Mastering the Science of Organizational Change

Martin Reeves, Kevin Whitaker, Martin Reeves, Kevin Whitaker

• Publisher: De Gruyter
• Year: 2021
• Print ISBN:
  9783110697711
• eBook ISBN:
  9783110697940
• Topic: Commerce
• Subtopic: Commerce Général

As the business context evolves more rapidly, driven by accelerating technological, political, and social change, an increasing strategic priority for business leaders is how to enact large-scale organizational change. Even companies that are current industry leaders are vulnerable to disruption. Company leaders need to watch over their shoulder for—and transform the company in anticipation of—the next disruption.

Mastering the Science of Organizational Change summarizes the work of the BCG Henderson Institute and its fellows and ambassadors over several years to develop a more scientific approach to change. Hundreds of companies are analyzed in the book's discussion on how to beat the odds in large-scale change management using an evidence-based approach—a large-scale analysis of what approaches actually work in which circumstances.

Part 1 of the book reviews the imperatives for self-disruption. The second part elaborates on how to manage the process of change. Finally, Part 3 discusses how organizations can take change to the next level.

Events around the book

Link to a De Gruyter online event in which, Martin Reeves, Chairman of the BCG Henderson Institute, will share lessons on how to develop a more scientific approach to change including how to self disrupt, how to manage the process of change, and how organizations can take change to the next level:
https://youtu.be/TfzFllmL4Cg

Part I: Six Steps to Successful Preemptive Change

Chapter 1 Preemptive Transformation: Fix it Before it Breaks

Martin Reeves

Lars Fæste

Fabien Hassan

Harshal Parikh

Kevin Whitaker

Cure the disease that has not yet happened.

– Chinese saying

In business transformations, there are plausible reasons to believe that time is an essential factor. Companies that change early may get a first-mover advantage, acting ahead of their competitors and potential disruptors. Besides, business organizations are complex systems, which often decline much faster than they grow,¹ an asymmetry that has been called the Seneca effect. This is driven by the fact that complicated systems are composed of many variables with non-linear feedback loops, which can lead to sudden and unpredictable transitions and collapse. Considering that transformations take time, moving preemptively may be the best way to prevent obsolescence and collapse.

Leaders may be reluctant to change their companies when they are in a comfortable position and they may understandably feel little urgency to change when current performance indicators are still healthy. Transformations are costly, monopolize management attention, and may create distraction or instability, leading many to follow the adage: “If it ain’t broke, don’t fix it.”

So, should business leaders engage in transformation preemptively or wait for a degradation of performance to trigger change? To answer this, we leveraged an evidence-based approach to transformation (Chapter 9).²

We analyzed hundreds of transformations involving restructuring costs launched between 2010 and 2014 by large listed US companies³ and we found that preemptive change does indeed generate significantly higher long-term value than reactive change, and it does so faster and more reliably.

The Value of Preemptive Transformation

Because each company’s circumstances are unique, we studied relative financial performance to identify preemption, rather than making qualitative timing judgments. If a company embarks on a transformation when it is outperforming its industry – as measured by TSR (total shareholder return) over the past year – the transformation can be described as preemptive. On the other hand, a transformation is categorized as reactive if it is launched while the firm is underperforming its industry on the basis of TSR.

Our analysis shows that in the three years following the start of a transformation, preemptive transformers have an annualized TSR that is 3 percentage points higher than that of reactive transformers. Outperformance following a preemptive transformation is true not only in the aggregate but across most industries, except in financial services (see Figure 1.1). In the period of our analysis, the financial sector was still recovering from the crisis and the subsequent regulatory changes, which may have caused anomalies.

Figure 1.1: The Difference in Median 3-Year TSR by Industry Between Companies that Restructure Preemptively and Those That Restructure Reactively.

Is this outperformance explained simply by the tendency of high-performing firms to continue outperforming? In fact, for companies that do not transform, there is no observable link between past and future long-term TSR. A small “momentum effect” – where previously outperforming companies continue to outperform – is observable over shorter time frames (up to one year); however, consistent with financial literature, we find that this effect disappears on longer time horizons.⁴

As Giuseppe Tomasi di Lampedusa famously wrote in The Leopard, “If we want things to stay as they are, things will have to change.” Our findings suggest that in order to maintain outperformance, companies should pursue preemptive transformation rather than relying on performance momentum to sustain itself.

Furthermore, the preemption premium is continuous: the higher the relative performance of a company when it initiates change, the higher its long-term relative performance. In other words, the earlier a transformation is initiated, the better (see Figure 1.2).

Figure 1.2: The Earlier a Company Transforms, the Better Its Future Performance.

In spite of this pattern, preemptive transformations are uncommon. In a given year, only 15% of outperforming companies embark on transformation, while 20% of underperforming and 25% of severely underperforming companies (the bottom decile of firm performance) do.

