Craig Eisele on …..

November 25, 2014

Why Effecting a Paradigm Shift In An Antiquated Management System Is So Problematic

Filed under: Uncategorized — Mr. Craig @ 11:12 am

In 1539, Copernicus overturned more than a thousand years of doctrine that the sun revolves around the earth with his theory that the earth is one of a number of planets revolving around the sun. No amount of tweaking the old theory led to progress. Scientists had to look at the problem in a totally different way to solve the problem.

In 1865, Gregor Mendel presented a paper in Moravia that eventually jettisoned decades of scientific work in genetics. The prevailing theory was that all genetic characteristics were passed from parents to the next generation in an average fashion. Mendel’s work in pea plants showed that genetics works over multiple generations with hybrid, dominant and recessive genes. No amount of tweaking the old theory led to progress. Scientists had to look at the problem in a completely different way to solve the problem.

In 1982, scientists knew that stomach ulcers were caused by stress, spicy foods, and stomach acid. So they ignored Barry Marshall, an Australian physician, when he presented evidence that peptic ulcers are caused by a bacterium living in the stomach. They knew that no bacterium could possibly live in the human stomach, given the presence of acid as strong as that found in a car battery. The breakthrough that won for Marshall the Nobel Prize for Medicine didn’t come by improving the conventional theory of stomach ulcers. He had to look at the problem in a totally different way to solve the problem.

Paradigm shifts are discontinuous

Paradigm shifts are discontinuous. Working ever more diligently within the existing paradigm leads to frustration, not progress. Instead, scientists have to look at the problem in a fundamentally different way to solve the problem.

Now, whether the business schools or managers want it or not, a discontinuous paradigm shift in management is happening. It’s a shift from a firm-centric view of the world in which the firm’s purpose is to make money for its shareholders to a customer-centric view of the world in which the purpose of the firm is to add value for customers.

Among many factors driving the shift is the realization that the new paradigm not only makes more money for the firm than shareholder capitalism: when correctly executed, it makes tons more money, as one can see from the results of firms when they implement the new paradigm, like Apple [AAPL], Amazon [AMZN], Salesforce [CRM], Costco [COST] or Zara [BMAD:ITX]. The fact that it’s also better for those doing the work and for those for whom the work is done will also help accelerate the transition.

The paradigm shift is as fundamental as the shift from a geocentric to a heliocentric view of the heavens, the realization that genes work over multiple generations, or the discovery that stomach ulcers are caused by a bacterium.

The shift in management is a shift from shareholder capitalism in which the firm revolves around the manager to a customer capitalism in which the firm revolves around the customer. No amount of tweaking the shareholder model of capitalism can fix it, because the goal of making money for shareholder entails a set of management practices—hierarchical bureaucracy—that are inherently incompatible with the goal of delighting customers: each tweak entails a new set of problems, that sooner or later lead the firm to regress back to the norm of hierarchical bureaucracy.

The experience of paradigm shifts in science can teach us a good deal about the ongoing paradigm shift in management, about which I wrote recently:Don’t Diss The Paradigm Shift In Management: It’s Happening!

Common sense is commonly wrong

One problem that paradigm shifts in science encounter is that the shifts appear to fly in the face of common sense. Copernicus’s theory of a heliocentric world ran flat smack into this problem. It was “obvious” that the sun and the stars revolve around the earth. Use your eyes! Half the stars are above the horizon and half are below the horizon at any given time. Can’t you see? The idea that the solid ground on which we are standing is whizzing through space at 60,000 miles an hour? Preposterous!

Before Barry Marshall, every scientist knew that no bacterium could live in the human stomach, as the stomach produced acid as strong as that found in a car battery. A bacterium in the stomach causing ulcers? Ridiculous!

To many managers today, the idea that the purpose of a firm is to make money for its shareholders is equally obvious. The shareholders created the firm. They own it. They control it. Why would they be doing all this if it wasn’t to make money for themselves? It’s common sense. Everyone knows that.

Everyone, that is, except anyone who has actually set foot into a marketplace and tried to operate on that basis. The commercial reality is that in a marketplace, people won’t part with their money unless they believe that we are offering something to them. They may do business with us once, but if they find out that we are simply out to make money for ourselves at their expense, they will stop doing business with us as soon as they can.

