Money, which represents the prose of life, and which is hardly spoken of in parlors without an apology, is, in its effects and laws, as beautiful as roses cash flow is nothing more than the movement of money in and out of your business. But in reality it is the lifeblood of your company. You need money to pay your vendors, landlord, and employees in order to stay in business.

As the term implies, cash flow is a moving target; money is constantly going in and out of the business so it can be difficult to pinpoint what your cash status is at any given time. The point of tracking cash flow isn’t to get a fix on your money. Rather, it is simply to make sure that there’s enough money on tap when you need it. Cash flow is not the same as profit. Your business may be profitable, yet face a serious cash flow problem. So it isn’t helpful to focus only on your bottom line and ignore your money supply. In this chapter you will gain a better understanding of what cash flow is all about and how you can analyze your company’s cash flow cycle so you can predict your future money needs. You’ll find out how to plan so that you don’t run out of money, and you’ll learn about a number of ways in which you can improve your cash flow by increasing the money that comes into your business and decreasing the money that goes out.

 Understand the Cash Flow Cycle

How does your cash flow run? As strong and as constant as the Mississippi River or as small and erratic as the little stream that sometimes dries up in the summertime? It is important to know about your company’s cash flow so that you can pay your bills to stay in business.

• Cash Flow

Cash flow is the cycle of money going in and out of your company. Usually, it is tracked from the start of the sales process. As a general rule, money flows out during the first phase of the cycle when you incur expenses to furnish your goods or services and flows in during the final phase when you collect the payment for sales. The first phase of the cycle erodes your cash stash; the final phase replenishes it. In other words, the cycle is the time it takes to convert a sale into cash.

• Cash Flow Analysis

Do you know how long it takes for money to come in during your business cycle? Without this knowledge you may be caught short of the cash needed to meet your obligations. Take the case of a wedding planner in Seattle. She was great at creating a bride’s dream event, but couldn’t get her mind around cash flow. As a planner she could schedule every component of the event, from the caterer and photographer, to the invitation printer and band. But she failed to take a sufficient down payment from the bride’s father to cover the deposits she owed to each player involved in the affair, leaving her dreadfully short of money to pay her own bills.

Cash flow analysis, which is also called cash flow projection or forecasting, involves an examination of the income coming in and the expenses for which money goes out. It lets you know how much money you’ll need at some future point to meet your expenses. Cash flow analysis also involves the time span in which these items occur. In an ideal situation, you hope your cash outflow will be less than your cash inflow, or will match as closely as possible. If outflow is more than inflow, the wider the gap between these events, the more problematic things can become. Experts differ on how long you need cash flow projections for. Some suggest that six months out is long enough, while others say that two years are mandatory. Obviously, you must find what will work best for you.

• Keep a Close Eye on Cash Flow

As the owner of your business, it’s your responsibility to keep tabs on cash flow. Whether you work with an accountant or have a board of directors or advisers, it is ultimately up to you to watch your money and initiate appropriate steps if there are cash flow problems.

In the old (precomputer) days, monitoring cash flow required a time-consuming projection on paper of your money needs, month by month. Doing this work the old-fashioned way—as an exercise— may help you better understand what cash flow is all about. The worksheet in Table 5.1 shows how to perform this analysis for the month of January; you would do the same analysis for each of the other 11 months of the year.

Today, monitoring cash flow can be automated with the use of software designed for this purpose. This cuts down considerably on the time it takes to track your money. If you work closely with an accountant, it is the job of this professional to closely watch your cash flow and to advise you if there is a problem. If you keep your own books, then use software to help you track your cash flow. For example, if you use QuickBooks to keep your books, you can find there two useful cash flow reports: Statement of Cash Flows and Cash Flow Forecast. You do nothing to complete these reports; they are filled in automatically based on the income and expenses you input to your books. All you have to do is be sure that you check these reports regularly to detect problems on the horizon. Other small-business accounting software, such as M.Y.O.B. Accounting and Peachtree First Accounting, have similar cash flow reports and tracking.

• Plan for Adequate Cash Flow

Lack of capital is one of the main reasons that businesses fail. They run out of the money needed to pay their bills, and creditors can force them into bankruptcy, requiring them to liquidate the business and distribute whatever money there is to those creditors. It doesn’t matter that there is a hot sales prospect in the wings or that the long-range forecast for the business is great. You need to have adequate sources of money to pay your bills when they come due.

Warning Signs of a Cash Flow Problem

You may not perform an in-depth cash flow analysis each and every month, but you can stay on top of things and avoid a potential problem by doing an easy check at the end of each month. Compare your sales with your expenses. If your expenses, including overhead and purchases to make your sales, are outpacing your sales, you have a potential problem. Danger signs that you may have or are about to have a cash problem include:

• Bank account balances drop below normal averages.

 Check the balances on your business checking and savings accounts each month to see that they approximate what you have been seeing in prior months. A decline does not necessarily mean you’re in trouble; you may simply have purchased new equipment or made an unusual purchase. But if there is a decline for an unexplained reason, it may indicate cash flow problems (e.g., that your expenses have gone up without the same increase in sales).

• Sales outlook is dim.

Depending on your type of business, you may continually have sales in the pipeline. For example, if you are an architect, you prepare proposals in order to keep new sales forthcoming. But if you notice that you are doing fewer proposals, you will probably have less sales in the future, something that can jeopardize your cash flow stability.

• Inventory is building up.

If you find items are sitting on your shelf for longer and longer periods, again you face an issue of reduced sales, which will bring in less revenue.

• Bills are being paid late.

Many bills you receive are due on receipt or within 10 days. Some bills may give you a 30-day period in which to remit payment. If you find that you are paying these bills in 60 days, 90 days, or longer, you know there’s already a serious cash flow problem.

• Major purchases are being postponed.

 Your company needs a piece of equipment, but you can’t afford to buy it now because money is tight.

• Banks are asking for financial statements.

You already have outstanding commercial loans and your lenders are getting nervous, as evidenced by their requests for your balance sheets, income statements, and other financial information.

• Improve Cash Flow

Just because you see a cash flow problem looming does not mean you are doomed to experience difficulties. Knowing that there’s a potential problem lets you take steps to avoid a crisis. There are two main ways to improve your cash flow: Increase the amount of cash that’s coming in and reduce the amount of cash that’s flowing out. Both ways help to ensure that you won’t run out of cash. It is usually advisable to tackle both ways simultaneously in order to avoid a cash crunch.

• Cash Reserves

If possible (and for many small businesses this is virtually impossible to do), create a cash reserve to help you ride out the lows you may experience. A cash reserve will help you avoid the need to take drastic measures when you experience a cash flow problem.

Warning: Pay Taxes First

In managing cash flow, always avoid problems with the IRS and state sales tax departments. Pay your tax obligations before other creditors, even if the other creditors are knocking at the door. If certain taxes are in arrears (check with your accountant as to which taxes you must pay immediately), these government agencies can freeze your bank account and/or seize your assets. By then it may be too late to address your cash flow difficulties. Once your accounts are frozen, you are no longer in a control of your money.

Strategies for Increasing Cash Inflow

Short of winning the lottery, receiving an inheritance, or depleting your nest egg and putting the funds into your business, there’s no fast and easy way to boost your company’s money supply. Generally, you must look to increase your sales and the collection of payments on these sales. There are, however, other ways to increase your money supply besides boosting sales or putting more of your own money into the business. You can also increase the return on your investments (e.g., interest on money market accounts) and look to find financing from loans, factoring (similar to loans), or grants.

• Increase Sales

Obviously, if you sell more, you’ll take in more cash through these sales. Thus, the first and main way to increase your money supply is to take steps to boost your sales, such as changing and rearranging marketing efforts. However, recognizing the old adage “It takes money to make money,” stepping up your sales efforts may initially cost you more than you take in. You’ll have to pay at the start of the sales cycle for these additional costs even though you may not see a return until later on. Thus, it’s a good idea to launch this approach well before you face serious cash flow problems.

• Raise Prices

Review your current pricing schedule to see if there is room to make upward adjustments. When was the last time you raised prices? If it was more than a year ago, it may well be time to revise your pricing schedule. What are your competitors charging? You may have fallen behind in pricing by not raising your fees sooner. How is the economy doing? A booming economy can better support your price increases than one in a recession.

• Improve Collection of Receivables

You may want to review your collection policies and become more aggressive about delinquent accounts. There are also incentives you can use to obtain payments more rapidly and to avoid slow paying and nonpaying customers.

• Tighten or Loosen Up on Extending Credit to Customers

Always try to get cash up front to avoid extending credit to customers. But this is not always possible. For example, if you are a Web designer who contracts to create a Web presence for a company, you may receive payment upon completion of the job. However, you can usually arrange to receive partial payment at stages of the job, including 25 percent to 50 percent of the total fee up front. If you are fortunate enough to be sitting on cash reserves, don’t let them sit idle. Invest (carefully). Make your money work for you, but choose investments that keep your money liquid so you can use the funds as needed at any time. For example, depending on the size of your reserve, you may invest in money market mutual funds or short-term commercial paper.

