Exxon CEO as US Secretary of State! Is business the problem or the solution?

So this week we hear that Trump has announced that his Secretary of State will be Rex Tillerson,  CEO of Exxon Mobil, the world’s largest private oil company.   Apart from all the additional jitters this creates around the environmental sustainability agenda, with one of the most powerful people in the oil industry becoming one of the most powerful global political leaders,  this is part of a bigger more significant statement – another business leader in a top political job.

As a business professional myself, now a professor teaching business leadership,  I must declare a bias towards the idea that business leaders could make particularly good political leaders.  There are  some reasons why I think this:

  1. Business leaders are familiar with the need to deliver sound economic results to achieve and retain their role as leaders. And economics continues to be a major driver of political success
  2. Business leaders of large organisations have had to operate effectively in a global arena. This means having to navigate the complex cultural differences around the world.  Political leaders increasingly need to be able to do this.
  3. Business leaders are pragmatic. They succeed by doing what it takes to get things done. Witness the Trump response to the question posed to him by a journalist after his election victory:  “Do you regret any of the things that you said during your campaign?” To which he apparently replied:  “Why would I?  I won, didn’t I?”
  4. Business leaders understand how to work effectively with risk. The business marketplace like the political landscape is a wild place. One minute you have a dominant position in an industry – the next minute, a disruptive digital technology is changing everything and your ship is sinking fast. He need to act fast – you need to make tough decisions regarding an uncertain future.  You need to be a strategic risk taker or you fail – as has happened to many organisations that failed to take the right strategic risks.

The interesting question for business leaders is the extent to which we, the “people”, trust them to work for our best interests.   Some would say this can never happen. Business leaders are primarily interested in personal wealth, and to achieve this, generally have to do whatever they can to maximise the profits of the organisations that they lead, and this tends to be in conflict with the interests of others who might be impacted by the organisation.  Others would argue that effective business leaders are only effective because they take account of the interests of all those impacted by a business organisation; so-called “stakeholders” who include customers, suppliers, employed staff and indeed the public at large.  This is a debate that has bubbled away for some time, and to some extent, polarises opinion on the purpose of business.

Over the past couple of years, I have been part of a team at Hult International Business School researching the business response to the issue of “Modern Slavery”.  [ http://bit.ly/2eWSm66  ]  This is the idea that certain extremely exploitative labour practices exist in the global supply chains of many leading business organisations.  It has been thrown into the spotlight in the UK by the passing of the Modern Slavery Act in October 2015, which requires UK-based business organisation to report on what they are doing to discover and address the issue.

Small Risky Strategy cover

EXTRACT FROM “Risky Strategy”

 

Today, we are witnessing Jenga towers toppling and collapsing, towers that previously looked strong.  Others on firmer foundations remain strong.  And new towers are being built all the time.

In our research on modern slavery, we have reached a situation where businesses at the end of a complex global supply chains, primarily the big brand retailers, are in a position to impact positively on the welfare of millions of workers in and from developing countries.  Historically, these businesses have competed to offer the best deal for consumers in the developed nations.  This is the essence of the capitalist model as originally set out by Adam Smith in his 18th century book The Wealth of Nations (Smith, 1997). We have international legislation that fiercely protects this competitive principle, on the basis that it protects the ‘paying public’ from exploitation.

However, we know today that in return for this privilege, there is still exploitation of workers that contributes to delivering this consumer benefit.   We know from our research that the only reasonable ways in which the developed world’s retailers and other major corporates can change this for the better is by collaborating – to maximise the influence and impact where it matters, including with national governments.   Ironically, in the UK and other countries, the latest legislation on modern slavery is a catalyst that encourages this collaboration.  But this flies in the face of naturally competitive instincts and competition law.   Is this a time for bold leaders to challenge this paradigm?  Could this be a time for a positive Black Swan?

Indeed, is this a time for business to become part of the solution, instead of part of the problem?

Timothy Fort, Professor of Ethics at George Washington University Business School, and Director of that university’s program on ‘Peace through Commerce’ (Fort, 2007), argues that for such a time as this, business itself has a role to play in bringing ethical leadership to the world in which it has become a core element.  He develops classical ’theory of the firm’ thinking:  is the purpose of business to maximise shareholder value, which gets further translated and simplified to maximise profit, or is it fundamentally to bring about positive social change?

