14 May 09 Time to test some axioms

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Or, how to avoid the blindfolded bus driver’s syndrome.

Overview
This briefing takes the position that the current crisis is at least partially due to the acceptance of certain assumptions or rules about the way that the world works.  The problem is that these assumptions may have passed into common usage as they sound plausible.  However, they have not been subject to rigorous testing and may be be misleading in a future, post recession, world.

An approach to start this process of testing is introduced here.

Avoiding the Blindfolded Bus Driver’s Syndrome
Before going any further, I should warn you that this post is rather longer than normal, but there is a pdf version to download for you to read at your leisure. This post also includes a small, but I think informative, exercise that you might like to try with your business colleagues to ensure that you avoid the blindfolded bus driver syndrome.

On the 7th April Nassim Taleb (the author of the Black Swan) published a range of pointers in the Financial Times[1] in an endeavour to help the world avoid another meltdown.

The problem is that I feel he missed one out – the need to bust some paradigms – or stress test some axioms.

But possibly it’s unfair to say he missed something out as (a) he was writing in the context of preventing another financial or banking sector meltdown – I’m going to be focusing on the broader issues of strategic meltdowns here – and (2) he did mention “blindfolded bus drivers”.  By blindfolded bus drivers, Taleb means the “experts” who were responsible for getting the financial sector into its current state.

I am going to borrow this term and use it in a slightly different way to refer to a culture in business and arguably in broader society whereby our actions are driven by a commonly and almost universally accepted series of “new rules” or “axioms”.

I will argue that these “new rules” that I will now call “doubtful axioms” are applied widely to guide behaviour in business.

The problem is that the doubtful axioms may lack any real foundation.  I would propose that they have received common acceptance as:

(a) They sound plausible.

(b) The doubtful axioms reflect our desired outcomes.

(c) The doubtful axioms are widely applied. Group behaviour is naturally attractive.   It makes one feel secure to be “one of the crowd” using the same rules or assumptions.

(d) In some cases they reflect an all too comfortable world.

(e) They, that is the doubtful axioms, appear to have been “tested”.

But, dealing with the last point, the “tests”, if they were applied, were conducted over a relatively short period of time. A period when, in hindsight, the world was going through an uncharacteristically stable period. Too short and too unrepresentative a period to now bet the company’s future on.

There is an emerging proposition that the doubtful axioms are largely responsible for the mess that we’re in. Doubtful axiom followers apparently range from the London G20 protesters[2] to the banks themselves[3]. The latter reference holds that, in effect, sophisticated models designed to guide decisions actually were based upon a false reality[4].

A false reality that encouraged false confidence.

Let us take one doubtful axiom as an example. This is the assumption that globalization will lead to the benefit of all – those in both the emerging and developed economies alike. It sounds sensible and reflects the desires of any decent thinking person. But is globalization really feasible? Some think that it may not be[5], [6].

The true reality may have been that we have created a vast inter-connected world that is far far too complex and irrational to either predict or to manage. Which is probably why no one knows how the global economy will react as new emergency measures, including quantitative easing, are applied.

It may also be a world too that is all too easy to disrupt.

Another example of a doubtful axiom is decoupling.

About 12 months ago many held that the emerging economies could stand on their own two feet. If the established economies of the developed world went into recession, the emerging economies would not be overly troubled. In other words, the emerging economies were decoupled from the developed economies. This “rule” now looks as if it will be consigned to the bin[7], [8], [9].

We don’t know which of the many doubtful axioms that underpin our business plans hold water and which don’t.

If you were to talk to academics (like me) who study why organizations fail they would tell you that success is potentially a fatal enemy for an organization as it can breed the development of an “enacted world”. The term “enacted world” means an artificial world that does not reflect reality but the shape of the world that we would like to see. Because we were successful we like to protect and return to the formula or strategy, that created this success. In time this affects the way that we choose to see the outside world. Over time therefore we could end up looking at a false reality. I have dealt with this issue in an earlier briefing – Success – Your Biggest Problem? – it is a very common trap – one that without certain safeguards we are all capable of becoming ensnared in.

The Priority
The immediate priority appears therefore to be to check that we are not exposed to “doubtful axioms”.

