativity can be taught, notes Kaufman, since everyone is creative, but rather demonstrating faith in the creativity of workers. “I am not talking about rebelliousness, but giving people time for constructive internal reflection and even daydreaming. A lot of research is suggesting that the more that you demand people’s external attention, the less chance you are allowing them to dip into the default mode where daydreams and reflection happen — and lot of great ideas are not going to come from the brute force of work but from personal life experience. Mind-wandering seems to be essential to the creative process, and I don’t think a lot of businesses are aware of that fact.”

Neither are most multitaskers — which means, these days, most people. In a recent New York Times op-ed piece, neuroscientist and musician Daniel J. Levitin made the case that tweeting, Facebooking and emailing your way through the day saps creativity. “Daydreaming leads to creativity, and creative activities teach us agency, the ability to change the world, to mold it to our liking, to have a positive effect on our environment,” wrote Levitin, author of The Organized Mind: Thinking Straight in the Age of Information Overload. In other words, we need time to hear the music in a babbling brook.

Measuring Creative Success

Is commercial viability the only gauge of creativity’s success? Wind points out that there are innovations in the arts whose value is best judged by other artists, and Goldenberg says peer expertise is sometimes required. “The only way to measure creativity is to use judges who grade

many cases including the idea you want to grade,” notes Goldenberg. “This is a complex process and usually done in a research setup and not in practice. This means that a creative person repeats his or her success, and this is not an after-the-fact judgment of one random event.”

But Wind points out that in general, newness and usefulness are the main indicators of acts of great creativity. “I would take the extreme position that creativity has to have value to be successful,” he says. “You can come up with a lot of ideas, but if you are not adding value to the stakeholders, then they are not creative ideas.” Twitter

Airbnb certainly meets the criterion of adding value to stakeholders, and, according to Maeda of Kleiner Perkins Caufield & Byers, the self-listing lodging clearinghouse stands an example of spectacularly creative thinking. “There are more people staying in Airbnb lodgings on any given night than all Hilton hotels combined,” Maeda notes of the company founded by the young and now-wealthy trio of Brian Chesky, Nathan Blecharczyk and Joe Gebbia. “It showed plasticity in their creativity that went beyond their design training in making physical goods. They recognized the excess capacity available in everyone’s home, and they designed a scalable service to enable anyone to access that capacity. Their successful design for a service solved the trust barriers inherent to a peer-to-peer economy.”

Wind cites Uber as his example. “Uber is a truly creative approach as opposed to the traditional taxi,” he says. “How wonderful it is that you could leverage the network idea and create a new business.” The Uber model is now being emulated and adapted to other sectors — Ubers for laundry, snowplows and even wine delivery. But while imitation might be the sincerest form of flattery, Uber’s success is actually a cue for the genuinely creative types to move on to other ideas. Says Wind: “The first one [to establish the model] is the example of creativity. The secondary companies following Uber — they are not.”

"Republished with permission from Knowledge@Wharton (http://knowledge.wharton.upenn.edu), the online research and business analysis journal of the Wharton School of the University of Pennsylvania."

http://knowledge.wharton.upenn.edu/article/can-creativity-be-taught/

THINKING, EAST AND WESTWestern companies and executives need a much deeper understanding of China

By IMD Professor Phil Rosenzweig - August 2014

For years, western multinationals have seen China as a source of cheap inputs, or as a growing market for their products. China is still both of these things, but nowadays it's also something else: an increasingly serious competitor. Chinese firms are investing billions to compete with established companies in western markets, and almost every industry is affected.

Haier (home appliances), Huawei (telecoms equipment) and Lenovo (PCs) are perhaps the best-known Chinese firms in the west, but they are far from alone. In the automotive sector, Geely now owns both Volvo and Manganese Bronze, the UK-based firm that makes the famous London black cabs. In the food industry, Shuanghui International bought US pork producer Smithfield Foods last year. In heavy equipment, Chinese firm Sany is now one of the largest producers in the world and acquired German pump maker Putzmeister in 2012.

Chinese companies are also global players in solar panels and wind turbines, while Xiaomi could be

the next big thing in mobile phones. And so on.

If western firms and their top executives are to meet this Chinese challenge, they need to think more deeply about how they do business with China. This involves going beyond simple lists, reexamining their first principles, looking again at strategy, and taking a fresh view of education.

The quality of this thinking, and the decisions that follow, will be crucial. China will soon overtake the US as the world's largest economy on a purchasing power parity basis, perhaps even this year. This increasing economic weight means that China's corporate expansion will continue to shape the world of business in the years and decades ahead. The rise of China is not a passing fad.

Going beyond dos and don'ts

Doing successful business with China involves a different way of working. For a start, it requires much more than just observing formalities and making lists of dos and don'ts for dealing with "them". Sure, hold your business card in two hands when presenting it to a new Chinese contact, respect hierarchy in table seating plans, and don't spill your tea. That's all fine, and these points are not unimportant.

But this sort of "five things to keep in mind" approach is superficial and insufficient. Simple-sounding lists of tips and bullet points crowd out a deeper understanding of business in China, which is profoundly different to that in the west.

Question your basic assumptions

Take the market economy. To the western mind, it's natural that individuals interact freely in the market, without some kind of overriding entity above them. This view is closely linked to the concept of universal suffrage and checks on the power of rulers. Firms, meanwhile, compete for capital and profits and are accountable to their shareholders. And companies exist in the first place because they reduce transaction

costs—meaning that they can do some things more cheaply than individuals can.

But this is certainly not a universal view. The starting point in China is not individuals acting freely, but rather notions of hierarchy, duty, responsibility and deference. Basic concepts of the firm and profit are also different, reflecting Chinese views of leadership, power, and the role of the state.

Strategy: chess or wei-chi?

These deep-rooted differences extend to corporate strategy and competition with rival firms, as reflected by the board games that are often used as metaphors for this.

In the west, strategic thinking is frequently compared to chess. All the pieces are on the board at the start of the game, and then players deploy these to attack their opponent. Each player tries to remove the other's pieces and capture the opposition king.

But in China, wei-chi (known in the west as Go) is a more popular game. In contrast to chess, players start with an empty board and put pieces on it with the goal of encircling and surrounding their opponent. Wei-chi is a slow, patient game, and it's not always easy to tell who is ahead. The key point is that players seek a longer-term positional advantage rather than a short-term gain. This is something western companies and executives need to bear in mind.

First, think

Western executives also need to be patient in learning about China. It's no longer good enough—if indeed it ever was—to apply a standard EMBA program structure to China and then dive straight into management basics such as accounting and marketing on day one. Instead, executives should start by understanding the historical, social and philosophical systems that underpin the Chinese way of thinking. Western managers also need to use programs to build the

personal contacts and networks (guanxi) that are so important to doing business with China. These too will deepen their understanding of east-west differences.

Opportunities and threats

A generation ago, western companies wanted to know how to do business with Japan. This thirst for knowledge reflected not only potential business opportunities, but also fear of the competitive threat from Japanese firms. If American and West European companies didn't wise up quickly, the thinking went, Japanese rivals would soon eat their lunch.

Today, western firms need to think about China, and for similar reasons. But whereas Japan has had a difficult couple of decades since the late 1980s, China's economic and corporate influence continues to grow. This means more and more western executives must learn to think in a different way.

Phil Rosenzweig is professor of strategy and international management at IMD. He co-directs the IMD-CKGSB Dual Executive MBA, which is designed for high-potential, internationally minded executives who are deeply committed to pursuing a career that leads the way between China and the world.

The article above is republished courtesy of http://www.imd.org/research/challenges/

Adaptive Leadership for the VUCA World: A Tale of Two Managers

By Paul Kinsinger, Clinical Professor, Thunderbird School of Global Management, and Executive Director, Thunderbird Executive Education (TEE)

Many organizations and managers are struggling to stay afloat and aligned in the volatile, uncertain, complex, and ambiguous nature of today’s global business environment. Turbulence—the rapid rate of change—is swirling around many of us, tipping us this way and that as we attempt to navigate a safe passage through it all.1

As an executive educator, I have been watching how companies and employees cope with the dynamism that defines the VUCA world. Over the last few years, I have been offered a unique window on how two different managers attempted to adjust to increasing turbulence in their company’s business environment, with dramatically different results for them and their organization.

The VUCA World

Volatility—The nature, speed, volume, magnitude, and dynamics of change

Uncertainty—The lack of predictability of issues and events

Complexity—The confounding of issues and the chaos that surrounds any organization

Ambiguity—The haziness of reality and the mixed meanings of conditions!

As a backdrop, the two managers work in a company providing professional services to a market segment that has been growing rapidly and globally. As the overall global business environment grows increasingly complex and competitive, many organizations of nearly all sizes are recognizing the need to avail themselves of these services. Moreover, the wave of new regional and global aspirants emanating from emerging markets, which in the past have dismissed the need for such services, are developing into a real growth market, with all the opportunities and challenges that accompany working with different cultural norms and, in some cases, markedly different business models. After bouncing around in low growth for much of the 2000s, this service-providing organization has seen double-digit YoY growth in the last three years as their customer base emerges from the recession and faces even greater growth and organizational challenges from the VUCA world.