 

Gut feeling works for financial traders – tigers in action!

“The study of 18 hedge fund traders found those with greater “interoception”, which is the ability to sense the state of their body, made more money and survived for longer in hectic financial markets. Results are published in the journal Scientific Reports

This work was led by John Coates, a Cambridge medical practitioner and former New York financial trader.

traders

In this extract from my book, “Risky Strategy” now available on Amazon and in certain Waterstones outlets, I talk about John’s work in the context of how “tigers” work with risk.

EXTRACT:

We learn from John Coates in his intriguing book on the “Hour between Dog and Wolf” (Coates, 2012) that risk is a ‘whole body’ experience.   Coates was formerly a financial trader in New York, and then switched careers to become a medical practitioner based in Cambridge in the UK.   His extensive research looks at how humans respond to risk physiologically, ie through the production and delivery of hormones.

It appears that three hormones play slightly different roles when we are confronted with situations involving some element of risk: cortisol, adrenaline and testosterone.  These hormones respond to variable inputs to the body:  visual input through the eyes, a sound, a smell or even some kind of impact to our skin’s sensory nerve endings.   What is interesting then is the role that the brain has in processing this information, and how the hormonal system is tied into that response.

Coates observes that in sport, for example, the speed of response needed by a player reacting to an approaching tennis or cricket ball, and making a skilful connection with that ball suggests that normal brain-based analytical processes can’t be too heavily involved.  There isn’t the theoretical time for the information to be sent to the brain, processed and sent back to the muscles that need then to respond.   It would appear that some kinds of pre-conscious and rapid communication between brain and muscles are what actually keeps us alive in fast-moving situations.  Hormones have some kind of role in facilitating this, even though the hormones themselves don’t move that fast.  Separately, conscious reflection shows up later, to analyse what has happened.

From this, we have the concept of muscle memory.   I am a keen tennis player, and am only too aware of the importance of muscle memory.  It works for you and against you.  Against in the sense that for most of my life I have not been hitting shots with a top spin action, which requires a loose wrist.  My muscles remember a firmer wrist flatter shot, and my mind is trying to convince them otherwise.   But it works for me in that once I have practised it a few thousand times, my mind doesn’t have to keep reminding my muscles what to do when I am playing in a match.  And that’s important when the ball is hurtling over the net onto my end of the court, and I need to react both quickly and accurately.

In the case of tennis, you wouldn’t typically refer to this kind of muscle memory as ‘intuition’.  But Coates observed something very similar, and quite mystifying, on the financial trading floor. Traders, it would appear, seem to develop muscle memory for responding to situations, even before they have very much information, and certainly before they have much time to analyse it.   He tells stories of traders sensing a buzz on the trading floor, or even change of tone of voice here and there, or the speed at which information was appearing on the screen … and issuing a “buy” or “sell” order immediately.

Speed, once again, in financial trading is of the essence.  Being even a couple of minutes slower in executing a trade can make huge differences in financial returns.  The trading floor is really a place for tigers – elephants need not apply!

Risky conversation at the hairdressers

I brought my newly published book, “Risky Strategy”, with me to my hair appointment this morning and placed it on the counter in front of me.  Lauren, who was cutting my hair, asked me about it, so I explained that it was about how we evaluate risk when we make decisions.

She asked me if I wanted a number 5?  I had never had this kind of cut before, and it sounded quite radical!  But I realised I was in a place where I could demonstrate something of what I had written about, so I said: “OK.  I’ll take the risk!”  She said a number of things to help me feel safe with this risk, like: “It wont be that short!” and “I wont apply the machine to the top of your head”, where things are a bit thinner.  And I instantly felt better.

I then talked about one of the other ideas in the book.  We tend to deal with risk either as “tigers” or “elephants”.  Elephants think about risks analytically, evaluate, take their time.  Tigers are more intuitive, quicker decision makers – work more on gut feeling.  We all have a bit of both in how we deal with risk, but some are more tiger and some more elephant.

