The March – April 2019 edition of the Harvard Business Review contains a short article entitled “The Innovation Equation” By Safi Bahcall, in which he tries to explain how it isn’t only culture that can change a company’s willingness to innovate, but also how the incentives within the company change as it grows.
Bahcall notes that many companies like GE, Nokia, RIM (Blackberry) went from being known as being extremely innovative and fun to, well, not. He sought to create a model that would explain how companies like these could so quickly shift from nurturing “crazy” projects – the “loonshots” that transform industries – to rejecting important innovations. In his search to explain this phenomena, he began to realize that it seemed to mimic the kinds of phase transitions that are seen in chemistry and materials science, wherein a sudden change occurs in the collective behavior of the many interacting parts of a system. In water this occurs at it’s freezing point.
In the Innovation Equation Bahcall shows that there is a certain size “at which human groups shift from embracing radical ideas to squashing them,” he calls this the number M. This number M, the number of people at which a corporate innovation phase transition occurs,is not fixed, but is a function of two competing forces: stake in outcome, and the perks of rank.
The numerator of this equation, the stake in outcome, encompasses Equity Fraction, E, Fitness Ratio, F, and Management Span, S. The perks of rank are largely modeled by Salary Growth, G. When put all together, as E, F, and S are increased so too does the number of people at which a transition occurs. When G is increased the number of people required for a transition decreases, as shown below.
The author uses the following example to illustrate what is being modelled: “Imagine that you’re a designer at a medical device company, and your job is to develop a better pacemaker. It’s 4 PM, and you need to decide how you’ll spend the final hour of the workday. Should you experiment a little more with your design, or should you use the time to network, currying favor with your boss or other influential managers? In other words, should you focus on project work or politics? Such daily choices, faced by pacemaker designers and midlevel workers of all kinds, are what really determine the level of innovation at a company – not cultural changes instituted from the top.
Bellow is a graphical illustration of equation 1, where it can be seen that Equity Fraction, Fitness Ratio and Management Span all drain into M, thereby increasing it, while Salary Growth takes away from M, thereby reducing it.
Equity Fraction, E
Equity fraction represents the extent to which incentives reflect the outcome of projects as opposed to rank within the organization. Equity fraction directly ties your pay to the quality of your work. Equity comes in two forms however, hard and soft. Hard equity is made up by stock options, grants, commissions, bonuses, etc. Soft equity on the other hand is made up by non-financial benefits, such as peer recognition. Relating back to the pacemaker example, regardless of the type of equity, if E is higher it is more likely that designer will spend the extra hour on project work and not politics.
Fitness Ratio, F
Fitness ratio describes the fractional relationship between project-skill fit (PSF) and return on politics (ROP): F = PSF / ROP.
Project skill fit measures the rewards from investing time in your project, whereas return on politics measures the reward from politicking.
If, for example, there is an excellent fit between one’s skills and their project, they would have a very high PSF and they are more likely to spend more time working on it. Ultimately, if this is the case, there would be no need for schmoozing with others, your skilled work would speak for itself. If, however, you are not well suited to the project that has been assigned to you, you would have a low PSF, and the incremental amount of time spent with your project wouldn’t matter much; it would make more sense for you to invest your last hour of the day in politics as it might be the best, or only, way for you to win a promotion. It should be noted that an overmatch of skills an also result in a low PSF. Imagine a very skilled person who is an expert in their field constantly given junior level tasks. They would likely become bored, not interested in doing their work, and would then become more interested in politicking.
The denominator above, the return on politics, is a difficult to measure parameter that all individuals feel. It’s the extent to which lobbying, networking and self-promotion affect promotion decisions. Bahcall uses the following example to illustrate how the ROP may be limited within a company: “Consider two global manufacturers, company A and company B. Each has a California office with three vice presidents and 30 product designers. In both firms, a spot opens for a fourth VP; one of the 30 designers will be selected. Company A is like most firms: the local office will decide who gets promoted. Through the decision making process – which will take nearly a year – those 30 designers will compete to curry favor with the VPs. The return on politics is high. At company B, however, an independent evaluator who has no ties to anyone in the California office will conduct an assessment and present the findings to an independent group of executives who will make the decision. Since there’s little benefit to lobbying, designers at company B will be likely to focus on their projects and on collaborating well. The return on politics is much lower.“
Management Span, S
Management span, also known as span of control, refers to the average number of direct reports that executives in a company have. If a company has a narrow span, and therefore managers have few direct reports, there are many layers to the company’s organizational structure, and promotions are on everyone’s minds. As a result, researchers are going to be more tempted to worry about titles and status than on actual problem solving. If, however, a company has a relatively large span, each manager has many direct reports, which results in few layers to an organizational structure, promotions won’t be on people’s minds as they rarely occur. This results in people focusing more on their work and less on politicking. Bahcall notes that narrow spans are generally better if you want low error rates and high operational excellence, whereas wider spans and looser controls are better for experimenting and developing new technologies.
Salary Growth, G
Salary growth characterizes the average step-up in base salary, and other perks, that employees receive as they ascend the corporate ladder. For example, if every step up the ladder also came with a 200% increase in salary, you’d try your hardest to make sure that every influential person knew exactly who you were. On the other hand, if each step was accompanied by only a 2% increase in salary, people wouldn’t really care too much.
Low salary step-up rates encourage people to use the last hour of the day on work, not on politicking. One recent academic study even went as far to conclude that “increased [wage] dispersion is associated with lower productivity, less cooperation, and increased turnover.”
What Should You Do?
In order to adjust the control parameters to increase M and enhance innovation Bahcall suggests trying a few different things:
Celebrate results, not rank. To increase the equity fraction and lower the salary growth rate, management must structure rewards to be based more on results than on level in the hierarchy.
Use soft equity. As I talked about in my post about The Five Love Languages, people are motivated by different things, and feel different emotional responses than others to the same experience. Some people may be more motivated by tangible financial rewards. Others may be more driven by peer recognition, or a sense of accomplishment and personal growth. Companies should try their hardest to identify and use all motivational means at their disposal.
Take politics out of the equation. Employees need to see that lobbying for pay and promotions will not help them. “When promotions are considered at McKinsey, for example, a partner from a different office and preferably a different functional practice interviews candidates colleagues and clients and then reports back to a group of partners who make a decision.”
Invest in training.
Perfect employee placement. Designate a person or team to regularly monitor the organization for good skill fit.
Fine tune your management span.
Appoint a chief incentive officer. “Organizations need top-level executives who are well trained in the subtleties of aligning incentives and solely focused on achieving a state-of-the-art compensation system. A good incentives officer can identify wasteful bonuses, reduce the risk of perverse incentives, and tap into the power of nonfinancial rewards. The goal of achieving the most motivated employees for a given compensation budget is as important and strategic to companies as is the goal of achieving the best sales for a given marketing budget (the province of a chief revenue officer) or the best T systems for a given technology budget (a chief information officer’s terrain).”
“Culture still matters, of course, but it’s time to pay a little more attention to structure.”