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

Implementing Organizational Change

Ashish NandaMorgan 143

Harvard Business SchoolSoldiers Field

Boston MA 02163

Tel: (617) 475 6506Fax: (617) 496 5271

e-mail: ananda@hbs.edu

March 25, 1996

Abstract

To secure the participation essential to move an organization from an inferior state to a superior staterequires that workers be offered two incentives: (1) security that they will be excused if coordination breaksdown, and (2) encouragement to make an effort to change rather than free-ride on the efforts of others. Ifoffering 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 orattempting to coerce workers to abandon established routines. Organizational change can be induced byactively managing the change process, as by shuffling parts of the work force and nominating change agentsfrom among the workers. Moreover, the change process can be designed to make an organization moreamenable to change: for example, starting with a “kick-off” event and making the process a vigorouslydisequilibrating phenomenon. Whether the change process is implemented incrementally or radically dependson how the manager trades off the cost of instituting wrenching change against the cost of having theorganization partially misaligned with strategic necessity.

For managers, who are agents of owners, we equate value with the profit that accrues to the owners. Hence, we presuppose1

that a) owners care about their profits, and b) suitable contracts exist between owners and managers such that the managers care aboutthe profits that accrue to the owners.

-1-

I. Introduction

This paper considers the puzzling case of resistance to change in positive sum games in which thealternate organizational configuration enhances the value pie. This case would seem to lead handily to a paretosuperior outcome, with everyone at least as well off as at present and, hence, with little reason to resist thechange. Yet managers often remark that their greatest challenge lies less in recognizing the need for thestrategic change (external environment, technological conditions, or the manager’s vision change themanager’s estimation of value that different organizational forms can yield such that the existing1

organizational configuration is no longer optimal) than in implementing the organizational change needed toredirect strategy.

We argue that organizational change is difficult to achieve because firms get stuck in coordinationequilibria that are no longer optimal. In the following section, we use case studies of managers challengedwith implementing organizational change to delineate what we mean by the term “organizational change.” InSection III, we consider existing theories of why organizational change is so difficult to achieve and thequestions that they leave unanswered, and in Section IV suggest why it makes sense to think of organizationsstuck in sub-optimal equilibria when we consider the dynamics of organizational change. A simple model isdeveloped in Section V to demonstrate that one reason organizations become stuck in inferior equilibria is thattheir managers are unable to make the desired states sufficiently attractive to workers. Strategies for gettingorganizations unstuck and implementing change are proposed in Section VI. In Section VII, we suggest thata 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 anylonger what a person using this phrase exactly means. It is important, therefore, to clarify which classes ofphenomena we refer to when using the term “organizational change.” One way to do this is to clearly delineatesituations that we do not focus on. There are three such situations, characterized by some academics andpractitioners 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-valueenhancing exercises that aim simply to redraw the pie-partition, typically between stockholders andworkers. The bargaining process in these zero-sum games is bound to be fractious and the partysitting on the opposite side of the table is bound to resist. The oft-encountered value creationsituations that involve value redistribution as well, on the other hand, are considered.

2) What Burns calls transforming leadership: “[E]ngaging with others in such a way that leaders andfollowers raise one another to higher levels of motivation and morality” (1978, p. 20). Examples ofsuch leadership would include Roosevelt’s New Deal, Gandhi’s non-violent campaign against Britishrule in India, and the unswerving commitment of Ben and Jerry’s chairman Ben Cohen to social

For expositional reason, we sharply distinguish between the challenges of push through change given people’s innate2

desires and molding people’s preferences. Real life does not take such extremes: Leaders confront having to push change givenpeople’s wishes even as they attempt to influence their desires. One can, however, envisage a continuum with some situations beingcloser to implementing change given preferences and other situations being closer to transforming people’s desires. This paperinforms situations that lie close to the former type of situations.

Hence, we exclude from consideration those conglomerate organizations whose sub-units operate entirely independently.3

However, we believe that the excluded group would be a tiny minority, since a key reason why activities are organized within a firmis that they need to be coordinated. Barnard’s (1938, p. 73) definition of an organization highlights the importance of coordinationin an organization: “[An organization is] a system of consciously coordinated activities or forces of two or more persons.”

-2-

causes and community support. Situations in which the leaders mold the preferences of theirfollowers, however powerful and moving, are not considered.2

3) Settings in which people work and produce results entirely independently of one another. Weare concerned with change in organizations in which productive output results from the joint effortsof 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 theboundaries so tight as to leave hardly any real life analogs. We do not believe this to be the case. Indeed, webelieve that managers are frequently challenged to implement precisely what we construe to be “organizationalchange.” Four examples from practice are related below.

A software company. Owing to the geographical distance between facilities in Silicon Valley, Californiaand Bangalore, India and differences in the programming capabilities of the respective workforces, a softwarecompany broke programming projects up into self-contained pieces that could be developed relativelyindependently 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 bandwidthcapability facilitated internetworking at a low cost, and Bangalore programmers had become as proficient astheir Silicon Valley counterparts. Believing the benefit of speeding development to outweigh increasedcommunications costs, the firm’s CEO proposed to restructure project allocation such that programmers at bothfacilities could work on the same project by exchanging code daily.

The restructuring called for project teams to span geographical boundaries and interactivity to takeprecedence over independent work. Project managers, hitherto organized under geographic heads, would haveresponsibilities spanning both locations. The CEO was struggling with the issue of how to effectivelyimplement the desired change.

A multinational consulting company’s European operations. A large systems and managementconsulting firm had developed a powerful presence in Europe by nurturing independent country practices. Butthe area managing partner (AMP) for Europe, perceiving that the firm’s clients were becoming increasinglyinternational, anticipated growing demand for consulting services that spanned geographic boundaries.Believing the benefits of developing a pan-European practice – uniform service to multinational clients andflexibility to move skilled consultants from one country to another – to outweigh the costs of reduced localsensitivity and autonomy, he proposed a significant organizational change. Industry heads who had previouslyreported to geographic heads would operate across countries, the role of the latter would be allowed toatrophy, and consultants would be expected to shift focus from developing local contacts to building industryexpertise.

