Thursday, March 31, 2011

The Problem with Financial Incentives

... and what to do about them

Bonuses and stock options often improve performance. But they can also lead to unethical behavior, fuel turnover and foster envy and discontent. In this opinion piece, Wharton management professors Adam Grant and Jitendra Singh argue that it is time to cut back on money as a chief motivational force in business. Instead, they say, employers should pay greater attention to intrinsic motivation. That means designing jobs that provide opportunities to make choices, develop skills, do work that matters and build meaningful interpersonal connections.

Enron. Tyco. WorldCom. The financial crisis. As corporate scandals and ethical fiascoes shatter the American economy, it is time to take a step back and reflect. What do these disasters have in common? We believe that excessive reliance on financial incentives is a key culprit.

Starting in the mid to late 1970s and 1980s, the view emerged in management thinking that the primary role of corporate leadership was to maximize the interests of shareholders. In time, this view came to be known as financialization, and maximizing shareholder value became the reigning mantra. Over time, the belief became almost axiomatic; questioning it was tantamount to heresy in many schools of thought.

This broader perspective translated at lower levels of organizations into an emphasis on rewarding employees with financial incentives contingent upon performance. The thinking seemed to be: Get the incentives right, and people will be motivated to perform better, resulting in better performance for the firm. Researchers Brian Hall of Harvard Business School and Kevin Murphy of the University of Southern California found that less than 10% of total executive compensation at publicly held firms was contingent on stock prices in the early 1990s, but by 2003 that share had ballooned to almost 70%. And despite the bad press and public uproar that big payouts generated in the wake of the financial crisis -- when critics pointed out that many top executives had been heavily rewarded for short-term performances that ultimately proved disastrous -- the system marches on. CEO bonuses at 50 big U.S. companies rose more than 30% last year, a gain not seen since before the recession, The Wall Street Journal reported in mid-March.

To be clear, we are not suggesting that companies abandon financial incentives. Indeed, there is a wealth of evidence that these incentives can motivate higher levels of performance and productivity. To assess results across multiple studies, researchers have used a technique called meta-analysis. As Sara Rynes of the University of Iowa and her colleagues summarize, on average, individual financial incentives increase employee performance and productivity by 42% to 49%.

But these gains come at a cost. Our concern is about the unintended consequences of financial incentives. What do they mean for unethical behavior, jealousy and turnover, and intrinsic interest in the work? And what measures can be taken to lessen their negative impact?

Three Important Risks
Several years ago, Green Giant, a unit of General Mills, had a problem at one of its plants: Frozen peas were being packaged with insect parts. Hoping to improve product quality and cleanliness, managers designed an incentive scheme in which employees received a bonus for finding insect parts. Employees responded by bringing insect parts from home, planting them in frozen pea packages and then "finding" them to earn the bonus.

This is a relatively benign example, but it points to a serious problem. Incentives can enhance performance, but they don't guarantee that employees will earn them by following the most moral or ethical paths. Research by Wharton management professor Maurice Schweitzer and colleagues demonstrates that when people are rewarded for goal achievement, they are more likely to engage in unethical behavior, such as cheating by overstating their performance. This is especially likely when employees fall just short of their goals. Harvard Business School's Michael Jensen has gone so far as to propose that cheating to earn bonuses -- such as by shipping unfinished products or cooking the books to exceed analysts' expectations -- has become the norm at many companies.

When strong financial incentives are in place, many employees will cross ethical boundaries to earn them, convincing themselves that the ends justify the means. When we value a reward, we often choose the shortest, easiest path to attaining it -- and then persuade ourselves that we did no wrong. This tendency to rationalize our own behavior is so pervasive that psychologists Carol Tavris and Elliot Aronson recently published a book called Mistakes Were Made (but not by me) to explain how we justify harmful decisions and unethical acts.

In addition to encouraging bad behavior, financial incentives carry the cost of creating pay inequality, which can fuel turnover and harm performance. When financial rewards are based on performance, managers and employees doing the same jobs receive different levels of compensation. Numerous studies have shown that people judge the fairness of their pay not in absolute terms, but rather in terms of how it compares with the pay earned by peers. As a result, pay inequality can lead to frustration, jealousy, envy, disappointment and resentment. This is because compensation does not only enable us to support ourselves and our families; it is also a signal of our value and status in an organization. At Google in 2004, Larry Page and Sergey Brin created Founders' Awards to give multimillion-dollar stock grants to employees who made major contributions. The goal was to attract, reward and retain key employees, but blogger Greg Linden reports that the grants "backfired because those who didn't get them felt overlooked."

This claim is supported by rigorous evidence. Notre Dame's Matt Bloom has shown that companies with higher pay inequality suffer from greater manager and employee turnover. He also finds that major league baseball teams with larger gaps between the highest-paid and lowest-paid players lose more games; they score fewer runs and let in more runs than teams with more compressed pay distributions. The benefits to the high performers are seemingly outweighed by the costs to the low performers, who apparently feel unfairly treated and reduce their effort as a result.

Similarly, Phyllis Siegel at Rutgers and Donald Hambrick at Penn State have shown that high-technology firms with greater pay inequality in their top management teams have lower average market-to-book value and shareholder returns. The researchers explain: "Although a pay scheme that rewards individuals based on their respective values to the firm does not seem unhealthy on the surface, it can potentially generate negative effects on collaboration, as executives engage in invidious comparisons with each other."
Other studies have shown that executives are more likely to leave companies with high pay inequality. The bottom line here is that financial incentives, by definition, create inequalities in pay that often undermine performance, collaboration and retention.

A third risk of financial incentives lies in reducing intrinsic motivation. In the 1970s, Stanford's Mark Lepper and colleagues designed a study in which participants were invited to play games for fun. The researchers then began providing rewards for success. When they took away the rewards, participants stopped playing. What started as a fun game became work when performance was rewarded. This is known as the overjustification effect: Our intrinsic interest in a task can be overshadowed by a strong incentive, which convinces us that we are working for the incentive. Numerous studies spearheaded by University of Rochester psychologists Edward Deci and Richard Ryan have shown that rewards often undermine our intrinsic motivation to work on interesting, challenging tasks -- especially when they are announced in advance or delivered in a controlling manner.

Autonomy, Mastery and Purpose
So, the good results generated by financial incentives need to be weighed against the bad: encouraging unethical behavior; creating pay inequality that reduces performance and increases turnover; and decreasing intrinsic interest in the work. To limit the negative effects, we recommend that financial incentives should be (a) used primarily for tasks that are uninteresting to most employees, (b) delivered in small sizes so that they do not undermine intrinsic motivation and (c) supplemented with major initiatives to support intrinsic motivation.

Stanford's Chip Heath has shown that managers tend to have a strong bias in favor of extrinsic incentives: They rely too heavily on financial rewards, underestimating the importance of intrinsic motivation. In Drive: The Surprising Truth About What Motivates Us, Daniel Pink summarizes a rich body of evidence that intrinsic motivation is often supported by three key factors: autonomy, mastery and purpose. High effort and performance often result from designing jobs to provide freedom of choice, the chance to develop one's skills and expertise and the opportunity to do work that matters. Evidence also supports the importance of a fourth factor: a sense of connection with other people.

Autonomy involves freedom of choice in what to do, when to do it, where to do it and how to do it. Extensive research has shown that when individuals and teams are given autonomy, they experience greater responsibility for their work, invest more time and energy in it, develop more efficient and innovative processes for completing it and ultimately produce higher quality and quantity. For example, in a study at a printing company, Michigan State's Fred Morgeson and colleagues found that when teams lacked clear feedback and information systems, giving them autonomy led them to expend more effort, use more skills and spend more time solving problems. Numerous other studies have shown that allowing employees to exercise choices about goals, tasks, work schedules and work methods can increase their motivation and performance.
Mastery involves the chance to develop specialized knowledge, skills and expertise. Research shows that when employees are given opportunities for mastery, they naturally pursue opportunities to learn and contribute. For instance, research by the University of Sheffield's Toby Wall and colleagues documented the benefits of giving operators of manufacturing equipment the chance to develop the skills to repair machines, rather than waiting for engineers, programmers and supervisors to fix them. The operators took advantage of this opportunity for mastery to create strategies for reducing machine downtime, and worked to learn how to prevent problems in the future. As a result, they were able to complete repairs more quickly and reduce the overall number of repairs.

