Federalism and Change

As business needs and methods evolve, top managers may come to realize that to stay competitive, they will have to make major changes to company structures that previously would have seemed impossible. The most painful change confronting a business leader is a revolutionary, or paradigm, shift. Paradigm shifts in business mirror the massive disruptions characteristic of major scientific discoveries, described by science philosopher Thomas Kuhn (1996) as periods when existing paradigms are subjected to attack before any reasonable changes can occur. This antagonism thoroughly compounds the difficulty of the change process.

Galbraith (2003) described a paradigm shift as the shifting of an organization’s entire makeup, which “requires a dismantling of the current power structure, rejection of parts of the old culture, and establishing all new management systems” (p. 234). Paradigm shifts are a worst-case scenario for business leaders, as a new idea’s or theory’s introduction causes extensive upheaval, as Galbraith suggested. In such a scenario, it is difficult at best to accept that creativity can have a potentially positive outcome. The transformation process from a current business paradigm to a new model or theory and eventually to a new standard is the crux of the management dilemma (Gilbert & Bower 2002). How does the manager embroiled in a revolution of management change cope with the ongoing operation without quashing the new design model, especially if the new model promises a better business?

The rapid growth of the Internet is a prime example of a paradigm shift that caused serious upheaval for businesses that were unable to anticipate the need to adopt the new idea for survival (Herber et al. 2003). The ability to adapt to changing conditions is requisite for accepting new management concepts, irrespective of their potential for improving the business or for threatening the core competency. Even successful businesses experience serious difficulty when reacting to changes that threaten their basic core competencies, regardless of the projected gains (Herber et al. 2003).

An example from recent industrial history is the problem Eastman Kodak encountered in trying to catch up to the new age of digital photography in the 1990s. At the peak of its success, Kodak was surprised by the onslaught of new digital technology, which top management initially thought was an inconsequential and harmless challenge to their core business. In reality, the digital revolution—the paradigm shift in the industry—had been slowly encroaching on Kodak’s business for years (Palumbo 2001). As Herber et al. (2003) observed,

“Dominant players often fail to adapt because it means dismantling the very organizations that have led to their success. They had mastered current technologies and customer needs, but by virtue of having established that expertise and focus they had also become ill prepared to face innovative technologies and customers. Past adaptations become inertial constraints, leading to a kind of ‘competency trap.’” (p. 234)

This is an accurate description of Kodak’s situation in the early 1990s and one of the most insidious obstacles to making sweeping changes in business or management models—past success. These successes, as Herber et al. suggested, can become organizational inertia that blocks advancement.

Kodak, always the indomitable leader in photography, became a victim of its own organizational inertia, compounded by the same factor that made it successful in the first place—its longstanding incumbency (Frangos & Bennett 1994). Kodak’s top management was unable to understand how theory and technology could be embraced together with incumbency. They were too far removed from the daily operation. They had been industry leaders for so long that they forgot to design flexibility into their management system, and by doing so, they eliminated the chance for innovators to repeat what George Eastman had done to found the company.

Eastman started Kodak by inventing the simple Brownie™ camera, which inaugurated the personal photography industry and set Kodak on the road to becoming one of the most stable and successful corporations in modern history (Tellis & Golder 2003). The entire Kodak empire was later built on film and chemicals as core technologies, but these were also core competencies, defined by Prahalad (1993) as the applied technologies specific to an organization that provide an edge over competitors. Kodak’s competencies moved Kodak into what equated to another dimension of success from which no one, until digital photography emerged, could unseat the giant.

Another organization that suddenly found itself shackled by the inertia of incumbency was the NBC television network. NBC was an established, huge enterprise that went through the pain of realizing that there were new and competitive ideas that could, at any time, undermine its longstanding success (Shamsie 2003). The NBC bureaucracy’s operating procedures were so ingrained and formalized that management paid no attention to people at the bottom when they spoke. Employees and management were so used to having the system roll along unfettered that any change failed because the organization was so inflexible.

NBC unfortunately lost several longstanding shows, such as “Seinfeld,” because top management did not listen to the network experts at the bottom when they warned of losing viewer share to competitors, just as Kodak neglected its own engineers’ desire to embrace digital photography. The NBC people who knew what needed to be done to compete with other networks were, in fact, nonentities to the NBC management structure. The top executives at NBC did not hear the people closest to the problem until it was too late; consequently, they lost heavily in market share (Shamsie 2003).

Kodak’s major difficulty was the fact that it maintained a near-monopoly on the film business for decades, and it became insensitive to any new ideas in manufacturing, managing research, or internal innovations. Kodak engineers actually invented the first digital camera in 1975 (Arner & Tiplady 2004), but management ignored the pleas of the design engineers. It was not that the company could not handle technology innovation, it was that its management strategy was not postured to recognize it; it was a matter of getting too comfortable with success (Macher & Richman 2004). In their case study of incumbent dynamics and organizational flexibility, Macher and Richman (2004) aptly described both NBC and Kodak: “Core competencies become core rigidities” (p. 92). Management was too far removed from the workings of the core technologies. They needed a way to hold together the corporation while giving lower departments the decision-making ability to foster true growth.

