Some years ago executives at British Petroleum – now BP Amoco, a $5 billion oil giant – noticed an unusual fact. While studying the company’s performance they discovered enormous disparities in the productivity of oil wells in different parts of the world. Intrigued by the discrepancy, John Browne, British Petroleum’s CEO, asked his associates to find out what was going on. The team that investigated the phenomenon soon found the answer: It turned out that tiny, seemingly insignificant innovations that the workers practiced – for example, the method they used to remove barnacles from a ship’s hull – cumulatively made a huge difference in results, and ultimately, in the oil well’s productivity.

Enthused by this discovery, British Petroleum set about trying to introduce these high-yield work techniques at all company oil wells. The initiative should have led to a massive, across-the-board increase in productivity, right? Wrong. British Petroleum learned, to its dismay, that productivity did not rise at all. The reason was simple. The oil workers, who saw these changes as dictates imposed from above, resisted them. British Petroleum had to spend large sums educating the oil workers and persuading them of the need for change. This time, the effort paid off. The company slashed drilling costs by $47 million per oil well. Lawrence Prusak, executive director of the IBM Institute of Knowledge Management, who worked with British Petroleum on the oil well exercise, told this story at an April 9 workshop on “Creativity and Knowledge Creation” organized by Wharton’s Reginald H. Jones Center for Management Policy, Strategy and Organization and the SEI Center for Advanced Studies in Management.

Like most parables, this one had a moral: Companies that capture knowledge about best practices and share it across the organization can sharpen their competitive edge.

That, essentially, is also the premise of knowledge management, an emerging discipline that has in recent years attracted as much interest in corporate America as did past trends like re-engineering and total quality management. Some skeptics regard knowledge management as a passing fad. Still, as Prusak’s British Petroleum example shows, successfully practicing knowledge management can reduce costs by millions of dollars.

Knowledge management has evolved out of information management. The increase in computerization since the 1970s has made it easier to capture data such as records of transactions, dates when employees are hired or terminated, names and addresses of customers or prospects, and so on. Also, as more companies have introduced sophisticated databases to store and analyze data, increasingly large numbers of people are better able to share information. (Peter Drucker describes information as “data endowed with relevance and purpose.”) Knowledge, however, is more abstract than either data or information. It consists not just of simple analysis, but of crucial insights that combine information with context. Knowledge, in short, is the most precious kind of information.

Few can doubt that knowledge has immense value. A senior investment banker’s insights into how to make a deal work, for instance, may never show up on a firm’s balance sheet but still have obvious worth. If the executive leaves to join a rival firm, that knowledge leaves with her. For companies seeking to compete in today’s business world, capturing and sharing knowledge has thus become an enormous challenge – and an expensive one. As Thomas H. Davenport, a leading knowledge management expert who has co-authored books with Prusak, observes, “While knowledge management is expensive … not managing knowledge is even more so. What is the cost of ignorance and stupidity?”

In recent years, consulting firms and information technology companies have invested heavily in knowledge management systems – for obvious reasons. Consulting firms, more than most, derive revenues from their people’s knowledge and expertise in a wide range of areas. As a result, firms like McKinsey & Co., Boston Consulting Group, Arthur Andersen and others have developed knowledge management systems to summarize what their consultants know and distribute knowledge across the firm. High-tech companies are into knowledge management for similar reasons. Since knowledge management systems use complex databases and computer networks to capture and distribute knowledge, this field clearly plays to the high-tech industry’s strength. Hewlett-Packard and IBM are among those at the forefront of setting up such systems.

Faculty members at Wharton studied knowledge management long before its current surge in popularity. In the mid-1980s, Sidney G. Winter, Deloitte and Touche Professor of Management and co-director of the Jones Center, wrote a chapter called “Knowledge and Competence as Strategic Assets” in a book titled The Competitive Challenge: Strategies for Industrial Innovation and Renewal. More recently, Winter and Gabriel Szulanski, an assistant professor of management at Wharton, have been studying knowledge transfer in companies that practice replication – for example, franchisers like McDonald’s or Starbucks. In addition, Szulanski has analyzed barriers to the transfer of best practices within firms and is also studying the need for “disciplined imagination” in knowledge creation.

Bruce Kogut, the Felix Zandman Professor of International Management and co-director of the Reginald H. Jones Center, has worked with Udo Zander of the Stockholm School of Economics in Sweden on issues of how firms create new knowledge and how it gets embedded in their organizing principles. More recently Kogut and Anca Turcanu, a PhD student, have been studying knowledge creation and distribution in the software industry. Anne Cummings, an assistant professor of management at Wharton, has explored issues in employee creativity, a theme she revisited during a presentation at the April conference.

Unlike many studies of knowledge management which focus on the transfer of ideas within organizations, Winter’s recent work with Szulanski looks at companies that “grow by creating and operating highly similar outlets at a large number of localities.” Companies like McDonald’s, Home Depot or H&R Block, which replicate their business models over and over again in new regions and countries, have grown rapidly and been financially successful.

How do these companies decide what to copy so that a McDonald’s in Boston is as lucrative as one in, say, Beijing? Winter and Szulanski say that such companies treat knowledge transfer not as a one-time act but as a process in which ideas are constantly adapted and refined. In addition, companies that replicate their business models make learning an important part of their business, down to the smallest detail. Example: before Ray Kroc bought the fast-food chain from the McDonald brothers, the restaurants already had fast service, cleanliness and even the ubiquitous golden arches. Kroc, however, raised organizational learning to an art by setting up Hamburger U., and by making recipe instructions as precise as: “Cook the french fries until the oil temperature has climbed three degrees above the low temperature reached when the potatoes are put in the oil.” That is one of McDonald’s recipes for success.

