Strategic plans as contracts

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Long Range Planning, Vol. 23, No. 1, pp. 102 to 115, 1990 Printed in Great Britain

0024-6301/90 53.00 + .OO Pergamon Press plc

Strategic Plans as Contracts Yvan Allaire and Mihaela

Firsirotu

No matter how unsettling, executives should think of strategic planning as a form of contract. Managers who receive, evaluate and monitor plans are very much like principals in their dealings with agents-managers who prepare, defend and implement these plans. The former cannot observe every move, every decision and action of the latter. So they must rely on various means of inducing the agents-managers to propose and implement plans which are optimal for the corporation. This paper shows how familiar issues and problems with strategic planning take a different dimension when the planning process is viewed as a contractual relationship: (1) By- identifying several planning modes and shbwing where and when each is appropriate, the paper helps to understand the potential for frustration that results from a poor fit between a planning system and the firms circumstances; (2) By depicting the powerful forces which push and shove corporations away from effective strategic planning modes, the paper singles out a set of conditions for high performance strategic systems; (31 6 y formulating recommendations and words of caution to strategic planners and CEOs, the paper may help to improve the performance of a much maligned but essential management process.

Introduction organizations are contract-ridden systems. Whether social, psychological or economic in nature, formal or informal, hard or soft, written or unwritten in form, contracts structure the life and functioning of all organizations. Economists, sociologists and, lately, financial theorists have stressed the pervasiveness and complexity of contractual relationships in large organizations.* Large

hardt (1989) lists numerous domains of organizational life where agency issues are bound to arise: regulation, leadership, vertical compensation, transfer pricing, acquisitions and integration, mergers, and so on. Oddly enough, the planning process and its output, the strategic plan, which embody all the characteristics of a contract, have never been examined from this perspective. Managers who receive, evaluate and monitor plans are very much like principals in their dealings with agents-managers who prepare, defend and implement these plans. The former cannot observe every move, every decision and action of the latter. So they must rely on various means of inducing the agents-managers to propose and implement plans which are optimal for the corporation. This article will focus on the contractual nature of strategic planning and, from this vantage point, identify several functional modes of planning, the requirements for success within each mode, and alterative mechanisms through which organizations attempt to structure individual behaviour and calculus. Specifically, the article introduces briefly the key notions of agency costs, information asymmetry, cultural vs structural means of controlling opportunism. It then goes on to show how familiar issues and problems with strategic planning take a different meaning when the planning process is viewed as a contractual relationship :

In the recent literature, the issues arising from such contractual relationships have been given the generic name of ‘agency issue’ and the propositions as to how to solve these issues have been labelled ‘agency theory’.? In a recent review article, Eisen-

(1) by

Yvan Allaire is Professor of Strategy and Mihaela Firsirotu is Associate Professor of Strategy at the School of Management, University of Quebec at Montreal.

(2) by

*Jensen and Meckling (1976); Fama and Jensen (1983); Pratt and Zeckhauser (1985). tSee Galbraith (1983) for a discussion of the concept; other terms were proposed to capture this phenomenon: driving force (Tregoe and Zimmerman, 1980). dominant logic (Prahalad and Bettis. 1986). driving skills and corporate mindset (Allaire and Firsirotu, 1986).

defining several planning modes and showing where and when each is appropriate, our contractual framework helps to understand why a poor fit between the firm’s planning system and its circumstances is so common and so frustrating; depicting the powerful forces which push and shove corporations away from effective strategic planning modes, it singles out a set of essential conditions for a high performance planning system;

(3) by formulating recommendations

and words of

Strategic Plans as Contracts caution to strategic planners and CEOs, it may help to improve the performance of a much maligned but essential management process.

Contracts and Agency Issues in Organizations As it grows in size and complexity, a firm, sooner or later, must face up to the issue of how to organize to operate effectively. All solutions to this problem involve, in one form or another, a delegation of responsibility, a granting of mandates, to specific managers. The grantor of mandates will define more or less precisely the nature of the mandate, the results expected and the basis on which the grantee will be rewarded for the outcome ofhislher actions. The grantee will be called an agent and the grantor, his/her principal, if in the course of carrying out this mandate, the grantee acquires more information than is available to the grantor and takes actions without reference to the grantor; furthermore, the latter is able to monitor the outcome of the grantee’s actions, but cannot monitor the level of effort nor the actual performance of the grantee. Such contractual relationships, frequent in large organizations, provide agents with many opportunities to use their information advantage over their principal in a selfserving manner. The principal’s problem and challenge is to devise a system whereby the manner and costs of monitoring and rewarding agents are such as to maximize the benefits (net of the costs of monitoring and rewarding agents, i.e. the agency costs) to the principal. ‘If information flowed costlessly and perfectly, superiors would know what their subordinates knew and what they were doing, the stockholder could be confident that managers were operating the corporation as if it were their own, and retailers would know that suppliers would provide goods of appropriate quality. In real life full information rarely is freely available to all parties, and so the problem becomes how to structure an agreement that will induce agents to serve the principal’s interest even when their actions and information are not observed by the principal.’ (Pratt and Zeckhauser,

1985, p. 2)

Two different sets of measures, structural or cultural in nature, have been used more or less explicitly to deal with agency issues within organizations: (a) the structural approach to this issue is heavily influenced by economic theory and tends to assume that both principal and agents are selfinterested parties seeking to maximize their economic benefits. Minimizing agency costs then entail the adoption of an appropriate organizational form and an effective control/inducement apparatus to protect the corporation against opportunistic behaviour. For instance,

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the multidivisional form of organizing is viewed in the context as a momentous innovation.* It allowed corporations to grow to a very large size, having ‘solved’ some of the problems arising from information asymmetry between different levels of management and from the opportunistic propensity of organization members. Basically, the multidivisional solution to the problems of agency in a large and diverse corporation consists in (1) dividing up the corporation into units of manageable size and clear market purpose and (2) in assigning responsibility and accountability for each unit to competent managers operating within a system of external controls (highly competitive product markets and efficient financial markets, tight corporate monitoring) and rewards (complex structure of salaries, bonus, stock options, ‘phantom’ stocks, etc.). The financial literature is replete with discussions of how and whether particular forms of control and rewards will reduce agency costs. Diamond and Verrechia (1982) claim that tying managerial reward to the price of the firm’s shares alleviates the incentive problem of motivating management. However, Strong and Waterson (1987) contend that a well-balanced remuneration package requires more sophisticated incentive mechanisms than share price alone, for instance a balance ofbonus, share options and ‘phantom’ stocks, the exclusion of strategic items such as advertising and R & D expenditure from the earning figure on which management salaries or bonuses are based, etc. Compensation packages are becoming ever more complex as ever larger corporations seek to make ever more calculative managers act in the interest of the corporation.

