How the Most Successful Leaders Will Thrive in an Exponential World

By

 Lisa Kay Solomon

 -

Jan 11, 2017

We live in challenging times. Geopolitical turmoil, local and national social unrest, cycles of deadly natural disasters, cyber hacks, rising distrust of media and tech companies—many recent disruptive events have taken us by surprise.

Nearly two decades ago, military planners coined an acronym to capture the nature of an increasingly unpredictable and dynamic world. They called it VUCA—an environment of nonstop volatility, uncertainty, complexity and ambiguity.

The world today embodies VUCA more so than any era we’ve recently experienced.

Why do so many of us—individually and collectively—fail to imagine, let alone anticipate, the massive and disruptive changes that are unfolding? Driven by fast moving technologies and globalization, the pace of change is accelerating, our brains are struggling to keep up, and surprise, discomfort, and unrest are the result.

This is no anomaly. VUCA isn’t going away. Change promises to speed up, not slow down. To thrive in a world where “change is the only constant,” leaders need to replace old thinking with a new framework.

Exponential change calls for exponential leaders. But what exactly does that mean?

In this article, we’ll explore the four pillars of exponential leadership. These are the critical skills leaders must learn to successfully navigate a rapidly changing world—not just to create strategic advantage for their organizations, but also to help build the kind of inclusive, equitable, positive and abundant futurewe all want to live in.

Some leaders already excel at some of these skills. An exponential leader strives to master them all, clearly understands how they influence each other, and in practice, models them as an integrated whole much more powerful than its parts.

The Futurist

The first skill of exponential leadership is learning to transform surprise into mindful anticipation. To do this, leaders have to become skilled futurists.

This does not mean simply extrapolating today’s pace of change into the future. It means imagining new possibilities boldly and optimistically—and understanding they are quite likely to arise sooner than expected. Leaders will have to get equally comfortable with what can be known and with exploring what is unknown.

This is not how many leaders currently operate.

Today, leaders typically manage risk with a variety of analytic processes and frameworks that identify and quantify known variables. In most organizations, the future is primarily projected through numerical forecasts and spreadsheets, reinforcing a perspective that the world is an extension of what we know today, and that we can plug in some numeric formula to calculate quantifiable predictions.

The problem, however, is these forecasts rely on understanding current variables and existing trends. We see future events as a new version of past events, presuming the pace of change will move in a straight line. In reality, the line curves upward, and new variables—unforeseen technologies, for example—always enter the equation.

The result? Forecasts fall short. At best, we’re shocked, at worst disrupted.

It’s not that we aren’t capable of imagining new narratives for the future or widening the set of probable futures we consider. It’s mostly that we’ve never been taught how or given permission to do this as part of our “day job.”

As futurists, leaders need to get comfortable asking open-ended questions about unspoken assumptions to see new possibilities. They need to be curious about the future and blend imaginative practices of strategic foresight, futures backcasting, science fiction design and scenario planning into traditional business planning.

The Innovator

In addition to imagining a range of new futures, leaders must also act as innovators, discovering new ideas through creative ideation and rigorous experimentation. These days, great product ideas can come from a single tweet or a surprising customer interaction and be tested with a working prototype in less than 24 hours.

Yet, many businesses still focus primarily on getting existing products to market faster while reducing costs and increasing margins.

The underlying strategic bet is placed on certainty by minimizing variability. And if they are experiencing success, the focus is on defending and expanding what exists rather than exploring new opportunities through ongoing discovery.

What’s often missing is a deep understanding of the customer on the other side of the transaction, much less any ongoing investment in designing and developing new products and services to satisfy emerging customer needs and requirements.

When leaders embrace their role as innovators, they realize they must always be thinking about the customer. They use human-centered processes, such as observation and questioning, to collect insights; they use visual thinking and storytelling skills to share hypotheses and ideas quickly and effectively; and they embrace a growth mindset to test and gather evidence on what they’ve learned.

Rigorous innovators do this continually, iterating over and over to uncover opportunities obscured by the fog of uncertainty.

The Technologist

As technology innovation accelerates, leaders have to understand which technologies will directly impact their industry and which will affect adjacent industries. Increasingly, technology can digitize, manipulate and replace physical products and services, challenging the status quo of many existing companies.

The best way to understand technological change is not to read about it, but to experience it first-hand by learning to code, building or manipulating a simple robot, trying new products and services that go beyond what’s familiar or comfortable, and seeking the resources of innovation and experimentation.

