A new working paper [PDF] out of Harvard Business School purports to show why some companies outperform those in similar industries. The answer, they researchers say, comes down to management practices.
The writers, Robert Gibbons and Rebecca Henderson, suggest that a certain type of management technique can help companies outperform their competitors. Gibbons and Henderson write, “…one important source of PPDs [Persistent Performance Differences] among SSEs [Seemingly Similar Enterprises] may be persistent differences in management practices.”
Management is more than making decisions and directing others on how to do them – management comes down to the good management of what the researchers call “relational contracts.”
Gibbons and Henderson set out to discover why competitor firms don’t latch onto the best practices in management that have propelled certain companies in their industries to success. Part of the reason could be that specific best practices are hard to pin down in an exacting way.
“We begin from the observation that many competitively significant management practices cannot be reduced to well-defined action rules that can be specified ex ante and verified ex post,” they write. These best practices rely on workers to make good decisions, rather than simply wait for order. They explain:
“For example, for many years the singularly successful retailer Nordstrom asked its sales associates to ‘use their good judgment in all situations.’ Similarly, Toyota’s chief request of its production workers was that they seek to ‘continuously improve the production process.’”
These kinds of management practices are based on relational contracts, they explain. These are, “…roughly, understandings that the parties share about their roles in and rewards from cooperating together, but understandings so rooted in the details of the parties’ relationship that they cannot be shared with a court.”
This kind of management technique requires workers and managers to be invested in success in such a way that they cooperate without having explicit rewards from doing so. It’s about trust and cooperation.
Diffusion of Best Practices
But why then, don’t all firms take on this kind of management style? Nordrom and Toyota, for example, have been incredibly successful building a work culture around relational contracts. Why don’t their competitors do it to?
According to Gibbons and Henderson, it’s a little more difficult than it seems. They describe four reasons other companies don’t join in: a mixture of ignorance (managers don’t know they’re underperforming compared to competitors), uncertainty (they know they’re underperforming but don’t know why), disinterest (they aren’t interested in making improvements to management style in order to act on par with competitors), and problems with implementation (they’re doing what they can to make improvements, but just can’t seem to get there).
But companies can tackle these problems and implement a management technique around relational contracts, they continue.
“Based in part on these cases, we suggest that the implementation of some relational contracts requires solving problems of not only credibility but also clarity. The credibility problem is familiar: should one party believe another’s promise? The clarity problem is new: can one party understand another’s promise? In fact, the clarity problem is tougher than this statement, for the usual reasons associated with common knowledge: I need to understand that you understand my promise, and so on.”
By working to improve communication, trust, and cooperation between line managers and employees, companies can instill relational contract values that can boost productivity.
Other challenges that companies face, they say, come down to “bad parameters, bad luck, and bad communication.” For example, measurement systems to examine performance disparities may not be appropriate, or environmental challenges may occur that impede performance. Finally, they focus on the importance of clarity – ensuring managers understand the importance of maintaining relational contracts.
By addressing these challenges, companies can work to leverage best practices in management around relational contracts that provide the competitive advantage. They write, “Finally, moving from our main focus on productivity to the neighboring notion of profitability, much of what we have described can be cast in reduced form as saying that relational contracts are an investment that might improve an enterprise’s productivity.”
When companies invest in training managers in best practices around relational contracts, they can become more profitable – particularly, Gibbons and Henderson suggest, when they are at a branding or geographic disadvantage.