Purpose involves the experience of contributing to a meaningful effort or cause. Adam Grant (one of the authors of this piece) has shown that when employees meet even a single client, customer or end user who benefits from their work, they gain a clearer understanding of the purpose of their jobs, which motivates them to work harder and smarter. For example, when university fundraisers met a single scholarship student who benefited from the money that they raised, the number of calls they made per hour more than doubled and their weekly revenue jumped by 500%. And when radiologists saw a photo of the patient whose X-ray they were evaluating, they felt more empathy, worked harder and achieved greater diagnostic accuracy. In The India Way, Wharton management professors Peter CappelliHarbir Singh, Jitendra Singh (one author of this piece) and Michael Useem observe that Indian companies have found success in motivating employees by cultivating a strong sense of purpose and mission. As Adam Smith, the father of economics, wrote in A Theory of Moral Sentiments: "How selfish soever man may be supposed there are evidently some principles in his nature which interest him in the fortunes of others, and render their happiness necessary to him, although he derives nothing from it except the pleasure of seeing it."

Connection involves a sense of community, belongingness and being valued by others. Although financial incentives can support connection for star performers, they often impede it for the rest of the organization by creating pay inequality. Studies consistently show that the strongest driver of turnover is not pay, but rather the quality of an employee's relationships with supervisors, co-workers and customers. In a meta-analysis led by Rodger Griffeth of Georgia State University, the quality of relationships with their direct bosses explained more than twice as much variance in employees' decisions to quit as did their objective pay levels or satisfaction with their pay. 

Even a small but genuine gesture of thanks can help employees feel valued. In a study conducted with Francesca Gino of Harvard Business School, Adam Grant found that the effort of call center employees increased by 51% during the week after an external manager paid them a single visit to express appreciation for their work. In short, relationships matter for retention and motivation.

Finding the Right Context
Researchers Amy Mickel of California State University, Sacramento, and Lisa Barron of the University of California, Irvine, have argued that managers should think more carefully about the symbolic power of financial incentives: who distributes them, why they are distributed, where they are distributed and to whom they are distributed.
When incentives are given by high-status leaders, employees may see them as more meaningful. For example, blogger Greg Linden notes that "Google rarely gives Founders' Awards now, preferring to dole out smaller executive awards, often augmented by in-person visits by Page and Brin." When incentives are awarded in public, they confer greater status but also make inequality more salient. Carefully designing financial incentive programs to carry symbolic meaning can be an important route to enhancing their effectiveness and reducing their adverse consequences.

So what does the overall picture look like? We believe that financial incentives have an important role to play in employee motivation, but the reality of human motivation is more complex than the simpler vision built into the financialization model. Excessive reliance on financial incentives can lead to unintended consequences that sometimes defeat the very goals they are designed to achieve. We feel that it is also important, for instance, to create cultural contexts that help shape norms, values and beliefs specifying guidelines for inappropriate actions, regardless of financial incentives.

Perhaps such an approach would have saved the school board members in Kenosha, Wis., from losing a large chunk of their teachers' retirement plan in risky investments called Collateralized Debt Obligations (CDOs). These investments should never have been sold to them. Although the financial incentives for all the actors in the decision chain were well aligned, what was apparently missing was the necessary ethical restraint.

'Gamification' and the Power of Analytics

From Jewel Quest to World of Warcraft, gaming has always occupied a niche online. By combining the social might of Facebook with the narrative element of experiential games like Oregon Trail or The Sims, Zynga -- a social network game developer based in San Francisco -- was able to become one of the fastest-growing companies on the Internet. Millions of Facebook users play FarmVille, Mafia Wars and the company's other titles -- with many shelling out real dollars to add to their virtual barnyards or crime syndicates. A recent New York Times report put Zynga's estimated value at $10 billion, noting that investments have quintupled its worth over the last two years.

Andrew Trader was a member of Zynga's founding team in 2007, and until last year served as executive vice president of sales and business development. Previously, Trader was CEO of, a social network sold to Cisco in 2007, and co-founded Coremetrics, a website marketing analytics firm. Trader (otherwise known as "AT") is currently entrepreneur-in-residence at Maveron, a venture capital firm with offices in Seattle and San Francisco. In a recent interview with Knowledge@Wharton he discussed the rise of social gaming, how "gamification" is seeping into other industries, the importance of analytics in Zynga's success, and the different strategies male and female users employ in building virtual worlds in its games.
An edited version of the transcript appears below.

Knowledge@Wharton: You're currently employed as entrepreneur-in-residence at Maveron, a venture capital firm. Can you tell me a little about what that job entails?
Andrew Trader: As an [entrepreneur-in-residence], I am looking for my next big opportunity.... I work with [the Maveron team] by bringing them interesting opportunities, and they show me interesting things that they're pursuing or that they're looking into. It's a great symbiotic relationship.... My next big opportunity has four criteria: It's a transformational consumer experience; something that's massively scalable; something that uses the same social gaming mechanics ... that have made FarmVille, CityVille and Zynga's other games so successful. It may not be a game per se, but [a project that] uses some of the similar mechanics, and also, something that has a little bit of social benefit. Zynga has raised $4 million for charities, including Haiti and Japanese [earthquake] relief. That, to me, is a really important part of the overall mission.

At the end of the day, that transformational consumer experience is what gets me excited. Part of the reason for Zynga's historic success and growth has been its ability to create a quick, easy, lightweight, fun, social interaction with your real friends. And it changed everything: It took online games out of the shadows and put them into the light of day, into the hands of the mass market. I've been lucky enough to be [part] of three big, transformational consumer experiences: Zynga with social games, Tribe with social networks, and Coremetrics with e-commerce and making sense out of e-commerce with data and analytics....

Knowledge@Wharton: What type of tech startups do you think will be the wave of the future? Is it going to be more social gaming? It seems like a lot of location-based services have sprung up in the image of Foursquare, and also clones of the Groupon model.
Trader: It's all social. We are just scratching the surface when it comes to social. Social media has changed everything. It has changed the user experience. It has lowered the bar for [being able to launch] startups, and created companies of historic proportions in terms of growth. I believe that the way that we find, use [and] consume media, commerce, shopping, services, everything, is going to involve a social component -- and that's [coming] over the next few years.... According to The Wall Street Journal, Groupon and Zynga are two of the fastest growing companies, if not the two fastest growing companies, in the history of commerce, and it's because they nailed that social component.

Knowledge@Wharton: It seems like a lot of people are trying to launch initiatives based around social media. There are many startups in this space, and a lot of people taking the Groupon model and trying to capitalize on that, or using the Zynga model, and trying to innovate from that. What sets apart the startups that make it from those that don't? What factors are the most important?
Trader: It's providing an authentic, compelling, valuable social experience. Zynga and Groupon are a little bit different. For Zynga, that ... social connection continues to be a very deep and real compulsion for the daily usage of the games. Groupon started that way. Groupon nailed that social selling piece [with the idea] that deals were only active once they tipped, which meant they hit a sort of minimum threshold. That was a reason for users to go out and send that [deal] to their friends, because they wanted ... to take advantage of the deal, but they could only get it if a certain number of people took advantage of it. The problem now is that those things tip --

Knowledge@Wharton: In two minutes?
Trader: In two minutes, right. And so it's lost a little bit of that social compulsion. I think Groupon has a massive potential opportunity if it could reignite that social dynamic, and I am confident that they probably will. With Zynga, it starts with that social element. What they've done amazingly well is use the social gaming mechanics -- for example, the harvesting [mechanic] in FarmVille, an energy and gifting mechanic in Mafia Wars and a neighbor mechanic in CityVille, all of which encourage the user to not only play today, but also to come back tomorrow. In Farmville, there's nothing worse than having your crops wither. In Mafia Wars, there's nothing that makes me happier than somebody adding me to their mafia. And I will want to repay that favor.