There are exceptions. When Jack Ma founded Alibaba in 1999, internet penetration in China was less than 1%. Growth in that area was expected, but no one could predict its precise course. So, early on, Alibaba took an experimental approach, in which leaders constantly reevaluated their vision and, when necessary, restructured the company accordingly.

By 2011, Alibaba’s online marketplace Taobao had captured more than 80% of the digital Chinese consumer market. Even though Taobao was highly successful, Alibaba decided to split it into three independent businesses⁵ in order to participate in three possible futures for e-commerce: one for consumer-to-consumer transactions (Taobao), one for business-to-consumer transactions (Tmall), and one for product search (Etao). The restructuring resulted in two successful mass-market businesses and one strong niche market.

Alibaba frequently reshuffles its more than 20 business units, so Taobao is just one example of many preemptive restructurings implemented as Alibaba grew from an 18-employee startup into a Fortune Global 500 company in less than 20 years.

Secondary Benefits of Preemption

In addition to having better financial performance, preemptive transformations offer three secondary benefits (see Figure 1.3). First, they take less time: preemptive transformations result in consecutive restructuring costs for an average of only 12 months, compared with 14 months for reactive ones. Second (and perhaps partly because of the shorter duration), they are less costly. The costs of restructuring in preemptive transformations total 1.5% of yearly revenues, on average, compared with 1.8% for reactive transformations.⁶ Considering that these costs are only a proxy for the total transformation costs (which typically involve other expenditures, such as investment in new capabilities, M&A, and repurposing of assets), the real effect may be even larger.

Figure 1.3: Preemptive Transformation Takes Less Time, Costs Less, and Increases Leadership Stability.

By combining the lower average cost with the superior returns, we estimate the return on investment (ROI) of preemptive transformation to be approximately 50% higher than that of reactive transformations.⁷

Finally, preemptive change is associated with increased leadership stability. The share of companies experiencing a CEO change in the two years following the start of the transformation is significantly lower in the case of preemption (16% versus 21%).

Preemption as the Primary Success Factor in Transformation

How can leaders successfully implement preemptive transformation? Previously, we found several factors that can boost the odds of success:⁸

• R&D spending: Spending more on R&D than industry peers leads to a +5.1% increase in TSR versus underspending. However, there is limited value in heavily outspending peers, as this effect levels off rapidly.
• Capital expenditure: Companies with capital expenditure higher than their industry peers perform moderately better. However, the size of this impact is a third that of the R&D effect, probably because capital expenditure tries to improve existing models instead of exploring new growth models.
• Long-term orientation: Companies that are strategically more long-term oriented (based on analysis of their strategic language by a natural language-processing algorithm) outperform their peers by 4.8% TSR. This effect size increases to 7% in turbulent environments.
• Leadership change: Starting the transformation with a new CEO increases TSR by 9.2% versus 4.6% with an incumbent CEO over a five-year period, but with a short-run TSR dip of –3.9% in the first year. Turnover in the broader leadership team also matters; companies with more than 20% turnover in their leadership team have a 4.4% higher TSR over five years.
• Large, formal transformation initiatives: Publicly announced transformation initiatives have a positive effect on TSR, an effect that is exacerbated if restructuring costs are sizeable (>2% of revenue) and if the programs run for multiple years.

Our analysis confirms that these success factors also apply to preemptive transformations. But a more fundamental question is whether and how timing affects that recipe for success. To answer that question, we used gradient boosting, a machine-learning technique based on decision tree models that measures how well each factor discriminates between successful and unsuccessful transformation outcomes.⁹ The results show that transforming preemptively as opposed to reactively is actually the most important success factor of the transformation – in other words, timing is the best predictor of success.

In preemptive transformations, R&D expenditure and capital expenditure are the next-most-decisive factors, reflecting a need to properly understand and invest in the future. In reactive transformations, leadership change is the second-most-important success factor – perhaps because companies that have already allowed performance to decline need to refresh their leadership and culture in order to accelerate change.

Microsoft illustrates how preemptive transformation with heavy investment in the future allows a company to sustain performance. After a few years of stagnating performance in 2009–2012, the software company managed to create strong momentum in 2012–2014 (36% annualized TSR). Rather than resting on its success, Microsoft changed its CEO and restructured again preemptively in 2014, which enabled it to preserve its momentum and continue to strongly outperform. The transformation aimed to orient the company to the new dominance of mobile and cloud,¹⁰ even though these trends had not yet damaged the bottom line....

Table of contents

• Title Page
• Copyright
• Contents
• Part I: Six Steps to Successful Preemptive Change
• Part II: Managing the Change Strategy
• Part III: The Next Level of Managing Change
• Index