The Fractal Model: Review of 500%

How internal market replaced the managers

‘500%: How two pioneers transformed productivity - the first truly self-leading organisation‘ tells the story of a company transformation. Matt Black Systems was failing back in 2003 and was about to go out of business. They tried Lean methodology and worked with expensive consultants. Nothing worked. The quality and productivity were below standards.

At that point, the owners decided to try something radical and see where it will lead them. What they achieved is a great exemplar of how market-based volunteer coordination can work within an organization leading to significant cost reduction, improvement in productivity, quality, employee remuneration and engagement.

The book goes into great detail about the stages and steps taken on this path of transformation. It went as a series of experiments. The first one was to change the overtime compensation.

Data showed little correlation between hours worked and output produced. It seemed possible that overtime payments were encouraging long work hours without increasing production.

So instead of paying for the overtime hours to complete the required orders, each employee got a fixed overtime bonus equal to their previous average overtime pay. What happened then is, once the overtime bonus was secure, employees started hitting the target in fewer hours. Quality remained the same; working hours fell by 20%. That was the first real productivity-increasing program the company was able to achieve in years.

When the employees' self-interest was directed in the right way a magic thing happened. People started doing more with less time.

Internal market

Step by step, experiment by experiment they build what they called the fractal model. Eventually, everybody was operating as a virtual company. Everyone had their individual P&L (profit and loss) account and balance sheet and was participating in the internal market trading and making agreements with each other.

the internal market... provided the price discovery that valued each person’s contribution to the organisation.

In a traditional company and at Matt Black pre-transformation, it is next to impossible to track individual contributions. The internal market made everyone's contribution visible. It improved cooperation and directly awarded better performance.

Coordination

Typically company buys working time from employees. Managers coordinate productive activities. They decide and control how employees spend their time. With the internal market, managerial coordination is replaced with price coordination. Market interactions uncover prices. Prices are used to decide what needs to be done.

[Employees] form consortia and internal supply chains to satisfy contracts. These voluntary, self-selected teams have proved themselves to be much more effective than the previous teams we allocated to projects, both in terms of capability and cost effectiveness. The individual virtual companies formed into a self-supporting network.

Cost-cutting

The problem with internal bureaucracy is that it tends to grow. Executives in charge of bigger teams have more status and influence. So often cutting costs is not in their interest. Are the costs warranted? It's hard to tell without seeing the real contribution.

The internal market made visible who was responsible for huge costs without producing much value. Admin functions such as 'supervision, quality management, stores, finance and accounting, human resource management and purchasing, as well as a range of bureaucratic activities associated with statutory and regulatory compliance' were dissolved. Their work either became obsolete or it was efficiently devolved to the employees in production cells. For example, production cells took on responsibility for purchasing and quality control.

It led to immense savings. It also improved the speed and quality of decisions because people with the most knowledge made the decisions.

The right parts were ordered at the right time and in the right quantity because they were purchased by the people most familiar with the requirements. On arrival, the parts were properly checked as they were being inspected by the people who were most familiar with them and who were going to utilise them. The price advantage of buying in bulk, the promise of centralised purchasing, proved to be insignificant compared to the many advantages of decentralised purchasing.

Employee compensation

The fractal model aligned employees' self-interest with the interest of the company and its customers. The internal market revealed how much value everyone is bringing. And then, everyone was paid accordingly.

The payment consists of a fixed salary and a 20% profit-sharing bonus. Everyone has an incentive to increase their individual profit because they get a significant part of it.

People can fast track their basic pay, mirroring their increased ability to utilise their talents and add value. In some cases, this new approach led employees to earn double or even triple what they could command in the wider employment market.

Delivering value is the focus. Before, the focus was to show up and follow the instructions no matter how well that served the customers.

They considered that their commitment only extended to making themselves available for work every day. They were not willing to make any promise with regard to their work, other than to be available to do what they were told.

The salary is less connected to time spent at work but to the value delivered. This led to higher productivity and higher compensation.

Can anyone work in a company like this?

In the new model, every employee needs to be entrepreneurial. Freedom and opportunity to earn more come with, as admitted, by one the employees with 'risk, responsbility and accountability'

“Sometimes it is pressurised because you are dealing with a lot of things at the same time. It can very easily get on top of you. We have all had sleepless nights.”

The question then is whether anyone is capable of working in such environment? The authors are quite explicit that old employees were resisting a lot of these changes. Especially those 'whose jobs are threatened or whose managerial importance will be diminished.' Often these people didn't find a place for themselves in the new environment and decided to leave the company.

At the same time, new graduate hires were much more receptive to this fractal model. They didn't have deeply engrained working habits and mental models about how the workplace should operate. So it was much easier for them to acclimatize to this unconventional company.

Performance management

Performance management is turned on its head in such a model. The numbers behind each virtual company speak for themselves. People who are not able to deliver based on their agreements are held accountable.

poor performance meant their colleagues looked elsewhere for a supplier, one who lived up to their promises. The rules of the internal market allowed each cell to choose where they sought internal services. Consequently, cells voted with their order books.

If someone is having a difficult month there is a system of internal loans. But they are only short-term. If bad performance is persistent and others refuse to give a loan the employee goes through 'Rescue and Recovery ' process. They need to

formulate a self-improvement plan, to identify educational needs and to submit to a much higher level of audit. When we needed to apply the policy, the operator’s income would be subsidised and upon its successful conclusion they would once again be authorised to re-join the internal market as an independent cell.

people would rarely spend long in this process. They would either quickly address the shortfalls that drew them into Rescue and Recovery, or claim the subsidised pay until they found another job.

Employee morale

The transformation affected not only tangible metrics like financial performance and quality but also the culture and employee engagement. Before the transformation

There always seemed something to complain about, sometimes bordering on the adversarial. Staff seemed to be demanding protection from the vagaries and threats of the outside world, but were not willing to respond directly to its demands and expectations.

Obedience, loyalty and dependability were valued more highly than the use of initiative.

After the transformation, people are engaged and proud.

There seemed a visible shift in demeanour which was hard to describe. People seemed to be walking taller, using more forthright language and were more confident. We didn’t understand how, but they seemed to extract extra personal meaning from their work that wasn’t there before.

The role of the company

The fractal model of the organization may also help us reframe how we think about the role of the company

The individual is the steward of the assets on their Balance Sheet and therefore they control their means of production. The financial imperative of this model is that they must provide an income for themselves, plus a surplus in return for the use of the resources. They must form contracts and make commitments, they must arrange their resources and activities such that they deliver on their commitments, satisfy their contracts and create a surplus”.

So everyone is a quasi-entrepreneur operating in a wider platform provided by the organization.

Here's how the Chartered Institute of Personnel and Development report summarizes it

Unlike most traditional business models, the business acts as the supplier to the employees (for example, providing the investment, the workspace, the brand and the business management software). Such a model puts pressure on the business to deliver more efficient and effective tools, so that the employees can deliver more efficiently and effectively to their customers.

Conclusion

The only downside of the book is that it's fairly short and doesn't provide a fuller picture of how the company operates. It would be curious to see more details and examples. E.g. of how the internal pricing mechanism coordinates the production of a certain item. Also, it would be great to see RnD operates in this model.

But overall it tells an inspiring story of how market coordination allowed achieving extraordinary improvements across the board.

And it provides insight into how companies can operate in a different way.