BUSINESS PLANNING AND STRATEGY



Chess board

 

A Business Continuity Plan is essential to any business. Its main function is to highlight all potential risks that may face your business as well as make you think about how you’d react and survive if something major were to happen, such as a natural disaster or an IT failure.

Many business leaders have spent their careers in times of relative economic predictability and political stability, punctuated by occasional market downturns. As a consequence, they have been able to focus on activities that are directly related to the business of business, such as competitive strategy, innovation, operations, and human resources. In hindsight, yesterday’s business game was a relatively easy one to play.

Leaders today increasingly find themselves in unfamiliar territory marked by high levels of uncertainty and instability, a global economy that is growing more slowly, and new political realities. These change the relationship between business and other parts of society; they also have profound implications for strategy and competitive advantage.

Today’s multidimensional uncertainty is in part a byproduct of two important drivers of economic growth in the past 40 years: global economic integration and technological innovation. Together, they have increased global prosperity but have also contributed to inequality within countries, giving rise to protectionist policies that directly affect trade, taxation, and talent mobility. The two forces have also coupled societies, economies, and businesses more intricately than ever before.

In this tightly intertwined world, companies feel the impact of political and economic factors more acutely. Many executives now devote more attention to reacting to and shaping political and economic issues. Does it matter? Firms that are more exposed to political and economic feedback tend to have lower profit margins.

This is not a surprise. Political and regulatory intervention and economic volatility do not generally help profits. But interestingly, the effects on growth and value creation are more ambiguous. Even in situations of high political and economic exposure, savvy leaders can mitigate negative effects and create competitive advantage.

The increasing interconnectedness of business, economic, and political spheres causes disturbances to spread more quickly. From the perspective of corporate leaders, that translates into increased change and systemic uncertainty, with tangible business consequences. The performance gap between winners and losers in all industries is already bigger than ever, and large companies in particular are struggling to find growth. As a result, companies are now dying sooner—the five-year mortality rate has risen from 5% in 1970 to around 32% today.

To thrive in this new climate, leaders need a different mental model for business strategy. Instead of seeing it as a self-contained game of chess, leaders should perhaps visualize it as a Russian matryoshka doll, the endearing set of wooden figures that are stacked inside one another. Why? Business today is part of a nested set of so-called complex adaptive systems: interconnected, dynamic systems in which local perturbations can give rise to unpredictable global effects and vice versa. As a consequence, leaders need to be able to both grasp each level and master the art of playing on more than one level at a time.

What does such a nested set of systems look like in business? Companies are part of business ecosystems, which in turn are embedded in local and national economies, which are interwoven with societies. Changes at lower levels (within industries and between firms) influence higher levels, such as the economy and the political system, which in turn reshape the fates of the systems within them—namely, companies.

In more predictable times, there is a stable equilibrium between levels, permitting business to focus mainly on business considerations. Today, the opposite is true. Many business leaders tell us that political and economic considerations currently impact performance expectations more than purely competitive considerations do. It is impossible to run a business nowadays without at least considering what is happening on other levels.

Take the US retail industry, for example. Encouraged by China’s entry into the WTO in 2001, US retailers built tightly orchestrated supply chains across the globe, taking advantage of a new politically induced opportunity for global cost arbitrage. These sourcing and logistics decisions have had significant effects on economic, social, and political levels. A first direct result was the lowering of domestic prices for many household goods—in fact, this effect was so strong that the US Federal Reserve took it into account when deciding on interest rates. A more indirect result of these business decisions was the displacement of production activity in the US, leading to job losses, a new sense of social and economic insecurity, and ultimately a nativist political backlash against the trade policies that started this particular wheel spinning.

These effects were complicated by technological advances, which increased factory productivity and further reduced manufacturing employment even as domestic manufacturing output increased. In recent years, US retailers have been trying to increase the weight of domestic sourcing. This comes late, possibly too late to preserve the current model of global economic arbitrage. A border tax, still under consideration in some US policy circles, could even undermine this game entirely by wiping out a majority of the industry’s profits.

What should business leaders do now? Above all, they need to understand that focusing only on the narrow game of business has become a risky proposition. They need new approaches for understanding, managing, and shaping the phenomena that arise from nested dynamic systems. Going forward, leaders should embrace five imperatives to expand their game and ensure that their companies thrive under more complex conditions.

