2015-07-25 - Innovation necessitates experimentation!

  Rodrigo Canales Interview Transcript

Dr. Rodrigo Canales of Yale University

Innovation necessitates experimentation!

An associate professor of organizational behavior, Dr. Canales researches the role of institutions in entrepreneurship and economic development. Specifically, Rodrigo studies how individuals purposefully change complex organizations or systems. His research and teaching interests include microfinance, business ethics, leadership education, and the Mexican war on drugs. You will enjoy his interesting insights on these topics.

1.   You have done considerable research in the area of microfinance and other areas of social enterprise. What has attracted you to this relatively new field?

I’ll start by saying that microfinance is actually not really new. It’s been around since the 1970s. There’s been a considerable amount of research done in the field, but most of the research has been done from the economic side of things: trying to understand what kinds of contractual structures, what kind of incentives allow microfinance to be as effective as it has been through history. As an economic phenomenon, microfinance is not that new.

The reason why I became attracted to it is because even though there is a lot of work on the contractual structures of microfinance and the incentive structures, actually when you look around the world and see microfinance organizations, you see organizations that have very different contractual structures, very different sets of incentives both for the clients and for the loan officers. Nonetheless, the organizations all seem to be performing well.

To me, the fact that virtually all of the research had focused on contracts even though they did not seem to be explaining most of the variation out there in the world meant there was something that people were missing. Surprisingly for me, no one had looked at the organizational side of microfinance, or the organizational structure of microfinance. This is interesting because microfinance is a very labor-intensive phenomenon, a labor-intensive type of service. For this reason, the micro-dynamics of organizations in microfinance were bound to be interesting and complex. That’s what drew me to the field.

There’s that side, the fact that no one had looked at the organizational dynamics, and there is also the side that all over the world, microfinance is often hailed as an example of the type of social-enterprise model that will allow us to fight poverty through market mechanisms. I was a little skeptical about that notion, because I also saw very mixed results in terms of how much microfinance was truly having a social impact. For these two reasons, I was attracted to microfinance. I was trying to understand why some organizations were delivering a social impact.

The second driver was the desire to understand what organizational structures allow microfinance to operate well. As an organizational scholar, I was attracted by this question. Furthermore, as someone interested in the developing world, someone interested in figuring out better solutions to development problems, I was initially attracted to microfinance. This work eventually led to an interest in other forms of social enterprise. Studying microfinance, I began observing some of the tensions and contradictions that any social-enterprise model is bound to encounter.

2.   In your compelling, recent T.E.D. Talk, you employed economic principles to explain how Mexican drug cartels are actually sophisticated enterprises. What can we learn from your analysis about how to reduce drug consumption in the United States and elsewhere?

I would say two things. First, I am not only applying economic principles, but also broader social principles, to understand the institutional implications of the way we have structured the world drug market. Let me break my explanation down into the two parts.

What I argue in that T.E.D. Talk is that if you actually look at the core of the issue, what is really driving the dynamics of drug trade and drug violence in the world, you realize we are always attacking the phenomenon as a supply problem. We are always going after the criminals. Actually, the problem is that the market is a multi-billion dollar one. The U.S. market is gigantic; the demand for drugs here is enormous. If you look at the margins available to the people willing to take the risk to deliver the drugs, you reach the unavoidable conclusion that as long as that demand is present, there will always be someone willing to do whatever it takes to fulfill that demand.

It’s impossible to deny this fact if you look at the size of the market, the margins that market provides, and the resilience of the demand. Drug users are willing to absorb large changes in the quality and price of their product and continue using it, so it is a very attractive type of demand. The supply will find a way to that demand. For this reason, no matter how much we try to combat the supply, we are never going to be able to halt it. The demand will always be there.

If you start from that premise, everything we are doing to stop the supply becomes absurd. You are not going to be able to eradicate the supply. Furthermore, you start realizing not only that it is absurd to go after the supply, but also that by doing so, we are only making matters worse. Why? Because if you are going after drug traders, you are obviously going to catch some. But the more you do this, the more you create an evolutionary dynamic ensuring that the only people who can survive as providers to this market for drugs are the most ruthless, aggressive, and sophisticated, the most strategically complex organizations, ones that can survive in a world in which they are being chased.

