Read an Excerpt
From Capitalism to
Democratic Enterprise
Minding the Economic Imperatives of Knowledge
IN LATE 1997, Bernard Ebbers, CEO of WorldCom, a small, obscure firm in Mississippi, announced that he was buying MCI for $42 billion of his company's stock. It was the largest takeover in history. How could this unknown man, a former gym teacher, emerge from nowhere with no capital to seize control of the second largest telecommunications company in America and gain immediate dominance over the global communications market?
Ebbers forged this empire with little more than a keen understanding of how a jumble of diverse companies could be integrated to deliver a complete stream of communication services around the world—a task that eluded AT&T, MCI, and foreign telecom giants.1 Because he grasped the underlying insight needed to create this system, all else followed.
Countless other examples show that today knowledge is the most powerful force on earth, primarily responsible for the collapse of communism, the restructuring of economies, and the unification of the world. After decades of glib talk about the Information Age, companies are becoming “learning organizations,” developing their “intellectual assets,” and hiring “chief knowledge officers” because we now see that knowledge is the source of all productivity, innovation, and competitive advantage. It is suddenly blindingly clear that knowledge is a boundless source of infinite power that promises to flood the world with creative progress. Bill Gates told a group of CEOs that information technology will “fulfill their wildest dreams.”2
THE CONTRADICTIONS BETWEEN CAPITAL AND KNOWLEDGE
The problem, however, is that this vast divide between a limited past and a boundless future has left business adrift in confusion—the flavor-of-the-month management fad syndrome—because we lack what economists call a workable “theory of the firm” for a knowledge-based economy. The “Old Management” of the Industrial Age is dying because it was based on capital-driven economics, and we now know that enterprise is no longer powered primarily by capital. Former Shell executive Arie De Geus says, “The critical resource is now people and the knowledge they possess.”3 This means that most corporate practices of today no longer make sense for the world we are entering.
Corporations comprise economic systems that are as large as entire nations, yet ironically our most admired companies remain committed to roughly the same type of centrally controlled hierarchy that failed in the Soviet economy. We have seen a few marginal changes, but the bulk of useful knowledge lies unused among employees at the bottom of the firm and scattered outside its walls among customers, suppliers, and other groups—while most decisions are made by executives at the top.
This yawning gap between promise and reality is merely a hint of the enormity of the upheaval that lies ahead. The entire social order is being uprooted by the move from a capital-centered past to a knowledge-centered future—even while we remain confused about what to do, where this is going, and what it all means. Without a theory of the firm based on the logic of knowledge, today's struggle for survival will remain an endless exercise in bewildering change and management fads.
A NEW FOUNDATION BUILT ON AMERICAN IDEALS
I want to suggest that a well-established foundation for a “New Management” of the Knowledge Age is readily available if we would simply look in the right place. America's heritage of democracy and free enterprise could serve us exceedingly well in this new frontier. Unfortunately, we tend to relegate these ideals to political elections and competition between firms. But if managers could extend the liberating power of democracy and markets inside business corporations, government agencies, and other social institutions that govern the daily flow of ordinary life, their widespread use would have a profound impact.
This is not some hopelessly utopian quest because, as I intend to illustrate, trends are moving rapidly in this direction.
To survive a world of constant change, massive diversity, and intense competition, leading corporations are dissolving their rigid hierarchies into fluid collections of self-managed units that use local knowledge to carve out successful market niches. As I will show later, this bottom-up approach should in time bring the power of enterprise to fruition as organizations melt into a churning sea of “internal markets” offering all of the creative dynamism of external markets—call it “the flowering of enterprise.”
The move to democracy is equally apparent in the way creative managers now work closely with tough competitors, empowered employees, and discriminating clients. After a long history of conflict, collaborative working relations have become one of the most powerful forces in business because companies have come to the hard realization that the mutual sharing of knowledge with other parties is beneficial. Some companies, such as GM Saturn, are uniting their stakeholders into complete “corporate communities”—think of it as “the extension of democracy.”
If managers could take a fresh look at these rich but misunderstood trends from the perspective of our traditions, the emerging pattern could guide our way ahead with confidence. As this book will demonstrate, the power of democracy and enterprise promises to transform institutions for a new era.
Why should we be surprised? This is the philosophy that gave birth to the United States and that has brought down dictatorship after dictatorship. Free markets and democratic governance are the twin pillars supporting modern civilization. They are proven methods that we have found most useful because they involve us all in making decisions that govern our society.
THE COMING PARALLEL REVOLUTIONS
This book describes leading-edge concepts and practices derived from my continuing study of the successful experiences of progressive companies. It's a strategic plan, a guidebook, designed to help us figure out where we are going.