    Build multilevel scenario analysis skills. In this new environment, firms need to become more politically and economically astute. For that, they first need to develop political and economic analysis capabilities in order to understand what is happening in each layer and to model implications and strategic choices. This analysis should rely not only on textbook theory and point predictions but also on empirical evidence from analogous situations.

    Consider exchange rate risk. While textbook economics suggests that the depreciation of the British pound would increase prices (and lower demand) for imports, past experience with exchange rate adjustments shows that the effect on a particular company relative to competitors depends on many firm-specific factors.

    Leaders should then probe the effects of political and social shifts on their strategies. Contingent thinking helps. This involves developing scenarios that are rich and broad enough to challenge the implicit assumptions behind strategies, investment plans, and initiatives. Ideally, scenario analysis is not a one-off (or annual) exercise but part of an ongoing examination of strategy. Leaders can use these scenarios to define signposts (“If we see events of type x, this validates belief y”), build better antennae to pick up signals earlier (“If we see x, type x events are likely to occur soon”), and discuss conditional actions (“If we see x, then do y”).

    This is easier said than done. Take European utility companies, for example, which—despite substantial political capacities and sophisticated scenario analysis skills—still struggled to grasp the impact of green energy preferences and policies on their business models.

    Become more resilient. Given the inherent unpredictability of nested complex systems, not every adverse effect on business can be foreseen or mitigated. This means businesses need to become more resilient so that they can sustain and possibly even gain relative advantage from external shocks.

    Biological systems have evolved this quality over time. In our research, we found that organizations are more robust if they have three qualities of such systems: redundant elements (in their manufacturing network, for instance), internal diversity (such as in problem-solving approaches), and modularity (a network of loosely linked instead of tightly integrated parts). For example, when a fire destroyed the production lines of one of Toyota’s key suppliers, the company was able to quickly activate and switch to other suppliers, avoiding assembly line interruptions that could have cost Toyota millions of dollars.

    Shape the system. To moderate their exposure to uncertainty, large firms can strategically shape their immediate neighborhood to build safe havens of relative predictability. They can do so by controlling the context in which value is created or exchanged. Ecosystem formation (of suppliers and partners, for instance) is one such strategy, because it can allow the orchestrator to shape the context by establishing control over information flows and pricing mechanisms.

    Consider Amazon. By partnering with thousands of smaller independent e-commerce players, Amazon sees external shocks sooner, can percolate change within its own operations faster, and can adjust the degree of coupling between itself and players by changing the terms of exchange. It can also buffer itself against change by being agnostic to the product portfolio transacted on its platforms.

    Recreate the narrative. In the long run, few things are as powerful as ideas. To get a better feel for the emergence of ideas that can spread and shape social and political layers, firms need to engage diverse audiences beyond their target customers and listen more closely to them. From that starting point, they should also aim to shape the discussion. Narratives, essentially storified ideas, are powerful because they can redefine what is legitimate and valuable.

    Take GE, for example. In a well-received and widely cited speech in 2016, CEO Jeff Immelt laid out a new vision for the future of globalization and reiterated GE’s commitment to building manufacturing centers and capabilities across the globe.4 In other words, GE is attempting to rewrite the narrative of globalization to address widening faults in the prevailing one.

    Reframe leadership. Leaders need to continue focusing on value creation for customers and shareholders, but they must do so within new constraints created by economic and political layers in the broader system. To do so, leaders need to broaden their leadership repertoire. In particular, they need to increase their contribution as antennae that sense changing political and social signals and as disruptors that translate external change signals into organizational action and overcome organizational inertia. To shape the system and the narrative, leaders must balance the need for higher visibility into and influence on economic and political layers with a sense of humility about their own degree of control over desired outcomes.

Individuals, companies, economies, societies, and political systems are increasingly and inextricably connected, making it harder than ever to understand and steer individual firms in terms of business considerations alone. In times like these, the business of business requires more than just executing or thinking about business. To refresh their game, leaders should see their firms as embedded in interconnected, nested local and global systems. Leaders who understand and are able to maneuver in this new environment will position their companies to take advantage of these new complexities.The purpose of an organization is to get ordinary people to do extraordinary things. For these extraordinary things to enhance the organization’s competitive effectiveness they must directly support the organization’s strategic goals. If a strategy exists only at the top of an organization, it will have little effect. To produce unity of action, strategy must be translated to and acted on at every level within the organization. No one is exempt.

