Pierre Casse and Loizos Heracleous challenge leaders to be aware of externalities that can push them off course.
There are many important factors that influence a leaders’ effectiveness. However, many of them are often overlooked or underestimated. For instance, one of the most important factors is what economists refer to as ‘externalities.’ Many leaders don’t appreciate the importance of managing externalities appropriately.
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What is responsible leadership?
“In economics, an externality is a cost or a benefit that results from an activity or transaction and that affects an otherwise uninvolved party who did not choose to incur that cost or benefit.” In other words, an externality is “a cost or benefit arising from any activity which does not accrue to the person or organisation carrying out the activity.”
In this article we explore some of the critical considerations and concerns for the leader regarding the issue of externalities and we underline the reasons why this issue is important for leadership effectiveness.
What is it?
From a leadership perspective, externalities are the unconscious, unintended and often unexpected consequences of our own behaviour on other people. It is the impact that we have on people without realising it. As such, leadership externalities are the shadow side of leadership. Leadership externalities give rise to consequences which people must endure.
In other words, the leader does something which they may believe to be both sensible and rational, yet other people must now pay the price, despite the fact that they may not agree. This is sometimes called ‘collateral damage.’
Gerald Ratner, former CEO of jewellery retailer Ratner’s is well known for telling a joke during a speech at the London Institute of Directors in 1991. During his presentation he mentioned that he was once asked how Ratner’s could sell a particular product so cheaply, and in reply he said: “Because it’s total crap.”
This ‘off-the-cuff’ comment cost the company £0.5 billion in value, and hastened the company’s collapse. As a consequence, employees paid for the boss’s gaffe by losing their jobs, through no fault of their own.
How does it work?
Leaders usually have at least some idea of their objectives and priorities. They also have some idea of what they must do to achieve them. As far as they can, leaders think and act rationally and consciously.
But this is only one part of the leadership drive. Most leaders behave according to a combination of what they have learnt from leadership and management development programmes (theories), personal experiences, beliefs and psychological traits.
In most instances, most leaders act in good faith to improve the situation and they have an idea of the intended impact of their behaviour on the team members. In other words, while they know what they are doing, they also have a sense of the price ‘to be paid’ to accomplish their goals. They think they control things and people and up to a point, their assumption is correct.
However, there is also a set of reactions or consequences which the leader’s behaviour will trigger but of which they are unaware. Some unforeseen consequences will be clear and observable whilst others will remain hidden. Some will prove positive but others will prove counter-productive.
Positive
A few people benefit from the action without doing anything special. Success comes along faster and better than planned; some people’s motivation increases as a result of a new optimistic trend in the workplace. For instance, when a new leader arrives with the potential to implement change, particularly in organisations with a history of a string of leaders that have failed to produce transformational change, even though such change was needed, there is positive effect on morale. Carlos Ghosn’s turnaround of Nissan is an example of such a scenario.
Negative
Some people are adversely affected by decisions made although they played no part in deciding on the related course of action; a team is penalised as a result of some action although the decision maker did not intend such consequence; leaders’ reputations may be negatively affected, senior managers get upset, peers may resent the leader’s initiatives.
To continue the example of Carlos Ghosn’s turnaround of Nissan, a leader who manages to produce outstanding results is not immune from negative externalities in the process. For example Nissan’s board had to be reduced from 40 people to less than 10 for example, factories closed, and tens of thousands of employees lost their jobs in Japan, something almost unheard of at the time.
These measures were necessary for Nissan to improve efficiency, control costs and regain its competitiveness. While everyone knew intellectually what had to be done, three previous CEOs failed to create change, also creating negative externalities through their inaction, or inability to take tough decisions and carry them through. Leaders should be aware of what those externalities may be and how to manage them.
Why is it so critical?
Leadership externalities can constitute major obstacles for success. They can undermine leadership effectiveness. If ignored, they can also jeopardise the success of organisational plans and have an adverse effect of leadership credibility. On the other hand, some externalities can also be used as levers to help leaders be more effective.
So it seems that leadership externalities can prove either damaging or supportive depending on the nature of the situation at a certain point in time. Finally, leadership externalities involve an important ethical dimension since the question as to why other people should suffer as a result of a leader’s behaviour will inevitably arise when externalities give rise to negative consequences.
Leadership externalities
There are four major types of externalities to which leaders must pay attention.
The undesirable
Many leaders’ actions have an unexpected and sometimes unacceptable impact on people who have not been involved in the decision making process. People must endure and eventually suffer from them.
