Implementing Organizational Change

Ashish Nanda
Morgan 143 Harvard Business School Soldiers Field Boston MA 02163 Tel: (617) 475 6506 Fax: (617) 496 5271 e-mail: ananda@hbs.edu

March 25, 1996

I am grateful to Chris Argyris, Joe Badaracco, Chris Bartlett, Richard Caves, Jay Dial, Jim Heskett, Jay Lorsch, Phil Rosenzweig, Julio Rotemberg, Don Sull, Dick Walton, Mike Whinston, and participants of Industrial Organization seminar as well as the informal General Management seminar at HBS for helpful comments and discussions.

Abstract To secure the participation essential to move an organization from an inferior state to a superior state requires that workers be offered two incentives: (1) security that they will be excused if coordination breaks down, and (2) encouragement to make an effort to change rather than free-ride on the efforts of others. If offering both incentives is too costly, the organization continues to languish in the inferior state. Organizational inertia will not be overcome by merely increasing the attractiveness of the desired state or attempting to coerce workers to abandon established routines. Organizational change can be induced by actively managing the change process, as by shuffling parts of the work force and nominating change agents from among the workers. Moreover, the change process can be designed to make an organization more amenable to change: for example, starting with a kick-off event and making the process a vigorously disequilibrating phenomenon. Whether the change process is implemented incrementally or radically depends on how the manager trades off the cost of instituting wrenching change against the cost of having the organization partially misaligned with strategic necessity.

I.

Introduction

This paper considers the puzzling case of resistance to change in positive sum games in which the alternate organizational configuration enhances the value pie. This case would seem to lead handily to a pareto superior outcome, with everyone at least as well off as at present and, hence, with little reason to resist the change. Yet managers often remark that their greatest challenge lies less in recognizing the need for the strategic change (external environment, technological conditions, or the managers vision change the managers estimation of value1 that different organizational forms can yield such that the existing organizational configuration is no longer optimal) than in implementing the organizational change needed to redirect strategy. We argue that organizational change is difficult to achieve because firms get stuck in coordination equilibria that are no longer optimal. In the following section, we use case studies of managers challenged with implementing organizational change to delineate what we mean by the term organizational change. In Section III, we consider existing theories of why organizational change is so difficult to achieve and the questions that they leave unanswered, and in Section IV suggest why it makes sense to think of organizations stuck in sub-optimal equilibria when we consider the dynamics of organizational change. A simple model is developed in Section V to demonstrate that one reason organizations become stuck in inferior equilibria is that their managers are unable to make the desired states sufficiently attractive to workers. Strategies for getting organizations unstuck and implementing change are proposed in Section VI. In Section VII, we suggest that a prescient manager can configure an organization in anticipation of circumstances that are yet on the horizon. Section VIII offers concluding remarks.

II.

What is organizational change? Some examples from real life case studies

Leading organizational change has been applied to such wide ranging activities that few know any longer what a person using this phrase exactly means. It is important, therefore, to clarify which classes of phenomena we refer to when using the term organizational change. One way to do this is to clearly delineate situations that we do not focus on. There are three such situations, characterized by some academics and practitioners as organizational change phenomena, that we specifically exclude from consideration. 1) Activities that do not enhance value but merely redistribute it among the various stakeholders. Terms such as restructuring and reengineering are sometimes used to connote non-value enhancing exercises that aim simply to redraw the pie-partition, typically between stockholders and workers. The bargaining process in these zero-sum games is bound to be fractious and the party sitting on the opposite side of the table is bound to resist. The oft-encountered value creation situations that involve value redistribution as well, on the other hand, are considered. What Burns calls transforming leadership: [E]ngaging with others in such a way that leaders and followers raise one another to higher levels of motivation and morality (1978, p. 20). Examples of such leadership would include Roosevelts New Deal, Gandhis non-violent campaign against British rule in India, and the unswerving commitment of Ben and Jerrys chairman Ben Cohen to social

2)

For managers, who are agents of owners, we equate value with the profit that accrues to the owners. Hence, we presuppose that a) owners care about their profits, and b) suitable contracts exist between owners and managers such that the managers care about the profits that accrue to the owners.

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causes and community support. Situations in which the leaders mold the preferences of their followers, however powerful and moving, are not considered.2 3) Settings in which people work and produce results entirely independently of one another. We are concerned with change in organizations in which productive output results from the joint efforts of specialized sub-units of workers who must coordinate their activities.3 A skeptic might argue that in delimiting the meaning of organizational change we have drawn the boundaries so tight as to leave hardly any real life analogs. We do not believe this to be the case. Indeed, we believe that managers are frequently challenged to implement precisely what we construe to be organizational change. Four examples from practice are related below. A software company. Owing to the geographical distance between facilities in Silicon Valley, California and Bangalore, India and differences in the programming capabilities of the respective workforces, a software company broke programming projects up into self-contained pieces that could be developed relatively independently in order to save communication costs. Advanced programming projects went to Silicon Valley, routine tasks were sent to Bangalore. But circumstances changed. Enhanced telecommunications facilities with expanded bandwidth capability facilitated internetworking at a low cost, and Bangalore programmers had become as proficient as their Silicon Valley counterparts. Believing the benefit of speeding development to outweigh increased communications costs, the firms CEO proposed to restructure project allocation such that programmers at both facilities could work on the same project by exchanging code daily. The restructuring called for project teams to span geographical boundaries and interactivity to take precedence over independent work. Project managers, hitherto organized under geographic heads, would have responsibilities spanning both locations. The CEO was struggling with the issue of how to effectively implement the desired change. A large systems and management A multinational consulting companys European operations. consulting firm had developed a powerful presence in Europe by nurturing independent country practices. But the area managing partner (AMP) for Europe, perceiving that the firms clients were becoming increasingly international, anticipated growing demand for consulting services that spanned geographic boundaries. Believing the benefits of developing a pan-European practice uniform service to multinational clients and flexibility to move skilled consultants from one country to another to outweigh the costs of reduced local sensitivity and autonomy, he proposed a significant organizational change. Industry heads who had previously reported to geographic heads would operate across countries, the role of the latter would be allowed to atrophy, and consultants would be expected to shift focus from developing local contacts to building industry expertise.

For expositional reason, we sharply distinguish between the challenges of push through change given peoples innate desires and molding peoples preferences. Real life does not take such extremes: Leaders confront having to push change given peoples wishes even as they attempt to influence their desires. One can, however, envisage a continuum with some situations being closer to implementing change given preferences and other situations being closer to transforming peoples desires. This paper informs situations that lie close to the former type of situations.
3 Hence, we exclude from consideration those conglomerate organizations whose sub-units operate entirely independently. However, we believe that the excluded group would be a tiny minority, since a key reason why activities are organized within a firm is that they need to be coordinated. Barnards (1938, p. 73) definition of an organization highlights the importance of coordination in an organization: [An organization is] a system of consciously coordinated activities or forces of two or more persons.

