Is Organizational Hierarchy Getting in the Way of Innovation?

Is Organizational Hierarchy Getting in the Way of Innovation?

An RV rolling through a parking lot in Louisville, Kentucky, does not normally turn heads.  But this case was different. The geometric beige patterns that typically adorn RVs had been boldly wrapped over by the corporate colors and logo of GE Appliances (GEA). And the RV was driving not into a public lot, but onto the tarmac of GEA’s corporate headquarters during a company-wide event.

In its nearly 120 years of existence — having built everything from air conditioners, refrigerators, and washing machines to microwaves, ovens, and trash compactors — GEA had never intentionally targeted the RV market. Its products were made for stationery use in homes, offices, and commercial spaces.

The RV was a rallying cry from two GEA employees to change that. They saw a promising growth opportunity for the company. RV ownership in the U.S. had been steadily growing for over a decade and the employees felt GEA’s experience building and selling appliance technology — such as air conditioning, refrigerators and microwaves — could translate into a competitive position for the company to sell AC units, refrigerators, and other appliances into the RV market. They had created what GEA, and its parent company Haier, call a “microenterprise” — a small, autonomous business unit, comprised of a handful of internal entrepreneurs, who are able to take action on ideas they are passionate about that they think could become valuable businesses.

That the employees had the autonomy within their role to take this kind of action is surprising enough. But perhaps even more astonishing is the fact that they didn’t need to go through arduous steps standard in most organization to get permission, like putting together a business case or detailed financial projections for their idea. They just got on with it, starting small, with the company providing just enough funding to allow them to start testing their idea.

This approach is just one of many examples of decentralized organizational models that GEA, and a growing number of other companies, are adopting — models that run in direct conflict with the hierarchical tendencies of nearly most companies today.

In this article, we explore why and how these new models are surfacing, looking specifically at how emerging technologies have created a tipping point for the shift to more competitive alternatives to the traditional firm. We share the findings of our research, which looks at the move towards decentralization and identifies the key characteristics of one the most successful and promising models. And we provide practical advice on how companies who want to keep ahead of the curve can start adapting their organizational designs.

The Rise of New Organizational Models

Over the past few decades, there has been much debate about the demise of traditional hierarchical structures. The consensus appears to be that while bureaucracy still has a place in some circumstances, it is increasingly becoming less fit for the needs of today’s businesses.

So, what exactly brought us to this point? Technology has, of course, been a major factor. Robotics, automation, and 3D printing are enabling companies to develop and launch new products faster and more economically, and in ever smaller quantities than before.

Further, the broader adoption of the internet of things (IoT) to produce data, blockchain and APIs to share data, and analytical and AI capabilities to understand the data, are enabling companies to test both product and internal ideas more rapidly, frequently, and with lower cost and risk.

Much of the attention around these advances has focused on the new possibilities they are opening up in the market. But the internal organizational implications are at least as profound. New and emerging technologies are making it possible for organizations to evolve into new ways of organizing and acting by pushing the boundaries of what technology can enable. But this potential will only be realized if firms are prepared to adapt and embrace them enthusiastically.

Historically, organizations have attempted to do this by experimenting with a range of alternative approaches: a team of teams (small independent teams with an overarching umbrella team), an open organization (communities of people with a common purpose and no top-down hierarchy) and Holocracy, to name a few. But most have proved inadequate, with no clear front runner emerging.

Our research shows, however, that the defining design elements of a winning new organizational model are coming into focus: RenDanHeYi, or a version of it, which was introduced by Haier. This organizational philosophy and system is composed of several innovative characteristics, including the breaking of large hierarchical units into “microenterprises” (MEs), turning support functions into profit centers that must sell into the enterprise rather than cost centers, and relating to employees as intrapreneurs.

Companies who embrace four elements of this approach in particular are significantly outperforming their peers. GEA, for example, has doubled its business organically in the last four years, according to GAE CEO Kevin Nolan. We believe we are on the brink of a seismic shift, where companies are waking up to the fact this new model offers them the opportunity not just to adapt, but to substantially replace their hierarchical, bureaucratic perspective with something radically different.

