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Take heed, managers: your “best practices” are killing your company

If you are a manager, you need to understand the ideas of W. Edwards Deming. Deming wrote several books about management, in which he chastised American business schools and American corporate management for perpetuating a failed philosophy and failed management techniques.

Deming proposed a new philosophy of management motivated by quality and grounded in systems theory. The Deming philosophy is too deep, too broad, and too rich to be explained in a mere blog post. Volumes have been written about it, and as I read those volumes I am sharing my thoughts through this venue (with apologies to Mr. Deming if I misrepresent anything, I am still learning.)

Probably the best introduction to Deming and his theories is his Red Bead Experiment. The experiment is detailed in Chapter 7 of his book, The New Economics for Industry, Government, Education. The experiment is extremely educational, and I highly recommend you watch it play out in the video below (you’ll need about an hour).

Deming’s Red Bead Experiment

In case you haven’t the time to watch the video version, here is the one paragraph summary of the Red Bead Experiment.

The experiment simulates a company, the White Bead Corporation, whose job is to ship white beads to its customers. Several employees are recruited from the audience, including line workers and quality control workers. Workers are presented with a box containing 3,200 small white beads, and 800 red beads of the same size. They are given a tool to extract beads from the box 50 at a time, and strict instructions on how to carry out their task of “making” white beads. They use the tool as instructed, then report each batch to quality control for inspection, where the number of defects (red beads) is recorded. The foreman (the instructor) tries several management techniques to improve the performance of his workers: he puts up motivational posters, sets numerical goals, introduces pay incentives, conducts individual performance reviews, and finally lays off the poorest performers. In the end, the company goes out of business because it cannot meet customer demand for defect-free white beads.

Now, observers of this experiment can see that the game is rigged. The workers are destined to fail, and that is precisely the point that Deming is trying to make to the managers.

“Apparent performance is actually attributable mostly to the system that the individual works in, not to the individual himself,” Deming wrote.

Despite the fact that there were observable differences between the output of individual workers, those differences were entirely the result of common cause, that is, the variation is inherent to the system itself. All the efforts spent trying to improve the individual performance of the workers is wasted, because the flaw is not in their performance, but in the system under which they work.

Deming warns, “Instead of setting numerical quotas, management should work on improvement of the process.” As a manager, it is your job to understand the difference between special causes that should be remedied individually, and common causes that can only be eliminated with a change to the system itself. And as a manager, the system is your responsibility, not to be delegated.

Deming describes how numerical quotas and incentive are not only useless, but actually counter-productive. He gives several examples where workers may report misleading figures, or make poor business decisions that game the system so that the numbers work out. A grocery manager accountable for inventory pulls cashiers to audit a delivery while paying customers wait in line. He stops stocking certain items that move slowly and might spoil on the shelf, forcing customers to shop elsewhere for those items. “He knows 55 other ways to help to meet his allowance of 1 percent shrinkage, all of which hurt the business. Can anybody blame him for living within his allowance?”

Listening to Deming, you have to conclude that those annual performance reviews you conduct as a manager are aimed in the wrong direction. Performance of your employees is not a result of the employee’s competence, but of the manager’s competence to build a system in which they can be productive. If your employees are not performing up to standards, you as a manager need to ask yourself what you are doing wrong. What changes must be made to the process of your business to make these employees productive? Ask them, they can probably tell you several, because they actually want to achieve, and they can see what parts of the system are holding them back.

Incentive programs and performance reviews are considered management “best practices” and this is why Deming chastised American managers. These practices simply don’t produce the results managers are looking for. Have you ever had a performance review or bonus program result in an order of magnitude increase in productivity? Never. At best, you’ll squeeze out a few percentage points. At worst, you make your employees feel micro-managed and powerless, removing all desire they may have to improve.

To move the needle on organizational productivity, you need to focus on the process by which your company produces value, and constantly improve that process.

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A Framework for Innovation

How does a large company create an environment that encourages and leverages internal innovation? Here is my checklist of prerequisites for “enterprise” innovation:

Great people. You may think this goes without saying, but it cannot be emphasized enough. You cannot hire drones who put in 8 hours for a paycheck and then head out the door. You need passionate, creative people, people who love their work, people who are impatient with “getting by” and want to be the best at what they do. These are the Innovators. Without them, innovation does not happen.

A clear vision. Innovation happens at the edges. It is not a top-down directed process, it is an organic, bottom-up growth. In order for the innovators at the edge to produce innovations that are relavent to the business, top management must articulate and communicate a clear vision for the direction of the company. If the innovators can see the direction, they will innovate in that direction and get you there faster. If not, they will innovate in random directions, and you won’t get the full benefit of innovation. A clear vision is the difference between innovation and distraction.