I will suggest that you question the broad assumptions that you may have used in strategy making over the last few years. Some may be “true rules” others may prove to be either “doubtful axioms” or axioms that are too fragile to bet the company’s future on.

An exercise
So how do we check our assumptions for exposure to “false rules”?

Try running through this exercise with your team and business colleagues:

Activity Step 1: Rule Identification
Individually, as preparation work, list out all the assumptions made when preparing your business plan. Remember that such assumptions can be both both written and “subliminal”. By subliminal I mean “rules” that we and our colleagues just take for granted. A good example is the view that globalization is unstoppable.

I looked at a good few business plans that were prepared around 6-12 months before the meltdown of 2008 and here are examples of common “rules” or axioms:

(a) “Globalization is good for all – and is an unstoppable force.”
(b) “What gets measured gets done”.
(c) “If we have an economic slowdown – it will be short – a year or less.”
(d) “Our primary quest is to maximize shareholder value”.
(e) “The boom bust cycle is dead.”
(f) “All the BRICs will win through.”
(g) “China will overtake the US economically but US-led definitions of capitalism will prevail.”
(h) “Service based economies are a sustainable platform for developed economies”.

I’m sure that you will find more.

Activity Step 2: Axiom Testing
Readers will now be familiar with my set of four scenarios from 2009 – Signposts to Where? reproduced below:

Let’s now take two of the more challenging scenarios, Capitalism II and The Jigsaw.

In Capitalism II, the following extreme picture could unfold:

• The global recession continues into early 2010.

• Further toxic debt and derivative based losses are largely avoided.

• The US government bails out GM, but the recovery plan heralds a slow dwindling death for western car makers.

• The US and most EU economies emerge from recession in early 2010 but a period of low economic growth – between 1% to 1.5% of GDP – follows for these economies over the next 2 years. The world enters a period of low, but stable growth. The UK in particular faces difficulties. Employment in financial services slowly declines as a result of a mix of continued offshoring and contraction in investment banking.

• The G20 establishes itself as a powerful body for economic reform, but the roles of the US and the UK in particular diminish. France and Germany initially become the architects of regulation in the financial services sector, but India and China steer the long-term shape of capitalism.

• The “57 state” initiative[10] is successful and heralds a period of conciliation in the Middle East and Asia.

• In summary, a new, arguably more mature and aligned world emerges. The ravages of protectionism and conflict are largely avoided. The migration of economic and political influence shifts more quickly that previously envisaged from west to east. Capitalism is redefined over a 10 – 15 year period.

The Jigsaw is more demanding and, illustratively, could unfold as follows:

• Further write-downs appear in the banking sector. Total write-downs exceed the $4.7trn estimated by the IMF in April 2009[11].

• Economic contraction in the developed countries continues through 2010. A slow recovery period emerges with GDP growth not exceeding 1.5% over a 4 year period.

• Eastern Europe suffers. Political instability ensues. One or more of the so called PIIGS (Portugal, Ireland, Italy, Greece, Spain) defaults on  sovereign debt.

• The US government bails out GM, but the recovery plan heralds a progressive death for western car makers. Further employment cut backs are made beyond the scale estimated in the current GM recovery plan.

• Despite their best efforts, the NATO intervention reaches stalemate in Afghanistan. Politicians lack the stomach (and the funding and public support) for the continuance of this venture. A withdrawal is negotiated. The Afghan government falls and instability progresses through Afghanistan, Pakistan and into India and Southern Russia.

• US attempts to “reset” relationships with Russia falter.

• The world starts to divide. Globalization dies. History shows in this scenario that a globally inter-connected world is just too unstable and too vulnerable to survive in the long-term.

Both these scenarios challenge established views.

But they can help you to “stress test” the axioms that guide your business.

