Evolution toward Fit Nicolaj Siggelkow · 2020-01-07 · #9133—ASQ V47 N2—March 2002—file:...

#9133—ASQ V47 N2—March 2002—file: 05-siggelkow

This paper uses a longitudinal case study of the mutualfund provider, The Vanguard Group, to understand thedevelopmental processes that lead to organizational con-figurations and fit. A new method for determining anorganization’s core elements is developed, and fourprocesses are identified that describe the creation andsubsequent elaboration of these core elements: thicken-ing (reinforcement of an existing core element by newelaborating elements), patching (creation of a new coreelement and its reinforcement by new elaborating ele-ments), coasting (no further elaboration of a new coreelement in a given period), and trimming (deletion of acore element and its elaborating elements). The fourprocesses are used to describe organizations’ develop-ment paths toward configurations and their transitionsbetween configurations, including two new ideal types,termed thin-to-thick and patch-by-patch, as well as twoknown paths between configurations, the punctuatedequilibrium path and reorientation through linear pro-gression.•Scholars in a variety of literatures have conceptualized firmsas systems of highly interdependent elements (e.g., Miller,1981; Milgrom and Roberts, 1990; Porter, 1996; Levinthal,1997; Whittington et al., 1999). In these analyses, organiza-tional elements such as firms’ activities, policies, structuralelements, and resources are seen to form complex systems,or configurations. Although scholars have established a longtime ago that consistency, or internal fit, among an organiza-tion’s elements is positively correlated with performance(e.g., Khandwalla, 1973; Drazin and Van de Ven, 1985),research about how organizations evolve toward such config-urations of tightly reinforcing elements is much less devel-oped (Miller, 1996). Moreover, no adequate vocabulary existsthat would allow a consistent description of organizations’developmental paths toward configurations—a vocabularythat would be helpful in developing further theory that linksorganizational development and organizational performance.

In describing organizations, many scholars have argued thatsome organizational elements are more central or core to anorganization than other, more peripheral elements (Hannanand Freeman, 1984; Singh, House, and Tucker, 1986). Forinstance, Hannan and Freeman (1984: 156) identified as“core aspects of organization” the organization’s statedgoals, its forms of authority, its core technology, and its mar-keting strategy. While the distinction between core and non-core elements has become common in the organizationalliterature, little progress has been made to date in distin-guishing them systematically. As a result, Hannan, Burton,and Baron (1996: 507), summarizing the research efforts con-cerning organizational core elements, concluded, “Althoughthere seems to be a general agreement that some organiza-tional features fall nearer the core than others, we see noconsensus on exactly what constitutes the core.”

To better understand the nature of core elements and theunderlying developmental processes that lead to configura-tions, I engaged in an inductive study of the developmentalpath of The Vanguard Group, the second-largest mutual fundprovider in the U.S. Through an iterative process, involving

125/Administrative Science Quarterly, 47 (2002): 125–159

© 2002 by Cornell University.0001-8392/02/4701-0125/$3.00.

•I would like to thank Daniel Levinthal,Christine Oliver, Michael Porter, DanielRaff, Claus Rerup, Jan Rivkin, LoriRosenkopf, Harbir Singh, Gabriel Szulan-ski, Christian Terwiesch, Sidney Winter,Mark Zbaracki, Rosemarie Ziedonis, threeanonymous reviewers, and seminar par-ticipants at the University of Pennsylva-nia, University of Münster, the StrategicManagement Society Meeting 2000, andthe University of Utah and Brigham YoungUniversity Winter Strategy Conference2001 for helpful comments. All remainingerrors are mine.

Evolution toward Fit

Nicolaj SiggelkowUniversity of Pennsylvania

the data of the case, existing literature, and broader concep-tual reasoning about organizational evolution, I identified fourdevelopmental processes that were intimately related to thecreation and further elaboration of organizational elementsthat had core characteristics. To define these developmentalprocesses more tightly, a characterization of organizationalcore elements was required that allowed a systematic identi-fication of such elements. As a result, the inductive study ofthe developmental processes went hand-in-hand with creat-ing a methodology that allowed the identification of an orga-nization’s core elements at various points in theorganization’s history. To identify core elements, the notion ofinteractions among the elements of an organizational systemplayed a key role.

ORGANIZATIONAL CORE ELEMENTS ANDORGANIZATIONAL SYSTEMS

In previous work, core elements of organizations have beenidentified by declaring ex ante a number of critical activitydomains and then selecting variables that represent thesedomains. For instance, Miller and Friesen (1982), in theirstudy on quantum changes, measured structural variablesfalling into three categories: uncertainty reduction (e.g., useof formal rules), differentiation (e.g., decentralization), andintegration (e.g., use of coordinative committees). In a similarvein, Romanelli and Tushman (1994: 1147), in testing thepunctuated equilibrium model, argued that organizational cul-ture, strategy, structure, power distributions, and control sys-tems are “important to organizational survival and central toorganizational activities” and thus form core activity domains.Changes in these activity domains were measured by intro-ductions of new product lines (strategy change), by generalreorganizations of the firm (structural change), and byturnover of senior executives (power distribution change).Due to data limitations, they dropped the culture and controlsystems domains from their analysis.

The advantage of an ex ante specification of core elements isthat changes in these elements can be measured consistent-ly across firms. The disadvantage of this approach is that itassumes that the same elements are equally central or corein all firms. Empirical evidence suggests, however, that thesame elements are not equally central in all firms. Forinstance, Singh, House, and Tucker (1986) argued that chiefexecutive change is a peripheral change in their sample ofvoluntary social service organizations, while Romanelli andTushman (1994) coded such a change as a core change fortheir sample of minicomputer producers. The ex ante specifi-cation approach also implies that the number of core ele-ments is constant across different firms and constant overtime for any given firm. Rather than specifying core elements(or domains from which core elements are selected) ex ante,it may be preferable to identify core elements more directly.

Even though the organizational literature contains no agree-ment as to what particular elements should be included in anorganization’s core, consensus exists as to the properties ofan organizational core element. In particular, an element issaid to belong to the core if it has one of the following two

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features: (1) a high interdependency with other current orga-nizational elements and (2) a large influence on future organi-zational elements. As to the first property, Hannan, Burton,and Baron (1996: 506) noted: “A feature forms part of theorganizational ‘core’ if changing it requires adjustments inmost other features of the enterprise. A feature lies at theperiphery if it can be changed without imposing changes onother features. . . . Coreness means connectedness, ele-ments in the core are linked in complicated webs of relationswith each other and with peripheral elements.” Thus, an ele-ment is core if it interacts with many of the organization’sother elements. The second property of a core element is itsprofound effect on future organizational elements. Studyingcore elements of employment relations, the sum of whichthe authors call an “organizational blueprint,” Baron, Hannan,and Burton (1999: 531) noted, “once formulated and articulat-ed, a founder’s organizational blueprint likely ‘locks in’ theadoption of particular structures; it also ‘locks in’ certainpremises that guide decision-making.” Thus, an element is acore element if it affects or interacts with many future ele-ments. Taking both features of core elements into account, Idefine an organizational core element as an element thatinteracts with many other current or future organizational ele-ments.

This definition implies that the number and identity of organi-zational core elements might not be constant over time. Overany period of time, a firm might add a new core element,delete a core element, or replace a core element with a newone. Besides changing core elements (typically a rare event),an organization is engaged in supporting or elaborating itscore elements. For instance, as will be described in moredetail later, one of Vanguard’s core elements was a policy toengage in candid communication with its clients. Other orga-nizational activities that elaborated this core element includedclearly written annual reports, letters to shareholders warningthem that high performance of certain funds was unlikely tocontinue, and “Plain Talk” brochures that explained funda-mental issues of investing. Each core element of an organiza-tion is thus supported over time by a series of elaboratingelements, which are defined as organizational elements thatreinforce existing core elements.

The definitions of core and elaborating elements use theterms interaction and reinforcement, which deserve furtherexplanation. I use a definition of interaction that has beenused in the literature on complex interdependent systems(e.g., Rivkin, 2000). Two elements are said to interact if thevalue of one element depends on the presence of the otherelement. In particular, two elements are said to reinforceeach other if the value of each element is increased by thepresence of the other element, that is, if the two elementsare complementary to each other (Milgrom and Roberts,1990). Examples of reinforcement can be found, for instance,in Raff’s (2000) description of the bookstore chain Borders.Given Borders’ focus on having a wide assortment of booksavailable in each store, investments in software that allowedtracking of inventory and enabled better sales forecastsbecame more valuable. Conversely, given a sophisticated

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inventory and procurement system, an increase in bookselection within stores was made economically more feasi-ble. Both elements reinforced each other. Analogously, in thecontext of manufacturing, flexible manufacturing systemsand wide product variety are complementary elements, rein-forcing each other: the wider the product variety, the morevaluable are investments in increasing the flexibility of themanufacturing system; and conversely, the more flexible themanufacturing system, the greater the benefit (i.e., the lowerthe cost) of increasing product variety (Jaikumar, 1986; Mil-grom and Roberts, 1990).