I am grateful to Jay Lorsch for bringing this case to my attention.4

-3-

Rather than attempt to move directly to a pan-European organization, the AMP divided Europe intothree regions and simultaneously announced a number of new assignments. Some high-performing countrymanagers assumed the new responsibilities of regional managers while former geographic managers assumednew functional responsibilities. Emphasizing that these changes were but one step towards a pan-Europeanorganization, the AMP believed, provided sufficient indication of forthcoming change to afford erstwhilegeographically-focused executives time to alter direction and cultivate industry skills.

A commercial vehicles manufacturer in a developing country. Protected from foreign competition by dutiesand tariffs, the commercial vehicles industry in a developing country had for more than three decades remaineda duopoly. In the face of licensing constraints that held output well below potential demand, the industryleader, which commanded 70% of the market, focused on maximizing production.

When political and macro-economic considerations led the government to eliminate import barriersand encourage foreign collaborations, five foreign commercial vehicles manufacturers promptly entered thecountry in collaboration with domestic firms. Recognizing the need to shift priorities dramatically, the CEOof the dominant local manufacturer proposed that marketing’s role be changed from rationing agent topurveyor of market intelligence and production’s philosophy be shifted from maximizing capacity utilizationto meeting customer requirements.

To drive these changes, the CEO organized weekly meetings of senior marketing and productionexecutives to discuss production plans. After six months of having these meetings, the CEO was frustratedthat decision processes were still mired in the old framework. Manufacturing continued to be preoccupied withproduction bottlenecks, countering sales executives’ requests for products that varied from production planswith concerns about switch-over costs and inventory, and unable to countenance sales’s inability to quicklydispose of the vehicles that came off the line. The CEO’s strong encouragement notwithstanding, salesexecutives often slipped into asking manufacturing executives what they planned to produce. Such forecastsas were produced were wildly inaccurate and subject to dramatic revisions, reflecting less an enthusiastic beliefin them than a desire to satisfy the CEO.

Procurement activity in a defense equipment manufacturing firm Perceiving impending difficulty4

securing essential raw materials, the president of a large concern that made equipment for the U.S. armedforces asked an executive appointed to a newly created position of vice president in charge of purchasing tocoordinate purchase decisions across all 20 of the company’s plants. Believing that centralized purchasingwould yield significant economic benefits as well as afford the company the leverage to demand better termsfrom suppliers, the new vice president asked the plant executives responsible for purchases to clear with himin advance all purchase contracts that exceeded $10,000. Although the executives enthusiastically accededto the request, the head office received not a single request for purchases over the next six weeks, yet the plantscontinued to function busily in their usual routine. Upon enquiry, the vice president discovered that the localpurchasing 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 thatimplementation of change was fraught with difficulties. We explore in the following section some rationalesfor why this is so often the case.

-4-

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 somerationales for why they become mired therein in the first place. We attempt below to synthesize theaccumulated 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 Vandermerweand Vandermerwe (1991, p. 174) conclude that the principal obstacles to implementing organizational changeare “people related.” Attempts to account for this have tended to follow one of three broad lines of reasoningrelated to: lack of communication; uncertainty avoidance; and defensive routines. We explore below theassumptions 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 management’sfailure 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 howmuch better the changed state might be. Tichy and Devanna (1986, p. 44) term this organizationalcomplacency the “boiled frog phenomenon,” asserting that companies’ thresholds for recognizing the need forchange 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 inmanagement’s 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 setof 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 changeremains an unknown,” observe Bucholz and Woodward (1987, p. 145), “the organization will be like thekingdom in the fairy tale – unproductive. But as more and more people ‘call out the dragon’ – that is, specifythe problem – they will be able to define objects and then, as if by magic, come up with creative and innovativeways of dealing with those problems.”

Communicating the message that change will benefit the organization may be an extremely difficulttask, requiring that workers be acquainted with complex issues, such as competitive dynamics and marketforecasts. Indeed, communicating the entire message may be well nigh impossible, and even to the extent thatit is communicated effectively, employees may withhold their buy-in unless they are assured of management’scredibility and astuteness of judgement. Exhortations to change are frequently met with employee skepticismexpressed in remarks such as “We have been fed this line before,” and “All that management wants to achievethrough these ‘change programs’ is a reduction in head count.”

How does a manager surmount the twin hurdles of conveying what is often complex information andovercoming low credibility? A powerful and efficient way is to protect the employees from potentialdownsides and offer them an upside if they make the desired transition. Assume, for example, that the present

pz% (1&p)y ' B%b

For clarity of exposition, we employ the shorthand of attributing owners’ surplus to management. The underlying5

assumption is that the owners have suitably contracted with the managers so that the latter make decisions that are in the former’sinterests.

We make the standard assumption here that workers are risk-averse and owners, represented by management, risk neutral6

towards firm returns.

-5-

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 toreorganize with an offer to compensate employees at a+"b units (0<"<1), indicating that employee buy-in tothe reorganization will ultimately boost their earning as well. Employees are likely to accommodate, evenembrace, change that increases their compensation. An offer of increased compensation makes crediblemanagement’s 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 broadsense, to refer not just to money, nor even just to money and satisfaction of egoistic values such as status andprestige, but also to improved work environment, expanded social responsibility, and so forth, with all thefactors of concern to the employee being brought together under the common denominator of utils. Butoffering employees greater utils as inducement to accept change is effective only so far. Utilities are non-separable, interactive, and interpersonal, as observed by Tichy (1977, p. 346), who remarked that resistanceto change might emanate from a power motive, over-dependence, or interpersonal comparisons. If it is notpossible to compute the impact of a change on, or even to influence, employees’ utilities, management’s abilityto 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 beconcerned about both their own and the communal well being. The consulting firm’s country manager, forexample, might well be unhappy to be losing power and unhappier still that power was accruing to thefunctional 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 withtheir 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 theknowledge gap, they can communicate intensively the benefits of the proposed change. To make their messagecredible, 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) haveposited that employees prefer a certain present to an uncertain, even if rosier, future. If management could besure 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 sharedthus: a by employees and B-a by management. An alternative configuration is expected to generate , withprobability p, z>B units of value and, with probability (1-p), a low profit y<B. In expected value terms,

where b>0. Employees, being risk-averse, prefer a certain compensation a to uncertaincompensation with an expected value of a. An optimal solution under these circumstances would be formanagement to insure employees against the consequences of accepting change by offering to compensate

-6-

them, say, a+"b units (0<"<1) regardless of the outcome of the change. On an expected value basis, themanagement 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, perhapsby building excitement through engagement in the change process. If, however, management is itself risk-averse, 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 maybe impossible, moreover, for management to insure against possible downsides in non-monetary facets of theircompensation – colleagues, work environment, and so forth (Tichy, 1977, Beer, 1991).

