Considerations for determining executive compensation

We have often discussed problems with financial incentives. It has been shown that stock options lead to excessive risk taking. Corporate Executive board suggest we ask the following question in Exec Comp: The Ultimate Decider:

Will this executive compensation policy provide meaningful incentives for executives to create long-term shareholder wealth without incurring excessive risk?

Their suggestion is to keep the following in mind – it is a pretty good list:

Calibrating Compensation: The ideal exec comp plan is less about motivation than about providing guidance to executives as they navigate ambiguous decisions.

No Silver Bullets: Do not put faith in any one policy, such as mandatory share ownership, for aligning executive and investor incentives. Use a mixture of long-term metrics appropriate for your company.

Reasonable Ceilings: While setting stretch targets for annual variable cash compensation, high performers also impose a reasonable ceiling to discourage unchecked risk taking.

Longer Vesting: The executive labor market is increasingly converging on longer vesting periods of four or more years.

Balanced Equity Vehicles: Executives can over-optimize to any individual metric, including share price. Embrace some extra complexity to encourage a more three-dimensional view of firm performance.

Objective Performance Measures: Reduce the role of board discretion in your compensation; use more objective metrics, even for soft factors like customer satisfaction and employee engagement.

Clearly this is hard to do, but as Prof. Kaplan pointed out, “If you have high power incentives, you’d better have even higher power controls.”

Necessity is the mother of Innovation (Continued)

We have had a theme here at the blog: Innovation does not happen by accident, it requires challenges. If the external environment does not generate the challenges on its own, R&D managers have to create those challenges. Here is some more evidence to support the thesis. Last year, China clamped down on the export of rare earths metals crucial for modern electronics and motors.
The industry has responded with innovation! The first is a rare earth-free motor from Continental Corporation that provides better efficiency than rare earth magnets without the rare earths!

As for the drive unit, Continental has opted for an externally – excited synchronous motor. Compared with a permanent magnet electric motor, this technology offers an better overall level of efficiency across the whole of an electric vehicle’s operating range, and also enhances the safety of the electric drive system. In addition, no expensive rare earth metals are needed for magnets.”

The new motor would have been developed regardless of the shortage of rare earths. However, the shortage is definitely driving innovation elsewhere. A Japanese group is focusing on developing novel materials that provide rare earth performance:

A Japanese research group succeeded in producing powder of iron nitride (Fe16N2) by the gram. The group, which consists of Migaku Takahashi and Tomoyuki Ogawa, professor and associate professor, respectively, at a graduate school of Tohoku University, and researchers at Toda Kogyo Corp, succeeded in generating Fe16N2 powder with a purity of 91% and a reproducibility for the first time in the world.

This technology will have repercussions beyond replacement of rare earths. Another technology being pursued is recycling of rare earths from old components:

Hitachi Ltd developed a technology to recover rare earth materials such as neodymium (Nd) and dysprosium (Dy) from rare-earth magnets used in the motors of hard disk drives (HDDs), the compressors of air conditioners and so forth.
The company developed equipment that separates rare-earth magnets from used products and succeeded in recovering rare earth materials from the magnets by using a new method.

In summary, three new (and hopefully innovative) approaches to address a challenge posted by lack of availability. May be we need to pose more challenges….

Yahoo: Bet Big, or Die

Recently Yahoo appointed a new CEO (Tim Morse). Here are some suggestions to Yahoo from Knowledge@Wharton in The ‘Morse Code’ at Yahoo: Bet Big, or Die: “

Hosanagar suggests that Yahoo should go back to its roots in media products. “It needs to come out with a new compelling product that is not an effort to catch up with Google or Facebook or anyone else, but instead is revolutionary. It should think about how to create that culture of innovation within and find that spark that resulted in Yahoo being formed in the first place.” Efforts to catch up or beat Google at search or email, or to compete with Facebook in social marketing, “will be misguided,” he notes. ” Just like Nokia, the challenge is in developing new products.

Interesting! Just like Nokia, the answer to Yahoo’s trouble is also in getting innovation to market through effective R&D.