Kodak now struggles to catch digital technology competitors like Fuji. Kodak’s last-minute switch to digital photography may or may not rescue the company (Desmond & Kahn 1997), and Kodak management continues to revise strategies to accommodate creativity in engineering while maintaining the bulk of the revenue-producing product lines that will eventually succumb to digital technology. NBC is rapidly trying to restructure its programming division. One method that may save both companies is to adopt an interesting organizational structure first developed in the late 1700s called federalism.

Several major corporations have embarked on a new journey into organizational design that promises to afford a modern conglomerate the ability to maintain the financial status quo while encouraging innovation, creativity, and positive change (Mintzberg 2003a). The design these industry players are chasing is a revival of federalism. Founding Father James Madison helped create the idea of federalism in the late 1780s and eloquently sold the American public on the idea in his now-famous The Federalist Papers (Madison 1787/1981). The idea still makes sense today.

Federalism is fundamentally a management system in which many autonomous organizations, sometimes very large ones, are grouped around a central core that ties them together with a common identity, with the central core providing services that the individual units cannot (Handy 1996). Our U.S. government, of course, is a good example of a successful federal structure, successful because of the mutual division of power and limited control of the central core over the peripheral units. A major advantage of federalism is that people in the autonomous units have responsibility for their own functions. The central core does not try to overpower, just to coordinate within the overall vision for the organization (Handy 1996; Mintzberg 2003a). This is the answer for a company that wants to maintain a money-making production line without sacrificing innovative research and development efforts. The autonomous units can operate with their own budgets to prevent drawing down the main operation, as Kodak did in their 1990s catch-up operations.

Today some of the largest corporations in the world are splitting their operations into federalist structures to gain the benefits of innovation without financial drain. Mintzberg (2003a) reported, “The majority of the Fortune 500, America’s largest corporations, use this structure or a variant of it” (p. 434). Among the largest are Lockheed Martin, Benetton, Coca-Cola, and Asea Brown Boveri (ABB; O’Toole & Bennis 1992; Lockheed Martin Corporation 2008). ABB represents an extreme implementation of federalism, yet it works very well; almost 1,200 separate companies are managed by fewer than 100 people in its Zurich corporate headquarters (O’Toole & Bennis 1992). Lockheed Martin, with over $42 billion in sales in 2004, operates as four separate business segments that are independent companies coordinated by a relatively small corporate headquarters in Bethesda, Maryland (Lockheed Martin Corporation 2008).

Federalist organizational structures do more than posture an organization for independently thriving business units. A federalist organization pushes authority to the lowest levels where decisions can be made quickly and accurately—critical for allowing the innovative people in an organization to create and promote the next generation of theories and ideas. Central coordination and distributed autonomy are the elements Handy (1996) claimed are the most important for keeping an organization looking toward the future; he called these elements “two of federalism’s chief ingredients” (p. 39).

Handy (1996) saw federalism for industrial and business organizations in the same manner in which Madison (1787/1981) first outlined the concept in his contribution to The Federalist Papers. Madison viewed federalism as an organization of sovereign states and a central core government that was concerned only with issues affecting the entire body, while the real power was retained by locally motivated leaders who were closest to the issues—the states. This is exactly what Kodak and companies like it need for continued prosperity: local, innovative, and independent leadership at the level where new concepts are generated, helping eliminate the issue of blindness to creativity and change. The people at the periphery are not just the creators; they make their own decisions on how and when the creations should become the norm.

One final factor in the equation governing the ability to create new business models and adopt new philosophies is the requirement for an organization to hire, encourage, and retain the most talented innovators possible. The federalist structure provides a framework in which to nourish creativity, but innovative skills must be recruited within a management system substantiated and controlled by the peripheral elements where the talent is best used (Mintzberg, 2003b). This does not necessarily mean a highly educated workforce, because skills are a function of the business model. However, the workforce needs to be highly skilled at the business they are in, or there is not enough current knowledge to stretch the bounds of current solutions and proven ideas.

Organizations must encourage innovative behavior by eliminating the rigid management structure and organizational obstacles that inhibit free thinking and risk taking. They must also focus on capturing a high level of professional expertise to engage in innovative and creative endeavors as a function separate from, but equal to, the generation of revenues. The innovative environment necessary to encourage new ways of solving problems will thrive better in a unit that has a flexible management style and an independent organizational structure. A federalist organization can provide just such an environment. Employees have to be confident that they will not be stifled for devising off-the-wall concepts that may fail or that seem unacceptable to remote or detached top managers. A management system must be flexible enough to encourage, rather than belittle, new ideas and theories that may initially seem to undermine a company’s hard-earned successes.