On the downside, this particular segment is very fragmented with no major provider accounting for more than 5% of the market; it is also highly substitutable, with several different types of providers ranging from large and established, to small or one-offs; and it is more competitive, with new entrants from different sectors and now from emerging markets as well. Moreover, the segment has not developed clear-cut “gold standards” for what constitutes a high-quality customer experience. In a space which still

contains some alchemy, one buyer’s “wow” might be another’s “ho-hum.”

Furthermore, the segment is a high-touch, relationship-oriented business which still suffers from a dearth of experienced professionals on either the provider or the buyer sides. Many players are still in “learn” mode while they seek to professionalize, especially on the provider side, where employees must master multiple skills sets very rapidly to keep up with the steep and increasingly dynamic growth opportunities. In fact, like other fast-moving organizations trying to keep pace today, working in this company has been characterized as being in a “permanent nose-bleed learning environment.”

Partly as a reflection of this, the provider’s senior leadership changed about three years ago, with a new Chief Operating Officer (who is the chief executive of the unit) coming in from a much more established competitor. This COO brought a game plan that featured several critical changes to the underlying business model, as well as an ambition to grow the business both financially and globally faster than it had ever done.

Finally, this service provider’s overall holding company has, itself, been on a pretty turbulent ride over the last decade, with several “spiky” financial and organizational challenges at the macro level. This has combined to produce a situation where the service provider has had to operate in an extremely “VUCA” organizational climate even while working with its clients’ own VUCA business environments. In other words, for both good and bad, this service provider has been sailing through high seas almost continuously for several years, and has many bruises to show for it. By the same token, many of its leaders have had to develop the kind of adaptability that it takes to thrive in a VUCA world or move on.

Drawing lines in the sand…

Both leaders in my mini-study are managers of

others, leading client-facing teams. The first, a seasoned veteran of the field who had joined the organization in the mid-2000s, functioned as a team leader with responsibilities for business development, client management, and overall engagement delivery. This manager’s reputation for being a straight talker, a quick decider, and for having a strong sense for the “numbers” of the business, quickly rendered him a more senior role among his peers on the larger management team. Moreover, his steady ability to provide clarity and direction was popular with his direct reports and made him a charismatic team leader. This manager always seemed to have a clear explanation for things; to ask the straightforward questions of more senior managers when necessary; and to have an action-oriented bias that focused his team strongly on results. The combination of these qualities had a significant impact on this manager’s ability to deliver above his target a few years ago, and led the organization to increase the size of his client base and to raise his salary accordingly. He seemed on his way to bigger things.

With the onset of the recession, the organization’s business environment became increasingly turbulent, with some clients cancelling or postponing contracts while new opportunities required more economical models. As was the case for many companies, the business environment following the recession transformed into a “new normal” that became increasingly reflective of the conditions of the VUCA world—new, exciting, and challenging opportunities combined with much more severe turbulence in terms of client expectations, pricing constraints, emerging competition, and greater complexity all across the acquisition and delivery of services. It was clear that the organization would have to flex dramatically to adapt to these new and fluid market conditions and that its leaders would need to pave the way by demonstrating an ability to adapt themselves. The new COO was the embodiment of this style of leadership, providing a vision but empowering

managers to broadly interpret it across their teams; restructuring the organization to provide for increased collaboration while encouraging competition; and openly embracing the new complexity and ambiguity in the market.2

…leads to a Failure to Adapt

In his series of blogs in HBR in late 2010-early 2011, the late former US Army Colonel Eric Kail outlined adaptive leadership tactics for operating in a VUCA world as follows:

For Volatile Situations…Communicate clearly Ensure your intent is understoo

For Uncertain Situations…Get a fresh perspective Be flexible

For Complex Situations…Develop collaborative leaders Stop seeking permanent solutions

For Ambiguous Situations…Listen well Think divergently Set up incremental dividends

While his advice was constructed within the context of small-unit combat activities in the military, I believe it is easily convertible into applications for all organizations.

During the COO’s first several months, this manager emerged as quietly skeptical of the new strategic direction and of the organization’s perception of changes in the external business environment. He started resisting the need to adapt, retreating instead to the apparent safety of tried-and-true business models. He clung to past measures of success and failure despite evidence that some were no longer applicable or, worse, had become roadblocks to future growth. He also refused to learn new skills, acting as if the new tools introduced by the COO were unnecessary even to target a new, more complex set of client

opportunities that were presenting themselves. Once open to many other employees in the organization, he began to divide them into “friends and foes” while steering his team in its own direction within the larger organization and actively discouraging collaboration. Seeing the world through a distinctly black-and-white lens, he argued that “ambiguity” was being used to mask problems that could be solved by bold, decisive leadership and that the real way to lead in the VUCA world was to draw some lines in the sand and stick to them. What had once been conversations turned into one-way diatribes, as the manager seemed bent upon demonstrating that he had the answer for everything.

Despite mentoring, this manager, who has since moved on from the organization, basically became an oar rowing hard the other way. For a time, his ability to focus attention on legacy clients in the “tried and true” business model helped meet revenue goals, but this masked how the failure to adapt to new skill sets and more complex client situations would eventually erode the team’s topline performance. Team members, initially energized by this manager’s clear, declarative, top-down leadership style, gradually became confused about direction and disconnected from others in the organization. The manager’s sharp-edged, “us versus them” stance put most of the team in difficult situations, eventually causing many to become part of the “them” as well. Lapsing into constant “tell” mode, he basically stopped listening to anyone except the echo chamber provided by close allies.

What happened to this particular manager? Was it just a question of a bad fit; the kind of thing that could happen in any organization? The answer is “yes,” to some degree, but in a larger way, the real issue was this manager’s unwillingness to adapt to the increasing turbulence faced by this organization. The heart of this, in the eyes of many in the company, came from a fear of failure, which undergirded the refusal to want to change, to try new approaches and learn new skills, and to accept that the world

has become a much more turbulent, complex place where some leadership styles were now outmoded. Was this manager self-aware? Colleagues did sense some inner struggle on his part at times, but in the end, it seemed as if his ultimate point of self-reflection was to tell himself he was always right.

…while Checking One’s Ego…

Contrast this with that of another manager of others at the same organization whose essential ability and willingness to adapt has had a much different and more beneficial outcome for the organization and its employees. This manager, who had nearly 15 years of management experience under his belt, had actually held a leading position in the organization for several years before stepping aside four years ago to address some personal needs and then shifting to a lower-level management position.3 For some months, as could be expected, there was skepticism elsewhere in the organization that this “experiment” would work; as well as “office cooler“ predictions that this person’s ego or legacy from managing at a higher level would quickly get in the way. There was also doubt that this person, as an “older dog,” could “learn the new tricks” it would take to perform across the much more demanding level of skills that the organization’s new leader was requiring.

But from the get-go in the new mode, this manager plunged into the world of adaptability and essentially re-tooled himself for a business model that required at least 4X the skill set bandwidth and another 4X the span of control, compared with before the COO had joined. It seemed like slow-going at first, largely due to the drag coefficient associated with concerns about the person’s ability to “step down” from his previous role. However, this masked a determination by the manager to find a way to refit into the organization and to leverage the new dynamics introduced by the COO as the vehicle.

So, what did this manager do to adapt to leading in a VUCA world?

First, and perhaps most important to becoming an adaptive leader for turbulent times, he has been able to let go of a lot of what defined success in prior roles and organizational models, essentially shedding the impact of years of performance reinforcement and standards and getting set to measure up to new ones.

Second, and related, was an ability to keep his ego in check—an enormously difficult challenge for a seasoned performer who had risen to higher heights only to shift backwards.

A third was the keen desire to keep learning, and the ability to see the new leadership and new organization as an escalator to on-boarding a whole new set of skills.

A fourth was to adopt an “open-to-everyone-in-the-organization” stance, indeed, even to those who initially were doubters or detractors as well as to new employees.

Finally, a fifth was the ability to work with the contradictions and paradoxes that increasingly come with navigating the VUCA world, rather than railing against them. Indeed, many organizations are finding themselves living in the world of “both, and” instead of “either, or;” those most affected by the VUCA world face them more frequently and more often surrounded by uncertainty and ambiguity, to boot.4

Countering VUCA: VUCA Prime

“We are moving from a world of problems, which demand speed, analysis, and elimination of uncertainty to solve, to a world of dilemmas, which demand patience, sense-making, and an engagement of uncertainty.”

Countering VUCA requires:

Vision - an intent that seeks to create a future

Understanding - the ability to stop, look, and listen

Clarity - the ability to help make sense of the

chaos

Agility - organizations where ”wirearchy” is rewarded over hierarchy

One might posit that these are traits of good leadership in any situation, not just for the VUCA world. I agree, but I think they are particularly valuable in turbulent times, where so much of what is traditionally available for leaders to judge themselves upon falls away or is dangerously outmoded. Perhaps at the heart of this leader’s success in adapting has been his growing sense of self-awareness over the last several years. Known as someone who had very carefully guarded his life and reactions, this leader took the opportunity of the position change and new organizational direction to re-examine some core values and re-align career goals, shifting flexibly within the avenues for each that the increasing turbulence offered. Grounding one’s self in who one really is in this world and what one wants to stand for as a leader are also even more essential to leading in a VUCA world, where one’s moorings need to be as steady as a buoy, especially in stormy waters.