Knowledge@Wharton: Looking at FarmVille and CityVille and some of those other Zynga games on Facebook, it brings me back to those days when I was a kid and I was playing Oregon Trail [a computer game about 19th century pioneer life,] where you're trying to make sure your settler doesn't die of cholera. What do you think it is about social gaming that's really made it catch on with customers? What is it that makes people really almost obsessed with coming back and making sure their farm is staying alive, making sure they're taking out people in Mafia Wars?
Trader: It's funny that you bring up Oregon Trail. There were two versions of Oregon Trail in the early days of the Facebook platform that both took off and then went to zero. The problem was that there wasn't enough depth in the game.... It ended too fast. If you weren't developing those games in a way that had significant depth, so that a user found value in it every single day, every single visit, they're just short lived. That was the problem with a lot of gaming. If you remember all the way back to 2006, the online gaming experience was ... casual games that you could play on Pogo or Yahoo Games or AOL Games, where it was a single player experience. It was solitary. You felt dirty after you played the games [because] they were fun and a little bit addictive. You couldn't stop once you started.
But it wasn't a fulfilling experience because it wasn't social, you weren't playing with your real friends, and you're looking over your shoulder trying to see if anybody's watching you.

The other experience was the hardcore MMOs [massively multiplayer online games, which support hundreds or thousands of players simultaneously], like World of Warcraft, which is a great niche of 10 million monthly users. But it's still a niche.... It's not for everybody; users invest, three, four, five hours a day in games like that.

Social games hit a mass market for three reasons. This was our belief when [Zynga co-founder] Mark Pincus and I and the rest of the founding team at Zynga were talking about social gaming. Our belief was we could reach a mass market by, one, making the [games] fun and quick and easy; two, by making them real social, so you're playing with your real friends, and three, enabling the user to express themselves in the game. If [users] were willing to express themselves, and if you provided a way for them to express themselves, they'd be willing to invest their time, their social network and even a little bit of hard dollars.

Knowledge@Wharton: To make sure that a game is going to create that value and that experience for a consumer, it would seem that if you're developing it, you would really have to play it all the way through and sort of delve into those layers to make sure that it does. Can you tell me a little bit about that process in terms of your experience at Zynga, and maybe in terms of some of the projects you're working on now?
Trader: I still remember the first time that I really had that emotional connection. I was playing one of our first word games, which was a game called Scramble. I was playing with ... a good buddy of mine. He ... lives in the neighborhood, but I never see him. I hardly ever call him on the phone and we rarely email each other. And forget about texting or IMing each other. There's no time for that, right? We have busy lives and families.

When I was playing Scramble with him, it was an asynchronous game, which meant you didn't have to be online at the same time. When we were playing that game, it felt like no time had passed between the times that I actually did see him because there was that real, fun, quick, competitive connection that we were sharing. That's when the lights came on for me. It was at that moment that I felt very confident that Zynga's games could reach the mass market and could deliver this really satisfying social experience....

Knowledge@Wharton: Was everyone at Zynga becoming obsessed with not letting their crops die on FarmVille a couple of months before the Facebook users were? Just to make sure the game was going to work the way you intended it to work?
Trader: Big studios are not only managing all kinds of new features, but building on those social gaming mechanics. You're really zeroing in on the stuff that drives that compulsion. As a user, you're not exactly sure that's what's at work there. You just know that getting a gift from somebody feels really good. And when you do, you want to return a favor. Or [if] somebody is asking you to be their neighbor [in a game, you think], "Hey, that feels really good. I want to pay that person back. And oh, by the way, it felt so good that I want to invite a couple of other friends of my real friends to be my neighbors. Oh, and by the way, by doing that, it's actually helping me progress faster in the game. I'm accelerating my experience in the game."

All of those things are at play. We had phenomenal product and development teams that innovated around those social gaming mechanics and added features.... But that's also why Zynga has 1,600 [employees] now. Each [gaming] studio can have 60, 80, 100 people in it.

Knowledge@Wharton: How do you think that customers' affinity for social gaming can be leveraged into other sectors? Can you take what made FarmVille work, what makes CityVille work, and apply that to the business world, for example?
Trader: The trend now is called gamification, which I find a little bit hard to say. But suffice to say, gamification means applying those successful social gaming mechanics to other areas.... There's nothing that I find more valuable than when a friend suggests an article for me to read. I don't find anything more valuable than when a friend says, "Hey, I got these climbing shoes at REI. You should check them out." There's nothing more valuable for me than when a friend says, "Hey, I just found a new financial advisor" or "I found a new doctor...." Almost every aspect of my life is better, satisfying, more fulfilling and easier when my friends are suggesting or recommending, or are able to have some input on the things that I do and buy and see and watch and consume and eat. I believe every one of those industries that are affected will benefit from social.

Knowledge@Wharton: How do you take that idea of friends suggesting things to friends and apply it to other industries, and where does the game part come in?
Trader: Take health and wellness -- imagine if a health insurance company was so progressive that they said, "You know what? For everything that you do that's healthy or that benefits you from a wellness standpoint, we're going to give you points. Eat a healthier diet, see a doctor more regularly, have your blood pressure checked, take vitamins [and] you're going to get points in the game of health, the health game, the wellness game. As you progress, you're not only going to get these virtual benefits -- [where the insurance company will] put you on a leader board among your friends saying, "Here's AT and he's a super healthy guy" -- [but where the company will] also turn it into a real, valuable experience by having it affect my premiums....

Knowledge@Wharton: As social media has grown, there's been a lot of talk about this idea that people are more comfortable sharing things that might have been kept private years and years ago. What are the challenges creating a profitable social gaming application, but balancing that with a need to protect users' privacy? And also to protect users against scams?
Trader: Zynga has always been super, super sensitive to privacy issues and has made sure to follow the Facebook Terms of Service and [the] terms of service [of whatever platform] that we've been on, and to follow those extremely closely.... I'm a consumer, too. I want my privacy protected. I think the best news has been Facebook's aggressive approach to privacy, [which] has had significant backlash in the last half year. It's made them rethink a number of their policies and approaches, and I think it's better for everybody. Facebook, its users and its development community, are all benefiting from that.

Knowledge@Wharton: Because Zynga and other applications like it have been so successful, there are a lot of other companies wanting to be a part of that, and tie offers from that business to different benefits users can purchase to move forward in the games. How do you protect users against spam or scams?
Trader: That whole process has been totally redefined in the last almost two years now. Once [leadership at Zynga] realized that there were offers that were misleading, were scammy or spammy, were confusing, were fraudulent, we took a really, really hard line. We dropped all of the offers from our site for over a month. We wanted to make sure that we had a system in place that would help monitor, as well as have a manual process for evaluating and approving every single offer that went back onto the offer walls. Facebook also changed its policies to insure that the user experience was protected. I feel good now that the industry as a whole has addressed that for the benefit of the consumer.

Knowledge@Wharton: What type of conversations do you expect going forward in terms of privacy concerns?
Trader: Those [scam] offers have been around a long time on different places, in different forms. You can find them all over the web. They're not as regulated, frankly, as they are on Facebook and some of the other networks, and they don't have companies like Zynga, who are championing the user experience, who put forth the understanding that if you violate the trust of a user, that user will never come back....

Knowledge@Wharton: Now getting back to your health care example, if someone's playing this "health care" game, they're not only gaining benefits, they're also providing a great amount of data to that company. How are companies able to leverage this?
Trader: The dirty little secret of Zynga is, of the five corporate values, none is more important than being metrics driven. For Zynga, that meant if you can't measure something, don't build it. If you couldn't measure the results, don't try it. Because how do you know it's working? How do you know it isn't? Especially in the early days, it was hard to be true to that value. But what it did was it instilled in our culture, in our company's DNA, a real significant emphasis on metrics.

I believe that that was a differentiator between Zynga and a lot of our competitors: The ability to test, analyze, optimize [and] repeat that cycle was instrumental in driving significant growth. I hear this all the time from companies. They've got eight people, 12 people, 25 people, and they say, "You know, we're thinking about hiring an analytics person." And then I say, "Well, it's too late. If that wasn't in the fabric of your DNA from the outset, it's really, really hard to try to backfill that." Everybody at Zynga -- developers, product managers, business people, executives, CEO, everybody -- had that focus on metrics and transparency, which really did allow us to innovate quickly, test things really, really aggressively, and ultimately, kind of dominate this space....

Poker was the first game that we launched [on Facebook], and we weren't the first. We were the third poker game to launch. It wasn't about being early. It wasn't about being in the right place at the right time. It was Mark Pincus' stroke of genius to launch poker. But it took great execution and understanding of both the viral piece of it, and innovating around the social elements. Every step of the way, every incremental improvement was always about testing, analyzing, optimizing, repeating. It almost sounds clichéd, but it comes down to execution always. Once you get the strategy generally right, it's about who can execute against their plan better.