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Rather than attempt to move directly to a pan-European organization, the AMP divided Europe into three regions and simultaneously announced a number of new assignments. Some high-performing country managers assumed the new responsibilities of regional managers while former geographic managers assumed new functional responsibilities. Emphasizing that these changes were but one step towards a pan-European organization, the AMP believed, provided sufficient indication of forthcoming change to afford erstwhile geographically-focused executives time to alter direction and cultivate industry skills. Protected from foreign competition by duties A commercial vehicles manufacturer in a developing country. and tariffs, the commercial vehicles industry in a developing country had for more than three decades remained a duopoly. In the face of licensing constraints that held output well below potential demand, the industry leader, which commanded 70% of the market, focused on maximizing production. When political and macro-economic considerations led the government to eliminate import barriers and encourage foreign collaborations, five foreign commercial vehicles manufacturers promptly entered the country in collaboration with domestic firms. Recognizing the need to shift priorities dramatically, the CEO of the dominant local manufacturer proposed that marketings role be changed from rationing agent to purveyor of market intelligence and productions philosophy be shifted from maximizing capacity utilization to meeting customer requirements. To drive these changes, the CEO organized weekly meetings of senior marketing and production executives to discuss production plans. After six months of having these meetings, the CEO was frustrated that decision processes were still mired in the old framework. Manufacturing continued to be preoccupied with production bottlenecks, countering sales executives requests for products that varied from production plans with concerns about switch-over costs and inventory, and unable to countenance saless inability to quickly dispose of the vehicles that came off the line. The CEOs strong encouragement notwithstanding, sales executives often slipped into asking manufacturing executives what they planned to produce. Such forecasts as were produced were wildly inaccurate and subject to dramatic revisions, reflecting less an enthusiastic belief in them than a desire to satisfy the CEO. Procurement activity in a defense equipment manufacturing firm4 Perceiving impending difficulty securing essential raw materials, the president of a large concern that made equipment for the U.S. armed forces asked an executive appointed to a newly created position of vice president in charge of purchasing to coordinate purchase decisions across all 20 of the companys plants. Believing that centralized purchasing would yield significant economic benefits as well as afford the company the leverage to demand better terms from suppliers, the new vice president asked the plant executives responsible for purchases to clear with him in advance all purchase contracts that exceeded $10,000. Although the executives enthusiastically acceded to the request, the head office received not a single request for purchases over the next six weeks, yet the plants continued to function busily in their usual routine. Upon enquiry, the vice president discovered that the local purchasing executives had broken large contracts into smaller orders, each well below $10,000. Top managers in each of the foregoing companies had delineated, in response to strategic changes, alternative organizational configurations that promised to generate greater value, only to discover that implementation of change was fraught with difficulties. We explore in the following section some rationales for why this is so often the case.

I am grateful to Jay Lorsch for bringing this case to my attention.

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III.

A review of existing scholarship on why organizational change is so difficult

Before considering what might be done to extract firms from suboptimal equilibria, we explore some rationales for why they become mired therein in the first place. We attempt below to synthesize the accumulated wisdom of the field with particular emphasis on issues upon which researchers agree or differ. The examples cited in the previous section suggest, and management scholars such as Vandermerwe and Vandermerwe (1991, p. 174) conclude that the principal obstacles to implementing organizational change are people related. Attempts to account for this have tended to follow one of three broad lines of reasoning related to: lack of communication; uncertainty avoidance; and defensive routines. We explore below the assumptions that underlie these lines of reasoning. A. Workers are unaware of the benefits of change

Resistance to change can arise out of ignorance of its potential benefits, implying managements failure in communicating these benefits. This rationale rests on the assumption that employees are uninformed, either complacent with the existing state which they perceive to be better than it actually is, or unaware of how much better the changed state might be. Tichy and Devanna (1986, p. 44) term this organizational complacency the boiled frog phenomenon, asserting that companies thresholds for recognizing the need for change are too high. This rationale can obtain only if management possesses, but does not share with employees, knowledge about the benefits of change. If change will, indeed, increase the size of the value pie, it is in managements interest to communicate this intelligence in order to motivate employees to effect the change. Management scholars have remarked on the importance of communicating the change vision as a set of blueprints for what the organization will be in the future (Tichy and Devanna, 1986, p. 128). Kirkpatrick (1985, p. 35) has identified in the literature a common theme that: [e]ffective communication is a must. People must be informed in advance and must understand the reasons for change. As long as the change remains an unknown, observe Bucholz and Woodward (1987, p. 145), the organization will be like the kingdom in the fairy tale unproductive. But as more and more people call out the dragon that is, specify the problem they will be able to define objects and then, as if by magic, come up with creative and innovative ways of dealing with those problems. Communicating the message that change will benefit the organization may be an extremely difficult task, requiring that workers be acquainted with complex issues, such as competitive dynamics and market forecasts. Indeed, communicating the entire message may be well nigh impossible, and even to the extent that it is communicated effectively, employees may withhold their buy-in unless they are assured of managements credibility and astuteness of judgement. Exhortations to change are frequently met with employee skepticism expressed in remarks such as We have been fed this line before, and All that management wants to achieve through these change programs is a reduction in head count. How does a manager surmount the twin hurdles of conveying what is often complex information and overcoming low credibility? A powerful and efficient way is to protect the employees from potential downsides and offer them an upside if they make the desired transition. Assume, for example, that the present

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organizational configuration generates B units of value shared thus: a for employees and B-a for management.5 An alternative organization can generate B+b units of value. Management might accompany a proposal to reorganize with an offer to compensate employees at a+"b units (0<"<1), indicating that employee buy-in to the reorganization will ultimately boost their earning as well. Employees are likely to accommodate, even embrace, change that increases their compensation. An offer of increased compensation makes credible managements message that an alternative organizational arrangement will be more beneficial. The term compensation, used here and in subsequent arguments, is meant to be construed in its broad sense, to refer not just to money, nor even just to money and satisfaction of egoistic values such as status and prestige, but also to improved work environment, expanded social responsibility, and so forth, with all the factors of concern to the employee being brought together under the common denominator of utils. But offering employees greater utils as inducement to accept change is effective only so far. Utilities are nonseparable, interactive, and interpersonal, as observed by Tichy (1977, p. 346), who remarked that resistance to change might emanate from a power motive, over-dependence, or interpersonal comparisons. If it is not possible to compute the impact of a change on, or even to influence, employees utilities, managements ability to credibly communicate to the workers that an alternative organization is superior are compromised. In the examples related in the previous section, affected workers might reasonably be expected to be concerned about both their own and the communal well being. The consulting firms country manager, for example, might well be unhappy to be losing power and unhappier still that power was accruing to the functional managers who previously reported to them. The Silicon Valley programmers, on the other hand, if motivated by what Etzioni (1983) termed communitarian feelings, might view the prospect of working with their Bangalore counterparts in terms of the potential to further the collective interests of the organization. Managers are thus not without means to enlist employees in the change process. To bridge the knowledge gap, they can communicate intensively the benefits of the proposed change. To make their message credible, they can commit to employees a portion of the surplus that is expected to be generated by the change. Finally, they can appeal to their employees sense of doing what is right for the organization. B. Workers are worried about an uncertain future