Then the next door hairdresser immediately piped up that she had a friend who was very tiger,  and that she tended to be the elephant in the relationship, encouraging her to think more carefully.  My hairdresser then responded that  she was probably more tiger and that sometimes our tiger, gut feeling, can be spot on for some reason.

I then mentioned that in the book I talk about a New York trader, who went on to study medicine at Cambridge University.  He has written about a phenomenon involving our hormones,  and gave examples of how traders would sense a slight change of tone in someone’s voice, and know instantly they needed to sell their investment –  a fast decision that would turn out to be necessary just before the price dropped dramatically.

The client in the chair next to me then said that she had previously worked in the City in London back in 2008, and that a trader had noticed a slight change in a price index, and known intuitively that there was something wrong with the market.  A few days later, the banking crisis started to unravel!

I talked about how the cover of my book, showing a Jenga Tower, related to a scene from a recent movie, “The Big Short” in which a banker, Ryan Gosling anSmall Risky Strategy coverd colleagues is trying to convince Steve Carrell, a hedge fund manager and colleagues to invest in a financial instrument to go “short” on the US mortgage fund market.  He explains that bricks in the Jenga Tower represented different low quality investments that were going bust, as he pulled bricks out and threw them dramatically into a metal bin behind him.  Then as the tower collapses,  he says: “Then this happens!”.   Carrell responds: “Whats this?”.  Gosling replies”  “The American mortgage market!”  Great drama.   And I’m thinking, I hope I don’t experience this level of drama when I see the result of my haircut!

Then we get on to talk  about the mystery of intuition, and this is a clue to a parallel universe or time zone!   This depth of conversation across multiple clients in the hairdressers has never happened to me before.  And all because I mentioned that I had just published my book:  “Risky Strategy”

Check it out on Amazon and who knows what risky conversations you might end up in the most unlikely circumstances.  See https://www.amazon.co.uk/Risky-Strategy-Understanding-Strategic-Decisions/dp/1472926048?ie=UTF8&*Version*=1&*entries*=0

 

 

BREXIT is more risky, but is it the land of opportunity? Beware loss aversion!

All change is risky because we are moving into territory we are less familiar with, so we are not as well informed as to what could happen as when we stay where we are.

The REMAIN campaign appears to be largely based on the understandable fear of what might go badly in a new territory – that of being outside Europe.  Risk psychologists like Daniel Kahneman, in his Nobel prize winning work, call this  “loss aversion”.
Change brings more risk because it brings a greater variability of possible outcomes, but those outcomes can be better than expected as well as worse.  The problem is that our evaluation of these two possibilities is not symmetrical.  We tend to be more concerned about possible loss than we are excited about possible gain.

In my book, “Risky Strategy”, now available on Amazon on pre-order to be published in August  (http://amzn.to/1Q3L2Gn), I talk about this phenomenon and illustrate it with the diagram below,  which is a representation of the risk-return trade-off which most financial analysts and investors are familiar with.   The idea is that risk is actually about greater variability of possible future outcomes.  And with greater risk, we generally expect to achieve a better outcome than with less risk.

So when we look at what statisticians call the “normal” curve (or bell curve) below, mapping possible quantified  future outcomes (x axis) against the likelihood of them occurring (y axis), the more risky option is represented by the flatter bell, and the less risky, the taller narrower bell. What the diagram illustrates is that the peak of the flatter more risky bell represents a better expected outcome than that of the taller less risky bell.

160615 brexit chart

So if we plug into this our European referendum options, I argue that BREXIT is represented by the flatter curve, and REMAIN by the taller curve.  The shaded area to the left represents the possible outcomes that could be worse in a BREXIT situation.  The shaded area to the right represents what could be better in a BREXIT situation.   Human nature apparently tends to focus more, and therefore be more concerned about, the loss area.  This is our loss aversion.   But the area of opportunity is significantly bigger!

So what area of opportunity would BREXIT offer? I would like to suggest that we would be able to do more of what we believe is right, and not be constrained in this by Brussels.   I would like to suggest that we would not lose anything that is currently working well to mutual benefit – why would we?

Why would we see reduction in any trade with Europe that is beneficial to both buyer and seller?  We remain committed to free and fair trade, why should that change?  All that might change are those things which are not mutually beneficial.  For example, we would allow workers from Eastern Europe who brought value to the UK economy, as many do now.  But we might discontinue acceptance of those who come to diminish our society in some way.

