People + Strategy Journal

Fall 2020

Linking Theory + Practice

According to OrgPhysics, three types of leadership reside in every organization, carried by three types of structure that have different characteristics and serve different needs and purposes. All organizations possess these three structures.

By Niels Pflaeging, Silke Hermann and Brad Winn
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OrgPhysics: Value Creation and the Three Leadership Structures

Since the 1920s at least, when organizational theorist Mary Parker Follett famously complained about the loftiness of the entire concept of leadership, the world of business and academics writers have not been able to agree on either the parameters or the components of leadership. Linking a robust theory of leadership into organizational design appears to be even more elusive. A concept of leadership that would satisfy theorists as well as practitioners has so far appeared utterly impossible. Instead, the concept of leadership has become even more clouded over time and has turned into a catch-all label, now attached to an indefinite number of facets of organization life.

But while the quest for a shared theory on leadership seems utopian to most, the concept of OrgPhysics1 that we present in this article proposes exactly that: A robust connection between organizational design, power and structures, and a clear scientific suggestion to what leadership is and must be in the context of “organizational physics.” Two sets of beliefs tend to be continuously repeated in the field of leadership. On one hand, the tale of heroic leaders and their followers combined with calls for hierarchical control. On the other hand, the story of the coming end of hierarchy and the rise of democracies within organizations. According to the science of OrgPhysics,2 both sides are wrong.

OrgPhysics is an explanation of leadership, power and the reality of three separate but parallel organizational structures: formal, informal and value creating. The latter is the least well-understood of the three. Yet in order to balance the three structures of every organization, value creation structure must come first and not be overridden by the formal structure. 

Our work incorporates several fields of scientific study, including sociology, social psychology and systems theory. We believe that OrgPhysics will appeal both to those who have faith in the usefulness of hierarchy and to those who reject the notion of hierarchy, intuitively. It offers clues to the place of self-organization, social dynamics and team structures in contemporary organizations.

As a theory of leadership, OrgPhysics does not suggest that organizations can select from a menu of structures. There is no decision to be made about whether or not to have the three structures. None of the structures is optional or nice to have. They are part of organizational physics—universal laws that apply to every organization, large or small, old or new, for-profit or social. Conceptually, this bridges the business sciences and sociology, and thus offers a fresh look at economic and social dynamics at play in organizations.

According to OrgPhysics, three types of leadership reside in every organization, carried by three types of structure that have different characteristics and serve different needs and purposes. All organizations possess these three structures to solve their inescapable problems of compliance, of social interaction and of value creation

The Three-Faceted Nature of Organizations

The notion that organizations can be described through a single structure—a structure that has, since the glory days of the railway corporation in the middle of the 19th century, been usually depicted in the shape of an organizational chart—is one of the biggest misunderstandings in organizational science. While it is clear to most practitioners today that organizational charts, or connected boxes, cannot even remotely describe organizational complexity and reality, theory and organization development have not advanced much from the original metaphor of organizations as top-down pyramid structures, silos and stand-alone functions. In reality, though, all organizations are comprised of three structures: formal, informal and value creation.

1. Formal Structure: The Realm of Hierarchy

The most widely understood concept of power in organization is that of hierarchy, which resides within formal structure. This structure it is neither networked nor complex, but it is necessary.  It has been over-used since the industrial age. Formal structure is capable of producing one important thing: compliance, or the capability of being within policy and the law. No less, no more. Because formal structure is the domain in which compliance is produced, every organization, large or small, old or young, has one. Formal structure includes the appointment of a CEO, an audit committee, and a bookkeeping office. It further includes contracts of all kinds and an external reporting function. 

But formal structure is dramatically over-emphasized in most companies, even though we sense that too much use of formal power by managers, or too much emphasis on hierarchy, has serious downsides. As only one of three powers within any organization, too much use of formal power by managers, or too much emphasis on hierarchy, can trigger the two other structures to push back, or kick into a dysfunctional mode. The epic struggle between formal structure and the two other structures that make up OrgPhysics is one of the key sources of reduced organizational effectiveness, diminished complexity-robustness and lack of innovation in most companies.

Why this excessive reliance on hierarchy? The problem is that most managers, or in fact most working people, are blinded to the two other structures found in every organization.