Managers often expect employees to support change initiatives without any assurance that they willthrive, or even survive, past the programs. Workers who do survive, moreover, are likely to be devastated bythe firing of colleagues and friends and end up uncertain about their own value to or role within theorganization. Little wonder that the next time management announces a change campaign the workers run forcover. This is in contrast to the president of the software company mentioned earlier who launched a teammanagement initiative and developed, in consultation with managers at both locations, a graduated roll-inschedule for cross-border projects was developed. Group training sessions and personal tutoring affordedprogrammers opportunities to explore both the mechanics and psycho-social aspects of the change. Theprogrammers were subsequently eased into cross-border projects and awarded bonuses if they made thetransition ahead of schedule.

In summary, suitably encouraged, employees will embrace change; their risk aversion is mosteffectively 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. Theenergy and effort expended learning the skills they are currently using is a sunk cost for employees; it cannotbe recouped. They will resist an organizational arrangement that requires them to make a further investmentin learning new skills.

This conclusion makes two assumptions, (1) that workers dislike learning new skills, and (2) that theexisting and alternative arrangements yield equal benefits. Yet workers can be found who enjoy learning newskills, even value such skills beyond what they contribute to organizational productivity, finding them to beintrinsically satisfying or increasing their employability. Even if skill development should incur disutility onworkers, 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 “left-handed” workers, to whom a units of surplus accrues. As a consequence of a strategic change, the organizationcan 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 managementpromises them a+G+"(b-G) provided B+b profit is generated, they will willingly make the effort to becomeright-handed.

Management’s offer of countervailing benefits will be moot, however, if workers’ concern is not withexpended effort but rather with “competence insecurity.” Workers, comfortable with the skills they possessand uncertain of their ability to master new skills, will shy away from learning. Pyschologists have

-7-

documented the compulsive, security-oriented behavior which people often resort to in order to preserve thestatus quo even against change for the better (Diamond, 1986).

Researchers have remarked that organizations function in accordance with established routines (Nelsonand Winter, 1982, chapter 5). For excellent evolutionary reasons, these routines enable parsimoniousoperations that minimize adjustment and learning costs. Although they promote efficient functioning understable conditions, routines become stumbling blocks when change is desired. Routines nurture robustness atthe cost of introducing organizational inertia. Among the varied manifestations of this in-built organizationalresistance to change are: “idea killer advice,” “the rule of repeated action” (Hornstein, 1986), “skilledincompetence,” “fancy footwork,” and “apparent motion” (Argyris, 1990).

Argyris (1990) asserts that resistance, however irrational under a given set of circumstances, is aprogrammed human and organizational defensive routine. It can be overcome, he suggests, by increasing self-awareness and promoting stewardship among the members of an organization. Reflection by the individualand meta-routines in the group can help people who perceive change to be clearly for the better to break thebonds of inertia.

Competence insecurity can be overcome by introducing change gradually rather than all at once.Recall the consulting firm’s AMP whose plan to transform a country-based organization involved anintermediate stop at a three-region organization. The transitional organization was both harbinger andmitigator of more change to come. It afforded the consultants, whose expertise was geographically-based, timeto develop industry-related skills, thereby avoiding the frenzied sense of incapability that would haveenveloped 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 ofcountervailing benefits that will make the investment worthwhile, concern about the mastery of new skills byeasing into the change and encouraging workers to reflect on their attitudes towards change and nurturing theirsense of identification with the organization.

-8-

Cause of First order Why first order suggestions may Second order suggestionsresistance to suggestions not workchange

Workers are Convince workers . Workers’ utilities may be non-sep- . Communicate intensively andunaware of the that they will be arable, interactive, and interpersonal. credibly the benefits of change.benefits of better off if they . Management may be unable to . Appeal to workers’ sense ofchange change than if they compute the impact of the change on, doing what is right for the

don’t. or influence, the workers’ utilities. organization.

Workers are Insure workers aga- . Management may be unable to . Try to minimize workers’worried about inst potential down- compute uncertainty. aversion to risk.an uncertain sides to the change. . Management may be risk-averse. . Explore management’sfuture . Workers’ utilities may be non-sep- evaluation and attitude towards

arable, interactive, and interpersonal. the risk inherent in the changeprocess.

People stick to Recompense . Workers may suffer from . Ease workers into the changeold habits and workers for effort competence insecurity. process.routines expended to . The organization may be mired in . Encourage self-reflection and

develop new skills. defensive routines. stewardship.

Table 1

Table 1 suggests that, were human beings to behave in a manner consistent with the classicaleconomics assumptions of rational, self-centered, and well-informed behavior, the first order suggestionsenumerated in the table would deal handily with resistance to change. The principal reason that the threecauses 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 homoeconomicus? Not by our reckoning. As we argue below, even in a world of rational, well-informed peoplewho 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-optimalequilibria

Management scholars’ recommendations for implementing organizational change suggest that theprincipal 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 (seeTable 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 newarrangement.

Why does an organization become “frozen”? We believe lack of fluidity is due fundamentally to theinability of organization members to transition to a new state in a coordinated manner. Previous coordinationis implicit in the existing, stable organization, a “strategic change” dictates that further coordination is possiblein 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

-9-

desirable than the existing, inefficient equilibrium. Fear of such an outcome keeps organizations stuck in sub-optimal equilibria.

Model Process

Lewin (1947) Unfreezing Changing Refreezing

Beckhard and Harris (1977) Present state Transition Future state

Tichy (1977) Start-up System developmentStabilization (leading to

self-renewal)

Conner and Patterson (1981) Preparation Acceptance Commitment

Kanter (1983)Departure from Strategic decisions and Action vehicles and

tradition and crises prime movers institutionalization

Tichy and Devanna (1986) Act 1 Awakening Act II Mobilizing Act III Reinforcing

Woodward and Buchholz (1987) Endings Transitions Beginnings

Nadler and Tushman (1989) Envisioning Energizing Enabling

Nadler and Tushman (1995b) Recognition Strategic choice Re-creationTable partially adapted from Kanter et al (1992), p. 376.

