Sunday, February 15, 2009

Strategic Planning Analogy #240: Clowns With Scissors

Back when my son was about four years old, I took the family to the mall. My wife had an appointment to get her hair styled at a shop in the mall. I was going to entertain our two kids at the mall while my wife was at the salon.

As I suspected, when we were done touring the mall, my wife was still being worked on at the salon. My son poked his head in to see what was going on. He saw the women stylists in there working on people’s hair. Now the types of women who go into that profession tend to be a bit extreme in their fashion preferences. In general, when compared to the rest of the population, they tend to have wilder hair styles, wear wilder clothing and use more makeup.

So my four year old son is trying to figure this all out. Using his limited experience, he’s trying to figure out who these women are with wild hair, wild clothes and heavy make-up. He finally comes to a conclusion.

He starts pointing at them and shouting to me over and over again, “Look Daddy! Clowns!”

Sure enough, in his little world of experience, the only people who have wild hair, wild clothes and lots of make-up are clowns. Therefore, these ladies must be clowns.

I try to quiet my son, but to no avail. He keeps shouting “Look! Clowns!” Not wanting to offend these women (who, by the way, are carrying scissors as weapons and are working on my wife), I quickly take my son back out into the mall.

It is quite natural for us to use our experiences from the past in order to understand what we see in the present. Unfortunately, our past experiences may lead us to the wrong conclusions.

My son had limited experiences, so when he saw those stylists, the best interpretation of what he saw was that they must be clowns. After all, he knew of no other profession where people dressed that wildly. But he was wrong.

This happens in the business world all the time. The environment changes. New products emerge. New technologies are born. Consumer expectations evolve. If we evaluate these changes merely by our own past experiences, we may misinterpret them. We can come to wrong conclusions, as my son did.

Sometimes, we need to use more than our past experiences to make sense of where the world is going.

This principle has been referred to as “The Black Swan,” in reference to a 2007 book of the same name by Nassim Nicholas Taleb. The idea behind the title is that for centuries it was common knowledge that all swans are white—that is, until black swans were accidentally discovered in Australia. Since all past experience was to only see white swans, there was no reason to believe that any other colored swan existed. It was a complete surprise when the black swans were found. All that common knowledge about swan colors had to be thrown away.

The application to the business world is this: our past experiences may have limited usefulness in preparing us for the new and unexpected. Almost by definition, if it is unexpected, then we are not prepared for it. And guess what? Unexpected events seem to happen all the time.

I remember when Alan Greenspan was brought before congress in October 2008 to find out what his role might have been in the housing collapse, financial meltdown and resulting recession. Greenspan said he had not anticipated problems of this magnitude because we had never had problems of this magnitude before. To quote Greenspan, “I was shocked [by the problems in the banking industry], because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”

Greenspan was confronted with financial black swans which disrupted his way of looking at the world. His 40 years of experience let him down. Like my son, he thought he saw happy, innocent clowns, when what he was really looking at were institutions cutting things up with scissors.

Sometimes, the Black Swans are great, unexpected positive opportunities. However, because we never saw that opportunity before, we may not recognize it for the opportunity it is. Take, for example, computers.

Univac pretty much invented the commercial mainframe computer and was in the best position to exploit the computer industry. It did not. Instead, it was IBM who exploited the invention. It forged ahead with production while Univac held back. Why? Univac did some research in 1950. Their research predicted that by the year 2000, there would be only 1,000 computers in use. That averages out to only 20 computers per year. This hardly seemed like a sufficient enough demand to warrant a major investment. By contrast, IBM didn’t conduct this type of research, so they didn’t know how “bad” their decision was in the eyes of the “experts.”

Contrary to the research projections, by 1984 more than one million mainframe computers were in use. Why was there a big discrepancy between research and reality? The problem was that the experiences of the past did not show a great need for great computing power. Nobody was doing it at the time (of course they couldn’t do it, because the computer hadn’t yet been invented). The only ones clamoring for it were a few scientific research centers. Not enough to build a business on.

Since IBM was a business-based product corporation, they could see the potential new business applications of the computer, which would prove to be a much larger audience. As a result, IBM forged ahead while Univac remained tentative.

However, before we give too much credit to the visionary leadership of IBM, look at how they approached the personal computer. Steve Jobs and Steve Wozniak invented the Apple Computer in a garage in their spare time. They took the prototype concept to a number of firms, such as IBM, Atari, and Hewlett-Packard in hopes of finding someone to back their idea. They all turned them down. IBM’s past indicated that people wanted mainframes. The people who ran the mainframe departments of large businesses (their key customers) weren’t asking for it. IBM could not envision a different world where individuals would want a machine of their own. IBM misjudged the good surprise of the PC black swan. It wasn’t until years later that IBM failed in its attempt to catch up and be a major player in personal computers. /

Other times, the black swan can be a bad surprise. The unintended consequences of the unregulated world of complex financial derivatives and the like have hurt us beyond the wildest expectations of the so-called experts.

So what should we do to make sure we don’t miss out on the good black swans (like computers) and avoid the bad black swans (like unregulated derivatives)?

1) Don’t look at events only through the lens of the past
Although it is important to use our past experiences when making decisions, we should not use that as our only guide. Try to imagine scenarios which deviate from behavior of the past.

2) Try to Envision “Unintended Consequences”Every action causes a reaction. Don’t evaluate the strategic action in isolation. Evaluate it along with potential reactions. For example, people reacted to computers with behavior they had not done before computers. If you do not evaluate the consequences properly, you’ll miss the value (good or bad) of the action. And remember, these consequences are often a deviation from the past. This is particularly important in finding the negative black swans. We talked about this in more detail in a blog on unintended consequences.

3) Evaluate in terms of Solutions, Rather than Products or Behaviors
It is often difficult to evaluate the potential of new products and new technologies, because nobody has had sufficient experience with them. Consumers may tell you what they think about them in research, but they really don’t know due to a lack of experience, so their answer may be unreliable. One thing we do know is that people have problems, and they will switch behavior if they are convinced that a new behavior will lead to a better solution. Therefore, do like IBM did with the mainframe. Try to envision if there is a way in which the new invention will lead to a superior solution to a problem, regardless of initial market reaction.

4) Weigh Upside Versus Downside Risks
Nassim Taleb emphasizes this concept. Some trends have more potential for downside risks than upside risks. Others, have the opposite. His advice is to be conservative on the former, and aggressive on the latter.

Although the past is useful in evaluating the future, it by itself can lead to the wrong conclusions. Use other tools, like unintended consequences, solution analysis, and upside/downside risk analysis to bring further clarity to the problem.

After the beauty salon incident, my son had another early opportunity to test his conclusions. He was about four or five at the time. We were in a store at the mall that had someone dressed up in a cartoon character costume. He looked at that character and was a bit confused. She was a lot bigger than she looked in the cartoons. And he wasn’t sure that cartoon characters should be alive. Was she really for real? So this time, he did some further research. With all his might, he kicked her in the shin. Well, based on the reaction, he learned something. I learned something, too: stop taking my son to the mall. Seriously, don’t take everything for granted. Kick it first.

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