Performance, Risk, Complexity & All That Jazz

What do we mean by “performance?”  It’s not a philosophical question to ponder over a Starbucks.  The world is awash with complexity and uncertainty. It’s show time, folks.

Performance? Are your expectations realistic?  Better yet, are your expectations relevant?How do you know?

We know from ecology that some entities – fish, fauna, football teams, multi-nationals –  become “super adapted” or “super competent” in relation to their environment, i.e. they develop unique characteristics that give them a competitive edge.  However, when the environment changes, whether you are a fish in a pond or a football team, sometimes you need to abandon what worked so well in the past and move on to develop other skills….of become “de-selected” i.e. a euphemism for being terminated with extreme prejudice.

At the very core of this issue is “what is performance?” If we get this wrong nothing else is going to work. And I am not as concerned about the measurement issue as getting the “what is?” question right. Legend has it that the Emperor Nero played the harp while Rome burned…perhaps the ancient Roman equivalent of collecting irrelevant KPI’s (key performance indicators) while the city went up in smoke. But I digress…

At one time I thought performance could be easily captured! That was back in the days when everybody thought “market cap” was the end all for performance measurement.  Then it became obvious that market factors often overshadowed company-specific factors. Research (courtesy of McKinsey & Co.) showed that from 1990 to 2000 about 70% of the returns to individual companies was due to market factors and that only about 30 percent was due to company specific factors. There are so many elements beyond management’s control, i.e. trader psychology, herd behavior, and most certainly the velocity of trades in a global economy. Let me be even more blunt: “Why am I busting my tail controlling costs and investing in product improvements when they only account for 30% of my value?”  Good question.

Next question: when did makets get so damned smart?  I have a good friend, an actuary, whose philosophy is “you can never fool the market.” Of course he made that rather sweeping statement prior to the 2007 financial meltdown on The Street and the remarkable Mr. Bernie “Trust Me” Madoff.  So you can still do everything “right” and end up in Bankruptcy Court.

It begs a question: “what is the purpose or goal of the corporation?”

I knew the answer from my work in national defense – survival.

Plain and simple: at the end of the day your Army must be  functional, operational and ready to respond. If you invest in horse cavalry and the era of the tank is dawning – you lose. If your doctrine is massed artillery and the era of maneuver warfare arrives – you lose. There is an evolutionary logic at work here and it is brilliantly captured in the concept of generational warfare. Is there anything like that in business?

Yes.  If you do not survive you have absolutely no hope of increasing shareholder value (assuming you buy into “agency theory” in the first place).

Eric Beinhocker, a McKinsey Fellow,  uses an evolutionary framework for thinking about performance, suggesting that evolution is a search algorithm for fit designs. For Eric, the objective of any business is survival. The fit are selected to go on, to continue to live and prosper. “The objective function of any schema must be the survival and replication…”  Makes sense to me!

Fitness is an appealing, intuitive, fairly low tech, commonsensical way of thinking about performance.  The market senses designs that are poor, and lets them wither away (sometimes quite quickly). Obviously business shares a few thorny problems with evolutionary biology in determining the exact mechanisms for selection, but we can leave that for another day. For now leave the “how” of selection as a black box.

Here’s the deal: If you’re fit, you get to stick around.

And Beinhocker adds a little spice to the story. He references work done in the late 1990’s and early 2000’s that competitive advantage is both rare and short lived in both the biological and business worlds. Speaking from empirical data, he demonstrates there is no sustainable competitive advantage (apologies to Michael Porter ) only a never-ending race to create new sources of temporary advantage.

“This then changes our definition of an excellent company from one that has continuous high performance for very long periods (an achievement that is almost non-existent) to one that can string together a series of temporary advantages over time – in other words running the ‘red queen’ race from Alice in Wonderland, i.e. running with all one’s might to just stay in place.”

Yes, but that was then (1990’s) this is now. Beinhocker may be too conservative. Perhaps survival is today’s core strategic issue. Forget about high end performance or even the “red queen race,” and hope you don’t end up like Leman Brothers.

The Problem With Beinhocker…Times Have Changed, Gotten More Complex

Beinhocker is a great theorist, but his data is old and, I think, less relevant in today’s highly connected and interdependent world. Complexity has exacerbated risk. Beinhocker was an optimist!

Empirical studies always have data lag. The world has changed from the 1980’s and 1990’s. Stationarity – the assumption that the distribution of outcomes does not change – can lead to tragic outcomes. Not everything fits under the bell curve and failing to take into account the randomness generated by complex systems interplay creates gigantic “black swans” that can devour whole industries.

Today is it about survival, endurance and longevity? Maybe so!

More about performance, risk and complexity in on going blog discussions.

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2 thoughts on “Performance, Risk, Complexity & All That Jazz

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