Knowledge@Wharton: Users probably don't think about it, but every bushel of corn that they buy, there's a number behind that, that you can use to learn different things about the site.
Trader: That's right. And in fact, the three priorities that we always had at Zynga were: reach, retention and revenue. We called them the three R's. In the early days, it was about reach. Then it was about reach and retention, and then reach, retention and revenues. We never did anything in those early days for revenue at the expense of reach and retention. But within each one of those priorities, there are a set of metrics that you look at. For reach, you're looking at viral growth, paid cost of acquisition [and] cross promotion capability.

[For] retention, you looked at my day one retention, how many of those users that came the first day ever returned? What's my week one retention? What's my average number of days per user? On the revenue side, you've got metrics like average revenue per user, it's called ARPU, or we sometimes call it revenue per DAU, daily active user. For each one of those metrics, you're analyzing it and optimizing to the extent that it doesn't impact your overall priorities. We found some great insights.

In managing reach, the insight was growth is a leaky bucket. If you don't offer users a valuable experience every single day, every single time they come back, and keep building depth into the game, that leaky bucket will have no bottom. No matter how fast you keep putting users into the top of that funnel, they're just going to spill out. The insight around retention was that retention is really the leading indicator. Of the three priorities ... retention [was] the leading priority, the leading indicator. If you get retention right, revenue and reach will follow.

On the revenue side, it was really about self-expression. If you allowed a user to express themselves through the game, they [were] willing to spend hard dollars on that game. A couple of sub-insights: The way that men and women spend money, why they spend money, is a little bit different. Women are very aspirational. If a woman is playing FarmVille, she says, "Hey, if I had a farm, this is how I would want it to look. I would have a beautiful red farm house with a white picket fence." And a lot of women were willing to pay for that.

Knowledge@Wharton: So women were nesting.
Trader: Perhaps. And men were all about ruthless efficiency, "I must beat my buddy, do it in less time and I'm willing to pay for that privilege." Hunting and gathering.

Knowledge@Wharton: Changing tack a bit, what is your biggest challenge as a leader?
Trader: It's managing a balance between those professional values and personal values. What I love is a company where you can integrate both. Zynga did a masterful job at getting the professional values right. I see other companies, like Groupon, where they're doing a really good job now of integrating the personal values, too. You can hear it, by the tone of their emails, by the bios of the executives. They're letting their personalities creep into their management styles.

I think that's great, and it's something that I definitely aspire to. It's not necessarily easy, especially in the world of startups where there's a level of intensity and uncertainty that you're constantly fighting. You don't know whether or not this product is going to take off. You don't know if the business model is going to work. You don't know if the funding is going to come through. There's so much uncertainty that it gets hard at times to strike a good balance. That has an impact on the people who work with you. It can be a real challenge.... People have families, and people have interests outside of work, and you want to foster those things. You want to give people time and energy and space to have those other fulfilling things. And it can be challenging when you're in the heat of a startup.

Knowledge@Wharton: What is your favorite part of the job? And conversely, what keeps you up at night?
Trader: I love working with entrepreneurs. It is so fabulous. The energy and the ideas and the creativity, the intellectual horsepower, and the exchange of ideas, that open communication and exchange are so fun and so exciting, it's like being on an idea conveyor belt. The approach at Maveron is putting entrepreneurs first. They focus on the entrepreneur; less so, the business model. It's such a great and unusual approach because they correctly presume that the entrepreneur or the team, whatever their idea is currently, it's going to change, and they're going to have to pivot. You just want to back people [who you are confident] are going to be able to pivot quickly, correctly, and keep on a successful path. That's what I like so much about my current role and Maveron in particular.

Knowledge@Wharton: Conversely, what keeps you up at night?
Trader: What keeps me up at night? I can't stop thinking about the next big opportunity. I've been going deep on a few things recently, social applications, and when I start getting the wheels turning, it's really, really hard to shut them off. I think about product, and I think about business model, I think about competition, I think about a team, I think about execution. It's fun, but 
there are times I wish I could shut that off a little easier.

Building a Brand on the Smell of Mom's Kitchen: How Panera Found Success in a Down Economy

Published: March 30, 2011 in Knowledge@Wharton

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Stroll into any Panera in the country -- whether it is in Portland, Ore.,or Portland, Maine, St. Louis, Mo. or St. Augustine, Fla. -- and the setting is the same: a wide-open airy space with stylish light fixtures, walls painted in rich red and yellow hues, an assortment of cushy, upholstered seats and perhaps a gas fireplace. The scent of fresh bread baking wafts through the café. Panera's menu offers hearty $7 sandwiches made on artisan breads, as well as soups, salads and baked goods. It serves its meals on real dishware rather than on plastic plates, and invites customers to sit on elegant wooden chairs rather than in Formica booths.
It is not your average fast food joint. Today, Panera attracts both everyday customers and Wall Street investors; it is one of the fastest-growing chains in the U.S., with 1,420 stores, and a roughly $3 billion market capitalization. During the depths of the downturn, when most companies contracted, Panera's management invested in its product line and increased the number of stores. The strategy worked: In 2009, the company posted revenues of $1.4 billion, up from $640 million in 2005.

The reason for Panera's success is simple: The chain has pursued a niche strategy, differentiating itself as a fast food restaurant that serves healthy, tasty, affordable food, according to Lawrence Hrebiniak, a Wharton management professor. And at a time when two-thirds of adults in the U.S. are classified as obese and many Americans are paying more attention to the food they eat, Panera offers a wholesome alternative to purveyors of fatty burgers and burritos. Equally important, Hrebiniak says, it provides an appealing customer experience.

"Panera has become a symbol of warmth," he adds. "In advertisements, they position themselves as a warm, welcoming place. They want you to bring your friends and family. They want you to come to Panera to have lunch with a good old friend.... When times are tough, people go back to the basics. You can't go out to dinner and drop $250, but you can go to Panera with a friend and have a tasty bowl of soup and smell the bread baking."

As the economy improves, however, there are challenges ahead. Panera's management must stay close to the market, paying particular attention to whether customers' needs or demands are changing, and adjusting their products accordingly. The company must also maintain solid entry barriers for potential competitors, which will ensure that customers perceive they are getting a good value. "This is a challenging and difficult task," Hrebiniak notes.

'Self-service Gas for the Human Body'
Panera started out as the St. Louis Bread Co., a modest chain that ran 19 bakery-cafes in urban Missouri. In 1993, Ron Shaich, who at the time was head of the similarly-minded chain Au Bon Pain, bought the company for $23 million and renamed it Panera, Latin for "time of bread." By 1999, Shaich sold off Au Bon Pain to concentrate on the Panera division. "At the highest level -- and I've been doing this for 30 years -- what I am trying to do is bring real food to people in environments that engage them," says Shaich in an interview with Knowledge@Wharton.

According to Shaich, who stepped down as CEO last year but remains chairman, Panera's growth is due to a larger trend driven by American consumers' rejection of commodities. "After World War II, McDonald's and Burger King were special, but by 1993-1994, they had become self-service gasoline stations for the human body," he notes. "There was a reaction to that; people wanted specialness, and an end of commoditization. We saw it happening in specialty soft drinks, ice cream, beer and coffee. It was also happening in the food industry. This was a trend that I understood would play out over decades, not quarters. My vision for how Panera would compete was rooted in specialty artisan bread, made with no chemicals and no preservatives."

And compete it has. By the beginning of the financial downturn, Panera was one of the best performing restaurant stocks. Between 2007 and 2009, its earnings per share grew by more than 50%. Panera, which appears in the Quick-Serve and Quick-Casual market grouping, consistently ranks third in financial performance, trailing only McDonald's and Chipotle.

"As we began the recession, we made a decision to increase our investment," says Shaich. "At a time when almost every other restaurant was driven to cost cutting, and pulling back, we invested in the quality of the product, in growth and in marketing."

During the recession, Panera introduced a range of low-fat fruit smoothies and brought out new dishware for its dine-in customers. It retooled its salad line, introducing new dressings, and new signature dishes. The company also moved toward growing its own lettuces. "These details actually matter Shaich states. "In the middle of a recession our salad business was up 30%."

The company increased its labor force, paid bonuses and gave raises. It made significant investments in the quality of its stores and built new ones, taking advantage of the fact that construction costs were down 20%. In addition, Panera rolled out a loyalty program during the recession, giving its most devoted customers opportunities to earn free pastries and coffees, and offering invitations to cooking demonstrations.