Table 2

Consider the following thought experiment. An organization employs two workers, each of whomearns a units of compensation working left-handed. Environmental or technological changes make it desirablefor 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 workleft-handed, each will earn a-d units. The situation can be described by the payoff matrix in Figure 1 (thebottom left term in each box is A’s utility, the top right term B’s utility). Both LL and RR being NashEquilibria, if they have been in the LL equilibrium, employees need not shift to the “better” RR equilibrium.

B

L R

A

La a-d-G

a a-d

Ra-d a+c

a-d-G a+c

Figure 1

Each of the four organizations described in Section II faced the challenge of moving from oneequilibrium to another: the software company from geographical to project-driven teams; the consultingcompany from a country to an industry-based organization; the commercial vehicles company from productionto 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 programmerspersisted in a geographic, approach to work, clashing expectations would almost certainly diminishproductivity. Similarly, were the industry heads of the consulting company to begin to operate acrosscountries, but the country heads to continue to manage resources on a geographic basis, chaos would surely

Although we are taking this case for ease of exposition, the resulting argument is quite general and applies even more7

vigorously in the case of a number of workers each of whom can develop multiple skills.

I do assume, however, that the manager can verify, and hence, explicitly prevent idling by a worker.8

Section VI.E discusses how relaxing the assumption of mutual unobservability of skill development can ameliorate the9

problem of organizational inertia.

-10-

result. The industry heads would bring in increasingly international projects for which expertise would beavailable only on a country-by-country basis. If the commercial vehicles company’s marketing departmentbegan to request products strictly per its forecast, but the production department maintained its focus onovercoming 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 executivesto continue to operate with the expectation that their needs would be quickly fulfilled, the defense equipmentsmanufacturing company would begin to experience severe stock-outs in its factories. What hampered changein each of these instances was the uncertainty of the Bangalore programmers, industry heads, marketing andpurchase 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 notdo so. Large sample empirical studies also indicate that executives contemplating organizational change arepreoccupied 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 theirattitudes towards organizational change (1989, p. 440): “Significantly, the managers who were surveyedoverwhelmingly 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 wasskepticism 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 whatconstrains managers from getting their organizations “unstuck.” Recalling Figure 1, for instance, whatprevents a manager from changing payoffs to workers such that RR becomes the dominant equilibrium? Weargue here that such a high level of compensation must be offered to make the desired equilibrium dominantthat it may no longer be attractive. We develop a simple model that helps to concretize this line of reasoningand 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 developtwo skills, which we label L (left-handed) and R (right-handed). A worker can perform a task either “left-7

handed” or “right-handed,” but cannot use both skills simultaneously.

The manager cannot observe the skills developed by the workers, nor the workers each other’s skills,8

during the skill development process. A manager able to observe the skills developed by workers (and verify9

them to a third party) could make compensation skill-dependent and thereby directly incent development ofthe desired skills. Absent such observability, the manager must indirectly motivate development of the

B1LL > B1

RR

B1LL > B1

RR > B1LR ' B1

RL

We are ascribing all the bargaining power to the manager by assuming that the employment contract is based on a “take10

it or leave it” offer. The argument below does not change materially if we assume a different scenario, except that the problem oforganizational inertia becomes less acute the greater the workers’ bargaining power relative to the manager.

The argument presented below is robust to these assumptions.11

These assumptions are made for expositional reasons. One could model skill development as a process incurring disutility12

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.

In Section VII, we discuss the case in which but the manager still desires that the workers develop right handed13

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

-11-

appropriate skills by making workers’ compensation contingent on the profits generated, which the managercan 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 ofpurchase 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 eachof 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 thespecific skill needed to perform productive tasks and generate profit. Greater profit is generated if the workerscoordinate 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 theircompensation, net the disutility of making the effort to develop their skills. Again, for ease of exposition, weassume the workers to be risk neutral and their utility to be additively separable in income utility and effortdisutility.11

The manager is willing to continue operations so long as net payoff is greater than 0; the workers areinterested in continuing employment with the firm so long as their net utility is at least equal to the utility tobe gained from engaging in the next best task. We assume this reservation utility to be U unit per period.0

We model the skill development process as if it were akin to learning how to ride a bicycle: up to acertain threshold level of effort, no skill is developed; beyond that level, the worker learns the skill, butadditional effort does not increase the skill level. We assume that skill developed in the first period can beemployed 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

period profit matrix is as given in Figure 2, where . By offering them greater

compensation if first period profit is B , the manager motivates the workers to develop left-handed skills inLL

the first period.13

B1LL B1

LR

B1RL B1

RR

B1LL

B1LL

B1LL

B2RR > B2

LL > B2LR ' B2

RL

B2RR & B2

LL > 2G

B2RR B2

LL

-12-

B

L R

A

L

R

Figure 2

If the profit matrix does not change in the second period, the manager will continue to desire that theworkers apply left-handed skills. And this can be assured by offering compensation that matches the workers’

reservation utility of U only if profit generated is .0

Interestingly, were the manager to offer even higher compensation, of say U +"G (where 0<"<1) if0

the profit generated in the second period is not , the workers would still apply their left-handed skills. This

is because the workers care about their utility, not compensation, and profit other than 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

skill application is decidedly better: . The cost to each worker of the added effort to

develop right-handed skills notwithstanding, the RR equilibrium is superior to the LL equilibrium:

. Yet, as we demonstrate below, the organization can find itself stuck in the LL equilibrium.

B. Why shifting from LL to RR is difficult

It would seem that in order to motivate the workers to develop right-handed skills the manager needonly offer compensation such that the utility of implementing the RR equilibrium is greater than that of

implementing LL. Offering the workers U +G each if the profit generated is , 0 compensation if it is ,0

would lead the workers to prefer developing right-handed, to applying left-handed, skills, since the formerwould yield a net utility of U , the latter 0.0

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 ofassurances are needed to motivate them to make the change from applying left-handed skills to developing andapplying right-handed skills. To make RR the dominant equilibrium, the compensation schemes offered tothe workers must satisfy two incentive compatibility conditions.