Hosanagar notes that Bartz seemed focused on financial and organizational re-engineering. That “was fine to an extent … but she never successfully positioned herself as an innovative CEO who is seeking to bring new products and services to consumers.”

Furthermore, just as in case of Nokia, the resources and R&D teams are in place. Effective R&D management remains the most important challenge.

Morse has sufficient momentum to build on, says Werbach, pointing to Yahoo’s “valuable assets, lots of users and some very talented people.”

The mangers need to come up with a vision and challenge the R& D team to innovate.

Yahoo needs to find a strong future strategy if it wants to remain an independent company, he adds. “The very few large tech companies that have successfully turned around [such as IBM and Apple] had long-term visions that played to their unique strengths.”

However, this is very hard to do. I wish them luck…

Procter & Gamble: Mastering the Art of the Innovation Tournament

Knowledge@Wharton has an interesting article Procter & Gamble: Mastering the Art of the Innovation Tournament. P&G CEO has set up a great challenge for the company (A great way to foster innovation is for the leader to create or emphasize challenges):

Procter & Gamble CEO Bob McDonald is a man with a plan. Last year, he and his company declared a bold vision — one that includes making all products and packaging with recycled or renewable materials, and ensuring that no waste from P&G products touches a landfill. Prominent in the vision, too, is powering all plants with renewable energy. Because all of this will take decades to achieve, P&G also declared a series of shorter-term, 10-year goals to guarantee that the company is making progress. The 2020 renewable energy goal is to power 30% of P&G’s energy needs for 180 plants worldwide with renewable sources.

Interesting: the no waste recyclable product idea became accessing renewable electricity. The challenge could have been used to drive P&G engineers to develop new innovative renewable products… Anyway, the energy problem was solved by an Innovation Tournament. I am not sure if accessing renewable energy can be counted as innovation, but there are some interesting lessons in the article.

First: P&G defined a narrow scope for the brainstorming (innovation tournament). This would help focus the discussion and help generate more useful results.

Second, P&G involved both internal and external experts in the brainstorming. There were more internal participants than external. Hopefully, this would get more internal buy-in to ideas and ease the transition of external ideas into practice.

Instead of a far-flung event like X-Prize, P&G chose a more controlled process, inviting seven external experts to propose and brainstorm solutions with a team of 20 internal experts. Common among corporations that need to protect proprietary information, this format also made sense in P&G’s case “because a lot of it was about process innovation,” says Favaloro. “We wanted to engage people in an ongoing process that involves interaction between internal and external teams. They needed to be steeped in the process itself, instead of the next big widget.”

Third, everyone was asked to do preparatory work before the brainstorming sessions. This not only increased the quality of ideas, but also ensured external experts’ discussion was more relevant to company needs:

Moreover, significant spadework at the outset resulted in a fast-paced, productive final round in late July. To start, P&G’s internal teams delivered in-depth briefs via webinar to bring the external experts up to speed on the plants so they could frame more workable, tailored recommendations. Then the outside experts submitted 150 ideas, which the internal and external teams together winnowed to 45 via online voting. By the time the groups met in person, “it was a supercharged environment,” says Favaloro. “Everyone was up on the problem and had already worked on it independently.” Adds Stefano Zenezini, P&G’s family care product supply vice president: “One hour into the discussion, [and] you’re already discovering new things.”

Fourth, a very broad set of experts were selected that could represent a wide variety of perspectives (e.g a public policy expert and a project finance expert):

From this discussion came one of the biggest differences in perspective between the external and internal teams. External finance expert Gardner suggested that P&G should add utility-sized renewable power projects to its portfolio. “Their overall electricity demand is 800 megawatts worldwide,” says Gardner. “At each plant, if you have less than five megawatts of renewable energy potential, that’s not significant enough to move the needle to 30% renewable energy at each plant. You could get 25% of your goal with one few-hundred megawatt wind project.”