If we can overcome our loss aversion, then the risky BREXIT option could bring us more upside than downside – it could be the land of opportunity!

Innovation & getting past loss aversion

Extract from book: “Risky Strategy” to be published by Bloomsbury in August

 

At Procter & Gamble this was referred to as ‘minimising the cost of failure’. The idea is that we reduce cost, and therefore the risk of failed innovation, by having regular check points or gates at early stages in the process, which provide opportunities to check out of the innovation process before too much is invested.   Our old friend ‘loss aversion’, and its close cousins ‘cognitive inertia’ and ‘confirmation bias’, are increasingly at work, seeking to trip this process up. At what point is too much invested in the process to feel comfortable to walk away with a guaranteed loss, while there is always the chance that it could still be a successful gain? To what extent do we continue to look for reasons why the innovation may not be right, compared to our reasons for persevering?

The Silicon Valley phraseology for this kind of approach is ‘failing fast’. The implication is that your expectation is managed because you expect to fail – the thing that’s important is that it happens quickly, you learn quickly and move on. Speed is of the essence. It would appear that, not just because in a world where technology is supposedly changing fast and markets are changing swiftly, being ahead of your competition is a distinct advantage. But also, ‘failing fast’ means you have not got too fond of your pet project; it’s not your baby to try and protect. As a result, cognitive inertia doesn’t have a chance to set in. And ‘failing fast’ means you have not built up too much cost before it becomes sunk cost.

 

It takes a certain type of character (or deep pockets) to be able to walk away from a lot of sunk cost on an innovation project that is going nowhere. I was at Mars Confectionery as a management trainee, in my early career years, when I witnessed Forest Mars turn up to our offices in Slough, and tell local management to start ripping up the Banjo line. Banjo was a chocolate wafer bar that was innovative because its main ingredient was a chocolate substitute, which was significantly lower cost than real chocolate. It had tested positively in research and test markets, and gone to full production. The Banjo line was the biggest and most efficient in the factory, using latest technology, for packaging as well as product. However, it was not tracking to plan, and while it was achieving profit, it was not achieving the required level of return on assets that the Mars family set for all its businesses. As far as Mars was concerned, it was therefore taking up valuable space and management time which could be better employed on better ventures. So it was stopped, and the investment written off. This type of risk mitigation is itself high risk for most business leaders.

Expect to gain when you take the right risk

We should expect there to be a reward for taking risk.  This is the principle on which the stock markets work, and financial investment in general.   This is different from thinking that flirting with danger of itself should be rewarded, and instead reflects the way that financial investors see risk – as variability rather then the prospect of danger or harm.   Statisticians and analysts measure variability in financial data – they call it things like variance or standard deviation in outcomes like profit.  And one way that they picture this is in  normal curves  (a.k.a “bell” curves) like the ones below.  Narrow tall bell curves represent limited variability of likely outcomes – and therefor represent low risk options.  Wide bell curves represent high levels of variability of outcomes, and therefore higher risk.

This diagram seeks to show that when comparing different financial investments with different risk profiles, we should expect to gain from the higher risk option.  This is sometimes referred to as the risk/return tradeoff.

riskreturncurve

[Extract from book: “Risky Strategy” to be published soon]

The risk in financial markets is measured as variability over time or between investments, as I touched on in Chapter 4 when talking about definition of risk. This may be variability of share price, or indeed profit, or some other important measure. So an investment where this key measure varies a lot over time is higher risk than one where the measure is more stable.  This risk and variability tends to follow patterns by certain groupings of investments, for example by industry sector.    So a new technology sector such as the bio-technical sector, with smaller companies and unproven technology would be a higher risk sector than for example consumer goods,   with established large organisations with mostly established brands and technologies.  So according to our risk-return thinking, we would expect to get a higher return from an investment in the bio-medical sector compared to the consumer goods sector.

As we explored in Chapter 4, one way we represent this variability is through the normal curve, sometimes called the bell curve. So for example, our likely financial returns in a given sector, are distributed around our expected return, the peak of the normal curve.  If there is a wide range of expected returns, this is a high risk situations which is represent by the wide normal curve.  A lower risk sector with a smaller range of possible returns is represented by the taller narrower normal curve.