Interactions can exist both between and among elaboratingand core elements. An elaborating element usually reinforcesat least one core element, and each core element interactswith many elaborating elements. An elaborating element mayinteract with more than one core element and with otherelaborating elements as well. Not every elaborating elementhas to interact directly with a core element. An element mayelaborate a core element indirectly via another elaboratingelement that directly interacts with the respective core ele-ment. Finally, core elements themselves may interact witheach other. A firm with many organizational elements thatreinforce each other is said to have a high degree of internalfit (Siggelkow, 2001). This notion of fit is consistent withMiller’s (1996: 511) suggestion that “the fit among the ele-ments of an organization may be evidenced by the degree towhich strategy, structure and systems complement oneanother.”

Not all organizational elements interact with each other. If thevalue of an element is independent of the presence of anoth-er element, both elements are said to be independent fromeach other. Moreover, a firm may adopt elements that areinconsistent. For instance, in the early 1980s, many U.S.firms did not pair their investments in flexible manufacturingsystems with a change in product variety or increased train-ing for their employees but continued with high-volume pro-duction of a few parts produced by employees with relativelylow levels of skill (Jaikumar, 1986). The combination of thesechoices created a misfit between manufacturing and productstrategy, leading to a decline in performance as comparedwith using conventional technology (Jaikumar, 1986).

At any point in time, one can thus describe a firm as an orga-nizational system composed of various types of elements(core elements, elaborating elements, independent elements,and inconsistent elements) and the interactions among theseelements.1 This conceptualization of an organizational systemhas a close parallel in Porter’s (1996) notion of an activity sys-tem and in Miller and Friesen’s (1984) notion of a configura-tion. The concept of an organizational system is broader,however, than the notion of a configuration. The term config-uration usually implies that the core elements are reinforcing,such that the overall system is in a state of coherence orconsistency. For instance, Miller and Friesen (1984: 21)noted, “Configuration, in essence, means harmony.” In con-trast, an organizational system may well consist of core ele-ments that are not reinforcing. A possible definition ofconfiguration is thus an organizational system with no incon-

1Formal representations of such organiza-tional systems have been studied byGavetti and Levinthal (2000), Ghemawatand Levinthal (2000), Rivkin (2000), andRivkin and Siggelkow (2002).

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sistent core elements and a number of reinforcing core ele-ments.

The existing literature thus provides a number of conceptsthat allow one to describe an organization at a point in time:at the detailed level of the organization’s core elements, itselaborating elements, and the interactions among these ele-ments or, at a higher level, by matching the organization’sconfiguration to one of the configurational ideal types pro-posed by various researchers (e.g., Burns and Stalker, 1961;Miles and Snow, 1978; Mintzberg, 1979). How an organiza-tion evolves over time toward such a full-fledged configura-tion and how to describe such development appear to beopen questions, however. It was to answer such questionsthat I undertook the inductive study of The Vanguard Group.

METHODS

Research SettingStudying the underlying processes of organizational develop-ment required a research setting that allowed an analysis ofan organizational system, comprising elements and interac-tions, at various points in time. The Vanguard Group had sev-eral features that made it suitable for this purpose. First,Vanguard was founded in 1974, providing more than 20 yearsof data, while members of the firm could be interviewed,including the founder, who had experienced the entire historyof the firm. Second, and more important, founder JohnBogle, who played a pivotal role in the development of Van-guard, had been a prolific writer, penning dozens of speechesand memos throughout his career, even before becoming theleader of Vanguard. These documents provided an excellentopportunity to gain insights into the contemporaneous think-ing of Bogle at various points in Vanguard’s history. Moreover,these documents served as a check to retrospective sense-making and potentially biased memories of interviewees(Golden, 1992). Third, due to its unique organizational struc-ture (explained below), Vanguard enjoyed extensive presscoverage, generating a large amount of secondary data thatwere helpful in identifying Vanguard’s organizational systemthroughout its history.

Data Collection

To map out Vanguard’s organizational systems, I used a longi-tudinal case-study design (Eisenhardt, 1989). The researchwas carried out in three stages. In the first stage, I primarilyrelied on secondary sources and several company documentsto develop a chronology of Vanguard’s organizational ele-ments from its inception to the beginning of 1997. I furtherstarted to identify interactions among elements and to createmaps displaying the elements and interactions. In the secondstage, I engaged in a series of interviews with members ofVanguard’s management team to amend the maps. I dis-cussed both the elements contained in the maps and theinteractions among them. The third stage involved in-depthinterviews with John Bogle and an analysis of the memoran-dums and speeches he prepared throughout his career, lead-ing to further refinement of the maps. While these threestages broadly describe the research process, the overall cre-

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ation of the maps depicting the organizational systems wasmuch more iterative. Whenever I gathered new informationeither through interviews or archival material, I triangulated(Miles and Huberman, 1984: 234) the information throughinterviews with different members of the organization orthrough other archival material before refining the maps.

Stage 1: Analysis of archival data. An extensive search onLexis-Nexis for articles written about Vanguard in trade jour-nals and magazines yielded approximately 500 articles thatwere used to identify the elements of Vanguard’s organiza-tional systems over time. A biography of Bogle (Slater, 1997)and company documents provided further information. Tosystematize the analysis, I found it helpful to lay out the ele-ments of a typical value chain (Porter, 1985) of a mutual fundprovider (detailed below). The different stages of the valuechain provided helpful categories for grouping elements andto ensure that elements from all stages of the value chainwere included for analyses at different points in time.

After the organizational elements for a particular year hadbeen recorded, I identified interactions among the elementsusing the logic outlined in the previous section. For each twoelements A and B, I assessed whether the value of elementA was dependent on element B and, in particular, wasstrengthened by element B, or not. A common thoughtexperiment was, if Vanguard did not engage in element B,would the value of element A be affected and, in particular,decrease? A similar approach for establishing the comple-mentarities among the set of activities the Lincoln ElectricCompany engaged in can be found in Milgrom and Roberts(1995). Identifying elements and interactions was only prelim-inary, serving as a starting point for the subsequent inter-views. Putting elements and interactions together, I createdmaps of Vanguard’s organizational systems for its foundingyear, 1974, for 1977, when Vanguard internalized its distribu-tion, for 1981, when Vanguard started internal asset manage-ment of several funds, and for 1997, the end of the study.

Stage 2: Interview data. Over the period 1996–97, I con-ducted 11 personal interviews with members of Vanguard’ssenior management team and several junior managers. Man-agement team members interviewed included the currentchief executive officer (CEO), chief financial officer, seniorvice president for information technology, general counsel,principal responsible for institutional client services, anddirector of portfolio review. The interviewees’ tenure at Van-guard ranged from three years to over 20 years. The inter-views lasted between one and two hours and usuallyconsisted of three parts. In the first part, managers wereasked to outline key developments in Vanguard’s evolution. Atypical question asked in this part was, “Over your tenure atVanguard, what have been some important initiatives andchanges that Vanguard has engaged in?”

In the second part, we discussed the preliminary maps I hadconstructed from the archival data and previous interviews.With managers with a long tenure at Vanguard, I discussedall maps. With managers who had joined Vanguard only a fewyears earlier, I discussed the maps of the most recent years.

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The main goal of this second step was to verify the elementsthat I had identified up to that point and to discuss the inter-actions that I had sketched out. I explained to the managersthe definition of interaction (i.e., what the lines in the mapsrepresented) and talked through several examples in themaps, usually using a variant of the thought experimentdescribed above. After studying the maps, intervieweespointed out further interactions among elements or ques-tioned the existence of interactions I had indicated. I tried toconfirm or disconfirm each interaction with at least two dif-ferent managers. Interviewees also suggested that I outlinean organizational system for 1991, a time at which Vanguardhad increased its efforts to gain business in the retirementmarket.

Each interview typically ended by asking the manager somespecific questions concerning his or her department, forexample, to provide more information on Vanguard’s strategywith respect to information systems or details on institutionalservices. Several shorter follow-up interviews were conduct-ed on the telephone to clarify inconsistencies or questionsthat arose during the subsequent analysis. Overall, while theinterviews were important in verifying the elements andinteractions, the original archival analysis proved to be fairlyaccurate. Only about 10 percent of the elements and interac-tions were changed through this interview process.

Stage 3: Interviews with Bogle and further analysis ofarchival data. After the interviews with members of Van-guard’s management team, I conducted two extensive,several-hour interviews with John Bogle. These interviewsdiffered from the interviews with the other Vanguard man-agers in that Bogle had received, prior to the interviews, awritten chronology on Vanguard’s history that I had compiledand the maps depicting the individual elements and interac-tions. After the first interview, I gained access to a largenumber of additional documents, in particular, an 89-pagestudy John Bogle had prepared at the inception of Vanguard,in which he outlined “The Future Structure” of Vanguard(Bogle, 1974) and a series of 37 speeches that Bogle deliv-ered over the last 30 years in front of various audiences (e.g.,to Vanguard’s employees, fund analysts, and industry associ-ations). After I had analyzed and incorporated these newsources into the analysis, I conducted a second interviewwith Bogle, who again provided extensive comments on thechronology and the maps provided to him prior to the inter-view. Interviews were not recorded, but I made extensivenotes during and after the interviews.

