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Global Competitiveness: Financial Manager’s Leadership Role in Knowledge Creation Daniel F. Twomey

EXECUTIVE SUMMARY

Global competitiveness requires the ability to quickly and continually bring superior value to diverse marketplaces in the face of rapidly changing needs, technologies, and environments. These competitive forces and increased complexity are prompting major changes in organizations. Successful firms are integrating functions and processes. For this is to happen, financial managers need to take a leadership role in an integrative and collaborative learning process. Financial managers are encouraged to play a substantial role in transforming the metrics of the firm from a control/score-keeping system into a true knowledge creation system. The challenge is to turn knowledge into action

INTRODUCTION Financial systems and flows are the lifeblood of an enterprise. They reflect the strength, prosperity and results of its highly complex and interdependent operations. These systems provide highly reliable and valid measurements of a firm’s outcomes both in the short and long term. Furthermore, financials are the profile of the organization that, in large part, determines external value and vulnerability of the firm. That, along with well-defined terms and processes across firms and industries, makes them the language of business. Yet they are not the life force of the business. The life force comes from human capital, which today is less about “labor” and more about talent, knowledge creation, and innovation. Increasingly, it is about collaboration, internal motivation, and self-direction. This article addresses emerging challenges for the firm and its financial managers-- challenges that are beyond the traditional scope of their jobs, but that are essential for gaining and maintaining competitiveness in today’s global marketplace.

Financial Managers’ Strategic Role There are three possible roles for financial managers with regard to influencing the direction and success of the firm. 1. Information provider--provides information to top management and others that is used in strategy development and implementation. 2. Narrow strategic partner--joins in strategy discussion and strategy formation in areas that are narrowly defined, e.g. financial areas.

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3. Broad strategic partner--participates in all aspects of strategy formation and implementation processes. As enterprises become more complex and interdependent, both internally and externally, the synergies between and among the parts become more important. The ability to provide meaningful integration across specialties, functions, units, and businesses increasingly determines the influence and value of managers. Furthermore, this integration, which has existed at the top, is now becoming essential at all levels of the organization (Kaplan & Norton, 2001). Functional units within organizations are recasting themselves in ways that fundamentally affect other areas. Financial managers need to respond to these changes and develop synergies in the emerging alignments and use them to increase the competitiveness of the firm. By taking a leadership role in both the formation and strategic articulation of these new alignments, financial managers strengthen their role within the firm. For example, the Human Resource (HR) function has been going through a transformation that cannot be fully effective without realignment with other functions. In the past decade HR has split into two operations, commonly labeled “transactional” and “transformational.” Transactional activities have a local effect; for example, those directly involved in the transaction, such as benefits management. The transformational activities, on the other hand, have a fundamental systems impact; for example, organization change, organizational effectiveness, quality and competitiveness, and talent management. Also, central to the transformational aspect of HR, the HR manager is a businessperson and a business partner with line managers. In that emerging role of “business person” the HR manager must know numbers, be able to understand the implications and relationships inherent in financial statements, and to be comfortable using numbers to identify opportunities and problems. Therefore, to be effective, HR managers must have a robust relationship with financial and line managers. Financial managers have a unique opportunity to raise the competitiveness of the firm. There is recognition that human assets (talent) are becoming a primary basis for competitive advantage. From the traditional perspective, one might think that is good news for HR, but it is not unless HR activities are directly connected to the organization’s strategy and the competitiveness of the firm. That will happen only if HR connects directly to the financials (lifeblood) of the firm. For example, there is a growing expectation that the Human Resource function will provide training and development that directly impacts results, and major HR activities contribute to short and long-term results. However, the effectiveness of HR systems and activities are limited by how well they are measured, evaluated, and integrated into the firm’s strategy.

NEW REQUIREMENTS FOR COMPETITIVENESS

Traditional financial systems have addressed the outcomes of the firm and provided an accounting of its physical and financial resources (Srinivasan, 1999). This information, while valuable, is becoming less and less adequate to insure the competitiveness of the firm--the ability to prosper in the future. When physical and financial resources were the bases for competitive advantage, relying on these data was an acceptable business practice. As these advantages become neutralized and as human assets, in particular knowledge creation and innovation, increasingly determine future success, a new set of metrics is needed. Not only are additional metrics needed, but also a means of measuring and integrating all of the major factors that contribute to competitiveness. While this role will be shared by many functions, for example, marketing may measure “customer satisfaction” and HR may measure “employee satisfaction,” there is nothing more central to competitiveness metrics than the financial managers.

