23 May 2019

By Jérôme Barthélemy

Executives tend to take the value of best practices as a given. We have an abiding faith in the idea that the most direct route to improved performance is to study what successful companies do and copy them.

Best practices certainly do have their benefits. In Bordeaux, France, for instance, many wineries now follow practices recommended to them by winemaking consultants, such as micro-oxygenation, a technique that involves injecting controlled doses of oxygen into wines during fermentation. Micro-oxygenation softens tannins, which minimizes the need for long-term storage and makes wines easier to drink young. For most vintners, this leads to an improvement in quality. But there is a downside: Micro-oxygenation also makes wines taste more similar, and thereby reduces brand distinction and competitive advantage.

This phenomenon isn’t peculiar to winemaking. After following the outsourcing, franchising, and wine industries closely for the past 15 years, I’ve come to the conclusion that adopting a best practice is a great way to achieve average results. Not only that: Adopting a best practice that is wrong for your company can destroy value.

What’s Really the Best?

Managers often assume that everything a successful company does is a best practice. But many such practices aren’t actually critical to the success of the organizations that embrace them. For instance, a best-selling author once claimed that creative companies such as Pixar Animation Studios all have centralized restrooms. He argued that locating the restrooms in the middle of a company’s offices fosters creativity because it leads to chance encounters among employees from different departments who might not otherwise mix with one another. In reality, the practices that explain a company’s success are rarely that obvious. Nor does correlation prove causation: Many analysts believe that Pixar’s creativity owes more to its nurturing peer culture, which allows employees to get candid feedback on their unfinished work, than to the location of its restrooms.

Consider also a very different example: In corporate finance, the use of stock options is often viewed as a best practice. CEOs tend to be more risk-averse than shareholders would like them to be, so the boards of many organizations now offer top executives a portion of their compensation in the form of stock options. This encourages leaders to take greater risks on behalf of shareholders because they stand to gain from increases in share price. By being bolder, the theory goes, CEOs make more money for the company (and its shareholders). Research confirms that the more CEOs are paid in stock options, the more aggressively they invest in research and development (R&D), capital expenditures, and acquisitions. Bigger bets, in turn, lead to bigger gains — but also bigger losses. Risky practices that lead to extreme performance — either big wins or big losses — cannot really be considered best practices at all. On the contrary, best practices are tried and tested practices that consistently enhance performance.

Therefore, on a risk-adjusted basis, copying practices that are just OK may be a better bet than copying practices that ostensibly promise a huge upside.

For instance, a team of researchers examined the impact that three standard management practices — targets, incentives, and monitoring — have on performance. Using data on thousands of organizations across several countries, they found that implementing these standard management techniques enhances productivity, profitability, and sales growth. It also decreases the likelihood of bankruptcy. Setting targets, rewarding employees based on performance, and monitoring what goes on within your company are not particularly glamorous activities, but they are generally more effective than many best practices that are more highly touted.

To reduce the risk of adopting the wrong best practice, begin by considering how similar your organization is to the businesses that follow the practice. For instance, because McDonald’s Corp. is famous for using a policy of granting geographically nonexclusive licenses to franchisees, many new franchisers have adopted this practice. However, research has shown that granting nonexclusive licenses increases the likelihood that a new franchiser will fail. Prospective franchisees fear that the value of their license will suffer if another unit of the same brand opens nearby, and they look skeptically at licenses that don’t have territorial exclusivity. Their objection is not a major concern for established franchisers such as McDonald’s that have enough resources to open and operate their own outlets, but new franchisers need franchisees in order to grow. Indeed, McDonald’s itself followed an exclusivity policy in its early years when it was still growing.

Most best practices are similarly situational. Should you outsource a process or perform it in-house? My research suggests that outsourcing is a best practice when the activity is surrounded by a lot of uncertainty, but not when it offers the potential for competitive advantage and the supplier is likely to behave opportunistically. For instance, Apple Inc. outsources manufacturing because production does not generate a competitive advantage in computers and consumer electronics. On the other hand, design is crucial to Apple’s success, so the company performs that activity in-house.

Hidden Costs

Finally, it’s important to understand the hidden costs of a best practice. The implementation of a new practice often depresses short-term performance because it disrupts the company’s existing processes. The more the new practice differs from the old one, the greater the implementation cost.