(b) The

cultural solution to agency issues assumes that shared values, goals and experience are very effective in reducing the costs of self-serving behaviour, that people are more susceptible to control by the terms of a psychological contract than by the prescriptions of an economic one. While they do not deny the importance and usefulness of adequate structural means to cope with agency issues, many management theorists and practitioners put a great deal more emphasis on shared values and goals, on corporate culture, as a means of managing large size.?

The prescription here is for the firm to grow around a core set of skills, to invest heavily in socializing members to a common set of values, beliefs and management principles, and to define a long term relationship between the individual and the firm such that the employee’s

‘Williamson (1975, 1981); Chandler (1962, 1977). tSee Parsons (1956); Selznick (1957); Ouchi (1981); Pascale and Athos (1982); Peters and Waterman (1982) for examples of authors making this point more or less clearly.

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interest and that of the firm converge and mesh. The driving axiom is that mere control of outputs through external means is inefficient and self defeating. Control of inputs through internalized values, shared goals and common decision premises is the most satisfying and eventually the more cost effective way of managing a vast and geographically dispersed corporation. When this is achieved, relationships between levels of management are more akin to a partnership than to a contractual, principal-agent type of relationship. An important corollary of culture as a control mechanism is that the firm should limit its diversity to businesses which are dependent upon the same set of critical skills. Too much variety in products, technologies and success factors will make it impossible to develop a single cohesive and encompassing culture for the entire corporation. Although tives, with latter and and often

they are often presented as alternaenthusiasts of the former ignoring the vita versa, both approaches may be are combined in the same firm.

Neither structural nor cultural means of dealing with agency problems are cost-less and the degree of emphasis on each is often a matter of choice. However, these choices, once made (often implicitly) are very hard to reverse.

Strategic Plans as Contracts This general issue of agency takes a particular relief when it comes to setting up a strategic planning process in a complex organization. By their very nature, strategic plans present, in exacerbated fashion, all the potential pitfalls of principal-agent relationships. Managers who prepare the plans may know a great deal more than managers who revise and approve them; linking reward systems to strategic plans in order to produce optimal results for the principal is tricky and expensive; monitoring real performance is difficult and costly. Managersagents will want to use their superior information to avoid, or even reverse, control by their principals. Corporations have tried many ways of coping with such issues, ranging from faith in market control, close corporate staff oversight to reduce information asymmetry, investment in value-building to guard against self-serving behaviour, to ingenious remuneration packages and innovative organization designs. Some of these ‘solutions’ have proved very ineffective and have contributed substantially to the widespread dissatisfaction and disappointment with strategic planning. In order to clarify why this occurred, it is useful to define various ways of planning according to their

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position on the two crucial relationships:

(9

dimensions

of agency

the sharing of values, skills and experience between those who prepare plans (agents) and those who receive, approve and monitor them (principals) ; there is an inverse relationship between the degree of sharing and the probability of successful opportunistic behaviour on the part of organization members;

asymmetry between agents and (ii) the information principals. This is, whether the principal has as much (P=A) information as the agent or the agent has more (A > P) or much more (A $ P) information than the principal about the tasks and real performance of the agent.

rive Strategic Planning Modes These two dimensions define five planning modes as well as a number of common paths of change in these planning modes as sketched in Figure 1. Under different but specific conditions, three of these five strategic planning modes are appropriate and functional. Indeed, leader-driven, culturedriven or line-driven strategic planning, given the right circumstances, represent different but effective means of coping with agency problems. However, under the pull of strong currents at work in large corporations, the process may drift to any of the other two planning modes: numbers-driven or staff-driven planning mode. These will prove unstable and inefficient under any circumstances and are most likely to lead to feelings of disappointment and frustration with strategic planning. Of course, two key arguments of this paper are (1) that successful strategic planning hinges, in good part, on making the right choice of planning mode and on sticking to the criteria for effectiveness within that mode of planning and (2) that shifting planning modes at the right time is critical to the success of the firm but has proven tricky in most circumstances.

Three Functional Planning Leader-driven

Modes of Strategic

Planning The founder/entrepreneur/leader imbues the organization with his preferences, vision and whims. Planning is in his head or in very short form; if any plan is prepared by others (agents), he (the principal) knows as much about their areas of responsibility as they do. There is here not much reason or use for explicit statements of strategy and plans; budgets and related controls are all that is required and useful. If the firm is essentially one main business, it

Strategic Plans as Contracts

Agents Advantage

in Information

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Over Principal

High ’

Leader Driven Sharing of Values Skills and Experience Between Principal and Agent

Path of Internal Growth

.

)

Culture Driven

Line Driven Planning

: I I

t I I

. 7

‘I Staff Driven

Numbers 4

_ _ . _ _ . . . __. . . I _. . . _ _. . . .

Planning Low

Driven Planning

-

I I - ti

Path of Effective Planning Modes

-

Path of Unsatisfactory

Planning Modes

Principals: Those Who Recieve, Review and Approve Monitor and Reward Management Performance Agents: Those Who Prepare, Propose and Implement and Manage the Businesses

Plans,

Plans

Figure 1. Planning modes and the growth of the corporation

may become quite large and geographically dispersed without taxing its leader-driven planning system. Federal Express, Toys-R-Us, The Limited, Wall-Mart and Marriott are (or were at one time) large, one-system corporations run by a leader who knows intimately all the nooks and crannies of a business he has built. Theirs is a one-game business, and it is a game they play with passion and at which they have become highly proficient. These leaders are the managerial equivalent of chess grand masters who can play with cognitive ease against dozens of opponents. In these leader-driven organizations, there are often few agents in the true sense of the word, as the leader is capable (or believes he is) of controlling all aspects of his subordinates’ actions and performance. However, when the leader-founder is replaced by professional managers, or when the firm has grown in scope and complexity beyond the capacity of leader-driven systems, or the firm moves to new business areas which call for different skills, the organization must shift either to a culture-driven or line-driven management and planning mode. However, the growing firm, uncertain as to how to cope with a by-now bewildering complexity, may easily gravitate to staff-driven or numbers-driven planning. Or, in what is a sad and too frequent occurrence, the founder-entrepreneur may cling to a leader-driven management style despite its glaring