The Balanced Scorecard

Incorporating customers and human resources in the firm’s financial metrics provides a robust picture, not only of the firm’s performance, but also of the firm’s competitiveness. These

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additional measurements enable management to use metrics as leading strategic indicators. The balanced scorecard can become an integral part of the enterprise’s strategic change process, instead of just a measurement of its past performance (Kaplan & Norton, 1996 & 2001). The benefit of an expanded metrics system derives more from its strategic integration than from having additional measurements. That is, merely adding metrics without creating new communications and conversations across functions and levels will not make metrics strategic--a driver of organization performance and change. A change that will be immediately evident with the use of the balanced score card is greater focus on the long-term performance of the firm. The balanced scorecard adds “leading” (performance) measures of employees, customers, and internal processes. These leading metrics are integrated with “lagging” (outcome) financial measures (Frigo and Krumwiede, 2000). Hence, simplistic solutions that create short-term satisfaction but long-term weakness, such as cutting the workforce to increase profits, should become less common as the consequences of those decisions become more evident. Furthermore, adding leading metrics to the set by which managers’ performance is evaluated may broaden their focus to include long-term cross-functional issues. These are important benefits but, alone, they do not identify and focus energy on the strategic drivers of the business--they do not transform the organization. Additional metrics provide new information, but they do not, by themselves, create new thinking, commitment, and innovation. Financial managers and human resource managers, along with line managers, must integrate the information in more effective ways.

Business Drivers To become more strategic and operationally more efficient and effective, managers must increase their understanding of the dynamics of the business, that is, the cause and effect relationships (Kaplan and Norton, 2001; Oliveira, 2001). For example, managers need to understand the relationship between employee satisfaction and customer satisfaction and the relationship between customer satisfaction and repeat sales. It is not enough to know the relationships--what the metrics tell us. Insight into leveraging those relationships is also needed (Wright et al., 1998). That takes a much deeper inquiry--an inquiry that goes beyond metrics, beyond the balanced scorecard and beyond any one function within the organization. The experience, insights, and judgments (tacit knowledge) across functions and levels need to be tapped, developed, and integrated. This calls for ongoing processes that not only drive the firm’s strategy, but also influence initiatives at all levels of the organization. The economic drivers, derived from the metrics, should be as simple and clear like as Walgreen’s “profit per customer visit” or Wells Fargo’s “profit per loan per employee” (Collins, 2001). The multiple and changing contributors to that economic driver need to be understood and appreciated in ways that allow for innovation and action. An output of the analysis and integration of metrics is a clear and concise understanding of the most important relationships that contribute to competitiveness.

GLOBAL COMPETITIVENESS METRICS A problem with metrics is that “lead” metrics--future, qualitatively based--are frequently treated like “lag” metrics--historical, quantitatively-based. With lag metrics much of the emphasis is on understanding the numbers, but for lead metrics the same level of information and understanding is not in the numbers, per se. Without a substantial appreciation of their origins, lead metrics may be seriously misleading. For example, the managerial attributes and skills of transnational managers are potentially important predictors of a firm’s global competitiveness (Ali, 2000). It is a potentially important metric, but the competencies are not easily measured, and when measured, not fully understood. Competencies for global managers may be substantially different from those needed by domestic managers and/or traditional international managers. Competencies for