The overall research process was highly iterative (Miles andHuberman, 1984). I started with the question, “How do orga-nizations evolve toward highly complex systems of interde-pendent elements?” and “How can we describe thesedevelopmental paths?” for which the literature did not appearto provide satisfying answers. I then engaged in collectingdata, attempting to outline the evolutionary path of an organi-zation. While the type of data collected was guided by thebroad framework of treating firms as systems of interdepen-dent elements—leading to an emphasis on gathering data atthe level of individual organizational elements and on their

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interactions—the data collection was not influenced by an apriori theory of developmental processes. Through the analy-sis of the data, I started to recognize patterns in the overalldevelopmental path of the organization under study. I thenreferred back to the literature to seek concepts that mighthelp to explain these patterns. By going back and forthbetween the data and the literature, a reiterative process thatincluded responding to the creative challenges raised by thereviewers, I identified four lower-level processes of organiza-tional development: thickening, patching, coasting, and trim-ming. Since the underlying developmental processes areintimately tied to the concept of an organizational core ele-ment, I developed an operationalization of the definition of anorganizational core element that would allow me to system-atically identify Vanguard’s core elements within its organiza-tional system at various points in time.

VANGUARD’S ORGANIZATIONAL SYSTEMS AND COREELEMENTS

To understand the elements of Vanguard’s organizational sys-tems, a brief account of the typical organizational structureand the typical value chain of a mutual fund provider is nec-essary. Each mutual fund (e.g., Vanguard’s Index 500 Fund)consists of a board of directors and the capital paid in by fundshareholders. Most commonly, all mutual funds offered by afund provider have the same directors on their boards, creat-ing one fund board of directors, as shown in figure 1.Formally, the fund board of directors hires an investmentmanagement company to operate the fund. In practice, how-ever, the investment management company (alternativelycalled the fund provider) decides to create a new fund,assigns a fund manager to operate the fund, and thenappoints a board of directors to monitor the handling of thefund’s assets. The investment management company itself isusually a publicly or privately held firm, which also has aboard of directors. In the unique case of Vanguard, however,the fund shareholders are also the owners of the investmentmanagement company. In the following, I will refer to thisorganizational arrangement as Vanguard’s “mutual structure.”

To offer funds, a fund provider has to engage in a series ofother activities besides asset management. Its value chainincludes account management activities, such as record-keeping services for fund shareholders and distribution of div-

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Figure 1. Typical organization of mutual fund providers.

Owners/Shareholders

Fund Shareholders

Board of Directors

Fund Provider(Investment Management Company)

Fund Board of Directors

Mutual Fund 1 Mutual Fund 2 Mutual Fund 3

idends; selling and marketing activities, such as distributionof fund shares to individual or institutional customers; andinformation and customer service activities, such as providingcustomers with information about investment choices andafter-sale services. Not all of these activities have to be con-ducted by the fund provider itself. For instance, some fundproviders out-source the account management and distribu-tion activities. Human resource practices concerning activitiesthat remain in-house have to be stipulated as well. Lastly, allactivity and resource decisions by the fund provider are madein the context of the fund provider’s organizational structureand the product portfolio that the fund provider offers. I usedthese different activity categories to systematically catalogueVanguard’s activities at various points in time and to color-code elements in the maps depicting Vanguard’s organiza-tional systems. More detail on the individual elementscontained in these systems is provided below. While spaceconstraints do not permit a detailed discussion of all interac-tions, I can provide the flavor of the underlying reasoning byfocusing on some of the key interactions within Vanguard’ssystem in 1997.

Vanguard’s low-cost strategy reinforced its focus on conserv-atively managed funds, such as index funds. Since indexfunds of different fund providers hold the same securities,the performance differences between index funds are entire-ly driven by differences in cost. Similarly, for funds with lowvolatility and relatively low returns (e.g., conservative bondfunds and money market funds), cost differences createnoticeable performance differences. The same cost advan-tage is much more difficult for investors to discern in themore volatile, actively managed stock funds. Vanguard’s costadvantage translated directly into an ability to offer moreattractive funds, in particular, within the types of funds itfocused on. In other words, the value of Vanguard’s low-coststrategy was positively affected by its product choices, while,conversely, the value of its product choices was positivelyaffected by its low-cost strategy.

The performance advantage of Vanguard’s funds was pro-nounced when viewed over the long run. For instance, inBarron’s 1996 ratings of five-year and ten-year performancesof mutual fund families, Vanguard was ranked number one(Savitz, 1997). Vanguard’s overall focus on long-term perfor-mance, including various provisions that made short-termtrading difficult, and its candid communication efforts withinvestors, which included a series of educational efforts tostress the importance of long-term investing, made the long-term performance advantage of its funds visible to cus-tomers. Customers, thus sensitized to the higher long-termperformance of Vanguard’s funds, invested more of theirassets with Vanguard: over the period 1980–1996, Vanguard’sassets grew at a compounded annual rate of 31.4 percent,while the mutual fund industry as a whole recorded an annu-al growth rate of 22.6 percent. This enormous growth inassets, in funds that were easily scaled up, allowed Vanguardto lower its costs further. Vanguard’s focus on long-term per-formance and its efforts to educate customers thus rein-forced its low-cost strategy.

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Identification of Core Elements

From Vanguard’s organizational systems, I identified Van-guard’s core elements by operationalizing Hannan, Burton,and Baron’s (1996: 506) notion that “coreness means con-nectedness” and that “elements in the core are linked incomplicated webs of relations with each other and withperipheral elements.” Following the suggestion of Ghe-mawat and Levinthal (2000), I treated organizational systemsas networks consisting of nodes (organizational elements)and connecting edges (interactions). Given the definition ofcore elements as elements that interact with many current orfuture organizational elements, two types of core elementsneeded to be identified. First, elements that affect manyother contemporaneous organizational elements, i.e., thoseelements that are central nodes in the organizational systemat a given time t, are current core elements. Second, ele-ments that are not central at time t yet become central at afuture time are emerging core elements. To identify emerg-ing core elements, a retrospective analysis was thus neces-sary as well.

I proceeded in two steps. I first identified the most centralelements in Vanguard’s organizational system in 1997, thelast year for which I collected data. While Vanguard’s set ofcore elements in 1997 might include unidentified emergingcore elements, this set of central elements is a good approxi-mation of the set of Vanguard’s core elements, without spec-ulating about future developments. I then traced theidentified core elements back in time to assess when Van-guard adopted these core elements. In the second step, Ianalyzed Vanguard’s organizational system at various pointsin time to assess whether other core elements existed thatdid not survive until 1997.

If coreness is to represent connectedness, a suitable centrali-ty measure needs to capture how many other elements anygiven element affects. Freeman’s (1979) degree centrality,which measures the number of directly affected elements, isone suitable centrality measure. The first column of table 1shows the 15 elements that have the highest degree centrali-ty in Vanguard’s organizational system in 1997.2 But ele-ments may have more far-reaching ramifications than justdirect interactions. If element A affects element B, which inturn affects element C, then A is also affecting element C. Icomputed a second-order degree centrality by also countingthe number of elements that any given element affects indi-rectly via one other element. The second column in table 1contains the results with a weighting scheme that equalizesthe total effect of direct and second-order interactions. Onaverage each element in Vanguard’s 1997 system affected3.0 other elements directly (average degree centrality) and14.2 elements indirectly via one other element. If d is theFreeman degree centrality of element A and m is the numberof indirect elements A affects, the second-order degree cen-trality of A is computed as d + �∗m. I chose � = 3.0/14.1 =0.21, so that the first and second term in the calculation ofsecond-order degree centrality are equal on average, but theidentification of core elements is robust to a wide range of �(details available from the author).

2For the purpose of computing centralitymeasures, I ignored misfits between ele-ments, since network theoretic measuresare not geared toward taking such nega-tive interactions into account. Since rela-tively few misfits occur in Vanguard’sorganizational systems, this simplificationshould not affect the identification of theappropriate core elements.