• Find Grant Money

While there may not be an abundance of grants for small businesses, this financing mechanism should certainly be explored. Grants are free money because they do not have to be repaid. To find grants for small business, go to the Small Business opportunities.

• Borrow Money

You don’t have to take out a loan and keep the money sitting in the bank to be in a good position to avoid a cash flow disaster. All you need is to put financing options in place so that you can call upon them when necessary. It is always better to make these arrangements when you are in a good financial position than to wait until you really need the money. Consider the following financing options.

• Line of credit

Set up a pot of money you can draw upon as needed. A line of credit is a loan you obtain from your bank up to a fixed limit. Usually, this type of loan is a revolving line. As you pay back principal you have more to draw on later on. The line runs for a set term, but can be extended as needed if the bank is agreeable.

• Factoring

If your business has accounts receivable that you must wait to collect upon, consider using a company, called a factor that will buy your receivables (outstanding invoices) from you. Factoring originally was used exclusively in the clothing industry, but today it is being used by many different businesses. The amount you receive has nothing to do with your creditworthiness, but rather the creditworthiness of businesses that owe you money. With factoring, you’ll receive 50 percent to 80 percent of the receivables’ face value up front. The factor then collects on the receivables and remits to you the amount collected, less the factor’s fee. This fee is usually 1 percent to 5 percent of the face value of the receivables. So, in effect, you may receive up to 99 percent of what you are owed, with the bonus of getting half or more of those funds immediately for working capital. Using a factor can be a short-term arrangement to help you over a rough spot. But some small businesses, especially those with continual cash flow swings resulting from seasonal payroll or peak sales periods, may work with a factor as a long term arrangement. Try to obtain “nonrecourse” on the financing so that the up-front money is yours, even if the factor fails to collect on one or more of the receivables. It is usually a good idea to work with a broker specializing in factoring (and who is compensated by a finder’s fee that may be pricey). The broker can shop around for the best factoring company for you and help negotiate the best deal. To locate a broker, do an Internet search in your favorite search engine for “factoring brokers” (make sure you are dealing with a broker and not a factoring company). To check on a factor, contact the Commercial Finance Association (CFA), a trade association for the asset-based financial services industry .

FINANCING FROM SUPPLIERS

Your vendors may be able to offer you extended payment terms, minimizing your current need for cash. For example, ask for 180- day payment terms. Of course, this will cost you more overall if there are financing costs, but it can help you get over the hump.

Strategies for Decreasing Cash Outflow

You can improve your cash flow by minimizing the drain on your money supply. Usually this means tightening your belt. But there are also a number of creative ways to reduce or delay the outflow of cash from your business.

• Cut Expenses

Obviously, the less money you spend, the less you need to take in and the better your cash flow will be. But reducing expenses can be challenging, especially if it requires laying off a valued employee or waiting another year to buy a needed piece of equipment. Examine carefully everything you spend money on; there’s surely room for savings. Try to renegotiate the cost of products or services you regularly purchase since these sellers may be willing to work with you to keep you as a satisfied customer. Buy smarter. The less you pay for something, the better off you will be. Today, you can check the prices of everything from supplies to heavy machinery at online sites and may, in fact, save money by making your purchases online through auction sites or remainder sellers. If you are experiencing severe cash flow problems, you may have to make drastic and painful cuts. You may, for example, need to scale back wages (at least temporarily) in order to avoid firings.

Caution: Do not overlook your obligation to pay so-called trust fund taxes—this is not the place to cut. Trust fund taxes are payroll taxes you withhold on behalf of your employees (income taxes and the employee share of Social Security and Medicare taxes). No matter how your business is legally organized, you are personally liable for 100 percent of these funds. You do not want to pay another creditor over the U.S. Treasury in this case.

• Trim Inventory

If you sell goods, you have an inventory on hand for sale. Ideally, you can switch to a just-in-time inventory management system where you do not stock anything until it is needed. You might, for example, be able to arrange shipment directly from a manufacturer rather than warehousing items yourself. But most businesses can’t do this, so you might want to aim for minimizing the amount  of inventory you carry. Again, this is simply a matter of cutting back—ordering less and stocking a smaller variety of items. Of course, you must maintain sufficient inventory to offer your customers a good selection of items and be able to deliver promptly, so scaling back requires some finesse. Also work with suppliers to increase delivery time for your receipt of inventory items so you can cut back on your stockpiles.

• Delay Paying Your Bills

You don’t want to fall delinquent on your obligations—doing so can cost you interest charges, damage your credit rating, and cause you to lose standing with existing vendors or suppliers. But you don’t have to pay immediately. Take advantage of the payment terms. For example, if you have a 30-day window, remit payment on the 27th day. Pick and choose carefully which creditors to pay if funds are tight, paying careful attention to interest rates that may apply. Use online payment options to finely time your payments. Since transfers are instantaneous, you can send payments at the very last minute. If you must be late, talk with your suppliers to gain their understanding. Try to arrange for extended payment options, even if it costs you some interest charges, if you are experiencing a temporary cash crunch.

The study of innovation in industry draws on insights from several social science disciplines: economics, sociology, economic geography, political science and management. The economics of innovation developed as a subdiscipline based on the work of pioneers such as Schumpeter (1942/1975), who coined the term “creative destruction” to describe the transformation that accompanies radical innovation under capitalism. He was followed by the economists Arrow (1962), Nelson and Winter (1982), Freeman (1982), Lundvall (1992) and Metcalfe (1998).

“Innovation” in the productive sector, whether in manufacturing or services, is usually defined as the creation of novelty of economic value. This translates into viewing innovation as the creation of new products and services, as change in the processes of producing these products and services and as organisational change, including new work practices. Innovation in industry may also mean using new methods to produce services and the creation of “product-service packages”, either as “generics” for a market or to solve particular client needs (Marceau, Cook and Dalton 2002). An example of a new “product-service” package is the set of services provided as part of the “deal” or “bundle” when purchasing a mobile phone.

Both creativity and invention can be found in innovation. Here I define “creativity” as the creation of new ideas or a recombination of existing knowledge that has no immediate or particular market drivers. Invention is a new product (usually) or service whose economic value has not been tested in the market or whose value has been tested but has been found deficient and the new product remains unused. In this sense, creativity is similar to invention. Creative people are viewed as drawing on their thinking and research to find solutions to “problems”, with an emphasis on thinking “outside the box”, “playing” with existing products or services (cf. Dodgson, this volume) to find new ideas for product or services and new understandings of how “things work”. Creative people are also those who can recognize new knowledge and apply it to address both scientific and product-related problems. Creativity is difficult to define in relation to innovation. It is clear that successful innovation depends on creative people as new products and processes require people to think outside the box. This is especially true for radical innovation where new products, processes or services combine new and older knowledge in particularly novel ways. The creative spark is also involved in designing the organisational forms to improve production and sales. The creative leap involved in thinking of and about new knowledge combinations is seldom examined by innovation theorists. Accordingly, even in the management literature, creativity and innovation tend to occupy different conceptual spaces, as argued by Mark Dodgson in this volume.

Innovations may be “radical” or incremental. Some innovations change fundamentally the kinds of products produced, for example, computers and automobiles, while some are small improvements on existing products or manufacturing processes. Incremental innovations are far more common than radical innovations as most fi rms prefer to stay on familiar ground and make only small changes to minimise risk. Radical innovations, such as those in the information and communications technology, which begin life as products, may lead to major process changes; examples are computer- aided design and computers in manufacturing. Some new technologies begin as scientific breakthroughs—examples are biotechnology and nanotechnology—and take considerable time to become the platform for new products.

Modern economies tend to comprise a mix of firms making radical and incremental innovations. Firms may move between radical and incremental innovation as the platform technologies mature and the business environment changes. Radical innovation is more likely to stem from R&D, while incremental innovation, including process innovation, is more likely to stem from customer suggestions and feedback or by experience with the product. The different kinds of innovation all necessitate “creativity” as they involve doing things differently. The new business models essential for commercial breakthroughs also require creative thinking (an example is the Just-in-time operations management system), but often take time to emerge in the marketplace.

The so-called “high-tech” industries are considered significantly more innovation-intensive than their “low-tech” counterparts, but recent studies have shown that the so-called low-tech sectors often use leading-edge technology for product and process innovation (von Tunzelman and Acha 2005). “Old” industries, such as mining and agriculture, are in fact highly knowledge- and R&D-intensive, and have become constant innovators through the application of new science and new business models, including the outsourcing of key activities. The leading mining fi rms, for example, often outsource mine tunneling operations to engineering and construction firms with “cutting- edge” expertise in tunneling. This is an example of how links between different industries can transform operations in another. There are many models of the innovation process.