If we build in our risk-return thinking into our normal curve model, and combine our broad, high risk curve with our narrow low risk curve,  we end up with something that looks like the diagram below.  First of all, in the low risk case, represented by our red curve, our expected outcome or return is more likely, than in our high risk case;  hence it is taller.  More to the point, the expected return or outcome from our high risk option is higher than the expected return from our lower risk option.  This is risk return thinking. And the difference in return between the two options is referred to as the risk premium

Lets look at this diagram more closely because it highlights a fascinating insight when we look at risk in this way. There are two shaded areas in the diagram. The shaded area on the left, what I have called the area of danger, is the main reason why we may not go for the higher risk option.   This represents all those possibly outcomes or returns that are worse than our expected outcome, that are more likely to occur if we choose the high risk option.

But now, lets look at the shaded area on the right side. This is the area of opportunity, and represents all the outcomes or returns that are better than our expected outcome, which are more likely to occur if we select the high risk option. What is interesting is that this is a much bigger area than our area of danger.  This is because, when we look at risk in this way, there are two important assumptions that lead us to this place.

  1. Our risk profile is symmetrical as represented by a normal curve. That means that better than expected outcomes are just as likely to occur as worse than expected outcomes. This is clearly not the way we always think about risk, and when we think of it in terms of possible crisis situations, it generally doesn’t have this symmetry. But in the case of financial investment, and more generally, business innovation, it probably often does.
  2. Risk-return thinking is valid. We should expect on average to earn more from a high risk investment than a low one.

When looked at like this, there is quite a compelling case for taking more risk. Our chances of doing better are disproportionately higher than our chances of doing worse.

It begs the question, if we saw business investment in this way more clearly, would we be inclined to take more risk.

The reality appears to be that we tend to be drawn to focus more on the smaller shaded danger zone on the left , almost like Greek sailors to the siren call. This leads to the phenomenon of “loss aversion”, which I shall pick up in more detail in Chapter 7, when I talk about illusions and traps.

Feeling safe with risk

In this Christmas season when some of us celebrate the idea of a saviour sent to our planet to rescue us from sin and death,  it seems appropriate to explore what it is that actually helps us to feel safe. It is part of the human condition to need to feel safe,   while at the same time recognising that we live with risk, and regularly take it.  I explore this paradox in the penultimate chapter in my book: “Feeling safe with risk”

feeling safe on a girder

[Extract from “Risky Strategy” to be published in 2016]

So in handling this paradox of safety with risk, our approach to risk will of course therefore be determined by where or how you experience safety. We tend to experience safety where we can truly place our faith.

I am reminded of the exploits of the Niagara Falls tight rope walker in the mid nineteenth century known as “The Great Blondin”, whose real name was Jean Francois Gravelet. He repeated the stunt of crossing the falls on many occasions, sometimes using other props, like bicycles and wheelbarrows.  On one occasion he is reputed to have taunted the crowd with the question: “How much do you believe in me?” and getting loud affirmation.  He then asked who in the crowd who said they believed in him would get on his back as he crossed the falls.  No one was prepared to do that – no one had that much faith in him. He did apparently eventually do it with his own manager, which caused quite a stir not just for the crowd but also for the manager.

How can you feel safe with risk? To whom or what can you put enough faith to feel safe?

  • For some it’s more in numbers and logic – the evidence is enough.
  • For some it’s in relationships – and knowing that certain key people are in the same place as me.
  • For some it’s in intuition and gut – I know it down deep – it’s a whole body experience
  • For some it’s in a belief or worldview – perhaps a cultural or religious view which also informs values

 

My initial interest in exploring the subject of risk in leadership was shepherded by another related interest – the role of faith in business. I have for some time been fascinated by how some people make quite difficult decisions, on issues involving quite high levels of uncertainty, with an almost equally high degree of confidence.  I am particularly fascinated when this happens with leaders in business.  And I would tend to express this confidence as faith.  Normally there is some object of that faith, and actually the real sentiment attaching that leader to that “object of faith” is trust.