A number of scholars (e.g., Bennett, 1961; Tichy, 1977, p. 344; Tichy and Devanna, 1986, p. 75) have posited that employees prefer a certain present to an uncertain, even if rosier, future. If management could be sure that the change will definitely be better, it could insure the employees against variability in the outcome.6 Assume, for example, that the present organizational configuration generates B units of value shared thus: a by employees and B-a by management. An alternative configuration is expected to generate , with probability p, z>B units of value and, with probability (1-p), a low profit y<B. In expected value terms, pz % (1 & p)y ' B % b where b>0. Employees, being risk-averse, prefer a certain compensation a to uncertain compensation with an expected value of a. An optimal solution under these circumstances would be for management to insure employees against the consequences of accepting change by offering to compensate

5 For clarity of exposition, we employ the shorthand of attributing owners surplus to management. The underlying assumption is that the owners have suitably contracted with the managers so that the latter make decisions that are in the formers interests. 6 We make the standard assumption here that workers are risk-averse and owners, represented by management, risk neutral towards firm returns.

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them, say, a+"b units (0<"<1) regardless of the outcome of the change. On an expected value basis, the management earns B-a+(1-")b, and, being risk-neutral, is better off than in the unchanged organization. Change might be further facilitated if management could reduce employees risk-aversion, perhaps by building excitement through engagement in the change process. If, however, management is itself riskaverse, it is unlikely to be willing to insure employees against the consequences of change. Indeed, management may even be unable to compute the extent of the risk, never mind insure its employees. It may be impossible, moreover, for management to insure against possible downsides in non-monetary facets of their compensation colleagues, work environment, and so forth (Tichy, 1977, Beer, 1991). Managers often expect employees to support change initiatives without any assurance that they will thrive, or even survive, past the programs. Workers who do survive, moreover, are likely to be devastated by the firing of colleagues and friends and end up uncertain about their own value to or role within the organization. Little wonder that the next time management announces a change campaign the workers run for cover. This is in contrast to the president of the software company mentioned earlier who launched a team management initiative and developed, in consultation with managers at both locations, a graduated roll-in schedule for cross-border projects was developed. Group training sessions and personal tutoring afforded programmers opportunities to explore both the mechanics and psycho-social aspects of the change. The programmers were subsequently eased into cross-border projects and awarded bonuses if they made the transition ahead of schedule. In summary, suitably encouraged, employees will embrace change; their risk aversion is most effectively overcome by insuring them against possible downsides of the change. C. People stick to old habits and routines rather than learn new ones

A number of researchers (e.g., Tichy, 1977, pp. 344-347; Kanter, 1985; Tichy and Devanna, 1986, p. 75) have concluded that workers are reluctant to alter situations with which they are comfortable. The energy and effort expended learning the skills they are currently using is a sunk cost for employees; it cannot be recouped. They will resist an organizational arrangement that requires them to make a further investment in learning new skills. This conclusion makes two assumptions, (1) that workers dislike learning new skills, and (2) that the existing and alternative arrangements yield equal benefits. Yet workers can be found who enjoy learning new skills, even value such skills beyond what they contribute to organizational productivity, finding them to be intrinsically satisfying or increasing their employability. Even if skill development should incur disutility on workers, management might recompense them such that their added investment in learning pays off. Returning to our numeric example, assume that an organization earns B, from the labor of lefthanded workers, to whom a units of surplus accrues. As a consequence of a strategic change, the organization can earn B+b from right-handed labor. The investment in learning right-handedness is G, where b>G. Unless their compensation is adjusted, the workers will not make the requisite investment. But if management promises them a+G+"(b-G) provided B+b profit is generated, they will willingly make the effort to become right-handed. Managements offer of countervailing benefits will be moot, however, if workers concern is not with expended effort but rather with competence insecurity. Workers, comfortable with the skills they possess and uncertain of their ability to master new skills, will shy away from learning. Pyschologists have -6-

documented the compulsive, security-oriented behavior which people often resort to in order to preserve the status quo even against change for the better (Diamond, 1986). Researchers have remarked that organizations function in accordance with established routines (Nelson and Winter, 1982, chapter 5). For excellent evolutionary reasons, these routines enable parsimonious operations that minimize adjustment and learning costs. Although they promote efficient functioning under stable conditions, routines become stumbling blocks when change is desired. Routines nurture robustness at the cost of introducing organizational inertia. Among the varied manifestations of this in-built organizational resistance to change are: idea killer advice, the rule of repeated action (Hornstein, 1986), skilled incompetence, fancy footwork, and apparent motion (Argyris, 1990). Argyris (1990) asserts that resistance, however irrational under a given set of circumstances, is a programmed human and organizational defensive routine. It can be overcome, he suggests, by increasing selfawareness and promoting stewardship among the members of an organization. Reflection by the individual and meta-routines in the group can help people who perceive change to be clearly for the better to break the bonds of inertia. Competence insecurity can be overcome by introducing change gradually rather than all at once. Recall the consulting firms AMP whose plan to transform a country-based organization involved an intermediate stop at a three-region organization. The transitional organization was both harbinger and mitigator of more change to come. It afforded the consultants, whose expertise was geographically-based, time to develop industry-related skills, thereby avoiding the frenzied sense of incapability that would have enveloped many of them had he attempted to fold back the geographic dimension immediately and altogether. To sum up, concern about the effort required to develop new skills is best allayed by an offer of countervailing benefits that will make the investment worthwhile, concern about the mastery of new skills by easing into the change and encouraging workers to reflect on their attitudes towards change and nurturing their sense of identification with the organization.

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Cause of resistance to change Workers are unaware of the benefits of change Workers are worried about an uncertain future

First order suggestions Convince workers that they will be better off if they change than if they dont. Insure workers against potential downsides to the change.

Why first order suggestions may not work . Workers utilities may be non-separable, interactive, and interpersonal. . Management may be unable to compute the impact of the change on, or influence, the workers utilities. . Management may be unable to compute uncertainty. . Management may be risk-averse. . Workers utilities may be non-separable, interactive, and interpersonal. . Workers may suffer from competence insecurity. . The organization may be mired in defensive routines.

Second order suggestions

. Communicate intensively and credibly the benefits of change. . Appeal to workers sense of doing what is right for the organization. . Try to minimize workers aversion to risk. . Explore managements evaluation and attitude towards the risk inherent in the change process. . Ease workers into the change process. . Encourage self-reflection and stewardship.

People stick to old habits and routines

Recompense workers for effort expended to develop new skills.

