Strategy in the media - recession and innovation

Strategy & Leadership

ISSN: 1087-8572

Article publication date: 8 May 2009

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Citation

Henry, C. (2009), "Strategy in the media - recession and innovation", Strategy & Leadership, Vol. 37 No. 3. https://doi.org/10.1108/sl.2009.26137cab.003

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Emerald Group Publishing Limited

Copyright © 2009, Emerald Group Publishing Limited


Strategy in the media - recession and innovation

Article Type: CEO advisory From: Strategy & Leadership, Volume 37, Issue 3

Dealing with a “cosmology episode”

A cosmology episode is the opposite of a déjà vu experience. When you experience déjà vu, everything suddenly feels inexplicably familiar. By contrast, in a cosmology episode, everything seems completely strange and dangerous, unknown. In cosmology events, people feel that they don’t know what to do because they’ve never been here before. Panic and fear bubble to the surface, and folks become so anxious that they find it almost impossible to take action.

Weick’s insight about how to move forward during a cosmology episode is as counter-intuitive as it is compelling. The people who really get in trouble, he says, are those who rationalize everything before taking any action. Instead, leaders need to act before they have defined and refined all their hypotheses. “Action, tempered by reflection, is the critical component in recovering from cosmology episodes,” he told HBR readers. “Once you start to act, you can flesh out your interpretations and rework them. But it’s the action itself that gets you moving again. That’s why I advise leaders to leap in order to look, or leap while looking.”

A psychology professor at the University of Michigan Business School at Ann Arbor, Weick offered a practical example of his theory. Some Hungarian troops who got lost in the Alps wandered around aimlessly until one of the soldiers found a map in his pocket. The platoon found their way to safety, only to learn that the map they used was, in fact, a map of the Pyrenees. “I just love that story,” Weick laughed, “because it illustrates that when you’re confused, almost any old strategic plan can help you discover what’s going on and what should be done next. In crises especially, leaders have to act in order to think – and not the other way around.”

Diane Coutu “Leap while you look: moving forward in the Recession,” HBR Editor’s Blog, 26 January 2009, http://blogs.harvardbusiness.org/hbreditors/ 2009/01/leapwhileyoulookmovingfor. html

Why businesses repeat the mistakes of others

There are many, many instances of financial incentives driving behavior that then causes organizations major problems. This fact raises the question of why no one ever seems to learn anything – which explains why the current situation with home mortgages looks remarkably like the case of making bad loans to countries that couldn’t repay them about 25 years ago and a little like the savings and loan mess of the late 1980s.

I can point to three key reasons why collectively we seem to learn nothing from past mistakes:

  1. 1.

    Lack of focus on understanding failure. Go to a leading business school and find me the business historians. Good luck. Or, for that matter, the cases on failure. We find history boring and are much more interested in successes – witness all the media attention to Google – than on learning from mistakes.

  2. 2.

    Over-reliance on compensation as a management tool. Most people suffer from an “extrinsic incentives bias” – the belief that others are motivated by money even if we know we are not. For instance, Kaplan, the test preparation company, gave a survey to some people taking the LSAT. While only 12% of those responding said they were interested in law school for the money, these same people thought that 60% of their fellow test-takers were. Coupled with the large compensation consulting industry and a belief held with almost religious fervor that properly designed incentive schemes are necessary to get the right behavior, most organizations overemphasize pay as an element in their management system.

  3. 3.

    Omnipresent managerial hubris. Finally, there is the amazing resilience of managerial hubris – pride. Although executives obviously know many instances of how poorly designed reward systems produced behavior that caused other companies problems, they cling to the belief that such things won’t happen in their organizations because – they are smarter! Wrong again.

