By: Marco Morán

“If you want different results, don’t always do the same thing”
Albert Einstein

In recent decades, we have witnessed a rapid evolution in the way of doing business, and models that were useful for many years have quickly become obsolete.

Some of the biggest challenges companies are facing today lie in the ability to envision new business models, find new markets and seek out ways to generate revenues.

Only 20 years ago, many organizations focused their strategies on ensuring stability. Despite some modifications, they basically carried out the same productive activities with no major change; the idea was to obtain a strong position in the market, and defend it.

Today, the only constant is change. Competitive advantages tend to weaken without a strategy based on innovation. Business models are being reinvented in many ways. Some industries, like consumer products, financial services and telecommunications, offer products and services and interact with clients in a totally different way than they did 20 years ago. Suffice it to consider how much these activities have changed since the birth of the Internet.

Information technologies are rapidly changing the way businesses are started up and evolve; other factors, like the growth in emerging markets and changes in consumer tastes, are putting more pressure on organizations to adapt to situations that they could never have imagined before.

Most companies are designed not to innovate, but to operate continuously, with a high level of efficiency. The day-to-day pressures they face leave them little energy for innovation. Many of them begin with a creative idea, but once they achieve their first commercial success, they change their focus to ensure that their operations are as profitable as possible.

Innovation has evolved from being a merely intellectual pursuit to being a prerequisite for survival in an increasingly competitive environment. We can find it in various programs within a company, for example:

• Formal initiatives for continuous improvement and programs that motivate employees to propose changes in products, services and processes
• Design departments that have specific processes for innovation, for example, companies that regularly release new versions of their products or services.

These programs are centered around innovation in processes, products or services, but not in business models. Here, we still have a long way to go. Organizations like Amazon, IBM and Apple have innovative business models, and today they are very different from what they were in the past. Of course, there are always organizations that do not require fundamental changes, but this is increasingly the exception rather than the rule.

To start up an innovation program, an organization must calibrate certain aspects of its capacities in order to combat the four forces that restrict innovation:

• A lack of leadership to chart a course toward innovation and establish the direction in which the organization must move, and to overcome a cultural inertia that tends to oppose change.
• A lack of human resources with the abilities and experience to develop and implement new ideas.
• A structure that lacks roles and responsibilities with the adequate freedom for innovation.
• A management structure that neither rewards nor encourages the adoption of new ideas.

To blaze a trail toward innovation, the company needs habits and discipline. It needs a series of components that can help to overcome these obstacles. For example:

• A leader who is enterprising, who is prepared to take risks, and has the authority needed to influence the organization.
• Employees who are willing to experiment, to develop and to continually test new ideas
• An understanding of the needs of the market and changes in customers’ preferences
• The ability to face new technological challenges.
• The introduction of mechanisms for governance, processes and collaboration applicable to innovation
• A budget for product development, market testing and product launch.

In conclusion, in the current business climate, where even the largest markets are no longer growing as rapidly, clients have become more demanding, competition is more intense and margins have narrowed. Innovation is crucial. In the future, organizations must seek a balance between efficiency (day-to-day operations) and innovation (remaining competitive over time), because there are obstacles to overcome.

They must also take into account certain aspects before introducing an innovation program that can not only produce new ideas on improving products, services and processes, but also seeks out, and establishes, new paths for the organization?

References

• Govindarajan, Vijay y Trimble, Chris. “The Other Side of Innovation. Solving the Execution Challenge”. Harvard Business Press, 2010
• Harvard Business School Press.Innovator’s Toolkit: 10 Practical Strategies to Help You Develop and Implement InnovationHarvard Business Press, 2009
• Knight, Dan. Randall, Robert M.Strategy & Leadership: Special Report on Innovation Strategy & Leadership: Special Report on Innovation Vol. 33, Núm. 1, 2005,Emerald Group Publishing

By: Paula Beatriz Morales¹
and Jorge Omar Moreno²

Real options represent an extension of the theory of financial options applied to non-financial assets. This theory is based on management’s flexibility to modify its decisions when it identifies changes in the business climate. In this paper, we analyze the characteristics of these financial instruments, their types and valuation, and present some examples of how they can be used in administrative practice.

1. Introduction: Types of Options

Since the 1990s, as international markets began to integrate at an astounding pace and automated systems sprung up that allowed for instantaneous, across-the-globe movements of funds, the complexity of transactions carried out through the financial system has grown exponentially. This situation has been one of the most influential incentives for the creation of innovative financial instruments that meet new needs for hedging and investment and help companies become more competitive and profitable.

One of the most popular and widely-used instruments for investors is what is called an option, which provides a hedge against the volatility and risk of commodity prices, inputs, the exchange rate and other variables. Options enable a company to plan and guarantee the flows it requires, reducing uncertainty in the markets in which it participates.

According to Trigeoris (1999), a financial option is defined as the right, but not the obligation, to purchase (a call or C option) or sell (a put or P option) a specific asset (underlying), paying a given price (strike price) during the life of the instrument or at a specific future date (maturity or expiration date). If the option can be exercised before expiration, it is called an American-style option; if it can only be exercised at expiration, it is known as a European-style option. The value of the contract depends on the amount of the underlying over time, its price, the strike date and interest rates.

Where:

• C is the intrinsic value of a call option
• S^t is the price of the underlying in t; so that t=1,…,n
• K is the strike price
• P is the intrinsic value of the put option

Following the logic of risk hedging, real options represent an extension of the traditional theory of financial options, but applied to non-financial assets, such as extensions and alternatives in the decisions made regarding productive projects. This theory is based on management’s flexibility to modify its decisions when it identifies changes in the business climate. New information can help it to better adapt its business strategy to minimize new costs or take advantage of expansion opportunities, among other factors.