The Four Elements of the New Organizational Model

Over the past eight years, we have been conducting a research study into the barriers within organizations to internal innovation and the emergence of new organizational models that address these barriers. Over the course of the study, we spoke to over 150 employee innovators, discussed the topic with around 100 heads of strategy from mid-to-large enterprises. These enterprises include financial services, media, technology, pharmaceuticals, real estate, professional services, NGOs, education, and infrastructure firms. Most are large ($1 billion to $60 billion revenue), and about 20% are mid-sized ($100 million to $900 million revenue). We interviewed around 20 of today’s leading authorities on this topic (Rita McGrath, Michael Tushman, and Martin Lindstrom to name just a few). And we conducted a quantitative survey of around 500 mid-level managers and interviewed experts on the key defining characteristics of Haier’s RenDanHeYi model.

Two clear, overarching messages emerged from an in-depth analysis of this wealth of data and interviews.

First, that firms are gradually becoming less centralized — although their evolution towards decentralization has been a slow and nonlinear process.

Second, there is clear and statistically significant evidence to show that companies who use elements of a looser RenDanHeYi model outperform their peers in terms of entrepreneurial activity, the ability to attract and retain top talent, and ultimately financial performance.

This research also brings into focus four clear characteristics of these organizations, most of which replace their traditional hierarchy. These characteristics are:

We describe these four characteristics below, the advantages they bring, and some examples of how forward-thinking organizations are applying them.

Treat employees like intrapreneurs.

Our research showed that firms whose employees feel they are treated more like intrapreneurs enjoyed a level of entrepreneurial intensity — the frequency and degree of innovation and risk that employees undertake — that was nearly 3x higher than their peers. They were also more likely to outperform their competition (1.4x) and were better and recruiting and retaining top talent (1.6x). Treating employees like intrapreneurs can involve rewarding proactive behavior, encouraging them to get close to customers, and celebrating ideas and even failed attempts at innovation.

You only have to look at examples from corporate history to see how much potential has been missed by companies who have failed to give their employees the freedom to explore new opportunities. As an employee at HP, Steve Wozniak, for example, proposed the design that would become the first Apple computer and was turned down all five times. How much more valuable would HP be today if it had given Wozniak a greenlight?

Embedding an intrapreneurial culture doesn’t always have to mean the constant pursuit of new product ideas. MacMillan Learning, for example, recently held an innovation competition, where they invited employees to enter innovative projects they had been working on over the past year. More than 200 employees engaged with the competition, entering 46 projects — which helped to reinforce the message that staff were in fact already acting as internal intrapreneurs and, because most of the ideas were internal process and organizational innovations, entrepreneurial action need not always be market-facing.

Work in smaller independent units rather than larger traditional business units.

In RenDanHeYi, employees group together in microenterprises, which can range in size from five to 20 employees, to innovate around specific opportunities or challenges. GEA, for example, launched 14 MEs while its parent, Haier, is organized into thousands.

Our quantitative research showed that firms that adopt this type of organizational model were able to unleash greater entrepreneurial behavior (1.5x), achieve better financial performance relative to peers (1.3x), and were better at recruiting and retaining top talent (1.2x). When a group of Haier employees saw an opportunity to provide a one stop cooking solution for consumers, for example, they banded together to form their own microenterprise. The resulting Internet of Food microenterprise now covers everything from designing and installing “smart” cookers and fridges that recognize their owners, to providing precisely timed recipes and allowing users to interact with each other via smart screens on their cooker hoods.

“Manage” MEs with decentralized marketplaces instead of centralized authority.

Our findings confirm that empowering units and teams to act with autonomy and make their own decisions is a powerful driver of entrepreneurial intensity. Firms that do this enjoy over 2x higher entrepreneurial intensity rates. They are also 1.5x better at recruiting and retaining top talent and enjoy a more marginal, but significant advantage in financial performance (1.3x).