There’s an old saying in investigative reporting – follow the money. Turns out that’s a pretty good clue to understanding lots about organizations and the troubles they encounter. While pundits expound endlessly on how the current financial mess arose, the answers are, in virtually every case, quite simple. People did what they were paid to do – make (bad) loans, take excessive risks, package and resell worthless paper, leverage up the balance sheet, and so forth. Unless we get better at the seemingly simple task of predicting what reward systems are actually going to do, and unless we get smarter about designing rewards that don’t produce destructive behavior, the current bad news will just get recycled in the future. That’s because we don’t seem to learn anything from experience.

Jeffrey Pfeffer, “When will we ever learn?,” The Corner Office, 18 December 2008, http://blogs.bnet.com/ceo/?p=1576

The perverse incentives that fueled the financial bubble

Everyone now knows that Moody’s and Standard & Poor’s botched their analyses of bonds backed by home mortgages. But their most costly mistake – one that deserves a lot more attention than it has received – lies in their area of putative expertise: measuring corporate risk.

Over the last 20 years American financial institutions have taken on more and more risk, with the blessing of regulators, with hardly a word from the rating agencies, which, incidentally, are paid by the issuers of the bonds they rate. Seldom if ever did Moody’s or Standard & Poor’s say, “If you put one more risky asset on your balance sheet, you will face a serious downgrade.”

The American International Group, Fannie Mae, Freddie Mac, General Electric and the municipal bond guarantors Ambac Financial and MBIA all had triple-A ratings. (GE still does!) Large investment banks like Lehman and Merrill Lynch all had solid investment grade ratings. It’s almost as if the higher the rating of a financial institution, the more likely it was to contribute to financial catastrophe. But of course all these big financial companies fueled the creation of the credit products that in turn fueled the revenues of Moody’s and Standard & Poor’s.

These oligopolies, which are actually sanctioned by the SEC, didn’t merely do their jobs badly. They didn’t simply miss a few calls here and there. In pursuit of their own short-term earnings, they did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it …

In 1990 MBIA was in the relatively simple business of insuring municipal bonds. It had $931 million in equity and only $200 million of debt – and a plausible triple-A rating.

By 2006 MBIA had plunged into the much riskier business of guaranteeing collateralized debt obligations, or CDOs. But by then it had $7.2 billion in equity against an astounding $26.2 billion in debt. That is, even as it insured ever-greater risks in its business, it also took greater risks on its balance sheet.

Yet the rating agencies didn’t so much as blink. On Wall Street the problem was hardly a secret: many people understood that MBIA didn’t deserve to be rated triple-A. As far back as 2002, a hedge fund called Gotham Partners published a persuasive report, widely circulated, entitled: “Is MBIA Triple A?” (The answer was obviously no.)

At the same time, almost everyone believed that the rating agencies would never downgrade MBIA, because doing so was not in their short-term financial interest. A downgrade of MBIA would force the rating agencies to go through the costly and cumbersome process of re-rating tens of thousands of credits that bore triple-A ratings simply by virtue of MBIA’s guarantee. It would stick a wrench in the machine that enriched them. (In June, finally, the rating agencies downgraded MBIA, after MBIA’s failure became such an open secret that nobody any longer cared about its formal credit rating.)

Michael Lewis and David Einhorn, “The end of the financial world as we know it,” The New York Times, 4 January 2009.

Why Wall Street ignored its risk models

In the bubble, with easy profits being made and risk having been transformed into mathematical conceit, the real meaning of risk had been forgotten. Instead of scrutinizing VaR for signs of impending trouble, they took comfort in a number and doubled down, putting more money at risk in the expectation of bigger gains. “It has to do with the human condition,” said one former risk manager. “People like to have one number they can believe in.” …

At most firms, risk managers are not viewed as “profit centers,” so they lack the clout of the moneymakers on the trading desks. That was especially true at the tail end of the bubble, when firms were grabbing for every last penny of profit.