shortcomings and thus endanger the very survival of the firm. Culture-driven Planning The corporation has become large, quite diverse and geographically dispersed but its goals, skills, values and management principles, its centre of gravity, form a holistic, integrated entity shared by members in all units of the corporation. This description fits a number of successful North American corporations, which, albeit very large, have managed to grow around a ‘single centre of gravity’, a core of technologies and skills, and to instill a high degree of shared values and goals throughout the organization; for instance: IBM, around the world-wide design, manufacture and marketing of computer systems; 3M around its bonding and coating technologies; McDonald, around the franchising and marketing of fast food products; Johnson and Johnson, in pharmaceutical/medical products; Procter and Gamble around the development, marketing and distribution of consumer packaged goods. These firms have made substantial investments to create a functional culture which they support and reinforce by every tangible means, from promotion policies to symbolic and monetary rewards. Although

managers

preparing

business

plans

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(agents) may have a substantial information superiority over those who receive and approve their plans, the shared culture and the convergence of self interest and corporate interest tend to check, or channel, opportunistic impulses.

insuperable fact of a sharply increased interfirm mobility of manpower* (in North America and Europe) and of hiring (and firing) practices which support this trend. Increasingly, as result of their own actions, North American and Western European corporations are peopled by mobile, calculative managers and technicians who will not buy (and are not offered) the traditional psychological contract of life-long employment and secure promotions in exchange for loyalty and devotion to the corporation’s aims;

(b) the

Plans are simple, short and action-oriented as it is unnecessary to express what is known by all. Because of the extensive sharing of values, experience and skills between principals and agents, information flows between them with stenographic efficiency. Here, culture, not plans or budgets, is the main control mechanism which protects the corporation against the agent’s opportunistic behaviour. The relationship in these cases may best be described as one of partners and associates, rather than as one of principal and agent. Or, perhaps more accurately, the relationship between principals and agents should be understood in these cases as a psychological contract (or ‘soft’ contract; see Williamson and Ouchi, 1983) rather th an a purely economic one. To be effective, a culture-driven planning and management system must satisfy a set of five .demanding requirements:

(1) managers

are tenured; promotions are ‘from within; there is low inter-firm mobility of managers; company-specific management talent is developed in-house;

(4

top management must be experienced in all key facets of the corporation’s operations;

(3) diversity of operations is limited in terms of skill requirements, technologies and key success factors; (4) substantial investments are made to socialize members to common values, beliefs and action premises; (5) firms must enjoy considerable market power and/or slack resource to afford the up-front investments required for a culture-driven management and planning system.

(4

variations in market power and therefore in slack resources available for investments in culture and value development and enforcement.

A consequence of these factors, singly or in combination, has been the reduced capability of firms to build all-encompassing cultures with enduring commitment of the employees to the organization and vice-versa. The culture-driven mode of management and planning is being eroded where it exists, and may not be a viable option where it has not been built years ago. Line-driven Planning As corporations become increasingly diversified, as they increasingly operate in a social context of high personnel mobility, as they have not committed (or could not afford to commit) the up-front resources required to build a culture-driven system, they must find alternative means of planning which will work for them. Scherer (1988), writing about his empirical observations of cases of acquisitions and subsequent divestments, notes that the ‘ . . . sell-off was often precipitated by managerial control loss and incentive breakdowns. These in turn had roots in the more complex organizational structures in which the acquired units were thrust, knowledge lacunae that impaired the conglomerate parent’s ability to solve emerging problems, and the inability of top management to develop incentives stimulating sustained, vigorous performance by unit operating heads’. (pp. 76-77) planning, by addressing these issues, can prove very effective in this type of circumstances; but only if it is well implemented and satisfies five key requirements : Line-driven

When these requirements are met, a culture-driven system is an attractive concept, one which provides a powerful check on opportunistic behaviour and allows a corporation to grow in scope and span without incurring the dramatic loss of efficiency which often results from escalating agency costs. However, changing circumstances have made it very difficult to abide by some of the requirements for an effective culture-driven management and planning system. Indeed, the large modern corporation is increasingly characterized by:

(1) Legitimacy and Credibility of Principals Line managers are in charge of strategic planning for their unit. These line managers must submit their strategic plans to corporate officers. A key requirement of effective line-driven planning is that the line managers consider executives who receive, approve and monitor their plans as having legitimate authority (they are line not staff people) and

(a) a substantial diversity (although with some second thoughts and retrenchment recently) of markets, technologies and competitive conditions;

‘For instance, a recent Furrune (1988) article notes. . ‘15 years ago, a manger worked for an average of only two companies in his or her career. Today, the average is closer to seven and appears to be rising.’ (P. 28).

Strategic Plans as Contracts substantive credibility (they have a deep knowledge and understanding of the businesses reporting to them). Of course, the issue here is a structural one. How can a firm grow, spread geographically and across product categories, and still maintain this essential relationship? In its original manifestations, the multidivisional structure did meet this first requirement for linedriven planning. Indeed if the firm grew and divisionalized within the same industry and promoted from within, as was the practice in earlier times, all corporate officers would be knowledgeable about, and experienced in, the core business. Sharing of experience and skills was then so common, and taken for granted, that early theorists failed to and practitioners of divisionalization recognize that it was an important prerequisite to effective monitoring and control of divisional management by the corporate office. However, as the firm grew bigger without investing sufficiently in creating a common culture throughout the organization, as it became diversified in weakly related areas, as corporate manage. ment became more professional with corporate officers and staff recruited for their generic management expertise from other industries and from business schools, the corporation moved inexorably towards numbers-driven or staff-driven planning. The bond of legitimacy and credibility between agents and principals had been irremediably cut, with nothing to replace it but control by numbers or by corporate staff enforcement. In time, the highly diversified firm sought to recapture the benefits of line-driven planning. The concept of group or sector executives was introduced. These executives assisted by a very small staff have a corporate responsibility for all operations in a well defined industrial sector about which they are thoroughly knowledgeable. Then, agents (SBU, divisional or subsidiary managers) are monitored and controlled by a principal (the group or sector executive) who is familiar with, and experienced in, their business operations. These executives play a critical, albeit thankless and often ambiguous, role. They establish some symmetry in the relationship between the corporate office and heads of business units and ensure that incentives do reward performances beneficial to the corporation. Lately, it has become fashionable to change the role of group or sector executives from one of corporate officer (and thus of a principal in his relations with divisional/SBU management) to that of an officer responsible for managing the businesses in his/her sector and preparing integrated strategic plans. The stated purpose is to foster a greater degree of integration and co-ordination among operations in a given sector in order to reap maximum benefits from linkages and synergies among different busi-