However, understanding technology solely from an engineering or R&D perspective is not enough. Exponential leaders will also have to grapple with the ethical, moral and social implications of the technologies they build their organizations around.

Technology disruption is quickly outpacing existing regulations, laws, and societal norms. There are already on-going tax and labor feuds between industry disruptors such as Airbnb and Uber and the communities they serve.

But those legal battles pale in comparison to the ethical battles we may soon face when workers in large industries such as food or transportation are replaced by autonomous systems. And we’ve hardly begun to explore the implications of a future in which genetic modifications have become significantly more accessible and widespread.

Policy and ethics are not independent of technology, and technology does not operate in a protected silo apart from either. If leaders bet on the massive new revenue potential or cost saving opportunities that technology offers, they must also embrace the societal and moral implications that will inevitably follow.

This will require a whole new set of discussions and decisions in the boardrooms of every corporation, new behaviors and norms in every product development lab, and new ways of educating, rewarding (and even penalizing) tomorrow’s leaders.

The Humanitarian

Exponential leaders use the skills and behaviors of futurist, innovator and technologist to improve the lives of the people they touch, and society as a whole. They aim to do well by doing good—not as a separate set of “corporate social responsibility” activities, but as part of the integrated company mission.

Leading as a humanitarian can mean explicitly building a business using technology to create positive impact. B corporations, for example, are for-profit companies certified to meet rigorous standards of social and environmental performance, accountability, and transparency. It can also mean investing in humane policies and practices that create a positive culture and a meaningful work environment. A workplace that inspires employees and partners to strive toward their full potential.

Increasingly technology can also generate fundamentally new business models and growth opportunities enabling and empowering more new parts of the world to become sustainable and autonomous economic centers of growth.

When Google’s high-altitude balloons connect the most rural and underdeveloped areas to universal high-speed internet, or drones deliver medical supplies after natural disasters, we can start to imagine a world where the ultimate resource technology amplifies is our imagination to believe anything is possible.

Our Future Needs Exponential Leaders

These roles—futurist, innovator, technologist and humanitarian—are interconnected and enhanced when knowledge and insights flow between them. The four pillars are a holistic system of learning to imagine, create, capture and scale hidden value in an increasingly complex and dynamic world.

This is the essence of exponential leadership.

By practicing these new skills, all leaders can improve their capacity to not only anticipate change, but also make proactive choices leading to more positive, productive futures for their organizations, communities and the world.

Image Credit: Shutterstock

Future of Organizations | Global Summit 2017 | Singularity University

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How Business Leaders Turned Into Vampires

By Steve Denning

How did America—a country dedicated to the proposition that all men are created equal—become one of the most unequal countries on the planet? Why do the nation’s leaders now spend so much of their time feeding at the trough and getting ever more for themselves? Why has public-mindedness in our leaders given way in so many instances to limitless greed?

These questions are being raised, not in some anti-capitalist rag from the extreme Left, but in the staid pro-business pages of the Harvard Business Review, in a seminal article by Roger Martin, the former dean of the Rotman School of Business and the academic director of the Martin Prosperity Institute: “The Rise and (Likely) Fall of the Talent Economy.”

One key factor, argues Martin, is a fundamental shift in nature of the economy. Fifty years ago, “72% of the top 50 U.S. companies by market capitalization still owed their positions to the control and exploitation of natural resources.” But in the latter part of the 20^th century, a new kind of organization began to emerge: an organization that prospered not by natural resources but through “the control and exploitation of human talent.”

“By 2013 more than half of the top 50 companies were talent-based, including three of the four biggest: Apple AAPL +0.21%, Microsoft MSFT +0.35%, and Google GOOGL +0.69%. (The other one was ExxonMobil.) Only 10 owed their position on the list to the ownership of resources. Over the past 50 years the U.S. economy has shifted from financing the exploitation of natural resources to making the most of human talent.”

As a result, “the talent” got much richer. “Skilled leaders saw a major boost in income… after it was recognized as the linchpin asset in the modern economy… the vast majority of Forbes billionaires are self-made.”

So, what’s wrong with that? Nothing, you might say: it’s simply part of “the American Dream, in which hard work and the cultivation of talent deserve rewards.”

Not so, says Martin, who asks the tough questions: Is it truly hard work and talent that is leading to these super-sized rewards? And are the rewards deserved? Are the rewards sustainable? His answers are clear: no, no and no. Let’s look at the issues, one by one.

Talent that adds value

Is it truly hard work and the deployment of genuine talent at play here?  The word, “talent” has generally positive connotations, implying that the people involved add real value to society. And certainly the talent economy described by Martin includes categories of such people.

