29th March 2004

"Getting tacit knowledge to work"

By AMIN RAJAN

"If HP knew what HP knows, we would be three times as profitable," said Lew Platt, former chief executive of Hewlett-Packard.

His observation was based on the widely accepted view that, as humans, what we speak and write every day is less than one per cent of what we actually know. The rest is tacit knowledge that cannot be articulated easily because it resides in our insights, instincts and intuitions.

The key to business success, then, is to download this knowledge wherever possible by creating special inter-personal encounters in which ideas breed new ideas, akin to the law of increasing returns.

Mr Platt's views sparked off a worldwide interest in how to tap in to tacit knowledge, and leverage it to create new products, improve processes, reduce costs and increase return on capital.

IBM, hitherto Hewlett-Packard's arch rival, was the most prominent early convert, after posting the biggest loss in corporate history back in 1993. Paradoxically, the company had record sales that year: it was able to sell everything that it could make.

The only problem was that cost exceeded revenue by some Dollars 5bn. Despite its renowned army of marketing specialists and technologists, it could not see that its products were getting out of date in the face of rapid miniaturisation.

The problem was that these people did not share ideas among themselves or with customers: in management jargon, they worked in "silos". In a sales-driven culture, the only thing that mattered was the top-line, not unlike fund management in the last bull market.

Some seven years later, IBM achieved an amazing turn-around. Lou Gerstner, its architect, linked it with many factors, not least of which was the company's newly-created elaborate personal networks where people shared their ideas freely in the belief that knowledge is only power if it is shared - it's not power otherwise.

To underline the point, it is probably true to say that the person who invented the first wheel was almost certainly a lucky fool, while the one who invented the other three was a genius.

In fund management, the centrality of tacit knowledge cannot be exaggerated: it lies at the heart of alpha generation. Not surprisingly, therefore, attempts are being made to capture and incorporate it into corporate "memory" by getting portfolio managers to share their ideas freely and inviting response.

Pimco, for example, account managers do a lot of research on their clients and share it with portfolio managers. The quality and intensity of their interaction has put Pimco in an enviable situation where it not only generates excellent investment performance but also provides top quality client service. Its client retention rate is exceptional by industry standards.

Similarly, at F&C Management, analysis and portfolio construction interact intensely across investment desks, identifying the strongest ideas to meet client needs. The firm's compensation scheme is tailored to reward good ideas wherever they come from, as well as good performance.

T Rowe Price, analysts are rewarded for coming out with good ideas even if these are not implemented by portfolio managers.

Generally, in global fund management firms, there is a growing interest in setting up communities of interests which bring professionals together in a bid to discover what they know, share it with colleagues and in the process create new knowledge for their firm. Their interactions are informal and usually last for an indeterminate period of time.

Compared to other industries, these initiatives are modest in scope and scale. But their importance cannot be underestimated. Symbolically, they underline the point that fund management is becoming a mature industry which has no place for lone rangers doing their own thing. Commercially, they recognise that new investment ideas come from people of diverse styles and views interacting regularly. After all, if two people think similarly, what have they got to offer each other?

Alexander Fleming never set out to discover penicillin; nor did the scientists at Pfizer who stumbled on Viagra initially realise the full potency of their new drug.

In both cases, serendipity played a major role by exposing the innovators to people who saw the results of early experiments in very different lights.

Their questioning attitudes in a risk-free environment led to outcomes that were undreamt of.

Such an engagement has transformed IBM into the largest software and consultancy company in the world, startlingly different from a commoditised mainframe manufacturer.

In fund management, one of the key challenges in this decade is how to go from knowledge-hoarding to knowledge-sharing in a way that ideas can breed new ideas. The cult of individualism is still powerful in the front office. As an unintended consequence, it also creates a chasm between the front and back office in numerous firms around the world. Blame cultures are all too evident, as a result. In people business, this is a recipe for failure. Many enlightened initiatives have had the same effect as re-spraying an old car: better external appearance but the same old engine performance.

Although Mr Platt saw a direct link between knowledge and business success, firms which have implemented new initiatives on knowledge-sharing report numerous other benefits, including more resilient business cultures and higher market value; the latter reflecting higher intellectual capital emerging from the accelerated flow of ideas. Knowledge exchange and creation is in its infancy in the fund management business. But the future belongs to firms that take up the challenge.

Amin Rajan is CEO of CREATE, a research consultancy specialising in new business models in financial services: amin.rajan@create- research.co.uk.