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ness units. But one may suspect that it has as much to do with the desire of these group or sector executives for a change in their neither-horse-nordonkey role. Their new status gives them a clear authority and much power over all operations in their sector and a mandate to push for integration. (2) Relative Information

Balance between

Agents and

Principals

Corporate line officers to whom strategic plans are presented for approval and monitoring must have independent sources of information which provide them with performance indicators and customerbased measures. The aim here is (a) to provide a common pool of strategic information and leading indicators of performance, the kind of information that can point to trouble down the line instead of the usual accounting tally of what was not done right in the past; and (b) to keep line managers focused on markets and competition, to ensure that the degree of market pressure experienced by unit manager is high and constant. If the structure of the market does not naturally provide such pressure, as is often the case and will be discussed in the section on numbers-driven planning, then the corporate office must generate market indicators to increase market discipline on business units. Corporate planning staff is small and primarily focused on these information tasks. Fie3efmall

Set of Corporate

Values and Unifving

The line-driven system we are describing here is designed to cope with the complex corporation which typically shelters many disparate cultures, as a result of the diversity of its operations, and which is increasingly populated by professionally mobile individuals. But even if henceforth, large modern corporations cannot hope to drive and control their operations on the basis of a single, mind-shaping culture, they should nevertheless define and propose a set of engaging, generic values that the corporation stands for and lives by. These core values should be broad enough to apply to all industrial areas in which the firm is engaged or is likely to enter. Man does not live by bread alone. Corporate leaders should heed Rousseau’s warning ‘Ancient statesmen spoke endlessly of morals and virtue; ours speak only of commerce and money.’ These generic values provide unifying themes across the diverse businesses of a large corporation and define broad strategic thrusts: Innovation, Quality, Leadership, People. For instance, Japanese corporations, always keeping their options open as to which markets, products and technologies they will end up in and with, tend to propose broad, highminded values that give spiritual meaning to one’s work, but with no functional tie-in to present markets and products.

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Long Range

At Canon statements statement:

Planning

for example, make up its

contribute firm;

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Vol. 23

the following broad mission and objective

to prosperity

by building

create the best and most unique on leading-edge technologies; trust and respect each other, in a harmonious atmosphere,

an ideal

products

based

and work together and so on.

At Philip Morris, ‘Leadership in Product Innovation and Quality’ is proposed as the overarching value. General Electric calls upon all its mangers to view change as a constant, customers as the prime driver of their action, communication as a means of gaining trust and commitment, and ethical behaviour as a prerequisite to working for GE. The absence of any emotional bonding, of any psychological succor between the employees and their firm may turn the workplace into an auction market which no amount of ingenuity at designing structures and incentives can make to work in the long run. ‘However, this particular feature of a line-driven planning system is not observed in all large diversified corporations. Indeed, it may be the distinguishing characteristic between a financial conglomerate and a diversified corporation with a strong personality. General Electric would be a good example of the latter, spending considerable sums of money on promoting a single set of values and striving for employee identification with GE as a corporation. Primerica, Hanson Trust or Imasco are typical of the former. People working for Hardee’s hamburger chain or People’s Drug Marts may be only dimly aware that their business is owned by Imasco, could hardly feel any sense of identification with it and would be hard pressed to define what Imasco stands for. (4) Adaptive and Fkxible Incentive Systems Incentive systems must achieve a careful calibration of short and long run perspectives and be linked to key strategic indicators. The incentive system should be flexible and adaptive; business units implementing different strategies should be rewarded on the basis of different and relevant strategic indicators; and as strategies evolve and change, the incentive system must adapt quickly to support and drive emerging strategies. (5) Line Skills Implementation

at Strategic

Thinking

and

The corporation must implement an effective educational and change programme to make strategic planning into a ‘success skill’ for line managers. Strategic thinking and strategy implementation

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must become as essential to success as other more operational skills line managers had to master along the way. Line-driven strategic planning calls for a sizeable corps of line managers who can think through strategic situations and steer an organization in new strategic directions. It cannot function with a spurious task specialization, with corporate thinkers who concoct strategies and operational doers who implement them! And, raising the level of strategic abilities throughout managerial ranks should be understood as a fundamental change, not as some superficial tinkering with management systems.

Ineffkient

Planning Modes

As the preceding discussion makes evident, a number of forces are continuously bearing upon the firm’s planning process pushing it towards less efficient planning modes. Numbers-driven

Planning

The corporation has grown by diversifying in different fields or has grown large and geographically dispersed but failed to develop a cohesive culture across all units. It is trying to plan but without satisfying the key requirements for linedriven planning. As a result, managers preparing plans share few values, skills and experience with those receiving and approving plans. Furthermore, the agents have a great deal more information and knowledge than their principals about their areas of business. Very quickly, given their ignorance of the business specifics, the principals focus on the financial/quantitative part of the plan and turn strategic planning into a post facto control mechanism. For instance, a recent issue of The Economist contained a relevant observation: ‘Managers spend too much time looking at published results and not enough looking at what drives those results. Most chairmen know their company’s overall return-on-sales. Surprisingly few know what percentage of their products are delivered on time or what the age-profile of their machinery is. Such figures are aften not even collected. That is rather as if a tennis player watched the scoreboard, but not the ball.’ The Economist,

11 June 1988, p. 72

Plans in such situations may become long and detailed; but the agents are well aware of their principal’s ignorance and of his/her attempts to control them through the planning process. They will rely on the former to elude the latter. Prosperous times and good fortune are supportive of numbers-driven planning. Then, it’s hands off and hail to managerial autonomy. But when results sour, corporate management and the board may be the last to know and then will have few options other than replacing management or prolonging their tenure if their self-disculpating explanations sound plausible.

Strategic

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This situation is very unsatisfactory and even dangerous for the corporation. Yet, it is still in evidence in many corporations and characterizes most relations between management and boards of directors in North America. In time, some means have to be found to reduce the information imbalance between principal and agent and the corollary risks of opportunistic behaviour detrimental to the principal’s interest.