1. Entrepreneurs who take huge risks and generate huge benefits for society and for themselves. Even if most entrepreneurs fail, some succeed: Steve Jobs at Apple, Bill Gates at Microsoft, Larry Page and Sergei Brin at Google and Mark Zuckerberg at Facebook. They contribute in different ways to adding real value to society by giving the world a better products and creating employment. They are part of the Creative Economy.
2. Skilled workers, whose talents and attributes add value for customers. This includes great designers, brilliant software engineers, even sportsmen, movie stars, models and television personalities. In some instances, the attributes are more significant than the skills. For instance, Tom Brady’s wife, Gisele Bundchen, has earned more money in modeling than he has in the NFL at around $300 million, and Kim Kardashian notoriously receives around $30 million a year for doing no more than “being famous for being famous.” They are also part of the Creative Economy.
3. Administrators, who hold positions in bureaucracies, both in the public and the private sector. They oversee systems, processes and practices, following rules and regulations and allocating capital among different categories of action. Administrative CEOs create little in the way of extraordinary new value. They take ongoing enterprises and administer them efficiently. They are solid performers. The jobs require no particular imagination or creativity. Their skills are not unique and they can be easily replaced. They oversee steady and modest improvements. In the public sector and in the private sector, they have been paid moderately—until several decades ago— roughly in proportion to their moderate contributions in terms of value.

Talent that extracts value

Martin’s article focuses mainly on three other categories of ‘talent’ whose pay appears to have lost any connection to their skills or attributes, or to its contribution to society. These are people who, for one reason or another, find themselves in privileged positions and are able to exploit the situation. Some of these roles involve skills, but the skills are deployed in zero-sum games or activities that are socially harmful. They might be called ‘vampire talent’ in the sense that they suck value from their organizations, their customers and from society, rather than creating it. They include:

1. ‘Super-managers’ are people who hold administrative positions in the C-suite of private-sector bureaucracies but are masquerading as entrepreneurs. They are, to use Thomas Piketty’s slyly ironic term, “super-managers.” As such, they have been able to extract extraordinary levels of compensation. They have been lavished with stock and stock options and have been able to “manage” the share price of their firms with massive share buybacks and other financial engineering so that they receive massive bonuses. As Bill Lazonick documented in the September 2014 issue of HBR, the net effect of their activities is to extract value, rather than create value. A prime example is Sam Palmisano’s $225 million payout for his stint at IBM, while systematically extracting value from the firm for himself and the major shareholders over a period of years.

2.  Hedge funds act as gamblers, speculating with other people’s money, for instance in the $700 trillion derivatives market. “Modern market structures enable hedge funds to trade like this by borrowing stock in large amounts, which means they can take short positions as well as long ones. In fact, hedge fund managers don’t care whether companies in their portfolios do well or badly—they just want stock prices to stay volatile. What’s more, they want movement in prices to be large: The more prices move, up or down, the greater the earning potential on their carried interest. They aren’t like their investment management predecessors, long-term investors who wanted companies to succeed.”

3.  Tollkeepers, or what Charlie Munger calls ‘rats in the granary.’ They extract rents or baksheesh, simply by reason of being able to do so. Examples include high speed trading, dark pools and some facets of banking. Martin cites one of the notorious examples: “James Simons, the founder of Renaissance Technologies, ranks fourth on Institutional Investor’s Alpha list of top hedge fund earners for 2013, with $2.2 billion in compensation. He consistently earns at that level by using sophisticated algorithms and servers hardwired to the NYSE servers to take advantage of tiny arbitrage opportunities faster than anybody else. For Renaissance, five minutes is a long holding period for a share.” Simons is hardly an isolated example. Others include:

• Goldman Sach’s efforts to corner the aluminium market and JP Morgan’s effort to do something similar in the copper market.
• Price fixing at LIBOR, in which most of the biggest banks were involved.
• Money laundering by some of the biggest banks for illegal drug money and illegally funneling cash to Iran.
• Facilitation of tax evasion by major Swiss banks.

Vampires only part of the time

Keeping the activities of the “vampire talent” in perspective is complicated by the fact that not everything these characters do is bad. CEOs head organizations that provide real goods and services to the economy. The financial sector, in addition to these questionable activities, serves a useful social function in funding the real economy of goods and services and providing citizens and businesses with financial security. The issue is: where do the “value-adding activities” end and the “value-extracting activities” begin?