Fifth and final point, there was enough time allocated to follow through and have detailed discussions about new ideas:

The P&G team was intrigued enough to ask for more information, and Gardner spent the first evening of the tournament preparing a presentation on project finance for the next day. From the presentation, it was clear that new approaches could be beneficial, in particular for large projects.

Pretty good addition to the checklist for my next brainstorming session!

Apple Without Steve Jobs

As most regular readers may know, I admire Steve Jobs for his ability to manage R&D and deliver innovative products. Here is a summary of a series of articles that might help us learn a bit more of his methods. Let us start off with INSEAD Knowledge (Apple Without Steve):

Steve Jobs was a master at the five skills of disruptive innovators. He personally excelled at connecting the unconnected, or associational thinking. He was constantly on the hunt for new insights by observing the world through the eyes of an anthropologist. He regularly networked for new ideas with people who were 180 degrees different than himself. And he constantly experimented with different prototypes of every product and service Apple ever produced. At the very core, Jobs was exceptional at asking provocative questions, ones that challenged the status quo, inside Apple and out. Put simply, Jobs thinks different because he acts different — habitually.

It is a great summary of skills we might all want to develop. However, it is easier said than done! The simple (but wrong) path would be to ask “What would Steve Do” and try to imitate. As shown by Disney (when Walt Disney passed away), imitation would inhibit innovation. Knowledge at Wharton points out that it would be a mistake to copy Jobs and suggests the following to the new CEO [Cook]:

A copy of anyone is going to come off looking bad. It will never be as good as the original, and people will spend their time focusing on the differences,” Cappelli notes. “I think [Cook] should be himself.” But when it comes to Apple’s business strategy, Cappelli says it would be unwise to depart in any significant way from the path set under Jobs. “I think a ‘steady as she goes’ approach is a good idea, and also about the only option at this point.

A better approach would be to ask “How would Steve address this situation” and “What should I do.” Jobs answer to this seems to have been Apple University (LA Times):

With Apple University, Jobs was trying to achieve something similar, people familiar with the project say. He identified tenets that he believes unleash innovation and sustain success at Apple — accountability, attention to detail, perfectionism, simplicity, secrecy. And he oversaw the creation of university-caliber courses that demonstrate how those principles translate into business strategies and operating practices.

It is a fine line though. The same article says this as well:

“It became pretty clear that Apple needed a set of educational materials so that Apple employees could learn to think and make decisions as if they were Steve Jobs.”

Another article in Knowledge @ Wharton points out that:

But there is no getting around the fact that, as it moves from a company built around one man’s vision to more of a team approach, Apple will have to start doing things differently. And beyond any leadership challenges, the company is also operating in a highly competitive and quickly evolving sector where a number of companies are grappling to take the lead on smartphones, tablets, digital music and cloud storage initiatives. “At this point, Apple has a firm, loyal customer base,” says Wharton legal studies and business ethics professor Andrea Matwyshyn. “What happens in two to three years may be different story.”

So, the idea is for the Apple executives (or all R&D managers) to be themselves. Instead of trying to imitate or think like Jobs, learn from him and bring their own unique flavor to the company:

But Apple’s success is due to more than Jobs alone, says Wharton operations and information management professor Eric Clemons. “Apple leadership has been brilliant,” he notes. “The team, clearly led by Jobs, but clearly more than Jobs alone, has become the best technology style house in the world. We pay a premium for Apple products because of how they look and how they feel foremost, and then how easy they are to use and to integrate into the rest of our technology and into our lives.”

p.s.: One last bit of useful info about small team organization structure at Apple:

Mueller’s research illustrates the challenges Apple may face as it transitions from moving product decisions primarily through Jobs to a team of executives and managers. In a study that looked at 212 knowledge workers in 25 teams ranging from three to 19 members in size, she found that larger groups at the top often “experience more coordination loss or difficulty and inefficiency.” “It is so hard to get ideas through the pipeline at large companies,” Mueller says. “Creativity is viewed as risky and the corporate culture is designed to squash creative ideas. Will the average person rising through the ranks be rewarded for being creative?