The only vaIid definition of business purpose

This social reality is expressed in Peter Drucker’s dictum of 1973: “There is only one valid definition of business purpose: to create a customer… It is the customer who determines what a business is. It is the customer alone whose willingness to pay for a good or for a service converts economic resources into wealth…The customer is the foundation of a business and keeps it in existence.”

However, the idea that a firm is in business to make money for its shareholders wasn’t invented by people who had spent time in the marketplace and asked customers to part with their money. It was invented by money men trying to figure out how to get rich from a pre-existing franchise and by academics in back-rooms aiding and abetting their cause. They didn’t notice that if firms devoted themselves to making money, the firm would soon start doing things that got in the way of making money, like making money from bad profits, like seeking quick wins that destroyed the firm’s sustainability, like shying away from innovation as too risky or like encouraging the C-suite to feather its own nests.

“The current paradigm used to work”

Another interesting facet of paradigm shifts in science is that the older paradigm is difficult to displace precisely because it has been shown to work in solving problems in the past. Thus in astronomy, the geocentric system, espoused by the Hellenistic astronomer Claudius Ptolemaeus in the 2nd century AD, was accepted for over a thousand years as the correct cosmological model by European and Islamic astronomers. It offered accurate predictions of celestial events, such as planetary positions. So why replace it?

Copernicus’s heliocentric model did no better than predicting celestial events than the Ptolemaic system. All the Copernicus’s model could offer was the nebulous promise of better, simpler, solutions to other problems, that might be developed at some point in the future.

Fifty years ago, when a few big firms could dictate terms to the marketplace, the idea that the firm could simply focus on making money worked. But as globalization and the Internet steadily shifted the balance of power from the seller to the buyer, firms that simply focused on making money found it steadily more difficult to achieve profitability.

Now what used to be common sense is obsolete. If you want to make money, focus on delivering value to customers. Making money is the result of the firm’s activities, not the goal.

The social cost of replacing paradigms

Copernicus’s theory was a better theory, but the social and political cost of accepting it was horrendous: it risked undermining the entire religious basis of medieval society, along with the authority of the Pope. It wasn’t until several centuries later that the Roman Catholic Church finally capitulated and accepted they theory.

Similarly the shift from a firm-centric view of the world to a customer-centric view of the world has horrendous psychological costs for managers who have perceived themselves as being in control of the workplace and the marketplace. To accept the new paradigm they would have to accept that the customer is the boss. Unthinkable!

Criteria for assessing competing paradigms

Thomas Kuhn suggested criteria to help determine whether a shift in paradigm is warranted. The criteria are:

  1. Accurate – empirically adequate with experimentation and observation
  2. Consistent – internally consistent, but also externally consistent with other theories
  3. Simple – the simplest explanation, principally similar to Occam’s Razor
  4. Broad Scope – a theory’s consequences should extend beyond that which it was initially designed to explain
  5. Fruitful – a theory should disclose new phenomena or new relationships among phenomena

What is fruitful?

Both the geocentric and the heliocentric views of the world were accurate, consistent and simple. Where they differed was in “broad scope” and “fruitfulness”. The geocentric theory offered no explanation why the planets were revolving in these circles and offered no plausible picture of the universe as a whole. The heliocentric theory answered these questions and suggested a whole range of useful hypotheses about the rest of the universe. As a result, it triumphed, despite the social cost to earthly authority.

Similarly the firm-centric view of the world and customer-centric view of the world are both simple and internally consistent. Where they differ most is in terms of accuracy and fruitfulness.

In terms of accuracy, the firm-centric view of the world offers no explanation why the rates of return on assets and on invested capital have been in decline for more than four decades and no suggests no way forward in an economy where there is low demand for the foreseeable future.

In terms of “fruitfulness” of management, the dimensions are whether the shift is (1) good for the firm and its shareholders, (2) good for those doing the work, (3) good for those for whom the work is done and (4) good for other stakeholders in the community and society in which the firm operates.

Much of the writing about reforming management over the last century has focused either on (2) what is good for those doing the work, or (3) what is good for those for whom the work is done  or (4) what is good for the society in which the firm operates.

However the decisive advantage for the customer-focused view of the firm is that it is better for the firm itself i.e. makes more money for the firm and its shareholders. The other elements of fruitfulness are nice. What makes the paradigm shift inexorable is the fact that it makes more money.

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