Follow me through the many examples, surveys, forecasts, and mini–case studies I've organized in the following chapters and you'll learn about three parallel revolutions that make up this transition to knowledge-based organizations. The figure on the facing page sketches out the flow of revolutionary advances along three major paths:
1. the Information Revolution that is driving this transition
2. the resulting transformation of business, government, and other institutions
3. the creative new forms of leadership emerging to handle all this change
Note that these trends follow a rising exponential curve that is characteristic of all change today—the typical “J curve” depicted on the cover of this book. Whether it is the number of computers in use, strategic alliances, or new ventures, the trendline is curving sharply upward.
THE TECHNOLOGY REVOLUTION:
JUST THE BEGINNING OF UNSTOPPABLE CHANGE
Thus far we have seen only the first rumblings of the information technology (IT) explosion that is yet to come. The simple changes are over and the most innovative, wrenching innovations lie ahead. I conduct a forecast of technological advances every two years, and the latest study detailed the arrival of eighty-five revolutionary breakthroughs.4 This wave of technological change is poised to crash over society during the next few decades as the rising power of IT feeds back to improve itself. Technology is basically knowledge, and the widespread use of IT is now driving our understanding of technical knowledge at ever faster rates. Here's a rough timetable of three major breakthroughs:
2003 +/− 2 years. Interactive multimedia should be used by people everywhere to work, shop, study, and conduct all other activities electronically over life-sized wall monitors. Electronic commerce is expected to reach $12 billion by the year 2000 alone.
2009 +/− 3 years. Smart machines, robots, and software should be able to interact with people, learn and reprogram themselves, and translate languages. Bill Gates said, “The future lies in computers that talk, listen, see, and learn.”
PARALLEL REVOLUTIONS IN TECHNOLOGY, ORGANIZATION, AND LEADERSHIP
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2014 +/− 4 years. Optical computers and storage devices (as depicted in the Superman movies) should be available to process limitless information in any form. Andrew Grove, CEO of Intel, said, “Computer power will be practically free and almost infinite.”
In short, this is just the beginning of historic changes that seem destined to alter all aspects of life. The IT of today—PCs, the Internet, cellular phones—will look primitive in a decade or so. The U.S. stock market has advanced roughly 1000 percent between 1985 and 1998 because Americans sense the economy is entering an era of almost limitless progress.
THE ORGANIZATIONAL REVOLUTION:
MANAGEMENT FROM THE BOTTOM-UP AND THE OUTSIDE-IN
The heart of this book shows how the two principles of enterprise and democracy form a theory of the firm based on the laws of knowledge—The New Management. Two heretical applications follow from this philosophical foundation:
• Internal Markets. Complexity is best managed not through planning and control—but by permitting widespread entrepreneurial freedom at the bottom of organizations.
• Corporate Community. Economic strength flows not out of power and firmness—but out of the collaborative exchange of knowledge among the community of corporate stakeholders.
Top-Down Control Destroys the Bulk of Corporate Wealth
During the 1990s, the decade of Capitalism Triumphant, we have constantly heard about the evils of central planning and authoritarian control, but anybody in business will tell you that the prevailing corporate system remains a centrally managed hierarchy adorned with a few gentle touches and good intentions. Despite fervent claims about empowerment, networking, teamwork, and other hot management concepts, this has also been a decade of harsh downsizing, top-down change, and extravagant executive pay.
For instance, IBM's Louis Gerstner may have pulled Big Blue back from the brink but only by reinforcing fierce discipline and hierarchical control. IBM managers described their new boss this way: “His blunt style sent tremors through the organization.” In 1997, the value of IBM's individual divisions totalled $115 billion while the parent company was valued at $65 billion; the missing $50 billion was consumed by corporate bureaucracy. IBM's managers claim the software division alone wastes $200 million each year getting headquarter's approval for its 10,000 software projects.5
Meanwhile the shock therapy approach to restructuring has become a way of life in America—even though this method is now notorious for creating meager economic gains, overburdened staffs, badly served clients, and alienated employees. In 1998, for example, GE's John Welch was planning to close plants, sell divisions, cut wages, and lay off thousands.