How ‘Undiscussables’ Can Undermine an Organization

The article Don’t Mention It: How ‘Undiscussables’ Can Undermine an Organization in Knowledge@Wharton has some interesting pointers about how and why risks are ignored:

After everything falls apart, the failures to act become obvious: Why didn’t somebody at Penn State do more to pursue allegations that former assistant football coach Jerry Sandusky was sexually abusing young boys? Didn’t anybody at MF Global Holdings notice that something was wrong before $1.2 billion in customer cash disappeared? Why, decade after decade, didn’t anyone at Olympus protest $1.7 billion in accounting irregularities?

So, why does this happen? The article lays out the following scenarios:

Lack of Clarity: Problems are not obvious to everyone, many have self doubts
Fear of Retribution: Difficult to point a finger at the boss or his peers
Group Loyalty: Protecting the team
Group Dynamics: Desire to not stir the water

So what we R&D managers do to ameliorate this? The article suggests the following (very hard to do, and almost impossible to do well):

Companies should also establish metrics, routines, audits and incentives to help identify problems and suggest areas of change, says Wharton management professor Lawrence G. Hrebiniak, who has acted as a consultant to dozens of companies such as General Electric, AT&T, Microsoft and DuPont. When top management diligently works to measure performance, elicit feedback and respond openly to problems when raised, it can usually make progress, Hrebiniak has found. “Control systems are important to implementing strategy and identifying problems,” he says.

The problem, of course, is with the senior leadership that makes topics undiscussable:

When companies have a culture in which managers are “more interested in hiding things than solving problems,” there is little anyone can do to help, Hrebiniak says. “You need top management to react strongly. If they bury the stuff, they’re dead.

Is Morale Irrelevant?

A quick post about Is Morale Irrelevant? in the Sloan Review:

“However, a lackluster economy should not give organizational leaders a “free pass” to ignore morale issues. With all of the changes that occur in any organization over time, employee morale will undoubtedly be affected. ”

Here is the take away:

While turnover associated with low morale may not be as likely during uncertain economic times, productivity and performance issues should command executives’ attention. There is still debate over whether a happy worker is always a productive worker, but researchers and businesspeople alike are likely to agree that low morale will not help boost productivity or improve performance. More generally, senior leaders should realize that low morale can be detrimental to the overall climate and culture of their organizations. Low morale stifles “going-the-extra-mile” behavior, and an “it’s-not-my-job” syndrome can become epidemic when managers are not paying attention to the organizational climate they are creating. Over time, a decline in organizational citizenship behavior can translate into an unhealthy cultural shift that erodes the business’s overall competitiveness.

Gaining a New Understanding of Risk

A short article in the Sloan Review discusses Gaining a New Understanding of Risk: “

In these days of uncertain markets – and an uncertain economy – risk can seem almost omnipresent in business. But how do you manage risk prudently – yet still grow your company? Harvard Business School Professor Robert S. Kaplan That timely question reminds me of an interesting talk I heard this past summer by Harvard Business School professor (and MIT alumnus) Robert S. Kaplan. Kaplan is perhaps best known for his work codeveloping the Balanced Scorecard concept.”

The article points out that risk management is hard:

On the other hand, it’s not easy measuring risk – something Kaplan acknowledged. What makes risk management so hard, he observed, is that you’re trying to quantify things that may have never occurred and may never occur. “You can’t rely totally on measurement,” he said.

The article discusses three types of risks and approaches to address them (listed below). The key take away for me is that some employees will take unauthorized actions to maximize their rewards. Organizations have to work more more diligently to control this behavior. I really like this quote:

“If you have high-powered incentives, you’d better have even higher-powered control systems”

We have often talked about problems with incentive plans (risk taking, performance, fudging results, etc). The common complaint I hear from executives about properly controlled incentive plans is that it is too hard to do. May be we need to remember this quote from Prof. Kaplan…

Getting more from your training programs

The article Getting more from your training programs in McKinsey Quarterly has some interesting data:

Companies around the world spend up to $100 billion a year1 to train employees in the skills they need to improve corporate performance
Only one-quarter of the respondents to a recent McKinsey survey said their training programs measurably improved business performance, and
Most companies don’t even bother to track the returns they get on their investments in training.
Training is generally provided because employees often need new skills to deal with changes in an organization’s strategy or performance.