At the height of the bubble, there was so much money to be made that any firm that pulled back because it was nervous about risk would forsake huge short-term gains and lose out to less cautious rivals. The fact that VaR didn’t measure the possibility of an extreme event was a blessing to the executives. It made black swans all the easier to ignore. All the incentives – profits, compensation, glory, even job security – went in the direction of taking on more and more risk, even if you half suspected it would end badly. After all, it would end badly for everyone else too. As the former Citigroup chief executive Charles Prince famously put it, “As long as the music is playing, you’ve got to get up and dance.” Or, as John Maynard Keynes once wrote, a “sound banker” is one who, “when he is ruined, is ruined in a conventional and orthodox way.” …

“The question is: how extreme is extreme?” Viniar said. “Things that we would have thought were so extreme have happened. We used to say, What will happen if every equity market in the world goes down by 30 percent at the same time? We used to think of that as an extreme event – except that now it has happened. Nothing ever happens until it happens for the first time.”

Joe Nocera “Risk mismanagement,” New York Times Magazine, 4 January 2009.

How mental processes drive bad decisions

Decision making lies at the heart of our personal and professional lives. Every day we make decisions. Some are small, domestic, and innocuous. Others are more important, affecting people’s lives, livelihoods, and well-being. Inevitably, we make mistakes along the way. The daunting reality is that enormously important decisions made by intelligent, responsible people with the best information and intentions are sometimes hopelessly flawed …

Brigadier General Matthew Broderick, chief of the Homeland Security Operations Center, who was responsible for alerting President Bush and other senior government officials if Hurricane Katrina breached the levees in New Orleans, went home on Monday, August 29, 2005, after reporting that they seemed to be holding, despite multiple reports of breaches …

We depend primarily on two hardwired processes for decision making. Our brains assess what’s going on using pattern recognition, and we react to that information – or ignore it – because of emotional tags that are stored in our memories. Both of these processes are normally reliable; they are part of our evolutionary advantage. But in certain circumstances, both can let us down.

Pattern recognition is a complex process that integrates information from as many as 30 different parts of the brain. Faced with a new situation, we make assumptions based on prior experiences and judgments. Thus a chess master can assess a chess game and choose a high-quality move in as little as six seconds by drawing on patterns he or she has seen before. But pattern recognition can also mislead us. When we’re dealing with seemingly familiar situations, our brains can cause us to think we understand them when we don’t.

What happened to Matthew Broderick during Hurricane Katrina is instructive. Broderick had been involved in operations centers in Vietnam and in other military engagements, and he had led the Homeland Security Operations Center during previous hurricanes. These experiences had taught him that early reports surrounding a major event are often false: It’s better to wait for the “ground truth” from a reliable source before acting. Unfortunately, he had no experience with a hurricane hitting a city built below sea level.

By late on August 29, some 12 hours after Katrina hit New Orleans, Broderick had received 17 reports of major flooding and levee breaches. But he also had gotten conflicting information. The Army Corps of Engineers had reported that it had no evidence of levee breaches, and a late afternoon CNN report from Bourbon Street in the French Quarter had shown city dwellers partying and claiming they had dodged the bullet. Broderick’s pattern-recognition process told him that these contrary reports were the ground truth he was looking for. So before going home for the night, he issued a situation report stating that the levees had not been breached, although he did add that further assessment would be needed the next day.

Andrew Campbell, Jo Whitehead, and Sydney Finkelstein, “Why good leaders make bad decisions,” Harvard Business Review, February 2009.

Why did the financial forecasters fail?

We wish that we had been wrong, but readers of our blogs will know that my partner Gerry Riskin and I foretold as long ago as mid-2007 that the economy was heading for a wall and that law firms needed to take heed and prepare for rocky times. We do not have huge mainframe computers and sophisticated economic analysis software. Most others that do, at that time held precisely the opposite view to us. At least publicly.

We were not alone, though. Renowned economist Nouriel Roubini (http://www.rgemonitor.com/) earned the nickname “Dr Doom” for his then (in 2007) contrarian view of the economy.

“The bursting of the housing bubble is going to lead to broader systemic banking problems,” he told an IMF audience in 2007. “The rest of the world is not going to be able to decouple from the US even if it is not going to experience an outright recession like the United States.”