1 Full-time professor in the Accounting Studies Department at ITAM where she teaches courses on Corporate Finance and Strategic Cost Analysis. E-mail: paulam@itam.mx.

2 Full-time professor in the Business Administration Department at ITAM where he teaches courses on Corporate Finance and Finance Theory. E-mail: jorge.moreno@itam.mx.

Without flexibility in decision-making, the probability distribution of the net present value (NPV) associated with the project would be reasonably symmetrical, in which case traditional valuation methods would be sufficient. However, when management has the opportunity to adapt to changes in financial and economic situations, traditional NPV does not capture this capacity to act. This asymmetry introduced by management’s flexibility is known as the expanded net present value criteria, which reflects two components: traditional NPV from cash flows, and the active part of the project, which incorporates the effect of competition, the synergies generated by a project, the interaction between various phases of the project, and management’s response to all of these factors. This response capacity can be expressed as follows

Thus, we can view investment as a collection of options, or choices, regarding real assets, to which we can apply financial options valuation techniques. Table 1 sums up the similarities between a real option and a stock call option.

Table 1. Similarities between a financial option and a real option

Fuente: Trigeorgis (1999)

Financial and real options are similar in many ways, but not identical, particularly when dealing with noncommercial projects, such as the case of a new product that was not previously on the market. However, when there is difficulty in estimating the parameters shown in the table, we can solve the problem taking a “twin asset” as a reference, meaning one that has a similar risk and return to the project is being considered, and is also interchangeable in the economy. The difference in evaluating a project with a twin asset requires us to adjust the yield of this twin asset according to the additional risk inherent in the project.

Where:

• ? is the expected return on the project
• ? is the return on a similar asset a that is found on the market
• ? is the risk premium of the project, also known as dividen yield

As for the types of applications of real options, Table 2 shows the most common in business management and productive projects. In the next section we will explain in greater detail some of the options contained in the table and will provide a brief example of each one.³

Table 2. Types of real options

Fuente: Trigeorgis (1995)

3 As with financial options, real options can be valued using the methodology of stages or with a continuous time model. In this article we will only explain some options using the stage model. For more information on continuous time valuation, see Dixit and Pindyck (1994).

2. Examples and stage analysis

Company A wants to expand its distribution channels, and has an opportunity to buy 60% of the shares of another company, B, to do so. It will have to invest of 115 million pesos. Upon valuing company B, we find that discounted cash flows total 100 billion pesos, so based on NPV criteria, company A should not acquire company B, because the initial investment is superior to the total amount of discounted cash flows (-115+100 equals -15 &#60zero).

We also have the following information: the project value can increase by 120% or decline by 80% in each period, according to the demand for the product being sold. There are similar projects whose average yield is 20% and risk-free rate is 4%. The cash flow tree for company B is as follows:

Table 3: Estimated trajectory of underlying (Figures in millions)

2.1 Option to defer

Depending on the economic or political situation, certain projects can wait for their value to justify the initial outlay; accordingly, management has the right, but not the obligation, to make the investment in the following period. The option to defer can be viewed as an American-style call option, in which the underlying is the cash flow in each natural state (V in Table 3) and the strike price, the initial updated investment (I) at a rate of 8%. The general formula for this category is as follows:

Taking the data from this example, let us say that company A has the option to defer acquisition of company B for up to two periods. Again, this option is similar to an American-style call option, so management must decide whether to exercise the option before its expiration or to wait for flows in the following period.

The restated value of the initial investment is for t1=115 pesos, x the value by which the investment increases, which is equal to 124.20 pesos; and for the following period t² =124.2 x 1.08 = 134.136 pesos. The intrinsic value of the option to defer is represented by Figure 1.

Figure 1. Intrinsic value of option to defer

If management decides it would be better not to invest in t0 or wait to invest in the following period, this option can be viewed as a European-style option, discounting the expected flows from the future period, weighted by the risk-neutral probability and using the risk-free rate as the discount rate.

Table 4. Value of the option evaluated as European-style (figures in millIons)

To make a decision, we must compare the option to wait or to exercise before expiration. We take the highest result in each node of these two trees. In this case, the company would benefit more from waiting until the second year to invest, provided flows remain around 135 million pesos. As the table shows us, management should wait until the following period to acquire company B, so the value of the option to wait is the same as shown in Figure 2.

Investing any earlier would mean sacrificing the option to wait. Investment at this point would only be justified if V>I1 + Option. The difference between this model and a decision-making tree is that we take the risk free rate and risk-neutral probabilities to value the option, which avoids distortions that could be created by the use of subjective rates imposed by management.

2.2. Option to expand

Once the project is underway, management has the flexibility to change its initial decision. If conditions are favorable, the company may choose to increase the scale of production by a certain percentage (%X), at an additional cost (I2). This alternative is similar to an American-style call option:

Let us assume that the company in this example has the opportunity to expand the production of Company B by 100% starting from the first period, at an additional cost of 90 million pesos. The intrinsic value of the option would be as shown in Figure 3, while the value of this flexibility is 116 million pesos, which is almost 17 million pesos more than the additional project value estimated under the traditional system of discounted cash flows (Table 4).

Table 5. Intrinsic value of the option to expand (figures in millions)

Table 6. Value of the option evaluated as European-style (figures in millions)

Waiting for the last period to expand the scale of operations would be equivalent to valuing the option as European-style. Once this is done, we compare the values of the results node to node and we choose the highest. Finally, the highest values must be discounted at t0 to determine the value of the option to expand.