In fact, it is our approach of going after supply that has created these increasingly violent organizations. We have created an environment where only the most ruthless and sophisticated enterprises can survive. There is no doubt they are going to strive to survive because there is this massive market that we are not doing anything about. In going after a symptom we don’t like, namely, the drug dealers whom we don’t like, we ignore the root cause for their existence, and we are making things much worse. The situation is like creating antibiotic-resistant bacteria. By using antibiotics for the wrong illnesses at the wrong times, you end up creating super-resistant bacteria. This is part of the problem.

Applying economic demand principles and examining the incentives and the structure of the market created by that demand, we realize we are making things worse. Because we have created an environment where the organizations have to be very sophisticated in order to survive, they do not just have well-designed strategies for serving the market in terms of their distribution and transportation networks. They’ve also developed pretty sophisticated strategies to legitimize themselves, to institutionalize themselves within both the Mexican and international landscape. They’ve developed sophisticated public-relations and media campaigns seeking to institutionalize what they do within the Mexican market. In the process, they have managed to weaken the institutional position of the state in very important ways. Not only are we failing to weaken these organizations, we are actually weakening the state, the tool we were trying to use to fight them. This situation is caused by our misguided approach to the problem, which stems from our failure to understand the root cause of the problem.

If you ask me what we are supposed to learn from this situation, number one, our solution is just not going to work. It is going to make things worse. Therefore, number two, we have to change the entire narrative around what this problem is about. I am not certain what the solutions would be. I’m not a proponent of legalization, but I do not oppose it, either. What I am proposing is that we need to accept that going after the supply is not only ridiculous, but also counterproductive. Therefore, we need to have a more honest debate about what it is that we can and should do to address this problem. This debate must begin with our acceptance of the enormous demand and our inability to curb it. We need to start from there. At that point, we might decide we should legalize everything, but find ways of limiting people’s consumption. We should stop thinking, “Let’s just put all the drug dealers in jail.” That is not going to happen.

We tend to experience drug violence as something happening separate from us: There are these criminals fighting each other in Mexico. I just want people to realize that if you either are a consumer or friends with a consumer, or you tolerate that consumption, if you are not doing anything to change policy, you are part of the problem. You are making it worse. One of the goals of my T.E.D. Talk was to generate some awareness that we need to become much more active in changing the policy. By we, I mean everyone because we are all responsible.

3.    Reading your vita, I was struck by the title of your 2010 Working Paper “From Buddha to the Boardroom: Leadership Education and the Four Pillars of Courageous Leadership Type.” What is that paper about? Where did you conceive of the idea of relating Buddhism to management education?

The title is a play on words on two or three different levels. The framework that we introduce in the paper was developed through a series of transformative leadership workshops that we designed for the Dalai Lama Center for Ethics and Transformative Values at MIT. I am a member of the Center’s Steering Committee. One of the goals of the Center is to design and provide executive education programs that are aimed at bringing tools and frameworks to help leaders be more ethical, more value driven in their decisions.

Another goal of the Center is to bring ethics-based / values-based training to professional schools: MBA students, medical students, lawyers, police officers, etc. We had been experimenting, and we ended up designing executive workshops about ethics- and values-based leadership. The paper discusses the four pillars we aim to introduce through our workshops. Regarding the question about the title “from Buddah to the Board room”, the workshops use some of the tools from Buddhism although the workshops are completely secular and non-religious in both content and presentation.

The founder and director of the Dalai Lama Center is actually a Buddhist monk who has also received very significant training in the West, and I’m a Buddhism practitioner, so a lot of the workshop content came from Buddhist practices, including some of the exercises we use for introspection and exercises to help participants become more aware of their emotional state, as well as exercises to help them become more aware of their connections to the people around them and those intended to help participants develop more humility so they are able to ask for help.