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Other centrality measures are suitable as well. Stephensonand Zelen’s (1989) information centrality and Freeman’s(1977) betweenness centrality take even more far-reachinginteractions into account than the second-order degree mea-sure. Stephenson and Zelen’s measure accounts for how fre-quently a given element lies on all interaction chains betweenany pair of other elements, while Freeman’s measurerestricts itself to direct interaction chains, i.e., geodesics.Since no strong theoretical reason exists to confine the analy-sis to geodesics, Stephenson and Zelen’s measure might bepreferable. Given its widespread use (Wasserman and Faust,1994), however, I included the betweenness measure intable 1 as well. All four centrality measures point to the sameseven elements as the most central: low cost, high-qualityservice, a focus on conservatively managed funds, candidcommunication, direct distribution, mutual organizationalstructure, and a focus on long-term performance. This agree-ment, which stops after the first seven elements, in additionto a distinct break in the distribution of the second-orderdegree and betweenness measures after the seventh ele-

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Table 1

Centrality Measures of the Fifteen Most Central Elements in Vanguard’s Organizational System in 1997*

Centrality Measure

Rank Degree Second-order degree Information centrality Betweenness

0102

03

04

05

0607

08

09

10

11

1213

14

15

*Core elements are in italics.

Low costHigh-quality service

Focus onconservative funds

Focus on long-termperformance

Direct distribution

Mutual structureCandid

communication

Investor education

Internal managementof funds

Reduced fees foroutside managers

High esprit de corps

Little advertisingBogle’s openness

Limited research

Moderate wages

1711

10

9

8

66

5

4

4

4

33

3

3

Low costFocus on

conservativefunds


Direct distribution

High-quality service

Mutual structureCandid

communication

No-load distribution

Reduced fees foroutsidemanagers

Investor education

Swiss Army

Toll-free serviceClient services for

retirementsponsors

Moderate wages

Servicing of definedbenefit plans

22.2915.51

14.29

13.72

13.12

12.9912.14

8.08

7.60

7.54

7.08

7.087.08

7.02

6.66

Low costFocus on

conservativefunds


Direct distribution

Mutual structure

High-quality serviceCandid

communication

Investor education

Internalmanagement offunds


Limited research

Moderate wagesReduced fees for

outsidemanagers

High esprit decorps

Web University

1.211.08

1.08

1.06

1.05

1.040.99

0.92

0.92

0.88

0.85

0.850.84

0.84

0.80

Low costCandid

communication


Focus onconservativefunds


Direct distributionMutual structure

Reduced fees foroutsidemanagers

Bogle’s openness

Moderate wages

High esprit decorps

Swiss ArmyToll-free service

Client services forretirementsponsors

Investor education

498.53283.78

282.40

216.78

166.89

121.06115.76

58.50

36.40

36.00

34.81

33.8933.89

33.89

30.86

ment, makes the seventh element a natural breaking pointfor distinguishing between core and elaborating elements.

In the second step, I analyzed Vanguard’s organizational sys-tem for each year for which I had constructed a map. Theresults of these analyses are shown in table 2, in which the

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Table 2

Centrality Measures of the Ten Most Central Elements in Vanguard’s Organizational System in 1974, 1977,

and 1978*

Centrality Measure

Rank Degree Second-order degree Information centrality

1974

01020304

05

06

07

08

0910

1977

0102030405

06

07

08

09

10

1978

0102030405

06

07

08

09

10

*Core elements are in italics.

Low costFocus on conservative fundsMutual structureCandid communication


Administrative functions in-house

Bogle’s openness

Missionary zeal

Moderate wagesReduced fees for outside

managers

Low costFocus on conservative fundsMutual structureCandid communicationDirect distribution


Outside investmentmanagement companies

Reduced fees for outsidemanagers

Little advertising

Bogle’s openness

Low costFocus on conservative fundsMutual structureCandid communicationHigh-quality service

Direct distribution




Little advertising

7544

3

2

2

2

22

118655

3

3

3

3

3

118665

5

4

3

3

3

Low costFocus on conservative fundsMutual structureFocus on long-term

performanceCandid communication

Moderate wages


Bogle’s openness

Small investment in ITNo perks for management

Low costFocus on conservative fundsMutual structureDirect distributionFocus on long-term


Little advertising



Moderate wages

Low costFocus on cons. fundsMutual structureDirect distributionCandid communication


Little advertising




10.569.008.897.89

5.78

5.11

4.67

3.78

3.673.67

15.2912.2911.5110.518.21

7.45

7.29

6.06

5.68

5.37

15.6912.6911.9410.639.75

9.63

7.69

6.56

6.13

5.75

Low costMutual structureFocus on conservative fundsFocus on long-term


Moderate wages


Administrative functions in-house

Bogle’s opennessHigh esprit de corps

Low costMutual structureFocus on conservative fundsDirect distributionCandid communication


Little advertising



Bogle’s openness

Low costMutual structureFocus on conservative fundsCandid communicationFocus on long-term

performanceDirect distribution

Little advertising



Bogle’s openness

1.050.950.930.89

0.88

0.70

0.70

0.68

0.650.60

1.231.101.101.050.99

0.95

0.89

0.88

0.86

0.80

1.050.960.950.950.91

0.91

0.81

0.78

0.76

0.75

ten most central elements for the respective year are listed,using degree, second-order degree, and information centralityscores to rank the elements. The analyses reveal that Van-guard did not drop any of its core elements throughout itshistory. More discussion of these results, especially for 1978,are provided below. Lastly, I conducted similar analyses for1981 and 1991 to check whether other core elements exist-ed, which was not the case (results available from theauthor).

DEVELOPMENTAL PROCESSES

The Founding of VanguardThe circumstances leading to Vanguard’s founding are relatedto the history of another mutual fund provider, the WellingtonManagement Company (WMC). Founded by Walter L. Mor-gan in 1928, WMC had offered the fourth open-ended mutualfund in the U.S., a fund later known as the Wellington Fund.This fund, based in Philadelphia, was the first balanced fund,carrying up to 60 percent high-quality government and corpo-rate bonds. In contrast, all other mutual funds at the timeheld only stocks. In 1951, Morgan hired John Bogle, laterVanguard’s CEO, who had impressed Morgan with his under-graduate thesis on the nascent mutual fund industry. In June1966, WMC merged with Thorndike, Doran, Paine & Lewis(TDP&L), a Boston-based investment management company.By 1970, Bogle had succeeded Morgan as president of WMCand as chairman of the funds. Three years later, a decliningequity market, which prompted many shareholders to with-draw their investments, reduced WMC’s assets under man-agement by a third. Tensions grew between the partners inBoston and Philadelphia, culminating on January 23, 1974 inBogle’s being fired by the board of WMC, which was con-trolled by the Boston partners. The day after Bogle was fired,the fund board of directors met and decided that Bogleshould retain his position as chairman of the fund board andconduct a “Future Structure Study” of the Wellington Funds.In March 1974, in his report to the fund board of directors,Bogle discussed three increasingly radical options for thefuture relationship between WMC and the funds (Bogle,1974): option 1: WMC would continue to provide investmentmanagement and distribution services, but the funds wouldtake over administrative services; option 2: WMC would con-tinue to provide investment management but, in addition toadministrative services, the funds would take over distribu-tion; and option 3: the funds would purchase WMC andthereby take over investment management, underwriting,and administrative services.

In June 1974, the fund board decided to adopt option 1: thefunds were to take over and be responsible for all tasksinvolving legal compliance, financial accounting, shareholderrecords, share transfers, filing tax reports, and balancing andauditing the books. While the funds performed the fundaccounting themselves (e.g., computing fund prices), mostactivities tied to shareholder accounting (e.g., processing ofnew deposits) remained initially out-sourced to a third-partyprovider. WMC continued to provide investment manage-ment and distribution services. In August 1974, the fund

137/ASQ, March 2002



board ruled that the funds would not use the Wellingtonname any longer (except for the Wellington Fund), since thefunds were now distinct from the Wellington ManagementCompany. Bogle decided to name the fund complex “Van-guard,” after the HMS Vanguard, Lord Nelson’s flagship inthe victory over the French fleet at the Battle of the Nile in1798. In September 1974, The Vanguard Group was incorpo-rated, with the Vanguard name serving as the new collectiveidentifier for the funds. Vanguard was owned by the share-holders of its 11 funds and provided the administrative ser-vices to them at cost.

Figure 2 depicts Vanguard’s organizational system by the endof 1974. As shown in table 2, five of the eventual seven coreelements were present. As described above, Vanguard hadadopted its mutual structure by making the fund sharehold-ers the owners of the fund provider. Second, Vanguard start-ed on its strategy to reduce its costs wherever possible. Afocus on low cost had already been prominent in Bogle’sthinking in his honors thesis, in which he concluded that“there is some indication that the cost of management [inthe mutual fund industry] is too high” (Bogle, 1951: 18) andthat the industry’s “future growth can be maximized by con-centration on a reduction of sales loads and managementfees” (Bogle, 1951: 122). Similarly, for each of the threeoptions that he had proposed to the fund board in his “FutureStructure Study,” the emphasis of his analysis was on thepotential cost savings that the increased independence fromWMC would afford. Bogle estimated annual cost savingsfrom $1 million for option 1 to up to $3 million for option 3(Bogle, 1974). Now that the fund board had agreed to option1, Vanguard was able to reduce the management fees it paidto WMC from $7.4 to $6.4 million. This reduction in feesincluded not only the shifted costs of the administrative ser-vices but also WMC’s 40 percent mark-up (Bogle, 1975).