This top-down approach may work in the short term, but like paint over rotted timbers, it masks the underlying weakness and invites catastrophes, such as we've seen in the decline of AT&T, Sears, GM, and many other former corporate giants. Top-down management is not going to withstand the massive changes looming ahead as relentless hypercompetition drives open a frontier of new products, markets, and industries that nobody really understands. Andrew Grove of Intel put it best: “The Internet is like a tidal wave, and we are in kayaks.”6
Downsizing, for instance, seems to make sense from a capital-centered view, but the knowledge held by employees comprises 70 percent of all corporate assets!7 To put it more sharply, the economic value of employee knowledge exceeds by far all of the financial assets, capital investment, patents, and other resources of most firms. Firing people is akin to throwing the bulk of corporate wealth out the window.
Downsizing can be best understood as a palliative, ritualistic practice, akin to bloodletting in primitive medicine, that reveals a far more serious organizational illness. Corporations shed workers repeatedly because they suffer from a chronic inability to create growth in a confusing new economic frontier. Instead, they downsize. It is like a bad habit, providing temporary relief by reducing labor costs while actually draining energy as companies lose skilled workers, creative ideas, loyalty, and other vital assets.
Internal Markets Release Knowledge from the Bottom
The solution is a fundamentally different approach that harnesses the creative talents lying dormant in average people. While Fortune 500 dinosaurs downsized by laying off three million employees during the 1990s, smaller firms and new ventures upsized by creating 21 million new jobs. This salient fact shows that the key to vitalizing organizations is to bring the liberating power of small enterprise inside of big business.
In short, we need to shift the locus of power from top to bottom, to think of management in terms of enterprise rather than hierarchy. I know this sounds revolutionary, but this is a revolution as dramatic as the Industrial Revolution. We tend to hear the Information half of the phrase Information Revolution but ignore the Revolution half. The idea that Communism might yield to markets seemed preposterous a few years ago, but it did happen. Now similar change is needed in big corporations—“Corporate Perestroika.” Robert Shapiro, CEO of Monsanto, put it this way, “We have to figure out how to organize employees without intrusive systems of control. People give more if they control themselves.”8
The following chapters offer hundreds of examples describing the clever forms of internal enterprise being used to solve problems directly, creatively, and quickly. Pay-for-performance plans are being expanded to form small, self-managed units that are held accountable for results but free to choose their workers, leaders, strategies, work methods, and generally “run their own business.” Line and support units are being converted into profit centers that buy and sell from each other and from outside the company, converting former monopolies into competitive business units. MCI, Xerox, Johnson & Johnson, Hewlett-Packard, Motorola, Siemens, Lufthansa, and other companies have developed fully decentralized bottom-up structures that form complete “internal market economies.”9 ABB's 4,500 independent profit centers stand out as a model.
It only takes a little imagination to extend these trends to the point where the logic of free markets governs corporations rather than the logic of hierarchy. Internal markets have profound implications for business because they shift the source of knowledge, initiative, and control from top to bottom, thereby providing the same benefits as external markets: better decisions through price information, customer focus, accountability for economic results, and as much entrepreneurial freedom as possible.
Yes, markets are messy, but they are also bursting with creative energy—roughly like the Internet, our best model of a self-organizing market system. Nobody could possibly control the Internet's complex activities, yet by allowing millions of people to pursue their own interests, somehow the system grows and thrives beyond anything we could imagine.
In the final analysis, only a new form of management based on enterprise can meet the explosive challenges lying dead ahead. The hope that “participation,” “team spirit,” “inspiring leadership,” and other vague ideas can create dynamic action among tens of thousands of people in the typical organization is little more than pious wishing. Anyone who has ever managed knows that it is almost impossible to get more than twenty people to agree on anything. Mayor Steve Goldsmith of Indianapolis told me that he struggled for years trying various management methods, but nothing worked as well as turning his departments into self-supporting units competing with outside contractors.
Difficult issues are involved in this change, of course, and we will explore them in the following chapters, as well as many progressive new ideas. For example, here are three simple but bold actions that highlight surefire ways to jumpstart your organization:
• Link resources to performance. Rather than use budgets and other crude controls that are unrelated to results, link resource allocations to economic and social value created by units.
• Allow units total freedom. Allow all units almost total operating and strategic freedom, including the right to buy and sell from partners both inside or outside the firm.
• Replace downsizing with self-sizing. Let units handle their own staffing rather than impose layoffs. That is, use “self-sizing” instead of downsizing.
Why would tough-minded executives yield control over these crucial matters? Because they can thereby lead an organization where everyone shares the responsibility for success.
The Profit-Motive Destroys the Power of Social Purpose
This does not mean that CEOs give up power or that corporations are balkanized into warring camps. The role of executives shifts to designing these self-managed systems and providing leadership to unify diverse interests into a strategic whole—the concept of “corporate community.” Saturn, The Body Shop, IKEA, and scores of enlightened companies develop trusting relations with clients, share power with workers, and cooperate with suppliers, while also making more profit for investors.