Department of Transportation information is compiled and analysed allow airline management of different companies to claim superior performance. Furthermore, because of market structure, poor service performance, published and acknowledged, does not seem to have any short-term impact on level of sales. During a period when ‘Northwest Airlines’ service was dismal, its sales actually increased.*

Two Assumptions

When market control is weak, it is possible for management to camouflage poor performance for a considerable peroid of time or get undeserved credit for excellent results, particularly with the characteristicallv ineffective monitoring: bv the corporate office under numbers-driven pranning.

of Numbers-driven

Planning

Corporations are lured to this type of planning systems in good part by two related, but misguided, assumptions : (1) Belief in market

control

(2) Belief in control

by incentives

(1) Beligin Market Control The large corporation often operates in many markets and industries. So, goes the standard d’rvi‘d e up the firm into strategic prescription, business units (SBU) or profit centres, each one responsible for a specific product/market. This arrangement will bring the market’s bracing disci. pline to bear upon the unit’s management. The assumption is transparent: with strong market controls over the business unit, the corporation will be provided with clear, quick and unchallengeable feed-back about the unit’s performance. And unit management can do well only by becoming an effective competitor. As a consequence, monitoring a few quantitative indicators (market share, return on utilized assets, profits, cash flows) and positioning SBU’s on synthetic strategy grids is all that is required to ensure proper corporate control and direction. But there is a basic problem with this assumption. By its very strategic choice, the corporation will avoid operations in fragmented, purely competitive markets, where firms or business units will indeed get a quick verdict on their performance. In more concentrated industries, the market tends to provide only lagged and often confusing indicators of performance. Thus, Pratt and Whitney recently lost to General Electric its leadership in the jet engine business; yet, according to some large clients (notably Japan Airlines), they had been unhappy with Pratt and Whitney’s service for many years and were just waiting for their next (infrequent) purchase to signify tangibly their displeasure. In this case, there was a considerable time-lag between market share figures and degree of customer satisfaction. The difficulty of providing unquestioned indicators of performance is further illustrated by such a seemingly simple issue as airline performance. The variations in conclusion according to how U.S.

I

corporate When this eventually dawns upon management, they may react with a substantial increase in corporate staff capability at generating . information and conducting analyses of divisional performance. The firm can easily swing to a staffdriven planning mode. (2) Belief in Control by Incentives A second assumption underlying numbers-driven planning holds that ingenious compensation schemes will ensure that calculative managers can maximize their self interest only by acting for the good of the firm. Most boards of directors discharge their role as principal in this fashion. Whatever else may be included in the plan, the essence of planning here boils down to preparing and monitoring a set of numbers which can be tied to a compensation package. However, a calculative and opportunistic manager will always find inventive ways to make the numbers optimal for his purpose. The range of discretion in producing and interpreting data, the difficulty in devising reward schemes which do not over-emphasize one aspect of performance to the neglect of others, the lagged nature of many quantitative indicators and the principal’s relative ignorance of the specifics of the agent’s business, provide ample opportunities for a manager to maximize his own welfare to the detriment of the firm’s long run welfare. No doubt, an effective incentive system is critical to the success of the firm. The point here is that a poor governance structure and numbers-driven planning make it very difficult to design a compensation package which will ensure a coincidence of interests between the frm and its managers. Indeed, studies regularly report the weak relationship between total compensation paid to top executives (presumably ‘New data on airline performance may end up misleading travellers. Wall Street Journal, p. 29, 23 November (1987).

110 determined performance

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by their board of the firm.*

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of directors)

February and the

There is some evidence that, under numbers-driven planning, the relationship between incentives and performance is not any stronger for business units within the corporation. Hamermesh and White (1984) write: ‘clearly, the connection between incentive compensation and business unit performance is not easily explained and we suspect often mismanaged . . .‘. (p. 107)

Staff-driver2

Planning

One way of reducing the information gap between agent and principal is for the latter to build an information base and analytical capability under his/her control. In other words, setting up a staff capability which, in theory, should establish some information symmetry between principal and agent. However, this capability can quickly turn into top-down planning with corporate planners and consultants taking a leadership role in defining what are appropriate strategic plans. When that happens, line people abdicate their planning responsibility and strive desultorily to implement plans they have not developed and may not believe in. Alternatively, staff people may accumulate a great deal of information with which to control and catch line people. Unit management will soon understand that it is not really the market which controls their destiny. Their fate depends on their ability to control political pressures from headquarters, and to manage the numbers whch are important to staff planners. The planning process may turn into a cat-andmouse chase between staff planners and line managers. Eventually, .the planning process tends to become more professional and technical. A selffeeding dynamics brings about increasingly fancy and elaborate plans based on multiple ‘predict-andprepare’ scenarios. That is, until events repeatedly surprise and dumbfound the planners and lead to some tough questioning of the planning process.

An Illustration:

GE

The General Electric corporation has been for many years the beacon of strategic planning, the fulcrum of innovations in planning systems as its leadership struggled with agency and governance issues. The history of strategic planning at GE,? as sketched in Figure 2, illustrates quite well the planning modes described in this paper. GE for a long period

of time was a culture-driven

‘See Business Week (1986) and Loomis (1982) for practical illustrations. More formal treatment may be found in Llewellyn (1968) and White (1985). tSee Hamermesh (1986a.b). Aguilar and Hamermesh (1985). Fortune (1986). Business Week (1987). Potts and Behr (1987). GEAnnual Report (1987).