What led us to the conclusions that we reached, while those focusing on highly quantitative analytical models did not? In short:

  • Markets are far too complex to allow all the variables to be built into predictive software programs.

  • Barring artificial intelligence software (which is still too far on the fringes of R&D … for now) software by definition can only process data that are inputted, so is not able to account for unforeseen circumstances.

  • Economic data are inherently retrospective and therefore only a reliable predictor of the future when current circumstances sufficiently resemble previous circumstances already captured in the data.

There has been far too much slavish reliance on the output of complex quantitative econometric formulae, at the expense of rigorous qualitative logical thought. “Show me the numbers” is all very well and Peter Drucker’s admonition that “if you can’t measure it you can’t manage it” has much truth in it. But the most sophisticated quantitative analysis in the world is no replacement for well-informed, critical-analytical human brains looking at the qualitative aspects in ways that computers simply cannot.

Rob Millard “Number crunching vs analytical thought,” Adventures of Strategy, 9 January 2009, www.robmillard.com/archives/megatrends-number-crunching-vs-analytical-thought.html

In bad times, failure is a virtue

Unfortunately, even though there is massive evidence that innovation is impossible without action, that no learning or creativity is possible without failure either, we have entered an era of fear. I feel it everywhere, in every industry, even among the companies and people who are riding out the bad times well. The unstated motto these days is “Reward Success and Inaction, Punish Failure.” This is a perfect recipe for REAL failure. It seems that trying and failing are now out of fashion. I am not saying urging people to take risks that are too big. Just as I have argued about the virtues of small wins, I believe that one of the keys to getting out of this mess if for all of us to find ways to accept and learn from small loses.

It is worth remembering research on difference between the most creative and successful people versus their more ordinary peers. Einstein and da Vinci had more bad ideas than their peers. Babe Ruth struck out more. That is because they acted, failed, learned, and kept moving forward …

Some advice for all of us … I am having trouble following too, I confess, but let’s try:

  1. 1.

    Take a little risk.

  2. 2.

    Try something you are bad at.

  3. 3.

    Encourage someone who has given their all and failed – don’t humiliate or punish them.

  4. 4.

    Remember that by insisting on perfection and worrying too much that something bad will happen, you preclude the possibility that something great happen – or of suffering failure that will teach you a lesson that will make you a huge success the time after.

  5. 5.

    Talk about your mistakes and let others know what you have learned from them.

  6. 6.

    Punish inaction.

  7. 7.

    Punish CYA behavior – that isn’t the kind of action we need right now.

Bob Sutton, “Reward success and failure, punish inaction” Work Matters 10 February 2009, bobsutton.typepad.com/ myweblog/2009/02/reward-success-and-failure-punish-inaction.html

Requirements for transformation

Organizational transformation is a tough task. Just about everyone has lived through a failed effort to transform a team, unit, or broader organization. Done well, however, a transformation can set an organization up for decades of success. Look at what has happened to Apple during this decade or IBM in the 1990s.

There are three lessons from corporate transformation efforts that could help the new government achieve its aims:

  1. 1.

    Transformation doesn’t come from doing what you are currently doing better. It isn’t just about doing what you are doing differently. It involves stopping some things, and starting others. Over the past two decade Procter & Gamble has exited many food-related businesses, stepped up investment in health and beauty businesses, and changed its overall approach to innovation.

  2. 2.

    Start small. Asking everyone to do things differently is a sure recipe for failure, because you don’t know what you don’t know. Get some early wins before expanding efforts.

  3. 3.

    Invest in the human side of transformation. It’s hard to ask people to do what they are not capable of doing, or what they don’t understand. Invest to build capabilities, bring in fresh mindsets, and develop a common language of change.

Succeeding with transformation is tough, but possible. And it is increasingly necessary; the “new normal” of constant change requires every organization to improve its ability to master transformation.