An apt metaphor is the teamwork that propels a rowing eight. Any rower who falls out of rhythm or reduces the team’s pulling power will impede the progress of the boat. Everyone must, quite literally, pull their weight. There is simply no room for passengers.

Yet most companies fail to achieve this level of strategic alignment. A survey found that two-thirds of employees either do not know or do not understand their company’s strategy, and only one-third felt fully engaged with their jobs and their company.

There is a connection between these outcomes. Employees cannot engage with companies that cannot express a sense of purpose. The cost of this engagement deficit is heavy. A 2013 Gallup survey found that companies in the top quartile for employee engagement achieved 10 percent higher customer ratings and 22 percent greater profitability.

This challenge goes to the heart of what it takes to be a leader. We cannot think of strategy and leadership as separate domains. They are essential parts of each other. Every failure of strategy is a failure of leadership — either to set the right priorities or to mobilize the hearts and minds of employees. It is strategy and leadership working hand in hand that is the key to success.

For a strategy to be translated to every unit in an organization, there needs to be a shared understanding of the process by which this will be achieved. The graphic below describes a method I have found to be successful in numerous companies I have worked with.

Here is the logic: Strategy is about harnessing insight to make choices on where to compete and how to win the competition for value creation in an organization’s chosen markets. At the corporate level, the primary choices on those questions must be made. Then within each organizational unit, these primary choices need to be translated into derived choices in a process of systematic alignment.

Within each organizational unit the first order of business is to develop a clear line of sight to the corporation’s strategic goals and then to use this as the springboard and inspiration for this process of translation. In military parlance an operating unit must first understand the “commander’s intent” and then set priorities and commit resources accordingly.

Executives in staff functions sometimes ask why they need to have a strategy since they don’t generate revenue, and are therefore simply cost centers. My response is to counsel them not to think of themselves as cost centers but as value centers. With this change of mindset, their mission becomes clear: to generate greater value than the costs they incur. If they fail to do this, they will simply be reducing their company’s profits.

Managers complain that their executives have not clarified the organization’s strategic goals. But we need to accept that leaders are not perfect, and do not always present this kind of clarity on a plate. Life is messy. The answer is not just to sit back and complain, or simply take shots in the dark. That is victimhood, not leadership. Effective managers take responsibility for finding clarity through dialogue with their leaders; they are able to lead both up and down. They know they owe this to their teams.

Organizations create their future through the strategies they pursue. In a dynamic world, this invariably involves change and uncertainty. As employees seek clarity of purpose, there are always three questions in their minds. At times of change, the need for clear answers is intensified:

  1. What are we aiming to achieve, and why should I care?
  2. Where does my department fit in, and what is expected of me?
  3. How will we measure success, and what’s in it for me?

The task of strategic leadership at every level is to ensure that these questions are answered honestly and clearly, and that everyone has the chance to contribute meaningfully to the end result. As Henry Kissinger once observed, “No strategy, no matter how ingenious, has any chance of succeeding if it is born in the minds of a few and carried in the hearts of none.”

In a seminar one of the participants asked the CEO how he saw his role as the head of such a big enterprise. He walked up to a flip chart and drew a gearbox. Then he explained: I see my responsibility as controlling the large wheel in a gearbox. The role of a gearbox is to transmit power. Every time I turn that large wheel just one notch, all the smaller wheels will spin progressively faster. Those smaller wheels are you and your teams. My most important job is to turn the big wheel on just the right issues so that all the energies of the company are driving the few things that matter most to our success. All of you also have your hands on a large wheel, and you owe it to your teams to turn that wheel on just the right issues — those that line up with our corporate priorities.

All too often top leaders believe that their key task is to communicate the strategy to the organization in a one-way process. But just telling people what to do produces compliance at best — and resentment at worst. It is a fact of life that people will support what they help to build. People will do almost anything if you give them a good why.

True commitment comes from the dedication to a cause greater than ourselves combined with the knowledge that we can make a difference that matters. All motivational research points to one fundamental truth. Success resides in the gap between compliance and commitment.

Macromanagement is managing the big issues rather than the small ones. Time and effort spent on macromanagement enables leaders to be as clear, decisive, and disciplined at the macro level — on the big strategic questions the organization is facing — as their managers are at the micro level, i.e., about how these decisions might be implemented.