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transnational managers include: 1. understanding the worldwide business environment, 2. creating culturally synergistic organizational environments, and 3. willingness to transpatriate for career and organization development (Ali, 2000: Adler and Bartholomew, 1992). The attributes for transnational managers may not lend themselves easily to cross-cultural measurement and interpretation. Other more generic qualities and/or skills may provide a more effective basis for the “global manager” metric, such as, 1. effectiveness in dealing with human resources, 2. level of technical literacy, 3. comfort in different cultures, 4. knowledge of social, economic, and political environments of other nations, and 5. collaborative experience and ability (Ali, 2000; Caligiuri and Di Santo, 2001). In a recent study Caligiuri and Di Santo (2001) found that knowledge and ability dimensions were easier to change than the personality dimensions. The “ability to develop” might also affect choice of metric. From the discussion above it should be evident that the nature of “lead” metrics is qualitatively different from that of “lag” metrics and therefore the processes for integrating the two need to reflect that difference. The choice of competencies, design of the metrics interpretation of results, as well as the integration with other lead and lag metrics, should be a collaborative process. The robustness of the knowledge is a function of the quality of the interactions, and of the diversity of people, their competencies and experiences. The validity of the knowledge depends on having the right people, those with the relevant experience. If we are developing and/or interpreting metrics on transnational managers, then persons with that experience and persons who are from those countries will provide validity to that knowledge creation process. The problem of treating lead indicators as if they were lag indicators can be seen in (Pfeffer and Sutton, 1999) work on “the knowing-doing gap.” Things that make the knowing-doing gaps worse include: 1.treating knowledge as a tangible thing, as a stock or a quantity, and thereby separating knowledge from its use, 2. not considering tacit knowledge because it cannot be easily stored or transferred, and 3. not understanding the actual work being documented (Pfeffer and Sutton, 1999, p. 22). In essence, lag metrics provide a high explicit (tangible) to tacit knowledge ratio, and can thereby be stored and transferred while retaining much of its value. Conversely, lead metrics have a lower explicit to tacit ratio, making storing and transfer problematic. This problem is reduced by converting tacit knowledge into explicit knowledge--conceptualization of tacit knowledge (Nonaka et al., 2000). As with the choice of lead metrics, its interpretation and integration needs a more robust process. Lead metrics are not as complete or valid as the lag metrics. Therefore, to fill some of the gaps, as well as to integrate lead metrics with lag metrics, a different process is needed. A four-stage knowledge creation model (SECI) developed by Nonaka et al. (2000) provides an effective guideline. 1. Socialization (tacit to tacit) is the process of extending tacit knowledge through shared experiences. (Creating new tacit knowledge and converting it to explicit knowledge is a major source of innovation.) For example, managers gather information from sales and production sites, share experiences (tacit knowledge) with suppliers and customers and engage in dialogue with competitors. In socialization, self-transcendence is fundamental because tacit knowledge can only be shared through direct experiences, which go beyond individuals. 2. Externalization (tacit to explicit) is the process of articulating tacit knowledge into explicit knowledge. Here the individual and group insights are fused with the metrics, increasing both the value and validity of the metrics. 3. Combination (explicit to explicit) is the process of converting explicit knowledge into more complex and systematic sets of explicit knowledge. All of the metrics, both lead and lag, are integrated into planning strategies and operations. 4. Internalization (explicit to tacit) is closely related to ‘learning by doing.’ Explicit knowledge, such as a selection program based on global manager metrics, is implemented. During the implementation, new insights (tacit knowledge) are developed by reviewing and reflecting on the new competencies, procedures, etc. (Nonaka et al., 2000).

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Seven-Eleven: Integrating Tacit and Explicit Knowledge

Seven-Eleven of Japan is the most profitable convenience store franchiser in Japan with 7000 stores. They systematically integrate lag and lead information to learn how to better serve their customers. Store employees are encouraged to develop insight into markets and customers. Sales and other financial data are gathered with state-of-the-art information systems. The insights from employees are collected, integrated into hypotheses--cause and effect statements--and then combined with hard data. All of these data are widely shared, discussed, and used to direct future implementation. The effectiveness of the new actions is compared with the hypotheses, generating new insights. Hence, a new cycle of knowledge creation begins (Nonaka et al., 2000).

Southwest Airlines: Financial-Cultural Synergism The elevation of the “soft” side of management to a measurable activity has done much more that broaden the metric base of the firm. It has demonstrated both the differences and the interdependencies between the hard side and the soft side (Hollowell, 1996). The soft side (lead) scorecard is more subjective--it lacks the precision and consistency of the hard side, for example, financials. While the hard side historically tells us how we have done, it has not provided much insight into the future well being of the firm. The soft side provides a unique insight into future capabilities. For example, as a result of the 9/11 terrorist attacks, airlines, in order to survive, cut operations and employees, with the notable exception of Southwest Airlines. Many people attribute Southwest’s ability to weather this storm to its corporate culture and to highly energized and dedicated employees. They claim that culture is a cause and lead indicator of future success, but that is only part of the story. Success was built on the integration of both lead and lag metrics and activities. That integration is aligned with a corporate philosophy that puts employees first, customers second, and stockholders third. Southwest’s sustainable success in the face of an external crisis is based on both the hard and the soft sides of management. However, it is not just culture and cash. It is the synergy between them. Southwest built that cash reserve, in part to insure the jobs and well being of its employees during industry downturns. That move itself validates and strengthens the culture of dedication to the company and other employees. After 9/11 Southwest employees also took a voluntary pay cut to insure jobs and the ability of the firm to grow during a time of zero corporate profits. Contrast this with the behaviors of firms that focus on short-term profits where profits and bonuses are pushed ever higher during good times by cutting anything that is marginal including employees and cash reserves--a reasonable approach when viewed from only the hard-side metrics.