Similarly, if market conditions are favorable, management may decide to operate below its theoretic production capacity and keep costs down. This alternative is similar to an American-style put option on the part of the project that can be reduced, with the strike price equal to the cost savings:

In the example, if demand for the product does not respond as administration had planned, starting from the third period, it may decide to scale back its operations by 40%, in other words, to keep the company working at 60% of its installed capacity, which would avoid variable costs amounting to 45 pesos. The intrinsic value of the option is shown in Table 7:

Table 7. Intrinsic value of the option to reduce scale (figures in millions)

But there is also the possibility of waiting until the last period to decide whether or not to reduce the scale of production. In this case, the option can be evaluated as European-style (Table 8)

Table 8. Value of the option evaluated as European-style (figures in millions)

Once this is done, we compare node to node and choose the highest, so the highest values must be discounted through time t0 to determine the value of the option to reduce scale. As Figure 5 shows, it would be better to reduce the scale of operation in the two nodes of the first period, to attain an expanded present value of 103 million pesos.

2.3. Option to abandon

As an alternative to the choice of reducing the scale or suspending operations, there is always the possibility of abandoning the project altogether in exchange for obtaining the salvage value of the assets used in the project. This option may be valued as an American-style put option, comparing the salvage value with the project value at each of the nodes.

Let us assume that the company has conducted an analysis of the real-estate market to determine the trajectory of the salvage values of the assets of Company B (see Table 9).

Table 9. Estimated trajectory of Company B assets (figures in millions)

The next step is to compare node to node and find what would be more beneficial to the company. If we assume that this option can be exercised starting in t1, the company must choose the maximum value between abandoning or continuing the project, in other words, obtaining the intrinsic value of this option (Table 10).

Table 10. Intrinsic value of the option to abandon (figures in millions)

As with the previous options, management can also wait until the last period to make a decision, which would mean considering the option as European-style with risk-neutral probability (Table 11):

Table 11. Value of the option evaluated as European-style(figures in millions)

As in the preceding cases, we must compare the intrinsic value of the European-style option to abandon and choose the highest value. Finally, the highest values must be discounted across time t0 to determine the final value of the option. According to this valuation, we find the best decision would be to sell the subsidiary company during the last period, provided is at the highest node; otherwise, it would be best to retain the shares of Company B.

3. Conclusions

Real options are a much more powerful tool than the traditional present value methodology because they incorporate administrators’ optimal reaction to changes in the business climate for the company or the project managed.

The analysis of these instruments enables us to assemble variant financial and market scenarios, so their study and evaluation is more complex because more parameters must be calculated. One of the most important parameters in evaluating real options is the volatility of the project, because this depends on the modeling of the underlying’s trajectory, as well as the probabilities assigned to relevant events that are taken into account.

Real options are increasingly popular among investors and project managers; but for the Mexican market it is still difficult to estimate the values of the key parameters. This difficulty arises from the lack of complementary information on the project, and on the flows that will be valued, for example a long series of the products that will be sold or variations in the number of units sold. However, the ability to take advantage of investment opportunities and lock in competitive advantages against rivals are good reasons for a company to begin allocating resources to compiling this type of information, and thus to use real options in deciding whether or not to undertake new productive projects.?

References

• Amram, M.y Kulatilaka N. Real Options, Managing Strategic Investment in a Uncertain World, HBS Press, 1999.
• Dixit, A.K. y Pindyck, R.S.Investment under UncertaintyPrincenton University Press,1994
• Trigeorgis, L. Real Options in Capital Investment, Models, Strategies, and Applications. Praeger, Westport, Connecticut, London, 1995.
• Trigeoris, L. Real Options, Managerial Flexibility and Strategy in Resource Allocation, Fourth printing, The MIT Press, 1999.

By: Kristina Poto?nik
Business School
University of Edinburgh, UK

In competitive markets and especially within current global recession in which businesses are striving for survival, the organizations need to continuously innovate in order to gain competitive advantage (Poto?nik & Anderson, 2012). However, any organization, either profit or non-profit, needs innovative talent to be able to produce organizational innovations. Companies are hence experiencing the challenge of how to select those individuals who will show innovative performance in their workplaces.

What personality traits and skills make employees innovative? What selection and recruitment methods are the most suitable for selecting for innovative performance? Surprisingly, important as these questions might be, the selection and recruitment literature to date has not yet offered any sound implications for practitioners concerned with these issues. There are many challenges related with selecting for innovative performance which could explain this rather unexpected finding. In this piece I discuss some of these challenges and suggest a few implications for practitioners concerned with selection of the innovative talent.

On one hand, implications for practice can be drawn from some previous studies in the field of selection and recruitment which has witnessed an increasing interest in selecting for innovative performance (Burch, Pavelis, & Port, 2008). For instance, different valid and reliable psychometric tools have been designed to predict innovative performance in the context of employee selection (e.g., Innovation Potential Indicator (IPI), Patterson, 2000). Practitioners could use these tools as part of their psychometric assessment when selecting for innovative performance.

On the other hand, research addressing selection for innovative performance in the real-life selection and recruitment contexts is almost inexistent (Poto?nik & Anderson, 2012). One reason for this could be the difficulty to adequately operationalize the criterion (i.e. innovative performance). In the human resource management field innovative performance has most often been conceptualized as “the intentional introduction and application (within a role, group or organization) of ideas, processes, products or procedures, new to the relevant unit of adoption, designed to significantly benefit the individual, the group, the organization or wider society” (West & Farr, 1990, p. 9).