Shaich says that Panera had gained credibility with investors before the recession, which gave management more room to maneuver when the economy worsened. "We had a highly supportive board, highly supportive investors, and we had a pristine balance sheet," he notes. "We stayed the course, and we became an even better competitive alternative.

"We're not doing anything new and different; we're trying to get closer to our vision," he adds. "I believe the biggest detriment to other companies is intense overreaction. There is intense pressure for short-term results. I compete for two, five, 10 years out, but if you're competing for the next two quarters I have a lot more options than you do."

The Customer Experience
The success of Panera's brand is mainly because the company clearly has a deep understanding of what drives its customers, according to Yoram "Jerry" Wind, professor of marketing at Wharton. In a down economy, one of the main drivers is price. "Right now, we're in an environment where 17% of people are either unemployed or underemployed. That's a huge part of the population, and it has made customers very price conscious," says Wind. "The value equation must be strong in a bad economy. This is part of why Panera, which has affordable food, is winning."

Panera also recognizes its customers' patterns and preferences, and pays attention to the seemingly small details that comprise the customer experience, notes Wind."Starbucks created this idea of 'the third-place': You have home, you have work and you have Starbucks. You see people sitting at Starbucks all day long drinking coffee, talking, reading the newspaper, on their computers," he says, noting that this is also true of Panera.

"In other words, it's not only the product; it's customer experience you're providing. Starbucks does this very well: They have just the right music, the right kind of furniture and the right ambience. Panera also appears to have created a customer experience that consumers respond to."

Indeed, in many cities and towns, Panera has become a de facto community center. Customers go to Panera to socialize, work (the chain has one of the largest industrial strength wi-fi networks in the country), and participate in clubs and meetings. The price of admission is the food.

"We're seeing the evolution of the common space and the community space, and Panera is a part of that," according to John Ballantine, a senior lecturer who specializes in strategic management at Brandeis University International Business School. "Before, it was a good bakery with quality food at decent prices. But now it's become a place where people gather. There is ample room, plenty of comfortable chairs. You often see the elderly gathered there for clubs, as well as young people and students hanging out, and others with their laptops using it as their virtual office. It's welcoming, and it's comfortable. It's almost an extension of the café world of Europe."

Riding the Health Food Trend
Panera's popularity is helped by market forces that are working in the chain's favor, namely concerns over eating habits. According to the Office of the U.S. Surgeon General, nearly one in three children is overweight or obese, and the U.S. spends $150 billion a year treating obesity-related illnesses. In addition to several federal government initiatives to combat the problem, there has been a significant increase in media attention to the importance of healthy eating.

Panera's emphasis on artisan sandwiches made with wholesome ingredients and soups -- menu items include a low-fat vegetarian black bean soup, a Mediterranean veggie sandwich, and a turkey and artichoke panini - fits neatly into the movement toward healthy eating. Panera is increasingly gaining a reputation in this area, too: A survey by Zagat, the restaurant guide, ranked it first for "best healthy option," while Health magazine has rated the chain as one of the healthiest "quick serve" restaurants.

The restaurant has gained traction with health-minded customers, but more importantly, the chain is winning over the nutritionally apathetic because its menu has the appearance of offering foods that are good for you, according to Ambar Rao, professor emeritus of marketing at Washington University's Olin School of Business. "Even with this health food craze, most people don't really change their eating habits, unless their doctor tells them they need to," he says. "But if they dine at a place like Panera, which doesn't serve burgers or fries, and is big on salads, sandwiches and vegan soups, they at least have the illusion that they're eating more healthy."

It is not exactly diet food, however. Panera's Fuji Apple Chicken Salad served on a bed of baby field greens -- ostensibly a healthy-sounding dish -- has 520 calories and 31 grams of fat. Add to that a dressing of Asian sesame vinaigrette and the meal weighs in at 680 calories and 44 grams of fat. For the record, a McDonald's Big Mac has 540 calories and 29 grams of fat.

Even if it is merely an illusion, customers take solace in the fact that Panera is at least giving them the option to make healthier choices, notes Rao. While many foods on the chain's menu appeal to health-conscious customers, there are also plenty of breads, bagels and baked goods for those unmoved by the trend toward healthier eating. "When you order a sandwich at Panera, you have a choice of either a small apple or roll or a bag of chips as an accompaniment," he says. "This makes the customer feel like the restaurant is giving them the choice to be healthier."

Too Much of a Good Thing?
Panera has done well pursuing a strategy as a supplier of healthy, flavorsome, and affordable food. Many experts, including Brandeis' Ballantine, predict that as long as Panera stays true to that market niche, the company will continue to be profitable. "The spacious, welcoming and convenient environment and the high quality, reasonably priced coffee, snack, or meal is something that many middle class customers want," he points out. "Panera seems to have found that niche."

But, he says, if the company veers from this strategy and attempts to move up the food chain, so to speak, there could be problems. "If Panera tries to create a more complicated menu with fancier, more involved dishes and then charge a higher price for the food, it could run into trouble."

Over-saturating the market is another concern. "Clearly that's what happened to Starbucks," Ballantine notes. Over a five-year period from 2002 to 2007, Starbucks nearly tripled its number of stores worldwide, from 5,886 to 15,011. But by the start of the economic downturn, Starbucks' revenues and profit tumbled. Customer traffic declined, and in 2008, the company closed 600 underperforming stores.

"I'd worry about over-expanding," Ballantine states. "Panera's management has to understand market dynamics in different parts of the country and understand the demographics. Every city and town has slightly different target clientele: Some cities have more elderly and retired, others young professionals and families, others are state university towns, and the needs and demands of each are slightly different. Panera needs to be mindful of that."

The primary challenge for Panera will be to maintain its "special factor," or else it risks becoming just another commodity, agrees Wharton's Hrebiniak. "To maintain the basis of differentiation, you need to make the customer feel that you're not like everybody else. You don't want to be on every corner. You want to have some exclusivity.

"Frankly there aren't that many competitors out there that are doing the same thing as Panera," he notes. Subway, for instance, positions itself as offering healthy and cheap food, but not necessarily a cozy environment. The Olive Garden, meanwhile, is building its brand around family and friends, but it is not positioning itself as healthy. A Belgian chain, Le Pain Quotidien (French for "daily bread") is more upscale and polished, and could perhaps one day become a rival but it's early yet, Hrebiniak says. Le Pain Quotidien has a presence in 11 countries, including 42 cafes in the U.S., 20 of them in Manhattan.

Still, Hrebiniak adds, management must work hard to ensure that customers perceive that they are getting a good value. "As in any other company, management must keep a close eye on industry forces and competitors' moves. They must stay close to the market, talking to customers and ascertaining any changes in their needs or demands. Success always breeds imitation, and management must maintain solid entry barriers and stay one step ahead of competitors to reinforce the company's value proposition.
"When you're on top what you do? It's difficult to maintain that advantage," he says.

Wednesday, March 30, 2011

Stan Ovshinsky’s Solar Revolution

His inventions from 50 years ago enabled cell phones, laptops, and flat-screen TVs. Now, at age 88, he’s aiming to make solar power cheaper than coal.