2. Informal Structure: The Realm of Influence

With the rise of social networks, informal structure became more popularly known and talked about, but it has long been a well-known phenomenon in the social sciences. Informal structure can be thought of as “clouds” of interconnected individuals, with varying numbers of links placing individuals either in central or more peripheral positions in the cloud. Informal structure is networked. It is ever-present whether or not the formal structure approves or not. Imagine a larger meeting, including a topic on which opinions are divided. Maybe the highest-ranked manager (formal structure) would end up deciding on the matter. 

Walking away from the meeting, however, someone whom everybody likes or fears would say, “We will of course ignore that nonsense” and everyone would comply. That is the power of informal structure. It is where social phenomena such as water cooler and corridor talk, gossip, conspiracy and bullying emerge. But it can also bring about solidarity. There is power in the informal structure, which expresses itself in the form of influence. The informal structure is alive, dynamic, pervasive and powerful; but it also produces taboos and is thus impossible to accurately pin down, analyze or map.

It should be mentioned that the informal structure and the formal structure are interdependent. If a CEO determines to hire a consulting firm to conduct a “restructuring exercise,” both structures will duly react. In the formal structure, managers will immediately act to secure their turfs. In the informal structure, coalition-building, politicking and other phenomena will arise to protect positions, coalitions or connections. These responses in both structures are extremely influential and capable of preventing even the most well-planned restructuring effort. Especially those run by consultants and managers whose repertoire almost exclusively covers interventions suited for the formal structure. In fact, many consultants and managers today are rather oblivious to the powers that lie within the informal structure.



3. Value Creation Structure: The Realm of Reputation

Neither success nor performance can be produced in the formal structure or informal structure, because these are just carriers of the compliance dimension and the social dimension of the organization. For actual work, all organizations possess a third structure: the value creation structure.

Tragically, the value creation structure is the least understood of the three structures of any organization, but it flexes great power due to its focus on the intersection and interaction between the organization and the customer market. It is here where the key to a much-improved understanding of organizational effectiveness lies. Because it is the one structure in which actual work can get done, and from which competitiveness, performance, innovation and success can arise.

From the value creation structure, a particular third kind of power arises that is neither hierarchical nor influence: we call this power reputation. You have likely seen this power in action. It is attached to those with mastery, or meaningful and unique expertise. Reputational power is sought after when people who have a work problem turn to someone else and ask, “Who really knows about this?” or “Who is the expert on this particular matter?” They are looking for people with mastery, meaning an individual capable of solving a complex, potentially new problem by generating ideas. They can find such individuals by connecting with the network of power that is value creation structure. 

In the value creation structure we see the value of consistent and coherent decentralization of decision-making power from the center of an organization to its periphery—because the center is isolated from the market by the periphery. It is teams and individuals in the periphery, exclusively, who have direct market contact, and are thus well-equipped to make customer-related decisions. That is why decentralization of decision-making to teams close to the market is the key to making organizations fit for both complex markets and for human beings. 

The value creation structure is inevitably networked, as is the informal structure. All value creation flows from the inside out: from teams in the center, to teams in the periphery, to market (see Organize for Complexity3). Value creation structures can be mapped as networks of cells, which contain functionally integrated teams and which are interrelated by value flow, pay and communication relationships. In this structure, any cell either creates value for other network cells (in case of the center) or for the outside market (in case of the periphery).4 Cells, or teams, respond to market pull—not hierarchy. It is the cells that create value in their interrelations “with-each-other-for-each-other”—not individuals. The value creation structure and its workings make it clear that individual performance, or individual value creation, actually does not exist in organizations; actual performance emerges not from individuals, but in the space between individuals, or cells, through collaboration.
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Organizations as Three-Layered Systems

The formal structure and the informal structure can be enablers of value creation and lubricants of work. But they cannot themselves produce performance, success, competitiveness or value. While the formal structure is the domain of positions and the informal structure is the domain of relationships, the value creation structure is the domain of work.

With few notable exceptions (e.g. Southwest Airlines, W.L. Gore, Toyota and MorningStar), the value creation structure is rarely understood nor consciously and systematically curated by organizations. These exceptional companies have developed mastery in fostering their value creation structures and have turned it into the dominant structure among the three structures they possess. Intelligent curation of value creation occurs with those teams that reside closest to the customers in the periphery of an organization. It does not occur through steering, commands or controls executed by individuals in the center or at the top.