…led to an Engaged and Impactful Leader

So, what have been the results of this leader’s adaptation? Being able to let go of many past measures of success has allowed the leader to be open faster and more agnostically to new performance imperatives from both the client base and from within the organization. While this manager still has some business growth goals to meet, he has re-oriented much of his portfolio growth strategy toward more complex and risky, but more lucrative, potential client engagements—the kind that are the future of the business. He has also steadily embraced new performance measures by trying to put personal insecurities aside and bring humility to his development. Similarly, his ability to embrace working with the contradictions and paradoxes that often accompany uncertainty and ambiguity

has helped him keep his team fully engaged in the organization’s vision and strategy.

Keeping his ego in check in the face of an extraordinary career move and demonstrating a keen desire to keep learning has gradually earned him newfound respect from others in the organization—a crucial characteristic for VUCA times when employees are constantly looking for leaders who can acknowledge their own imperfections and willingness to try to address them. Moreover, the active learning “gene” has helped the manager get the new skill sets under his belt as well as to be a role model, first for his team, and gradually for others. Indeed, the ability to embrace learning, “un-learning,” and “re-learning”5 is critical for leaders in the VUCA world, where many bodies of knowledge are changing so fast and information and insight becomes irrelevant quickly.

Finally, this leader’s ability to remain open and welcoming to everyone in the organization—another practice that is grounded in humility and self-awareness—has resulted in the gradual gaining of trust and a spread of this manager’s influence with many employees, peers, and bosses. This, too, has been critically important to the organization’s overall leadership posture in VUCA times, as employees look for leaders to be available and to communicate often and honestly; as peers look to each other for ideas, support, and easy collaboration; and as senior leaders look for ideas, honest feedback, and clear input into, and loyalty toward, the vision, mission, and strategy.

This leader has some distance yet to go in adapting his leadership for VUCA times—no question—and he admits to it. Goals include further enhancement of some critical skill sets that essentially require facing up to longstanding insecurities about innate abilities, as well as continued shaping of his communication style toward more “straight-shooting” and away from the kind of “sugar-coating” that has, in the past, left some to doubt the intent and value of his

comments. Leaders who hold back out of fear and whose words are discounted or interpretable are in danger of being rip-tided in VUCA times.

Still, this leader has made enormous strides toward adapting to VUCA times, and is increasingly making a positive impact on the business and organizational culture, with their attendant personal rewards.

Addressing the Challenges of Adaptability

The need for humans to adapt is nothing new and, indeed, those who point out that humankind has faced even more dramatic adaptation imperatives in the past are no doubt right. That said, we are where we are in the history of human development and in the scope and pace of dynamic change in the marketplace and in our organizations. A failure to meet the challenges will leave many companies behind and the human capital potential of their employees unfulfilled.

At Thunderbird Executive Education, we work with globally focused companies and organizations from many industries and fields of endeavor to help their leaders develop or further enhance their ability to adapt to turbulent times. We help leaders become more comfortable and agile with ambiguous and seemingly contradictory demands through focusing on managing paradoxes. We focus on the skills and mindsets that it takes to move nimbly and often without specific authority in making fast decisions through influencing and networking. We address the need for speed and for bringing all applicable resources to bear for impact in collaborating across silos. And, we focus on the self-awareness, reflection, and the need for quick recovery from failure in sessions on resiliency. Above all, we help leaders embrace a mindset of change that is so critical in navigating the turbulent times of the VUCA world.

Footnotes

1. Some observers downplay the concept of VUCA, claiming that there is no way of knowing whether or not these times are any more turbulent than many in the past. Research by the Boston Consulting Group, published in The Most Adaptive Companies of 2012, points out that from 1980 to 2010, companies faced an increasingly rapid rate of change that was more dynamic, taking place more often, and longer lasting.

2. For more on the role of a senior leader in a VUCA-driven organization, see pages 159-164 in Light Footprint Management: Leadership in Times of Change, by Charles-Edouard Bouée, Bloomsbury, 2013

3. In retrospect, this act pointed to a predisposition to the kind of adaptability it would take to thrive and lead in an organization facing a VUCA world.

4. See pages 120-125 in Light Footprint Management for more on the paradoxes that characterize organizational balance in the VUCA world.

5. See, for example, Chapter Two: The Social Brain in a VUCA World, in Maximizing Business Results with the Strategic Performance Framework: The Cultural Orientations Guide, Sixth Edition, by Putz, Schmidt, and Walch, the Training Management Corporation, 2014

The article above is republished courtesy of http://knowledgenetwork.thunderbird.edu/research/

http://www.thunderbird.edu/article/adaptive-leadership-vuca-world-tale-two-managers

Will my idea work?

Successful entrepreneurs insistently ask why their idea will or won’t work. John Mullins explains.

Passion. Conviction. Tenacity. Without these traits, few entrepreneurs could endure the challenges, setbacks and twists in the road that lie between their often path-breaking ideas – opportunities, as they call them – and the fulfilment of their entrepreneurial dreams. But the very best entrepreneurs possess something even more valuable: a willingness to wake up every morning and ask a simple question: “Why will or won’t this work?”

Aspiring entrepreneurs – whether contemplating a raw start-up or buried deep in the bowels of an established company – ask this question for a simple reason. They understand the odds. They know most business plans never raise money. They know most new ventures fail. Most of all, they don’t want to end up starting and running what long-time venture capitalist Bill Egan would call a “lousy business”, one that consumes years of their energy and effort, only to go nowhere in the end. Despite asking this crucial question every day, their passion remains undaunted. So committed are they to showing a reluctant

world that their vision is feasible that they want to know why they might be wrong before bad things can happen.

Haste makes waste

If the entrepreneur can find flaws before they launch or before the flaws take down their new business, they can often work around them. They can modify their idea, shaping the opportunity to better fit the hotly competitive world in which it seeks to bear fruit. If the flaw they find appears to be truly fatal, they can abandon the idea before launch in some cases, or soon enough thereafter to avoid wasting months or years in pursuit of a dream that simply won’t fly.

Better yet, if after asking their daily question and probing, testing, and experimenting, the signs remain positive, they pursue their opportunity with renewed passion and conviction. This evidence translates to new-found confidence that the facts – not just intuition – confirms their prescience. Their idea really is an opportunity worth pursuing.

In today’s lean start-up world, the urge to launch right away and just learn as you go is appealing. It gets you out into the marketplace, which is the best place to learn. And it provides a release for your entrepreneurial energy that is probably bubbling over. But it’s all too likely to result in a waste of your entrepreneurial energy and talent. Why? As the 20th century’s most incisive management thinker Peter Drucker observed about new ventures, “If a new venture does succeed, more often than not it is:

• In a market other than the one it was originally intended to serve

• With products and services not quite those with which it had set out

• Bought in large part by customers it did not even think of when it started

• And used for a host of purposes besides

the ones for which the products were first designed.”

“OK,” you might ask. “Is there a better way to go? There is, and there’s a framework to help entrepreneurs avoid missing the obvious pitfalls in their ventures, the seven domains.

An idea that worked

Consider this entrepreneurial story. In 2004, Paul and Alison Lindley were facing a bit of a challenge in getting their six-year-old daughter Ella to eat. In his Caversham kitchen, 40 miles west of London, Lindley concocted blends of natural and organic fruits and vegetables that were fun, colourful, and fitted the family’s on-the-go lifestyle. Realising that there might be a market for his tasty creations – which Ella loved – Lindley soon moved his lean start-up out of his kitchen and into a couple of barns nearby.

Before long, Ella’s Kitchen baby and toddler food pouches – filled with all-natural purées of organically grown fruits and vegetables – began finding their way into the homes of many British families with young children. Organic smoothies in four kid-friendly colourful favours – red, green, purple and yellow – followed, as did a range of toddler-sized fruit snack bars and a host of other products.

Lindley then expanded internationally; after all, eating should be fun, tasty, and cool for kids, and healthy, too, no matter where they live. Ella’s Kitchen was then acquired by Hain Celestial, a leading American marketer of natural foods and beverages, in 2013.

Assessing opportunities

Was Lindley’s idea for Ella’s Kitchen an attractive opportunity? Opportunities are best understood in terms of three crucial elements: markets, industries, and the one or more key people that make up the entrepreneurial team. The seven domains model (see below), articulated in my book, The New Business Road

Test: What Entrepreneurs and Executives Should Do Before Launching a Lean Start-Up, brings these elements together to offer a clearer way to answer the crucial question that aspiring entrepreneurs must ask themselves every morning: “Why will or won’t this work?”

The model offers a toolkit for assessing and shaping market opportunities and a better way for entrepreneurs to assess the adequacy of what they bring to the table as individuals and as a team. The model also outlines a customer-driven feasibility study to guide entrepreneurs’ assessments before they invest precious time and effort in writing a business plan.

Let’s put the seven domains to use and examine Lindley’s opportunity.