“The Institute for Amorphous Studies,” reads the simple black-on-white sign at a former elementary school in the leafy Detroit suburb of Bloomfield Hills. The sign represents a bit of nerdish humor: The scientists and engineers working here know that it might prompt a visitor to imagine a new-age Silicon Valley–style think tank. But this is southeastern Michigan, and the sign is also serious, reflecting Stanford R. Ovshinsky’s discovery half a century ago of amorphous materials, the science at the core of such diverse products as nonvolatile memory chips, flat-panel displays, and rewriteable optical discs.
That discovery created an entirely new field of materials science, and Ovshinsky’s achievements have continued over the subsequent decades. Although his formal education ended with high school, he has written some 300 scientific papers; has more than 400 patents to his name for technologies that have improved daily life in myriad ways; and has been awarded dozens of honorary degrees, awards, and academic accolades. Now, at age 88, he has formed Ovshinsky Solar, a company with an audacious goal: to drive the unsubsidized cost of solar power below that of coal — to create, in effect, a Moore’s Law for energy.
The automatic response to a man late in his ninth decade announcing such an objective is disbelief, perhaps tinged with amusement. Certainly the doors of venture capital firms do not open readily to octogenarians, no matter how accomplished. But Ovshinsky has spent his entire career ignoring the naysayers, and time after time he has proved them wrong the best way he knows: by overturning conventional scientific wisdom, creating breakthrough technologies, and building things that work. In this new endeavor, feeling he has no time to waste, he has assembled a small team of scientific and engineering talent to make low-cost solar power a reality as rapidly as possible.
The Economist once called him “the Edison of our age,” and he has also been compared to Einstein. But Ovshinsky sees himself less as an inventor or a theorist than as a pragmatic problem solver. He views complex problems not as existential dilemmas or subjects for detached study, but as fundamentally comprehensible tasks lacking only an obvious solution. So global warming and foreign oil dependence are not cause for dissertations or despair, but simply tough equations to solve for multiple unknowns.
It was perhaps coincidental that amorphous materials science, Ovshinsky’s pivotal discovery, was equally suited to energy technologies, such as the nickel–metal hydride batteries in the Toyota Prius, and to computer applications, such as memory chips that retain their data after the electricity is turned off, both of which are his inventions. But that duality inevitably shaped his career and his world view.
“I picked energy and information as the twin pillars of our economy very early on, when I was quite young,” Ovshinsky says, touching on past times as a prelude to a proximate future. “If you change the energy equation to no use of coal and no climate change, you’re ending one era and opening an entirely different one. I’m an activist, but what I do is go out and do it, if I know how.”
Ovshinsky keeps his office in the former school’s library, and sits at a wooden desk surrounded by scientific texts and the scholarly journals he still reads and contributes to avidly. Pride of place here, and in nearly every room at the company, is given to a large chart of the periodic table of elements, which colleagues say Ovshinsky knows the way a master pianist knows the musical scales. Time after time, when those colleagues have reached an impasse, he will point to the table and remind them that the answers to their questions are all there.
He points to it today to explain why all his work, including his current focus on low-cost solar power, ultimately comes back to the primacy of the hydrogen atom. “We have a universe, and the first thing out of the Big Bang, which created it, was hydrogen, some helium, and a little bit of lithium. The hydrogen atom is what the whole periodic table is made out of. All matter that we know is, by far, hydrogen: a gas out in the universe that condenses into stars, and gives out energy by fusing hydrogen into helium. That creates the photon light particles that are absorbed onto photovoltaics to generate electricity.”
Decades before green became a modifier for technology, Ovshinsky and his second wife, Iris, opened the doors of Energy Conversion Laboratory in a small Detroit storefront. This was his third company in less than 10 years, but it would be his primary focus for the next half century. It was 1960, yet already the Ovshinskys dreamed of a world free of the wars and pollution caused by dependence on carbon-based fuels and petrochemical products. Iris had the academic training that Stan lacked, including a Ph.D. in biochemistry from Boston University. Working as a team, they created breakthroughs in energy generation, energy storage, information systems, and atomically engineered synthetic materials, now known as nanotechnology.
Indeed, when the clean-energy economy comes to pass, it will owe much to the holistic, practical, and dogged way Ovshinsky and his colleagues have pursued it over the decades. In Ovshinsky’s view, inexpensive solar power will make energy both plentiful and clean, eliminating the scarcity-driven conflicts and carbon-based pollution that have dogged humankind for centuries. Furthermore, he is confident that this transition, once begun, will occur rapidly, with the same relentless acceleration that has driven computers from mainframes to iPads in a scant four decades.
Ovshinsky has a touch of vanity — he clearly delights in the svelte figure he still cuts in a well-tailored suit, and he takes a similar pleasure in countering skeptics by displaying patents, peer-reviewed publications, and functioning prototypes that prove his concepts work. The wispy-haired gentleman with the modest manner awaits your interrogation with a kind smile, knowing that you may have tough questions, but that he has the answers and the data to back them up.

Birth of a New Science

Ovshinsky grew up in Akron, Ohio, the elder son of working-class Jewish immigrants who fled eastern Europe in 1905. His father, Benjamin Ovshinsky, made his living collecting metal scrap, but he was also a liberal social activist who introduced his son to the Akron Workmen’s Circle, an organization focused on labor rights, civil rights, and civil liberties. In later years, Stan Ovshinsky marched in civil rights protests and hosted activists in his home.
His first jobs were in machine shops around Akron, and his first inventions and first company, Stanford Roberts, were devoted to machine tools. The Benjamin Center Drive, an automated lathe he named for his father, was used to manufacture artillery shells for the Korean War effort. Accepting an offer from the Hupp Motorcar Company, he moved to Detroit in 1951, where he invented a technology for electric power steering. But Hupp’s president blocked negotiations with General Motors to complete the project, and it was shelved as the industry moved toward hydraulic power steering.
But Ovshinsky was already moving on, pursuing his fascination with human and machine intelligence. He read deeply in the research literature of neurophysiology, neurological disease, and cybernetics. Despite his lack of formal education, he came to comprehend and make strides in these seemingly disparate and arcane disciplines with the same intuitive and iconoclastic bent he brought to precision machine tools. His own publications in peer-reviewed journals confirmed his insight and innovation in these fields.
With his younger brother, Herb, a mechanical engineer, he established a small company called General Automation to research and develop energy and information technologies. Together they built, in 1959, a mechanical model of a nerve cell, a semiconductor switch they called the Ovitron, in the process pioneering the use of nanostructures. A year later, Stan and Iris opened the Energy Conversion Laboratory.
The Ovitron itself had no practical application, but in developing it, Ovshinsky made a breakthrough that would define his career, and make the “Ovshinsky effect” a science textbook phrase. He discovered that certain types of glassy thin films, known as amorphous or disordered materials, turn into semiconductors upon application of a low voltage. Semiconductors, the foundation of modern electronics, are materials that conduct an electrical charge but can be regulated, unlike common conductors such as copper.
At the time, in the early 1960s, scientists believed that semiconductors could be formed only from crystalline materials, such as purified silicon, in which all the atoms are arranged in a long-range order. Ovshinsky demonstrated that it was possible to form semiconductors from amorphous or disordered materials, like common glass or silicon alloyed with less-costly elements. Amorphous silicon made possible the production of devices that are now inexpensive and ubiquitous in computing and energy applications.
“He invented the field of disordered materials,” says Hellmut Fritzsche, former chairman of the physics department at the University of Chicago. “It was so revolutionary at the time that people at Bell Labs and other major research labs said, ‘This man is crazy.’ Stan’s contribution was to say that [crystalline material] is not necessary, and it is too restrictive. You can make semiconductor materials in many ways when they are not crystalline, when they are disordered. Then you have a great freedom to alter their properties by chemical modification.”
Soon a phalanx of physicists, chemists, and engineers were making a pilgrimage to the Ovshinskys’ modest Detroit lab, including a young Robert Noyce and Gordon Moore, who were then planning a company to produce computer memory products, the future Intel Corporation. Many who came to scrutinize Ovshinsky’s work stayed on to collaborate, captivated as much by Stan and Iris’s lively warmth as by the novelty of the science. Fritzsche and others who have known him over the years say he always exuded a remarkable confidence in his own abilities.
Ovshinsky made his major discovery while trying to develop an artificial neuron as the first step toward developing a cognitive computer, a working model of the cerebral cortex that he still dreams of completing one day. But he soon put the discovery to work. In September 1966, he filed the first patent on phase change technology, which enabled a new type of computer memory. The most common type of computer memory is dynamic random access memory, or DRAM, which replaced the magnetic core memory of the earliest digital computers. But DRAM chips lose their data when the power is switched off. Phase change memory, which Ovshinsky called ovonic unified memory, registers data by changing the physical characteristics of the semiconductor material, from amorphous to crystalline and back again, and that change remains in effect even without electrical current. When a cell phone user’s battery dies, but the phone retains her contact list, she has Ovshinsky’s invention to thank. The same basic technology underlies rewriteable optical discs, enabling consumers to download music onto CDs.
Driven by the joy of discovery and their stated intention to use science and technology to solve serious global and societal problems, Stan and Iris kept the company small and nimble by licensing their technologies to major manufacturers. Profits were poured back into research, and growth came almost despite the founders’ intentions. Energy Conversion Laboratory licensed its phase change technology to Intel and STMicroelectronics NV, both of which continue to develop and improve such chips.
The big change to the company came when Ovshinsky applied amorphous materials technology to solar energy. In 1983, when he first began to explore the field, photovoltaic cells were still the size of a thumbnail, and made of costly crystalline silicon in small volumes. To considerable skepticism, even within his own company, Ovshinsky insisted that photovoltaic materials should be made of amorphous silicon deposited on flexible plastics by the mile, like newsprint rolling off a press. The deposition process requires high vacuum and absolute isolation from outside contaminants that the manufacturing equipment of the day could not achieve. But Ovshinsky was first and foremost a machinist, so he designed and produced his own tooling. Reflecting its move into mass production, the company changed its name to Energy Conversion Devices, or ECD.
With the success of its solar panels, ECD entered a rapid growth phase that took revenues from a few million dollars a year into nine figures, and the employee roster from perhaps two dozen close associates to more than 1,000. Ovshinsky was now a manufacturer and manager of a large corporation, two roles he had never sought, and for which his iconoclastic temperament proved an awkward match. Although his company had gone public two decades earlier, in the 1960s, its small size and relatively slow growth had kept it below Wall Street’s radar. With the growth and profitability of solar products came increased attention from securities analysts, as well as pressure to concentrate on cash generation. Ovshinsky simply ignored the pressures.

