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November 2012

Hybrid Organizations

I wrote in March about the rise of a new type of business, which combines aspects of for-profit companies and of nonprofits to reflect an increased sense of corporate social responsibility among companies. For today’s post, I thought I’d mention articles I read on the topic not too long ago, all from the Stanford Social Innovation Review.

The first one, “In search of the hybrid ideal” (Summer 2012), describes the results of a Harvard Business School study (done in partnership with Echoing Green), whose purpose was to better understand these new models, in recognition of the “trend among social innovators toward creating hybrid organizations that primarily pursue a social mission but rely significantly on commercial revenue to sustain operations.” Because such a structure is so novel, hybrid companies face distinct challenges due to the lack of a supporting ecosystem and the risk of mission drift.

The article lists four broad types of issues:

  1. Legal structure (New legal structures in the US include the L3C – low-profit limited liability company – the Benefit Corporation and the Flexible Purpose Corporation, but they are not available in all states.)
  2. Financing (hybrids don’t have a clear path to funding and often experience difficulties in raising capital, but an increase in impact investing would certainly help them)
  3. Customers and beneficiaries (both need to be differentiated in the hybrid model, since the beneficiaries usually cannot afford to pay for the full price of the product transacted.)
  4. Organizational culture and talent development (hybrids must foster a specific culture to thrive, and “because hybrid organizations are not widespread, job candidates with extensive experience or training in hybrid working environments typically do not exist”, so the authors recommend to hire young people right out of school and train them.)

In the Fall 2012 issue, “The truth about Ben and Jerry’s” claims that, “contrary to myth, the sale of Ben and Jerry’s to corporate giant Unilever wasn’t legally required.” While proponents of the new legal structures such as the B-Corporation claim that they would have prevented the sale if they had existed back then,

  • the author of the article points out that “the best and arguable support for this view [that corporate directors must always act to maximize shareholder value] is from Dodge v Ford, a 1919 decision from the Michigan Supreme Court… [but] other courts have not followed its view of shareholder primacy.” (Background information on the case can be found here.)
  • he quotes a Cornell Law professor, Lynn Stout, as saying that “shareholder maximization is not a modern legal principle” (you can read her essay on the topic on the SSRN website),
  • the New Jersey Supreme Court has stated, according to the author, that “modern conditions require that corporations acknowledge and discharge social as well as private responsibilities as members of the community within which they operate.”
  • the author also mentions that some state legislatures have enacted statutes that “expressly authorize corporate directors to look beyond shareholder wealth maximization” (they are called “other constituency” statute in Vermont, for instance).

The author’s point is that the much-touted new forms for social entreprises are not actually necessary, although he concedes that they may help reinforce perception that a company will not pursue profit maximization above all.

Finally, “Bettering the Used Book Business” provides a real-life example of a successful hybrid company, Better World Books (BWB), which “has found a way to make a profit and donate more than $11 million for literacy programs and libraries worldwide.” From its inception in 2003 by two University of Notre-Dame graduates, the company was set up as “a for-profit company with a social purpose – to sell books to finance literacy programs.” BWB now employs 350 people and has been profitable for the past 3 years; it has also partnered with 5 literacy programs. It receives 100,000 books at its Indiana warehouse every week (mainly from book drives) and “donates 7 to 10 percent of its sales proceeds to its nonprofit literacy partners.” (If a library donates a book, it receives 15 percent of the book’s net sale.)

I was impressed by the sophistication of its analytics software which, when an ISBN is scanned, makes a decision based on past historical data, of “whether to put the book into its for-sale inventory, donate it, or recycle it.” Because of its B-Corp status, the company is required to “provide documentation every two years on how its operations aid all its stakeholders, not just its shareholders.” Such hybrid models are important to attract talented employees who might be reluctant to step into the nonprofit world but want to feel the work they do serves a good cause. You can find more info on Better World Books here. I know where I'll be sending my books!

Health care and cheesecake (factory)

A recent issue of The New Yorker had an article by Atul Gawande as part of the Annals of Health Care series and, as usual with Gawande’s articles, I found this one just fascinating. As you probably know, Gawande is a surgeon at Brigham and Women’s Hospital in Boston, a professor at Harvard School of Public Health and Harvard Medical School, and the best-selling author of Complications, Better and The Checklist Manifesto.