Table 1 Table 1 suggests that, were human beings to behave in a manner consistent with the classical economics assumptions of rational, self-centered, and well-informed behavior, the first order suggestions enumerated in the table would deal handily with resistance to change. The principal reason that the three causes of resistance to change operate so powerfully is that human beings deviate from these assumptions. Does this imply that resistance to change is a function solely of homo sapiens behaving differently from homo economicus? Not by our reckoning. As we argue below, even in a world of rational, well-informed people who evaluate change purely in terms of how they will be affected by it, organizational inertia would still exist.

IV.

Change is difficult because organizations become mired in sub-optimal equilibria

Management scholars recommendations for implementing organizational change suggest that the principal challenge managers face is that of nudging the organization from one equilibrium to another. Although each author describes the change process differently, their descriptions are remarkably similar (see Table 2). Organizational change is typically modeled as a three-stage process: (1) the organization frozen in an existing equilibrium, (2) the organization liquefied and molded, and (3) refrozen into a new arrangement. Why does an organization become frozen? We believe lack of fluidity is due fundamentally to the inability of organization members to transition to a new state in a coordinated manner. Previous coordination is implicit in the existing, stable organization, a strategic change dictates that further coordination is possible in an alternate, pareto superior organization. In the absence of coordination, the shift will precipitate chaos. Some employees will persist in old, others will struggle to adopt new, patterns. The result would be even less

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desirable than the existing, inefficient equilibrium. Fear of such an outcome keeps organizations stuck in suboptimal equilibria.
Model Lewin (1947) Beckhard and Harris (1977) Tichy (1977) Conner and Patterson (1981) Process Changing Transition System development Acceptance Strategic decisions and prime movers Act II Mobilizing Transitions Energizing Strategic choice

Unfreezing Present state Start-up

Preparation Departure from Kanter (1983) tradition and crises Tichy and Devanna (1986) Act 1 Awakening Woodward and Buchholz (1987) Endings Nadler and Tushman (1989) Envisioning Nadler and Tushman (1995b) Recognition Table partially adapted from Kanter et al (1992), p. 376.

Refreezing Future state Stabilization (leading to self-renewal) Commitment Action vehicles and institutionalization Act III Reinforcing Beginnings Enabling Re-creation

Table 2 Consider the following thought experiment. An organization employs two workers, each of whom earns a units of compensation working left-handed. Environmental or technological changes make it desirable for them to learn how to work right-handed at a cost of G units of disutility each. If both work right-handed, they will earn a+G+c units. If, on the other hand, one works right-handed and the other continues to work left-handed, each will earn a-d units. The situation can be described by the payoff matrix in Figure 1 (the bottom left term in each box is As utility, the top right term Bs utility). Both LL and RR being Nash Equilibria, if they have been in the LL equilibrium, employees need not shift to the better RR equilibrium. B L L A R a a a-d a-d-G a+c Figure 1 Each of the four organizations described in Section II faced the challenge of moving from one equilibrium to another: the software company from geographical to project-driven teams; the consulting company from a country to an industry-based organization; the commercial vehicles company from production to market-driven; and the defense equipments company from decentralized to centralized purchasing. Managers in each organization were convinced that the transition was essential to improving performance. Partial transitions, on the other hand, as suggested earlier, might grievously impair performance. If, for example, the Bangalore programmers adopted a project-driven, and the Silicon Valley programmers persisted in a geographic, approach to work, clashing expectations would almost certainly diminish productivity. Similarly, were the industry heads of the consulting company to begin to operate across countries, but the country heads to continue to manage resources on a geographic basis, chaos would surely -9a-d a+c R a-d-G

result. The industry heads would bring in increasingly international projects for which expertise would be available only on a country-by-country basis. If the commercial vehicles companys marketing department began to request products strictly per its forecast, but the production department maintained its focus on overcoming capacity constraints, inventories would pile up even as order fulfillment time would lengthen. Finally, were its purchasing executives to begin to centralize key purchases and its manufacturing executives to continue to operate with the expectation that their needs would be quickly fulfilled, the defense equipments manufacturing company would begin to experience severe stock-outs in its factories. What hampered change in each of these instances was the uncertainty of the Bangalore programmers, industry heads, marketing and purchase executives about the willingness of their Silicon Valley, country manager, production department, and manufacturing executive counterparts, respectively, to participate in the change. The cases suggest that the unwillingness to change had its roots in the concern that others would not do so. Large sample empirical studies also indicate that executives contemplating organizational change are preoccupied with gauging others reactions while moving from one state to another. Concluded Collins, Ross, and Ross from the responses of 485 upper-level managers in 59 industrial companies surveyed about their attitudes towards organizational change (1989, p. 440): Significantly, the managers who were surveyed overwhelmingly expressed their own willingness to support the change. There was some concern, however, with regard to expected resistance from other company personnel to the organizational change....There was skepticism as to the reaction of their colleagues and subordinates.

V.

The underlying cause of organization stuckness

Accepting that organizations are becoming stuck in sub-optimal equilibria, it is not yet clear what constrains managers from getting their organizations unstuck. Recalling Figure 1, for instance, what prevents a manager from changing payoffs to workers such that RR becomes the dominant equilibrium? We argue here that such a high level of compensation must be offered to make the desired equilibrium dominant that it may no longer be attractive. We develop a simple model that helps to concretize this line of reasoning and use it to demonstrate how organizations become stuck in sub-optimal equilibria. A. A model of an organization operating in a coordination equilibrium

Consider a firm with one manager, P, and two identical workers, A and B, each of whom can develop two skills, which we label L (left-handed) and R (right-handed).7 A worker can perform a task either lefthanded or right-handed, but cannot use both skills simultaneously. The manager cannot observe the skills developed by the workers,8 nor the workers each others skills, during the skill development process.9 A manager able to observe the skills developed by workers (and verify them to a third party) could make compensation skill-dependent and thereby directly incent development of the desired skills. Absent such observability, the manager must indirectly motivate development of the

7 Although we are taking this case for ease of exposition, the resulting argument is quite general and applies even more vigorously in the case of a number of workers each of whom can develop multiple skills. 8

I do assume, however, that the manager can verify, and hence, explicitly prevent idling by a worker.

9 Section VI.E discusses how relaxing the assumption of mutual unobservability of skill development can ameliorate the problem of organizational inertia.