LEVELS OF INFLUENCE AND INTEGRATION Financial managers, depending on their level are responsible for particular systems and metrics, which, if well managed, will help drive the firm’s performance, growth, and innovation. The senior management level, where short-term financials often dominate, offers the financial manager a unique opportunity. As the developer and keeper of the financial systems and metrics, the senior financial executive can be influential in not only validating the importance and role of other metrics, but also in developing conversations that convert the metric data into a strategic knowledge creating process. It is unlikely that this shift to a knowledge creation process will occur without the skill and leadership of a senior financial executive who fully appreciates the importance of human assets and the human resources activities of the firm. At lower levels the focus becomes more operational. The cross-functional conversations are more about performance, for example, efficiency and effectiveness of units and cross-functional activities. At these levels it is easy for line and staff managers to lose sight of both the true short-

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term and long-term financial implications. The financial manager needs not only to take a leadership role in integrating all of the metrics into problem solving conversations, but also to help other managers understand the systemic financial implications.

Taking a Strategic-Leadership Role For the financial manager to take a strategic-leadership role in the firm that is different from the traditional role requires a new and distinctive set of competencies. In addition to insuring the integrity of the financial systems and financial data, s/he must help build the future of the enterprise by creating the knowledge that will be the bases for change. Financial managers live in a world of explicit information. To be leaders in knowledge creation they must enter the world of tacit knowledge and help integrate it with the explicit knowledge. Experiences, reflections, and insights must be integrated with costs, revenues, margins, cash flow, cost analyses, etc. in ways that make innovation possible and feasible. This integration is created through the interactions of people. Managing and influencing these interactions are keys to the long-term success of the firm. To facilitate these interactions and conversations, managers must first understand the process of knowledge creation and what might block it. Earlier in this paper the SECI knowledge creation process was presented. Here some barriers to effective interaction will be covered. Major power differences among parties, whether by level or by function, limit learning and may completely block the sharing of tacit knowledge. The expected dynamic between a high-power party and a low-power party is for the powerful party to focus on its own gain while the low-power party conforms. (Twomey, 1978; Thomas, 1976). The low-power party defers to the high-power party; for example, the low-power party withholds uncertain and unfavorable information, and the high-power party discounts the value and reliability of experience, insight and information from the low-power party. There is the tendency for the high-power party to dominate the interaction that shapes the outcomes (Kabanoff, 1991). In a study of organizational effectiveness and functional power differences (Quazi et al., 1994) found power imbalance to be a significant limiting factor for both the high-power and low-power parties. Collins, in his book, “Good to Great,” provides some useful guidelines on how to treat “brutal facts” (e.g. metrics) in a way that confronts the issue while building trust: 1. Lead with questions, not answers. 2. Engage in dialogue and debate, not coercion. 3. Conduct autopsies, without blame. 4. Build red flag mechanisms that turn information into information that cannot be ignored

(Collins, 2001: 87). This is a collaborative learning process that depends on cooperation and trust, not on internal comparison and competition. Tacit knowledge creation cannot be forced; it can only be enabled. Von Knogh, et al. (2000) say that traditional forms of compensation and organizational hierarchy do not sufficiently motivate people to develop the relationships required for continuous knowledge creation.

Global Applications International financial managers have particular challenges and opportunities. They have to work with different and sometimes not so well developed financial systems. Also they operate in diverse cultures and locations. This diversity is a potential source of knowledge creation innovation. Even if the firm has the same primary economic driver, the cause and effect contributors will vary even more than in single country operations. In order to understand and manage the activities and behaviors that support the economic driver, both the tacit and explicit knowledge of employees need to be systematically developed, integrated and applied. This can be an enormous challenge because of the cultural and language discontinuities, which are especially prevalent in non-financial areas. It is an opportunity for financial managers to help develop and

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support a full range of metrics and to use them to support the strategy and change initiatives of the firm.