Vanguard’s third core element, candid communication with itsinvestors, was initiated by Bogle’s starting to write nearly allthe annual reports for the mutual funds, a practice he contin-ued until he retired in 1999. Bogle pursued an additional goalwith the annual reports. As he announced at the time, “Theshareholder will receive Fund reports that will ‘tell it as it is,’with candor and fairness. If results are good, we will say so;and if they are not, we will be equally candid. In short, ourreports will be written from the perspective of the sharehold-er” (Bogle, 1975). In contrast, shareholder reports of mostother funds were described by an industry observer as “asparse listings of holdings prefaced by a ghostwritten letterfrom the fund president. . . . Among major fund-companyexecutives, Bogle was the first to sweat out the details.Bogle’s letters have consistently been candid . . . and clearlywritten” (Sanders, 1996).

In these early years, spurred by the need to explain the ratio-nale of the very uncommon organizational structure (only oneother fund provider had a similar structure and would laterrevert to the traditional one), Bogle also started his very openand ample communication with the press. He frequentlytalked about his philosophy of what made for sound mutualfunds—in his view, funds that were inexpensive to run and

138/ASQ, March 2002


139/ASQ, March 2002



Leg

end

:

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-ter

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rfor

man

ce

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rced

shar

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der

acco

untin

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ure

2.

Van

gu

ard

’s o

rgan

izati

on

al

syste

m a

t th

e e

nd

of

1974.

that focused on long-term performance—as well as his viewof the organizational form mutual fund providers shouldadopt. Only a few months after Vanguard was founded,Bogle started to discuss implications for the industry, sug-gesting in a speech at the FBA-CCH Conference on MutualFunds and Investment Management that other fund groups“might want to consider some form of internal manage-ment,” a decision to which fund groups would be led by “anenlightened sense of self-interest about the optimal structurefor the conduct of a fund group’s activities” (Bogle, 1975).Bogle’s missionary zeal to restructure the industry so thatfund shareholders’ interests would become paramount creat-ed a climate at Vanguard in which many employees felt thatthey were actively involved in pursuing a noble goal. Theresulting high esprit de corps enabled Vanguard to compen-sate its employees with more than just a monetary rewardand helped to keep wage costs down (Hallowell, 1997).

The other two core elements, the focus on conservativelymanaged funds and the focus on long-term performance,Vanguard inherited from WMC. WMC had created a series offunds that were conservatively managed and that benefitedshareholders who invested for the long term. Although Van-guard inherited these core elements, they were also consis-tent with Bogle’s investment philosophy of low risk andlong-term investing (Slater, 1997).

Patching

An organization adopts many new elements over the courseof its history. New elements might reinforce existing coreelements, they might be independent, they might create mis-fits with existing elements, or they might constitute newcore elements. I term the process of adopting a new coreelement, and its subsequent reinforcement, “patching.”Since a central element interacts with many other elements,graphically, a new central element gives rise to a new patchin the map of an organizational system. Two types of newcore elements exist: immediate core elements and emergingcore elements. A new element that is at once central withinthe organizational system, interacting directly and indirectlywith a large number of the existing organizational elements,is an immediate core element. A new element that is origi-nally not a central element but, over time, becomes centralthrough further elaboration is an emerging core element.

An interesting parallel exists between the patching processdescribed here and the patching process described by Eisen-hardt and Brown (1999). For Eisenhardt and Brown, “Patch-ing is the strategic process by which corporate executivesroutinely remap businesses to changing market opportuni-ties. It can take the form of adding, splitting, transferring,exiting, or combining chunks of businesses” (pp. 73–74). Inboth cases, patching refers to the association of a number ofinterdependent elements to a higher-level construct, in thiscase, to a core element, or, in Eisenhardt and Brown’s case,to a business unit. But my use of the term patching is morerestrictive. Patching refers here only to the adoption of newsets of elements that are highly interdependent with eachother, creating a patch, and that contain elements that are

140/ASQ, March 2002


highly interdependent with other elements of the firm andare therefore central. The patching process described byEisenhardt and Brown also contains the notion of decompos-ing a given set of elements into smaller subsets to betterexploit business opportunities, a process related to the patch-ing procedure for solving highly interdependent decisionproblems, as described by Kauffman (1995).

Two patching events are evident in Vanguard’s evolution. Thefirst patching event took place in 1977, when Vanguardadopted a direct distribution system. This new element wasimmediately a central element in its organizational system asshown on the left side of figure 3 and in the middle panel oftable 2. The second patching process commenced in 1978,when Vanguard started to create a new focus on high-qualityservice. This element became a central element only overtime. I describe each patching event in turn.

In February 1977, the fund board accepted Bogle’s proposalsto take the distribution function in-house and to market itsfunds as no-loads, eliminating the sales load, which had beenon the order of 8 percent. In other words, the fund boardagreed to option 2, which Bogle had suggested in 1974. Thedecision to take distribution in-house had wide-ranging ramifi-cations on many existing elements of Vanguard, and it imme-diately became a central element in its organizational system:direct distribution allowed Vanguard to abolish sales fees,which strengthened its focus on low cost. Moreover, havingdistribution in-house allowed Vanguard to negotiate contractterms with investment management companies at arm’slength, in particular, with WMC. Before, the threat to switchthe investment management function to another firm hadbeen fairly empty, since the investment management compa-ny controlled the distribution of fund shares. In September1977, Vanguard used its newly gained freedom to hireCitibank to run its new Warwick Municipal Bond Fund. Thiswas the first time that WMC did not manage a fund for TheVanguard Group. Because Vanguard had taken over the distri-bution function and had more of an arm’s length relationshipwith WMC, it was also able to cut management fees paid toWMC by $2.9 million, or 39 percent (Slater, 1997: 105). Thus,the interplay between its mutual structure, which allowedarm’s-length negotiations with investment managers, and itsdirect distribution system, which provided it with indepen-dence from investment managers’ distribution capabilities,allowed Vanguard to strengthen its focus on low cost.

Beginning in 1978, Vanguard started to create a new patch ofactivities around a focus of high-quality service, as shown onthe lower right in figure 4. The first step to improve servicemarkedly was Vanguard’s decision to partially in-source itsindividual shareholder accounting system in 1978. In-sourcedtasks included dealing with deposit checks, creating cus-tomer accounts, sending out balance statements, handlingshare exchanges, and answering fund shareholders’ ques-tions. Previously, a third-party supplier, DST Service Bureau,had handled these tasks, but Vanguard felt that DST providedpoor quality (personal communication with Robert DiStefano,January 24, 1997). In-sourcing the individual shareholderaccounting system was a natural starting point for a focus on

141/ASQ, March 2002



142/ASQ, March 2002


Leg

end

:

Co

reel

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ts

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t

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143/ASQ, March 2002



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per

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ting

Hig

h-qu

ality

serv

ice

Fig

ure

4.

Van

gu

ard

’s o

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izati

on

al

syste

m a

t th

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nd

of

1978.

quality service. As a direct distributor, Vanguard had only afew personal contacts with its customers, since it did notuse brokers or a branch network. As a result, most customercontacts arose when customers inquired about theiraccounts. When customers had previously called for anaccount question and did not receive good service from DST,it was Vanguard that received the blame. By in-sourcingthese services, Vanguard regained control over the interfacewith its clients.

A series of other choices further elaborated and strength-ened Vanguard’s new core element. For instance, Bogle start-ed to distribute throughout the organization monthly “BogleBarometers,” which indicated the number of shareholdercomplaint letters he had received that month and which list-ed the kinds of problems customers were complaining about.In the area of human resources, Vanguard adopted a series ofparticular hiring practices that helped to improve quality. Van-guard hired primarily college graduates and rarely hired appli-cants from Wall Street, as their trading mentality usuallymade them a poor fit in Vanguard’s culture, which was basedon fostering long-term investing. Similarly, Vanguard rarelyhired fresh M.B.A.s, since they tended not to stay long.While its focus on high quality was supported from the startwith these new elaborating elements—giving this element arelatively high degree measure—the focus on high quality didnot immediately affect many of the existing elements of Van-guard’s organizational system. This weak interdependencecan be seen in the centrality measures that take more far-reaching interactions into account. Thus, while focus on highquality is the fifth-highest-ranked element using the degreemeasure, as can be seen in the bottom panel of table 2above, it is only ranked eighth by the second-order degreemeasure and fails to make it into the top most central ele-ments, using Stephenson and Zelen’s (1989) centrality mea-sure.