Scott Anthony, “Three ways to transform the US government (and your business),” Innovation Insights, 20 January 2009, http://blogs.harvardbusiness.org/anthony/ 2009/01/threewaystotransformtheus.html

Selling software: still lucrative, but different

As computers burrow ever more deeply into our lives, the market for good software only grows. Ten years ago, the PC was the only device that ran a recognizable operating system. Today, your cell phone, your music player, your TV’s set-top box, your camera, your GPS navigator, your video game console, and dozens of other devices require code to keep them humming – and to keep them working together. Not only that, but people are willing to pay for software that makes these devices easy to use. Look at the iPhone. Sure, it’s pretty on the outside, but its main innovations are inside: its user interface, Web browser, App Store, and seamless connection to your PC and the Internet cloud. The iPhone carries no ads; it is supported entirely by customers’ monthly contributions to Apple and AT&T – to the tune of around $2,000 over the life of a two-year contract.

The success of the iPhone and other smartphones demonstrates how the market for software is changing. Applications are no longer bound to a single device – your programs come in different flavors on different gadgets and share data across the Internet. The model by which we pay for software is also shifting. Once, we bought applications in boxed units; now, depending on your need, you may buy a subscription to an online service (see what 37 Signals does with its Web collaboration software), you may download software for free in conjunction with a gadget (sales of iPods and Macs subsidize Apple’s development of iTunes), or you might get an app in return for viewing ads (that’s how Google supports most of its Web apps for consumers).

As Henry Blodget has pointed out, free, ad-supported Web applications pose little threat to Microsoft’s most profitable business – selling software to corporations. It’s true that companies are increasingly replacing their desktop software with Internet apps – but many still want to pay for the stuff they’re using. Google charges firms $50 per employee for a suite of its online programs; in return, employees see no ads, and companies get technical support from Google. Salesforce.com, one of the most successful online software companies, also shuns the ad-supported model – and last quarter, its revenues jumped 43 percent …

Last month, I praised Windows 7, Microsoft’s excellent successor to Windows Vista, which the company says will run well on netbooks. But many people who load up Windows 7 will still go elsewhere for most of the software they run on it – they’ll download iTunes to manage their music, Google’s Picasa to manage their pictures, and Firefox or Chrome to get online. When we think of the software that powers our most personal apps, we rarely think of Microsoft.

Farhad Manjoo, “Forget Yahoo – buy palm,” Slate, 20 January 2009, www.slate.com/id/2209139/

Social activists can be the allies of radical innovation

Activists who challenge the status quo play a critical but often overlooked role in both promoting and impeding radical business innovation. Their importance stems from the very nature of innovation, which frequently challenges existing interests, norms, values, social practices, and relationships. As a result, the joined hands of market rebels – activists and their recruits – have with surprising frequency exerted significant influence on market acceptance of breakthrough products and services.

For example, nearly all of the technical aspects associated with personal computing were available by 1972, but the PC didn’t take off until a few years later when hobbyists, rebelling against centralized computing, organized groups such as the Homebrew Computer Club. These clubs were spawning grounds for actors – such as inventors, founders of companies like Apple, and developers of programs and games – who collectively established the market for personal computers and eventually stimulated the entry of larger companies. Similarly, the hybrid car succeeded partly because market rebels in the environmental movement paved the way by arousing collective enthusiasm for “green” causes among consumers and regulators.

By contrast, radical innovations (such as the Segway personal transporter) have often floundered because their developers overlooked the social and cultural mobilization needed to excite their targeted consumers.

Hayagreeva Rao, “Market rebels and radical innovation”, McKinsey Quarterly, January 2009.

Key to survival: smarter, not bigger

When will big-company CEOs ever learn that using acquisitions to get bigger almost never makes their companies better? It would be funny if the consequences weren’t so depressing. Giant hookups make so much sense on paper – and yet the minute the ink dries on the contracts, all sorts of nonsense gets in the way. There’s nothing wrong with these acquisition-driven behemoths other than the fact that talented people don’t want to work for them (the politics and bureaucracy are paralyzing), customers hate doing business with them (they lose any sort of human touch), and investors don’t trust them (which is why the stock price of the acquirer almost always drops on news of a deal).