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appropriate skills by making workers compensation contingent on the profits generated, which the manager can observe (and verify). The skills required by the companies described in Section II e.g., cross-border project management, industry-specific consulting expertise, commercial vehicles demand forecasting, and advance forecasting of purchase requirements are neither quantifiable nor verified by a third party. Consequently, employees compensation could not have been made directly dependent on the acquisition of new skills. It could, however, have been made dependent on verifiable outcomes generated by the application of these skills. Returning to the model, assume that the firm engages in productive effort over two periods, in each of which the manager estimates the state of nature and offers workers an employment contract for that period.10 The employment contract provides a basis for workers to decide whether or not to exert effort to develop the specific skill needed to perform productive tasks and generate profit. Greater profit is generated if the workers coordinate by developing the same type of skill than if they do not. The manager cares about the profit, net the workers compensation, the workers, about their compensation, net the disutility of making the effort to develop their skills. Again, for ease of exposition, we assume the workers to be risk neutral and their utility to be additively separable in income utility and effort disutility.11 The manager is willing to continue operations so long as net payoff is greater than 0; the workers are interested in continuing employment with the firm so long as their net utility is at least equal to the utility to be gained from engaging in the next best task. We assume this reservation utility to be U0 unit per period. We model the skill development process as if it were akin to learning how to ride a bicycle: up to a certain threshold level of effort, no skill is developed; beyond that level, the worker learns the skill, but additional effort does not increase the skill level. We assume that skill developed in the first period can be employed in the subsequent period and that skills have no terminal value.12 G units of effort being required to generate either the left-handed or the right-handed skill, the first 1 1 1 1 period profit matrix is as given in Figure 2, where BLL > BRR > BLR ' BRL . By offering them greater compensation if first period profit is BLL, the manager motivates the workers to develop left-handed skills in the first period.13

10 We are ascribing all the bargaining power to the manager by assuming that the employment contract is based on a take it or leave it offer. The argument below does not change materially if we assume a different scenario, except that the problem of organizational inertia becomes less acute the greater the workers bargaining power relative to the manager. 11

The argument presented below is robust to these assumptions.

These assumptions are made for expositional reasons. One could model skill development as a process incurring disutility that is a continuous, increasing, and convex function of the effort made to develop the skill, skill could depreciate between periods, and it could have a terminal value: the ensuing argument would still hold.
13

12

In Section VII, we discuss the case in which BLL > BRR but the manager still desires that the workers develop right handed

skills. Assume, for now, that the manager does, indeed, desire that the workers develop left-handed skills in the first period.

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B L L A R R

BLL

BLR

BRL

BRR

Figure 2 If the profit matrix does not change in the second period, the manager will continue to desire that the workers apply left-handed skills. And this can be assured by offering compensation that matches the workers 1 reservation utility of U0 only if profit generated is BLL . Interestingly, were the manager to offer even higher compensation, of say U0+"G (where 0<"<1) if 1 the profit generated in the second period is not BLL , the workers would still apply their left-handed skills. This is because the workers care about their utility, not compensation, and profit other than BLL can only be realized if they incur an effort disutility of G to develop right-handed skills. We now consider the case in which the second period profit matrix changes such that right-handed 2 2 2 2 skill application is decidedly better: BRR > BLL > BLR ' BRL . The cost to each worker of the added effort to develop right-handed skills notwithstanding, the RR equilibrium is superior to the LL equilibrium: 2 2 BRR & BLL > 2G . Yet, as we demonstrate below, the organization can find itself stuck in the LL equilibrium. B. Why shifting from LL to RR is difficult
1

It would seem that in order to motivate the workers to develop right-handed skills the manager need only offer compensation such that the utility of implementing the RR equilibrium is greater than that of 2 2 implementing LL. Offering the workers U0+G each if the profit generated is BRR , 0 compensation if it is BLL , would lead the workers to prefer developing right-handed, to applying left-handed, skills, since the former would yield a net utility of U0, the latter 0. It is not sufficient, though, for the manager to be concerned only with the two coordination equilibria. The workers must also be convinced that they will not be penalized if an uncoordinated equilibrium results. It is this requirement that makes organizational change difficult. Workers concern about their payoffs in the event that coordination fails implies that two types of assurances are needed to motivate them to make the change from applying left-handed skills to developing and applying right-handed skills. To make RR the dominant equilibrium, the compensation schemes offered to the workers must satisfy two incentive compatibility conditions.

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(1) security14: a worker is not penalized for developing skill R if the other worker defects by applying skill L to the task; and (2) payoff dominance: if the other worker has invested in skill R, defecting by applying skill L does not pay. Security requires that workers be excused if chaos ensues, that is, they end up at least as well off as when coordinating in the LL equilibrium. The workers are thus told that they will be paid more if chaos occurs than if the old equilibrium persists. As skill is not directly observable, the workers must be compensated on the basis of output. Unable to identify which worker has not developed the requisite skill, the manager pays them equally. Payoff dominance, on the other hand, assures workers of higher utility if the RR equilibrium results than if there is no coordination. The manager must offer higher compensation if the optimal equilibrium (rather than chaos) results. Hence, workers should be offered the lowest compensation if the earlier equilibrium results. The lowest compensation the manager can offer a worker is 0, if extortion is proscribed. If workers are told they 2 will receive 0 compensation if BLL units of profit are generated (LL equilibrium), security requires that each be offered compensation of at least G if profit BLR is generated (LR or RL equilibrium). Offering each worker compensation of G % ,1 (where ,1>0) if profit BLR results ensures that they feel confident developing the new skill even if their colleague does not develop it. The worker who does not develop the right-handed skill receives a utility of G % ,1 if chaos results. Payoff dominance requires that the workers find it beneficial to develop right-handed skill. The 2 manager thus needs to offer the workers compensation of at least 2G % ,1 each if profit BRR results (RR equilibrium). Workers are offered compensation of 2G % ,1 % ,2 (where ,2>0) if profit BRR results. These are efficiency wages compensation that yields utility in excess of reservation utility. The workers utilities are as shown in Figure 3, in which RR is, indeed, the dominant equilibrium.
2 2 2

14

The terminology is that used by Van Huyck, Battalio, and Beil (1990) in describing coordination games.

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B L L A R ,1 0 G+,1 G+,1+,2 0 G+,1 G+,1+,2 R ,1

Figure 3 If, however, each worker is paid 2G % ,1 % ,2 in the RR equilibrium, the manager may find it preferable to implement the LL equilibrium by offering the workers compensation of U0 each if they generate BLL units of profit, G units of compensation otherwise. As can be seen in Figure 4, there is a range of profitability values for which, even though it is a superior outcome, the RR equilibrium is not implemented and the organization remains stuck in the old LL equilibrium.
2

RR BETTER

ARR
STUCK

4G-2U0
LL BETTER CLOSE DOWN

2U0

ALL
Figure 4

Here we have the reason that organizations become stuck in existing equilibria. In order to effect change, the manager must offer each worker not one, but two forms of assurance that together translate into a compensation level for implementing the optimal equilibrium that is unacceptably high from the managers perspective.