B2LL

B2LR

G % ,1 B2LR

G % ,1

2G % ,1 B2RR

2G % ,1 % ,2 B2RR

The terminology is that used by Van Huyck, Battalio, and Beil (1990) in describing coordination games.14

-13-

(1) security : a worker is not penalized for developing skill R if the other worker defects by applying14

skill L to the task; and(2) payoff dominance: if the other worker has invested in skill R, “defecting” by applying skill L doesnot pay.

Security requires that workers be excused if chaos ensues, that is, they end up at least as well off aswhen coordinating in the LL equilibrium. The workers are thus told that they will be paid more if chaosoccurs than if the old equilibrium persists. As skill is not directly observable, the workers must becompensated 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 resultsthan 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. Thelowest compensation the manager can offer a worker is 0, if extortion is proscribed. If workers are told they

will receive 0 compensation if units of profit are generated (LL equilibrium), security requires that each

be offered compensation of at least G if profit is generated (LR or RL equilibrium). Offering each worker

compensation of (where , >0) if profit results ensures that they feel confident developing the new1

skill even if their colleague does not develop it. The worker who does not develop the right-handed skillreceives a utility of if chaos results.

Payoff dominance requires that the workers find it beneficial to develop right-handed skill. The

manager thus needs to offer the workers compensation of at least each if profit results (RR

equilibrium). Workers are offered compensation of (where , >0) if profit results. These2

are efficiency wages – compensation that yields utility in excess of reservation utility. The workers’ utilitiesare as shown in Figure 3, in which RR is, indeed, the dominant equilibrium.

ALL2

ARR2

CLOSEDOWN

LL BETTER

RR BETTER

STUCK

2U0

4G-2U0

2G % ,1 % ,2

B2LL

-14-

Figure 4

B

L R

L 0 ,1

A 0 G+,1

R G+, G+, +,1 1 2

, G+, +,1 1 2

Figure 3

If, however, each worker is paid in the RR equilibrium, the manager may find it

preferable to implement the LL equilibrium by offering the workers compensation of U each if they generate 0

units of profit, G units of compensation otherwise. As can be seen in Figure 4, there is a range of profitabilityvalues for which, even though it is a superior outcome, the RR equilibrium is not implemented and theorganization remains stuck in the old LL equilibrium.

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

B2RR B2

LR

B2LL

B2LL

-15-

Consider these two forms of assurance in the context of the companies described in Section II. Ifperformance declined during the transition, the manager ought to excuse the workers rather than try toapportion blame. The manager thus needed to convey to the workers that chaos was a less unwelcome resultthan persistence of the status quo. Were the entire workforce to make the transition, performance wouldimprove. The manager needed to convey to the workers that they would be handsomely rewarded if this wereto happen. To make both assurances credible, a manager would have to create a significant differentialbetween what workers would receive if the desired state were to be achieved versus and what they wouldreceive if the existing state were to persist. Often this is done by extolling the virtues of moving to the desiredstate while simultaneously characterizing the present state as a “burning platform.” “The leader’s job is to helpeveryone see that the platform is burning,” remarks Allied Signal’s chairman and CEO Lawrence Bossidy,“whether the flames are apparent or not. The process of change begins when people decide to take the flamesseriously...” (Tichy, and Ram Charan, 1995). Such a contention, however, has a lower bound in that utilitybelow 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 theorganization embrace needed change? We consider first two seemingly obvious and simple strategies thatwould 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 task-assignments of workers, initiate change with some sort of “kick-off,” and “shaking the organizational tree” bymaking the change process itself a disequilibrating experience for the organization.

A. The “stick” isn’t quite as effective as the “carrot”

Rather than “sell” the RR equilibrium, why not threaten dire consequences if workers persist in theLL equilibrium. A manager might, for example, offer U +G units of compensation if the profit generated is0

, U -, units of compensation (where , >0) if the profit generated is , and U -G-, -, units of0 1 1 0 1 2

compensation (where , >0) if the profit generated is . Figure 5 plots the workers’ utilities for this set of2

circumstances. The dominant equilibrium RR is preferred by the manager too.

B

L R

A L U -G-, -, U -G-,0 1 2 0 1

U -G-, -, U -,0 1 2 0 1

R U -, U0 1 0

U -G-, U0 1 0

Figure 5

Workers are warned away from the LL equilibrium by telling them, “If a gross profit of occurs,

you will each be fined” (since U <G). Employment being a voluntary relationship, however, such a threat is0

not credible. A worker whose utility falls below a threshold, say 0, can simply walk away from the offendingrelationship. It is generally impossible to charge workers an ex-post penalty. Asking the workers to post bonds

B2RR B2

LR B2LL

-16-

up-front and forfeit them if they implement the LL equilibrium might be construed to circumvent the ex-postissue. But the legal standing of ex-ante employee bonds is tenuous, at best.

B. Simply making the desired equilibrium more attractive to the workers isn’t sufficient

Must RR be made a dominant equilibrium? Wouldn’t it suffice, workers being rational and self-interested, if it were simply the most attractive of several possible Nash Equilibria?

Returning to our model, Figure 6 plots workers’ payoffs given compensation of U +G if a profit0

of is generated, U -, if a profit of is generated, and 0 units if a profit of is generated. Both LL0 1

and RR being Nash Equilibria, and workers being better off in the RR equilibrium, the latter would seem tobe the logical choice.

B

L R

L 0 U -G-,0 1

A 0 U -,0 1

R U -, U0 1 0

U -G-, U0 1 0

Figure 6

The coordination game described in Figure 6 has been studied extensively by game theorists. Theyhave given this class of game an interesting name, the “stag hunt” (Aumann, 1990) in acknowledgement ofthe stag hunt parable discussed by Rousseau in motivating his analysis of the social contract. Two hunters cancollaborate in a stag-hunt (RR equilibrium) or individually hunt a rabbit (LL equilibrium). If only one hunterchooses L, that hunter benefits, since an individual can hunt rabbit; the result for the other hunter, who haschosen R, is a “wild stag chase,” since stag hunting requires coordinated effort by the hunters. If the twohunters could coordinate, they would engage in a stag hunt. If they do not, they are unable to implement thesuperior 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 periodssuggest that such is not the case. History matters enormously in such games: players opt for equilibria theyhave implemented before (Van Huyck, Battalio, and Beil, 1991; Knez and Camerer, 1994). Considerationsof security, moreover, promote a focus on the inefficient rather than payoff dominant Nash Equilibria (VanHuyck, 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 defenseequipment company’s purchase executives knew that it was better for both the firm and them personally tocentralize the purchase of key items, the commercial vehicles company’s marketing executives that demandingproduction against their forecasts would be better for both them and for the company, yet uncertainty about

2G % ,1 % ,2 B2RR G % ,1 B2

LR B2LR

U0 % G B2RR

B2RR

-17-

how their counterparts in manufacturing would behave led both sets of executives to prefer to remain with thestatus quo.