This very definition of the innovative performance implies that employees will exhibit novel behaviours which are beneficial to their organizations and are unexpected, in other words, unknown before they actually take place (Poto?nik & Anderson, 2012). Furthermore, not all employees will exhibit optimal innovation potential in every situation and in every context. Finally, innovation research has also highlighted that producing innovations is, to a large extent, contingent on the wider organizational or institutional context.

According to this argument, organizations should develop a climate supportive of innovation in which employees feel psychologically safe to put forward their ideas and perceive sufficient organizational support to eventually implement them. In other words, because engaging in innovative behaviours does not only depend on employee innovation potential, a selection of innovative talent might not be enough to generate organizational innovations.

Considering these arguments, it is very difficult to select for very specific behaviours needed to produce innovations in a specific job. What can be done, however, is to select for specific personality characteristics and abilities which have been found to predict innovative performance in general. In this sense, some implications for practitioners can be drawn from the innovation and creativity studies which have explored the role of different personal characteristics in employee innovation (Hammond, Neff, Farr, Schwall, & Zhao, 2011; Poto?nik & Anderson, 2012).

For instance, among the Big Five characteristics, openness for experience and extraversion have been consistently linked to innovative performance in the workplace (Hammond et al., 2011). Creative and proactive personality and core self-evaluations have also been found to predict innovative performance. Hence, practitioners are advised to screen job candidates against these characteristics if they are recruiting specifically for innovative performance. Regarding skills and abilities, practitioners are recommended to assess creative ability and intuitive thinking styles to increase the probability of selecting employees with higher innovation potential (Hammond et al., 2011; Poto?nik & Anderson, 2012).

Taking into account these arguments, cognitive ability and personality tests seem to be highly suitable selection methods when selecting for innovative performance, but they should also include the assessment of creative ability and intuitive thinking styles together with the general mental ability and creative and proactive personality in addition to Big Five personality characteristics, respectively. Other highly suitable methods for selecting for innovative performance could be assessment centres and situational judgement tests.

Assessment centres normally comprise a mix of diverse selection methods, many of which can be used to assess the innovative dimension of candidates’ future job performance. For instance, written analysis exercise, semi-structured interview, mock presentation, team exercise, and simulation and role-play exercises in which job candidates should come up with novel and useful suggestions to solve problems or improve their work roles or established procedures of doing work, could be used to predict how successful job candidates will be in their future innovative endeavours.

Also situational judgement test can be very useful for the assessment of innovation potential of job candidates in specific situations which they will most probably experience in their future jobs. These are some intuitive suggestions, however, as future research should empirically establish the value and criterion-related validity of different selection methods when selecting for innovative performance.

After having outlined the above implications for practitioners concerned with selection of the innovative talent some final considerations warrant further attention. To start with, it is important to understand that innovative performance will in most cases constitute only one dimension of job performance (Poto?nik & Anderson, 2012).

In other words, there are very few jobs, if any at all, in which employees are expected to engage only in innovative behaviours. Hence, practitioners should design their selection and recruitment strategies in a way that would allow them to select for different dimensions or facets of job performance at the same time.

This means that selection and recruitment practices should also take into consideration knowledge, skills and abilities needed to perform well in different areas of job domain, such as task efficiency, meeting deadlines and so forth. It is also important to highlight that it is not recommendable to look for an ideal profile trying to find a candidate who would score high on all of the above outlined characteristics to increase the probability of exhibiting high innovative performance.

Hiring an individual who would be very open to experience, highly extroverted, with high creative and proactive personality and intuitive thinking styles at the same time as opposed to conscientious individuals and those with more systematic thinking styles would very likely pose significant challenges to the organizations, such as maintaining discipline or other performance issues. Therefore, practitioners are advised to consider all aspects of candidate future job performance when designing their recruitment and selection procedures.?

References

• Burch, G.S.J., Pavelis, C., & Port, R. L (2008), Selecting for creativity and innovation: The relationship between the innovation potential indicator and the team selection inventory,International Journal of Selection and Assessment, 16, 177-181.
• Hammond, M.M., Neff, N.L., Farr, J.L., Schwall, A.R., & Zhao, X (2011), Predictors of individual-level innovation at work: A meta-analysis. Psychology of Aesthetics, Creativity, and the Arts, 5, 90-105.
• Patterson, F (2000), The Innovation Potential Indicator: Test manual and user’s guide. Oxford: Oxford Psychologists Press.
• Poto?nik, K., & Anderson, N (2012), Assessing Innovation: A 360-degree appraisal study. International Journal of Selection and Assessment, 20, 497-509.
• West, M.A., & Farr, J.L (1990), Innovation at work. In M. A. West & J. L. Farr (Eds.), Innovation and creativity at work: Psychological and organizational strategies Chichester: Wiley.(pp. 3-13).

By: Francisco Mendoza

Compensation management practices most widely used among the mid-sized and large companies of Mexico have been imported by subsidiaries of major multinational firms and adopted by Mexican organizations, on the assumption that these constitute best business practices.

However, in most of these organizations (and probably in most major multinationals), these practices are an irritant to the workplace environment and an obstacle to retaining talent and improving performance, rather than an element that supports the firm’s business culture.

In our experience, executives at the vast majority of these organizations are unsatisfied with the strategies for talent management and compensation because, as they often explain it, they do not help to identify or compensate top-performing employees, nor do they help to improve the results of the business.

Most of the employees of these companies are unsatisfied as well. They complain basically about the slow pace at which their salaries grow, about the lack of internal equity, about “how little” they earn compared to colleagues who “do the same thing” in other companies and, in general, about the obscure and illogical rules of the game that seem to underlie decisions affecting their pay. Of course, there will be those who believe this is merely a widespread perception that is fueled by emotional argumentation, and that the problem can be resolved with more information and better communication.