Over time, however, the focus on high quality becameincreasingly reinforced by additional elaborating elements andemerged as a core element in Vanguard’s organizational sys-tem. For instance, in 1984, Vanguard inaugurated its Awardfor Excellence Program. This quarterly award was given toemployees, especially those working in the lower ranks ofthe organization, who had excelled in their performance. Topmanagement treated these ceremonies very seriously andalmost always attended the award presentations. Other ele-ments that elaborated Vanguard’s focus on high qualityincluded extensive training for Vanguard’s telephone opera-tors, mostly college graduates, and a Vanguard Quality Pro-gram initiated in 1990. Under this initiative, projectimprovement teams were formed to tackle particular qualityissues and recommend solutions. Finally, to gain completecontrol over the customer interface, Vanguard completed itsin-sourcing of the individual shareholder accounting system in1991. Analyzing Vanguard’s organizational system in 1991reveals that the focus on high quality is among the most cen-tral elements by all centrality measures (analysis availablefrom the author), a conclusion that continues to hold for1997, as was shown in table 1. Overall, Vanguard’s efforts to

144/ASQ, March 2002


elaborate its new core element bore fruit. In 1990, FinancialWorld magazine conducted a customer satisfaction survey onmutual fund providers; Vanguard was voted number one. Inall subsequent surveys (1991–1995), Vanguard won top hon-ors again.

Thickening and Coasting

While an organization may adopt new elements that are, orbecome, very central within its overall system, most new ele-ments are not new core elements but reinforce existing coreelements. I term the process of reinforcing an existing coreelement with subsequent elaborating elements “thickening,”because it leads to an increasingly thick network of interac-tions involving the respective core element. Thickening isthus a process at the level of a given core element. Over anyperiod of time, any given core element might become furtherreinforced through the addition of elaborating elements. If acore element is not reinforced over a given period of time,the organization is said to be “coasting” with respect to thiscore element. The process of thickening can also involve thereplacement of former elaborating elements with new ones.Technological advance, for instance, may allow elaboration ofa certain core element in a new manner, thereby makingolder elaborating elements obsolete. Thickening occurredaround Vanguard’s core elements of focusing on conserva-tively managed funds, low cost, communication, and focuson long-term performance, as can be seen in figure 5, whichshows Vanguard’s organizational system at the beginning of1997.

Thickening around conservatively managed funds. Imme-diately after its founding, Vanguard elaborated its core ele-ment of focusing on conservatively managed funds, while itcoasted with respect to its other core elements. In 1975,Vanguard offered its first money market fund. In August1976, Vanguard introduced the industry’s first market indexfund, an idea Bogle had first expressed in the “Future Struc-ture Study” two years earlier. The fund, which tried to mirrorthe performance of the S&P 500 index, was initially not wellreceived and had a difficult time finding investors. Criticschided the fund as pandering to mediocrity, or even as “un-American,” since the aspiration to achieve more than theaverage was seen as part of the American heritage. Boglebelieved, however, that over the long run, a broad index fundwould outperform most actively managed equity funds, large-ly because of its much lower operating and transaction costs(Bogle, 1977).

Vanguard continued to elaborate its product focus on conser-vatively managed funds by starting to offer municipal bondfunds in 1977. Paralleling the skepticism that any firm couldoutpace the stock market for a long period of time—whichhad led Vanguard to offer an equity index fund—Bogle har-bored doubts that any firm could consistently forecastchanges in interest rates (Bogle, 1999). Consequently, Van-guard did not follow other fund providers in forming a man-aged municipal bond fund, in which managers tried tocapitalize on their predictions of interest rates by shifting theaverage maturity length of the securities held in the fund.

145/ASQ, March 2002



146/ASQ, March 2002


Fig

ure

5.

Van

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Rather, Vanguard created the first municipal bond funds thatfocused on particular maturities: one fund holding solely long-term municipal bonds, a second only short-term, and a thirdonly intermediate-term securities. This investment strategy ofdefined asset classes provided investors with a clear pictureof what types of securities the fund would hold and, hence,what type of risk and relative performance to expect.

Thickening around low cost. After 1977, Vanguard strength-ened its focus on low cost through a series of decisions. Forinstance, Vanguard decided against operating branch offices.Since the decision to take distribution in-house had been dri-ven mainly by cost considerations, engaging in costly distrib-ution using a branch network would have beencounterproductive. Vanguard also did not engage in muchadvertising. Bogle believed that advertising did not providevalue to existing shareholders, who shouldered the costs.Bogle’s openness to discussing Vanguard, which was thefocus of frequent business reports because of its uniqueorganizational structure, served in part as a substitute foradvertising. Over time, Vanguard actually decreased its adver-tising as a percentage of assets by increasing its advertisingexpenses only slightly to about $8 million. In comparison,Fidelity was reported to spend on the order of $100 millionannually on advertising. In similar cost-conscious fashion,Vanguard did not engage in large capital expenditures. At thetime, being a leader in computer and information technologywas considered unnecessary, given Vanguard’s product offer-ing and low-cost strategy.

In 1981, the Vanguard board permitted the firm to take overasset management for the municipal bond funds fromCitibank and for the money market funds from WMC. Thetwo fund portfolios amounted to $1.5 billion, roughly one-third of the company’s total assets at the time. These fundsshared important characteristics that made them good tar-gets for internalization of the asset management function.First, the funds had large economies of scale, which wereonly partially passed on by asset management firms, so sub-stantial cost savings were possible. Second, managing thesefunds required no particular industry or research experienceand no relationships with industry analysts. Thus, in-sourcingasset management for these funds was not very difficult orcostly.

To strengthen employees’ incentives to reduce costs, Van-guard initiated a “partnership plan” for its employees in1984. Incentive pay was coupled to the “cost saved” (the dif-ference between its expense ratio and the average industryexpense ratio) and the performance of its funds relative topeer funds. The incentive component represented about10–15 percent of total compensation for new employees butcould rise up to 30 percent for longer-term employees.

Besides monetary incentives, Bogle had created a climate atVanguard in which many employees believed they were pur-suing an honorable goal of putting fund shareholders’ inter-ests first. To convey his ideals and to create a high esprit decorps, Bogle started in the early 1980s to address Vanguard’semployees at every billion-dollar milestone of assets under

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management. Almost without fail, he repeated in thesespeeches his vision of a low-cost mutual fund providerwhose highest obligation was the fiduciary duty it owed to itsfund shareholders. As Bogle put it, the reasons for thesespeeches were “to celebrate, to communicate, and to incul-cate” (Bogle, 1986). Vanguard benefited from the high moraleof its “crew” to offer high-quality service to its clients whilekeeping costs low. For instance, to guard against under-staffing in its telephone operations in times of sharp marketdeclines, Vanguard did not increase its regular phone person-nel but cross-trained its existing employees. Under the nameof “Swiss Army,” each employee, from clerical workers tothe CEO, had to perform several hours of phone serviceevery month to stay in practice. In times of high demand,these employees could be drafted to take client calls. Thanksto its Swiss Army operation, Vanguard was able to handle theOctober 1987 stock market crash without a glitch in its oper-ations.

Similarly, Vanguard solved its frequent office space con-straints, due to its rapid growth, by simply halving its man-agers’ offices (“scrunching”), rather than by rentingexpensive temporary office space. Such measures were fea-sible in a company whose culture demanded that everyone,from the lowest ranks to the top of the organization, kept lowcosts in mind. Top management, with its high visibility,played an especially important role. In that vein, it was notsurprising that Vanguard’s management did not fly first class,did not have perks such as dedicated parking spots, and didnot have a privileged dining area, eating instead in the com-pany cafeteria, the “galley.”

Its greatest cost savings, however, came in the area of assetmanagement. First, Vanguard’s costs decreased because ofscale effects. For instance, its 20 index funds, with $56 bil-lion of assets as of end 1996, were completely managed byonly five managers. Second, due to its arm’s-length negotiat-ing power, Vanguard was also able to press its 18 differentoutside investment advisers to pass along scale effects aswell. Its average fee paid to external investment advisers forequity funds fell to 0.15 percent, compared with an industryaverage of 0.75 percent for similar funds. Vanguard, in con-trast to most other fund providers, had also incorporated per-formance-based incentive provisions in 24 of its 38 contractswith outside advisers.

Overall, the effects of Vanguard’s mutual structure and low-cost approach were visible in its funds’ expense ratios, whichexpress the fees paid by the funds as a percentage ofassets. In 1975, Vanguard’s average expense ratio was atparity with that of other major fund complexes at 0.68 per-cent and below the industry’s average of 1.08 percent. By1995, Vanguard’s average expense ratio had dropped to 0.31percent, while major fund complexes were charging, on aver-age, 0.96 percent, and the industry, 1.11 percent.

Thickening around candid communication. To strengthenits core element of candid communication, Vanguard not onlycontinued to send out clearly written annual reports but alsocreated a quarterly newsletter, “In the Vanguard,” in which

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investment relevant topics were discussed. In addition tothese newsletters, on several occasions, Vanguard contactedinvestors who held shares of funds that had performedexceedingly well, warning them that their fund’s performancewas unlikely to continue to be this outstanding. For instance,in 1991, Bogle wrote in a letter to shareholders of Vanguard’sHealth Care industry fund: “It is highly unlikely that such[high] absolute returns—or even the Portfolio’s relative per-formance advantage—will be matched in the future.”