One study of large U.S. companies examined the relationship between financial performance and the adoption of eight IT best practices (use of application service providers, implementation of business process reengineering projects, participation in e-commerce, and use of customer relationship management, data warehouse, enterprise resource planning, groupware, or knowledge management systems) and found that the implementation of IT best practices leads to an initial performance dip. According to the study, performance starts to improve only after the third year of adoption. Clearly, the stakes for implementing a new practice — however “best” it may appear — can be quite high.

Sometimes, in fact, adoption costs are so high that switching to a likely better practice can be worse than staying the course. For instance, research on technology startups in Silicon Valley found that of the five most popular management models, the one that is far and away the best is the so-called commitment model, which focuses on hiring employees based on cultural fit and developing strong emotional bonds with those employees. Startups using the commitment model are less likely to fail and more likely to go public than startups that follow other management models. However, the same study found that switching management models after launch triples the likelihood of failure, even when the change is to the admittedly superior commitment model.

Best practices also often come with hidden long-term costs. In 2001, Jim McNerney was appointed CEO of 3M Co. Within three years, he converted the entire company to Six Sigma, a system of best practices whose goal is to boost operational quality and reduce errors. Six Sigma was developed at Motorola Inc., and one of the most high-profile companies to embrace its principles was General Electric Co., McNerney’s previous employer. Initially, Six Sigma generated substantial cost savings for 3M. But there was a downside: By mid-2005, when McNerney left 3M to become CEO of Boeing Co., Six Sigma had contributed to compromising 3M’s ability to innovate, which had always been the company’s most important competitive advantage. To limit the damage, George Buckley, 3M’s next CEO, largely discontinued the use of Six Sigma in research and development (R&D). As he explained: “You can’t put a Six Sigma process into [R&D] and say, well, I’m getting behind on invention, so I’m going to schedule myself for three good ideas on Wednesday and two on Friday. That’s not how creativity works.”

The hidden costs of a new practice are particularly large when its implementation alters a company’s core pursuit (such as 3M’s focus on innovation). If your organization is doing well, think twice about adopting new practices. If you’re in trouble, however, you may want to adopt a new approach temporarily. For instance, Six Sigma was arguably the right prescription for 3M in the short run, despite the nasty side effects. When McNerney first arrived, 3M’s profitability was low and its stock price was lagging. Thanks to Six Sigma, 3M’s efficiency improved, and by 2005, it was in a better position to focus on innovation again.

Finally, it is important to keep in mind that even the best of best practices has a limited shelf life. The more popular a practice becomes, the less likely it is that adopting it will enable you to outperform your competitors. A similar dynamic often occurs in sports. In football, for example, when Bill Walsh became head coach of the National Football League’s San Francisco 49ers in 1979, he implemented and popularized an innovation known as the West Coast offense. With the West Coast offense, Walsh led the 49ers to Super Bowl championships after the 1981, 1984, and 1988 seasons. The team went on to win two more Super Bowls under George Seifert, but the distinctiveness of the benefits associated with the West Coast offense started declining after other teams began hiring coaches who had worked as assistants to Walsh and those coaches implemented similar schemes with their new teams. As micro-oxygenation is to wine, so the West Coast offense was to football.

The key is to find a best practice early, while it is still in use only by a small number of organizations. For example, while most mergers and acquisitions fail, research has shown that a practice known as staged investment can significantly increase their likelihood of success. Staged investment involves entering into a strategic alliance with the partner before eventually buying it. Although this technique significantly decreases the odds of merging with the wrong company, only 1% of buyers are currently taking advantage of it. A potential explanation is that staged investment delays the synergy creation process. Therefore, companies prefer to make outright acquisitions — that often end up as failures.

As is the case with so many things, the successful use of best practices is found in moderation: Be selective about which practices you choose to follow, and be realistic about the returns you will achieve. The right best practices can help improve your performance, but they alone cannot turn you into an outstanding performer.

Read the full article here.
This content was originally published by MIT Sloan Management Review. Original publishers retain all rights. It appears here for a limited time before automated archiving. By MIT Sloan Management Review

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