There is little doubt that sharing relevant information can greatly improve peoples’ perception of any issue, but in this particular case, perceptions are grounded in problems that are not only evident to the eyes of those who are affected, but are also painfully obvious to those who observe the phenomenon objectively. These people frequently face practices that really have nothing to do with business common sense.

To exemplify this, I will review some common practices relating to principles that support any healthy compensation management system: competitiveness and internal fairness.

Competitiveness is, by most definitions, the principle that states that talent should be compensated according to compensation market practices and pay levels.

I know very few companies th at do not claim to pay competitively. Although it is rare for them to specify what precise position they intend their compensation to have with relation to the market, or what their market reference is (which organizations they are considering), they at least explicitly state their intention to pay as “other companies” in the market pay (expressed those in generic terms). However, in practice, the way in which compensation is often managed keeps them from paying competitively.

To do this, we must first understand that talent has a market “price”, resulting of supply and demand for specific expertise. For example: while recent systems engineering graduates (without experience) are today paid between 14,000 and 17,000 pesos a month, those who have followed their careers and are considered experts are paid an approximate average of 25,000 pesos. The significant difference between both “prices” means that the more specialized and developed the talent, the higher its “price” (due mainly to less supply of it there is in the market).

But the law of supply and demand (is there anything more important in business common sense?) is ignored by many of these companies. The following is a frequent example: the typical organization hires a recent engineering graduate with a salary near the bottom of the salary range.

Once she is on board, the organization trains her before assigning her to the position she will occupy, and once she has assumed her duties, she is subject to an ongoing program of professional development that includes an induction program, the assignment of growing responsibilities, technical training, the development of leadership abilities and finally, a host of actions to develop this talent until she is ready to climb further up the organizational ladder.

Throughout this time, the employee’s salary is regularly increased (usually by between 3% and 5% a year) according to the annual budget… until one day, still earning a salary not far from the bottom of the range, the engineer appears before the Human Resources Department and resigns to join another company that is offering her a salary 25% to 30% better than what she is currently making.

The initial reaction of those who feel abandoned by the talent they put so much work into developing is to accuse the other company of “pirating” their employees. They fail to realize that they set themselves up for the loss with two simultaneous and contradictory actions: developing the talent of the employee, and ignoring the increase in the market “price” resulting from such development. This is diametrically opposed to basic business common sense.

Furthermore, most companies also claim that they have a policy of paying for performance. But they actually fall well short of applying this policy in reality, as can be attested to in the vast majority of organizations, where we frequently find that the best employees do not, in fact, earn more than other.

The reason for this discrepancy lies primarily (but not exclusively) in the practice of linking a salary increase percentages with performance ratings. Thus, the “decision” to raise the salary of each employee is based on a matrix that correlates a very narrow range of percentages with performance ratings (and in some cases, with position of the salary within pay range). I have put “decision” in quotes because this is actually such an automatic and rigid process that does not admit but very minor adjustments, limiting managers’ ability to apply their own discretion.

There are many problems with this approach, so I will just mention the two most important: 1) the system focuses on managing increase percentages, rather than managing salaries; in other words, the focus is on the means (percentages) while forgetting about the ends (salaries in pesos and cents); and 2) the increase matrixes state pay raises for its best employees just a little higher than the ones stated for other employees.

This means that even an outstanding employee must wait 10, 15 or more years to reach the maximum of their pay range (which is the natural target for someone with such a performance) while during those same 10 or 15 years, average performance employees may earn more if, for any circumstantial reason, began their career with a salary above the midpoint of that same range.

The obvious questions for any observer are: how can a company claim to pay for performance if their practices prevent the best employees from really earning more than the others? And, what business logics could there be behind a practice that allocates more money to paying the least valuable talent in the organization? Or differently put, how much time should a truly outstanding employee wait to be paid what his talent is worth, before deciding to leave the company?

In defense to statu quo, it is often argued that this problem is a result of the limited availability of resources for the annual salary plan. It is true that most companies have limited resources to increase salaries each year, but this is not the central problem. The real problem is that companies manage salaries based on two erroneous premises: 1) a very narrow range of increase percentages; and 2) every employee must have a pay raise every year.

Effective pay for performance implies resources rationalization based on totally different premises: 1) maximum differentiation, which should allow for double-digit salary increases for the best; and 2) employees already paid above their pay target should not have a salary increase (as they are paid more than what their talent is worth). The second premise will leave money to fund the first premise.

In conclusion, salary management practices should be reviewed following a process focused on employee talent. Maintaining a healthy competitive position means not only paying salaries that are appropriate at the time the employee is hired, but recognizing that talent of each employee evolves and their salaries must keep pace with this evolution.

Paying for performance also requires a different strategy than what we have described. One that is based on pay goals associated with talent levels, prioritizing salary levels instead of increase percentages, allowing for high salary increases for those who are the organization’s best talent, and funding those high salary increases with the savings that come from employees already compensated at above their pay goals.

It is time to begin managing employee compensation with business common sense. Talent has a market price, and paying it in the short, medium and long terms, is far more profitable than continuing to manage a very narrow range of increase percentages.?

References

• Cascio, Wayne y Boudreau, John (2008),Investing in People, FT Press-Pearson Education, Inc.
• Chambers, E., Foulon, M., Handfield-Jones, H., Hankin, S., Michaels, E., (1988),The War for Talent, The McKinsey Quarterly, Número 3, McKinsey, páginas 44 a 57.
• Martocchio, Joseph, (2008), Strategic Compensation. A Human Resource Management Approach, Prentice Hall.
• Lawler, Edward E. III (1990)Strategic Pay, Jossey-Bass
• Mendoza, Francisco (2012),Remunerar estratégicamente… es más rentable que simplemente pagar, Guverni

By: Francisco Gil-White
School of Business
ITAM

In the popular media–and hence in popular imagination–psychometricians have advanced so far they can tease apart our motives and traumas with tremendous ease and almost supernatural precision. Perhaps the psychometric industry is relying for its growth on such popular perceptions, because the scientific research, at least, suggests that psychometric products do not work as advertised.