“Most of the writing on these subjects,” writes John Lanchester in The New Yorker, “was done either by business journalists who thought that everything about the world of business was great or by furious opponents from the left who thought that everything about it was so terrible that all that was needed was rageful denunciation. Both sides missed the complexities, and therefore the interest, of the story.”

Although there are plenty of grounds for rage against the over-paid executives and wrong-doing in the financial sector, the challenge is to sort out which are the activities that grow the real economy of goods and services, and which are the activities that are zero-sum games or socially harmful.

Since this is difficult, there is a tendency to dismiss the activities of ‘vampire talent’ asde minimis. “That’s capitalism, right? Every man for himself. It’s no big deal if there’s an occasional bad apple in the barrel. The ‘invisible hand’ of capitalism will make everything come out right for society in the end.”

Not so, says Martin. His article documents how the excessive compensation of ‘vampire talent’ is making everything come out very wrong for the organizations involved, for the economy and for society as a whole.

The problem today is that the super-sized executive compensation, the gambling and the toll-keeping of the financial sector aren’t tiny sideshows. They have grown exponentially and are now macro-economic in scale. They have become almost the main game of the financial sector and the main driver of executive behavior in big business. When money becomes the end, not the means, then the result is what analyst Gautam Mukunda calls “excessive financialization” of the economy, in his article, “The Price of Wall Street Power,” in the June 2014 issue of Harvard Business Review.

No trickle down

One “basic grievance” says Martin, “with today’s billionaires is that relatively little of the value they’ve created seems to trickle down to the rest of us… Real wages for the 62% of the U.S. workforce classified as “production and non-supervisory workers” have declined since the mid-1970s… since the mid-1980s inequality has rapidly increased, with the top 1% of the income distribution taking in as much as 80% of the growth in GDP over the past 30 years (estimates vary).”

“Consequently, labour’s earnings have been suppressed and real wages have stopped growing. This has exacerbated income inequality in America, especially between the very rich and everyone else: The differential between 50^th percentile incomes and 90^th(or 99^th or 99.9^th) percentile incomes has widened dramatically since 1980 and shows no signs of stabilizing, let alone narrowing. Meanwhile, the differential between 10^thpercentile and 50^th percentile incomes has changed very little.”

“The move from building value to trading value is bad for economic growth and performance. The increased stock market volatility is bad for retirement accounts and pension funds… talent is being channeled into unproductive activities and egregious behaviours.”

These imbalances cannot endure for long. “The income gap between creativity-intensive talent and routine-intensive labour is bad for social cohesion. … In a democratic capitalist country, it is not sustainable to leave the members of the largest voting bloc out of the economic equation.”

One risk is that the fear of damaging the talent that really does add value to the Creative Economy will defer needed action in dealing with the ‘vampire talent’ that extracts value. That in turn may lead to steady aggravation of the activities of the ‘vampire talent’ until the eventual remedial action is a massive societal spasm that causes unnecessary social and economic havoc.

Negative economic impact

We might argue over a glass of wine whether Gisele Bundchen really deserves $300 million for prancing up and down the fashion runway, or whether Kim Kardashian’s antics warrant $30 million a year. However these “talents” do no further harm to society. It’s all good, relatively clean fun. Pure entertainment — no collateral damage.

Not so with the ‘vampire talent’ whose activities are distinctly unentertaining and causing massive collateral damage for organizations, the economy and society.

The C-suite

The growth of super-sized executive compensation is inversely related to performance. The super-managers are in effect being rewarded for doing the wrong thing. “Across the economy,” writes Martin, “ the return on invested capital, which had been stable for the prior 10 years at about 5%, peaked in 1979 and has been on a steady decline ever since. It is currently below 2% and still dropping as the minders of that capital, whether corporate executives or investment managers, extract ever more for their services.”

Yet even as the members of the C-suite are delivering less and less return on invested capital, it has yet to register in their paychecks. In the period 1978 to 2013, CEO compensation increased by an astonishing 937%, while the typical worker’s compensation have declined. These executives are administrators masquerading as entrepreneurs. As Bill Lazonick has documented in his recent HBR article, these executives are “takers,” while posing as “makers”: they are extracting value, not creating it.

Thus between 2003 and 2012, publicly-listed firms in the S&P 500 used a colossal amount of their earnings—54% or $2.4 trillion—to buy back their own stock. These firms are engaged, Bill Lazonick’s article showed, in “what is effectively stock-price manipulation.” The consequences of these share buybacks are an economic and social disaster: net disinvestment, loss of shareholder value, crippled capacity to innovate, destruction of jobs, exploitation of workers, windfall gains for activist insiders, rapidly increasing inequality and sustained economic stagnation.