The linear model (knowledge–push) suggests that new knowledge moves directly from its creators in public-sector research organisations into commercial hands. Over time the linear model has been modifi ed to include factors such as market pull, feedback loops, organisation of the fi rm, knowledge management and links with outside organisations. The new generation models point to distributed or “open” forms of innovation and establishment of networks to share knowledge and capabilities of several organizations (global and local), permanent and transient (Chesborough, Vanhaverbeke and West 2006; Bessant and Venables 2008). In the new generation innovation model, new IT-based “innovation technologies” enable new product and process simulation, rapid prototyping, team design and rapid steps to manufacturing through a process Dodgson, Gann and Salter (2005) refer to as “think, play, do” (see Dodgson, this volume).Creativity plays its clearest role in the new generation models. The opportunity for highly creative ideas based on multiple sources of knowledge and perspectives to become an innovation grows as innovation becomes a more open, distributed and networked activity. As the new models of innovation take hold, creativity may attract greater attention among writers on innovation. With changes in the organisation of innovation we may see a deeper examination of creativity in firms and organisations.

COMPONENTS OF INNOVATION SYSTEMS

Innovation in an industry is dependent on the context (e.g. nation, region and city) in which industrial firms and related institutions function. Here I describe the components frequently identified as critical for innovative capability and performance and how they can be understood as elements of an integrated system.

• human capital
• science system
• research and development
• business system
• trade
• venture capital
• technology change
• innovation

INNOVATION IN INDUSTRY: LARGE FIRMS, SMALL FIRMS, HIGH TECH AND LOW TECH

What determines the level of innovation across different industries? International surveys (OECD 2002, 2003) have measured the levels of innovation activity undertaken by companies and suggest that expenditure on R&D is a critical differentiator for success. The surveys show significant differences in levels of innovation-related expenditure between nations, industry sectors (high versus low tech) and between firms of different sizes. High-technology firms, such as biotechnology, are innovation-intensive and spend up to 10 per cent or more of turnover per annum on R&D; science-based start-up firms may spend considerably more.

Many firms obtain their innovation ideas externally. Studies have shown that customers are the single most important source of innovation knowledge, followed by suppliers and competitors (see e.g. von Hippel 1988; Marceau 1999). Maintaining close links with customers as end-users reduces innovation risk and smoothes the innovation process, especially in regard to product design. Some observers suggest that the most successful firms rely on multiple sources of innovation ideas and seldom a single source (Hyland, Marceau and Sloan 2006), especially, of course, if their markets are differentiated and consist of more than a few large clients. The size of a firm, however, does not alone determine the degree and direction of innovation activity. The type of technology central to the firm, the stage of development of that technology and the type of market in which

a company operates also shape decisions about innovation and investment in new products (Whitley 2000). Some recent studies attempt to identify the different sources and “packages” of influence (Hollenstein 2003). There is likely to be considerable industry variation as, for example, biotechnology firms may behave very differently from, say, metals manufacturers, at least in the early stages of development. The information exchange relationships between four key players (customers/users, producers, regulators, etc.) in a product system. This is a “perfect” map of information and knowledge exchange. All four players are linked equally in information and knowledge exchange across all combinations. We would predict much innovation, unless of course the four players spend all their time informing and not implementing! Few real-life situations approximate equality of information flows and influence. However, under some conditions, such as rapid technological change or a dramatic shift in the regulatory environment (e.g. removal of tariff protection), the industry may rely on powerful dominant players to shift the organisational and operational arrangements and push suppliers into compliance in order to survive. Under other conditions, the major players may be the only ones able to negotiate and coordinate the necessary but complex changes in relationships between all the players in the industry (e.g. with the regulators and the training institutions). Tensions may arise between the “creative” elements of the industry (who value their autonomy and independence) and their “innovative” counterparts who place a premium on business results and industry survival. In practice at any time some players dominate the activities of the industry. The case examples have been selected to focus on industries with significant creative elements—architecture and engineering in the building industry and fashion design in the clothing industry.

Our mapping of an industry product system has implications for policy. For example, the map might reveal perceptions and evidence of too little input from customers or from R&D organisations (information dimension) or too heavy-handed a policy and regulatory compliance framework from government (power relations). In each case this pinpoints the location of an obstacle to innovation. In interviews we look at information

flow and degree of influence from the player’s point of view. Thus, one player (producers) might claim there is little input from research technology organisations, and another reports there is too much interference by powerful regulators. The “maps” thus generated are slices of subjective reality designed to highlight issues and dynamics which industry and policymakers may wish to address for improving innovation.

• uses
• producer
• research and development
• training institution
• regulator

While globalization has opened up markets everywhere, it has also thrown the inherent tension between government economic activism and entrepreneurial freedom into sharp relief. We now take up crucial questions about the proper role of government on the one hand, and the place, indeed the very future, of entrepreneurship on the other. In our global economy entrepreneurs are frequently competing with companies supported and directed, and often controlled, by the governments of the countries where they do business. It is hardly an even match: such policies inevitably engender hidden or overt preferences for buying local products.

Clearly, state-controlled economies pose a serious challenge to the basic concept of entrepreneurship and the ability of foreign corporations to operate freely within those economies. By raising barriers to international sales opportunities, they clearly increase the inherent risks of launching new entrepreneurial businesses. Under such conditions, it is fair to ask whether the individualistic and “random” entrepreneurial process, gated by so many unpredictable circumstances, can be counted upon in the future as a significant economic driver. Must governments everywhere become much more involved in supporting ambitious entrepreneurs focused on creating new markets? This is a pressing issue for countries like the US, which have a tradition of free markets and limited government support of their industries. We opened this book on the entrepreneur in the global economy by outlining how governments involve themselves in building local economies.

The succeeding chapters tracked the fortunes of twelve entrepreneurs, from David Sarnoff of RCA in the first half of the twentieth century to Lynn Liu of Aicent at the opening of the twenty-first, as they strove to build competitive companies in an increasingly globalized economy. In this chapter we will ask whether and how governments and entrepreneurs can coexist and cooperate, and explore the ramifications of that question. This covers such topics as, to what extent will governments take on the roles of venture capitalist and entrepreneur, choosing the technologies and building the industries of the future? In what areas is government participation most likely to be healthy and productive? How can entrepreneurs and corporations responding to market conditions make better decisions? The hazards of targeting industries To set the stage, we will review two diametrically opposed views of economic development, as described initially in our opening chapters. They represent the most extreme positions in the argument over industrial policy in the developed world: pure free markets versus heavy state involvement. There is plenty of public support for an untrammeled entrepreneurial approach. Free-market advocates insist that the US government (and by extension governments in other free-market countries) should stay out of the markets and let entrepreneurs chart their own course. According to these proponents, “The country needs to unleash entrepreneurs, who will only be held back by tax-funded make-work projects.”

Others question the efficacy of this approach. They believe that the idea that “entrepreneurs are the foundation of the [US] economy” is a myth,3 and that the US and other free-market countries might be better off with a targeted industrial policy to ensure the growth (and protection) of domestic industries, particularly new ones based on domestic innovations. A better way to frame the argument is to ask the following question. Is it realistic to believe that government planning, supported by taxpayer money, can force-feed industrial innovations into the commercial marketplace? Can it totally replace the more chaotic but much more flexible and dynamic entrepreneurial process? As an approach to answering this question, it is worth keeping in mind the observations of Nassim Taleb in his book The Black Swan,4 in which he summarizes the views of Nobel Laureate economist Friedrich August Hayek, a famous proponent of the free market For Hayek, a true forecast is done organically by a system, not by fiat. One single institution, say, the central planner, cannot aggregate knowledge; many important pieces of information will be missing. But society as a whole will be able to integrate into its functioning these multiple pieces of information. Society as a whole thinks outside the box. Hayek attacked socialism and managed economies.

Owing to the growth of scientific knowledge, we overestimate our ability to understand subtle changes that constitute the world, and what weight needs to be imparted to each such change. On a theoretical level, then, there are limits to what can be done with “top-down” economic planning. Hayek suggests that any attempt to dictate a national approach to a dynamic market will be unsuccessful in the long run. Instead, the most productive strategy  for fostering economic growth is likely to be the creation of national policies that focus government on what it does best, leaving private capital and entrepreneurs to areas where they function more efficiently. We will clarify the dividing line between these two spheres by looking at some examples of government actions and their outcomes.

Government as entrepreneur

On the face of it, it seems like a good idea to have the national government fund the creation of industries around promising technologies in the hope of expanding the economy and building exportable products. Proponents of this approach envision using subsidies and other incentives to accelerate the growth of the chosen industries.