1990

organization : an engineering dominated firm with strong patent and customer franchises in consumer electronics. In the early 1960s however the company’s technology-driven culture, unchanneled and unbridled, led to a stupendous growth in the number and diversity of its businesses. By 1968, GE competed in 23 out of 26 two-digit SIC industry categories, including jet engines, computers and nuclear reactors. Culture-driven planning with its informal processes and its reliance on shared skills, experience and values as control mechanism could not cope well with such diversity. By the second half of the 196Os, the company was moving quickly to numbers-driven planning, setting up elaborate data bank (the basis of the PIMS data base) to assess the performance of its businesses. However, structured around numerous (close to 200) departments, many without any direct connection to markets, the results were unsatisfactory. In the early 197Os, portfolio planning is adopted (indeed it was devised for GE) and pushes the corporation some distance toward line-driven planning. Some 43 strategic business units are defined, each one competing in an external market. Line managers are responsible for their business strategies and plans. However, the corporate executives cannot discharge their role as principals for 43 business units submitting strategic plans to them. They have to resort to simplifying devices: summary grids of business positions and industry attractiveness, a set ofbroad generic strategies (hold, invest, divest, etc.), monitoring key numbers (investments, profits, etc.). The corporate office starts feeling that they cannot orient the development of the corporation. The strategic planning system is driven by SBUs as corporate executives lack the time and detailed knowledge of businesses to really influence SBU strategic plans. In 1977, strategic planning at GE takes another important step towards line-driven-planning. Six sector executives are appointed; each one is to supervise and co-ordinate, from a corporate perspective, a set of closely related businesses. At the same time, the corporate office increases its staff capability, giving itself the tools and resources to define an overall strategic direction for the corporation. The number of corporate planners grows to over 200; corporate plans are developed for human resources, financial resources, technology and production. The planning process however starts taking some of the characteristics of staff-driven planning: formality, form over substance, technocratic style, large meetings, etc. Business Week (1987) tells how Welch perceived situation at GE before 1981.

the

Strategic

Plans as Contracts

Great Diversity of businesses Type data - 1965 Numbers - driven

Portfolio Planning 1970 \

_ Sector executives 1977

0

I 43 SBU Executive Overload

Corporate Plans for Human Resources, Finance Technology and Production

Emphasis on People and Numbers of SBUs; Simplified Planning Process ,d

Operating Officer ---_____---

Figure 2. Strategic

planning

dynamics

at GE

?

111

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Vol. 23

February

‘He saw just how a bloated bureaucracy can muck the works. He remembers corporate staff bothering people by meddling and nitpicking, demanding reports, presentations, facts and figures that contributed nothing to making and selling better products. He recalls how the business wasted time and energy cozying up to staff, throwing them lavish parties in hopes that they’d be nice at appropriations time. In one incident, that still rankles Welch, managers in the light bulb business spent $30,000 putting together a slick film to demonstrate some production equipment they wanted.’

When Welch took over as CEO in 1981, he took steps to push the corporation to line-driven planning; he substantially reduced the total planning staff at GE and stripped entire echelons out of the GE hierarchy. The planning staff at corporate headquarters in Fairfield, Conn., was reduced to 30 members, while the number of local planners at GE’s operations was reduced proportionately, or more. The company’s major appliance group, for example, reduced its 50-member planning staff to zero in the past few years. Welch reduced the number of SBU’s and redefined some sectors to give more focus to areas critical to GE’s future. The 15 major GE businesses he identified as critical for the company’s future, were .broken into three groups, each contributing roughly equally to GE’s revenues: (a) the company’s traditional ‘core’ businesses, such as lighting, electric motors, transportation systems, and appliances, (b) high technology lines such as aircraft engines, medical systems, plastics and factory automation; and (c) services, including credit, insurance and leasing. The acquisition of RCA has given GE several businesses to add to this core of businesses. Welch is clearly sensitive to the requirements for effective line-driven planning. For instance, reviewing the experience of the members of his corporate executive office, he observes: ‘Vice Chairman Larry Bossidy knows GE credit. He built it. I know the plastic business. Vice Chairman Ed Hood know jet engines. After that we start to get into very shallow water. But we know people. We know how to spot good ones more often than we spot bad ones.’ (Fortune, 1986)

This is a succinct, practical definition of the agency issue. For some GE businesses, the corporate office is informed and credible: for other businesses, alternative means must be found to reduce the information assymmetry between agents and principals. Therefore, Welch is experimenting with various devices and tactics. For instance, he and other corporate officers cultivate independent sources of information at all levels in the company. As an ex GE officer puts it: ‘If you are a manager who gets upset if the boss goes around you, you’ll spend a lot of time being upset.’ (Fortune, 1986) He has also created in 1986 a Corporate Executive Council which brings together, every quarter, the 14 business leaders and the heads of the corporate

1990

staff departments plus the CEO. Business plans are scrutinized, ideas exchanged, suggestions offered, practical ways of getting at synergies are sought and implemented. Welch also redefined and clarified the roles of sector executives. He chose to make them chief operating officers for their sector. In doing so, he has changed their ambiguous but important role as extensions of the CEO and principals for the businesses reporting to them. They have assumed line responsibility for plans and performance and will thus report and behave as agents for their principal, the Corporate Executive O&e. In other words, these sector executives which provided the corporation with a set of credible and informed principals to deal with agents in charge of the various business units, are now agents themselves. This leaves as ultimate corporate principals at GE only the three members of the Corporate Executive Office. As the quote above makes clear, Welch is aware of the difficulty when it comes to business sectors other than credit, plastics and jet engines which are very familiar to the members of the CEO. Welch seems to think that the solution to this tricky issue lies in part with people selection and training. Listen carefully

to Welch:

‘I am the ultimate believer in people first, strategies second. To me, strategy starts with the person you hire. If a business lacks a good strategy, then put in charge of the business someone who will develop a vision of what he or she wants their business, their unit, their activity to do and be. . . Somebody who is able to articulate to the entire unit what the business is, and gain through a sharing of the discussion-listening and talking-an acceptance of the vision. And (someone who) then can relentlessly drive implementation of that vision to a successful conclusion.’ ‘For GE to have one culture makes no sense. We have a lot of different cultures. But we try desperately to have one company with one set of values. . . This new set of values means a new GE concept, which will replace the old social contract between employer and employees.’

The set of values GE hopes to instill in its people clearly stated in its 1987 Annual Report:

is

‘While we derive strength from the diversity of GE’s businesses, we are also proud that the men and women who lead them share a strong set of values: *

They accept that change is a constant and that success is measure by how well we shape tomorrow.

$r They recognize that customers’ needs, not internal bureaucracy, are the real drivers of our activities. Q They practice open, candid, interactive, continuous communication up, down and sideways in our organizations-and externally to all our publics-convinced that this is the only way to gain trust and commitment. *

They understand

that moral,

legal and ethical behaviour

Strategic Plans as Contracts at all levels is a fundamental prerequisite for working at GE.’

The top management of GE believes that old concepts of company loyalty may be outmoded anyway . . . ‘It makes them happier, more self-confident, more energized individuals, much more so than doing something on the basis of loyalty to the institution. . . We now want to create an environment where employees are ready to go and eager to stay.’