To educate its investors, in particular about the benefits oflong-term investing, Vanguard started issuing a series of“Plain Talk” brochures, which explained in simple terms therisks of investing. As new technology became available, Van-guard further elaborated its efforts to educate its investors.Vanguard was the first 401(k) vendor to establish a presenceon America Online (since January 1995) and later on theWorld Wide Web (Rohrer, 1995). The main functions of itsextensive Web site (at the time) were education and servicerather than marketing and sales. In 1996, Vanguard createdon its Web site a free “University,” comprising ten courses,from “What Is a Mutual Fund?” to “Retirement Investing:Allocating Your Retirement Assets.”

Thickening around long-term performance. In addition toeducating its investors concerning the benefits of long-terminvesting, Vanguard engaged in a number of activities thatstrengthened its focus on this core element. For instance, itdid not offer telephone redemptions for its popular Index 500Fund and limited substantial “round trips” (selling and pur-chasing back into the fund) to no more than twice a year.Through these rules, Vanguard tried to avoid customers whodid not want to invest for the long run. Similarly, with respectto institutional investors, Vanguard made a name for itself bynot accepting assets that it expected to remain in its fundsfor only a short time. George U. Sauter, head of Vanguard’sequity index funds, estimated that 5 percent of all bigdeposits were declined, because the cost of buying and sell-ing large blocks of securities would be mainly borne by exist-ing shareholders and not by the shareholder who made thetransaction (Easton, 1996).

Misfits

At times, Vanguard experienced misfits within its organiza-tional system. Misfits arose from two sources. First, in somecases, a new core element created misfits with existing ele-ments. For instance, Vanguard’s initial (inherited) choices ofasset management performed solely by WMC and of loaddistribution through brokers were inconsistent with Van-guard’s low-cost core element. Similarly, as Vanguard adopt-ed high-quality service as a new core element, its existingsmall investments in information technology became incon-sistent. Since Bogle held a strong belief about keepinginvestment costs down, Vanguard resolved this misfit onlyslowly. While Vanguard was one of the first adopters of 1-800phone numbers, Bogle still asserted in 1985 that “we’re notgoing to be a technology leader. It’s too expensive” (Heins,1985: 221). Only after an intense off-site strategy meeting inJune 1992 was Bogle willing to “slaughter Vanguard’s sacred

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cow” of not investing heavily in information technology(Slater, 1997: 194) and to use information technology toimprove its communication with clients.

The second way in which misfits were created was throughnew product introductions that had attributes that madethem inconsistent with Vanguard’s existing organizational sys-tem. For example, in 1983, Vanguard started to offer itsclients brokerage services. The main function of this exten-sion was to accommodate clients who wanted to trade partof their portfolios themselves. This service created a misfitwith Vanguard’s core element of focusing on long-term per-formance, since with brokerage, money was earned on trans-action volume. In the 1980s, Vanguard entered anotherbusiness that did not fit well into its organizational system.Following the example of several competitors, in a style thatVanguard’s current CEO John Brennan called “a worst caseof emulation,” Vanguard offered real-estate funds patternedafter limited partnerships (personal communication with JohnBrennan, February 5, 1997). These investment vehicles werevery costly to operate, contradicting Vanguard’s core elementof low cost. Moreover, their fee structure was akin to load-funds, creating an inconsistency with Vanguard’s no-load dis-tribution. After a year and a half, Vanguard’s managementrealized that this product was inconsistent with the existingstructure at Vanguard and decided to exit the business.

DISCUSSION

The study of Vanguard’s developmental path highlightedthree processes: patching, thickening, and coasting. One fur-ther developmental process that relates to a core element isthe process of “trimming”: the deletion of an existing coreelement and most of its associated elaborating elements.Partly due to the fact that Vanguard never experienced alarge number of misfits caused by one of its core elements,it never eliminated one of its core elements. Thus, theprocess of trimming could not be observed at Vanguard. Arecently published study on Liz Claiborne, a leading U.S. man-ufacturer of women’s apparel, however, provides an accountof such a process (Siggelkow, 2001). Responding to newcompetitors, changed requirements by distributors, and tech-nological advances in supply-chain management, Liz Clai-borne replaced one of its existing core elements concerningthe organization of its production system with a new coreelement. Indicative of a trimming process, the old core ele-ment of not offering production to order was eliminated inconcert with a change in a large number of elements thatsupported this core element. Together with the adoption ofthe new core element of partially producing to order, Liz Clai-borne changed the location of a number of its suppliers fromthe Far East to the Western Hemisphere, focused on suppli-ers that had the financial resources to invest in new informa-tion and production technology, reduced the number of itsdesign cycles, and modified its distribution schedule. Liz Clai-borne thus engaged in a trimming process coupled with apatching process.

The concepts of thickening, patching, coasting, and trimmingallow us to describe the developmental path of an organiza-

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elements. Its developmental path can be compactlydescribed as follows. At its founding in 1974, five of its even-tual seven core elements were created: mutual organizationalstructure, focus on conservatively managed funds, low cost,candid communication, and focus on long-term performance.Over the period 1974–77, Vanguard elaborated its focus onconservatively managed funds, while coasting with respectto its other core elements.3 In 1977, Vanguard patched ontoits organizational system a new core element, direct distribu-tion. Over the period 1977–78, Vanguard thickened its sys-tem around its core elements of mutual structure, focus onconservatively managed funds, and low cost. In 1978, Van-guard created another core element, a focus on high-qualityservice, which it subsequently elaborated. From 1978 to1997, Vanguard did not create any other new core elementsbut continued to thicken its system around its existing coreelements.

3For the first period of an organization’shistory an ambiguity exists whether tocall the process of elaboration patching,since all core choices that are created arenew, or thickening, since after the birthevent all core choices exist. To maintainconsistency with the thin-to-thick patterndescribed below, I opted to call this first-period process thickening.

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tion consistently. In particular, the addition, deletion, andreplacement of core elements create natural periods within afirm’s organizational history. Within each of these periods theorganization can engage in three processes with respect toeach existing core element (thickening, coasting, or trimming)and one process with respect to new core elements (patch-ing). Figure 6 traces Vanguard’s evolution in terms of its core

Figure 6. Stylized evolution of Vanguard’s organizational system.

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Legend: • = core element; t = thickening; p = patching; c = coasting

Core element 1 = mutual structure; core element 2 = focus on conservatively managed funds; core element3 = low cost; core element 4 = candid communication; core element 5 = focus on long-term performance; coreelement 6 = direct distribution; core element 7 = high-quality service.

thickens its first core element. Over its history, the organiza-tion creates a number of core elements. After creating a newcore element, the organization devotes itself entirely to fur-ther elaborating this core element. After a new core elementis created, the organization coasts with respect to previouslycreated core elements. Brown and Eisenhardt (1997) report-ed an empirical observation resembling this pattern. In theirstudy of firms in the computer industry from 1993 to 1995,they described how one firm, Cruising, had transformed itselffrom a poor performer to a good performer:

[Cruising’s managers] began by focusing on current projects andgetting rid of their lock-step and bureaucratic processes, increasingcommunication, and adding project-level responsibilities. With thataccomplished, they concentrated on developing their sense of thefuture through tactics such as futurists and alliances with leading-edge technology providers. Lastly, they turned to the transitionbetween current and future projects, ultimately settling on a 4/8quarter rhythm and a marketing-led transition. . . . Cruising man-agers did not instantly create their organization but, rather, “grew” it

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The four developmental processes, together with the con-cepts of core and elaborating elements, form a grammar(Pentland and Rueter, 1994) that can be used to provide con-sistent descriptions of the developmental paths of differentorganizations. Moreover, the vocabulary allows the characteri-zation of a number of ideal types that can serve as a startingpoint for a classification scheme for observed paths of organi-zational development. I describe below two such ideal pathstoward a single configuration, called “patch-by-patch” and“thin-to-thick.”

Figure 7 illustrates an organization that develops purely bypatching, except in the first period when, by definition, it

Figure 7. Patch-by-patch development.

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over a period of several years. They developed and stabilized somepieces of the process, and then moved on to the next. (pp. 30–31)

A second ideal type of organizational development I termthin-to-thick. Figure 8 displays this pattern. Here, the organi-zation is founded with a number of core elements that it con-tinues to elaborate over time. No new core elements areadded later. The organization thus engages only in a thicken-ing process of its core elements. Its overall system starts outthin and thickens over time with elaborating elements. Whilecore elements stay constant, individual elaborating elementsmight still change over time. The thin-to-thick pattern is char-acterized by important early decisions about core elementsthat consequently guide the developmental pattern of thefirm. In the terminology of Mintzberg and Waters (1985), thisdevelopmental pattern can be described as a mixture of an“entrepreneurial” and an “umbrella” strategy. Early in theorganization’s history, its founders express their vision for theorganization by making several key strategic and structuraldecisions that subsequently serve as general guidelines forbehavior throughout the organization.