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Consider these two forms of assurance in the context of the companies described in Section II. If performance declined during the transition, the manager ought to excuse the workers rather than try to apportion blame. The manager thus needed to convey to the workers that chaos was a less unwelcome result than persistence of the status quo. Were the entire workforce to make the transition, performance would improve. The manager needed to convey to the workers that they would be handsomely rewarded if this were to happen. To make both assurances credible, a manager would have to create a significant differential between what workers would receive if the desired state were to be achieved versus and what they would receive if the existing state were to persist. Often this is done by extolling the virtues of moving to the desired state while simultaneously characterizing the present state as a burning platform. The leaders job is to help everyone see that the platform is burning, remarks Allied Signals chairman and CEO Lawrence Bossidy, whether the flames are apparent or not. The process of change begins when people decide to take the flames seriously... (Tichy, and Ram Charan, 1995). Such a contention, however, has a lower bound in that utility below a certain level for not making the transition is simply non-credible.

VI.

Strategies for implementing organizational change

Given an organization stuck in a sub-optimal equilibrium, what can a manager do to help the organization embrace needed change? We consider first two seemingly obvious and simple strategies that would not help, then five strategies that would. The keys to implementing change in an organization are: create winners among the workers, identify part of the workforce as change agents, shuffle the taskassignments of workers, initiate change with some sort of kick-off, and shaking the organizational tree by making the change process itself a disequilibrating experience for the organization. A. The stick isnt quite as effective as the carrot

Rather than sell the RR equilibrium, why not threaten dire consequences if workers persist in the LL equilibrium. A manager might, for example, offer U0+G units of compensation if the profit generated is 2 2 BRR , U0-,1 units of compensation (where 1, >0) if the profit generated is BLR , and 0 U -G1 2, -, units of compensation (where ,2>0) if the profit generated is BLL . Figure 5 plots the workers utilities for this set of circumstances. The dominant equilibrium RR is preferred by the manager too. B L A L U0-G-,1-,2 R U0-G-,1 Figure 5 Workers are warned away from the LL equilibrium by telling them, If a gross profit of BLL occurs, you will each be fined (since U0<G). Employment being a voluntary relationship, however, such a threat is not credible. A worker whose utility falls below a threshold, say 0, can simply walk away from the offending relationship. It is generally impossible to charge workers an ex-post penalty. Asking the workers to post bonds -152 2

R U0-G-,1-,2 U0-,1 U0-,1 U0 U0 U0-G-,1

up-front and forfeit them if they implement the LL equilibrium might be construed to circumvent the ex-post issue. But the legal standing of ex-ante employee bonds is tenuous, at best. B. Simply making the desired equilibrium more attractive to the workers isnt sufficient

Must RR be made a dominant equilibrium? Wouldnt it suffice, workers being rational and selfinterested, if it were simply the most attractive of several possible Nash Equilibria? Returning to our model, Figure 6 plots workers payoffs given compensation of U0+G if a profit 2 2 is generated, U0-,1 if a profit of BLR is generated, and 0 units if a profit of BLL is generated. Both LL

2 of BRR

and RR being Nash Equilibria, and workers being better off in the RR equilibrium, the latter would seem to be the logical choice. B L L A R U0-G-,1 0 U0-,1 U0 0 U0-,1 U0 R U0-G-,1

Figure 6 The coordination game described in Figure 6 has been studied extensively by game theorists. They have given this class of game an interesting name, the stag hunt (Aumann, 1990) in acknowledgement of the stag hunt parable discussed by Rousseau in motivating his analysis of the social contract. Two hunters can collaborate in a stag-hunt (RR equilibrium) or individually hunt a rabbit (LL equilibrium). If only one hunter chooses L, that hunter benefits, since an individual can hunt rabbit; the result for the other hunter, who has chosen R, is a wild stag chase, since stag hunting requires coordinated effort by the hunters. If the two hunters could coordinate, they would engage in a stag hunt. If they do not, they are unable to implement the superior equilibrium. Faced with two Nash Equilibria, how will the players behave? Game theorists Harsanyi and Selten (1988, p. 81) argue in favor of the RR equilibrium because it payoff-dominates the LL Nash Equilibrium. Yet, laboratory experiments involving many participants indulging in multiple choices over several periods suggest that such is not the case. History matters enormously in such games: players opt for equilibria they have implemented before (Van Huyck, Battalio, and Beil, 1991; Knez and Camerer, 1994). Considerations of security, moreover, promote a focus on the inefficient rather than payoff dominant Nash Equilibria (Van Huyck, Battalio, and Beil, 1990; Cooper et al, 1990; Knez and Camerer, 1994). In our model, the workers, having coordinated on the secure LL equilibrium in the first period, tend, in the second period, to stick with it, notwithstanding that the RR equilibrium is payoff-dominant. The defense equipment companys purchase executives knew that it was better for both the firm and them personally to centralize the purchase of key items, the commercial vehicles companys marketing executives that demanding production against their forecasts would be better for both them and for the company, yet uncertainty about -16-

how their counterparts in manufacturing would behave led both sets of executives to prefer to remain with the status quo. C. Creating winners helps

Whether it is the software professionals in Bangalore, the consulting firms industry heads, the commercial vehicles firms marketing executives, or the defense equipment firms purchase officers, some members of the organization gain more from the change program than the others, either in terms of compensation or in terms of power and status. Some of this asymmetry in rewards may be due to intrinsic differences in tasks and workers skills, but even if the tasks are similar and workers are entirely identical, managers may want to create winners who will champion the change process. In our model, assume that worker A is offered higher compensation than worker B. A is offered

2G % ,1 % ,2 if profit BRR results, G % ,1 if profit BLR results, and 0 if profit BLR results, whereas B is only
offered U0 % G if profit BRR results, and 0 otherwise. Figure 7 plots the utilites of the workers in those circumstances. B L L A R ,1 0 0 G+,1+,2 0 G+,1 U0 R -G
2

Figure 7 Bdoes not have to be offered security since A will definitely develop right-handed skill. The cost of making the transition becomes less onerous since only part of the workforce is being offered efficiency wages. However, by creating winners, and by implication, losers, such a process can lead to demotivation, jealousy, and politicking, effects that may prove deleterious to organizational well-being. D. Designating some workers change agents helps

Change agents appointed from the work force can help a manager pull an organization from an inefficient towards a superior equilibrium. And the rationale for that has to do with more than some workers being more amenable than others. Even among workers identically disposed to the prospects of change, identifying some as leaders simplifies the coordination task. The designated leaders developing new skills in the full glare of publicity encourages their associates to follow suit. In our model, suppose the manager decides to anoint as change agent one of two workers with identical proclivities, say A. Suddenly, the skills developed by A are no longer unobservable by B. If the manager 2 offers the workers compensation of U0+G units if BRR profit results and 0 units otherwise, they face the game

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sketched in Figure 8. Once skill development by A is observable by B, the desired equilibrium becomes the only Nash Equilibrium.