C. Creating “winners” helps

Whether it is the software professionals in Bangalore, the consulting firm’s industry heads, thecommercial vehicles firm’s marketing executives, or the defense equipment firm’s purchase officers, somemembers of the organization gain more from the change program than the others, either in terms ofcompensation or in terms of power and status. Some of this asymmetry in rewards may be due to intrinsicdifferences 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

if profit results, if profit results, and 0 if profit results, whereas B is only

offered if profit results, and 0 otherwise. Figure 7 plots the utilites of the workers in those

circumstances.

B

L R

L 0 -G

A 0 G+,1

R 0 U0

, G+, +,1 1 2

Figure 7

B does not have to be offered security since A will definitely develop right-handed skill. The cost ofmaking 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 aninefficient towards a superior equilibrium. And the rationale for that has to do with more than some workersbeing 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 inthe 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 identicalproclivities, say A. Suddenly, the skills developed by A are no longer unobservable by B. If the manager

offers the workers compensation of U +G units if profit results and 0 units otherwise, they face the game0

-18-

Figure 8

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

The consulting company’s AMP named some of the country executives regional managers in the neworganization. Thus identified as leaders in the change process, these executives began to push for the neworganization. Recognizing that they were moving in the direction of cross-border assignments, the remainderof the executives in the geographical organization followed suit.

Management scholars stress the importance of identifying within the organization change agents ortask 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 changeprocess. As the foregoing analysis suggests, task forces and management teams perform the critical functionof 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 intensivelymonitoring one another’s 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 thingsbeing equal, workers prefer to use existing skills rather than develop new ones. This root cause of resistanceto change can be mitigated by making workers indifferent to different skills. This is done by changing theworkers themselves. It may involve rotating the work force such that a significant number of workers are newto 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 ifworkers are entirely identical and their reassignments decided by the flip a coin, the mere fact that some aremoving will help pull an organization out of an inefficient equilibrium. The reason new assignments help thechange process is that new workers are equipoised in their attitudes to old and new skills, and can be motivatedto learn the new skills by a small difference in compensation. Understanding that the compensation structurewill motivate new workers to develop new skills, and wanting to avoid the uncoordinated outcome, workerswho have stayed in their jobs will also develop the new skills. The logjam of workers sticking to old habitsis thus broken and the organization transitions to the superior equilibrium.

B2RR B2

LR B2LL

-19-

In our model, assume that the flipping of a coin determines that worker B is to be replaced by a newworker B!! – whether through firing and hiring or job-rotation – and both A and B!! are offered compensation

U +G if a profit of is generated, U -, (where , >0) if a profit of is generated, and 0 if a profit of 0 0 1 1

is generated. The game these workers would confront is charted in Figure 9.

B!!

L R

L -G U -G-,0 1

A 0 U -,0 1

R U -, U0 1 0

U -G-, U0 1 0

Figure 9

The only Nash Equilibrium the workers can achieve is RR, the reason being that the compensationschedule makes learning the right-handed skill the dominant choice for the new worker, B!!. Given that B!! isdefinitely 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 jobreassignments and/or the firing of part of the work force and hiring of new employees. Although to someextent, this may be motivated by a desire to achieve a better fit between people and the changed tasks, theforegoing analysis suggests that a major benefit of getting fresh people in is that it helps an organization breakout of established habits.

In the wake of the AMP’s announcement that widespread reassignments would accompany theconsulting company’s reorganization, a number of country executives were moved to regional offices or to newindustry-oriented positions. Executives’ responsibilities were shuffled to ensure that they were not heavilyinvested in the existing system.

F. A “kick-off” can help initiate change

Six months into his failed attempt to introduce change, the CEO of the commercial vehicles companyrealized that one reason the change program had not taken hold was that there had been no sharp point ofdeparture. Reorganization and reassignments in the consulting company, in contrast, had been made effectiveon a particular date. The software company had implemented its change program on an aggressive time-boundschedule. The chief executives of both the consulting and the software companies announced specific datesfor 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 attitudestowards impending changes. The chief executives used these settings and other formal and informalmechanisms 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 cleanbreak from the past, (2) affords an opportunity for workers to inform one another whether or not they are goingto make the switch, and (3) offers managers an opportunity to exhort workers to make the desired switch. Areany of these features of a “kick-off” significant to the prospects for effective change?

Technically, a separating equilibrium exists in the signaling game between manager and workers: a manager who stands15

to derive personal gain from a non-value enhancing change keeps quiet; only a manager who knows that change will be beneficialincurs the cost of exhorting workers.

-20-

Nominating a specific date on which change will become effective enables workers to coordinate ona focal time. In the absence of such a date, workers must confront uncertainty on two dimensions: (1) who willmake the change, and (2) when will they make it? Establishing a “kick-off” date eliminates one of thesesources of uncertainty, significantly reducing the risk of non-coordination and thereby increasing the possibilitythat 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, afterall, 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.A’s non-credible promise to play R should be ignored by B.

A number of researchers, however, have argued that, when multiple Nash Equilibria exist, suchcommunication can help bring one of the equilibria to salience (Crawford and Sobel, 1982; Farrell andGibbons, 1989; Van Huyck, Gillette, and Battalio, 1992). Farrell (1995) has speculated with respect to Figure6, that if B is uncertain whether A will play L or R, A’s talk might influence this subjective probability andthereby might affect B’s choice. Overall, it seems reasonable to make the weak claim that ex-antecommunication among the workers does not harm, and may actually help, an organization’s change effort.

Next, we consider the importance of manager’s exhortations to workers regarding their skill choice.The underlying question here is: Why would workers be disinclined to trust a manager’s exhortations tochange? The problem is one of asymmetric information: workers are not as well informed as managers aboutall the ramifications of proposed changes, and worry that they are being sold a “bill of goods” that mayeventually be harmful to them.