• Macro market: The trend toward natural and organic foods has been an attractive wave to ride for Ella’s Kitchen. Numerous other organic and natural entrepreneurs now ride the same wave.

• Micro market: Lindley, having gained a good understanding of kids as consumers from his nine years at Nickelodeon, the children’s cable TV channel, was able to work out that his daughter Ella and others like her would love healthy organic fruit and vegetables prepared in kid-friendly ways. If the kids loved the products, Lindley reasoned, parents would buy them.

• Macro industry: The prepared food industry was and still is hotly competitive – a drawback for Lindley’s nascent company. But he reasoned that his clearly differentiated products would catch on.

• Micro industry: Could Lindley sustain competitive advantage for long? Other fruit and vegetable processors could copy him, he knew, and competitors such as Heinz, Danone and Nestlé’s Gerber had deep pockets. So he had to move fast. Selling the company just seven years after inception, to a buyer with a substantial market presence and resources he lacked, made good sense,

giving Lindley and his UK team the free-power they needed to compete on a global scale. The goal was never to sell the company,” he says. “The goal was to use our products to improve children’s health.”

The entrepreneurial team

As with many entrepreneurs, Lindley brought relevant skills to the table, skills he’d built at Nickelodeon, where he had been Deputy Managing Director of its UK business. Where there were gaps, he built a team that complemented his skills and brought connections the business would need. Hain Celestial thought so much of the team Lindley assembled that it kept them in charge post-acquisition and asked them to manage the company’s kids’ product line in America, too.

So, was Lindley’s entrepreneurial opportunity an attractive one? It wasn’t perfect, in seven domains terms. But they never are. Wisely, Lindley crafted a strategy that capitalised on his opportunity’s strengths in market terms, and mitigated the risks on the industry side.

Putting the seven domains to work

At first glance, the seven domains model simply summarises what everybody already knows – or claims to know – about assessing opportunities. Upon more careful scrutiny, however, the model goes further to highlight three crucial distinctions and observations that most entrepreneurs – not to mention many investors – overlook:

• Markets and industries are not the same.

• Markets and industries must be examined at both macro- and micro-levels.

• The keys to assessing entrepreneurs and entrepreneurial teams aren’t found on their resumes, in character surveys or psychological tests.

Moreover, the model’s seven domains are not

equally important. Nor are they additive. A simple checklist won’t do. In fact, the wrong combinations of them can kill your venture. On the other hand, sufficient strength on some factors can mitigate weaknesses on others. Attractive opportunities – such as the one Lindley identified – can be found in less attractive industries such as prepared foods.

As the seven domains graphic shows, the model is comprised of four market and industry domains, including both macro and micro levels, and three additional domains related to the entrepreneurial team. These seven domains (everybody knows at least some of these, too, but I found most don’t think of them in this way) address the central elements in the assessment of any market opportunity:

• Are the market and industry attractive?

• Does the opportunity offer compelling customer benefits as well as a sustainable advantage over other solutions to the customer’s needs?

• Can the team deliver the results they seek and promise to others?

Why won’t my idea work?

In examining your opportunity through the seven domains lens, concerns will inevitably crop up: the potentially fatal flaws that can render your opportunity a nonstarter. The key task in answering the question, “Why won’t my idea work?” is to find any major flaw that cannot be resolved, the opportunity’s Achilles’ heel. Thus, the crucial things to look for on the downside are elements of the market, industry, or team that simply cannot be fixed by shaping the opportunity in a different way.

If flaws that cannot be fixed are found, the best thing to do is to abandon the opportunity at this early stage and move on to something more attractive. Persisting with a fundamentally flawed opportunity is likely to have one of two

outcomes, both of which are exceedingly unpleasant:

• Best case: the best and most likely outcome is that experienced investors or other resource providers – suppliers, partners, and so on – will see the flaws that you have ignored and refuse to give you the resources you need, despite your business plan that papers over these flaws. Fortunately, their refusal will save you the agony of investing months or years of your life in a “lousy business,” though your efforts in preparing and pitching your business plan will have been wasted. The harsh reality is that this is the case for the majority of business plans, which seek to develop opportunities that are fatally flawed. Most business plans should have been abandoned before they were written.

• Worst case: the second, though less likely, outcome of pursuing a fundamentally flawed opportunity through the business planning stage is that, in spite of the flaws, you are able to secure the resources you need and actually start the business. At some point, the flaws will rear their ugly heads, and you’ll need to scramble to recast the business before it goes under.

Some readers of this article may find themselves in this unhappy predicament today, and it’s not a pretty place to be.

Why will my idea work?

The good news is that opportunities are not static. They can be shaped in many ways. Potentially fatal flaws are sometimes fixable. You can choose a different target market that is more receptive to your proposed offering. The offering can be adapted to better fit market needs. The opportunity can be pursued at a different level in the value chain – as a distributor, rather than retailer or manufacturer, for example – if a different industry setting would be more hospitable. Adding individuals to help the team deliver on the critical success factors or who bring connections up, down, or

across the value chain can strengthen the entrepreneurial team.

So, take heart. Road test your entrepreneurial dream before you even think about launching a lean start-up. If the seven domains road test looks positive, you will have jump-started your journey, and you will have gathered a body of evidence with which to guide your launch. And what if you’ve found fatal flaws? You can redirect your entrepreneurial time and talents to another opportunity with greater potential. Enjoy the drive!

Author

John Mullins, [email protected]

John Mullins is Associate Professor of Management Practice in Marketing and Entrepreneurship at London Business School. His latest book is 'The Customer-Funded Business: Start, Finance, or Grow Your Company with Your Customers’ Cash' (Wiley, August 2014).

The article above is republished courtesy of London http://bsr.london.edu/lbs-article/823/index.html

Social Media and the Marketing Mix Model

Joerg Niessing, INSEAD Affiliate Professor of Marketing | August 29, 2014

Listening tools can help companies determine social media ROI in terms of real financial impact. But this only works if consumer sentiment is part of a more holistic marketing mix model.

In 2012, Red Bull attempted to bring its slogan “Red Bull Gives You Wings” to life. An estimated eight million people watched live on YouTube as skydiver Felix Baumgartner became the first person to break the sound barrier in free fall, jumping 39 kilometers to earth from a stratospheric balloon as the culmination of Red Bull Stratos, a seven-year brand-sponsored project.

The Stratos campaign sent Red Bull’s social media metrics sky-high. According to company stats, the event generated approximately 60 million interactions across all social media channels, and inspired almost one percent of all tweets sent on the day of the jump. And there were indications of a longer-lasting impact: Social media discussions about “drinking or needing” Red Bull were up seven percent three months after the campaign ended.

But all that buzz didn’t come cheap. Media estimates of Stratos’ cost have run in excess of US$50 million. And although the project is generally considered a big win for Red Bull, the standard methods companies use to measure ROI provide no direct way to trace how online chatter converted to real-world revenue. It is one thing to share or click a link from Twitter or Facebook, quite another to walk into a shop and buy a product. The familiar marketing attribution problem – identifying a set of user actions that contribute in some manner to a desired outcome such as a purchase – is getting even more complex in the digital world. The most common method for attribution, the so-called “last click”, grants full credit to the customer interaction immediately preceding the outcome, an easy but wholly inaccurate practice.

It’s time we started treating social media like any other marketing channel by assessing its impact in terms of genuine brand engagement and revenue, rather than solely relying on more ambiguous stats such as clicks and likes.

Sentiment Analysis

My thoughts on this matter echo those of my colleague David Dubois, who recently wrote on INSEAD Knowledge, “What businesses need to do when measuring ROI is take into account both the positional and relational to reflect social media’s true added value.” Luckily, in the last few years social media listening tools have become available, giving companies a thorough overview of not only how many fans and followers they have online but also the range of reactions to brands on social networks.

These tools make it easy for companies to get a quantitative estimate of how social media users feel about their brand (and its competitors). In the industry, this metric is widely referred to as “sentiment”, and is calculated in its simplest form by assigning emotional values to the words used in brand-related social media posts. (E.g., the word “good” would indicate positive

sentiment; “awesome” would register as strongly positive). This is not an exact science, to be sure, but it has been known to produce broadly accurate and actionable assessments.

Of course, gauging ROI is a complex endeavor and can never be reduced to a single metric. But sentiment is an important part of the package because it measures more than an audience’s size. As Dubois points out, a company would probably see better ROI from 1,000 passionate fans than from one million disengaged ones. Having a tool that is accurate in measuring the sentiment is a very important first step (‘Garbage in, garbage out’). Once we have measured the sentiment over time we could use this as one input variable – besides many other variables – in a classical marketing mix model (MMM).

The “Marketing Mix Model”

In recent years, MMM has emerged as the gold standard for evaluating marketing ROI. MMM employs regression modeling and historical performance-based data sets to gauge the business performance, and to determine the optimal use of a variety of marketing channels. The results are often surprising to companies that have grown used to buying eyeballs: Using MMM, Procter & Gamble found that BeingGirl.com, a community for girls sponsored by the Tampax and Always brands, was several times more effective at driving sales than a similarly priced television ad campaign.