Batteries and Betrayal

For Ovshinsky, a clean-energy source begged for a clean-energy storage solution, but the batteries of the time were highly toxic, endangering workers’ health and the environment. He responded by inventing a rechargeable nickel–metal hydride (NiMH) battery, made of nontoxic and recyclable (and less expensive) materials. NiMH rapidly displaced nickel-cadmium cells in portable electronic devices, and in 1992 the U.S. Advanced Battery Consortium selected the Ovonic Battery Company, a subsidiary of ECD, to scale up its NiMH technology for electric vehicles. Ovshinsky’s battery technology still powers the Toyota Prius and Honda Insight hybrid cars, though more recent electric vehicles like the Tesla Roadster and Nissan Leaf use lithium-ion batteries, a newer technology developed for cell phones and laptops.
In December 1996, GM began a limited launch of its EV1 pure electric car. The California Air Resources Board (CARB) then agreed to delay implementation of the first phase of a zero-emissions vehicle mandate that had been scheduled to go into effect in 1998, ordering that the seven biggest carmakers — the largest of which was GM — would need to make 2 percent of their fleets emissions-free by 1998, 5 percent by 2001, and 10 percent by 2003. Powered by lead-acid batteries, the first-generation EV1 had a range of 70 to 100 miles.
What should have been Ovshinsky’s greatest triumph came when General Motors selected his tiny company over 60 other bidders to provide batteries for the second-generation EV1 in 1999. His battery doubled the EV1’s range to 140 miles. GM acquired a majority stake in the company, changing the name to GM Ovonics, and the future looked bright. Robert Stempel, who wrapped up a 37-year career at GM as chairman and CEO in 1992, joined ECD Ovonics as an advisor in 1993, and became chairman in 1995. Time magazine called Ovshinsky “a hero for the planet.” But General Motors was ambivalent about the EV1, and its small base of early adopters.
As shown in the documentary film Who Killed the Electric Car? oil industry groups lobbied successfully to end California’s zero-emissions mandate. In the meantime, GM sold its stake in GM Ovonics to Texaco, which in turn was acquired by Chevron. Despite candlelight vigils by EV1 owners, GM recalled all its leased electric cars and crushed all but a few, which were donated — minus their drivetrains — to museums.
“It’s a maze of betrayal,” says Ovshinsky. “We had an agreement that if Texaco was bought out, we could withdraw, but they lied to us. They said, ‘We’ll support you, make it happen.’ Within months it was obvious they weren’t going to do that. As soon as possible they got me off the board.”
In fairness to GM, which has clearly made its share of mistakes, the arithmetic supports the company’s argument that the EV1 was not commercially viable at the time. GM based the leases for the EV1 on an initial vehicle price of US$33,995, with lease payments ranging from $299 to $574 per month, depending on state rebates. Industry analysts estimated the production cost of the car at as much as $100,000. In justifying its decisions, GM said some EV1 parts suppliers had quit, making it hard to guarantee future repairs and safety. Nonetheless, with the benefit of hindsight, and given the subsequent volatility of gasoline prices, some GM executives’ opinions of the EV1 have changed. Former chairman and CEO Rick Wagoner told Motor Trend magazine in 2006 that his worst decision during his tenure at GM was “axing the EV1 electric-car program and not putting the right resources into hybrids.”
The rest is history. Japanese automakers seized the lead in hybrid gas/electric vehicles using NiMH batteries, although only after Panasonic EV, a joint venture between Matsushita and Toyota, settled a patent infringement suit brought by Cobasys, the successor company to GM Ovonics.
His treatment by “Big Oil” chastened Ovshinsky and made him wary of corporate partners, but he pressed on to develop the missing components of what he came to call the hydrogen circle, by making it possible to use hydrogen to power automobiles and other vehicles. Hydrogen is the most common element in the universe and the most abundant potential source of clean energy; a car fueled by hydrogen is completely emissions-free. But on earth, all hydrogen is bound to other molecules. Separating hydrogen from carbon in fossil fuels, most commonly natural gas, requires reformation, which consumes energy and releases carbon dioxide into the atmosphere, exacerbating the global warming that hydrogen-based energy is supposed to ameliorate. Transporting hydrogen requires chilling it to liquid form, which is energy-intensive and expensive, or compressing it under high pressure, which is potentially dangerous and requires heavy tanks.
To produce abundant hydrogen gas that could be used to power vehicles, Ovshinsky invented a technology he named Ovonic BioReformation. It is a single-step reaction that produces carbonate, a solid widely used in industry, instead of CO2; takes place at low temperatures requiring less energy; and can be performed using a variety of fuels, including biomass. To tackle the transport issue, he developed low-pressure metal hydride containers, which absorb and release hydrogen like a sponge, and, for the U.S. military services, demonstrated a mobile refueling system requiring no costly infrastructure. This was typical Ovshinsky: No single invention stands alone.
The next step was to develop a new type of hydrogen fuel cell, a device that generates electricity through reactions between a fuel and an oxidant, triggered in the presence of an electrolyte. Ovshinsky’s fuel cell operated at lower temperatures than others, and without the costly platinum catalysts commonly used in these technologies. For those not willing to wait for fuel cells, he installed one of his metal hydride canisters in an ordinary 2002 Toyota Prius and ran the internal combustion engine on low-pressure hydrogen. Colleagues recall a visiting Toyota engineer looking on in disbelief until he finally cupped his hands beneath the exhaust pipe and tasted the pure water it emitted. Interest in hydrogen fuel cells has waned with the reduction in U.S. government research funds and with the industry-wide move toward electric vehicles and hybrids. However, some auto executives still insist the fuel cell is the technology with the greatest future potential.
In the midst of his technological advances, Ovshinsky ran headlong into an obstacle not described by the laws of physics: corporate governance regulation in the post-Enron age. He had always packed ECD’s board with Nobel Prize winners and world-renowned thinkers in diverse fields whose attendance was clearly more related to mutual intellectual stimulation than legal and regulatory compliance. After the passage of the Sarbanes-Oxley Act in 2002, he had to take on additional outside directors with government-mandated skill sets, who then pressured him to emphasize quarterly earnings at the expense of experimentation. He was also forced to impose a reporting hierarchy on the company, which had never known titles or more than two levels of separation between the lowest-paid employee and the CEO. The culture of the company, which had always been collegial, became more conventionally corporate. Longtime colleagues began to leave, and Ovshinsky found himself dreading days filled with meetings and administrative duties. When Iris died suddenly in 2006 at 79, after an apparent heart attack, he abruptly retired.
It was not necessarily the board’s fault. ECD’s technological lead had never translated into sales leadership, and companies not distracted by forays into hydrogen research or other intriguing technologies claimed a greater share of the photovoltaic market. Although ECD’s sales continued to grow at a steady pace, its 2009 revenues of $302.8 million pale in comparison to the $2.1 billion of market leader First Solar.
Ovshinsky says ECD would not have fallen behind had the board listened to him, and notes that the company’s share price has fallen only since his departure. In the later years, he says, he not only had to fight to preserve his research budget, but also had to battle his own executives to develop the 30-megawatt production lines that are now ECD’s greatest asset.
“The ECD machine I developed is larger than a football field, runs 24/7, and makes miles and miles of photovoltaics,” Ovshinsky says. “When I said I was going to do that, we had only 5-megawatt machines. I lost Iris and I lost the company at about the same time. The company I could have absorbed, but Iris was a deep, deep part of me.”