Dutch healthcare provider Buurtzorg, for example, has been able to provide better patient care by offering its nurses a high degree of autonomy. Small, self-managed teams of nurses are able to work with patients in the way they think best, based on professional standards, with a back-office IT and support system around them to free them from paperwork and bureaucracy. A recent KPMG study showed that by adopting this model of care, Buurtzorg has been able to halve the hours of care it delivers, while at the same time achieving high patient and nurse satisfaction scores.

Give MEs an option to choose which support services to use.

This is perhaps the most interesting and radical characteristic of the model. In hierarchical models, it is assumed that business units use the shared services provided by the company in order to create cost advantages — think IT, finance, R&D, etc. GEA CEO Nolan refers to these support functions as internal monopolies which need to be broken up because they “can easily within a company become like a ‘post office,’ where they feel there is no competition. There’s a [sense of] entitlement: [because they are] going to deliver the mail for everyone, [the business units] have no choice.” Instead, he says, they should “have to fight for their business every day. They have to improve, they have to be the best.”

What would this new approach to support services look like in practice? Let’s say a particular microenterprise is not happy with the support it is getting from their IT department. Because all departments are microenterprises, there are multiple IT microenterprises to choose from. They compete with autonomy for internal clients. The initial microenterprise can even decide to contract with an external, third-party IT service provider, if they so choose. And if a supporting ME is not competitive enough to win internal clients, its budget is effectively reduced or cut not because a centralized authority decided to cut it, but because they couldn’t succeed internally.

Our quantitative research shows fewer companies are adopting this practice compared to the other characteristics, perhaps because this implies a broad organizational redesign. But those who do enjoyed far higher levels of entrepreneurial intensity (2.1x) recruitment and retention (1.6x) and more marginal but significant advantage in financial performance (1.3x).

How to Implement the Four Elements

It’s simplistic to think that the right approach to adopting a new organizational model is the same for each company or each area of your company. In some situations, hierarchical models will maintain the advantages they have enjoyed for hundreds of years. And even where a less hierarchical model is likely preferable, the degree to which you implement an alternative model will vary. To design the right approach for your specific case, consider taking three steps:

Decide where to consider implementing a new organizational approach.

Sometimes, a more entrepreneurial, decentralized approach is not the best option. When you are building complex technology components on which rockets, airplanes, and spacecraft depend — components you designed, built, and tested to achieve extremely low failure rates — you don’t want your engineers improvising. You instead want them following detailed, prescriptive checklists.

So, the first step to implementing our findings is to decide where you should consider implementing them. The most promising candidates will be those a) most impacted by emerging technologies and b) those which benefit from higher levels of entrepreneurial behavior. You can prioritize the top candidates by asking two questions:

You can think of these as a two-by-two matrix:

Depending on where an area of the business sits on the matrix, you may want to embrace a different approach.

For those on the bottom left, maintaining a traditional, centralized, hierarchical model probably makes the most sense. Think of the engineers manufacturing missiles or airplane propulsion systems.

On the bottom right, you may want to encourage more entrepreneurialism, but not necessarily through tech-enabled changes. Rather, focus on traditional organizational tools like reporting structures, culture, storytelling, and hiring.

On the top left, where you want the advantages technologies offer but do not need or want more entrepreneurialism, you may implement a digital products approach. For example, you might build an algorithm to dictate which candidate a recruiter should give a larger signing bonus to.

On the top right, you’ll find areas that are the most ripe for opportunity by using a new organizational model.

As you can see from this matrix, two reasons we are seeing more experimentation of new organizational approaches are that a) new technologies are advancing the matrix upward and b) the need for entrepreneurial behavior is increasing as the pace of change is accelerating across many sectors, pushing the matrix to the right.

Decide how deeply to implement and initiate first actions.