The other way in which the title is a play on words is that one of the most interesting things we found out throughout these workshops is we got some very powerful results from combining populations of Buddhist monks, with, for example, MBA students. When we conducted these workshops across populations, we found very interesting complementarities between the strengths and weaknesses of Buddhist monks versus the strengths and weaknesses of MBA students in the U.S. We found that the strengths and weaknesses were almost perfectly complementary. Whereas the Buddhist monks are incredibly humble and introspective, able to achieve amazing insights, they struggle a lot with making their thoughts practical. They struggle with the question, “How can I transform these insights into something I can do today?” The monks struggle to structure activities that would allow them to exercise their insights and leadership.

The MBAs have exactly the opposite problem. They are all about taking action, structuring activities, doing things. But they have a really difficult time connecting internally and truly reaching deep insights about themselves. MBAs have been trained to overlook a lot, so they have a hard time making the connection. When you bring these two populations together, they can help each other in very interesting ways. The workshops were a wonderful experience and another origin of the title of the paper. We are weaving Buddhist practices into worships with these two populations and getting some interesting results in the process. 

4.   In an August 2012 interview, you noted that existing organizations are naturally resistant to innovations, which involve change. Like organizations, some countries, notably Japan, resist change, especially dynamic, dramatic change. Japanese people and organizations typically favor low-risk maintenance of the status quo over the pursuit of high-risk opportunities. For this reason, Japan continues to suffer from the effects of the lost “two decades,” characterized by prolonged recession despite some recent improvements following the introduction of Abenomics. What would be your suggestions for helping the Japanese government, Japanese enterprises, and the people to become more innovative about improving the economy and their nation’s overall competitiveness in global markets?  

My course on organizations consists of thirteen sessions where we cover a broad array of topics. One of the sessions is on experimentation and failure. When I teach that session, I always tell me students, “I am aware that you may remember only one of the thirteen sessions of this course. Though I prepare all of the sessions carefully, I am aware that you are going to forget most of them. If I am lucky, you will remember one. If you only remember one, I want you to remember this session on the importance of experimentation and failure.” If you truly internalize how important they are in driving innovation, then you can kind of figure out everything else around innovation. You will be able to develop organizational structures that will help you be more experimental. You will be able to figure out the type of organizational culture you need to cultivate to make failure more acceptable.

All of these decisions must be based on a deep acceptance of the importance of experimentation and failure in driving innovation. The reason is that innovation involves doing something that has not been done before. That means that you do not get to choose whether you are going to fail. No one has previously done what you are trying, so you will fail. The relevant question is how you are going to fail. Are you going to fail in a way that is small and controlled, in a way that teaches you something fundamental that, helps you move forward, to make nimble progress? Or are you going to fail in a massive way that completely impedes your ability to make progress? Given that the only choice is about how you fail rather than whether you will fail when you are dealing with innovation, the implication is that you want to set up as many small, inexpensive experiments as possible so you can figure out what works and what doesn’t.

I don’t know Japan that well, but I have many Japanese students. I also have many Asian students and have taught a lot in Asia. In the culture and history of many countries, especially Japan, I do find that society is very status-based. Hierarchy plays a prominent role in the social system. I also find that the cost of failure is very high. People make a huge deal when someone fails. Powerful shame accompanies mistakes. If you combine these two elements, you create a perfect environment for ensuring people are unwilling to innovate. Innovation usually comes from people lower in the status hierarchy who are closer to the market or the user, more familiar with the problems out there in the world. High-status people are generally far removed from the “real world,” so they tend not to have access to the insights that allow people to generate innovation or address problems. Innovation also requires experimentation and failure. If you have a system where hierarchy and high status are core values and where any type of failure is considered horrible and regarded with tremendous shame, you have the conditions for a perfect storm against innovation.

What I would promote in Japan is empowerment. I would empower people over status so they can be more experimental. I would also tweak the culture around the interpretation of failure. Is the organization interpreting failure to mean “We have failed,” or “Well, we haven’t succeeded yet, but the failure has taught us some important lessons. Let’s incorporate them into the next iteration of our experiment”?