The popular imagination is informed by such vectors as David Fincher’s movie The Game (1997). The star, Michael Douglas, is the protagonist of a company-administered ‘adventure,’ full of thrills and dangers he may not fully understand are part of the ‘game.’ For this to work, this peculiar company must predict his future behavior the way a physicist charts the trajectory of a rocket, for which a few preliminary hours of verbal responses to stimuli and checking boxes on paper are, amazingly, more than enough.

Modern human resources managers share this Hollywood faith. Among other goals, HR directors have been asked to: 1) reduce recruitment and rotation costs; 2) improve operational efficiency and worker productivity; 3) strengthen organizational harmony; and 4) bolster individual career coherence. With psychometric wizardry, they appear to believe, they can understand people as completely as the corporate psychologists in The Game, identify all the relevant personalities, fit them into their optimally functional cubbyholes, and properly articulate them for smooth system behavior: a corporate Swiss watch. But is the world like the movies?

Consider the Myers-Briggs Type Indicator (MBTI). Based on a (hotly disputed) interpretation of Carl Jung’s work, the MBTI proposes four dimensions of personality, each with two poles: 1) Extroversion (E) vs. Introversion (I); 2) Sensing (S) vs. Intuition (N); 3) Thinking (T) vs. Feeling (F); and 4) Judgment (J) vs. Perception (P). Your personality ‘type’ is determined by pegging you, for each dimension, to one of its poles. Thus, an ESTJ is an (E)xtroverted, (S)ensing, (T)hinking, (J)udging ‘type.’ Consulting Psychologists Press (CPP), owner of the MBTI, claims the MBTI will assist a company in ‘leadership and coaching,’ ‘team building,’ ‘conflict management,’ ‘career exploration,’ ‘selection,’ and ‘retention.’ For this, they will charge you.

So how good is the MBTI? In 1993, psychologist David Pittenger summarized an enormous mountain of studies that had, up to then, examined its quality. There was trouble.

First, for each dimension, in the raw data, there is no evidence of bimodal distribution: “[M]ost people score between the two extremes.” Nothing wrong with that so long as you respect the world, but the MBTI doesn’t. If two people in, say, the Extroverted-Introverted dimension, score nearly identical to each other on either side of the critical diagnostic value, the MBTI will call one an E and the other an I, making them artificially different.

This–together with run-of-the-mill sampling error–no doubt contributes to the MBTI’s rather striking ‘test-retest reliability’ failures: its inability in over half of all cases to assign the same personality to the same person (even when you retest just 5 weeks apart). This is embarrassing; the very idea of ‘personality’ requires (at least moderate) stability over time. In ‘test validity’ the MBTI does poorly too: results of factor analyses are inconsistent with the four dimensions posited. But the ‘ecological validity’ problem is perhaps the worst. For its backers, the very point of the MBTI is to assist human resources managers in career planning and placement, and yet the purported ‘personalities’ picked out by the test do not appear to correlate with significant behavioral choices–in particular, career choices. Neither is ‘type’ correlated with success in a given occupation.

At the time of Pittenger’s article the MBTI was the most widely employed tool for purposes of counseling, selecting, and placing staff in organizations all over the world. Appropriately, Pittenger’s devastating summary of MBTI shortcomings was published in the Journal of Career Planning and Employment in order “to caution against undue reliance upon its use without fully investigating the accuracy of its test results.” It had zero effect.

Two decades later Stephen Robbins and Timothy Judge, in their bestselling Organizational Behavior, a business college textbook, communicate a strong academic consensus that “most of the evidence” militates against “the MBTI’s validity as a measure of personality,” and conclude reasonably (though still tepidly) that “managers probably shouldn’t use it as a selection test for job candidates,” yet the MBTI continues to be, in their words, “the most widely used personality-assessment instrument in the world.”

This is interesting: hyper-rational bureaucracies focused on increasing revenue and reducing costs (private companies) are consistently choosing to pay good money for a test that fails entirely to fulfill its advertised function. Many companies using the MBTI are successful and wealthy–Robbins and Judge give some examples: “Apple Computer, AT&T, Citigroup, GE, 3M Co., many hospitals and educational institutions, and even the US Armed Forces”–so they can well afford the minimum expense required to find out whether the test they pay for is any good. (And shouldn’t they have learned by now that a best-selling college textbook cites them as examples of big companies that employ a useless test?)

But the puzzle is deeper because the problem is wider. In 2004 Annie Murphy Paul, a former senior editor at Psychology Today, published The Cult of Personality: How Personality Tests are Leading Us to Miseducate Our Children, Mismanage Our Companies, and Misunderstand Ourselves. There is an entire section devoted to the MBTI and its massive failures, but Murphy Paul’s investigation is exhaustive: every major personality test is examined–and found to fail miserably. And yet, in the last few decades personality tests have become an international growth industry as companies everywhere fall head-over-heels in their enthusiasm to employ such products in their recruitment, selection, and career placement processes (writes Paul: “Today personality testing is a $400-million industry, one that’s expanding annually by 8 percent to 10 percent”).