Figure 8 The consulting companys AMP named some of the country executives regional managers in the new organization. Thus identified as leaders in the change process, these executives began to push for the new organization. Recognizing that they were moving in the direction of cross-border assignments, the remainder of the executives in the geographical organization followed suit. Management scholars stress the importance of identifying within the organization change agents or task forces to lead the change effort (Lippitt, Langseth, and Mossop, 1985, pp. 55-59). Duck (1993, p. 116), for example, emphasizes the value of establishing a clearly defined management team to lead the change process. As the foregoing analysis suggests, task forces and management teams perform the critical function of leading in the change process so as to give others the confidence to follow in their footsteps. Intriguingly, this model suggests that hierarchical organizations in which workers can intensively monitoring one anothers actions may be able to implement organizational change more effectively than network firms with empowered workers who develop skills with little mutual monitoring. F. Shuffling the workforce helps

The cost of acquiring a new skill serves to keep organizations stuck in existing equilibria. Other things being equal, workers prefer to use existing skills rather than develop new ones. This root cause of resistance to change can be mitigated by making workers indifferent to different skills. This is done by changing the workers themselves. It may involve rotating the work force such that a significant number of workers are new to their jobs. In the extreme, it may mean firing some workers and hiring others. Ideally, managers decide which workers to move based on their differential capabilities. But even if workers are entirely identical and their reassignments decided by the flip a coin, the mere fact that some are moving will help pull an organization out of an inefficient equilibrium. The reason new assignments help the change process is that new workers are equipoised in their attitudes to old and new skills, and can be motivated to learn the new skills by a small difference in compensation. Understanding that the compensation structure will motivate new workers to develop new skills, and wanting to avoid the uncoordinated outcome, workers who have stayed in their jobs will also develop the new skills. The logjam of workers sticking to old habits is thus broken and the organization transitions to the superior equilibrium. -18-

In our model, assume that the flipping of a coin determines that worker B is to be replaced by a new worker B! whether through firing and hiring or job-rotation and both A and B! are offered compensation 2 2 2 U0+G if a profit of BRR is generated, U0-,1 (where ,1>0) if a profit of BLR is generated, and 0 if a profit of BLL is generated. The game these workers would confront is charted in Figure 9. B! L L A R U0-G-,1 Figure 9 The only Nash Equilibrium the workers can achieve is RR, the reason being that the compensation schedule makes learning the right-handed skill the dominant choice for the new worker, B!. Given that B! is definitely going to develop the right-handed skill, A does so without any offer of security. In practice, we observe that organizational change programs are often accompanied by job reassignments and/or the firing of part of the work force and hiring of new employees. Although to some extent, this may be motivated by a desire to achieve a better fit between people and the changed tasks, the foregoing analysis suggests that a major benefit of getting fresh people in is that it helps an organization break out of established habits. In the wake of the AMPs announcement that widespread reassignments would accompany the consulting companys reorganization, a number of country executives were moved to regional offices or to new industry-oriented positions. Executives responsibilities were shuffled to ensure that they were not heavily invested in the existing system. F. A kick-off can help initiate change 0 U0-,1 U0 -G U0-,1 U0 R U0-G-,1

Six months into his failed attempt to introduce change, the CEO of the commercial vehicles company realized that one reason the change program had not taken hold was that there had been no sharp point of departure. Reorganization and reassignments in the consulting company, in contrast, had been made effective on a particular date. The software company had implemented its change program on an aggressive time-bound schedule. The chief executives of both the consulting and the software companies announced specific dates for initiating organizational changes and prefaced their change programs with group meetings and seminars. These fora and advance notice afforded workers opportunities to freely exchange concerns about and attitudes towards impending changes. The chief executives used these settings and other formal and informal mechanisms to continuously sell the desired changes to their subordinates. A kick-off such as that employed by the consulting and the software companies (1) signals a clean break from the past, (2) affords an opportunity for workers to inform one another whether or not they are going to make the switch, and (3) offers managers an opportunity to exhort workers to make the desired switch. Are any of these features of a kick-off significant to the prospects for effective change? -19-

Nominating a specific date on which change will become effective enables workers to coordinate on a focal time. In the absence of such a date, workers must confront uncertainty on two dimensions: (1) who will make the change, and (2) when will they make it? Establishing a kick-off date eliminates one of these sources of uncertainty, significantly reducing the risk of non-coordination and thereby increasing the possibility that workers will make the transition in a coordinated manner. We now consider the power of mutual communication among workers. It would seem, at first blush, that discussions among workers would be unlikely to alter equilibria choices. Such communication is, after all, what economists call cheap talk: costless, nonbinding, and nonverifiable (Aumann, 1990; Farrell, 1987). Returning to Figure 6, A, even if intending to apply left-handed skills, will want to convince B otherwise. As non-credible promise to play R should be ignored by B. A number of researchers, however, have argued that, when multiple Nash Equilibria exist, such communication can help bring one of the equilibria to salience (Crawford and Sobel, 1982; Farrell and Gibbons, 1989; Van Huyck, Gillette, and Battalio, 1992). Farrell (1995) has speculated with respect to Figure 6, that if B is uncertain whether A will play L or R, As talk might influence this subjective probability and thereby might affect Bs choice. Overall, it seems reasonable to make the weak claim that ex-ante communication among the workers does not harm, and may actually help, an organizations change effort. Next, we consider the importance of managers exhortations to workers regarding their skill choice. The underlying question here is: Why would workers be disinclined to trust a managers exhortations to change? The problem is one of asymmetric information: workers are not as well informed as managers about all the ramifications of proposed changes, and worry that they are being sold a bill of goods that may eventually be harmful to them. Managers can overcome worker distrust by offering a credible guarantee of their own belief in the value of a change program. This entails a shift from the realm of cheap talk to that of committed action. Credible actions include investment of management time (which has a high opportunity cost) and putting ones reputation. Workers understand that managers incur a cost when they continuously promote a change program. Exhortations that genuinely represent a managers best estimate of the future cost considerably less than dissembly (since the dissemblers reputation will be sullied when workers discover the exhortations to be false). A manager who knows the future is not very rosy is not prepared to bear the cost of a sullied reputation, hence, only honest managers exhort workers to change and workers believe their exhortations.15 Of course, the signaling argument can work equally powerfully in the opposite direction. Recognizing that signalling that change will be especially painful can increase their compensation, workers may waste considerable time and energy complaining how grevious the change will be for them. Managers can counter such complaint signalling by announcing that workers who feel that change will severely hurt them can quit by taking a severance package. Such an announcement achieves the twin objectives of truly allowing potentially most resistant workers to leave and restricting complaint signalling. One can thus make the claim that a managers constant exhortations to change are likely to help shift the organization to the superior equilibrium. This is consistent with management scholars advice that

Technically, a separating equilibrium exists in the signaling game between manager and workers: a manager who stands to derive personal gain from a non-value enhancing change keeps quiet; only a manager who knows that change will be beneficial incurs the cost of exhorting workers.