By plugging sentiment into MMM, companies would finally be able to assess the impact of social media conversations on business performance. This would lead to a better understanding of how social fits alongside more established channels such as paid advertising in a successful media plan. We could measure the correlation between the sentiment index and potential outcome variables like sales or market share and also understand how it would interact with other media activities. For example, a Facebook campaign may or may not be more

successful if preceded by a TV ad. The downside here is that such analysis can be time-consuming and requires collecting a vast amount of varied data (sometimes even triggered through test and learn experiments).

From Facebook to the Factory Floor

In addition to measuring ROI, the champions of social media listening use the tools to spot and address product issues before they go damagingly viral. When Kraft Foods noticed alarming words such as “cut” and “blood” were appearing in online posts about their brand, they dug deeper and found some customers were hurting themselves trying to open a recently redesigned salad dressing bottle. Kraft took quick action to change the bottle, halting the potential for this minor boo-boo to become a more serious wound to the firm’s reputation.

This is yet another example of the importance of integrating social media strategy into brand or business strategy. (I wrote extensively about this in a previous post). These days, what happens in cyberspace affects companies in tangible ways; strategic objectives often succeed or fail online. Abolishing silos facilitates the speed and responsiveness that these new conditions demand. And including social media in the marketing ROI package is a great way to bring the digital world back down to earth – or, as in the case of Red Bull, into the stratosphere.

Joerg Niessing is an Affiliate Professor of Marketing at INSEAD. You can follow Joerg on Twitter @JoergNiessing

http://knowledge.insead.edu/blog/insead-blog/social-media-and-the-marketing-mix-model-3540

The article above is republished courtesy of INSEAD Knowledge http://knowledge.insead.edu

The China-EU BIT: The emerging "Global BIT 2.0"?by Wenhua Shan and Lu Wang*

Since China and the European Union (EU) announced their decision to negotiate a bilateral investment treaty (BIT) at the 14th China-EU Summit in February 2012, the two sides have engaged in two rounds of negotiations. If successful, it will be the first standalone EU BIT, a BIT between the world's largest developed economy and the world's largest developing economy, and will occupy a unique place in the history of BIT negotiations.

Although there are currently BIT arrangements between China and all but one EU member state, the China-EU BIT negotiations would involve far more work than simply consolidating or “[streamlining] the existing BITs between China and 28 EU Member States into a single and coherent text.”[1] Indeed, it can be expected that both parties would seize this opportunity to update and upgrade their investment treaty arrangements, taking into account recent investment treaty practices in general and those of the two parties in particular, including their investment treaty/chapter negotiations with the United States. The most challenging and promising issues are likely to be market access and dispute resolution.

It is well known that both China and EU members used to follow the traditional “European” approach towards BIT, focusing on investment protection without including concrete undertakings regarding investment market access or liberalization. However, this approach seems to have changed dramatically on both sides in recent years. The EU has been very keen to promote investment market access as well as investment protection, as demonstrated by the latest draft of the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada, which accepts pre-establishment national treatment on the basis of a negative list of reserved sectors.[2] China also seems to have accepted concrete market access obligations in BITs, as she has announced acceptance of pre-establishment national treatment obligations and the negative list approach in recent BIT negotiations with the United States.[3]

Against this background, it is possible that the China-EU BIT will contain concrete market access commitments. Nevertheless, this is much easier said than done, especially since both China and the EU (including its members) have had little experience in making market access commitments in their investment treaties.[4] The preparation and negotiation of market access commitments are

likely to take significant time, since both sides have to assess whether and to what extent each sector and industry is internationally competitive and should be opened up to international investors.[5]

In recent treaty practice, both the EU and China have been active in reforming investor-state dispute settlements (ISDS). Progress has been made, for example, in the draft EU-Canada CETA which establishes "the most progressive system" of ISDS, particularly by providing more details and greater transparency, while improving control over frivolous claims.[6] On the other hand, the Canada-China BIT contains a relatively new provision requiring financial prudential measures to be jointly decided by financial service authorities of the contracting parties, or through the state-state arbitral mechanism.[7] China and the EU share many similar concerns regarding ISDS reform, such as refining the scope of ISDS and state-state arbitration, and exploring the possibility of an appeals mechanism. It is therefore possible that they will agree on a progressive and innovative dispute settlement mechanism.

In short, the China-EU BIT is likely to combine investment protection with investment liberalization, while refining both substantive and procedural rules and embracing social concerns, in order to achieve a better balance between the rights of foreign investors and the regulatory needs of the host country. Indeed, it may be the "Global BIT 2.0,"[8] given that it will be the first new generation BIT that the EU and China conclude on their own initiative and is likely to significantly impact BIT practice worldwide.[9]

* Wenhua Shan ([email protected]) is the Ministry of Education Yangtze River Chair Professor of International Economic Law, Dean of Law School and Director of the Silk Road Institute for International and Comparative Law (SRIICL) at Xi'an Jiaotong University, and Senior Fellow at the Lauterpacht Centre for

International Law, University of Cambridge; Lu Wang ([email protected]) is a PhD Candidate at Liverpool Law School and Xi'an Jiaotong University Law School. The authors would like to thank Marc Bungenberg, Armand de Mestral and an anonymous reviewer for their very helpful peer reviews. The views expressed by the author of this Perspective do not necessarily reflect the opinions of Columbia University or its partners and supporters. Columbia FDI Perspectives (ISSN 2158-3579) is a peer-reviewed series.

[1] European Commission, “Commission proposes to open negotiations for an investment agreement with China,” May 23, 2013, http://europa.eu/rapid/press-release_IP-13-458_en.htm.

[2] Draft CETA Investment Text, November 21, 2013, arts. X.7 & X.14, available at https://www.laquadrature.net/files/CETA-Draft-Investment-Text-Nov21-2013-203b-13.pdf.

[3] MOFCOM, “MOFCOM spokesman Shen Danyang comments on China and US to promote energetically negotiations on bilateral investment agreement,” July 16, 2013, http://english.mofcom.gov.cn/article/newsrelease/policyreleasing/201307/20130700200566.shtml.

[4] Wenhua Shan and Sheng Zhang, “The potential EU-China BIT: Issues and implications,” in Marc Bungenberg et al., eds., EU and Investment Agreements (London: Hart Publishing, 2013), pp. 102–104.

[5] Id., at p. 104.

[6] European Commission, “Investment provisions in the EU-Canada free trade agreement”, December 3, 2013, http://trade.ec.europa.eu/doclib/docs/2013/november/tradoc_151918.pdf.

[7] China-Canada BIT (2012), arts. 20(2)(b) and 33(3). A similar arrangement can be found in

NAFTA, art. 1415.

[8] Wenhua Shan and Sheng Zhang, “Market access provisions in the potential EU Model BIT: Towards a ‘Global BIT 2.0’?” Journal of World Investment and Trade (forthcoming).

[9] The EU member states, with 1,400 BITs, have signed around half of the world’s BITs, and China has the world's second largest BIT network (with over 130 BITs). Together, they easily comprise the majority of the world's BIT stock. The European BIT prototype has also been followed by the majority of countries in the world.

acknowledgment: “Wenhua Shan and Lu Wang, ‘The China-EU BIT: The emerging “Global BIT 2.0”?’ Columbia FDI Perspectives, No. 128, August 18, 2014. Reprinted with permission from the Columbia Center on Sustainable Investment (www.ccsi.columbia.edu).”

For further information, including information regarding submission to the Perspectives, please contact: Columbia Center on Sustainable Investment, Shawn Lim, [email protected] or [email protected].

The article above is republished courtesy of http://www.vcc.columbia.edu/

Think you live in globalized world? Think againBy Samantha Stainburn, June 16, 2014

Photo via iStock.

The globalization of trade is so established that it has lost the power to astound us. Fresh-cut flowers from Kenya are flown daily to Europe’s flower markets. North Americans eat Peruvian asparagus that took only a day to get from field to supermarket. Boeing puts together planes in Seattle using parts from 10 different countries—parts that were preassembled in Japan, Korea, Kansas, and South Carolina. Meanwhile, trading blocs such as the 28-country European Union and trade pacts such as the North American Free Trade Agreement lower tariffs and promote the movement of goods among trading partners.

Yet the global economy is not as integrated or efficient as is widely believed, according to A. Kerem Cosar, assistant professor of economics at Chicago Booth. Asparagus and aircraft parts may be easily shipped from one country to another, but getting goods from their point of origin to international shipping centers within the same country can be expensive—sometimes more expensive than shipping them to a foreign destination. Moreover, exporting goods across borders can incur costs that deter trade even when tariffs have been negotiated down.

“Building good ports and having policies that help exporters may be good, but at the end of the day, firms can’t all pile up close to the seaports in order to export,” says Cosar. “Internal infrastructure is key for your competitiveness as well, to get those goods out.”

China's long road

Cosar cites the example of China, the world’s second-biggest economy. The country faces the South China Sea, the East China Sea, and the Yellow Sea on its southern and eastern coastlines, and borders Mongolia and Russia to the north, Central Asia to the west, and Vietnam to the south. Since 1978, when China began to open up to foreign trade and investment, the country’s exports have grown exponentially to $2.21 trillion-worth of goods in 2012, according to China’s National Bureau of Statistics.