 

So what are those objects of faith, those factors on which a leader bases a decision and which is the source of confidence?   They can be a number of things.  First and foremost, they can and often are other people.  I will take this decision because I trust you;  either that you have done your homework adequately in recommending this decision in the first place;   or that in going with this plan of action, I can trust you will make sure that it happens the way it needs to.  So my faith in taking this decision is in another person or group of people.

 

I have some experience of working with private equity investors and venture capitalists.   They take decisions involving risk all the time – that is their business calling.  They will review business plans, take positions on certain technologies and market sectors, and meet the proposed teams that will be leading the ventures that are requesting funding.  The single biggest factor that will determine whether or not to invest in that venture is what they think of the management team.  Essentially it is: do they trust them to do what they say they are going to do in the business plan.  The investors are primarily basing their risky decisions on whether or not to invest, on whether or not they have faith in the management team.

 

Leaders can also base their faith on other factors. A strong well-reasoned argument with good supporting evidence can also be a basis for faith.  This can be especially true where this forms part of a proven process.  This was the culture of decision making at Procter & Gamble (P&G) whom I joined as a trainee Marketing Manager, straight out of business school.  P&G has a culture of encouraging new young business managers (Brand Managers, Market Managers) to take ownership for a small portion of the business and take initiatives that require decisions involving some degree of business risk. The primary process for doing this were that juniors like me wrote proposals – often famously no more than one page long – which were submitted, approved and forwarded to increasingly higher levels of management, until they were finally approved for implementation at the appropriately highest level, quite often either the regional General Manager, or the President of the Division, which in my case was P&G’s Export and Special Operations Division, headquartered in Geneva, Switzerland.

 

I remember meeting my regional General Manager for the first time after I joined. He gave me a few tips. One of them was that when I submit a proposal for some kind of investment, if the decision comes down to a difference between his opinion and mine, his would always win.  But if it came down to his opinion, and a well-reasoned and evidenced argument on my part, mine would win.  Leaders at P&G place a high level of faith in evidence and logic,  not to the exclusion of faith in individuals, but the evidence is a major contributor.  And of course, because this is part of the P&G culture, the two go very much hand-in-hand.

We know people place their faith in a name. Customers make daily decisions on product or service purchases based on brand names.  There is risk in any purchase – we often cannot be sure that the product or service that we pay money for, will deliver what it is supposed to.  This is the basis of branding.  P&G launched the first branded soap, Ivory, in the mid nineteenth century because they noticed that unscrupulous soap makers were supplying poor quality soap to customers – the kind that would just disintegrate after a couple of washes, for example.  So you bought your soap from a vendor you trusted – you placed your faith in the person.  But as markets got bigger and more impersonal, you couldn’t do this any more.  Every purchase was a risk that you were buying a soap that would disintegrate. So P&G created a soap with a quality controlled process, and marked it with a name, a brand name, Ivory.  As it happens the brand name was inspired by Psalm 45: “From palaces adorned with ivory, the music of the strings makes you glad”.  Here was a soap you could trust – a brand name you could put your faith in.  One that effectively mitigated the risk of the purchase.

On a larger scale, where risk is a more blatant issue, faith in a brand still plays a significant role. Consider IBM and the mantra that echoed around the corridors of power in many organisations: “at least you won’t get sacked for buying IBM”. Similar stories could be told of other major service business-to-business brands.  “We are confident in this difficult decision because McKinsey or PwC have recommended it”.

My interest in this approach was also kindled by a conversation with a colleague, on leadership in sustainability, and a particular example from Coca Cola. They became aware that one opportunity to generate significant energy savings and environmental benefits was to put doors on their coolers in retail outlets.  And yet they also knew from research that doing this would have a significant adverse impact on sales and profit.  So what was the underlying “leadership mindset” that led them to put doors on all their retail coolers?  I was interested in how  leaders saw “faith” as playing a role in leadership  and I saw the link between risk and faith.

Bayesian tale of two cities

This season of Christmas and New Year are particularly well celebrated in the major cities like London and New York.  I remember people celebrating the New Year in, in both cities, by taking Concorde from London to New York and taking advantage of the time difference.