For Welch, these statements are not merely pie-inthe-sky concepts, rhetorical niceties. He is convinced that GE has the resources to develop a cadre of supermanagers. Recruitment and selection become critical processes and training a key strategic tool. Welch intensified GE’s training regimen and reoriented its aims so as to focus on the kind of values, habits of mind and styles of management that will henceforth be the norms at GE. The company’s training centre at Crotonville is used as a ‘change agent’ with a mission to make ‘GE managers more action-oriented, more risk-oriented, more peopleoriented. It’s supposed to develop leaders, not just managers’. More than 5000 people go through training programmes at Crotonville each year. They include every new manager and recruit as well as experienced managers and senior executives. Welch himself spends a considerable amount of time at Crotonville making presentations and leading discussions with trainees. Welch is an innovative manager who is betting that a mega corporation can best be managed and planned with a well thought-out line-driven system. He is aware that the structure he put in place creates many situations where the principal is not knowledgeable about the agent’s business. He hopes to curtail the risks of opportunistic behaviour in part by intense information exchange and networking, but mostly by inculcating in agents generic values and codes of behaviour that apply across all GE businesses and at all levels of management. This is a difficult goal which he pursues with exemplary vigour. However, any misstep or crossed signal can set in motion forces which will push the corporation towards less functional modes of planning.

Advice

to Strategic

Planners

and

CEOs Our close study, and participation in the setting up, of strategic planning processes in some 20 business firms have convinced us that the contractual and agency issues raised in this chapter play a major role in strategic planning.

113

Perhaps, what we have learned from the perspective of planning as contracts can best be summarized in the form of a few words of advice and caution to corporate planners and executives. (1) A Formal Strategic Planning Always Required Nor Desirable!

Process

is Not

There is an unstated assumption among professional planners (and many executives) that their medicine is always helpful and that no self-respecting corporation can do without a rational, deliberate, explicit planning process. As our Figure 1 makes clear, sizeable corporations (leader and culture-driven) can do very well without any formal strategic planning process and in the absence of any corporate planner. The 3M corporation, for instance, did not have a formal strategic planning system before 1981. By not distinguishing among different planning situations, the discussion of strategic planning and the prescriptions for improving it have been confusing and conflictual. One stream of publications, the Peters and Waterman (1981), Pascale and Athos (1982), Ouchi (1981) type, have focused on successful culture-driven organizations and, not surprisingly, have found strategic planning systems to be very simple, if not totally absent. At the other end of the spectrum the Harvard Business School production of Hamermesh (1986), Aguilar (1985) and others, examines the planning process of large diversified corporations and find that excellent companies have elaborate strategic planning processes. To implement such processes in culture-driven organizations would be wasteful, even detrimental. But to try to plan and control the future of a corporation operating in several industries as if it were a culture-driven or leader-driven organization would be foolish and reckless. (2) Keeping Planners’ Hubris in Check Corporate planners have to accept a good deal of the responsibility for the fact that planning drifts so easily to a staff-driven mode. Their proximity and access to the ultimate source of power, their knowledge of corporate-wide strategic information, their cognitive superiority at the games of planning and analysis, provide many opportunities for them to play, and be seen as, surrogate CEOs. Some line managers will cozy up to them, defer to their judgements; others will try to co-opt them and manage the numbers and processes which appear important and relevant to them. This taste of power and authority has inebriated many a staff planner; but sooner or later, problems arise. Line managers rebel openly or secretly sabotage the planning process. Top management starts questioning the usefulness of a planning exercise that produces little commitment and few results. There is another lurking temptation for corporate planners which will bring about a staff-driven mode

114

Long Range Planning Vol. 23

February 1990 Line-driven planning calls for very specific structural arrangements to keep in check these potential problems and maintain a bond of credibility and legitimacy between principal and agents.

of planning; that is the rational impulse to fight complexity with analysis and to stamp out every inconsistency with policies and procedures. When not kept well in check, this powerful drive leads to large number of staff people hell-bent on turning the corporation into a sanitized bureaucracy.

However, in the give-and-take of corporate life, these structural requirements get easily traded off against other pressures and priorities.

CEOs, pressed for time and finding comfort in dealing with only a few people close at hand, may quite inadvertently trigger the process of staff usurpation of line authority. CEOs should be particularly vigilant on this score as they may unwittingly trigger a drift to a staff-driven mode of management and planning at the top of their corporation. (3) The Roles ofStrategic Planners in Line-driven Planning Syrtems One of the key functions of strategic planners is the setting up and maintenance of an effective planning process for all divisions, units and subsidiaries of the corporation.

It is incumbent upon the corporate planner to remind corporate executives of why certain arrangements were made, to underline the stakes involved, to plead for the maintenance of a structure that protects the corporation against agency costs and safeguards the effectiveness of the strategic planning process.

(4

In many circumstances, a line-driven planning mode will be the most appropriate process for the corporation. In this context, strategic planners must assume a number of important roles: Information co-ordinator ad market surrogate. The corporate planner must organize the collection of key information on the market and competitive performance of each unit. The information should be collected at regular intervals (yearly, biyearly) so as to provide valid bases of comparison. The business unit’s management should be aware of the studies, participate in their design and have access to all results, including raw data. However, corporate planning should pay for these studies and assume responsibility for their being carried out. The information collected should consist of simple, non-controversial measures which directly relate to a business’s strategy and future performance. Thus, actual and potential buyers might be surveyed on competitive product quality, performance, after-sale service and so on, in order to develop market performance indicators which can be monitored at regular intervals. The result would be to provide corporate executives and business unit management with a common pool of market and competitive information. The purpose here is two-fold: first, to insure that markets, clients and competitors always remain the primary focus of the unit’s strategic plan; and, second, to provide the corporate office with an information base from which to discuss strategic orientations and monitor strategy implementation. Cw0dian of structtrral integrity. Principal-agent relationships are tricky and fraught with potentially serious problems for the large corporation.

Head strategic trainer. Training in strategic thinking and implementation for line managers is itself a factor of great strategic importance. It must receive the direct attention of the CEO and of the strategic planner. It should not be delegated to the human resources people with some vague mandate to set up courses in strategic management. The corporate planner must look for a comprehensive strategy framework which is relevant to the kind of issues faced by the corporation. What he/she should be searching for are not recipes and ready-made solutions but a set of adaptive, flexible tools to think about strategic issues. The corporate planner should be responsible for setting up the programs to teach these thinking tools to all pertinent managers and to link these tools to the strategic planning process.