This would be done in partnership with private industry if possible€– and without it if private funding is not available. This may sound familiar because it is an old idea. We encountered it in our discussion of Colbert, who targeted growth industries for seventeenth-century France. China runs a modern version of the strategy. Although this approach can achieve quick success, it usually runs into trouble later on. The availability of “easy” state money spawns enterprises with uncompetitive cost structures. They become too far removed from the discipline of the competitive marketplace to achieve profitability. Bereft of entrepreneurial management, companies built on this model risk becoming permanent wards of the state. This actually happened in Colbert’s France. There is a bigger problem with this approach: it too often fails, especially when newer technology is introduced. We can understand why when we contrast industrial development with infrastructure and defense, two functions crucial to economic growth and stability that governments can carry out quite effectively.

Infrastructure (roads, airports, and water and power utilities) is convenient for the citizenry€– and absolutely necessary for industrial development. Likewise, defense programs uphold national security€ – and also spur the growth of industry by underwriting R&D programs. Even the most radical proponents of limiting the power of

government would agree that both of these activities are the rightful province of the state. Governments are the only entities with the resources to plan and finance such sweeping programs. They are also dealing with known quantities: it is relatively easy to project infrastructure requirements and forecast future defense needs.

Deciding which new innovative industries to subsidize, on the other hand, is a far less certain undertaking than determining when and where people will need roads and sewers. It is nearly impossible to predict future market trends and competitive threats with any great degree of accuracy. As a result governments are notoriously poor at picking winning new commercial industries for long-range development. Such attempts have often generated disappointing results.

 Long-term planning, longer odds

There is another reason why governments have such a poor track record in planning technology industries: the nature of their A decision-making process. They are not the only entities affected by this shortcoming. It is common in large corporations as well.

As can well be imagined, thousands of planning meetings take place every day in large organizations around the world, with committees deciding economic and technological matters large and small. Whether these meetings occur in the government bureaucracies of planned economies or in the boardrooms of large corporations, one thing is certain. Lone visionaries, even if present, have little chance to influence the ultimate decision. In addition, most of the people in the room will be far removed from the actual technologies under discussion.

 Targeting growth industries: Government teams with the private sector

When state initiatives to develop new industries fail, it is the taxpayer who foots the bill. Where the government has recruited private capital and entrepreneurs to join such initiatives, however, the economic effects are amplified. Entrepreneurs and their investors are left stranded along with the taxpayers, potentially affecting the availability of funding for other, more promising innovations. Three US government “clean energy” programs illustrate how this can happen. Clean energy is currently one of the most popular areas for investment, so it was easy to persuade private investors and companies to participate. All the programs were targeted at reducing fossil fuel consumption and controlling greenhouse gas emissions, though in very different ways. Two programs addressed the electrical utility industry, while the third subsidized sales of hybrid electric automobiles. Of the two programs targeting electric utilities, the first

sought to replace non-renewable fossil fuels (oil and coal) in power plants with biomass (wood and other organic materials). Biomass was touted as a “clean” and renewable energy source. The other program aimed to build a so-called “smart grid” to improve the efficiency of the electrical power distribution network. With a more efficient grid, the electric industry could meet the demand for power with less fuel. Both programs had the worthwhile goal of reducing the amount of CO2 spewed into the atmosphere by generating plants.

Industrial planning vs. technology funding

Up to now we have looked at the difficulties of industrial planning. We have also reviewed the dismal record of planners and prognosticators in accurately predicting which technologies would prove successful in the marketplace. Fortunately, there are positive aspects to the planning process. These include government policies that recognize how important entrepreneurship is to economic development. As observed before, entrepreneurs do not generate new businesses in a vacuum. They need access to intellectual property developed by others on which to base product offerings. They have to identify and exploit promising new markets, develop funding sources, and attract talented employees. And contrary to myth, they rely heavily on the infrastructure, resources, and business environment established by government. Even in free-market countries like the US, the government has more involvement in the development of new industries than most people realize.

We saw how David Sarnoff took advantage of cooperation between the US government and private companies in the 1920s to create the broadcast industry as we know it. Without the original government initiative to establish RCA, he would not have had the opportunity. Of the entrepreneurial innovators we cover in this book, Sarnoff is the earliest by some sixty years. But he took full advantage of government policies and funding, and US entrepreneurs have followed his path right up to the present. To prove the point, consider a prominent example from our own era: the digital industries pioneered in the US after World War€II. Everyone talks about the famous entrepreneurs who created iconic companies such as Apple and Microsoft, but few mention that these and many other enterprises had their genesis in technologies developed under government-sponsored R&D funding. Many of the companies we discuss in this book replicate the pattern.

The technology that underlies RMI, RDA, and SanDisk can be traced to government-funded initiatives if you go far enough into the past. In the case of Ness Technologies, the roots of some of the technologies it commercialized can be traced to work sponsored by the governments of Israel and other countries. This research was conducted under government funding in

universities, national laboratories, and private industry, and originally may have been targeted at applications in the defense and space programs. But somehow the resulting technologies, developed in unrelated settings for different purposes, found their way to the world market. The results were spectacular: the creation of new electronics, computer, and telecommunications industries that have literally transformed the way people live, work, and communicate.

In this article we will examine

• What researchers and managers in R&D company do, and
• The way we can tell how well they do it.

We will also discuss the need for focusing less on “appraisal” (evaluation, judgment) and more on employee contribution to the company. Accepted wisdom would suggest that for a business company to function efficiently and effectively, the employees must work well toward meeting company goals and objectives. From a manager’s point of view, it would seem prudent to reward those employees whose performance contributes to company success.

Logically, performance appraisal systems need to be designed to motivate employees to improve performance and thus contribute to company productivity, effectiveness, and excellence. In practice, there are many problems. Few management activities have challenged and intrigued executives as much as performance appraisal has. To some, appraisal suggests supervisors sitting in judgment as “Roman emperors.” To others, performance appraisal is thought of as a method of manipulating employees and intruding into their lives.

SOME NEGATIVE CONNOTATIONS OF PERFORMANCE APPRAISAL

The problem may lie in the negative connotations of the words “performance appraisal.” Appraisal implies evaluation and making judgments as to the quality and quantity of an individual’s productivity. To make such an evaluation or a judgment, a certain yardstick has to be available to ascertain whether the individual has measured up to the performance level envisioned by the evaluator. How is one to compare the performance of one individual who has clearly exceeded the low standards he set for himself versus another individual who failed to meet the rather difficult standards she set for herself? Dimensions associated with the yardstick are variable, and procedures available to evaluate many of these dimensions are subjective and often not well understood by the employee or the supervisor.

 DIFFICULTIES WITH EMPLOYEE APPRAISAL

When a supervisor appraises a subordinate, the process of appraisal can be analyzed as follows. First, the supervisor must have observed some performances. However, such observations in the case of R&D personnel are unlikely to be sufficiently coherent to be valid. If the supervisor were to observe a simple operation, he might be able to judge it. But R&D work is complex, and doing any one thing well is unlikely to provide a clue to the total performance. Thus, rather than observe an individual’s specific performance, the supervisor is much more likely to observe large chunks of performance, such as the presentation of a research plan or the completion of a project. Usually these are products of groups rather than individuals. It then becomes difficult to know how much the particular scientist has contributed to the group product.

Second, the observations must be integrated into some sort of “schema.” Unfortunately, there are several biases in the formation of such schemata. For example, research has shown that first impressions are extremely important. If the scientist has a good reputation, many acts that are ambiguous will be evaluated positively. Also, recent events tend to be given more weight in the formation of such schemata than events that occurred during the middle of the period of observation.

The fact that negative events are given more weight in such judgments than positive events creates a further bias. If the supervisor has observed ten events, and eight are positive and two are negative, the negative ones will be given more weight because they “stand out” as “figures” against the “background” of the eight positive events. This is because in our own lives we generally encounter few negative events, but when we do they are major negatives (e.g., loss of loved ones). On the other hand, although we encounter mostly positive events, they are seldom major positive events (e.g., getting married, winning a million dollars), and so we become especially vigilant about the negatives.

 PERFORMANCE APPRAISAL AND THE MANAGEMENT SYSTEM

Performance appraisal needs to be linked to the managerial activities and the management system. It  has categorized the management system into two distinct areas: The process of management includes activities such as planning, organizing, controlling, budgeting, and staffing, and the key orientation of these processes focuses on integrating (work activities), making decisions, recording information, motivating, and negotiating. The function of management includes procurement, production, adaptation, and so on. The orientations of these functions are adaptability, productivity, efficiency, and bargaining.

The managerial processes are concerned with the administration of inputs, while the managerial function deals with the way inputs produce outputs (production) that are important and relevant to the organization. Managerial processes respond to day-to-day problems, and primarily involve problem solving. The managerial functions, on the other hand, are concerned with prescribing specific operations, procedures, and standards for achieving a certain level of production or output.

PERFORMANCE APPRAISAL AND ORGANIZATIONAL STAGES

Some of the purposes of performance appraisal relate to management control and to achieving the congruence of organizational and individual goals and objectives. Management control and strategies for goal congruence also depend on

• The stage of development of the organization, and
• Several other factors such as the technology of the organization.