Winter and Szulanski developed a concept they call “the template” to describe how such companies replicate their business models. A template is an existing outlet that offers some hints about what makes it successful. The researchers also developed the idea of an “arrow core,” which refers to the kernel of knowledge that lets a business make money through replication. Winter and Szulanski conclude that companies like McDonald’s and Home Depot, which have succeeded in replication, do so by developing a template, deciding which of its features to copy, refining core ideas about what makes the business succeed and also deciding when to change the template.

In addition to his work with Winter, Szulanski has studied the difficulties of knowledge transfer within organizations. As British Petroleum discovered with its oil drillers, people are often unwilling to accept ideas generated elsewhere. Another problem is that those who create successful ideas may be unwilling to share knowledge for fear of losing their competitive edge. This problem afflicts companies in all industries. General Motors had a tough time getting its managers to share manufacturing practices across divisions. IBM had problems transferring hardware design processes between its business units.

What can companies do to deal with such issues? Conventional wisdom suggests that difficulties in transferring knowledge – sometimes called “stickiness” – can be resolved by giving people incentives that motivate them to share ideas. That is not entirely true, argues Szulankski in a paper titled “Exploring Internal Stickiness: Impediments to the Transfer of Best Practice Within the Firm.”

Szulanski studied 122 best-practice transfers in eight companies and concluded: “contrary to conventional wisdom that blames primarily motivational factors… the major barriers to internal knowledge transfer [are] knowledge-related factors.” For example, the recipient’s ability to absorb forms an important barrier to learning, as do conflicts between teachers and learners.

Szulanski writes: “When best practice does not transfer, a gap develops between what an organization knows and what is actually put to use. The findings of the study suggest that it may be less because organizations do not want to learn what they know, but rather because they do not know how to.” This implies that if some drillers at British Petroleum refuse to accept the best practices generated at other oil wells, the reason lies not so much in lack of incentives but in lack of the ability to learn. The managerial response thus should aim at socialization and education, rather than tinkering with incentive schemes.

In their own studies of knowledge management, Kogut and Zander have argued that though knowledge in a firm resides in individuals, it also exists as part of the organization in the form of information (who knows what) and know-how (e.g., how to organize a research team). This implies that even though individuals may leave an organization, the company still has a body of knowledge, contained in its operating principles, which allows its work to continue with little disruption.

“Consider a company in a high-tech region such as Silicon Valley, where employee turnover is very high,” explains Kogut. “The firm must have operating principles that allow it to integrate new people into its work processes. This implies that a company is more than what is inside its people’s heads. The company’s knowledge is also embedded in its organizing principles.”

Kogut and Zander developed these ideas further in a later paper titled “Knowledge and the Speed of Transfer and Imitation of Organizational Capabilities: An Empirical Test.” They focused largely on how knowledge is transferred from one manufacturing facility to another – for example, how a high-productivity GM plant transfers its auto-making expertise to other factories whose performance may not measure up. One of the study’s key conclusions is that “the transfer of manufacturing capabilities is influenced by the degree to which they may be codified and taught.”

Explaining the study’s results, Kogut notes that researchers have always known that companies transfer knowledge about manufacturing practices among their various units. The question is, how easily can companies communicate such knowledge? The key, according to Kogut, depends on whether such knowledge can be easily written down or codified. “If something is easily written down, it can be easily transferred,” he notes. “Firms that are best at writing down are good at transferring knowledge.” A case in point: McDonald’s detailed instructions about the temperature of oil for its french fries.

Kogut’s recent research with Anca Turcanu focuses on knowledge creation in the software industry. That business has lately witnessed a seeming paradox. Since digital information is inexpensive to transfer (traveling as it does over phone lines or by satellite) the software industry has exploded in low-cost centers such as Bangalore, India, or Dublin, Ireland. Indian software exports, for example, have grown at a rate of 50 percent a year during the past decade. At the same time, however, software developers must work closely with one another and with their clients to create innovative software programs. At the Apri l conference, Kogut demonstrated a series of images that showed how face-to-face communication is very important in knowledge creation.

So how can companies resolve this paradox? The April conference featured executives from two companies – Trintech and Hewlett-Packard – who are dealing with these issues in unusual ways. Trintech, a software maker headquartered in Dublin, has a virtual organization in which software developed in Dublin is tested in Princeton, N.J., and employees communicate with one another over the Internet. Hewlett-Packard uses a system called the CubeCam – a camera that photographs employees working at their desk every 30 seconds – to develop a sense of physical closeness among people who work together but are located in distant offices.

Another theme at the conference involved the creation of innovative ideas. In her presentation, Cummings, who has studied employee creativity, presented a hypothesis: She argued that if companies want creativity that results not just in incremental but in radical change, a confining and restrictive environment can be as conducive as a nurturing and supportive one. “If you restrict people, they go off and do new things,” she says. In that sense, a stifling environment can spark the creation of new knowledge. Cummings posed her hypothesis as a companion view to an earlier presentation by Szulanski, in which he argued that knowledge creation requires exercising “disciplined imagination.”

These ideas and more will be studied and debated as the global economy continues to evolve. If knowledge is a source of competitive advantage, managing it will remain a crucial task for academics and executives alike in the next millennium. Finding solutions to the countless dilemmas that managing knowledge poses, however, is hardly easy.

Yoram (Jerry) Wind, director of Wharton’s SEI Center for Advanced Studies in Management, highlights this reality by pointing to a Charles Schultz “Peanuts” cartoon in which Charlie Brown tells Lucy in great technical detail how a kite flies. In her inimitable way, Lucy asks: “Charlie Brown, why is your kite down the sewer?”

Every company will have to answer that question in its own field. If it gets the answer right, it could well be as successful as British Petroleum and its oil drillers.