Managers can overcome worker distrust by offering a credible guarantee of their own belief in thevalue 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 one’sreputation. Workers understand that managers incur a cost when they continuously promote a change program.Exhortations that genuinely represent a manager’s best estimate of the future cost considerably less thandissembly (since the dissembler’s reputation will be sullied when workers discover the exhortations to befalse). 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. Recognizingthat signalling that change will be especially painful can increase their compensation, workers may wasteconsiderable time and energy complaining how grevious the change will be for them. Managers can countersuch “complaint signalling” by announcing that workers who feel that change will severely hurt them can quitby taking a severance package. Such an announcement achieves the twin objectives of truly allowingpotentially most resistant workers to leave and restricting “complaint signalling.”

One can thus make the claim that a manager’s constant exhortations to change are likely to help shiftthe organization to the superior equilibrium. This is consistent with management scholars’ advice that

DISEQUILIBRATIONREQUIRED

DESIREDSTATE

CURRENTSTATE

ORGANIZATION

VALUE

-21-

Figure 10

continuous evangelizing is crucial to the successful implementation of a change program (Vandermerwe andVandermerwe, 1991; Kotter, 1995). The importance of achieving impact through intensive communicationis 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 startingto get through. People in the organization may need to hear a message over and over before they believe thatthis time, the call for change is not just a whim or a passing fancy.”

G. “Rocking the boat” hard helps implement change

The consulting company’s AMP introduced reorganization in the company with massive reassigments,a new strategic approach, and an announcement that he believed that effective reorganization was absolutelyessential to the company’s 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 thecompany was run. Recall that the change process was successful in the consulting company, whereas it stalledin the commercial vehicles company.

A number of managers who have led organizational change efforts have vouched for the importanceof making the change process itself a disequilibrating experience for the organization. ABB Germanyunderwent a host of dramatic changes in a major restructuring program begun in 1988. The successfulcompletion of of that program in 1990 led prsident of the executive committee Eberhard von Koerber toreflect: “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 Ithought at the time.” (Uyterhoeven, 1993, p. 12).

2G > BLL > BRR > BLR ' BRL

B1LL (1%*) > 2G

B1LL > B1

RR B2RR > B2

LL

-22-

In light of the foregoing observations and the descriptions presented in Table 2, it would seem thatpractitioners experience the challenge of implementing organizational change to be akin to the processsketched in Figure 10. It is the conviction that subordinates will believe that “real” change is occurring onlyif turbulence crosses a minimum threshold that leads managers to prescribe “rocking the boat” hard. ObservedLawrence Bossidy, chairman and CEO of Allied Signal: “Companies don’t change incrementally. Theychange in quantum jumps. If you shoot for anything less, you don’t 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 currentorganizational choices. We argue here that they do. Workers in firms that have long time horizons makegreater investments in skill development. In the face of imminent change, a manager may be well advised toinitiate incremental adjustments that render the organization’s configuration appropriate to futurecircumstances. 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 currentrewards. Consider a firm facing the payoff matrix . Workers concerned about

productive activity over only one period would not want to develop any skill. If, on the other hand, they expectproductive activity to extend into the future, with future returns discounted by a factor * such that

, 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 thancompensate for the first period cost of development of those skills.

This result matches the commonly observed phenomenon that employees work hard early in theircareers as they are developing skills (period 1) and tend to slacken and enjoy the fruits of their hard work laterin their careers (period 2) (Holmström, 1982). Whether software programmers or consultants, the promise offuture 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 organizationalchange in anticipation of an imminent strategic change, or wait for strategic change to occur and thenimplement radical organizational change. If preponing the change is less costly than the disruption caused bysudden change, the manager might well prefer to configure the organization in anticipation of futurecircumstances. If, on the other hand, the strategic change is drastic, the manager should initiate radicalorganizational change.

In our model, the manager knows that applying the left-handed skill brings the most profit in the first

period ( ), applying the right-handed skill the most profit in the second period ( ).

Implementing organizational change is costly; it involves reassigning workers, starting change programs, andso forth. Assume the cost of implementing change to be ). The manager has two choices: (1) encourageworkers to develop the left-handed skill in period 1 and then institute a change program to develop the right-

ALL1

ARR1

CLOSEDOWN

RR

PREPONE RR

* [2G+)]

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

*(2G%))

B1LL & B1

RR

Radical organization change may also be necessitated by the occurrence of an unexpected strategic change. An event16

that the manager had assigned a low subjective probability of occurrence comes to pass. This may occur because the manager wasincorrect in judging the future or because the change was indeed a random phenomenon. In either case, the result is that the manageris faced with having to adjust to the changed circumstances. This adjustment may necessitate radical organizational realignment.

-23-

Figure 11

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

The decision hinges on trading off the cost of instituting the change program [ ] against the

opportunity loss due to first period misalignment [ ]. 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 inperiod 1 strongly favors application of the left-handed skill, the manager prefers to implement organizationalchange only after the strategic change has occurred.

This model suggests the trade-off a prescient manager must consider when deciding whether toimplement change in an incremental or a radical manner. When the opportunity cost of preparing for the futureis not very high and the saving from extending the change program over a long time horizon is significant, themanager is prepared to take lumps in the present in order to avoid the pain of wrenching organizational changelater. If, on the other hand, a drastic strategic change occurs such that very different skills are appropriatebefore and after the change and the cost of implementing the change does not vary significantly with theduration over which it is implemented, the manager is prepared to face the disruption of implementing radicalorganizational change in order to ensure that the organization is suitably configured to the strategicrequirements both before and after the change.16

Suddenly confronted by changed industry dynamics – relaxation of licensing rules and an industryquickly flooded by entrants from abroad – the commercial vehicles company’s CEO faced the challenge ofimplementing radical organizational change. The consulting company’s AMP, in contrast, foresaw thatcustomer needs were becoming increasingly pan-European and reorganized the European operations in

-24-

anticipation of acceleration of this trend. Rather than move in one step to a European organization, he tookthe intermediate step of establishing three regional offices, believing such a change trajectory would be lesstraumatic 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 areimplemented. Subordinates are encouraged to change by driving a wedge between their well-being in thecurrent state and their well-being in the desired state. But managers may simply be unprepared to incur thecost of driving this wedge. We suggest that organizational inertia is best addressed by such complementaryapproaches as identifying “winners,” shuffling part of the work force, nominating change agents from amongthe workers, starting with a “kick-off” event, and making the process a vigorously disequilibratingphenomenon for the organization. If a slow pace is less traumatic for the organization, change should beimplemented incrementally, but if strategic change is so drastic as to render the cost of organizationalmisalignment extremely high, the manager should accept the necessity of introducing wrenching change andimplement organizational change radically.