As both a practicing surgeon and an excellent, lucid writer, he offers a unique perspective on the challenges of health care that is grounded in his own experience with patients as well as his field research. His topic in the New Yorker this time got my attention before I had even finished reading the subtitle in the table of contents: “Should hospitals be more like chain restaurants?”

Indeed, for this article he studied the process at the Cheesecake Factory chain, which distinguishes itself by low cost, efficiency and (according to Gawande) surprisingly high-quality food. He comments: “In medicine, too, we are trying to deliver a range of services to millions of people at a reasonable cost and with a consistent level of quality. Unlike the Cheesecake Factory, we haven’t figured out how.”

The article touches upon recent development in health care, such as the launch of a for-profit chain called the Steward Health Care System, launched by the private-investment firm Cerberus in 2010, and attempts to link financial rewards to clinical performance. While medicine has long preferred single-physician or small private-practice groups to chains, such chains are gaining ground; hence, Gawande’s focus in the article was to study the restaurant chain process process and analyze which parts could be carried over to health care. If that's not cross-disciplinary thinking, I don't know what is.

Gawande writes: “Two things struck me [about the food preparation process]. First, the instructions were precise about the ingredients and the objectives… but not about how to get there.” Also: “In producing complicated food, there might be recipes, but there was also a substantial amount of what’s called “tacit knowledge” – knowledge that has not been reduced to instructions.” The kitchen manager, as he provided line cooks with feedback, “tried to be a coach more than a policeman,” a task made easier by the fact that he, like all the other managers, had risen through the ranks.

I also learned in the article that “the chain-restaurant industry has produced a field of computer analytics known as “guest forecasting””, which is aimed “at throwing away no more than 2.5 per cent of the groceries they bought, without running out”, using complex forecasting models which incorporate historical data but also weather forecasts and "scheduled events like playoff games that keep people at home.”

In a remarkable coincidence, the Cheesecake Factory regional manager has also had a glimpse into the health care system, due to his mother’s early Alzheimer’s disease. I found the description of the mother’s stay in the emergency room after a fall quite heartbreaking because of the enormous lack of coordination between providers supposed to care for her and the apparent indifference or downright callousness of some employees.

The manager told Gawande when asked for suggestions for improvement, that he'd "study what the best people are doing, figure out how to standardize it, and then bring it to everyone to execute.” He actually expected healthcare professionals to be already doing this. To his surprise, Gawande commented that it was, in fact, “not at all the normal way of doing things in medicine.”

The article then focuses on the total knee replacement surgery of Gawande’s mother (he is obviously aware that people remember better and react to real-life stories more than abstract facts or statistics), which was a success thanks to the efforts of a doctor at Brigham and Women’s Hospital named John Wright to standardize joint-replacement surgery. His efforts have had startling effects: “The distance patients can walk two days after surgery has increased from fifty-three to eighty-five feet… The amount of narcotic pain medications they required fell by a third.”

I found the implications of this in the specialization vs standardization debate particularly interesting. Bookstore shelves are full of volumes touting the importance of creativity, self-expression and the like. But the field of health care shows the cost inefficiencies that arise when everybody is left to do things his or her way, even if the people involved are best-in-league superstars. (Each of the nine surgeons used to have his preferred brand of knee implants. Wright “has sought to limit the staff to the three lowest-cost knew implants.” Interestingly, a surgeon whose preferred implant brand hadn’t made the cut was able to convince his rep to drop the price, so that he could continue with the implant type he was most familiar with, but at a lower cost. Of course this must be heresy to many manufacturers.)

The article also offers a fascinating glimpse into the I.C.U. command center where “banks of computer screens carried a live-feed of cardiac-monitor readings, radiology-imaging scans and laboratory results from I.C.U. patients throughout Steward’s hospitals.” This part of Gawande’s article, about the concept of “remote I.C.U.”, makes for a great read and points at some of the challenges ahead (some of the medical staff was less than enthusiastic about those cameras peering into their workspace and those strangers checking out on them, although they on occasion could see the benefits of it.) Using the remote I.C.U., specialists in critical-care medicine can “cover not just one but several community hospitals”, and can also identify “the kind of misses that even excellent nurses and doctors can make under pressure.”