It's important to stress that these companies are not simply “doing good.” They create value by pooling knowledge among stakeholders to solve management problems. In other words, corporate community is economically effective.
Beyond its many benefits, however, lies a vast and more powerful world of meaning and purpose. Corporate community is also essential to help us find our way through a turbulent world engulfed in an avalanche of expanding information. It is a great paradox that having so much more data often leaves us more confused because of its sheer limitlessness. We are beginning to understand that information is meaningless if it is not guided by relationships, values, and vision—all those subtle but very real qualities lying beyond knowledge.
Unfortunately, these concepts run counter to the ideology of capitalism. The traditional idea that corporations owe their allegiance to shareholders and profit places managers in an unrealistic position where they are opposed to the interests of employees, customers, and others whose support is essential. Employee pay and training, for instance, are viewed as simply costs to be avoided. But the reality is that employee welfare and profitability are perfectly compatible. Companies that form employee partnerships enjoy huge returns on their investment in labor.10
Consider how the health care industry provoked the public's wrath by cutting patient services to improve profits. Congress passed laws banning such practices, and 2,000 physicians called for change because HMOs (health maintenance organizations) are “destroying the soul of medicine.”11
How did a great profession dedicated to serving humanity get into such a mess? In pursuing today's notion of good business, HMOs lost sight of their social purpose. It's obvious that we must control costs and investors must be rewarded; however, any business must also serve society to survive.
This business-society conflict has everyone confused, wasting energy rather than working together toward common goals. Robert Haas, CEO of Levi Strauss, explained the problem. “People look through the wrong end of the telescope, as if profits drive business. Employee morale, turnover, consumer satisfaction … that's what drives financial results.”12
Corporate Community Draws Knowledge from Outside Groups
If American executives can look beyond the bottom line, they will find vast opportunities for profitable business flowing directly from joining with the interests of their stakeholders.
In the health care industry, for instance, progressive HMOs are involving all parties in decisions to improve health care while reducing costs. Typically, physicians, nurses, and other staff are organized into self-managed practices that are accountable for performance but given wide freedom and support. Education programs assist patients in better managing their own health and in preventing illness by adopting healthier lifestyles. And to keep the system honest, states provide access to medical performance data to let market forces work. Doctors are now often stunned to see patients show up with a clutch of medical research reports in their hands.
Here we see the power of knowledge-based enterprise. Progressive HMOs are redefining medicine into a more effective system of collaborative problem solving among administrators, medical staff, patients, their employers, and government—corporate community in action. This approach allowed Oxford Health Plans to double in size each year to serve one million members,13 Other companies in every industry could make a similar transformation.
But doesn't this approach compromise the need to make money? A knowledge economy is changing the old assumption that profit and social benefits are opposed. Unlike capital with its fixed limits, knowledge increases when shared, which is why cooperation has now become efficient. For instance, today's wave of strategic alliances is fueled by the pooling of technology, market access, and other forms of knowledge to increase value for all partners. Ray Smith, CEO of Bell Atlantic, calls it the principle of loaves and fishes. “Unlike raw materials, knowledge can't be used up. The more you dispense, the more you generate.”14
If cooperation can multiply the value of alliances with business partners, why shouldn't it be effective for social alliances with employees, customers, and other groups? Results reported in this book from my “Corporations in Transition” (CIT) survey of 426 managers show that more than 80 percent understand the need to collaborate with stakeholders.
Although I like this idea because it resolves the age-old clash between business and society, I do not argue this case on moral grounds. Corporate community is not social responsibility or business ethics—it's one of the few remaining ways to sustain competitive advantage.
In the following pages you will read detailed accounts of fascinating companies and business leaders who have pioneered this frontier. Imagine how the following creative but tough actions would electrify your organization with fresh knowledge from the outside parties you depend on to succeed:
• Democratize Corporate Governance. Invite responsible, well-informed representatives of employees, clients, and business partners to seats on the board of directors and other bodies.
• Evaluate Financial and Social Performance. Develop measures of performance that reflect the contributions and benefits of all stakeholders, as well as traditional financial performance.
• Collaborate among Stakeholders. Use this democratic form of governance and performance measures to engage all stakeholders in joint problem solving to improve the overall system.
These changes are not a luxury but a necessity for any business that hopes to meet the test of social purpose. The disorders of our time represent a vast frontier crying out for a new type of enterprise that creates value by integrating different interests to serve all needs better.