And it isn’t just personality tests. The other major branch of psychometrics is IQ testing, or so-called ‘intelligence’ tests. The history of these tests includes a striking series of scandals involving misused statistics and outright faking of data. Most infamously, (Sir) Cyril Burt, a leading psychologist of his day, invented nonexistent sets of identical twins and published under an assumed name in the journal he himself edited (British Journal of Statistical Psychology) in order to advance this idea. The point was to argue that ‘intelligence’ was a unitary trait with 80% heritability–a figure still bandied about today (and by Robbins & Judge, no less)–the better to sell innocent Western populations on the ideas and policies of the eugenics movement, which later culminated in German Nazism. One could expect such a history to make people at least suspicious about the reliability of such tests, and ordinary folk resistant to be submitted to them, especially when so much modern intelligence testing is underwritten by the infamous Pioneer Fund, created by public racists. But intelligence tests have grown in popularity in the last half century, in tandem with personality tests.

Finally, there is the question of what psychologist Joel Mitchell calls the ‘psychometrician’s fallacy’: psychometricians have been using “methods, such as rating scales, which numerically code ordinal relations, and yet in their analyses of such data psychologists [have] preferred statistical procedures… permissible only for interval or ratio scale measures, such as arithmetic means, variances, product moment correlation coefficients, and associated statistical significance tests (so-called parametric statistics).” The work of computing such statistics, though feverish, is essentially meaningless. It amounts to pretending that qualities are quantities; that numerals are numbers. In other words, it is an insoluble philosophical problem that was simply brushed aside in the early stages of the emergence of the psychological discipline. Even without doing statistics, the use of ordinal scales for subjective responses presents daunting problems (e.g. when I check ’4′–on a scale from 1 to 5–to a question that asks me to express the intensity of some subjective psychological experience, how can we know that this intensity is not precisely what you call a ’2′?).

How much of psychometrics has been flying under the scientific radar?

We have here, it appears, a phenomenon ripe for the kind of ‘systems analysis’ that has of late become so fashionable in business management academic circles. We need a better understanding 1) of the dynamics of the psychology profession itself, as an institutional system (a contribution to sociology of science); 2) of the internal articulation of roles and flows of information within businesses that explain their decisions on these questions of human resources management (a contribution to organizational behavior dynamics); and 3) of the manner in which business school graduates are being trained (or not trained) that makes them oblivious to–or insufficiently knowledgeable to address–the problems here discussed, with ensuing stability for these problems. In addition, we may need a better understanding of how different spheres interact and articulate with each other, including the general public’s perceptions, grounded in a person’s passage through the education system; the relationship between psychologists and the psychometrics business; the law regime concerning discrimination, plus official approval by government bureaucracies for purportedly ‘neutral’ psychometric tests (perverse incentives); and the contact between human resources departments and academic psychology. We may learn a lot about the joint operation of academic, legal, and business systems, and may emerge with important lessons concerning the sociology and philosophy of social science and academic business education.

But for those who care most about the bottom line, a proper investigation of these linked phenomena may start the ball rolling towards significant cost savings, and real improvements in recruitment, career placement, and rotation. A major sales argument for psychometric tests has been their supposed low cost, compared to alternative strategies, but only useful products can make claims to be relatively cheap; those that fail to achieve results–and which may be imposing all manner of costs–are always expensive, however little one paid for them. It’s time for more hard-nosed business, and less superstition.?

References

• Fancher, R. (1985).The intelligence men: Makers of the IQ controversy.New York: Norton.
• Mitchell, J. (2009).The Psychometricians Fallacy: Too Clever by Half? British Journal of Mathematical and Statistical Psychology, 62(41-55) Measuring the MBTI. . .And Coming Up Short. Journal of Career Planning and Employment, 54(1), 48-52.
• Paul, A. M. (2004). The Cult of Personality: How Personality Tests Are Leading Us to Miseducate Our Children, Mismanage Our Companies, and Misunderstand Ourselves. New York: Free Press.
• Pittenger, D. (1993). Measuring the MBTI. . .And Coming Up Short. Journal of Career Planning and Employment, 54(1), 48-52.
• Robbins, S. P., & Judge, T. A. (2011). Organizational Behavior (14 ed.). New Jersey: Pearson Education / Prentice Hall. (p.137)

By: Aída Ortega

In recent years, scientists and entrepreneurs have become increasingly interested in shared learning and knowledge. Authors have focused on the study of how learning contributes to the effectiveness of organizations. The definition suggested by Huber (1991) clearly exemplifies this: “learning means acquisition of knowledge recognized as potentially useful for the organization.”

This has been the starting point for the development of a wide number of theories about organizational learning and, more recently, about collective or group learning, since it is expected that teams can benefit their organizations more than individual employees.

Although the literature offers different definitions of the concept of “team learning,” the general tendency is to define it either as a process or a process and outcome. Team learning is defined as a continuous process of reflection and action directed toward obtaining and processing information in order to detect, understand and adapt to changes in the environment, and improve the team’s performance and results (Edmondson, 1999).

This process takes the form of a series of behaviors by team members, like asking questions, requesting feedback, experimenting, reflecting on the results and discussing errors or unexpected results of their actions. Team learning is defined as an outcome when it when it improves performance and efficiency. Given the importance of team learning, we might ask: what factors facilitate team learning in organizations? According to Gil, Rico and Sanchez-Manzanares (2008), some of the most important factors are the following:

a) Team composition. This refers to the attributes of the team members and how they combine to form effective, interdependent teams. The work teams can vary in composition depending on the type of attribute, the distribution among the team members and their stability over time. Two aspects of the team’s composition that have been the object of many studies are size (the number of people who integrate the team) and the characteristics of its members.