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References
[1] N. Taleb, “Ten principles for a Black Swan-proof world,” FT.com, Apr. 2009.
[2] M. Livermore, “The age of stupid or the age of gullible?,” Adam Smith Institute, Apr. 2009.
[3] D. Brooks, “Greed and Stupidity,” The New York Times, Apr. 2009.
[4] J. Muller, “Our Epistemological Depression,” The American, Jan. 2009.
[5] R. Florida, “The World is Spiky,” The Atlantic Monthly, Oct. 2005, pp. 48-51.
[6] J. Bivens, “Everybody wins, except for most of us,” Economic Policy Institute, Nov. 2008.
[7] J. Bajoria, “Financial Crisis May Worsen Poverty in China, India – Council on Foreign Relations,” Council on Foreign Relations, Nov. 2008.
[8] S. Johnson, “Testimony: The Economic Outlook and Options for Stimulus,” Peterson Institute, Nov. 2008.
[9] M. Wolf, “The world wakes from the wish-dream of decoupling,” FT.com, Oct. 2008.
[10] R. Beeston and M. Binyon, “King’s Ultimatum: peace now or it’s war next year,” The Times, May. 2009, p. 1.
[11] “IMF Global Financial Stability Report — Responding to the Financial Crisis and Measuring Systemic Risks,” International Monetary Fund, Apr. 2009.

Tags: capitalism, globalisation, meltdown, recession, stress test

27 Feb 09 Strategy and the Future World: Why the next three months may hold the key

Those of you who have been following my scenarios will know that I hold that future, not the past or even current events associated with the current financial crisis, will determine the shape of the the future business world.

In my scenarios as described in 2009: Signposts to where? – I refer to a range of shaping events that will separately, or in an inter-related manner, form the shape  of the future world.

These are the events to actively monitor.

In all, there are five shaping events.

The Real Issue
The real issue is that a range of these shaping events could be triggered over the next three to four months and alone or together they could have a tumultuous effect.

The five shaping events, which over time work together in an inter-related manner, are:

#1: Industry Contagion a widespread domino effect as the crisis spreads from the banks into the major employers of at least the developed economies.  The loss of an iconic employer could place massive pressure onto politicians to impose what others would see as protectionist policies.  Such a move would be a big step to a divided world – The Jigsaw in my scenarios.

#2: Banking Future Shocks the view being that not all of the bad news is behind us. More is to be revealed.

#3: Global Fragmentation in other words the emergence of protectionism.

#4: Energy arguably one for the medium term. At some point we will face an oil supply crisis following a lack of investment in production infrastructure.

#5: Conflict The unhappy fact is that there is a correlation between recession and social and national – upheaval.

My point is that three of these shaping events could be triggered in the next quarter.

Firstly, industry contagion. Both GM and Chrysler stand on the edge of an abyss. By the end of March, Chrysler must demonstrate progress to viability if it to received more state loans[1]. Massive corporate failures in Detroit could result in over 3m additional unemployed in the US alone[2].

Secondly, some observers feel that there is even more bad news to emerge for western banks especially from Eastern European operations[3], [4].

Thirdly, we have the spectre of conflict in the form of social unrest particularly in Eastern Europe that could, at an extreme, challenge democracy[5],[6].

These, I suggest, are the events to monitor now.

Each has the power to reshape our world for a generation. Ultimately, it may well not be the economists that define the future shape of our world but public reaction to these shaping events.

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References
[1] J. Reed, GM future in doubt after $31bn loss, FT.com, Feb. 2009.
[2] R. Scott, Automaker bankruptcies would cost up to 3.3 million U.S. jobs, Economic Policy Institute, Dec. 2008.
[3] N. Roubini, Roubini Interview On The Severe Global Recession And The Risks Of A Financial Crisis In Emerging Europe, RGE Monitor, Feb. 2009.
[4] A. Evans-Pritchard, European banks’ toxic debts risk overwhelming EU governments – Telegraph, Telegraph.co.uk, Feb. 2009.
[5] A. Aslund, Baltic Protests and Financial Meltdowns, Peterson Institute, Feb. 2009.
[6] S. Wagstal, Analysis – Variable vulnerability, FT.com, Feb. 2009.

Tags: economic recession, financial crisis, meltdown, protectionism, recession, scenarios, social unrest

13 Jan 09 Recession Survival: Look again at the outside world

Every once in a while a piece of academic research lands on my desk just at the right time.

Just last week I read a research article from two academics in the US focusing upon strategy and the way that managers see the business environment (please see References [1] at the end of this article).  In short, the way that managers and business leaders see and interpret the outside world shapes their decisions and of course the strategies of their organisations.  All very commonsense stuff.  But we are facing a period of environmental turbulence and one of those infrequent tipping points where the business world could change dramatically and forever.  So what can this piece of research contribute?

