co-authored with Gary Hamel and excerpted from the November-December 2018 issue of the Harvard Business Review

Bureaucracy has few fans. Walmart CEO Doug McMillon calls it “a villain.” Berkshire Hathaway vice chair Charlie Munger says its tentacles should be treated like “the cancers they so much resemble.” Jamie Dimon, the CEO of JPMorgan Chase, agrees that bureaucracy is “a disease.” These leaders understand that bureaucracy saps initiative, inhibits risk taking, and crushes creativity. It’s a tax on human achievement.

Though mindful of its evils, many people believe bureaucracy is unavoidable. Dimon remembers an outside adviser who defended it as the “necessary outcome of complex businesses operating in complex international and regulatory environments.” Indeed, since 1983 the number of managers, supervisors, and administrators in the U.S. workforce has grown by more than 100%, while the number of people in all other occupations has increased by just 44%. In a survey by Harvard Business Review, nearly two-thirds of respondents said their organizations had become more bureaucratic in recent years. Peter Drucker’s prediction that today’s organizations would have half as many layers and one-third as many managers as their late-1980s counterparts was woefully off the mark. Bureaucracy has been thriving.

Meanwhile, productivity growth has stalled. From 1948 to 2004, U.S. labor productivity among nonfinancial firms grew by an annual average of 2.5%. Since then its growth has averaged just 1.1%. That’s no coincidence: Bureaucracy is particularly virulent in large companies, which have come to dominate the U.S. economy. More than a third of the U.S. labor force now works in firms with more than 5,000 employees—where those on the front lines are buried under eight levels of management, on average.

Some look to start-ups as an antidote. But although firms such as Uber, Airbnb, Farfetch, and Didi Chuxing get a lot of press, these and other unicorns account for a small fraction of their respective economies. And as entrepreneurial ventures scale up, they fall victim to bureaucracy themselves. One fast-growing IT vendor managed to accumulate 600 vice presidents on its way to reaching $4 billion in annual sales.

Why is bureaucracy so resistant to efforts to kill it? In part because it works, at least to a degree. With its clear lines of authority, specialized units, and standardized tasks, bureaucracy facilitates efficiency at scale. It’s also comfortably familiar, varying little across industries, cultures, and political systems.

Despite this, bureaucracy is not inevitable. Since the term was coined, roughly two centuries ago, much has changed. Today’s employees are skilled, not illiterate; competitive advantage comes from innovation, not sheer size; communication is instantaneous, not tortuous; and the pace of change is hypersonic, not glacial.

These new realities are at last producing alternatives to bureaucracy. Perhaps the most promising model can be found at a company that would not, at first glance, appear to be a child of the digital age. Haier, based in Qingdao, China, is currently the world’s largest appliance maker. With revenue of $35 billion, it competes with household names such as Whirlpool, LG, and Electrolux. At present, Haier has some 75,000 employees globally. Outside China it has 27,000 employees, many of whom joined the company when it bought GE’s appliance business, in 2016.

Over the past decade the gross profits of Haier’s core appliance business have grown by 23% a year, while revenue has increased by 18% annually. The company has also created more than $2 billion in market value from new ventures. Those feats are unmatched by any of Haier’s domestic or global competitors. This remarkable journey hasn’t been entirely pain-free. In recent years Haier dismissed more than 10,000 employees. Yet it has also generated tens of thousands of new jobs in its rapidly expanding ecosystem. Haier’s logistics network, which stretches across China, now includes more than 90,000 independent drivers, for instance.

Haier’s shorthand for these practices is rendanheyi, a mash-up of Chinese characters that connotes a tight coupling of the value created for customers with the value received by employees. The rendanheyi model departs from bureaucratic norms in seven critical ways, which we’ll look at in depth in this article.

1. From Monolithic Businesses to Microenterprises

Large corporations often consist of a few dominant businesses, each with its own orthodoxy about strategy, customers, and technology. These tightly integrated entities and their monocultures make a company vulnerable to unconventional competitors and blind it to new kinds of opportunities. To avoid that risk, Haier has divided itself into more than 4,000 microenterprises, or MEs, most of which have 10 to 15 employees. To be sure, some MEs, particularly in manufacturing, have larger payrolls, but even in them decisions are made by small autonomous teams.

Microenterprises come in three varieties. First, there are roughly 200 “transforming” MEs—market-facing units that have roots in Haier’s legacy appliance business but are reinventing themselves for today’s customer-centric, web-enabled world. Zhisheng, which makes refrigerators for young urban customers, is a typical example.

Second, there are 50-plus “incubating” MEs, or entirely new businesses. Some, like Thunderobot, are focused on emerging markets such as e-gaming, while others, like Xinchu—a “smart” refrigerator that connects users with third-party services that sell fresh food and deliver it within 30 minutes—are wrapping new business models around familiar products.

Finally, there are roughly 3,800 “node” MEs. These businesses sell component products and services such as design, manufacturing, and human resource support to Haier’s market-facing MEs.

Microenterprises are key to Zhang’s goal of building the world’s first company for the internet age. That entails more than developing web-enabled products. It means creating an organizational model that mimics the architecture of the internet: “small pieces, loosely joined,” as the Harvard technologist David Weinberger famously put it. The web is incredibly diverse and yet still coherent. While it has spawned countless innovations, it’s held together by common technical standards that make cyberspace navigable and allow sites to swap resources like data.

Haier’s modular structure is similarly flexible but coherent. MEs are free to form and evolve with little central direction, but they all share the same approach to target setting, internal contracting, and cross-unit coordination.

Read the full article on the Harvard Business Review site.