The issue here is that the range of potential consequences which may arise as a result of leader’s action cannot be controlled. Therefore leaders must be aware of the risks. They must learn how to anticipate and plan for the possible undesirable impact of their behaviour.
A team illustration: The leader wants to recognise and reward certain team members who have been contributing effectively to the success of the organisation. Obviously, these team members will be encouraged by the honours bestowed upon them. However, the rest of the team is totally demotivated and upset. Steve Jobs at Apple was well known for discriminating between individuals in a very direct way and his behaviour did create – at times – some unexpected turmoil in the organisation. As a result, some good performers took offence and left the company.
Leadership tip: The antidote to this type of externality is to ensure a fair and transparent process for giving the awards. If everyone knows what the rules of the game are, they won’t be upset when others win; they may perhaps feel envious, but motivated to try and win next time around.
The unavoidable
It is the leader’s professional and ethical responsibility to ensure that the negative impact of their actions on other people is minimised and the positive impact enhanced. To achieve that, the leader must have an intuitive idea of what the consequences of their behaviour could be. They must reflect on the possible scenarios and prepare for them.
An organisational illustration: The leader trusts her team members and knows that by empowering them she will be sure to upset her boss who does not believe in giving people power.
The leader must then be prepared to convince her sceptical boss by providing concrete evidence of the positive impact on results and work environment of her leadership style. The BASF Group is very good at empowering people in the field but the culture at headquarters is more conservative. This can create major problems when people from one part of the company have different behaviours and assumptions to people in another part.
Leadership tip: A critical skill in controlling this externality effectively is to be able to ‘manage upwards’. One must understand the boss’s perspective and, where appropriate, convince the boss through reasoned argument and concrete evidence. Moreover, it is important to promote mutual understanding between sub-groups in the organisation.
The irreversible
A more important and challenging scenario arises in instances in which some of the consequences resulting from the leader’s actions will not only be unconscious and undesirable but also serious and irreversible. Such a situation will not prove so problematic provided such consequences have a positive impact on those affected. However, and unfortunately, this is not always the case.
A business illustration: Schlitz beer was a leading beer in America in the 1960s. In 1967 the leadership decided to increase profitability by fermenting the beer in an accelerated fashion and adding artificial ingredients, plus initiating a disastrous advertising campaign which consumers found too aggressive.
Soon beer drinkers realised the taste was different, there was haze in the beer, and market share started sliding, when in 1982 Schlitz was acquired by Stroh, which itself had to sell the Schlitz brand to Pabst in 1999.
This whole process amounts to almost incompetent leadership; taking actions that are well intended but that destroy a company, with adverse externalities felt by employees, communities and consumers. Currently the adverts proclaim that the brewing method has returned to the traditional process as used in 1960.
Leadership tip: The art of leadership is to turn the negative and unexpected outcomes of well-meaning actions into an opportunity. Blaming people does not solve anything. The question that the leader should ask is: How do I transform this problem into something good? Sometimes this is difficult to do, when well-meaning but ill-conceived actions backfire. In those cases, leaders have to try and salvage what they can.
The fortuitous
Sometimes externalities of leadership actions are positive, often unexpected. These may be hard to predict but it is a bonus when they happen.
A political illustration: When US states legalised abortion in the 1970s, there were substantial drops in crime about 18 years later. About half of the reduction in crime was attributed to the legalisation of abortion. Despite the ethical conundrums posed by abortion, the reduction of crime was a fortuitous externality3.
Leadership tip: Leaders should keep in mind the possibility that their endeavours may trigger some positive and unpredictable reactions in their environments. They should be flexible enough to build on those and maximise the return.
Leadership guidelines
Leaders can develop their overall leadership effectiveness by focusing on three key guidelines:
- Acknowledge the fact that all behaviours have positive and negative unknown consequences that one way or another will affect people who are not part of the leaders’ decision making processes. Everything a leaders does is symbolic and watched closely; keeping this in mind will help you act in a way that is consistent with your goals.
- Develop your ability to ‘anticipate’ or foresee what some of the consequences could be for those critical actions that you take. Systemic awareness is key in order to appreciate how things are interrelated, and people have goals and agendas beyond what they willingly or explicitly disclose.
- Be ready to maximise the positive consequences and minimise the negative ones. The ability to move quickly and turn mistakes or unforeseen negative consequences into opportunities is a critical issue for leadership in a fast changing world. Effective leaders are able to get people to focus on the good things and de-emphasise the negative aspects of a given situation.
About the author
Pierre Casse is Professor of Leadership from the Moscow School of Management-SKOLKOVO and Loizos Heracleous is Professor of Strategy at the Warwick Business School.