The essential question about size is what is the optimum number of members a team should have. As a team grows, it has more resources available, but it also needs more coordination. Wheelan (2009) has found that small teams are more productive and better developed than large teams, so this variable can be analyzed based on the hypothesis that there is an optimum size capable of favoring team learning. With regard to composition, a number of studies show that the diversity in areas and knowledge among the members can enhance team learning.

b) Task design and work context. The design of the team’s task is an issue that incorporates its autonomy, meaning the degree in which it has the capacity to make decisions about different aspects of its work (methods, scheduling, roles, etc.). A low level of autonomy indicates that the team has a very structured task that is defined by the organization, which minimizes the need to make collective decisions or manage internal processes.

On the other hand, a high level of autonomy implies that team members must collectively make a number of decisions about their job. Some research has shown that autonomy is a basic characteristic in the design of the team’s task, which modulates the effect both of other preceding variables (for example, team diversity) and the processes (team learning) on group efficacy

c) Interdependence. This refers to the degree with which the team members interact and depend upon each other to attain their goals. The team is perceived to be interdependent when its members see their actions and results as heavily affected by the actions and results of the others. Interdependence helps to develop team learning behavior

d) Virtuality. This is defined by three aspects: dependence of the members on information and communication technology to coordinate and execute team processes, the types of information the technologies contribute, and the synchrony of communication between team members. This factor significantly alters interaction among team members.

Working regularly in conditions of high virtuality limits signals from the social context present in face-to-face interaction, reduces the depth of discussion and analysis of the issues, and increases the amount of time needed to make collective decisions. Research into the relationship between virtuality and team learning is still scarce, so more studies are necessary, particularly on highly virtual teams.

e) Workplace environment. One of the more structured and widely studied models regarding the concept of workplace environment was developed by West (1990). Many researchers have adopted this model because of its use in predicting group yield in various organizations. The West model includes four dimensions of workplace environment: vision, secure participation, task focus and support for innovation.

The first dimension, vision, refers to the idea of a desired result that represents a goal and a motivating force on the job. Work groups with more clearly defined objectives are more likely to develop new work methods. The second dimension, secure participation, means that the people are involved actively in decision-making, influencing, interacting and sharing information.

Secure participation also refers to group interactions in an interpersonal atmosphere in which there is no threat, but rather trust and support. The third dimension, task focus, is evident by the emphasis on individual and group responsibility, control of a system to evaluate and modify yield, reflection on work methods, feedback and cooperation, mutual monitoring, evaluation of performance and ideas, clear criteria on results, exploration and difference of opinions, and a concern for maximizing the quality the results.

Finally, the fourth dimension, support for innovation, has to do with the introduction of new ideas and improvements in the way the work is done. More specifically, that the team expects, approves of and supports the introduction of better ways of doing things, which reinforce attempts at innovation and influence cooperation for the development of new ideas. All of this implies seeking out new ways of seeing problems, perceiving them as challenges and learning opportunities.

f) Leadership. Defined as “the process of influencing others to understand and agree on the needs that must be addressed and how to do so effectively, in the process of facilitating individual and collective efforts to achieve shared objectives,” leadership is inevitably a key factor in shaping the workplace environment and motivation for learning. Researchers have found that the team leader can considerably affect the internal dynamics and results of the team.

For example, team leadership based on team coaching is related to learning, because a leader helps minimize differences of power and promotes interaction between the members, like talking about questions, problems and concerns on the job. Empowerment leadership relates positively with shared knowledge and this, in turn, with the yield of management teams. Another type of leadership, people-centered leadership, has been found to have a significant relationship with team learning.

Accordingly, we can say that the leaders of teams with higher level of learning and adaptation to changes in the organization favor their groups in various ways: a) by communicating and motivating a vision of change; b) by creating a climate of secure participation; e) by recognizing his or her own limitations; d) by valuing the contributions of all team members; and e) by eliminating barriers based on differences in power or status within the organization.

We can therefore conclude that the composition of the team, the task design, the context, interdependence, virtuality, workplace environment and leadership are all key factors in the development of team learning. Organizations can also benefit, however, by taking into account and putting into practice some techniques that can help to improve team learning. There are two types of techniques or intervention programs: training programs and teambuilding techniques.

Training programs can include cross training (team members acquire knowledge about the roles and tasks of their coworkers), metacognitive training (in which members become familiar with the strategies used to learn and, on this basis, select and use the most appropriate), team coordination training (intended for members to learn and handle processes that lead to effective teamwork), self-correction training (members learn abilities for analyzing their own performance, reviewing facts, exchanging feedback and planning future actions) and exposure to stressful situations (members learn about the principles of stress that can jeopardize the performance of the team, along with effective strategies for dealing with it) (Gil et al., 2008).

Teambuilding programs, on the other hand, attempt to improve the general functioning of the team using different techniques like role clarification, target setting, problem solving and improvement of interpersonal relations. Of all of these techniques, cross-training and metacognitive training are the most appropriate for team learning because of the objectives they establish.

References

• Edmondson, A.C. (1999). Psychological safety and learning behaviors in work teams. 44, 350-383.Administrative Science Quarterly
• Gil, F., Rico, R. y Sánchez-Manzanares, M. (2008).Eficacia de equipos de trabajo, 29 (1), 25-31.Papeles del Psicólogo
• Huber, G. P. (1991) Organizational learning: The contributing processes and the literatures. 2, 88-115. Organization science
• West, M. A. (1990). “The social psychology of innovation in groups”. En M. A. West y J. L. Farr (Eds.), Innovation and Creativity at Work. Psychological and Organizational Strategies (pp. 309-333). Chichester: Wiley
• Wheelan, S.A. (2009).Group size, group development and group productivity”. Small Group Research, 40, 247-262.
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