Developing the Culture of Knowledge Creation

Learning and knowledge creation depend in large part on the organizational culture. Assumptions and beliefs about cooperation, competition, leadership and control play an important role in either blocking or enabling learning (Senge, et al., 1994). Financial managers are frequently in a position to set the agenda, surface assumptions, and facilitate fruitful integration of knowledge across functions and people. Below are some established principles that serve to identify learning cultures and learning processes. Argyris and Schön identify two sets of governing principles that generate divergent behavioral dynamics and outcomes--Model I and Model II theories-in-use. For Model I Theory-in-use the principles are: (1) control the purpose of the meeting or encounter, (2) maximize winning and minimize losing, (3) suppress negative feelings, and (4) be rational. Model II Theory-in-use principles are: (1) share valid information, (2) allow free and informed choice, and (3) foster internal commitment, for example, mutual monitoring of implementation (Argyris and Schön, 1996). Allowing one party to unilaterally initiate cross-functional integration (define goals and plan to achieve them)--the first variable in Model I theory-in-use--limits the exchange to explicit-to-explicit knowledge. One’s experience and insights are used in attempts to persuade or pressure others to carry out the initiator’s desires. The second Model I variable, “maximize winning and minimize losing,” is about one party individually owning and controlling the task, thereby defining success in ways that are unilaterally favorable. This prompts defensiveness and blocks learning. The third variable of Model I, “minimize generating or expressing negative feelings,” is achieved by smoothing over and suppressing conflict and by limiting disquieting information. In such a climate only politically correct and favorable information is likely to be shared. “Be rational (the fourth Model I principle) is an injunction to be objective and intellectual, and to suppress feelings” (Argyris and Schön, 1996: 94). They call this self-sealing behavior keeping insights and understandings to oneself. An outcome of a culture and process that is directed by Model I principles is what Argyris and Schön call “single-loop learning”--solving the explicit surface problem but not addressing the underlying cause. The reason is that the information shared is only at that (safe) level. Model II provides an alternative framework for cross-functional communications. The governing principle, "shared information," empowers all of the parties and brings some balance in terms of influence. It creates a genuine basis for trust. Collaboration in setting the agenda creates a genuine alignment of intent and goals. Hidden agendas, win/lose schemes, and other defensive reactions and strategies lose value and are more easily reduced. The governing principle of "free choice" minimizes win/lose elements and is the basis for powerful commitments. Anyone who is informed and has a real choice will not enter into an agreement in which he or she is the loser either in the short or long term--free choice generally fosters win/win outcomes. Also, free choice creates internal commitment, which is not only a powerful motivator, but is also the basis for learning and doing whatever is needed to achieve the freely chosen goal. McKnight, Cummings, and Chervany (1998); and Das and Teng (1998) suggest that building trust is a prerequisite to undertaking interorganizational activities.

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Model I values and behaviors often dominate performance appraisal systems, especially those that use predetermined (forced) distribution of ratings. GE’s performance appraisal system that requires 10 percent of the performance ratings to be “unsatisfactory” (dismissal) each year is an example. It is generally accepted that performance cannot be accurately assessed or measured at the individual level; therefore, this is a subjective, internal, win/lose rating system, which promotes both internal competition and hoarding of crucial information. Interestingly, the fact that managers are aware of these flaws is generally not discussed or even discussible. There is, of course, a rationale that supports the systems, that is, pay for performance; but the fact that performance cannot be effectively measured, hence not paid for, is not openly questioned. It is not hard to see how such a system blocks deep inquiry and the sharing of tacit knowledge. Performance appraisal systems are where metrics interfaces with individual employees. Unfortunately, for many firms this potentially fruitful learning opportunity is turned on its head.

CONCLUSION Financial managers have always been involved with knowledge creation but within a subscribed domain which was effective in stable domestic markets. Today’s business world and organizational dynamics call for a very different role and set of skills--a role that creates useful and usable knowledge not only by helping to create and integrate metrics across all areas and functions, but more importantly by creating the climate and processes that make it possible to learn from these metrics and effectively apply that knowledge. Three challenges to achieving this end are building collaborative attitudes and skills, tapping tacit knowledge, and managing the knowledge-to-action and action-to- knowledge-processes. Collaboration is not about holding meetings or sharing jobs. Rather it is about interactions among equals (regardless of level, function, or national origin) where a common purpose is mutually pursued. In those interactions it is the differences, the unique knowledge and experiences of others that are most valued. An major purpose of collaboration is to develop and convert tacit knowledge into explicit useable knowledge. Out of the interplay between individuals with unique insights and between hard and soft metrics, new actionable knowledge is created, for example, identifying the “cause and effect” drivers of the business. This new knowledge has three powerful outcomes: 1. Aligning activities and behaviors (performance) around these high leverage relationships. 2. Providing the foundation for extending tacit knowledge by deliberate observation of the effectiveness of implementation. 3. Linking the lifeblood of the firm with its life force.

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________________________________________________________________________ Daniel F. Twomey (Dtwomey@fdu.edu) is a professor of Management at Fairleigh Dickinson

University