All Organizations Know Three Kinds of Leadership

Within the three structures of organizations, three kinds of leadership exist. They are:
  • Compliance leadership—emerging from the formal structure.
  • Social leadership—emerging from the informal structure.
  • Value creation leadership—emerging from the value creation structure.
These types of leadership are present in every organization, but they are almost always dramatically out of balance. This can be concluded from a wide array of symptoms, such as high levels of failed or underperforming change initiatives, depressing levels of lackluster engagement found in the Gallup studies, and overall unsatisfying levels of agility and innovation in most organizations. 

Following the thinking above, it would be more accurate to speak of leadership as the leaderships. Just like the three structures from which they emerge, the three leaderships are interdependent and interwoven in a complex fashion, not independent or linear. In the presence of too much hierarchy, or formal power, the other two types of leadership are stifled. Social density and value creation deteriorate. Members of the organization find it harder to get work done as they are forced to engage in the politics of the formal structure and its complicated mechanics of steering and control. Organizational energy is wasted on bureaucracy as members defend themselves against command-and-control from the top.

The value creation structure should come first—not the formal structure. Only by empowering the value creation structure, including those teams that are closest to the boundary between the organization and its customers, will companies gain proper balance and achieve their greatest potential. A key tenant of OrgPhysics5 proposes that an organization can become balanced when the formal structure is subordinated to the value creation structure. The strongest evidence for demonstrating that this type of balance has been achieved is when the need for a conventional organizational chart ceases to exist.


Parker-Follett and McGregor Were Right All Along

A little over 100 years after Frederick W. Taylor’s pioneering and often misinterpreted work on management science, we may finally end the quackery around organizational structure, power and leadership. We propose a turn toward the practical theory and insights that have long been available to us, but that have been widely ignored by the business community and by academics. 

Douglas McGregor said the following about leadership and structure in his book The Human Side of Enterprise:6 “It is probable that one day we shall begin to draw organization charts as a series of linked groups rather than as a hierarchical structure of individual reporting relationships.” He was right all along. We have, however, only just begun to understand how to implement what McGregor proposed more than 50 years ago. 

A new, robust theory of organizational leadership—of the kind Mary Parker-Follett and McGregor theorized about—may best explain the organizational complexity and the complex phenomena of power and leadership that we all experience within organizations. Every organization has, not one, but three powerful structures and three potentially powerful kinds of leaderships.

Conclusion

All organizations possess three structures to solve their inescapable problems of compliance, of social interaction, and of value creation. Within OrgPhysics, the value creation structure is the only one of the three structures through which performance can be produced, and value-creating work can unfold. At the same time, different than formal structure and informal structure, the value creation structure and its particular form are usually overlooked and little understood in academia as in practice. In organizations today, the value creation structure is often ignored and usually crippled by steering, siloed divisions and top-down command-and-control.

Since the dawn of the industrial age, we have imagined our organizations as piles or pyramids of boxes stacked upon one another. This notion of organizing defies reality. OrgPhysics liberates us from a limited understanding of organizational design and strategy. The limitations of conventional organizational chart thinking blind us to the three-fold nature of organizational reality and structure. In this age of complexity, it is now time to turn organizations outside-in by putting value creation structure first. We need new language and distinctions based on the three leaderships in order to grasp constructive ways of strengthening value creation and of achieving robust, high performance.  

Niels Pflaeging is Founder of the BetaCodex Network and Co-Founder of Red42. He is the author of several books, including Organize for Complexity and OpenSpace Beta (together with Silke Hermann). He can be reached at niels.pflaeging@redforty2.com and through www.nielspflaeging.com.

Silke Hermann is an entrepreneur and Co-Founder of Red42. She is the author of five books, including OpenSpace Beta and Complexitools. She can be reached at silke.hermann@redforty2.com and through www.redforty2.com.

Brad Winn, Ph.D., is a Leadership and Strategy Professor in the Covey Leadership Center and Executive MBA Director in the Huntsman School of Business at Utah State University.  He serves as a Senior Editor for People + Strategy and is the Principal of Winn Consulting Services. He can be reached at brad.winn@usu.edu or through https://huntsman.usu.edu/directory/winn-bradley.

References

1 Pflaeging, N. & Hermann, S. (2011). OrgPhysics – explained. BetaCodex Network White Paper No. 11
3 Pflaeging, N. (2014). Organize for Complexity, BetaCodex Publishing
4 Pflaeging, N. & Hermann, S. (2012). Turn your company outside-in! BetaCodex Network White Paper
5 Hermann, S. & Pflaeging, N. (2018). OpenSpace Beta, BetaCodex Publishing
6 McGregor, D. (1960). The human side of enterprise. McGraw-Hill