A Roadmap Back to Business Fundamentals

One of the catch phrases I picked up in my university days, and still use when appropriate, is: ‘There’s nothing more practical than good theory’. During change efforts in any type of organization (i.e. profit, nonprofit, government), whether they are design changes or execution changes, it is always a good idea to keep a number of business fundamentals in mind to get, or keep, your organization on course. If it is true that it is more beneficial to study older literature that is still in print (see here) rather than reading the latest management book that might turn out to be another fad, you can do worse than read an old (2002) favorite of mine: What Management Is, by Joan Magretta, a former top editor at Harvard Business Review.

In a review of this book, Peter Drucker, arguably the most prolific writer on general management, wrote:

First rate as an introduction for the non-manager and especially for the beginner, but equally excellent as a rounded, complete, and comprehensive “refresher course” for the most experienced executive.

What Management Is defines a number of core management principles that, I suggest, should be at the core of what you, as a manager, try to achieve through your daily activities. By providing you with essential quotes from this book, I attempt to get the business fundamentals back into every activity and every change effort you pursue to help improve the performance of your team, department, business unit, or organization.

Throughout what follows I will use bullet points to highlight – what to me seem ­–fundamental insights into eight crucial management ideas. Beginning with why we need management in the first place, we then move onto the ideas themselves.

Why do we need management as a discipline?

  • Wherever our needs exceed our resources, we need management.
  • Management allows us to achieve a vast array of purpose that none of us could achieve acting alone.
  • We think we live in worlds of our own and can contribute as individuals, but this is only possible because some form of organization (through management) makes the specialized work we do productive.
  • Management is turning complexity and specialization into performance. As the world economy becomes increasingly knowledge based and global, work will continue to grow more specialized and complex, not less. So, management will play a larger role in our lives, not a smaller one.

Management Idea 1: Value Creation

  • Management’s mission, first and foremost, is value creation.
  • Value takes many forms and comes from many sources: a product’s usefulness, its quality, the image associated with it, its availability, the service. The more intangible the value appears, the more important it is to recognize that value is defined by customers. Value is not defined by what an organization does but by customers who buy its goods and services. There is really only one test of a job well done – a customer who is willing to pay for it.
  • Efficiency can be defined as doing things right; effectiveness as doing the right things. Effectiveness is what customers value.
  • The value chain is the sequence of activities and information flows that a company and its suppliers must perform to design, produce, market, deliver, and support its products:
    • you begin to see each activity not just as a cost, but as a step that has to add some increment of value to the finished product;
    • it forces you to see the entire economic process as a whole, regardless of who performs each activity. Managing across boundaries, whether these are between the company and its customers, or the company and its suppliers or business partners, can be as important as managing within one’s own company.

Note: for a discussion on shareholder value versus stakeholder value, see Beyond Shareholder vs. Stakeholder Value.

Management Idea 2: Business Model

  • A business model is a set of assumptions about how an organization will perform by creating value for all the players on whom it depends, not just its customers. Business models reflect the systems thinking that is so central to management.
  • A business model is a story of how an enterprise works.
  • A business model is a story about the basic human activities of making and selling. The twist in a new business model is almost always a variation on some aspect of an existing value chain.
  • Much of what ultimately determines a business model’s success is the behavior of people and organizations in markets.
  • For nonprofit or government agencies, the story always hinges on how the organization will change the world, or at least the specific aspect of the world its mission targets. Here, the twist in the plot – the critical insight about value – is what is sometimes called the organization’s theory of change.

Note: as tempting as stories on winning business models are, be aware that’s just what they are: stories. On why you should be very careful with prescriptive writing on business models, read Successful Businesses and the Halo Effect.