China ships most of its exports from coastal ports. Just 17.4% of exports to its top 20 trading partners depart by air, and only 6.7% of all its exports travel overland to neighboring countries.

When China’s manufacturing renaissance got under way, congested roads and overloaded railways made transporting goods to seaports slow, unreliable, and expensive, so exporters moved to cities such as Shenzhen and Dongguan in the Pearl River Delta in the south, Suzhou and Shanghai on the east coast, and Dalian in the northeast, between the Bohai Sea and the Yellow Sea, to cut costs. Residents of China’s interior provinces, seeking work that paid more than farming, followed the companies to the coasts.

These days, some 163 million Chinese are long-distance migrants who leave their provinces each year to join companies that employ hundreds of thousands of workers making electronic components, auto parts, appliances, clothing, and more. It’s not uncommon for workers to spend 12 hours a day, six days a week on an assembly line, sewing sweatshirts, stamping metal into kitchen appliances, or screwing components into

iPhones. They often leave their children behind in their home villages and live in crowded dormitories on factory property.

In a recent paper, Cosar teamed up with UCLA’s Pablo D. Fajgelbaum to study how international trade affects regional specialization, employment, and income in China. They used industry-level data from China’s 338 prefectures—regions that include several counties or a large city—between 1998 and 2007.

They find that distance from the coast has a sizeable effect on economic activity, particularly for industries that export a high percentage of goods. Firms located 275 miles inland in industries that export an average percentage of goods (20% of output) employed 17% fewer workers than firms in average-exporting industries located on the coast. Inland firms in heavily export-oriented industries, such as furniture manufacturing, which exports 40% of its output, employed 32% fewer workers than their counterparts on the coast.

The impact of poor infrastructure on economic activity in China is reflected in the researchers’ broader findings: when it’s expensive to transport export goods from the interior of a country to a port, export-oriented firms move closer to the ports to save money. Economic activity in these regions increase—the economic output of Guangdong Province on China’s southeast coast, for example, grew from $11 billion in 1978 to an estimated $1 trillion in 2013—and economic activity in the interior suffers.

This phenomenon depresses overall gains from trade as lagging regions drag down the national numbers, Cosar and Fajgelbaum note. At the same time, export-oriented manufacturers crowding into coastal regions force up real-estate rents and employee wages there. So poor infrastructure shrinks international trade gains even for firms that are able to locate close to gateways to foreign markets.

These are concerns shared by developing countries with poor domestic infrastructure that have opened up to international trade, such as Vietnam, where economic activity is concentrated near its ports, and Mexico, where economic activity has been highest along the US border.

Fortunately, infrastructure can be improved, Cosar notes. China has taken steps to better connect interior regions to the coast in recent years. In 2000, it launched a 20-year “go west” initiative, formally called the Western Development Strategy, to encourage companies to locate inland, enticing them with hundreds of billions of dollars’ worth of improvements to regional infrastructure and tax incentives. Between 2000 and 2012, China expanded its expressway network an average 16% a year, growing it to 75,000 kilometers of highways by 2012, KPMG reports. And China is undertaking one of the world’s biggest railway expansions, spending $1 trillion to add 120,000 kilometers of railway track by 2020.

Those kind of infrastructure investments make it more appealing for companies to invest in lagging interior regions. Among the companies that have moved production inland to take advantage of lower labor and land costs: computer manufacturers Intel, Dell, and Lenovo, which have opened factories in Chengdu, the capital of Sichuan Province, 1,500 miles from the eastern seaboard. Taiwan-based electronics firm Foxconn Technology Group, the Apple contractor known for its massive “factory cities,” has opened new factories in Chengdu and the inland provinces of Henan and Shanxi. And Unilever, maker of Dove soap and Lipton tea bags, has moved seven factories from Shanghai and Guangdong Province to Hefei

in Anhui Province, 250 miles west of Shanghai.

Ford built its first assembly plant in the southwest Chinese city of Chongqing, 700 long miles as the crow flies from the nearest major

port, Guangzhou, in 2001. After that it opened a second assembly plant in Chongqing, and plans to open a third this year, as well as a transmission plant. Chongqing is already Ford’s second-largest manufacturing region after southeast Michigan, and employees in Chongqing will produce 870,000 Ford vehicles a year once the new factories are up and running. “Logistics and transportation infrastructure have reached a level such that it’s profitable for Ford to utilize land in the interior and incur the transportation costs of bringing those [cars and parts] to the large cities on the coast or to export [them] to other Asian countries from those cities,” Cosar observes. Ford declined to comment.

Turkish traffic

Nineteenth-century farmers in the US midwest only brought their grain to major markets when the weather allowed. During the spring, roads could be too muddy to navigate, a problem eventually solved by pavement and train tracks. As infrastructure developed, so did the American heartland and economy. Two hundred years later, how much of a boost can better infrastructure—and roads, in particular—provide to an economy in the era of global trade?

Consider Turkey, the world’s 17th largest economy and 22nd largest exporter by value. Turkey stretches 1,500 miles west to east between Europe and Asia, and 90% of its freight travels by road. Yet, until about ten years ago, Turkey had just one highway, connecting Istanbul, its main economic engine, with Ankara, its capital 300 miles to the east. Most of the country’s roads had a single lane in each direction, making for slow climbs and descents through the country’s mountainous interior, particularly during snowy winters, to get to the low-lying port cities on the Black Sea to the north, the Aegean and Marmara seas to the west, and the Mediterranean Sea to the south.

Adding to the delays, collisions were common, as motorists determined to overtake slow

vehicles in front of them would drive into oncoming traffic to pass. Large logistics companies chose not to transport goods to and from certain areas with particularly congested roads because they could not guarantee the products would arrive on time. Independent truckers, whose vehicles were often older, overloaded, and more prone to break down, picked up the business.

In 2002, Turkey launched a major program to improve its infrastructure by upgrading dual-lane roads into four-lane expressways, with a safety divider in the middle. The amount of four-lane roads grew from 12% to 35% between 2003 and 2012. Cosar, who’s originally from Turkey, noticed the difference on a return trip. “What used to be an eight- or nine-hour drive from Istanbul to the Mediterranean seaside is now six or seven hours and much more pleasant,” he says. Even the Istanbul-Ankara route got an upgrade, with the opening of a motorway tunnel through Bolu Mountain in 2007, shaving 2.5 hours off the journey.

Cosar and Banu Demir of Bilkent University in Ankara have quantified the impact of that investment program. The researchers estimate that every $1 spent on upgrading the old roads generated an additional 10¢–15¢ in export revenues. The improvements particularly aided time-sensitive industries such as furniture, chemicals, communications equipment, electrical machinery, and office and computing machinery. They posted bigger increases in exports and employment than industries where fast delivery is less important to consumers, such as luggage and tobacco products.

While the road-improvement scheme was designed to relieve congestion caused by a growing economy and increasing urban population, it’s clear why exporters benefited from the new highways. Even as the number of vehicles on the road doubled, the average travel speed for freight-carrying vehicles increased.

Traffic-related fatalities per vehicle-kilometer dropped 40% from 2004 to 2011, likely contributing to increased speed. According to World Bank data, between 2007 and 2012, the median time it took to transport goods from their point of origin to ports and airports in Turkey decreased by 12 to 48 hours. Cosar speculates that higher-quality roads also lowered costs for exporters by reducing wear and tear on vehicles and causing a drop in their freight-insurance expenses as accidents decreased. After the roads were improved, logistics companies expanded scheduled freight services to more cities. The total volume of freight carried by all trucks in Turkey increased 29% between 2004 and 2012, from 157,000 million ton-kilometers to 203,072 million ton-kilometers.

Turkey has been closely watched by officials in countries such as Colombia, Brazil, and Ecuador. In mountainous Colombia, where it takes some 10 hours to drive 270 miles from Bogotá to the port city of Medellín, officials are attempting to attract $20 billion in private investment over the next five years to fund road improvements, which President Juan Manuel Santos has called a top priority.

Windmills without borders

Research suggests traffic and other problems involved in transporting goods from factories to ships or aircraft can be a significant drag on international trade, but there are also limits to what infrastructure investments could accomplish. Cosar has found that there’s another thing that makes it difficult for goods to leave the country: costs incurred at the border. Cosar and two coauthors spotted the phenomenon in a study of European wind turbines.

Along with Paul L.E. Grieco of Pennsylvania State University and Felix Tintelnot in the University of Chicago’s economics department, Cosar looked at wind-turbine manufacturers in Denmark and Germany in 1995 and 1996. The

researchers were interested in studying the effects of national borders on market segmentation, and the data on the wind-turbine industry in the two countries included the location of all manufacturers and wind farms, which were scattered throughout each country. This allowed them to account for actual shipping distances and separate the impact of distance from the impact of the border on costs.

