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Thinking outside the box again.
CIRCLE OF LIFE

Zappos has quietly backed away from holacracy 

Aimee Groth
By Aimee Groth

Journalist, Author, Strategist

From our Obsession

Modern Leadership

The people and companies embracing new paradigms.

Six years ago, Amazon-owned Zappos began upending its traditional management structure. In lieu of a typical corporate structure, with power concentrated at the top, the online shoe retailer would adopt a decentralized system with “no job titles, no managers, no hierarchy.”

CEO Tony Hsieh was originally inspired by the idea of creating a city-like environment without central planning. “Every time a city doubles in size, productivity per resident goes up 15%,” he has said. “The whole system just works, and it’s really resilient and flexible—whereas companies see productivity per capita fall as they grow.” He saw holacracy, a new kind of management structure predicated on decision-making authority being distributed throughout the organization, as the tool to access that kind of resilience and hyper-productivity.

Holacracy is a radical departure from the way most companies are run. Its adoption can be disorienting, even for people who already buy into the philosophy behind the idea. In March 2015, Hsieh gave employees an ultimatum to either fully commit to being a genuine participant in Zappos’s holacracy or leave; 18% took a generous buyout offer.

But in the last few years, Zappos has been quietly moving away from holacracy. It has done away with its at-times rigidly (and ironically) bureaucratic meetings and brought back managers, while retaining its circular hierarchy, a key artifact of holacracy.

Zappos executive John Bunch, who co-led the rollout of holacracy, has explained that the company, famous for its exceptional customer service, encountered some “big challenges” in its business metrics and sought to redirect employees’ focus back to the customer (an oft-cited criticism of holacracy is that it is too internally focused). By March 2017, the e-retailer had shifted its strategy to remedy this.

The solution? A marketplace system where teams operate like small businesses and manage their own profit-and-loss statements, rather than focusing on the scope of their holacratic authority to manage the company’s full P&L.

According to company sources, the internal small businesses are incentivized to develop new product lines and services for Zappos’s customers. They transact with one another at market rates, similar to the way they’d transact with the outside world. The bet is that market incentives, the resulting allocation of resources, and value-creation signals (e.g., profit) will more effectively help Zappos innovate—and that the costs added by internal negotiations, competition, and self-direction will be outweighed by the benefits of speed, innovation, scalability, and adaptability.

It’s still a decentralized system, encouraging an entrepreneurial spirit and high degree of self-sovereignty. But it isn’t pure holacracy. Rather, the shoe retailer has chosen to chart a slightly different course—albeit still in service of the principle of self-organization and that city-like atmosphere that Hsieh originally envisioned.

“Most other companies, the CEO is saying, ‘Here I’m going to go approve these next 100 businesses to launch,’” Hsieh told employees at a Zappos conference last April. “And all the research has shown that top-down approach doesn’t scale well and doesn’t work well for the long term. That’s part of going on this decentralized, self-organization path we’re going on. Really, whoever is closest to the customers should be making those choices and decisions.”

Zappos executives declined to respond to interview requests. But sources with knowledge of the company’s strategy say that under Zappos’ market-based system, employees earn their budgets by selling their skills and services to each other and directly to external customers. Even teams not typically focused on near-term profit, such as research and development, are incentivized to find a high-level sponsor or client to fund their expenses. This is quite different from an earlier era at Zappos, in which teams pitched the finance committee and secured annual budgets. That process didn’t always incentivize employees to be particularly cost-conscious.

Inspired by AWS

Since Zappos began rolling out holacracy in 2013, the company has reorganized into 460 team “circles” and 4,700 roles. The numbers are fluid, though; circles are created and disbanded depending upon the company’s needs at any given moment. And the 20-year-old company’s big need these days, according to Hsieh, is to differentiate itself.

“People can only wear so many shoes, the market is only so big,” he said in April, likening opportunities for Zappos to broaden its service offerings to the way Amazon branched out from bookselling to cloud computing and built its thriving Amazon Web Services arm. Hsieh asked employees to envision what it might look like to provide a suite of Zappos-branded services to entrepreneurs, providing everything from legal support to web analytics. “AWS has allowed a lot of startups to come out of nowhere and scale quickly,” he said. “Imagine if Zappos provided 900 of those services.”

To help employees vet and build out their ideas, Zappos provides an internal “48-hour founders” service that includes coaching, mentoring, and education based on the principles of lean-startup methodology. Promising ideas receive $5,000 in seed funding. The hope is that a year from now, the company will have many new lines of business.

“If every circle by the end of 2020 increases revenue by 5% more than what it is now, without increasing expenses, that’s $100 million to the bottom line for the company,” Hsieh explained in April at the Zappos conference. “That’s very doable for everyone.”

Still ahead of the curve

Although Zappos’ pursuit of self-organization has been non-linear and even chaotic at times, the company is still ahead of the curve, providing others with a model for what works and what doesn’t, under different conditions—notably for its parent company Amazon, which appears to regard Zappos as an incubator of sorts for new management practices.

The academic community is taking notice as well. In 2017, Harvard Business School professor Amy Edmondson and researcher Michael Y. Lee (now an assistant professor of organizational behavior at INSEAD) published a paper exploring the limits of hierarchical organizations and the “recent surge in interest in less-hierarchical organizing.” Edmondson and Lee highlighted Zappos as a case study and pointed to the influence of holacracy in particular.

Today, several hundred organizations operate as holacracies. Some of the early adopters, like Twitter co-founder Ev Williams’ Medium, have already abandoned it. “Longstanding research tradition suggests that managerial hierarchy functions more effectively in stable conditions,” Edmondson and Lee wrote, “but faces serious challenges in dynamic conditions.”

As business leaders redefine the purpose of a corporation and grapple with what a new version of capitalism might look like—with technology as an accelerant—our ideas about what a company structure should look like are evolving, too.

Of course, moving beyond the traditional pyramid structure to whatever default system comes next is not without risk and some trial and error. “What we’re doing is hard,” Hsieh told his employees back in April. “We’re basically trying to fly a plane and change the engine at the same time.”

Aimee Groth is a journalist and author of “The Kingdom of Happiness: Inside Tony Hsieh’s Zapponian Utopia.” She wrote this article with contributions from Maggie Hsu, a former chief of staff to Zappos CEO Tony Hsieh, and Rob Solomon, founder of the software startup Cone and former director of finance at Hsieh’s Downtown Project, an urban development effort in Las Vegas.

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