15

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continuous evangelizing is crucial to the successful implementation of a change program (Vandermerwe and Vandermerwe, 1991; Kotter, 1995). The importance of achieving impact through intensive communication is portrayed vividly by Duck (1993, p. 111): If there is a single rule of communications for leaders, it is this: when you are so sick of talking about something that you can hardly stand it, your message is finally starting to get through. People in the organization may need to hear a message over and over before they believe that this time, the call for change is not just a whim or a passing fancy. G. Rocking the boat hard helps implement change

The consulting companys AMP introduced reorganization in the company with massive reassigments, a new strategic approach, and an announcement that he believed that effective reorganization was absolutely essential to the companys future competitive success. In contrast, the CEO of the commercial vehicles firm, although he introduced the weekly production planning meeting, changed very little else about the way the company was run. Recall that the change process was successful in the consulting company, whereas it stalled in the commercial vehicles company.

VALUE

DISEQUILIBRATION REQUIRED

CURRENT STATE

ORGANIZATION

DESIRED STATE

Figure 10 A number of managers who have led organizational change efforts have vouched for the importance of making the change process itself a disequilibrating experience for the organization. ABB Germany underwent a host of dramatic changes in a major restructuring program begun in 1988. The successful completion of of that program in 1990 led prsident of the executive committee Eberhard von Koerber to reflect: In 1988, the limit to my actions was that I did not want to rock the boat so hard that it would sink. Today, in retrospect, I feel I could have rocked the boat a bit more and that I had some more room than I thought at the time. (Uyterhoeven, 1993, p. 12).

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In light of the foregoing observations and the descriptions presented in Table 2, it would seem that practitioners experience the challenge of implementing organizational change to be akin to the process sketched in Figure 10. It is the conviction that subordinates will believe that real change is occurring only if turbulence crosses a minimum threshold that leads managers to prescribe rocking the boat hard. Observed Lawrence Bossidy, chairman and CEO of Allied Signal: Companies dont change incrementally. They change in quantum jumps. If you shoot for anything less, you dont get any change. (Tichy and Ramcharan, 1995, p. 78).

VII.

Coming events cast their shadows before

We have thus far examined the circumstances of organizations challenged to make desired change. Moving back in time, one wonders if expectations about future strategic changes influence current organizational choices. We argue here that they do. Workers in firms that have long time horizons make greater investments in skill development. In the face of imminent change, a manager may be well advised to initiate incremental adjustments that render the organizations configuration appropriate to future circumstances. Radical organizational change is dictated only by drastic strategic change. A. Future promise spurs current industriousness

A long time horizon fosters investment in skill development even if the investment exceeds current rewards. Consider a firm facing the payoff matrix 2G > BLL > BRR > BLR ' BRL . Workers concerned about productive activity over only one period would not want to develop any skill. If, on the other hand, they expect productive activity to extend into the future, with future returns discounted by a factor * such that 1 BLL (1 % *) > 2G , they would prefer to develop the left-handed skill in the first period, the reason being that the handsome future profits generated by the application of the skills developed in the first period more than compensate for the first period cost of development of those skills. This result matches the commonly observed phenomenon that employees work hard early in their careers as they are developing skills (period 1) and tend to slacken and enjoy the fruits of their hard work later in their careers (period 2) (Holmstrm, 1982). Whether software programmers or consultants, the promise of future applicability of skills they are currently developing spurs workers to intensively develop their skills. B. Radical versus incremental change

The analyses presented here also bear on the question of whether to initiate incremental organizational change in anticipation of an imminent strategic change, or wait for strategic change to occur and then implement radical organizational change. If preponing the change is less costly than the disruption caused by sudden change, the manager might well prefer to configure the organization in anticipation of future circumstances. If, on the other hand, the strategic change is drastic, the manager should initiate radical organizational change. In our model, the manager knows that applying the left-handed skill brings the most profit in the first 1 1 2 2 period ( BLL > BRR ), applying the right-handed skill the most profit in the second period ( BRR > BLL ). Implementing organizational change is costly; it involves reassigning workers, starting change programs, and so forth. Assume the cost of implementing change to be ). The manager has two choices: (1) encourage workers to develop the left-handed skill in period 1 and then institute a change program to develop the right-22-

handed skill in period 2, and (2) prepare for period 2 in period 1 by motivating workers to develop the righthanded skill in period 1.

ARR
RR

PREPONE RR

CLOSE DOWN

* [2G+)]

ALL

We assume that RR is the optimal skill for period 2.

Figure 11 The decision hinges on trading off the cost of instituting the change program [ * ( 2G % ) ) ] against the opportunity loss due to first period misalignment [ BLL & BRR ]. As suggested in Figure 11, if the first term is greater, the manager proactively prepares for a coming strategic change. If, on the other hand, the payoff in period 1 strongly favors application of the left-handed skill, the manager prefers to implement organizational change only after the strategic change has occurred. This model suggests the trade-off a prescient manager must consider when deciding whether to implement change in an incremental or a radical manner. When the opportunity cost of preparing for the future is not very high and the saving from extending the change program over a long time horizon is significant, the manager is prepared to take lumps in the present in order to avoid the pain of wrenching organizational change later. If, on the other hand, a drastic strategic change occurs such that very different skills are appropriate before and after the change and the cost of implementing the change does not vary significantly with the duration over which it is implemented, the manager is prepared to face the disruption of implementing radical organizational change in order to ensure that the organization is suitably configured to the strategic requirements both before and after the change.16 Suddenly confronted by changed industry dynamics relaxation of licensing rules and an industry quickly flooded by entrants from abroad the commercial vehicles companys CEO faced the challenge of implementing radical organizational change. The consulting companys AMP, in contrast, foresaw that customer needs were becoming increasingly pan-European and reorganized the European operations in
1 1

16 Radical organization change may also be necessitated by the occurrence of an unexpected strategic change. An event that the manager had assigned a low subjective probability of occurrence comes to pass. This may occur because the manager was incorrect in judging the future or because the change was indeed a random phenomenon. In either case, the result is that the manager is faced with having to adjust to the changed circumstances. This adjustment may necessitate radical organizational realignment.

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anticipation of acceleration of this trend. Rather than move in one step to a European organization, he took the intermediate step of establishing three regional offices, believing such a change trajectory would be less traumatic for and more beneficial to the company.

VIII. Conclusion
When change programs grind to a halt, managers tend to place the blame on the non-rational behavior of others. We suggest that the root cause of such logjams may well be the way change programs are implemented. Subordinates are encouraged to change by driving a wedge between their well-being in the current state and their well-being in the desired state. But managers may simply be unprepared to incur the cost of driving this wedge. We suggest that organizational inertia is best addressed by such complementary approaches as identifying winners, shuffling part of the work force, nominating change agents from among the workers, starting with a kick-off event, and making the process a vigorously disequilibrating phenomenon for the organization. If a slow pace is less traumatic for the organization, change should be implemented incrementally, but if strategic change is so drastic as to render the cost of organizational misalignment extremely high, the manager should accept the necessity of introducing wrenching change and implement organizational change radically.

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