Also, Denmark and Germany both belong to the EU, which created a single market in 1992. Members strove to eliminate import or export restrictions by lowering nontariff barriers. In both countries, wind-farm operators are paid above-market rates, bumped up by government subsidies, for the electricity they generate and provide to the electric grid. Operators are free to buy whatever turbines maximize their profits, regardless of where in the EU they are manufactured. In this setting, formal barriers to trade are not creating border costs.

The researchers focused on the years 1995 and 1996 because national price subsidies for electricity generation had been in place for several years and the industry was stable. Subsequent years saw a wave of mergers and acquisitions, including a cross-border acquisition that would have complicated analysis of the border effect. Utility companies later became significant buyers of turbines, making purchases from the same manufacturer for different sites, further blurring the picture.

Pushed by high fuel prices, and because EU countries formally committed to protecting the

environment under the Maastricht Treaty, EU countries have moved away from fuel oil, coal, and

nuclear power while increasing wind, gas, solar, and other renewable power over the past two decades. A total of 117 GW of wind energy capacity is now installed in the EU, up from 2.5 GW in 1995, according to the European Wind

Energy Association.

Typically, EU wind-farm owners secure permits for their operation, and manufacturers bid to provide turbines, quoting a price that includes transporting three 100- to 150-foot blades and the 50- to 75-ton box that contains the generator and gearbox, on a massive platform trailer. The turbine is then assembled on site. The farther away from a wind farm a turbine is manufactured, the more it costs to transport, so the researchers expected German wind-farm owners located close to the border would buy turbines from nearby Danish companies rather than from more distant German companies, and vice versa.

In fact, manufacturers tended to sell their turbines domestically, even if there were closer wind farms just over a border, the researchers find. The top five German manufacturers produced 60% of the turbines purchased in Germany but only 2% of those purchased in Denmark. Similarly, Danish manufacturers captured 93% of the Danish market but only 32% of the German market.

This suggests that there are costs at the Danish-German border that make it more expensive for manufacturers to sell turbines and consumers to buy turbines across the border rather than within national boundaries. Among them, manufacturers face one-time entry costs, Cosar observes. These range from developing and installing technology to connect turbines to the foreign electricity grid to obtaining certification for turbines in the foreign country to hiring and managing a country-specific sales team. Manufacturers also have to pay to acquire local permits and to do business with unfamiliar officials. Once established across the border, a company faces yet more costs—associated with writing and enforcing international contracts, visiting foreign locations for maintenance, and dealing with a different currency, language, and culture. Consumers may anticipate having to spend more to settle a dispute with a foreign supplier because

it involves slightly different legal systems, Cosar says.

Cosar and his colleagues estimate that the postentry costs of selling turbines across the national border are 85% higher than the costs of selling across an internal provincial or state border for the German firms. “The level of integration between Denmark and Germany is supposed to be deeper than between Canada and the United States, but even there [in this integrated market], we found that the border creates huge friction,” Cosar says.

What would happen if Germany and Denmark were to remove all residual barriers to trade, including language, cultural, and administrative differences, so that the impact of the national border would be reduced to that of a state border? The researchers performed this thought experiment to show what removing barriers might accomplish, estimating that if all frictions could be removed, German firms’ share of the Danish market would increase from 3% to 19% and Danish firms’ share of the German market would grow from 32% to 42%. At the same time, Danish firms’ share of their home market would shrink 16% while German companies’ share of the German market would drop 8%.

However, because there are more wind farms in Germany than in Denmark, Danish firms would make higher profits in the larger German market that would outweigh their losses at home. That means eliminating national border costs would be, overall, good for Danish firms. All German companies would suffer losses, however, as the increased competition would outweigh the gains German firms would make as a result of better access to the Danish market. But wind-farm owners in both countries would benefit, as consumer surplus would rise by 9% in both places.

The work provides food for thought for pro-trade policymakers in countries that have already inked trade agreements, as it suggests they may want to

investigate how internal policies might be hindering international trade. Danish policymakers, for example, might want to revisit Denmark’s decision not to adopt the euro. Companies from eurozone countries doing business in Denmark pay costs when they convert their currency to Danish kroner.

“When there are no tariffs and an open border, what remains are residual, nontariff barriers, such as technical and regulatory differences,” Cosar says. “As our wind-turbine paper shows, it seems to have a big impact.”

Viewing trade as a domestic issue

Cosar is keen to increase awareness that barriers to international trade are internal as well as external.

Domestic policymakers aren’t typically focused on how internal regulations or state- or provincial-level investments impact foreign trade, he notes. “When people legislate things like what tests a car should pass in order to be sold in the US market, they do not have in mind, ‘Let’s shut out Japanese car producers or German car producers.’ But the results may create an entry barrier to foreign producers,” he says, adding that a new trade agreement being negotiated between the US and EU, the Transatlantic Trade and Investment Partnership, does aim to reduce such barriers. And poor roads that add the equivalent of a few hundred dollars to the cost of driving a container of goods from a factory to a port may motivate an exporter to set up shop in another country.

Cosar has started new research on the market-share differences of big car producers in different countries. “There’s a huge home bias—given similar price and quality of the car, people seem to buy domestic,” he says. He’s investigating whether policy- or border-related costs are behind this phenomenon.

Domestic policy decisions designed to increase international trade can greatly impact life inside

a country, creating new sets of winners and losers. Improving infrastructure may lead to interior regions gaining factories that would have otherwise invested in coastal regions, for example. “In the short run there are definitely losers,” when barriers at national borders are removed, Cosar says, referring to companies that chug along in a limited market but do not have the ability to compete in a larger one.

But he believes consumers and producers benefit from more openness in the long run—and from greater efforts on the part of individual nations to promote global trade.

“More competitiveness induces more innovation,” he says. “If you can sell your goods in a larger market, you are more likely to be willing to incur costly innovations.”

Works cited

A. Kerem Cosar and Banu Demir, “Roads and Exports: Evidence from Turkey,” Working paper, January 2014.

A. Kerem Cosar and Pablo D. Fajgelbaum, “Internal Geography, International Trade, and Regional Specialization,” Working paper, November 2013.

A. Kerem Cosar, Paul L.E. Grieco, and Felix Tintelnot, “Borders, Geography, and Oligopoly: Evidence from the Wind Turbine Industry,” Review of Economics and Statistics, forthcoming.

The article above is republished courtesy of www.ChicagoBooth.edu/capideas

All Too HumanFraud, Envy, and Opportunism Can Shape an Organization and its Fate

Corporations may or may not be people, but the managers who work for them certainly are, as the following three faculty research articles illuminate. They also describe how organizations change shape – or are forced to change – to accommodate their all-too-human executives.

In the first paper, David Yermack, the Albert Fingerhut Professor of Finance and Business Transformation, and his co-authors studied price-fixing by cartel companies and documented a range of accounting and governance strategies that, they say, cartel firms adopt in systematic patterns, apparently with an eye toward prolonging their conspiracies and evading legal liability.

In the second, Assistant Professor of Management Claudine Gartenberg and her co-author scrutinized how corporate pay scales shift to accommodate for the extent to which employees know about each other’s compensation, and how that peer comparison can affect productivity.

Finally, George Daly Professor of Business Leadership Joseph Porac and his co-authors studied a British Member of Parliament’s fall from grace to determine if elite politicians and executives crash and burn so publicly because they have so many more opportunities to exploit or if their celebrity exposes them to extra targeting by the media that, in essence, forces them from office.

A Handy Guide to Identifying Price-Fixers

Companies that seek to hide their wrongdoing share similar concealment strategies

For investigative reporters, prosecutors, and unhappy shareholders, new research from NYU Stern Professor David Yermack confirms what they have surmised for years: that managers of

companies that seek to conceal wrongdoing have many effective tricks up their sleeves. Most interesting, in the case of the so-called cartel firms that Yermack studied, the firms, which colluded on price fixing, worked from very similar playbooks, and their pattern of behavior may well help to guide investigators tracking future suspected offenders. Of course, defense attorneys and general counsels of misfeasor cartel companies will be equally pleased by this research: now they can devise alternative strategies to avoid detection.

Yermack’s paper, “Smokescreen: How Managers Behave When They Have Something To Hide,” was co-written with Tanja Artiga González and and Markus Schmid, of the Swiss Institute of Banking and Finance at the Universität St. Gallen. The authors studied financial reporting and corporate governance in 218 US companies accused by government authorities of participating in “hard-core” price-fixing cartels between 1986 and 2010. The starting point and duration of the cartels were identified by enforcement actions brought by government authorities, totaling more than 1,500 firm years. The authors point out that their sample represents only a minority of the price-fixing conspiracies that occur worldwide.

The authors document a range of accounting and governance strategies that, they say, cartel firms adopt in systematic patterns, apparently with an eye toward prolonging their conspiracies and evading legal liability. These patterns can be red flags to anyone closely following the company. To mislead readers of financial statements, for instance, companies engage in earnings smoothing and frequently reclassify the industrial segments for which they report line-of-business results. They file abnormally large numbers of financial restatements. In corporate governance, cartel firms favor outside directors who are likely to be inattentive monitors due to their status as foreign or “busy” (belonging to a large number of boards) and their low rates of meeting attendance. When directors resign, they

are often not replaced, and new auditing firms are engaged significantly less often than expected.