We have talked about the importance of evaluating and measuring training programs. We have discussed approaches to rigorously explore the value delivered by training programs. The overall message is that change through training is difficult and (as we have discussed in the past) managers need to be vigilant to get value out of training. This article provides a handy checklist:

1. Create a need or a desire in the staff to receive training. This can be done by clearly delineating the problem that the training is trying to solve and involving at least some of the staff in generating the training. Here is a handy description of how people avoid training.

Instead of approaching training as active learners, many employees behave as if they were prisoners (“I’m here because I have to be”), vacationers (“I don’t mind being here—it’s a nice break from doing real work”), or professors (“Everybody else is here to learn; I can just share my wisdom”).

2. Uncover the mindset or culture that is underlying the behavior that requires change. Ensure that the mindset is addressed explicitly – remembering that the training alone cannot change mindset.

For instance, a big-box retailer had been trying to increase its focus on customers for more than two years. It invested millions of dollars in teaching a five-step selling process, monitoring customer feedback, and rolling out e-learning programs to improve its employees’ knowledge of the products it sold. Salespeople passed every certification test they were given yet still didn’t use the new skills on the floor. Customer feedback and store performance remained lackluster.

An examination of the mindset showed that

salespeople clung to age, gender, and racial stereotypes about which customers would make purchases—and tended to ignore the others.

3. Ensure leaders and managers are on board with the new behavior that the training is supposed to implement. This has been the biggest problem in many implementations I have been part of. More on it below.

A closer examination revealed that the new marketing skills hadn’t taken root, because the company hadn’t trained the department’s leaders, who lacked the necessary skills and could not be effective role models. Further, the leaders were not prepared to change the way they ran meetings, made decisions about branding or advertising programs, conducted performance dialogues, or coached others on marketing skills.

4. Managers and executives should reinforce the new skills as frequently as possible. Unless leaders are completely sold on the new way of doing business, training will not be successful.

To show that things would be different this time, the executives insisted that the conversations take place and even shadowed the supervisors on the shop floor to help them. While this was uncomfortable for everyone involved, the supervisors soon gained confidence using the new skills and began to see results. Indeed, within just two months, productivity, reliability, and safety performance had all improved, and the plant was able to produce 25 percent more output than it had in the past.

5. Measure the impact of new training and ensure it is delivering value.

One more quick point:

“selected employees in the adjacent departments must be retrained in complementary skills. In a purchasing program, this might mean teaching product developers and people who find supplies for new products how to interpret total-cost-of-ownership analyses so they can set specifications that fit the new procurement strategy. Changes can go as far as altering the development of new products or launching processes to fit the new procurement system. Such a holistic approach helps to set the right expectations and to align employees collectively with the new behavior.”

Enhancing multinational multicultural team efficiency

We have discussed how team become virtual even if the members are just on different floors of the same building. We have also discussed barriers to the success of large teams. Corporate Executive Board provides two more points to keep in mind:

1. Set up organization structures and processes to work across cultural diversity.

The firm created “local growth teams” consisting of regional experts in sales, marketing, and distribution, and “global product teams” of engineers and product specialists with visibility across all regions to avoid product proliferation or cannibalization.
The local teams are given incentives to maximize local growth and the global teams to maximize global product revenue. The firm then runs frequent sessions where all regional teams meet with each other and the global team to share ideas. This clear structure with its division of labor and supporting rules and processes leads to a harmonious and effective team.

2. Provide teams with effective tools to address diversity and communicate effectively across cultural barriers.

Schlumberger, an oil services firm, provides its R&D teams with a set of guidelines to help overcome project execution problems common to global teams. These include detailed role descriptions for all team members, clear rules on working across time zones, training on common cultural differences and ways of working, and budget for initial in-person meetings between all team members, as well as check-in meetings every two to three months.