It has defined four stages of corporate development in terms of “the structure of operating units” (dependent variable) and “product-market relationships” (independent variable).

 In a general sense,

At Stage 1, the organization has a single operating unit, producing a single line of products on a small scale.

 At Stage 2, operating units increase and production becomes large scale, but the focus is still on a single line of product.

 At Stage 3, operating units may be at different locations and decentralized, each producing different or related products using multiple channels of distribution.

 At Stage 4, the number of autonomous units producing different products increases. Basically, as organizations move from Stage 1 to Stage 4, the number of autonomous operating units increases,

These units become geographically decentralized, and the operating units produce technologically different product lines or research outputs for diverse markets using multiple channels of distribution. As this development progresses the number of variables related to organizational products, operational centers, and market relationships increases. This would also point to the organization increasing in size (number of employees and volume of sales or the size of the research budget); it may, in some cases, lead to an increase in assets and profits. Management control at each of these four development stages is different. At the earlier stages, the organization is small, and one owner or director can oversee most of the activities. At later stages the organization grows in size and in number of products and may also be geographically dispersed.

 As authority becomes decentralized, performance elements need to be designed differently, depending on the development stage of the organization. For example, performance elements could be less formal during the early stages of development and more structured and quantitative later. This approach was successfully used by Salter for four high-tech electronic firms. It should be used also by managers whenever they are setting up an appraisal system. Start by analyzing your situation. In what stage is your laboratory? Then design a system that fits your stage.

 PERFORMANCE APPRAISAL AND COMPANY PRODUCTIVITY

Company productivity can be defined as the ratio of outputs to inputs. Inputs can be determined by the level of resources invested. Outputs can be conceived as income minus costs. For a profit-making organization, profitability can provide a good measure of the organization’s productivity. We must keep in mind that behavior is shaped by its consequences. If we want specific behaviors to occur, we need to use an appraisal system that rewards them when they occur. Output measures for a research organization can be subjective or objective, quantitative or non quantitative, and discrete or scalar and can include some measure of quality. While the measurement of quality requires extra effort and, at times, human judgment, this dimension of output should not be ignored. Since R&D organizations have multiple objectives and their outputs are often incommensurate, the output measures are usually non quantitative and subjective. Quantitative measures for the output elements are usually in different units, thus defying precise comparison between different quantitative outputs. It suggests that it might be feasible to combine a multidimensional array of indicators into aggregate units, which could then provide trends, indicators, and patterns of the individual (and organizational) output measures. One suggested categorization of output measures includes the following:

• Process measures (related to activities carried out in an organization; useful for the measurement of the current, short-run performance)
• Result measures (stated in measurable terms; end-oriented)
• Social indicators (stated in broad terms, related to overall objectives of the organization rather than specific activities; useful for strategic planning)

PERFORMANCE APPRAISAL AND MONETARY REWARDS

Giving monetary rewards to those who perform well seems logical enough. In an acquisitive and consumption-oriented modern society, higher pay satisfies basic human needs and more. For an individual, receiving monetary remuneration above what is required for basic human needs can also provide security, autonomy, recognition, and esteem. The motivation model, generally referred to as the expectancy model, suggests that high performance is likely to occur if the individual feels capable of achieving it, if pay is closely tied to performance level, and if the individual finds pay to be important (this would of course vary across individuals). In a research and development organization, indeed in most complex professional organizations, a number of reasons make tying pay inexorably to performance appraisal an imprudent approach:

• Significant accomplishments in an R&D company often require input by many individuals. Singling out one person for a monetary reward creates the problem of inequity for others.
• The purpose of performance appraisal shifts, on the part of the supervisor, to justifying the pay decision already made, and, on the part of the employee, to comparing himself or herself to others and shaping his or her performance data to outdo others.
• Cooperation among peers is reduced because of competition for pay for performance, where total monetary rewards are viewed as a zero-sum game.
• During performance appraisal the employee is likely to exaggerate (some might suggest falsify) his or her performance to gain higher monetary rewards. This would not create the proper environment for counseling and feedback—two of the important purposes of performance appraisal.

IMPLEMENTATION STRATEGY WITH EMPHASIS ON EMPLOYEE CONTRIBUTION

The preceding discussion identified some of the underlying issues associated with the performance appraisal system. Commenting on performance appraisal,  states that “few things have been more baffling to managers than the results of their attempts to develop workable performance measures and controls, thus channeling the energies of their employees towards the firm’s objectives.” Recognizing that many complex issues are involved in implementing a meaningful performance appraisal system, it is nevertheless useful to focus on three items:

• What an individual’s performance depends on
• Why performance appraisal is needed
• A suggested strategy

Which styles of leadership bring out the best performance in a company, department, team, or project? Finding the perfect way to manage knowledge workers remains elusive. The study of leadership, however, has proposed a variety of approaches. Some researchers have spent a good deal of time observing the behavior of groups and the emergence of leaders. As a result, they have seen that the activities of leaders fall into two general categories. The first involves maintaining (M) the group by paying attention to the needs of the members and making sure that conflicts do not become serious.

The second involves the actual task that the group must perform (P), the definition of the task, how and when it is to be done, and so on. We can label these two types of activities consideration and structure. “Consideration” involves paying attention to people, being considerate of their needs and goals, being employee-oriented, and paying attention to the human factor. “Structure” refers to what is to be done and to where the group is going. What is to be accomplished? How is it to be accomplished? How can the activities of the members be controlled?

For each job setting, the identified behaviors that are P or M for that particular job. What fits one laboratory does not necessarily fit another. The talks to people in the job setting and asks each subordinate to describe the behavior of the leader and rate him or her on their M or P behaviors. The uses the symbols M and P for those who use many behaviors, and he uses m and p to indicate that the leader does few maintenance or production behaviors. This way, in each setting, The identified four kinds of leaders:

mp = little maintenance, little production

mP = little maintenance, a lot of production

Mp = a lot of maintenance, little production

MP = a combination of high maintenance and high production

An interesting finding is that a leader who is high in production behaviors and also does many maintenance behaviors is seen as providing “planning” or “expertise;” but the leader who does a lot of production behaviors and few maintenance behaviors is perceived as “pressuring for production.” Pressure for production is resisted. In short, the same behavior (production) is perceived differently depending on the context within which it appears.

In different cultures the behaviors that express M can be quite different. Research has shown, for instance, that “to criticize a subordinate directly, privately in your office” is seen as high M in the West and low M in Japan. In Japan one is supposed to criticize indirectly—for instance, by asking a colleague of the subordinate to convey the manager’s criticism to him or her—so that the subordinate will not lose face. People who observe groups note that leaders may specialize in one of these activities or may sometimes engage in both; or in the case of “great leaders,” they will perform both activities with great frequency. First providing general theory and then focusing on a company , this article covers:

• Theories of leadership and leadership styles
• Leadership in R&D organizations
• R&D leadership—a process of mutual influence
• A leadership style case (where the problem of abdication style of leadership is presented)
• Leadership in a creative research environment.

IDENTIFYING YOUR LEADERSHIP STYLE

In characterizing the behavior of their supervisors, subordinates used similar ideas—for example, bossy or structured versus people-oriented or considerate. Similarly, when leaders are questioned, some claim that they pay attention to people and others say they focus on the task. As it turns out, however, the distinctions are not so clearly drawn. Extensive research by Fiedler (1967, 1986a) found that some people are task-motivated

when they are relaxed but person-motivated when they are under stress, while others show the opposite pattern—that is, they are person-motivated when relaxed and task-motivated when under stress. It might be useful to find out for yourself what kind of leader you are. To do that, look at Fiedler’s instructions in “Identifying Your Leadership Style” (Fiedler et al., 1977).

THEORIES OF LEADERSHIP AND LEADERSHIP STYLES

No leader can afford to ignore M and P behaviors. Ideally, leaders should do a lot of both. Supervisory behavior style impacts employee performance.

However, there are other leadership theories that suggest that in some situations the leader should emphasize one or another even more than is usual. Another way of looking at leadership is to say that the leader is supposed to supply what is necessary for the followers to reach their goals. This is called the path–goal theory of leadership. Basically, this theory argues that the way a leader acts should be determined by what the followers need. For example, if the followers do not know how to do the job, then it is necessary for the leader to be very structuring. If the followers have several needs that are not being met, then it is important for the leader to be especially considerate.

Consider the following different kinds of leadership styles:

1. The directive style, in which the leader simply makes the decision and tells the subordinates what to do.
2. The negotiator style, in which the subordinates give the information that the leader needs in order to make the decision, but then the leader makes the decision.
3. The consultation style, in which the leader asks for information and suggestions on what to do and makes the decision on the basis of these suggestions.
4. The participative style, in which the subordinates provide information and suggest solutions, the leader negotiates with them, and together they reach a mutually satisfying agreement and the best decision.
5. The delegation style, in which the leader provides information to the subordinates about the problem and suggests possible solutions. The responsibility for the decision is ultimately given to the subordinates. In this case, the leader does not even ask the subordinates to report what solutions were adopted.