Hedge funds

The situation is even worse with hedge funds. “Over the past 13 years,” writes Martin, “the number of hedge fund managers, by far the fastest-growing category, has skyrocketed from four to 31 on the list [of the 400 richest people], second only to computer hardware and software entrepreneurs (with 39) in possessing the greatest fortunes in America. If the LBO fund managers on the list are included, it becomes clear that far and away the best method of getting rich in America now is managing other people’s money and charge them 2 and 20. As Steven Kaplan, of the University of Chicago, and Joshua Rauh, of Stanford, have pointed out in a recent paper, the top 25 hedge fund managers in 2010 raked in four times the earnings of all the CEOs of the Fortune 500 combined.”

Hedge funds operate as a kind of speculator’s paradise: no-risk gambling. The standard fee is “2 and 20”; that is, each year the managers charge two per cent of the money invested in the fund, and also twenty per cent of any profit above an agreed-upon benchmark. So if you can put together a fund of $100 million, you make at least $2 million a year even if you generate no profits, or even lose a lot of your capital. Nice work if you can get it. It doesn’t really matter if you fail.

Indeed, “most hedge funds fail,” writes John Lanchester in The New Yorker. “Their average life span is about five years. Out of an estimated 7,200 hedge funds in existence at the end of 2010, 775 failed or closed in 2011, as did 873 in 2012, and 904 in 2013. This implies that, within three years, around a third of all funds disappeared. The over-all number did not decrease, however, because hope springs eternal, and new funds are constantly being launched.”

Once upon a time, hedge funds earned their outsize compensation by truly hedging investments. This risk-mitigation strategy reduced the gains when markets were up but avoided some of the losses when markets were down.

Today, most hedge funds are aggressive, highly-leveraged, speculative vehicles that are desperately chasing returns to outperform their benchmarks. They make huge returns for the managers regardless of the fund’s performance and generally end up transferring wealth from investors to hedge fund managers.

Objectively, hedge fund performance is poor. Hedge funds have failed to keep up with regular markets. According to HFRX Global Hedge Fund Index:

• Hedge funds returned a mere 3.5% in 2012, while the S&P 500-stock index gained 16%.
• Over the past five years, the hedge fund index lost 13.6%, while the indices added 8.6%.
• In 2013, most hedge funds fell even further behind, gaining 5.4% vs. the market’s rally of 15.4%.

That’s even before we get to the question of fees. The industry standard fee of “2 and 20” is outrageous compared to average mutual fund fees of 1.44% and under 0.25% for an index ETF. To add insult to injury, hedge fund managers get a special tax break that enables them to claim that their “2 and 20″ fees are capital gains.

The fee arrangements are a wealth-transference mechanism, systematically moving money from investors to hedge-fund managers. Some of the statistics cited in Simon Lack’s The Hedge Fund Mirage (2012) are astounding:

• From 1998 to 2010, hedge fund managers earned $379 billion in fees. The investors of their funds earned only $70 billion in investing gains.
• Managers kept 84% of investment profits, while investors netted only 16%.
• One-third of hedge funds are funded through feeder funds and/or fund of funds, which tack on yet another layer of fees. This brings the industry fee total to $440 billion. That’s 98% of all the investing gains, leaving the people whose capital is at risk with only 2%, or $9 billion.

Moreover it can be hard to get your money out of a hedge fund. Many hedge funds are “gated” with only small windows when you can withdraw your money.

Given these facts, why would any investor, let alone a supposedly-savvy institutional investor, hand over money over to a hedge fund? As Barry Ritholz explains in the Washington Post, it’s driven by greed and the swagger of the supposedly-superstar manager. The illusion of the guy who might make you fabulously wealthy attracts capital. Investing in hedge funds makes as much sense as trying to become a billionaire by gambling big money in Las Vegas.

A typical example is John Paulson, who got publicity when he became a billionaire in 2005-06 and so money flowed in. As a result of a couple of lucky bets, he was hailed as a financial genius and was soon managing some $36 billion. But lo and behold, shortly afterwards, he suffered massive losses: 52% in one fund and 35% in another.

Only a small percentage of funds have significantly outperformed the markets; an even smaller percentage have done so after fees are taken into account. And no one has the slightest clue which if any funds will outperform markets over the next decade. As Ritholtz notes, “Every fund in the world warns that past performance is no guarantee of future results. It is too bad that investors refuse to believe it.”

The rational conclusion is obvious: if you want to become fabulously rich, become a hedge fund manager, not a hedge fund investor.