Part of the theme of my book is in working with the juxtaposition of polarities of difference – and I kick off with reference to Charles’ Dickens “Tale of Two Cities”;  “it was the best of time, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going to Heaven,  we were all going direct the other way”.  I suggest that as we stand in the gap between difference, it can be uncomfortable but rewarding.

And this talk of two cities reminds me of the types of illusions that can throw us off the scent of how we evaluate risk.  It’s about Bayesian logic, and the basis of one of my favourite jokes, which is how I start the next extract from my book.

[Extracts from “Risky Strategy” to be published in 2016]

Tworisks

One of my favourite “one line” jokes goes like this: “Did you know, I am more likely to be mugged in London than I am in New York..[Pause for effect] … That’s because I hardly ever go to New York”

This is an example of Bayesian probability. The Reverend Bayes in the nineteenth century came up with a formula for calculating the results of conditional probability.  Put more simply, that is what happens to overall likelihood when you combine two types of variability.   So in our joke example, we have the variability of getting mugged in either London or New York,  and the variability of the amount of time I spend in either London or New York.  So given I am in New York, my likelihood of getting mugged is say 5%;  whereas, given I am in London, my likelihood of getting mugged is say 1%.  However, I only spend 10% of my time in New York, and 90% in London.  So overall the chances on any given day that I am mugged in New York are  0.5% (5% x 10%), whereas the chance that I am mugged in London is 0.9% (1% x 90%), ie London is higher than New York.

 

This might sound like a trivial example which doesn’t matter that much, but I believe we see Bayesian confusion created by authoritative voices in society, particularly when it comes to medical issues. Taleb picks up on this particular example in “Fooled by Randomness” (Taleb N. N., Fooled by Randomness: The Hidden Role of Chance in Kife and in the Markets)

You have a disease which can affect 1 in 1000 people (ie  0.1%), and the test for the disease is 95% accurate, which means there is 5% false positive. That means that in a sample of 100 test results, 5 of those will  indicate a disease which isn’t there. If someone gets a positive test result what are the chances they actually have the disease?  Many would say 95%.  Actually it’s much lower: 2%.  That’s a surprise to many of us. This is how it can be explained.  In a random group of 1000 people all who happened to have been tested, only 1 probably has the disease. However, of the remaining 999, about 50 (5% of 999) will have tested positive for the disease. So out of that 50, that chances that you are the one that have the disease is 1 in 50 ie 2%.  This is quite a powerful illusion. I wonder how many people who have been tested for a fairly rare disease with what appears to be a fairly reliable test, and testing positive, have been told there is a high chance they have the disease.

Illusions about acceleration of change impact our view of risk

A recent Economist article:  “The Creed of Speed”  http://www.economist.com/news/briefing/21679448-pace-business-really-getting-quicker-creed-speed   challenges some of the generally held views that change is accelerating, which makes long term strategy setting potentially futile.   This ties is with my chapter on mind games, covering some of the factors that can influence our approach to risk in developing strategy.

[Extract from “Risky Strategy” to be published in 2016]

One of the most pervasive concepts we have when thinking about strategy under uncertainty, is that it is getting more difficult because change is just happening more quickly.  So we tend to be more likely to conclude with Error Type B (See Chapter 1),  there is no point in making decisions because the chances are very high that we will have to change them in a little while, when something else big happens to change everything.

You will have gathered by now that I don’t support this view. I believe we do need to be prepared to make tough choices as leaders, even though they can entail significant risk.  Now comes perhaps one of the more radical ideas in this book:

“I’m not totally convinced that change is actually happening faster now than it was in the past”.

Oops there, I have said it.  Partly, I wonder if it’s the basis for not making decisions which as leaders, I believe we are often paid to make.  I wonder if it’s a bit of a cop out.

I also am aware that there is a growing body of business people who have a vested interest in the idea that change is happening fast. It is the fundamental calling card for management consultants, of which I am one and have been for much of my professional career.  So with this kind of vested interest, I naturally feel a tad suspicious that the very same people are the ones promoting the idea that “you’d better watch out, because change keeps accelerating!”

There is one example of where I am aware of an illusion that helps to promote this idea.  It is the illusion that our population has been growing faster in recent decades than it has been throughout the history of mankind. And it is captured in a graph that looks something like the one below.