LEADERSHIP IN R&D ORGANIZATIONS

While P behaviors of the leader are needed, most leaders do P, but many do not do enough M. M behaviors are especially important in R&D labs. However, subordinates still require a certain amount of guidance from the manager; otherwise their activities will become unrelated to the needs of the company have shown that when there is either excessive or insufficient autonomy, the contributions of the professional to the research organization are minimal. An intermediate amount of autonomy provides optimal conditions for the professional. Only then can the contributions of the scientist to the company be maximized.

Leadership in an business company is essentially a process of mutual influence between the supervisor and the employees. Knowledgeable workers don’t work toward a goal because someone else has set it. They work toward it because they believe that it is right. To bring a knowledge worker on board requires using multiple leadership styles. Based on mutual influence, Farris suggests four styles of leadership or supervision:

• Collaboration: Both the supervisor and the employees have a great deal of influence in making decisions.
• Delegation: The employees are given considerable responsibility for the decisions, and the supervisor has little influence.
• Domination: The supervisor has a great deal of influence, and the employees have very little input.
• Abdication: The supervisor neglects to assign a particular task to the employees and neglects to work on it himself. In this case, neither the supervisor nor the employees have much influence on a particular decision.

 Leadership Style

The leadership style is a combination of abdication and delegation. All technical responsibility is delegated to the department heads, integration at the division level is minimal, and responsibility for decisions normally made at the division level is abdicated and passed on to a higher level—the laboratory director, Dr. Cole. His views are sought and essentially all decisions normally made by the division director are in fact made by the laboratory director. The behavior pattern of the division director is characterized by his readily admitting lack of technical competence, building strong alliances with selected research divisions, degrading division directors who may have distinguished scientific records, doing what the laboratory director, Dr. Cole, wants him to do, getting marching orders on all division operations from Dr. Cole, and taking zero risk.

 Organization Performance

The company performance is fair. Increasingly, emphasis is on technical assistance instead of research. Innovative research programs never reach fruition; they are downgraded to technical assistance activities.

Leadership Problems

Clues to the existence of the problem manifest themselves via the leadership style and the behavior pattern in the division director and via lack of substantial innovation by the division over the years.

Organization Response

A company can cope with such problems in a number of ways. Before discussing that, it might be useful to see how such a situation arose.

 LEADERSHIP IN A CREATIVE RESEARCH ENVIRONMENT

In a business company, a person holding an important leadership position would normally have a significant business program. In many U.S. government departments and in industry, some individuals have oversight responsibility for the business Company, although they are not involved in business program execution. It is therefore useful to focus on those leadership and managerial aspects that are directly involved in managing and executing an important business program involving a significant number (say 50 or more).

Managerial economics applies economic theory and methods to business and administrative decision making. Managerial economics prescribes rules for improving managerial decisions. Managerial economics also helps managers recognize how economic forces affect organizations and describes the economic consequences of managerial behavior. It links economic concepts with quantitative methods to develop vital tools for managerial decision making.

Managerial economics identifies ways to efficiently achieve goals. For example, suppose a small business seeks rapid growth to reach a size that permits efficient use of national media advertising. Managerial economics can be used to identify pricing and production strategies to help meet this short-run objective quickly and effectively. Similarly, managerial economics provides production and marketing rules that permit the company to maximize net profits once it has achieved growth or market share objectives.

Managerial economics has applications in both profit and not-for-profit sectors. For example, an administrator of a nonprofit hospital strives to provide the best medical care possible given limited medical staff, equipment, and related resources. Using the tools and concepts of managerial economics, the administrator can determine the optimal allocation of these limited resources.

In short, managerial economics helps managers arrive at a set of operating rules that aid in the efficient use of scarce human and capital resources. By following these rules, businesses, nonprofit organizations, and government agencies are able to meet objectives efficiently.

Making the Best Decision

To establish appropriate decision rules, managers must understand the economic environment in which they operate. For example, a grocery retailer may offer consumers a highly price-sensitive product, such as milk, at an extremely low markup over cost—say, 1 percent to 2 percent—while offering less price-sensitive products, such as nonprescription drugs, at markups of as high as 40 percent over cost. Managerial economics describes the logic of this pricing practice with respect to the goal of profit maximization. Similarly, managerial economics reveals that auto import quotas reduce the availability of substitutes for domestically produced cars, raise auto prices, and create the possibility of monopoly profits for domestic manufacturers. It does not explain whether imposing quotas is good public policy; that is a decision involving broader political considerations. Managerial economics only describes the predictable economic consequences of such actions.

Managerial economics offers a comprehensive application of economic theory and methodology to management decision making. It is as relevant to the management of government agencies, cooperatives, schools, hospitals, museums, and similar not-for-profit institutions as it is to the management of profit-oriented businesses. Although this text focuses primarily on business applications, it also includes examples and problems from the government and nonprofit sectors to illustrate the broad relevance of managerial economics.

Organizing is the development of the company resources to achieve strategic goals. The deployment of resources is reflected in the company division of labor into specific departments and jobs, formal lines of authority, and mechanisms for coordinating diverse company tasks.

Organization structure

The organizing process leads to the creation of organization structure, which defines how tasks are divided and resources deployed. Organization structure is defined as:

• The set of formal tasks assigned to individuals and departments;
• formal reporting relationships, including lines of authority, decision responsibility, number of hierarchical levels, and span of managers’ control; and
• The design of systems to ensure effective coordination of employees across departments. Ensuring coordination across departments is just as critical as defining the departments to begin with. Without effective coordination systems, no structure is complete.

Characteristics of the business organization structure

A. Organization chart

The set of formal tasks and formal reporting relationships provides a framework for vertical control of the organization. The characteristics of vertical structure are portrayed in the organization chart, which is the visual representation of an organization’s structure.

The plant has four major departments—accounting, human resources, production, and marketing. The organization chart delineates the chain of command, indicates departmental tasks and how they fit together, and provides order and logic for the organization. Every employee has an appointed task, line of authority, and decision responsibility.

B. Work Specialization

Organizations perform a wide variety of tasks. A fundamental principle is that work can be performed more efficiently if employees are allowed to specialize. Work specialization, sometimes called division of labor, is the degree to which organizational tasks are subdivided into separate jobs. Employees within each department perform only the tasks relevant to their specialized function. When work specialization is extensive, employees specialize in a single task. Jobs tend to be small, but they can be performed efficiently. Work specialization is readily visible on an automobile assembly line where each employee performs the same task over and over again. It would not be efficient to have a single employee build the entire automobile, or even perform a large number of unrelated jobs.

Despite the apparent advantages of specialization, many organizations are moving away from this principle. With too much specialization, employees are isolated and do only a single, boring job. In addition, too much specialization creates separation and hinders the coordination that is essential for organizations to be effective. Many companies are implementing teams and other mechanisms that enhance coordination and provide greater challenge for employees.

C. Chain of Command

The chain of command is an unbroken line of authority that links all persons in an organization and shows who reports to whom. It is associated with two underlying principles. Unity of command means that each employee is held accountable to only one supervisor. The scalar principle refers to a clearly defined line of authority in the organization that includes all employees. Authority and responsibility for different tasks should be distinct. All persons in the organization should know to whom they report as well as the successive management levels all the way to the top. The payroll clerk reports to the chief accountant, who in turn reports to the vice president, who in turn reports to the company president.

D. Authority, Responsibility, and Delegation

The chain of command illustrates the authority structure of the organization. Authority is the formal and legitimate right of a manager to make decisions, issue orders, and allocate resources to achieve organizationally desired outcomes. Authority is distinguished by three characteristics:

1. Authority is vested in organizational positions, not people. Managers have

authority because of the positions they hold, and other people in the same positions would have the same authority.

2. Authority is accepted by subordinates. Although authority flows top-down through the organization’s hierarchy, subordinates comply because they believe that managers have a legitimate right to issue orders. The acceptance theory of authority argues that a manager has authority only if subordinates choose to accept his or her commands. If subordinates refuse to obey because the order is outside their zone of acceptance, a manager’s authority disappears.
3. Authority flows down the vertical hierarchy. Positions at the top of the hierarchy are vested with more formal authority than are positions at the bottom. Responsibility is the flip side of the authority coin. Responsibility is the duty to perform the task or activity as assigned. Typically, managers are assigned authority commensurate with responsibility. When managers have responsibility for task outcomes but little authority, the job is possible but difficult. They rely on persuasion

and luck. When managers have authority exceeding responsibility, they may become tyrants, using authority toward frivolous outcomes.