Aggravating volatility

The problem is not just that the hedge funds and executives are getting rich. They actively cause damage to the whole economy by undermining what the real economy needs—economic stability. Hedge funds and executive behavior generate price volatility.

“The real problem for the economy,” says Martin, “is that hedge fund talent and executive talent both have an incentive to promote volatility, which works against the interests of capital and is damaging to the cause of labor…. stock-based compensation motivates executives to focus on managing the expectations of market participants, not on enhancing the real performance of the company.”

What to do?

Martin suggests three categories of action:

1. “Talent must show self-restraint… Perceived greed of this magnitude will encourage retributive action. If top financial and executive talent wants to avoid that, they need to scale back their financial demands.”

2. “Investors must prioritize value creation.” Institutional investors in particular must stop three practices that facilitate abuse by talent: (a) They supply large amounts of capital for hedge funds. (b) They lend stock to hedge funds and (c) They support stock-based compensation.”

3. “Government should intervene,” including (a) Regulating the relationship between hedge funds and pension funds. (b) Taxing carried interest as ordinary income. (c) Taxing trades. (d) Revising the overall tax structure.

Martin himself is sceptical whether government action is likely. “Unfortunately, political gridlock in the United States makes it unlikely that government can implement such reforms.”

Similarly, it isn’t easy to imagine self-restraint being practiced by characters like hedge fund manager Steven A. Cohen, the principal formerly of SAC Capital Advisors (which pled guilty to insider trading and paid a $1.8 billion fine). It’s like imagining hungry wolves lying down with lambs and not satisfying their appetite. It’s not in the nature of a hedge fund manager to exercise restraint.

A wider set of issues for society

It’s possible that institutional investors will awaken from their delusions about hedge fund performance and refocus their investments on creating long-term real value. But this is only likely to happen if it is part of a much wider societal transformation.

The current situation is one of fundamental institutional failure across the whole of society. The behavioural breakdown is mutually reinforcing. Hedge funds are gambling risk-free with other people’s money. ‘Rats in the granary’ are raking in baksheesh in massive amounts. CEOs are extracting value from their firms, rather than creating it. CFOs are systematically enforcing earnings-per-share thinking in decisions throughout their organizations. Business schools are teaching these people how to do it. Institutional shareholders are complicit in what the CEOs and CFOs are doing. Regulators pursue individuals but remain indifferent to systemic failure. Rating agencies reward malfeasance. Analysts applaud short-term gains and ignore obvious long-term rot. Politicians stand by and watch. In a great betrayal, the very leaders who should be fixing the system are complicit in its continuance. Unless our society as a whole reverses course, it is heading for a cataclysm.

Thus change in behaviour is needed in a whole set of institutions and actors: CEOs, CFOs, investors, legislators, regulators, rating agencies, politicians, analysts, thought leaders and business schools—all need to think and act differently.

The intellectual foundation of all this behaviour is the notion that the purpose of a firm is to maximize shareholder value. Unless we do something about this intellectual foundation, the problem will remain. Changes in a few regulations or the tax code won’t make much difference. ‘Vampire talent’ will find ways around them.

Nor will change happen merely by pointing out that shareholder primacy is a very bad idea. Bad ideas don’t die just because they are bad. They hang around until a consensus forms around another idea that is better.

A different way of managing

Fortunately, a consensus is emerging around a better idea. The idea isn’t new. It’s Peter Drucker’s foundational insight of 1973: the only valid purpose of a firm is to create a customer. It’s through providing value to customers that firms justify their existence. Profits and share price increases are the result, not the goal of a firm’s activities

In the last few years, more than a score of books have been written about this better idea, including notably Roger Martin’s own book, Fixing The Game. The language, terminology and emphases differ somewhat from book to book, but there is a great deal of common ground on the overall direction of change.

Moreover in a recent report from the Aspen Institute, which convened a cross-section of business thought leaders, including both executives and academics, the most important finding is that a majority of the thought leaders who participated in the study, particularly corporate executives, agreed that “the primary purpose of the corporation is to serve customers’ interests.” In effect, the best way to serve shareholders’ interests is to deliver value to customers.

CEOs, institutional investors, legislators, regulators, politicians, analysts and particularly business schools must join in the effort to focus organizations on their true purpose. To be sure, there is still plenty of room for substantive debate on the details of implementation but the emerging consensus of the way forward is now becoming clear. What is needed is the courage and wisdom to pursue it.