A Cultural Innovator

Stan Ovshinsky always made a point of giving Iris equal credit for his insights and inventions, and longtime colleagues say she was also at least as responsible as he for the remarkably collegial corporate culture at ECD.
Before Sarbanes-Oxley, formal titles, reporting hierarchies, and standardized appraisals were nonexistent. A promotion simply meant taking on more responsibilities, and new hires were constantly encouraged to work outside their specialties or to take on tasks that challenged their skill sets. Many a chemist discovered a flair for physics, and a clerical worker could rise to senior management. Although the Ovshinskys did not use the rhetoric of participative management or nonhierarchical organizations, ECD embodied both concepts.
“My mom joined as a secretary when she was 35, after being a housewife forever,” recalls Joichi Ito, CEO of the Creative Commons, whose parents both worked for ECD for many years. (See “The Ambassador from the Next Economy,” by Lawrence M. Fisher, s+b, Autumn 2006.) Ito himself, now a globe-trotting venture capitalist and digital activist, began working at ECD as a teenager, and says that Stan Ovshinsky became a combination mentor and surrogate father to him after his parents’ divorce. His mother “quickly became head of personnel, then vice president of international sales and licensing, and then was sent to Japan to be president of the Japanese division, and became the chief negotiator with the Japanese clients who were the biggest slice of the royalty fees for the technology.”
Although ECD’s growth over the decades gave many employees a comfortable nest egg, it was slow and steady and never generated the kind of intense, instant wealth that rewarded employees at firms like Microsoft, Google, or Facebook. Headhunters often recruited the company’s multitalented engineers with promises of rapid riches, and some accepted lucrative offers only to find they missed the ECD culture.
“ECD was a reflection of Stan and Iris’s personalities, and each one of us was an integral part of the firm,” says Boil Pashmakov, who left ECD to work in the semiconductor industry and has now returned to work in Ovshinsky’s new company. “In Silicon Valley, it is all about the money.”
But notwithstanding Sarbanes-Oxley, Ovshinsky sometimes showed a side of his character that suggests he should not have been at the head of a publicly traded company. Like many a high-tech entrepreneur, he might have prospered more by taking the role of chief scientific officer while handpicking a cadre of professionals to manage the company. “He truly has a different set of beliefs. He’s out to change the world, and he doesn’t care about the money,” says Patrick Klersy, another ECD veteran who has joined the new venture.

Starting Over

After his retirement, Ovshinsky languished for a year. He says he felt he was waiting for his life to end. Then in 2007, in short order he married Rosa Young, a Ph.D. physicist who had worked at ECD since 1986, and launched his fourth company.
Rosa says that Ovshinsky’s proposal of marriage came as a surprise. She had already resigned from ECD herself, accepted a professor’s position in Sichuan province in southwestern China, where she was born, and purchased a small apartment there. But, she adds, Ovshinsky has been surprising her for nearly 25 years now, never more than when he hired her in the first place, and then put her in charge of projects far removed from her academic background.
Few of Ovshinsky’s old colleagues were surprised, however, when he announced plans for a new company. Considering the spotlight on global warming and renewed concerns about dependence on petroleum products, he simply could not remain on the sidelines. President Barack Obama’s appointment of Steven Chu, a Nobel-winning physicist, as secretary of energy appeared to signal a fresh opening for sustainable energy development, and Ovshinsky felt he had to contribute.
Ovshinsky bootstrapped Ovshinsky Solar with $3.5 million of his own funds, and is now seeking $16 million in new capital to move from proof of concept to a small production facility. He says he will need an additional $350 million to reach full-scale manufacturing by 2012. The goal is a machine capable of producing a gigawatt per year of solar capacity, which is more than the output of a typical nuclear power plant, and more than 30 times the output of the largest current production lines at any photovoltaic manufacturer.
“Other people’s idea of a gigawatt is to do it serially — build one machine and then another and another,” says Ovshinsky. “If you look at all the cost and time of doing that, you are never going to get there. You can actually put a couple of our gigawatt machines in an ordinary factory. My costs will be lower than burning coal. That means pennies per watt. And that’s the world revolution that’s needed.”
Increasing solar capacity requires improving the conversion efficiency of the semiconductor materials used or increasing the coating rate in production. It is presently impossible to have both high efficiency and high speed, and current manufacturing processes can be improved only incrementally.
Characteristically, Ovshinsky says he has found a way to push both parameters at once, and by significant amounts. “Our technology is a transformational advance in photovoltaics, combining higher conversion efficiency with 100-fold faster deposition rates,” he says. Indeed, his tiny pilot plant recently achieved this milestone, sustaining a deposition rate of more than 300 angstroms per second, compared with 1 to 5 angstroms per second in state-of-the-art commercial photovoltaic processes. That increase alone would allow the building of a 1-gigawatt capacity plant, but Ovshinsky says he will also soon announce a commensurate increase in conversion efficiency from the current level of about 10 percent.
Ovshinsky Solar currently has eight employees, all of whom had been at ECD for 25 years or more. They work in a tiny unmarked lab packed with elaborate instrumentation and prototype vapor deposition equipment of their own devising. A convoluted maze of stainless steel, the apparatus looks like a science fair project on steroids. The company has 14 patents pending, with more in the pipeline, but until they issue, Ovshinsky explains that he has to remain circumspect about exactly what he is doing. The breakthrough, he says, rests on the invention of an entirely new amorphous material — not a refinement of something he has done before — adding that his aha! moment came when he looked beyond the narrow science of solid-state physics as practiced today, much the way he did 50 years ago with the discovery of amorphous materials. “If you’re going to do something new, you have to overlap fields,” he says. “God didn’t make disciplines; man did.”
The capital sums Ovshinsky is seeking are not big relative to the billions that venture capitalists are throwing at green energy startups, but he says he is not looking to them as investors. “Why don’t I go to the venture capitalists? They don’t care about the achievement; they care about getting out of it at the right time,” he says. “I think countries are better. All they want is for you to build the machines. I prefer to get money from groups that want to answer the problem, and that understand that it has to be revolutionary.”
Ovshinsky won’t say which governments he is talking to about funding, but a glance at his calendar shows that he has been traveling a great deal, particularly to China. Chinese solar panels accounted for about half of total worldwide shipments in 2009, and that share is expected to grow. “China is doing the right things,” Ovshinsky says. “They have lots of good people, and they have a plan for energy. We do not have a plan for energy.”
Silicon Valley venture capitalists say that although Ovshinsky’s achievements are well known to them, so is his reputation as a difficult partner for investors. And they caution that he would find Beijing and Sichuan investors no easier to work with than venture capitalists in northern California.
“No matter what he’s come up with, people will pay attention because he has a track record of some pretty impressive breakthroughs,” says Sunil Paul, founder of Spring Ventures, a San Francisco–based fund that invests in and incubates clean-energy technologies and companies. “But Stan does have this complicated reputation; you want him to be Edison, but there’s a risk he’ll end up being Buckminster Fuller.”
For longtime participants in the solar industry, Ovshinsky’s ability to deliver a breakthrough technology is not in doubt, despite the magnitude of the advance he is claiming. They say the economic and environmental case for low-cost solar power is so compelling that it is almost inevitable but building a 1-gigawatt machine is only the first step in a long road to market. “I don’t know what technology he’s using, but it’s not something we know anything about,” says Travis Bradford, author of Solar Revolution: The Economic Transformation of the Global Energy Industry (MIT Press, 2006). “It’s not a current-generation technology. And that next gen is five to 10 years away. Then there are business model problems, even if he can build a gigawatt line.”
At 88, Ovshinsky is well aware of the actuarial tables, and though he plans to go on working for years, he has structured the new company so that it can function without him. But it’s also clear that he cannot function happily without a group of like-minded souls striving to take his concepts forward.
“I never did this for awards, money, power,” Ovshinsky says. “I did it because it had to be done, and because of my social drive to make a better and more beautiful world. That’s what I started doing when I was knee-high, and I don’t expect to stop now.”
Reprint No. 11111


  • Lawrence M. Fisher is a writer and consultant based in San Francisco. A contributing editor tostrategy+business, he covered technology for the New York Times for 15 years.