So let me take another shot at making a point I made back in September, during the Merrill Lynch deal. There’s nothing intrinsically wrong with being big. There are advantages to having the deepest pockets and the biggest market share. But size itself is not a strategy. How many industries can you name in which the biggest player is also the best in terms of productivity, customer satisfaction, or financial performance?

Sure, we live and compete in a world in which the strong often take from the weak. But the real story of our times, the logic of business moving forward, is not that the strong take from the weak. It’s that the smart take from the strong. And getting bigger, especially through mega-acquisitions, almost always makes you dumber.

Bill Taylor “Is Pfizer’s Jeffrey Kindler brave or crazy?”, Practically Radical, 28 January, 2009, http://blogs.harvardbusiness.org/taylor/2009/01/ispfizersjeffreykindlebrav.html

How strategy aids innovation

The more I work with senior leaders who are interested in innovation, the more clear it becomes clear that the number one barrier to innovation is what I’ll call strategic clarity. Some will call it “strategic intent” from Hamel or others, some will call it a “common purpose” or core strategy. I’ll call it what I think it really is – having a clear, communicated purpose and intent for the business.

Here’s the thought experiment. In a firm that has a very clear purpose or strategy that everyone understands, it is easy to generate and evaluate ideas. New ideas either support or augment the strategic purpose that people understand, or they don’t. In that environment, it may be difficult to obtain funding for an idea, but it shouldn’t be difficult to gain agreement that the idea aligns to the strategies and core purpose of the business. Now, consider a firm that does not have a clear, communicated strategy. How does one recognize a good idea, if the strategy and direction of the business is not clear? What may appear to be a good idea in one quarter of the business may be shrugged off in another, since each business unit or team may have its own interpretation of the strategy and direction of the business.

I suspect that whether you look at Apple or Google, or W.L. Gore or other “innovative” firms it is relatively clear top down and across the organization “what business they are in” and what their core objectives and strategies are. If it’s evident from the outside looking in, then certainly it must be relatively clear on the inside. This constancy of purpose and strategy, well communicated, reinforced and compensated, is what makes these firms successful at innovation. Since innovation is inherently risky and uncertain, the more clarity and direction provided, the easier the work becomes. On the other hand, I have worked recently with firms where mid and senior level managers are constantly struggling to understand what their core mission and strategic intent is – which leads to much back and forth as to what is innovation and how it can be applied within the firm.

Jeffrey Phillips “Strategic clarity and innovation,” Innovate on Purpose, 19 January 2009, http://innovateonpurpose.blogspot.com/2009/01/strategic-clarity- and-innovation.html

How Greenbox plans to save the world

The 2-year-old company is at the far end of the problem of turning energy awareness into consumer action. “Utilities have their backs against the wall in looking at what the demand for electricity is over the next five to 10 years,” Smith says. “In most cases, it’s outstripping what they have planned in terms of their generational capacity. There’s a general feeling that they can’t build their way out of this problem.”

Greenbox’s solution is much like a game, meant to help consumers understand their energy usage and how they can save money. To do this, the company is partnering with various utilities around the country to provide real-time data to consumers. A simple user interface at getgreenbox.com (http://www.getgreenbox.com/) lets users choose between various functions, including a basic overview of the energy being used in their home, the price of electricity, usage by day and month, an interactive timeline, rate structures and usage alerts.

“Power rangers “, Entrepreneur Magazine, February 2009.

Craig HenryCraig Henry, Strategy & Leadership’s intrepid media explorer, collected these sightings of strategic management in the news. A marketing and strategy consultant based in Carlisle, Pennsylvania, he welcomes your contributions and suggestions (Craighenry@aol.com).

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