Population growth

The headline is “here is another example of how much change is accelerating in the last hundred years or so”.  The reality is that this curve is the output from a mathematical model of population growth.   The rate of   growth actually remains the same throughout the time period represented by the x axis – ie as shown here, since the beginning of time.   The main driver of population growth is the average number of offspring per couple who then go on to reproduce themselves. If this growth factor is above 2, population grows; if it is below 2, population declines.   In this model, this growth factor is actually the same throughout the time period represented.  Population growth is not actually accelerating; the rate of sustainable reproduction has remained the same throughout the time period.

 

 

Do you embrace variability?

[Extract from “Risky Strategy” to be published in 2016]

As we have seen, variability is at the heart of risk.  We also know that the world would be a dull place without variability.  And we are somehow conditioned to want to do something about that variability – to work with it and at the same time against it.

Imagine a game of tennis where the ball bounced in exactly the same place and to the same height before you hit it.  So you would master the game very quickly by playing pretty much the same shot every time. You might become very good at it, but how interesting would it be.  Why don’t they make golf courses with all the holes the same length, in a straight line with same size greens, and the hole in the same spot on each of them.  You can see the point. We enjoy the variety, and at the same time, we are honing our skills to try and counteract that variability;  that we hit the same quality of tennis shot regardless of where it bounces and how high;  that the golf ball heads towards the green regardless of the distance we are away and what type of ground surface we are hitting it off.

Its as though life is designed to create risk, and then deal with it, either by going with it, or working to counteract it  … and that is part of how we enjoy life.

I am reminded of one of John Cleese’s Video Arts humorous training videos which were popular in the 1980s – the one on time management. Most of the film was about being ruthless with time-wasting activities.  Then there is a shot of John Cleese sitting at his desk when the phone rings several times, without him answering it. The voiceover asks him something like: “Why aren’t you answering it?”, to which Cleese responds that it would be just another distraction that would waste his time. The voiceover then says: “No, wrong. You need to answer it. That’s your job calling!”

While the elephant mindset is, to some extent, that variability is an annoying distraction,  for tigers it’s their job calling.  In fact, tigers are naturally anti-fragile, according to Taleb’s view of risk. (Taleb N. N., Antifragile – How to Live in a World We Don’t Understand, 2012). His proposition is that we as individuals and organisations are naturally fragile within the uncertain world in which we live.  The market can change due to new technology; our lives can change due to an unexpected illness or accident.  And we tend to respond by doing things to compensate for this fragility by trying to create robustness.  We diversify by investing in other products with other technologies in other markets.  We cut costs to save money for that unforeseen event, and we take out expensive insurance to cover eventualities of various kinds. And somehow it doesn’t seem to bring the peace we seek.

Taleb proposes an alternative model – anti-fragility. It’s a kind of working with the variability and risk, rather than against it.  He takes part of his cue from nature.  Plants work through a process of death being the source of new life. Part of the fruit or flower of the plant, a seed, is  deliberately disconnected from the plant and is buried – and this is what creates new life. Or the cutting of a branch through pruning creates an environment for even more vigorous growth than was there before.

“The best way to verify that you are alive is by checking if you like variations …. Food would not taste if not for hunger; results are meaningless without effort, joy without sadness, convictions without uncertainty;  and an ethical life isn’t so when stripped of personal risks”  [Taleb N. N]

Our human bodies are built to be anti-fragile – clearly designed to deal at least as much with the consequences of risk as to be able to avoid it.  Wounds heal themselves with relatively minimal outside help, and white blood corpuscles fight off unwelcome bugs which are part of the risky external environment that our bodies inhabit.   Our health systems seek to create robustness which is a pale comparison to the anti-fragility that is part of our human make-up.

Taleb’s arguments apply the lessons of organisms such as plants and the human body, to human organisations.  Those that try to create systems to constrain risk, by having checks and balances at every corner, will never be as effective as anti-fragile organisations that work with risk, where every part of that organisation is designed and motivated to take a risk situation and do something better as a result of it.

Organisational leaders could benefit so much from learning how to get more from their people in their natural capability to deal with risk and variability.