E. Accountability

Accountability is the mechanism through which authority and responsibility are brought into alignment. Accountability means that the people with authority and responsibility are subject to reporting and justifying task outcomes to those above them in the chain of command. For organizations to function well, everyone needs to know what they are accountable for and accept the responsibility and authority for performing it. Accountability can be built into the organization structure. For example, at Whirlpool, incentive programs tailored to different hierarchical levels provide strict accountability. Performance of all managers is monitored, and bonus payments are tied to successful outcomes. Another example comes from Caterpillar Inc., which got hammered by new competition in the mid-1980s and reorganized to build in accountability.

F. Span of Management

The span of management is the number of employees reporting to a supervisor. Sometimes called the span of control, this characteristic of structure determines how closely a supervisor can monitor subordinates. Traditional views of organization design recommended a span of management of about seven subordinates per manager. However, many lean organizations today have spans of management as high as 30, 40, and even higher. For example, at Consolidated Diesel’s team-based engine assembly plant, the span of management is 100.11 Research over the past 40 or so years shows that span of management varies widely and that several factors influence the span.12 Generally, when supervisors must be closely involved with subordinates, the span should be small, and when supervisors need little involvement with subordinates, it can be large. The following section describes the factors that are associated with less supervisor involvement and thus larger spans of control.

G. Delegation

Some top managers at Caterpillar had trouble letting go of authority in the new structure because they were used to calling all the shots, but the new structure was an important part of returning the company to profitability. Another important concept related to authority is delegation. Delegation is the process managers use to transfer authority and responsibility to positions below them in the hierarchy. Most organizations today encourage managers to delegate authority to the lowest possible level to provide maximum flexibility to meet customer needs and adapt to the environment. However, as at Caterpillar, many managers find delegation difficult. When managers can’t delegate, they undermine the role of their subordinates and prevent people from doing their jobs effectively.

H. Line and Staff Authority

An important distinction in many organizations is between line authority and staff authority, reflecting whether managers work in line or staff departments in the organization’s structure. Line departments perform tasks that reflect the organization’s primary goal and mission. In a software company, line departments make and sell the product. In an Internet-based company, line departments would be those that develop and manage online offerings and sales. Staff departments include all those that provide specialized skills in support of line departments. Staff departments have an advisory relationship with line departments and typically include marketing, labor relations, research, accounting, and human resources.

I. Line authority

Line authority means that people in management positions have formal authority to direct and control immediate subordinates. Staff authority is narrower and includes the right to advise, recommend, and counsel in the staff specialists’ area of expertise. Staff authority is a communication relationship; staff specialists advise managers in technical areas. For example, the finance department of a manufacturing firm would have staff authority to coordinate with line departments about which accounting forms to use to facilitate equipment purchases and standardize payroll services.

J. Centralization and Decentralization

Centralization and decentralization pertain to the hierarchical level at which decisions are made. Centralization means that decision authority is located near the top of the organization. With decentralization, decision authority is pushed downward to lower organization levels. Organizations may have to experiment to find the correct hierarchical level at which to make decisions. For example, most large school systems are highly centralized. However, a study by William Ouchi found that three large urban school systems that shifted to a decentralized structure giving school principals and teachers more control over staffing, scheduling, and teaching methods and materials performed better and more efficiently than centralized systems of similar size.

In the United States and Canada, the trend over the past 30 years has been toward greater decentralization of organizations. Decentralization is believed to relieve the burden on top managers, make greater use of employees’ skills and abilities, ensure that

decisions are made close to the action by well-informed people, and permit more rapid response to external changes. However, this trend does not mean that every organization should decentralize all decisions. Managers should diagnose the organizational situation and select the decision-making level that will best meet the organization’s needs.

Factors that typically influence centralization versus decentralization are as follows:

• Greater change and uncertainty in the environment are usually associated with decentralization.

A good example of how decentralization can help cope with rapid change and uncertainty occurred following Hurricane Katrina. Mississippi Power restored power in just 12 days thanks largely to a decentralized management system that empowered people at the electrical substations to make rapid on-the-spot decisions.

• The amount of centralization or decentralization should fit the firm’s strategy.

Top executives at New York City Transit are decentralizing the subway system to let managers of individual subway lines make almost every decision about what happens on the tracks, in the trains, and in the stations. Decentralization fits the strategy of responding faster and more directly to customer complaints or other problems. Previously, a request to fix a leak causing slippery conditions in a station could languish for years because the centralized system slowed decision making to a crawl. Taking the opposite approach, Procter & Gamble recentralized some of its operations to take a more focused approach and leverage the giant company’s capabilities across business units.

• In times of crisis or risk of company failure, authority may be centralized at the top.

When Honda could not get agreement among divisions about new car models, President Nobuhiko Kawamoto made the decision himself.

Goals determine a substantial amount of human behavior. Motivation to achieve these goals is a major factor in a business company and in any organizational effectiveness. For these reasons we devote a full post to this topic to show the relationship between individual goal and company goal and how does motivations take place through it. Individuals have goals and organizations have goals.

For maximal business company effectiveness it is important to make these two sets of goals compatible. In fact, that is the major role of management. The business company manager must have a clear understanding of both sets of goals and find ways to make them similar, overlapping, and at least non contradictory. Business company effectiveness depends on

• Individual motivation for organizational effectiveness (i.e., individual goals that are compatible with the goals of the organization),
•  Individual performance (just because one has the right goals does not automatically result in effective performance), and
• Adequate coordination of individual performances. Performance depends on more than motivation.

One must have adequate skills and abilities and proper training, and there must be a good match between the individual and the business company goals. Coordination depends on adequate communication, and it can be improved when there is participation by employees in decisions that affect them and when company goals overlap with personal ones.

In order to understand performance better, it is useful to focus on a model that links the probability of an act to particular determinants.

1. A MODEL OF HUMAN BEHAVIOR

For our purposes here an act is a short sequence of behaviors that eventually results in some outcome, such as the publication of a paper or the development of a good research design. In other words, we are using the word “act” in a very specific way. Hundreds of these acts are necessary to produce a publication or to develop a product. What we are trying to understand is what makes these small acts more or less probable. Actions have results that are evaluated, and considered as the outcomes of action that may satisfy individual needs.

Two variables are important in this case: previous habits and self-instruction. For example, when a person says, “I should look up these references,” that is a self-instruction or behavioral intention. Research has shown that behavioral intentions predict behaviors quite well. The model thus states that the probability of an act is dependent on two kinds of variables: habits and behavioral intentions.

However, even when people have the proper habits and intentions to carry out a particular act, they may fail to do so because external conditions may not be favorable. We utilize the concept of facilitating conditions in order to explain the phenomenon that even though the individual may have all that is required, the act may not occur. Reasons beyond the intentions of the individual may not allow it. For example, there may be a lack of proper equipment or there may be distractions in the environment. Facilitating conditions can be measured both with data obtained “outside the individual” (e.g., by asking objective observers, who know the conditions of work well, to judge if the act can occur) and with data obtained from “inside the individual,” by measuring the individual’s sense of “self-efficacy.” This can be measured by asking the individual, “Can you do that?” A scale can be constructed that measures the individual’s beliefs that the behavior can take place under different kinds of circumstances. The circumstances described in the scale can be more and more difficult. Those who think that they can do the behavior under the most difficult circumstances are highest in self-efficacy.

Thus, a high sense of self-efficacy is an especially important facilitating condition. For instance, we can ask, “Can you solve this equation?” A person who says no is very low in self-efficacy. Those who answer yes are higher in self efficacy. A person who says yes when the question is “Can you solve this equation when you are waiting to board a plane in a noisy airport?” is very high in self efficacy. Consider a more specific example. If a person said, “I will look up this reference,” but the book that contains the particular reference is not around, the probability that the act will occur decreases. Facilitating conditions modify the probability that habit and intention in them will result in the act. They reflect the situation within which behavior may occur.

Determinants of Habits

What are some of the variables that determine a habit? Habits build up as a result of previous rewards. We call such rewards “reinforcements” because they reinforce the link between stimulus conditions and behavior. Behavior is a function of its consequences. As people engage in a particular behavior in the presence of a certain configuration of stimuli, and when desirable events follow the behavior, the probability increases that the configuration of stimuli will in the future produce the same behavior. The behavior eventually becomes automatic, without thinking. When this happens, we say that the act has become “overlearned” and occurs under the control of habits. In that case, behavioral intentions are not relevant as explanations of the behavior.

Determinants of Intentions

Let us now examine what determines behavioral intentions. Three classes of variables are relevant for the determination of behavioral intentions: social factors, act satisfaction, and perceived consequences.

Social Factors. Social factors include norms, roles, self-concept of the person, and interpersonal agreements.