Given that the patch-by-patch and thin-to-thick patterns areideal types, not many organizations are expected to followeither pure path, but organizations may follow paths thatmore closely resemble one type or the other. The critical dif-ferentiator between the patterns is the temporal sequence ofthe creation and elaboration of core elements. Organizationsthat create most of their core elements simultaneously andthen continue to elaborate these elements simultaneouslywould display a developmental pattern that is closer to thethin-to-thick pattern. Organizations that create most of theircore elements sequentially and elaborate these core ele-ments sequentially would follow a path resembling more thepatch-by-patch pattern. For instance, Vanguard’s developmentwas much closer to a thin-to-thick development than a patch-by-patch development: Vanguard established and elaborated

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Figure 8. Thin-to-thick development.

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most of its core elements simultaneously rather than sequen-tially. As a result, for most of its history, Vanguard wasengaged in the process of thickening its system around exist-ing core elements.

As long as the core elements within an organizational systemremain consistent with each other, both patch-by-patch andthin-to-thick developments can lead to configurations withincreasingly tighter interactions, i.e., high internal fit. At somepoint, however, firms may need to move from one set ofconsistent core elements, or one configuration, to anotherset of consistent core elements. For instance, while the inter-nal fit of a configuration may still be intact, the external fit—the appropriateness of the configuration as a whole—mayhave declined, making a reconfiguration necessary(Siggelkow, 2001). Several transition paths from one configu-ration to another have been described in the literature (e.g.,Greenwood and Hinings, 1988). The constructs of thickening,coasting, trimming, and patching allow us to describe thesetransition paths as well. To illustrate, I focus on two transitionpaths that have received considerable attention in the litera-ture, the punctuated equilibrium model and a reorientationthrough linear progression.

A punctuated equilibrium pattern of organizational develop-ment (or a quantum-change model) has been described byvarious organizational scholars (e.g., Miller and Friesen, 1982;Tushman and Romanelli, 1985; Gersick, 1991). An organiza-tion that follows this developmental pattern experiences“convergent periods . . . relatively long time spans of incre-mental change and adaptation which elaborate structures,systems, controls and resources toward increased coalign-ment” (Tushman and Romanelli, 1985: 173). Very infrequent-ly, organizations experience “reorientations [that] are definedby simultaneous and discontinuous shifts in strategy . . . thedistribution of power, the firm’s core structure, and thenature and pervasiveness of control systems . . . [or] re-creations that are reorientations which also involve a dis-continuous shift in the firm’s core values and beliefs” (Tush-man and Romanelli, 1985: 179). The history of anorganization is thus punctuated by “reorientations and/or re-creations [that] define the end of one convergent period andusher in the next” (Tushman and Romanelli, 1985: 179).

Translated into the terminology of this paper, a punctuatedequilibrium path of development can be described as asequence of periods in which existing core elements areelaborated, interspersed with brief moments in which all (oralmost all) core elements are changed. Figure 9 illustrates thepure form of this developmental path. Dividing an organiza-tion’s history into periods based on changes in core elementsyields the same periods as Tushman and Romanelli’s demar-cation of convergent periods. At the end of each suchdefined period, the organization replaces all (or almost all) ofits core elements and creates an entire new set of core ele-ments. These new core elements are then elaborated overthe next period, after which the firm again replaces its set ofcore elements. Since an organization that follows such a pathalways creates its set of core elements simultaneously andthen continues to elaborate them simultaneously, one could

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describe the development of such an organization as asequence of thin-to-thick developments: at each recreationpoint a complete set of core elements is created; over theconvergent period, these core elements are elaborated, yetno new core elements are added; at the end of the conver-gent period, all core elements are replaced by new core ele-ments; and so on.

In figures 7–9, interactions between elaborating elementsand core elements were stylized with thin lines connectingthem, but core elements can interact and reinforce eachother as well. Moreover, these interactions can help explainthe dynamics behind a developmental trajectory. If core ele-ments reinforce each other, further elaboration of these coreelements is likely, since a new elaborating element for onecore element not only increases the value of that core ele-ment but also (indirectly) increases the value of other coreelements. Further elaboration of core elements that reinforceeach other is thus particularly valuable. The stronger theinteractions, the more the value of elaborating elements isaffected and the higher the incentive to adopt new elementsconsistent with the existing core elements. A positive feed-back loop can arise: core elements that reinforce each otherare likely to be further elaborated, which in turn increases thepositive interaction between them, leading to further elabora-tion, and so forth. The static interactions create dynamicfeedback effects: configurations develop a self-sustaining

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Figure 9. Punctuated equilibrium development.

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momentum (Miller and Friesen, 1980). In contrast, if core ele-ments are inconsistent with each other, strong internal mis-fits can arise, because two clusters of elements (the sets ofelaborating elements associated with each core element)work at odds with each other.

Additional types of transition from one configuration to anoth-er configuration (i.e., from one set of reinforcing core ele-ments to another set of reinforcing core elements) have beendescribed by Greenwood and Hinings (1988). Figure 10 illus-trates, for instance, a reorientation called “linear progres-sion.” In this case, an organization transitions from oneconfiguration (or archetype in Greenwood and Hinings’ termi-nology), consisting of core elements 1 and 2 through a“schizoid” phase, in which core elements of both configura-tions are present, to another configuration consisting of coreelements 3 and 4. In period 1, the gray double-headed arrowbetween core elements 1 and 2 is used to denote that theseelements are reinforcing, thus forming a configuration. Overperiod 1, the organization elaborates both core elements. Atthe beginning of period 2, the organization replaces core ele-ment 1 with core element 3. But core elements 2 and 3 arenot well aligned, denoted by a dashed, double-headed arrowbetween the core elements. Over period 2, the new core ele-ment 3 is elaborated. At the beginning of period 3, core ele-ment 2 is replaced with core element 4, and the organizationreaches a new configuration consisting of the mutually rein-forcing core elements 3 and 4.

By relying on interactions to identify core elements, thispaper thus provides a bridge between research that has char-acterized firms as configurations or systems of interdepen-dent elements (e.g., Porter, 1996; Gavetti and Levinthal,

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Figure 10. A linear progression development.

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2000; Rivkin, 2000) and work that has described firms usingthe imagery of core and periphery (e.g., Hannan and Free-man, 1984; Singh, House, and Tucker, 1986). The four con-structs of thickening, patching, coasting, and trimming, whichare based on the creation and elaboration of core elements,can thus serve as building blocks to describe various paths oforganizational development. Developments that can bedescribed include both paths toward more elaborated config-urations and transitions from one configuration to anotherconfiguration.

FUTURE RESEARCH DIRECTIONS

The constructs of thickening, patching, coasting, and trim-ming open two lines of inquiry for future research. First, whatcauses these processes to take place? An interesting obser-vation from the Vanguard case is that Vanguard adopted all ofits core elements within four years of its founding. Such afinding reveals the limitations of a single case study. A morebroadly designed study is necessary to address the questionof why firms add (or do not add) new core elements in theirevolution toward a configuration. One possible factor is thevolatility of the environment. Future research could tackle thequestion of whether environments that are stable are moreamenable to the simultaneous creation of entire sets of coreelements, and thus would give rise to patterns closer to thin-to-thick, than turbulent environments. In contrast, environ-ments that are characterized by turbulence might requiremore frequent patching and the full attention of managementto the elaboration of one core element at a time, asdescribed by Brown and Eisenhardt (1997) for the U.S. com-puter industry.

Similarly, the question of when and how firms modify theircore elements cannot be addressed with the present study.Besides trimming, a counterpart to the thickening process isconceivable: a gradual process of literally de-centralizing acore element by abandoning its associated elaborating ele-ments. Although such a “thinning” process did not occur atVanguard, and while the literature on punctuated equilibriumwould suggest that when firms change their core elements,the process is quick and wide-encompassing, future researchis required to investigate whether and when such a processmight take place.4

The second broad line of inquiry could investigate the organi-zational consequences of having followed one developmentalpattern rather than a different one. For instance, what is therelationship between a firm’s prior developmental path andits ability to respond to environmental change? Are firms thathave followed a patch-by-patch pattern able to react morequickly than firms whose development is closer to a thin-to-thick pattern? Similarly, successful transitions from one con-figuration to another may well be different depending on theprevious developmental pattern of an organization. The fram-ing of organizational development as it relates to thesequence of creating and elaborating core elements—thesequence of the processes of thickening and patching—thusraises an interesting set of new research questions. By hav-ing identified a set of developmental processes and a

4I am grateful to my reviewers for havingpointed out this possibility.

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method for identifying organizational core elements, I hope tohave laid a foundation on which future research efforts canbe built that will further increase our understanding of organi-zational evolution toward fit, and, in the process, the originsof misfit.

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Evolution toward Fit Nicolaj Siggelkow · 2020-01-07 · #9133—ASQ V47 N2—March 2002—file:...

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