Spare capacity. Innovation is experimentation. Innovators need time to experiment, and they won’t have that if 100% of their time is allocated to executing your current plan. This is the hardest thing for top managers to accept, but it is absolutely essential. You need slack time, or there simply will not be any innovation. Allocate one slice of your capacity for executing the plan. Reserve a second slice for unplanned work and process improvements. Allocate a third slice explicitly to innovation. The relative size of the slices will be entirely dependent on your own business and your desired outcome. My personal preference is 50/30/20.

Freedom to make decisions. Innovators by definition have to make decisions, make changes, form partnerships, and allocate resources from the pool of spare capacity. If permission is required to accomplish these things, then innovation will be quashed before it can succeed.

Accessible Business Intelligence. If you are going to give innovators permission to make decisions, you must give them the information and tools they need to fuel decision making. Innovators need transparent access to customer data, product data, sales data, cost data. Without it, they are shooting in the dark, and the chances of success are low. Innovators also need easy access to tools for gathering their own data, for evaluating experiments and measuring success vs. failure.

Freedom to fail. Innovation is experimentation, and experiments, by their nature, do not always have the expected outcome. When Innovators exercise their power to make decisions, some of the decisions will be wrong ones. Innovators need to feel secure that they will not be punished for taking a chance if it doesn’t work out. Remember, these folks are corporate employees, not risk-taking entrepreneurs. They don’t stand to make millions if their innovation succeeds, so they shouldn’t have to give up their health coverage and pension if it doesn’t. Make it clear that failure is a learning opportunity, not a firing offense.

The above are a few requirements for fostering innovation in large companies. Ultimately, innovation only happens where the culture supports it. Managers at all levels build company culture through their hiring and firing practices first, and management styles second. If your managers fear the new and different, your culture will never innovate. Ensuring the above factors at all levels of the organization should help to unchain your hidden innovation potential.

What’s missing from this list? How does your company encourage (or discourage) innovation? Drop me a note in the comments.

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Efficiency: Enemy of Innovation?

The science of management in the industrial age was all about efficiency. It had to be. The whole concept of capitalism is based on efficiency. An entrepreneur acquires capital at a cost, and that capital must be made to produce profit at a rate higher than the cost of capital. If you borrowed money at 10% to start your business, you had to make it earn 11% at least. That meant controlling costs ruthlessly and milking every bit of productivity from every penny’s worth of capital.

But talk to a systems administrator about efficiency. She’ll tell you that, in terms of percentage of server utilization, there are two numbers you never want to approach, numbers that will cause midnight pages and pale-faced panic. The first number, of course, is 0%. Everything is down! The second, more surprising but equally frightening number is: 100%! At 100% utilization, everything breaks, because you have no more capacity for work.

Now a capitalist might look at a well-run data center, and his first instinct is, “Look at all this waste! Half these servers are sitting idle most of the day.” But the clever sysadmin will tell him that spare capacity is what keeps the data center running. If your capacity is 100 requests per second, a 101st request can bring the whole system to a screeching halt. 100% and 0% are equally disastrous. If you want your Internet business to operate, you must have spare capacity.

Now, I’m not arguing that efficiency is somehow evil. If you are in a capital intensive business today, you still need to use that capital efficiently. Of course the capitalist theory goes that capital + labor = profit, but what often gets lost in the quest for efficiency is the fact that people are not labor. That’s a false assumption, and that formula was never correct (which should not surprise anyone given its source). It’s not labor that turns idle capital into profit; it’s creativity and its more productive sister, innovation.

In order to innovate, in order to create, you need some very special ingredients. First, you need people. Smart people, with a desire to solve problems, the ambition to tackle big ones, and the hubris to believe that they can do something better than everyone who has come before them. These people then need time to analyze the problem and devise or improvise solutions, and they need resources (read: money) to test those solutions.

So no, efficiency is not necessarily the enemy of innovation. Saving time and money on existing processes creates spare capacity that can be allocated to innovation. The extra people, time, and money that are not being used to operate the existing business, instead can be applied to solve the next big problem and give birth to new lines of business. But too many business leaders still see people as labor which, if not making capital productive, they label as “waste”. Spare capacity is inefficiency in their eyes. They see the tools of innovation as inefficiency, and so they attempt to eliminate it. With the result that they eventually become irrelevant because the industry has passed them by.

Don’t fall into this trap at your company. In established processes like manufacturing, efficiency creates value. In exploratory processes like innovation, efficiency destroys value. Use efficiency to generate spare capacity from your established processes. Then, use that capacity to tackle big problems. To stay relevant and keep growing, accept that creativity is inefficient, and pay the cost to gain the future rewards.