A vast societal drama

We are thus about to witness a vast societal drama play out. That’s because we have reached that key theatrical moment, which Aristotle famously called “anagnorisis” or “recognition.”  This is the moment in a drama when ignorance shifts to knowledge. Just as King Lear in Shakespeare’s play eventually recognized that his apparently virtuous daughters, Goneril and Regan, were a rather bad lot, and that his apparently disrespectful daughter, Cordelia, truly loved him, so society is learning that much of ‘the talent’ it thought was adding value have in fact been extracting value for themselves.

As usual with anagnorisis and the shock of recognition at a disturbing, previously-hidden truth, there is a disquieting sense that the accepted coordinates of knowledge have somehow gone awry and the universe has come out of whack. This can lead to denial and a delay in action, even though the facts are staring us in the face.

If the recognition of our error comes too late, as in Shakespeare’s Lear, the result will be terrible tragedy. If the recognition comes soon enough, the drama can still have a happy ending. We are about to find out in our case which it is to be.

Why Aren't Business Schools More Business-Like?

Steve Denning

“In every profession,” writes Schumpeter in The Economist, “there are people who fail to practice what they preach: dentists with mouths full of rotten teeth, doctors who smoke 40 a day, accountants who forget to file their tax returns. But it is a rare profession where failure to obey its own rules is practically a condition of entry.”

Business schools constitute such a profession, writes Schumpeter. “Business schools flout their own rules and ignore their own warnings.”

Business schools are well aware of the threat of disruption.  Everyone can see that deep change is looming. Business schools in emerging countries are on the rise. Massive Open Online Courses (MOOCs) can reach much larger numbers of students at much lower cost. Funding from government and industry is forcing greater attention to the practical impact of teaching and research. Results-oriented private schools are emerging to meet obvious pressing business needs.

And business schools themselves teach the very nature of the threat: the failure of businesses to respond to the competitive threat of disruption is a staple of the curriculum. So why don’t business schools themselves do something about the imminent threats of disruption that they themselves face?

Herds of academics

Schumpeter suggests two reasons:

“The first is that business schools have been captured by the academic guild. In 1959 two inquiries sponsored by the Carnegie and Ford Foundations argued that business schools were little better than trade schools and urged them to be more academic. Now they are little more than flags of convenience for academics. The surest way to get a tenured post is to write a PhD (on a subject only loosely related to business) and publish a string of articles in respected journals…. Oceans of papers with little genuine insight are published in obscure periodicals that no manager would ever dream of reading.

“The second problem is a herd mentality. Business schools suffer from a bad case of Harvard and Stanford envy: they dream of having fancy buildings and star professors.

But the cost of all this is going up, as business schools compete for stars, while the demand for an MBA is falling, with sharp declines in the number of people even taking the GMAT, the test for admission.

A failure to respond to disruption

Declining demand is a warning sign. “The obvious solution,” writes Schumpeter, “for schools outside the top tier is to compete on cost or innovation.” He notes a few schools that are doing so: Cornell, Rochester, Ashridge (shorter courses); and Maryland, UCLA (no fee increase).

“But” Schumpeter concludes, “too many continue to stick their heads in the sand” as disruptive competition emerges. Most business schools “are approaching the future in the most unbusinesslike manner.”

“The mood at this year’s meeting of business school deans in Gothenburg, Sweden, was a mixture of gloom and fatalism. They talked about academic inflation, image problems and the threat of MOOCs or massive open online courses. But they showed little confidence in their own ability to grasp opportunities or combat threats.

“The deans have few levers at their disposal to reorganize their schools or cut costs: more than 80 percent of their bills go on academic salaries. They also have few incentives to pull what levers they have: almost all of them are former academics who are appointed for a maximum of five years.”

Isn’t this just like business?

The argument that the business schools are acting differently from business may be too kind to business. In fact, business schools are acting just like business.

As Alan Murray, the executive editor of the Wall Street Journal, has written, firms practicing traditional management “missed game-changing transformations in industry after industry—computers (mainframes to PCs), telephony (landline to mobile), photography (film to digital), stock markets (floor to online)—not because of ‘bad’ management, but because they followed the dictates of ‘good’ management.”

A deeper problem: a flawed concept of management?

When “good management” leads us to consistently bad results, what does this tell us about our concept of “management”? The fact that many large firms still focus on maximizing short-term shareholder value is at the root of the problem, and business schools themselves reinforce this thinking. As Sarah Murray wrote recently in the Financial Times : “While there is growing consensus that focusing on short-term shareholder value is not only bad for society but also leads to poor business results, much MBA teaching remains shaped by the shareholder primacy model.”