In addition, since stability of the management team probably represents a necessary condition for continuing a conspiracy, cartel firms tend to promote CEOs from within, rather than hiring them from outside. They exhibit lower than expected rates of CEO replacement, controlling for performance, and feature abnormally large numbers of other managers who are chosen by the incumbent CEO. Cartel managers exercise their stock options faster than managers of other firms. The authors also found a pronounced pattern of political donations by cartel firms, as their political action committees (PACs) donate more frequently to political candidates and in larger amounts than firms in a matched control sample.

As an example, the authors point out, the pharmaceutical company Bristol-Myers Squibb was charged with participating in cartels in three different countries between 1999 and 2004. During this period, Bristol-Myers engaged in many of the practices the authors describe. The company reclassified its line-of-business segments nearly every year, constantly reorganizing them into different subcategories and at one point eliminating them altogether for a two-year period. Five years of earnings results were restated, including two years that were restated twice. The company was sued twice during this period for securities fraud. It retained the same auditing firm for the entire cartel period despite the outward signs of financial reporting problems. Three new outside directors joined the Bristol-Myers board between 1998 and 2005. Two of the three fell into the “busy” category, with three or more board memberships, and the third was based in a foreign country. Five of the incumbent outside directors from the start of the cartel period also had busy status. Both CEOs who served during this period had been promoted internally. At the end of its cartel period in 2006, soon before it agreed to plead

guilty to federal criminal charges arising from an antitrust investigation, Bristol-Myers appears to have undergone a governance and financial reporting overhaul. The CEO was replaced by an outside board member who had not previously worked for the company. The firm changed auditors, replacing

PricewaterhouseCoopers with Deloitte & Touche, and added a law-and-order independent outsider to its board, the former FBI Director and federal judge Louis Freeh.

Yermack and his co-authors concluded by broadening their thesis to include firms that engage in financial wrongdoing other than price fixing: “While our results are based only upon firms engaged in price fixing, we expect that they should apply generally to all companies in which the managers seek to conceal wrongdoing.” Firms that may wish to employ the strategies Yermack describes, and their audiences, are sure to take note.

DAVID YERMACK is the Albert Fingerhut Professor of Finance and Business Transformation at NYU Stern. TANJA ARTIGA GONZÁLEZ and MARKUS SCHMID are professors at the Swiss Institute of Banking and Finance at the Universität St. Gallen.

I’ll Have What She’s Having

How your perception of your colleagues’ pay affects company pay policies and productivity

Just as children with toys or animals with food, adults in the working world want to make sure they’re getting what the other guy has, and that for the work they do, they’re getting paid equitably in comparison to their peers. Employees’ curiosity about their colleagues’ pay and how that curiosity plays out in regard to their productivity and ultimately their firm’s compensation policy are the subjects of new research by NYU Stern Assistant Professor of Management Claudine Gartenberg and her co-author Julie Wulf, associate professor at Harvard

Business School.

The authors focused their study on the pay of division managers (heads of business units) at 300 large, well-established, publicly traded firms across a spectrum of industrial sectors between the years 1986 and 1999. This period provides a look at pay policies before and after what the authors consider a sea change event, the 1992 Securities & Exchange Commission proxy disclosure rule that mandated increased disclosure of executive pay. “The dataset is rather unique because it allows us to identify changes in pay within division manager positions over a 14-year period that is characterized by significant change in pay practices,” Gartenberg observed.

The authors looked at the trends in salary, bonus, and total compensation to determine the sensitivity of pay scales in firms that were both geographically dispersed and those that were concentrated. This distinction underscored the fact that managers located far apart had less access to what their distant counterparts earned than managers in the same venue, who shared pay information more frequently.

The study revealed that the impact of the SEC ruling on disclosure included an equalizing effect on the pay of managers who were geographically distant from each other, whereas in firms whose managers worked in the same area, the pay levels remained relatively stable. According to the authors, “These patterns are broadly consistent with our claim that dispersed firms were differentially affected by the rule change and are consistent with more peer comparison leading to less pay disparity.” In other words, while managers who worked more or less together usually knew what each was paid, shortly after previously isolated managers were able to find out what their geographically distant peers were earning, the various groups’ pay was equalized across the board.

As for productivity, the authors also explored the

interplay between that and greater pay transparency after 1992. They found that in firms with dispersed managers after the SEC mandate, individual pay was less a function of performance and at the same time the division’s productivity suffered, driven by managers who were unhappy once they discovered they were at the low end of the wage scale.

The implication of these findings for top executives and compensation specialists is that designing compensation to be equitable across a particular level of management – so-called pay harmony – has advantages and disadvantages. On one hand, performance-based pay is well known to motivate employees, so if it is removed in order to achieve pay harmony, productivity tends to suffer; on the other hand, variations in pay among peers can create friction and also lower productivity. As Gartenberg said, “Altogether, our findings suggest that horizontal wage comparisons within firms and concerns for ‘pay harmony’ affect firms’ policies on setting pay for executives, and that firms face a tradeoff between the incentive effects of performance pay and the effects of peer comparison that arise from unequal pay.”

CLAUDINE GARTENBERG is assistant professor of management at NYU Stern. JULIE WULF is associate professor of business administration at Harvard Business School.

How the Mighty Have Fallen

Temptation is plentiful for elites, and succumbing to it is extra-hazardous

Perhaps it’s their sense of invulnerability, or perhaps the opportunities are just too tempting, but even the minor peccadilloes of people in high positions seem to make for juicy scandals. 2013 New York mayoral hopeful Anthony Weiner’s sexting was silly, but it wasn’t a high crime – and yet it spelled the all but certain demise of his political aspirations.

Joseph F. Porac, the George Daly Professor of

Business Leadership at NYU Stern, and four co-authors – Scott Graffin, Jonathan Bundy, James Wade, and Dennis Quinn – recently explored this phenomenon in their recent paper, “Falls from Grace and the Hazards of High Status: the 2009 British MP Expense Scandal and its Impact on Parliamentary Elites.”

The authors were interested in how high-status individuals exploit their advantage for their own self-interest in a way that ultimately undermines them; in a related investigation, they explored how such high-status individuals might be more scrutinized than non-elites for the same behavior and held to higher standards of conduct. Both these phenomena – elite opportunism and elite targeting by, say, the media – are typical explanations for such falls from grace. Porac and his colleagues picked the members of Parliament (MP) scandal because it contained the requisite criteria: elite individuals; a situation where these individuals exploited their high status in violation of the organization’s rules; and ample media coverage, which played a significant role in shaping public opinion.

Their investigation into the general issue of the situational hazard associated with elites included an examination of career histories of the CEOs who won “CEO of the Year” awards from major business periodicals between 1999 and 2004. They compared this group’s rate of falls from grace (e.g., involuntary termination, leading the company to bankruptcy, being indicted) with that of a random sample of CEOs who didn’t win any awards. They found that 8 percent of those with no awards fell from grace, whereas 28 percent of those with five or more awards took a dive.

The 2009 parliamentary expense scandal involved improper use of a second-home allowance by members of Parliament who maintained a home in their districts but also had to be in London during session. One aptly named MP in particular, Lord Douglas Hogg, expensed a £2,115 bill for his “moat” to be cleaned. Although the moat was actually a weed-clogged

drainage ditch, the tabloids went to town on the phrase, pillorying Hogg. “By labeling it a moat, Hogg unwittingly triggered a media frenzy over the expense,” Porac said. The newspapers’ account caused a public uproar, embarrassed the Conservative Party leadership, and ultimately led to Hogg’s resignation.

Contrary to the authors’ expectation, opportunism like Hogg’s was no more rampant at the more elite end of the MP hierarchy than generally. Inappropriate expense behavior was so common throughout the ranks that the authors surmised that such abuses were “systemic” and probably due to a universal sense of entitlement.

However, Porac and his co-authors confirmed their hypothesis that the media focused an especially harsh light on the peccadilloes of the more elite MPs – “the party leaders, ‘Old Tories,’ and other greedy grandees [who] were taking advantage of public funds.” According to Porac, “Our results suggest that audiences consider the same transgression as more intentional when committed by elites and attribute egregious transgressions to unsavory opportunism even when the transgressions are no different from those of lesser-status counterparts.”

The authors were cautious about tying targeting by the media to the elites’ higher rate of disgrace compared to their less elite counterparts, but suggested that the “farrago of fascination” with elites’ bad behavior is at least an important linchpin in determining their ultimate fate: “Our research raises fundamental questions about the power of the media to influence the careers of elites, not just in publicizing elites’ transgressions but in shaping and channeling public opinions about such transgressions over time.”

JOSEPH F. PORAC is the George Daly Professor of Business Leadership at NYU Stern. SCOTT D. GRAFFIN is an associate management professor at the University of Georgia’s Terry College of Business, where JONATHAN BUNDY is a doctoral student. JAMES B. WADE is the Asa Griggs Candler Chaired Professor of Organization & Management at Emory University’s Goizueta Business School. DENNIS P. QUINN is a professor at Georgetown University’s McDonough School of Business.

The article above is republished courtesy of http://www.stern.nyu.edu/Newsroom/SternBusiness/

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