Management Idea 3: Strategy

  • Strategic thinking begins with a good business model.
  • Strategy goes further because the business model does not factor in competition.
  • When you cut away all the jargon, this is what strategy is all about: how you are going to be better by being different?
  • Strategy is about choices: which customers and markets to serve, what products and services to offer, and what kind of value to create.
  • Try to be all things to all people, and your organization will fail to find distinctive ways to compete.
  • A company’s profits are what’s left after subtracting costs from revenues. It follows, then, that there are only two ways one company can outperform another. It can get its customers to pay higher prices or it can operate on lower costs. To do either of those two things, it has to be different – or how else could you explain its ability to charge more or use fewer resources? That’s the simple arithmetic of superior performance.
  • One of the most effective roadblocks to pure competition is a unique positioning.
  • The five forces model (Michael Porter, 1979) has become a foundation of the strategy field. Porter identified the underlying forces that determine the attractiveness of any industry: the competition among existing players, the threat of new entrants, the power of suppliers, the power of customers, and the availability of substitute products. It is the interplay of these forces that determines where on the spectrum of competition – from perfect competition to monopoly – an industry is likely to be.

Note: in the last years, your organization’s positioning on non-financial aspects as environmental, social and human rights matters have become increasingly important for your customers and other stakeholders. For a discussion of non-financial aspects in relation to strategy, see What every manager should know about: Non-Financial Disclosure.

Management Idea 4: Organizational Structure

  • Management’s job, turning complexity and specialization into performance, requires it to draw three different kinds of lines. First, the boundary lines, which separate what’s inside and what’s outside. Second, the lines of the organizational chart, which map how the whole is divided into working units and how each part relates to the others. Third are the somewhat invisible, but always important, lines of authority. These determine who gets to decide what, and how the internal game is played.
  • Because strategy is dynamic, organizations must be flexible. Drawing the lines of organization is an ongoing struggle to stay relevant, not a job done once and for all.
  • Why do companies draw and redraw the lines that define how many of the steps in the value chain they perform themselves? Again, it’s a question of matching strategy and structure, of finding the organization best able to deliver a particular configuration of value at a particular moment in time.
  • Backward integration often made sense for two reasons: first, better coordination leads to lower costs; second, ownership guarantees a source of critical raw materials. With ownership, however, you lose the powerful incentive of the marketplace: the nervous edge that keeps suppliers on their toes.
  • Using participation instead of hierarchy, Toyota developed a host of techniques (collectively known as Total Quality Management, or TQM) to improve the quality of the manufacturing process: participation from everyone, cross-functional teams to solve problems, and cooperation and information sharing across company lines.
  • There is no one best way to organize. Scale, scope, and structure are enormously contingent on what you’re trying to do.
  • Designing an organization is frustrating, because most of the important decisions are at best trade-offs you’d rather not have to make. Treat the latest approach as a panacea, and you will surely be disappointed. Understand the trade-offs that have been made well enough to compensate for them, and everyone will perform better, whether it comes to drawing new lines or living within the existing ones.

Note: the need to manage ESG-risks in your supply chain can be another reason for backward integration. For an example, see the article on IKEA in my list of LinkedIn posts.

Management Idea 5: Measures for Your Mission

  • An organization’s purpose or mission determines what results are meaningful and what measures are appropriate.
  • One of the most fundamental managerial challenges of all is translating mission into action and into performance.
  • For most organizations, performance is multifaceted; it comes from striking the right balance. No one measure can capture 100 percent of what an organization needs to do to perform. And, like medicines, all measures have side effects, some of which can be dangerous to an organization’s health. In short, you can’t manage without measures, but neither can you apply them without thinking long and hard about how well they fit what you have to do.
  • As imperfect as any one measure might be, it’s impossible to work systematically on performance without them. Good managers know they can’t live without performance measures, but neither can they live by them without respecting their limitations.
  • Performance is all about realizing the mission. Performance and mission are never in conflict, if performance is properly understood and defined.
  • Whether we’re talking about a business or a nonprofit organization, performance is impossible without a mission.

Note: investors are increasingly calling for better performance on KPIs relating to ESG-factors, see for example my LinkedIn post on Impact Investing. This may call for an entry of some ESG-topics in your organization’s mission statement.

