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Why You Shouldn't Ignore Organizational Structure
What we can learn from General Electric´s downfall
Gaining an Edge on the Market
The decline of General Electric teaches us that organizational structure and culture is a must study.
General Electric ´s downfall is the most thorough lesson in business history of why you should not ignore the structure and culture of an organization. Very few people saw the company´s demise coming, in a time in which it seemed as dethronable as Apple and Alphabet today. It was one the world´s most valuable company.
Essentially what happened is that the company got so big, complex and rank focused, that accountability and visibility dwindled through time. This led to what were, in hindsight, self-serving decisions taken by management across the enterprise that brought the company to the ground spectacularly.
The company´s key property was that good news travelled fast and bad news not at all, because managers were mostly focused on getting promotions by meeting financial objectives. The culture was such that whoever failed to achieve those objectives, got fired.
Through time, this led to decisions that destroyed value in the pursuit of pleasing Wall Street on quarterly basis. All sorts of accounting tools were used to pump up numbers and eventually, the market discovered that $GE was actually a poor business.
This is of course easier said than done, but whoever was an avid student of company structure and culture at the time, had a good shot of spotting this. Below follow some key learnings on the topic, so you can better prepared for similar scenarios going forward.
Structure Precedes Culture
The structure of a company is defined by a tug of war between rank and stake related rewards. By tweaking this two, you can configure an organization to your preference.
The first lesson is that structure precedes culture, as Safi Bahcall proposes in his excellent “Loonshots” book. In order to have a given culture, you must provide a structure that facilitates it in the first place. You cannot have a flexible and agile culture unless the underlying structure enables such dynamics and so, a deep understanding of organization structure is a primary requisite.
Structure comes down to the battle between the rewards of rank versus stake. If in a given organization you get a big salary increase per promotion, that is a ranking reward. If you get a big equity stake and your work makes it go up in value, that is a stake reward.
Rank is about building a franchise - doing the same thing better and bigger per iteration. Stake is about doing new things.
We thus have the following structural options:
Rank > Stake: as an average employee, you have more of an incentive to climb up the ladder than actually produce innovations.
Stake > Rank: the company is more innovative, as people have a higher incentive to take on risks and produce new things.
The above is not an exact science in the sense that, depending on the stage a company may find itself at it may prefer a particular structural makeup. However, organizations function best when they are both able to innovate and franchise. It follows that the optimal scenario is when rank = stake.
A very qualitative aspect of this is that, generally, artists tend to be on the stake side of things, whilst “soldiers” prefer rank. Both tend to dismiss each other, as you may have seen throughout your life. I have definitely seen this repeatedly, specially when I was running my startup.
Operational and sales people tend to dismiss the creative coders, marketing professionals and viceversa. For this reason, reaching the above dynamic equilibrium, whereby rank = stake, involves getting the two broad personality types to respect each other.
This requires a form of separation, whereby creatives are free in pseudo-isolation to come up with innovations without getting squandered by the more practical minded individuals in the organization. It also requires the two “groups” to be in dynamic equilibrium with each other, so that the information flows back and forth.
Generally, when the structure of an organization does not permit the combination of phase separation and dynamic equilibrium (thanks Safi Bahcall), it is very prone to getting disrupted through time. Someone is going to come up with either a better product or a better strategy and the company will die a slow and painful death.
Else, an equilibrium between rank and stake seems to prolong the longevity of a firm which is great for everyone, but specially for investors that that wish to compound their capital in the long run.
Culture determines a company´s fate.
Somewhere along the structure conversation, we begin to enter the culture territory, whereby the focus is on understanding how people behave around the structure.
At a higher level of abstraction, it follows that flatter organizations that foster accountability and visibility tend to do better through time. My understanding of this is as follows:
An organization´s job is to process information and take appropriate decisions.
The wider the span of an organization, the more information it collects, but also the more dispersed the information collection is.
If operations are centralized, a lot of the information does not therefore get adequately collected and processed, leading to worse decisions than otherwise.
Additionally, if the people are not held accountable to their decisions and in turn, they are not visible to the rest of the organization, then there is no incentive for them to take good decisions.
Good decisions compound through time to produce exponentially positive outcomes and bad decisions gradually bankrupt a company. For this reason, a structure than tends to produce more good decisions than bad decisions tends to lead to organizational success.
Much of the usually positive results of accountability, visibility and autonomy (flat orgs) comes down to soft equity. Hard equity is about receiving stock. Soft equity is more about your reputation.
An environment with the aforementioned three characteristics is ripe for reputations to either flourish or wither in line with the contributions made to the organization and so people tend to act accordingly. In essence, soft equity further aligns the interests of individuals with that of the organization.
Adding to this, one cultural aspect that I consider key is the organization´s relationship with failure. Through time, I have seen not just companies but entire nations that have a taboo relationship with it, such as Spain, my home country.
Since failure is demonized in Spain, the incentive to innovate is lower than otherwise and hence the company is falling back in the GDP per capita rank quickly, whilst citizens are not sure of who to blame. The same happens in companies and I believe that increasingly more so as we move into the 21st century.
In the 1950s, R&D expenditure began to pick up across the world and this changed the nature of companies and of industry in general. Post 1950s, organizations were increasingly research driven and any company that ignored R&D was on its way to perish. With the entry of exponential technologies, this trend has accentuated even further.
The most succesful companies 10-20-30 years from now will totally embrace failure and learning from it as fast as possible.
Beyond this, I think every company is free to build its own particular culture, so long as it is coherent with its values. I have observed that the strongest brands tend to result from companies that align what they do, with how they do it and why they do it (dixit Simon Sinek, “Start With Why”).
This rare form of alignment not only produces very valuable brands, but tends to yield a coherent environment within and around companies which permeates the psyche of each individual. The company just makes sense to employees, managers and customers alike. A great example of this is Apple and perhaps less obviously so, GoPro.
Another key aspect of a company´s culture, that I consider an essential requisite, is a focus on the long term. A company that focuses on short term results and pleasing Wall Street quarterly has all but too many levers at its disposition to trade long term value creation for aesthetic short term financial results.
This disposition tends to get embedded into a company, with management increasingly striving to meet short term financial objectives, as happened in $GE, instead of focusing on long term value creation, which is ultimately how we investors make most money.
As a general note, I am always pleased to see companies like Spotify and Palantir dismissing short term guidance of any kind. It is surprising to me to see the market considering this as a sign of the two companies languishing in some way.
Coming up next, I will be going over Spotify´s structure and culture in depth.
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