Once you decide where to implement a new approach, consider implementing the four elements in a sequence of four stages:

This first step — treating employees like intrapreneurs — can be implemented with a change management or cultural transformation effort. Such efforts are not easy but there is already much known about how to do this. Using proven tactics such as rituals, leadership mirroring, storytelling, role titles, awards, office design, language, and symbols, a focused, coordinated effort can shift culture remarkably quickly.

Step two — breaking down units into microenterprises — can get complicated, as you must rethink reporting structures to pull smaller units out of larger units. But there is a good chance that your IT department has already implemented some form of smaller team-based approach having adopted “lean” or “scrum” approaches — and as those IT teams have interacted the business side, they too have started shifting toward teams at least as regards specific projects. Product and marketing teams may already be reorienting toward “growth teams” popularized by tech companies like AirBNB, Meta, and Uber. What is left to do is evolve such project teams into permanent team structures.

Step three — allowing management of small teams to be governed by a marketplace — adds an additional layer of complexity as you must untangle and redesign budgeting processes and performance management systems, as well as shift culture and leadership behaviors. This may seem a daunting task, but the first step is relatively straightforward: ensure that financial accounting practices allow the enterprise to measure the individual financial performance of product and customer segment teams. Some industries, such as consumer-packaged goods, are already structured to do so. They typically break down profit and loss by customer segment (a customer that buys a particular brand, through a specific channel, and in a defined geography). But other sectors, like banking, may require some untangling. Because they tend to track financial performance by product (e.g., mortgages or wealth management) rather than customer (affluent, retired, etc.), value-destroying conflicts can emerge. A second step here is to start decentralize reinvestment so that teams get to keep more of the value they generate.

Finally, step four — giving smaller teams freedom in deciding what central functions to work with — requires cutting deeper into your organizational norms to redesign functional departments that have long operated essentially as utilities and cost-centers into entrepreneurial profit-centers. This involves applying steps 1, 2, and 3 above to your support functions.

To do this, first involve them in the wider cultural change effort so they too start seeing themselves as intrapreneurs. Second, restructure support functions into a team structures, which may feel less alien than one might expect because many of them — HR, Finance, R&D, and, to a lesser extent perhaps, legal — are likely already organized into teams that support specific business teams. For example, the general counsel of one major media company structured her organization into dedicated sub-teams that support radio, broadcast TV, streaming, etc. Third, adjust financial reporting to start creating separate profit and loss statements for each team and, what seems the biggest leap for companies considering this step, to allow business teams to determine to which support teams they want to work with. As a result, instead of using political levers to ask for better service (such as asking the head of legal to replace the lawyer supporting their team), the head of a microenterprise is given the direct authority to choose to spend their budget on a different support team (or in this case, a different legal team).

The technologies that are coming to the fore are not only transforming the way firms go to market, but are also forcing companies to rethink the very way they operate. Bureaucracy — with its defining characteristics of hierarchy, clear lines of authority and division of labor into specialties — has been the dominant method of coordinating human effort over the past several centuries. But as IoT, AI and data analytics, blockchain, and a collection of related technologies take hold, new, more open models are emerging in some areas as more efficient alternatives.

Our research shows many of the organizations adopting elements of such open structures are experiencing higher levels of entrepreneurial behavior, are proving better at attracting and retaining top talent, and delivering superior financial performance as a result. We also believe that there is a danger that those who don’t adapt will get left behind. Strategy thought leader Martin Reeves points out, for example, that in our new data-driven, tech-enabled world, competitive advantage decays about 10 times faster than previously, making it imperative for companies to keep up with the game. And futures specialist Mark Esposito says firms that have not yet investigated new technologies need to be aware they are becoming ubiquitous, and if they don’t get on board, they will get left behind.

Evolving into a new organizational model is not easy. It involves unlearning and deconstructing management norms, processes, structures. But our research suggests a company need not embark on an across-the-board transformation to start seeing the benefits. The real opportunity is to embrace the organizational power of new technologies and implement the more decentralized models they make possible selectively in areas of the organization where new technology and/or non-hierarchical models offer a more competitive approach.