Cracking the Code of
Until now, change in business has been

an either-or proposition: either quickly

create economic value for shareholders

or patiently develop an open, trusting

corporate culture long term. But new

research indicates that combining these

“hard”and “soft”approaches can radically

transform the way businesses change.

T HE NEW ECONOMY has ushered in great businessopportunities -and great turmoil. Not since the IndustrialRevolution have the stakes of dealing with change heen so high. Most traditional organizations have accepted, in theory at least, that they must either change or die. And even Internet companies such as eBay, Amazon.com, and America Online recognize that they need to manage the changes associated with rapid entrepreneurial growth. Despite some individual successes, however, change remains difficult to pull off, and few companies manage the process as well as they would like. Most of their initiatives-installing new technology, downsiz- ing, restructuring, or trying to change corporate culture-have had low success rates. The hrutal fact is that about 70% of all change initiatives fail.

In our experience, the reason for most of those failures is that in their rush to change their organizations, managers end up immersing themselves in an alphabet soup of initia- tives. They lose focus and become mesmerized by all the advice available in print and on-line about why companies should change, what they should try to accomplish, and how they should do it. This proliferation of recommendations often leads to muddle when change is attempted. The result is that most change efforts exert a heavy toll, both human and eco- nomic. To improve the odds of success, and to reduce the hu- man carnage, it is imperative that executives understand the nature and process of corporate change much hetter. But even that is not enough. Leaders need to crack the code of change.

by Michael Beer and Nit±i Nohria

HARVARD BUSINESS REVIEW May-func 2000 133

Cracking the Code of Change

For more than 40 years now, we’ve been studying the nature of corporate change. And although every busincss’s change initiative is unique, our research suggests there are two archetypes, or theories, of change. These archetypes are based on very differ- ent and often unconscious assumptions by senior executives- and the consultants and academics who advise them- about why and how changes should be made. Theory E is change based on eco- nomic value. Theory O is change based on organi- zational capability. Both are valid models; each theory of change achieves some of management’s goals, either explicitly or implicitly. But each the- ory also has its costs -often unexpected ones.

Theory E change strategies are the ones that make all the headlines. In this “hard” approach to change, shareholder value is the only legiti- mate measure of corporate success. Change usually involves heavy use of economic in- centives, drastic layoffs, downsizing, and restructuring. E change strate- gies are more common than O change strategies among companies in the

United States, where financial markets push cor- porate boards for rapid turnarounds. For instance, when William A. Anders was brought in as CEO of General Dynamics in 1991, his goal was to maxi- mize economic value-however painful the reme- dies might be. Over the next three years, Anders reduced the workforce hy 71,000 people-44,000 through the divestiture of seven husinesses and 27,000 through layoffs and attrition. Anders em- ployed common E strategies.

Managers who subscrihe to Theory O helieve that if they were to focus exclusively on the price of their stock, they might harm their organiza- tions. In this “soft” approach to change, the goal is to develop corporate culture and human capability through individual and organizational learning- the process of changing, obtaining feedback, reflect- ing, and making further changes. U.S. companies

Theory E change strategies usually involve heavy use of economic incentives, drastic layoffs, down- sizing, and restructuring. Shareholder value is the only legitinnate measure of corporate success.

that adopt O strategies, as Hewlett-Packard did when its performance flagged in the 1980s, typically have strong, long-held, com- mitment-hased psychological contracts with their employees.

Managers at these companies are likely to see the risks in breaking those contracts. Because they place a high value on employee commitment, Asian and European businesses are also more likely to adopt an O strategy to chan