Short-term shareholder value thinking is embedded in the core curricula of MBA courses around the world. Managerial economics and accounting tend to assume that short-term profits will lead to long-term shareholder value. Profits are “the overall goal” of the firm.

Constraints to change in business schools

Ironically, business schools also find themselves chained to the treadmill of making money. Business schools often constitute a significant revenue stream for their universities. Students from around the world want “a standard MBA”. Administrators are hesitate to tamper with core curricula lest it jeopardize this revenue stream.

Moreover, business schools succeed in part because graduates get jobs in consulting and finance—sectors still dominated by direct financial goals. These firms are seen to want students schooled in efficiency and shareholder value theory.

Further, the accreditation process of business schools is slow, cumbersome and inflexible. This creates additional pressure to stay with the status quo.

Business school rankings by the Financial Times and others are built on criteria such as acceptance of articles in academic journals, the academic accreditation processes and starting salaries of graduates — thus reinforcing the status quo.

Finally, academics may take comfort in the view that disruption can sometimes be slow. Although there are spectacularly rapid collapses in fast moving sectors like mobile phones, as with RIM or Nokia, Roger Martin, the highly successful former dean of the Rotman School of Management, argues in an HBR blog article that disruption often happens in a more measured pace.

“When entirely new, transformative futures arrive (like the mouse in 1965) their effects take a long time to become evenly distributed — typically a long, long time even in the supposed fast-moving tech sector. Yes, Amazon is utterly transforming the way Americans shop, but 20 years after it was founded, it still has a fractional share of most goods other than books. Even in books, it took a decade for it to really hurt Barnes & Noble and Borders.

“One lesson from this is that real competitive advantage is enormously long-lived. I remember helping Mike Porter with his terrific 1996 HBR article What Is Strategy?  In it, he talked about the competitive advantage of Southwest Airlines, Vanguard Group and Progressive Insurance. Almost 20 years later, after huge changes in their industries, all three are still on top.”

While the leading schools may still have breathing room, the picture for the rest is less optimistic. As Schumpeter comments, “the most dangerous place for a business is to be stuck in the middle without an obvious advantage of cost or quality.”

What to do?

The issues facing business schools are principally issues of institutions, not individuals. Changes in personnel will have little effect without shifts in management processes. Last year, a group of us[i] got together and tried to figure out what business schools should do to get off the money-making treadmill. We concluded that business schools should consider the following five recommendations, which were published as an input for the Drucker Forum 2013:

1. A renewed focus on purpose: Business schools should be equipping graduates to be leaders of the 21^st Century organization that operates in a complex environment where innovation and responsiveness to customers and society are key.
2. Updating the core curriculum: A core curriculum built on shareholder value and efficiency is unsound education for the 21^st Century leader. Merely adding more relevant courses on the periphery will be insufficient. Forward-looking business schools should join together in generating textbooks and courses that reflect an updated view of management.
3. Changes to the ranking system of business schools: The ranking of business schools by the Financial Times and others should include a criterion that reflects practical relevance, vitality and impact. A new approach to measurement and metrics should reflect society’s complex expectations of business schools.
4. Putting “business” back in business schools: Academic recruitment and accreditation processes should be overhauled to reflect today’s complex business world and the need for greater practical relevance.
5. Interdisciplinary approaches in research and teaching: The complex problems now facing firms do not fit traditional disciplinary boundaries. They require radical cross-disciplinary thinking that challenges the old assumptions of each discipline. Some business schools are already experimenting with integrative approaches to teaching.

Scepticism about the likelihood of change

I discussed the issues this morning with Richard Straub, president of the Drucker Society Europe. He shares Schumpeter’s belief both in the need for change and in the unlikelihood of it happening any time soon. He told me:

• Business schools have no pressure to deliver quarterly results. Many of them are private or semi-private and embedded in foundations and are better positioned than publicly owned firms in the private sector to develop and implement mid- and long-term strategies. But sadly in most cases these strategies tend to be more of the same – incremental and not disruptive.
• Business schools suffer from the syndrome of their own success. At the bottom of their heart they don’t see the need to change what they believe is a winning model.
• Quite a number of business schools appointed managers from corporations as deans or presidents and most of those failed in the arcane world of B-Schools.
• Putting Management back into B-Schools (in what they teach in order to become more relevant) would be important—not only putting business back into them. Many business schools lack sound courses for conveying the importance of management and leadership as the foundation for long term success of business. The practice of management does not really show in the curriculum. Hence the specialized disciplines that they impart lack a common foundation.

What do you think?