While technology alone won’t solve the problem of soaring health care costs, examples like the ones in Gawande's article show that some health care providers are determined to do their part in providing the best possible care.

HBR on Mitigating Strategic Risk

The June issue of Harvard Business Review had an article on "Managing Risks: A New Framework" by Robert Kaplan (of Balanced Scorecard fame) and Anette Milkes. In it, the authors argue against the belief that "risks can be managed by establishing and following rules, standards and guidelines", as they repeat in a HBR blog post they wrote after JP Morgan's losses in its Chief Investment Office in London - the losses, brought about in the famous "London whale" case, could reach $9bn. ("Not all losses are failures of risk management — unless we expect to take no risk at all... [A] large loss in itself is not evidence of a risk management failure, because a large loss can happen even if risk management is flawless".)

The authors distinguish between three types of risk: preventable risks, strategy risks and external risks. They comment that "while a compliance-based approach is effective for managing preventable risks, it is wholly inadequate for strategy risks or external risks, which require a fundamentally different approach based on open and explicit risk discussions."

The authors advocate the use of independent experts, facilitators and/or embedded experts. They also make the case for the following tools:

  • for strategy risks, interactive discussions about risks using maps of likelihood and impact of identified risks and key risk indicator scorecards, resource allocation to mitigate critical risk events,
  • for external risks, "envisioning" risks through tail-risk assessments and stress testing, scenario planning and war gaming.

They talk about probabilities here and there, but overall I found the disregard for quantitative tools a bit annoying, as if managers didn't need to put in place contingency plans to, say, satisfy customer demand, no matter where the disruption will take place. (Or as if the uncertainty underlying them didn't need to be mitigated using analytical tools.)

Instead, we're treated to color-coded risk event cards and risk report cards, which come across as trying to make uncertainty palatable to managers who aren't trained in decision-making under uncertainty. Maybe in this day and age it is time to say that everybody interested in risk management should exhibit enough familiarity with randomness that you don't have to "prettify" things by color-coding them to shove probabilities down the throat of decision-makers.

The article itself explains: "The benefits from stress-testing... depend critically on the assumptions - which may themselves be biased - about how much the variable in question will change. The tail-risk stress tests of many banks in 2007-2008, for example, assumed a worst-case scenario in which US housing prices leveled off and remained flat for several periods." This should serve as a reminder of the pressures exerted on risk management groups because their cautious, downside-focused approach will always stand in the way of the upside-focused methods favored by the rest of the company. In turn, this will always result in pressure to consider overly optimistic assumptions. This is not the fault of the quantitative models, but of the very human people who implement them (or oversee said very human people).

Indeed, the authors state: "A firm's ability to weather storms depends on how seriously executives take risk management when the sun is shining and no clouds are on the horizon." A more in-depth mention of relevant quantitative techniques and analytics would have helped, besides the mentions of scenario planning and war gaming. It's tempting to conclude from the article that the environment is so uncertain you can't really use anything quantitative, when in fact the risk report card has numerical values for assessed risks and critical risks (with color-coded arrows for the trends). The article should become a reference for managers who have developed an interest in risk management while in "qualitative-driven" careers, but might be found lacking by managers who already possess quantitative skills.

The authors are right to say, though, that the purpose of risk management is to "neutralize their managerial bias of seeing the world as they would like it to be rather than as it actually is or could possibly become."

Further readings:

Herbert Hoover on Engineering

Below is a famous quote of Herbert Hoover about engineers. It is excerpted from an article Hoover wrote for Engineer's Week in 1954, entitled: "Engineering as a Profession."

"The great liability of the engineer compared to men of other professions is that his works are out in the open where all can see them. His acts, step by step, are in hard substance. He cannot bury his mistakes in the grave like the doctors. He cannot argue them into thin air or blame the judge like the lawyers. He cannot, like the architects, cover his failures with trees and vines. He cannot, like the politicians, screen his shortcomings by blaming his opponents and hope the people will forget. The engineer simply cannot deny he did it. If his works do not work, he is damned."

This is exactly why I decided to go into engineering.