1. Norms. Ideas about correct behavior for all members of the organization. They emerge in discussions among members of the organization. For instance, arriving at 8 a.m. would be a norm since it applies to all members of the group.
2. Roles. Ideas about correct behavior for the specific position that a member of the organization holds. These are evident when a person says to him or herself, “I am supposed to be doing this because it is my job.” In short, the role has become embedded in the person’s thinking and has certain activities associated with it. The probability of these activities (acts) increases when the person thinks that he or she is doing the job. Researchers who feel it is their job to keep supervisors informed are more likely to do
   • For instance, what behaviors are expected of a “principal investigator”? In some cases, these expectations are quantitative, such as “producing three papers a year.” In other cases, they are qualitative—for example, the expectation of an important scientific contribution, or the development of a new product that will benefit the company.
3. Self-Concept of the Person. This includes the ideas a person has about the types of activities that are appropriate for him or her. For example, if a researcher feels it is appropriate to present his or her views, even though they differ from others, he or she is more likely to participate actively in discussions and meetings.
4. Interpersonal Agreements. These are similar to management by objectives. The supervisor and subordinate agree that the subordinate will try to reach a particular goal. Interpersonal agreements increase the probability that the goal will be reached through behavioral intention (self-instruction). Some research projects use milestones that are really interpersonal agreements as conceptualized here.

Act Satisfaction. The second class of variables that determines behavioral intentions is satisfaction associated with the act itself. Many acts are enjoyable in themselves, such as eating certain types of foods, playing the piano, or working on computer problems. Often such acts associated with pleasure have been formed through classical conditioning. In other words, the activity itself was associated with pleasant events in the past and is pleasant to think about, so this factor involves affect (emotion) toward the behavior itself. This affect motivates the person to self-instruct to do the act, and this in turn becomes the behavioral intention that causes the behavior. Working on a challenging research project or working with a noted scientist could fall in this category.

Facilitating Conditions

There are a number of factors that facilitate the performance of a behavior. Most of them are situational, such as helpful conditions, the right setting, or access to the resources needed to carry out the behavior. However, there are also internal conditions over which the individual does not have much control, such as the person’s physiological state (e.g., hormonal balance), beliefs that the behavior is possible and likely to lead to the successful reaching of goals (sense of self efficacy), and the level of difficulty of the task relative to the person’s ability. For instance, no matter how intensive a researcher’s intention to invent a new product, and how brilliant the past record of inventions (habits), there are situations in which no invention will be possible because the person is feeling depressed, or he or she believes that they are not able to have a new idea, or the task is much too difficult relative to the available talent. Some of these conditions can be measured objectively, and others may be estimated by objective observers of the total situation. The point about the F component of Equation 1 is that when it is zero, it can bring the probability of the act to zero, no matter how high the levels of habits or intentions.

• STRUCTURING THE ORGANIZATION FOR OPTIMAL COMMUNICATION

People are more motivated if they have clear goals and know how their job fits the goals of the business company than if they do not have this information. Thus, structuring the company for optimal communication can help individual motivation. There has been a good deal of literature on the question of how to expose members of research and development department to the information they need to have to do their jobs well. One concern has been the accessibility of technical literature to the members of the department.

• REWARDS AND MOTIVATION

A variety of factors can be used to motivate an individual. Nonetheless, individuals will be just that when it comes to personal motivations, motivations for performance were based around pay and benefits, recognition, and opportunities for achievement. They concluded that motivations are dependent upon the employees and are likely to change within differing industries. Therefore the individual, company, and industry must be taken into account when motivators are applied.

The reason business company lack creativity or success is usually found in the nature and frequency of the rewards that are being distributed. Rewards can be given every month, such as salary, but this is not nearly as motivating as rewards that occur with a variable schedule. There is evidence that a variable schedule of rewards is much more motivating than one that occurs on a regular basis. Receiving recognition after each publication is less effective than getting a major recognition following a series of publications. While motivation is an important aspect of individual performance, we must not neglect to mention that the availability of proper skills and adequate training is also crucial to good performance. Furthermore, the rewards that the person receives from the business company should be tied to company performance.

Otherwise, the person may function extremely effectively, but his or her performance may have no impact on the company. Consider, for example, the case of an employee who is inspired on the job to invent something that could make a million dollars. However, the organization has neither the need for such a product nor the resources to take advantage of the invention. Such a person is performing well at the individual level, but not at the organizational level. The most important principles of compensation are

• Equity,
• Competitiveness, and
• Link to performance.

Equity is achieved by making sure that employees are rewarded according to their education and merit. Competitiveness requires salary surveys. Links to performance are difficult to establish but are important. Specifically, if salary is the major means of compensation, it does not correlate sufficiently to performance. Bonuses do so much more. Systems of compensation that review the employee’s achievements every few months and that provide a raise according to the outcomes of these reviews link compensation and performance even more effectively.

• SENSE OF CONTROL AND COMMUNITY

Business company effectiveness does depend on individual motivation and individual effectiveness. It obviously depends on individual performance, but it also depends on communication and coordination among individuals as well as between the individual and the company. Techniques such as gain sharing and profit sharing bring the goals of the individual and the company into line with each other and are also methods for motivating the individual. One of the most successful plans to motivate employees has been developed by Lincoln (1951) and involves profit sharing.

In addition, openness of information is necessary so that the individual knows what the company expects and hopes to get from him. Job rotation can help the individual get a better feel for what the business company is trying to achieve, and intrinsic rewards (getting a kick out of doing the job) that are tied to individual performance can help the individual line up his or her own rewards and goals with the goals of the business company.

Finally, designing jobs in such a way that individuals have a sense of control over their activities is very important. Individuals must feel that a lot of what they do is consistent with their goals. Thus, the individual should have a certain amount of choice. Individuals who see themselves as having some alternatives are much more satisfied and have a greater sense of control than individuals who are told “this is it.” Having only one alternative is demotivating.

The basic elements required for a business company to develop are

• People
• Ideas
• Cultural elements.

These three basic ingredients have to be coordinated with skill by the management of research and development in a business company in order to achieve high productivity and excellence. In this lesson we will cover some of the introductory topics concerning these basic elements. In the next lesson we will focus more specifically on the task of coordinating and managing.

It is obvious that the most important element is creative people. Such people have the bright ideas and skills to do develop ideas and then translate ideas results into useful products. However, these people must be organized into structures that permit effective cooperation. In doing so it is important to keep in mind that certain mixes of people work better than others. To ensure a smoothly functioning organization, one need unstated assumptions, beliefs, norms, and values—in other words, an organizational culture that will favor creativity and innovation. Last, but not least, one needs funds.

PEOPLE

People in Business Company normally would have graduate training and relatively high aptitude. They are socialized during their graduate training to work autonomously and show considerable initiative. An anecdote will help convey more clearly what is special about personnel. There are identified four different personality traits relevant to business in order to develop:

• Creative Type. Creative types are idea generators, comfortable with abstract problem solving and have a preference for working alone.
• Entrepreneurial Type. Entrepreneurial individuals are more likely to take and manage risk while giving the profitability of a product or project high priority.
• Analytical Type. Analytical people do well with complexity and prefer to have order and organization while also avoiding risk.
• Development Type. Development-oriented personalities tend to gravitate toward team projects and maintain high energy levels while cooperating with others.

IDEAS

Ideas in a business company are generated through research and development process, research and development brings knowledge and innovation. The personnel in a business company need to be technically competent in one or more fields and have the ability to conceptualize. They must be comfortable with abstract thinking and have a real interest in Business Company.

An invention is an idea, a concept, a sketch, or a model for a new or improved product, device, process, or system. Inventing is the creation of new knowledge or new ideas. The innovation process is the integration of existing technology and inventions to create a new or improved product, process, or system. Innovation in the economic sense is accomplished through the first utilization and commercialization of a new or improved product, process, or system. Various business companies look at the overall innovation process differently.

In a general sense, the innovation process includes

• Identifying the market need or technology opportunity,
• Adopting or adapting existing technology that satisfies this need or opportunity,
• Inventing (when needed), and
• Transferring this technology/opportunity by commercialization or other institutional means.

The innovation process integrates project need, invention and development, and technology transfer. Ideas and concepts are generated in each of these three major stages; the innovation process is accomplished when these three stages culminate in the utilization and commercialization of a new or improved product, process, or system.

A CULTURE FOR A BUSINESS COMPANY

The culture of an organization relates to both objective and subjective elements. For a business company , objective elements such as research department facilities and equipment and office buildings are different from those of other business company. Subjective elements such as rules, laws, standard operating procedures and unstated assumptions, values, and norms for an R&D organization are also different. For example, scientific discoveries, whatever their source, are subjected to impersonal judgments, and scientists often participate in organized skepticism and critically evaluate scientific ideas and discoveries.

This permeates all aspects of a business function. Management decisions affecting individuals are thus critically evaluated and questioned by the researchers. After attending a senior management conference, a newly assigned deputy administrator of a federal research organization stated that he had never worked in a business company where people were so vocal and where management decisions were reviewed and discussed as openly and fully.