(4

Incentive strategist. Incentive systems are crucial to strategy implementation but very difficult to design. In recent years, many innovative devices and plans have been cooked up to make incentives more effective. The practice common in many corporations is to give the personnel department a mandate to come up with suitable plans for employees and managers below a certain rank. As for executives, the CEO may work with outside consultants and make proposals to the compensation committee of the board of directors. Typically, this process results in uniform packages linked to a few, easily verifiable (and manageable) numbers: profits, returns on utilized assets, and so on. The corporate planner should be closely associated to the design of the incentive system, insist that it be linked to the strategic plan and to key factors monitored by the corporate office and argue for flexibility so that different business units may be rewarded on the basis of different strategic parameters. The corporate planner should become a source of wisdom and knowledge in the arcanes of management incentives.

Strategic Plans as Contracts

115

Conclusions

Executive compensation scoreboard, Business Week, 5 May (1986).

A number of critical points were emphasized in this article. We claimed that strategic planning often takes the character of a contractual, principal-agent, relationship and that this perspective can shed new light on perennial and baffling problems with strategic planning.

Jack Welch: How good a manager? Business Week, 14 December (1987).

On the basis of some fundamental dimensions of all psychological and/or economic contracts, we derived a typology of strategic planning modes. By distinguishing among various planning situations and their appropriate planning modes, we argued that there is no ‘one best way’ of planning for all organizations and for all circumstances. Under different conditions, leader-driven, culture-driven or line-driven planning may be appropriate. However, under the pull of strong currents at work in large organizations, the process may easily drift to numbers-driven or staff-driven planning modes, which will prove unstable and inefficient. Furthermore, although the point was made somewhat obliquely, several modes of planning may coexist within the same corporation. For instance, the firm may function with culture-driven or even leader-driven planning for its root operations but ‘resort to other planning modes for businesses acquired in the process of diversifying the corporation. Mixing planning modes in an effective manner, however, calls for a rare sophistication about agency issues. Our discussion also makes clear that powerful forces at work in and around strategic planning make for cyclical patterns. The rejection in the early 1980s of staff-driven planning in favour of line-driven planning may turn out to be just another phase. If (or when) the demanding requirements for successful line-driven planning are not met, the process may swing again to numbers-driven planning or back to staff-driven planning, in a repetitive cycle so common in the management field. This contractual perspective on strategic planning has also led us to formulate some recommendations and words of caution to corporate planners and executives. We believe that these suggestions could improve measurably the performance of strategic planning, a much maligned management process but one which is essential to the governance of large modern corporations. Further reading Francis J. Aguilar, Richard G. Hammermesh and Caroline Brainard, General electric: 1984. Harvard Business School, Case 9-385-315 (1985). Yvan Allaire and M. Firsirotu, How to implement radical strategies in large organizations, Sloan Management Review, Spring (1985). Yvan Allaire et M. Firsirotu, La gestion strategique des organisations, Editions Sciences et Cultures, Montreal, Quebec (1986). The new breed of strategic planner, Business Week, 17 September (1984).

A. D. Chandler, Strategy andStructure, (1962).

MIT Press, Cambridge, Mass.

A. D. Chandler, The Visible Hand: The Managerial Revolution in American Business, The Belknap Press, Cambridge, Mass. (1977). Kathleen M. Eisenhardt, Agency theory: an assessment and review, Academy of Management Review, 14 (1) (1989). E. F. Fama and M. C. Jensen, Separation of ownership and control, Journal of Law and Economics. c. 26,301-325 (1983). What Welch has wrought at GE, Fortune, 7 July (1986). The downside of downsizing, Fortune, 23 May (1988). Jay. R. Galbraith, Strategy and organization planning, Resource Management, 22, Spring/Summer (1983).

Human

Richard G. Hamermesh, Making planning strategic, Harvard Business Review, July/August (1986a). Richard G. Hamermesh, Making Strategy Work, John Wiley & Sons, New York (1986b). Robert H. Hayes, Strategic planning-forward in reverse? Harvard Business Review, November/December (1985). M. C. Jensen and W. H. Meckling, Theory of the firm: managerial behavior, agency costs, and ownership structure, Journal of Financial Economics, 3, 305-360 (1976). W. G. Llewellyn, Executive Compensation, Columbia University Press, New York (1968). Carol J. Loomis, The madness of executive compensation, Fortune, pp. 45-52, Mule 12 (1982). W. G. Ouchi, Theory Z, Addison-Wesley,

Reading, Mass. (1981).

Talcott Parson, Suggestions for a sociological approach to the theory of organizations II, Administrative Science Quarterly. September (1956). R. T. Pascale and A. G. Athos, The Art of Japanese Management, Warner, New York (1982). Thomas J. Peters and Robert H. Waterman, In Search of Excellence: Lessons from Americas Best-Run Companies. Harper & Row. Publishers, New York (1982). M. Potts and Peter Behr, The Leading Edge: CEOs Who Turned Their Companies Around, McGraw-Hill, New York (1987). C. K. Prahalad and Richard A. Bettis, The dominant logic: a new linkage between diversity and performance, Strategic Management Journal. 7 (6) (1986). J. W. Pratt and R. J. Zeckhauser, PrincipalsandAgents: TheStructure of Business, Harvard Business School, Boston, Mass. (1985). Edgar H. Schein, Organizational socialization and the profession of management, in The Art of Managing Human Resources, E. H. Schein (Ed.), Oxford University Press (1987). F. M. Scherer, Corporate takeovers: the efficiency argument, Journal of Economic Perspectives, 2 (1). Winter (1988). P. Selznick. Leadership in Administration, Harper and Row, New York (1967). Benjamin 8. Tregoe and John W. Zimmerman, Top Management Strategy: What it is and How to Make it Work, Simon and Schuster, New York (1980). Richard F. Vancil, Decentralization: ManagerialAmbiguity by Design. Dow Jones-Irwin, Homewood, Ill. (1978). Harrison C. White, Agency as control, in PrattandZeckhauser

(1985).

0. E. Williamson, Markets and Hierarchies: Analysis and Antitrust Implications, Free Press, New York (1975). 0. E. Williamson and W. G. Ouchi, The markets and hierarchies programme of research: origins, implications; prespects, in Power, Efficiency and Institutions: A Critical Appraisal of the ‘Markets and Hierarchies’ Paradigm, A. Francis, Y. Turk and P. Willman (Eds), Heineman Educational Books, London (1983).