-25-

REFERENCESC Argyris, C., 1990, Overcoming Organizational Defenses, Boston: Allyn and Bacon.C Aumann, R.J., 1990, “Nash Equilibria are not Self-Enforcing,” in Gabszewicz, J.J., Richard, J.-F., and

Wolsey, L., eds., Economic Decision Making: Games, Econometrics, and Optimization (Contributionsin Honor of Jacques Drèze), Amsterdam: Elsevier.

C Barnard, C.I., 1938, reprint 1982, The Functions of the Executive, Cambridge: Harvard University Press.C Beckhard, R., and Harris, R., 1987, Organizational Transitions, Reading: Addison Wesley, 2nd edition.C Beer, M., 1991, "Leading Change," Harvard Business School note number 488-037.C Bennett, T.R., III, 1961, Planning for Change, Washington D.C.: Leadership Resources.C Burns, J.M., 1978, Leadership, New York: Harper and Row.C Collins, D., Ross, R.A., and Ross, T.L., 1989, "Who Wants Participative Management?" Group and

Organization Studies, v14n4, pp. 422-445.C Conner, D.R., and Patterson, R., 1981, Building Commitment to Organizational Change, Atlanta: OD

Resources.C Cooper, R.W., DeJong, D.V., Forsythe, R., and Ross, T.W., 1990, “Selection Criteria in Coordination

Games: Some Experimental Results,” American Economic Review, v80n1, pp. 218-234.C Crawford, V.P., and Sobel, J., 1982, “Strategic Information Transmission,” Econometrica, v50n6,

November, pp. 1431-1449.C Diamond, M.A., 1986, "Resistance to Change: A Psychoanalytic Critique of Argyris and Schon's

Contributions to Organization Theory and Intervention," Journal of Management Studies, 23:5, pp. 543-562.

C Duck, J.D., 1993, “Managing Change: The Art of Balancing,” Harvard Business Review, November-December, pp. 109-118.

C Etzioni, A., 1983, The Moral Dimension, New York: Free Press.C Farrell, J., 1995, “Talk is Cheap,” AEA Papers and Proceedings, v85n2, May, pp. 186-190.C Farrell, J., and Gibbons, R., 1989, “Cheap Talk Can Matter in Bargaining,” Journal of Economic Theory,

v48, pp. 221-237.C Hornstein, H., 1986, Managerial Courage, New York: John Wiley.C Holmström, B., 1982, “Managerial Incentive Problems: A Dynamic Perspective,” in Essays in Honor of

Lars Wahlbeck, Helsinki: Swedish School of Economics.C Kanter, R.M., 1985, "Managing the Human Side of Change," Management Review, April, pp. 5-56.C Kanter, R.M., Stein, B.A., and Jick, T.D., 1992, The Challenge of Organizational Change, New York:

Free Press, 1992.C Kirkpatrick, D.L., 1985, How to Manage Change Effectively, San Francisco: Jossey-Bass.C Knez, M., and Camerer, C., 1994, “Expectational Assets in the Laboratory,” Strategic Management

Journal, v15, Winter, pp. 101-119.C Kotter, J.P., 1995, "Leading Change: Why Transformation Efforts Fail," Harvard Business Review,

March-April, pp. 59-67.C Lewin, K. 1947, "Frontiers in Group Dynamics," Human Relations, v 1, pp. 5-41.C Lippitt, Langseth, and Mossop, 1985, Implementing Organizational Change, San Francisco: Josey Bass.C Nadler, D.A., and Tushman, M.L., 1995b, "Types of Organizational Change," in Nadler, D.A., Shaw,

R.B., Walton, A.E., and associates, eds., Discontinuous Change: Leading Organizational Transformation,San Francisco: Jossey-Bass, pp. 15-34.

C Nadler, D.A., and Tushman, M.L., 1995, "The Challenge of Discontinuous Change," in Nadler, D.A.,Shaw, R.B., Walton, A.E., and associates, eds., Discontinuous Change: Leading OrganizationalTransformation, San Francisco: Jossey-Bass, pp. 35-44.

C Nadler, D., and Tushman, M., 1989, "Organizational Framebending: Principles for ManagingReorientation," Academy of Management Executive, v3, pp. 194-202.

-26-

C Nelson, R.R., and Winter, S.G., 1982, An Evolutionary Theory of Economic Change, Cambridge: HarvardUniversity Press.

C Tichy, N. M., 1977, Organization Design for Primary Healthcare, New York: Praeger.C Tichy, N.M., and Charan, R., 1995, "The CEO as Coach: An Interview with Allied Signal's Lawrence A.

Bossidy," Harvard Business Review, March-April, pp. 68-78.C Tichy, N., and Devanna, M. A., 1986, The Transformational Leader, New York: John Wiley & Sons.C Uyterhoeven, H., 1993, "ABB Deutschland (C)," Harvard Business School case number 393-132.C Van Huyck, J.B., Battalio, R.C., and Beil, R.O., 1991, “Strategic Uncertainty, Equilibrium Selection, and

Coordination Failure in Average Opinion Games,” Quarterly Journal of Economics, 106, pp. 885-910.C Van Huyck, J., Battalio, R., and Beil, R., 1990, "Tacit Coordination Games, Strategic Uncertainty, and

Coordination Failure," American Economic Review, v80n1, pp. 234-249.C Van Huyck, J.B., Gillette, A.B., and Battalio, R.C., 1992, “Credible Assignments in Coordination Games,”

Games and Economic Behavior, 4, pp. 606-626.C Vandermerwe, S., and Vandermerwe, A., 1991, "Making Strategic Change Happen," European

Management Journal, v9n2, pp. 174-181.C Woodward, H., and Buchholz, S., 1987, Aftershock, New York: Wiley.