THE LEADERSHIP REVOLUTION:
RELINQUISHING THE ILLUSION OF CONTROL
If I am right, organizations are heading toward some sort of “economic reversal”—a passage from hierarchy to markets and from conflict to community. We seem to be roughly halfway through this passage, and the principles of a New Management are quietly gathering momentum. Exploding complexity is forcing decentralized controls, while the benefits of collaboration are attracting diverse parties into pockets of shared understanding.
The way ahead seems clear. To manage organizations in a new era when ordinary people offer the most valuable resource available, leaders will have to push authority down to the bottom and out to all affected parties—a New Management based on shared leadership from the bottom-up and the outside-in. My CIT study shows that managers generally understand this shift is coming, and they expect it to arrive between the years 2000 and 2005.
It is certainly needed. Today's creative destruction of free markets is uprooting the old social order, with mounting potential for a serious economic backlash. The income gap between the top and bottom classes in the United States has returned to the levels seen prior to the Great Crash of '29, while indices of social well-being have reached new lows.15 And much more turmoil lies ahead because world industrialization is likely to increase tenfold. The industrialization of China alone will triple the use of scarce resources, global competition, social diversity, and pollution. George Soros, the most famous capitalist of our time, called today's market system “The Capitalist Threat.”
Moving through the Passage: Leaders as Gardeners
I suspect the only way this conflict can be resolved is by moving through the passage—by harnessing the potential of a New Management based on the laws of knowledge. The key is to see that capitalism is dying but enterprise and democracy are just beginning to flower. To realize these possibilities, however, leaders have to relinquish the illusion of control to adopt a more humble but realistic role of nurturing rather than commanding their organizations.
The new science of complexity and chaos theory shows that organizations today must become shifting clusters of self-controlled autonomous units, a living superorganism of countless small cells that constantly adapt to a turbulent world. The Old Management was good for mechanistic business, but the New Management asks executives to give up their old role as captains of commerce to become “economic gardeners” of organic systems.
I experienced an example of this coming role shift when attending a fundraiser at my son's high school recently. These used to be loud, hard-sell events that auctioned prizes to the highest bidder, leaving people dazed but feeling sort of loyal for attending what was basically an unpleasant bash. This time we were invited to enjoy a quiet dinner with a few other parents and teachers at small tables. The result was a meaningful dialogue about the raising of our children and the role of the school. Rather than leave the event with a headache as I usually did, I left this fundraiser with a deeper appreciation for the institution I entrust my son to. And the school benefited not only from our heightened support but from the more generous checks we willingly wrote after an enjoyable encounter that left us all feeling connected.
It seems to me that this is what leaders have to cultivate today. The glitzy marketing, brutal treatment of throw-away workers, and all the other relics of a more exuberant but thoughtless economic youth must yield to a maturity that is quieter but more powerful. Leaders must find a way to serve unmet social needs, develop information systems to sharpen our understanding, help employees organize into self-managed units, and form collaborative relationships to resolve the old conflicts between workers and managers, sellers and buyers, and all the other divisions we can no longer afford.
Leaders can't force people to do any of these complex tasks any more than gardeners can force nature to produce what they want. Gardeners have to be attentive to the subtle signs of need in their gardens. They must provide the right amounts of water, light, and nutrients and then lovingly allow plants to grow as they should. In other words, they must let go. Listen to how Bob Kuperman, CEO of Chiat/Day, described this new role:
Basically our organization is now a living thing with a life all its own. Management can support it and guide it, but not control it. If you let it design itself, it takes off and people use their best possible abilities. We've got to make this succeed because the old way doesn't work anymore.16
Heritage, Heresy, and the Laws of Knowledge
One particularly crucial, symbolic action would signify these three revolutions, help us grasp them, and live up to the challenge. Drawing on our heritage as a nation born through revolution, Americans should summon up our traditional courage to proclaim a modern heresy—our economic system should no longer be thought of as “capitalism.”
Capitalism is an outmoded type of market system dedicated to the pursuit of capital, profit, and the other material factors that worked in the industrial past. The main thing impeding us at this point is sheer ideology. If we want to draw on the energy of the future, we should define our economic system in terms of the laws of knowledge that define the future. Economic success is no longer powered by capital but by free enterprise and democratic community. I suggest a more accurate, fitting name for our system would be “Democratic Enterprise.”
Corporate executives are the primary candidates for creating this system because business is the most powerful institution in society. A system of democratic enterprise would allow us to more easily navigate this economic passage, and managers could then shed their old role as the bad guys to assume their rightful place as the heroes who make a knowledge society work.
WILLIAM E. HALAL
Washington, D.C.
July 1998