In summary, we have four pointers:

Pointer #1: Question your mental model. Now is the time to question some of the assumptions that we have taken for granted when we think about and formulate strategy.  An example would be what our customers want.

Pointer #2: Don’t just look at the usual indicators. There is a temptation to look at the world outside our organisations from an industry perspective.  But now the forces for change won’t emanate from inside our industries but outside.

Pointer #3: Change the way you plan. The danger of “battening down the hatches”.

I will now take a closer look at each of these three pointers.

Pointer #1: Question your mental model.

Arguably, there is just too much information coming in on changes both in the markets that your organisation operates in and the broader global environment for one person to digest.  During the last six months of 2008 I attempted to track the strategic implications of the financial sector ‘meltdown’ on a daily basis.  Apart from taking up time, it left me with a permanent headache!

But in all seriousness, we develop mental models to simplify this complexity to make sense of it all.  That is human nature – and we all do it.  The problem is that we tend to assume when using these mental models that the business world operates in a certain way and that certain strategies and approaches will always work.  In other words, we take predefined ’cause and effect’ relationships for granted. The temptation, as we enter recession, is to do exactly the same as we did during the last recession.  But this time the world may be starting to work in a different way.

So the message is to take a broad minded view of how changes in the outside world could hit your industry.  Don’t just assume that your sector will survive a recession relatively unscathed because it survived the 1990s downturn.  The general insurance sector is probably a good example.  This has its own strong industry cycle so some may think that in relative terms organisations in this sector will do quite well.  Perhaps they will if we extrapolate from the past. But perhaps they won’t – especially if we look at regulatory perspective emerging from the G20’s first meeting.

And here are some other established assumptions that must be revisited.

• Globalisation will continue. Well, it just might not.  Some point to a divided Europe emerging as we progress through a recession [2], others question if globalisation has and will deliver prosperity [3].  This brings the whole issue of BRICs based strategies back onto the drawing board.
• We know what our customers want and who they are. Well we might have done but we don’t now.  As food retailers at the luxury end of the UK food market are discovering, customers are rapidly changing their buying criteria.  And as I have argued before, this recession will deliver major change in the structure of the so-called advanced economies – and therefore major changes in who your target customers really are.

Pointer #2:  Don’t just look at the usual indicators.

Organisations, particularly those in fast moving environments, tend to focus on tracking changes and developments that happen within their industry.  New entrants, changes in distribution channels, changes in supply chains would be examples.  In times of major upheaval look further afield.  My argument is that the shape of your market place over the coming years won’t be shaped primarily by industry forces but by global forces (such as regulation) emanating from outside the industry.

Pointer #3: Change the way you plan

I hear the phrase ‘we’re going to batten down the hatches’ quite a lot at the moment. Now, this gives me the picture in my mind of an old sailing ship about to enter a storm.  The hatches are nailed down and the crew goes below decks and waits for the calm after the storm.  The only problems with this approach are that:

1. You can’t see where you’re going during the storm and
2. The world, I propose, will have changed quite fundamentally when the hatches are opened.

Research [1] tells us that those organisations that sense changes first and move the quickest change the way they plan.  They don’t rely totally on conventional business plans where we construct a plan in concrete for say a year ahead. They rely more on experimentation, deliberately going outside to test what’s changing and what new approaches might work and then bringing this learning back into the organisation to further develop strategy.

Paradoxically therefore recession isn’t a time to batten down the hatches, but to go out and experiment to sense emerging changes especially amongst your organisation’s customers.  If you stay under the hatches you might just lose your customers.

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REFERENCES

[1] S. Nadkarni and P. Barr, Environmental Context, Managerial Cognition and Strategic Action: An Integrated View, Strategic Management Journal, vol. 29, 2008, pp. 1395-1427.

[2] J. Pisany-Ferry and Z. Darvas, Policy Brief 2008/10 Avoiding a new European divide, Bruegel, 2008.

[3] J. Bivens, “Everybody wins, except for most of us, Economic Policy Institute, Nov. 2008.

Tags: business, financial sector, meltdown, recession, strategy