In organizations where failure is not tolerated, people go out of their way to make sure everything is perfect. Innovation is not going to happen because we do not know what we are doing when innovating. In the end, the failures are bigger, and that reinforces the culture of failure because every failure is massive and has deep implications. As a result, people try to avoid failure even more, try to come up with more perfect solutions. This is not going to work, but is going to lead to even more massive failures, resulting in a self-reinforcing system.

What you want to do is reel things back, help people be much more experimental. You also want to change the culture around how everyone experiences the failures. I am not a proponent of celebrating failure. But I do think the culture needs to value failure. We should learn from failure and share the lessons from it. We should frame failure as a critical step in achieving a solution.

5.   You cite IBM as an example of a company that tackled an innovation problem creatively. Do you think Google, Apple, Amazon and Facebook eventually will face innovation problems like IBM given they seem to already have introduced the inner-competition and cross-hierarchical teams you suggest for facilitating innovation? What other measure could these organizations take to maintain innovation at current high levels?

That’s a very interesting question. The short answer is we don’t know.

IBM almost died. It nearly suffered the same fate as the Polaroids and Kodaks of this world. But the CEO, board, and management team began to understand the problem at some point, and they were willing to get rid of everything dragging IMB down. That is extremely difficult to do because all of these things were providing a lot of revenue for the company. It’s not as if these parts were generating losses for IBM. At some point, the parts were core businesses, and they were still generating a lot of revenue for the firm. The management team realized that precisely because these parts were revenue generators, it would be impossible to retain them and transform IBM’s business model in the way required to perform in the changing world that constituted their new operating environment. The firm was willing to cut these things down and get rid of them, something extremely difficult to do.

Dick Foster, a colleague of mine here, and I have a lot of conversations about innovation. We both agree that the challenge for successful, established organizations is balancing several factors required to remain innovative and survive. Number one, the companies have to maintain operational excellence. They have to continue doing whatever provides the revenue today with excellence. As companies’ core source of revenue, these activities are going to draw a lot of energy and resources. But operating with excellence is not the only thing you need to do. You also need to generate options. You need to invest not only in providing incremental innovation to current operations, but also in generating a new portfolio of options for the future, the final value of many of which you will not be able to predict. That is the second imperative. The third is maintaining financial control of your organization. You have to be operating with excellence, generating options, and maintaining financial control all at once.

Amazon is a company that worries me a little because they are not operating under financial control even though they have structured an interesting, operationally excellent company. They are constantly losing money. The stock market has given Amazon a free pass so far, but when the market begins to tighten, something the market has signaled might be coming, that could generate a difficult moment for Amazon because they are not operating in a financially sound way.

A fourth requirement for organizations is the willingness to get rid of things and trade them. Pursuits that were once a core business but have limited potential to remain dynamic and nimble probably should be abandoned. You want to sell these things while they are still valuable. Doing this requires a lot of discipline. 3M is an organization that is very interesting in this respect. They’re always trading and closing companies and divisions not growing at expected rates, and they are always opening new divisions. These activities are part of their discipline. Apple is noteworthy in this respect, as well. They have no qualms about shutting down a product or business line that is no longer dynamic. Even if doing so ruffles customers, Apple will still discontinue a product. Google has also been relatively disciplined in terms of shutting down business lines that are not doing well.

I worry about Facebook. Namely, I am concerned that they have tied their identity to a particular service and product too tightly. Organizations that define their identity around a product put themselves in a fragile position. As their product proceeds through the life cycle the way all products do, the product is going to lose its ability to generate revenue. Companies that have defined their identities around a particular product are going to have great difficulty adapting as the environment changes. If your identity is built around providing solutions and services to clients, you will be much more willing to divest and trade products as the market changes. You see Apple doing this easily. I am not sure that Facebook has truly taken that approach. I see some signs that they are trying to, but I think that their identity is tied to their original product, Facebook, also the name of the company. As Facebook the product begins to cycle out of the market, I believe the company is going to experience some problems.