Management Idea 6: Innovation

  • Innovation is a very special kind of problem solving. It’s the search for new ways to create value, and new value to create.
  • An entrepreneur who doesn’t learn how to manage won’t last long. Nor will a manager last long if he doesn’t learn to innovate.
  • Gathering the information you need to create better bets requires active engagement, not just passive listening. It requires you to actively suspend your own intuition, to observe how other people behave, and without imposing your own logic, to ask why. This takes discipline because it goes against the grain in a number of ways. Most people prefer talking to listening. The more successful they’ve been, the more in danger they are of believing that when it comes to their business, they know best. True curiosity about other people – a passionate interest in understanding why people do what they do – is rare. Suspending judgment, observation, and curiosity – these are the necessary complements (and sometimes antidotes) to the prompting of instinct, intuition, and industry lore.
  • The fact that things can turn out in more ways than one is perhaps the defining characteristic of managerial decision making. You are forced to commit resources today toward performance in an uncertain future.
  • People confuse the best case (what they hope will happen) with the base case (what’s most likely to happen). The cash flows you lay out are only as good as your answers to these questions: What could go wrong? What could go right? How likely is it that those things might happen?
  • We forget that, like all models, Net Present Value rests on a number of assumptions. First, that you can translate your expectations about future events into a specific forecast of revenues and costs. Second, that you can capture the impact of both time and risk in the discount rate you use to adjust those cash flows. And third, that once you set out on the path those cash flows represent, you won’t change your mind along the way.
  • Without innovation and risk taking, there would be no economic progress. The discipline of management helps to increase the odds that the risky business of innovation will pay off.

Note: Magretta talks about ‘suspending your own intuition’. Tools to do just that, I described in Three tools to overcome confirmation bias.

Management Idea 7: Focus

  • Paraphrasing Pareto’s Law, performance will depend disproportionally on doing a few things really well. This is why it is critical to match an organization’s resources to those activities that make a difference.
  • Overriding point of Pareto’s Law: In most instances, a few things matter far more than others. An important corollary of the 80-20 principle is that averages and aggregate numbers are useless, if not misleading, because they obscure most of the decisions that are important to performance.
  • Drucker noted repeatedly that the greatest obstacle to innovation is the unwillingness to let go of yesterday’s success, and to free up resources that no longer contribute to results. The solution, says Drucker, is the discipline of “systematic abandonment”, a discipline Jack Welch applied at GE: ‘If you weren’t already in the business, would you enter it today?’ If the answer is no, then ask yourself: ‘What are you going to do about it?’
  • People much prefer to carry on in the hopes that their earlier decisions will be vindicated. The discipline of sunk costs (investments of time or money that can no longer be recovered or put to other use) helps managers avoid this trap, and can deter them from throwing good money after bad.
  • Benchmarking and best practices. These related disciplines are keeping more and more organizations marching to the steady drumbeat of continuous improvement. The idea is to compare the performance of your products or processes with those that are best in class, even if this means going outside your organization or industry.

Management Idea 8: Managing People

  • Most people are deeply – and rightly – resistant to being managed. In fact, the real insight about managing people is that, ultimately, you don’t. The best performers are people who know enough and care enough to manage themselves.
  • Management creates performance through others. Without the willing cooperation of others, management can accomplish very little.
  • Shared beliefs constitute an organizational culture – its set of assumptions about how we do things and who we are.
  • An organization’s values, unlike ethics, are matters of deep belief about which honest people can disagree. The question isn’t whether one company’s values are better than another’s, but which are better-suited to helping the organization achieve its purpose. The real measure is fit.
  • Setting an example is not the main means of influencing others, it is the only means.’ (Albert Einstein)
  • We saw earlier how performance measures make an organization’s mission concrete. Similarly, story, ritual, and symbol are powerful ways of making values tangible.
  • If management had its own golden rule, it would be this: Trust others as you would have them trust you.
  • If management is not trustworthy, employees will neither share their best ideas nor give their all.
  • Increasingly, economics has become a quantitative discipline, one of the “numbers” subjects. But its underlying aim has always been to explain human behavior. Its eighteenth-century pioneers, like Adam Smith, studied ethics and moral philosophy.
  • A manager can help people discover their strengths, and help people get better at what they’re good at, but a manager can’t and shouldn’t change who a person is.
  • Empathy is yet another instance of the outside-in perspective, of seeing the world through other people’s eyes. Working effectively with other people means accepting the limits of your own authority and of your own perspective.
  • As individuals we’re slow to apply the principles of value creation to our own efforts. We persist in defining our performance by how hard we work at something, rather than by the results we achieve.

Now ask yourself: How is my organization doing on these business fundamentals? And how can we improve our performance by looking more closely to what a manager should really do?

 

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