So, what are these big strategic questions that leaders aren’t spending enough time on or aren’t answering in a sufficiently clear or disciplined way? They are questions about:

  • why the organization exists and what its purpose is
  • what it offers (and does not offer) its customers, and how and why this offer delivers value to these customers
  • what this produces for the business and for shareholders — the critical outcome metrics by which the organization will be judged
  • how the people within the organization will behave — toward customers, other stakeholders, and each other

I don’t know many leaders who would say they don’t think these questions are important. But I know lots of leaders who don’t spend enough time answering them, and even more who don’t answer them with sufficient clarity so their people can then get on with delivering the answers.

A lack of time, too many so-called priorities, and the gnawing presence of the urgent masquerading as the important are usually quoted as the main reasons why leaders’ answers to these macro questions aren’t clear enough.

But an even more fundamental reason is at play here. For the past 30 years, the literature on leadership and empowerment has advised leaders not to be too prescriptive about these questions, lest they undermine employee empowerment. We have been told that participative leadership, rather than prescriptive leadership, is what we should aim for; that organizations should be agile, with change the only constant; and that empowerment is critical for employee satisfaction and long-term value.

Empowerment is critical. But in order to be meaningful, empowerment requires some boundaries, some rules that have been decided on within which empowerment can be exercised. Ironically, in order to truly empower employees, leaders need to be prescriptive, at least about certain things. And these things are precisely the macro questions of why the organization exists, what it will deliver, and how it will behave.

If leaders aren’t providing clarity and certainty about these critical macro questions, then the best, most motivated employees flail in their so-called freedom because they can’t be sure they are doing what leaders want or are using their time and resources in the best way possible. And because they want to do that, they find this lack of prescription stressful — and a huge constraint on them acting in an empowered way. Equally, the less keen and the less motivated on the payroll take this lack of prescription by leaders as license to do what they want (and perhaps what they were already doing), which, of course, may be diametrically opposed to what the leaders had in mind.

Making time for such macro questions is not a luxury — it is a necessity. And is it not something that can be delegated or outsourced. Nor is it something that leaders should do only once a year, at the strategy offsite or at the start of the strategic planning round. It needs to become part of their weekly routine.

Companies are dying younger because they are failing to adapt to the growing complexity of their environment. Many misread the environment, select the wrong approach to strategy, or fail to support a viable approach with the right behaviors and capabilities.

Some business thinkers have argued that companies are like biological species and have tried to extract business lessons from biology, with uneven success. We stress that companies are identical to biological species in an important respect: Both are what’s known as complex adaptive systems. Therefore, the principles that confer robustness in these systems, whether natural or manmade, are directly applicable to business. To understand how, let’s look at what these systems are and how they function.

In a complex adaptive system, local events and interactions among the “agents,” whether ants, trees, or people, can cascade and reshape the entire system—a property called emergence. The system’s new structure then influences the individual agents, resulting in further changes to the overall system. Thus the system continually evolves in hard-to-predict ways through a cycle of local interactions, emergence, and feedback. In nature we see this play out when ants of some species, for example, although individually following simple behavioral rules, collectively create “supercolonies” of several hundred million ants covering more than a square kilometer of territory. In business we see workers and management, through their local actions and interactions, shape the overall structure, behavior, and performance of a firm. In both spheres these emergent outcomes influence individuals and create new contexts for their interactions. Whether we look at team dynamics, the evolution of strategies, or the behavior of markets, the pattern of local interactions, emergence, and feedback is apparent.

Complex adaptive systems are often nested in broader systems. A population is a CAS nested in a natural ecosystem, which itself is nested in the broader biological environment. A company is a CAS nested in a business ecosystem, which is nested in the broad societal environment. Complexity therefore exists at multiple levels, not just within organizational boundaries; and at each level there is tension between what is good for an individual agent and what is good for the larger system.
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What does this mean for business leaders?

First, they need to be realistic about what they can predict and control, what they can shape collaboratively, and what is beyond the reach of managerial influence. In particular, they need to expect that unpredictable and even extreme emergent outcomes will cascade from actions at the lower levels. A clear example is the financial crisis of 2007–2008, during which risk created by subprime lending in the U.S. real estate market spread catastrophically throughout the global financial system.

Second, they need to look beyond what their firms own or control, monitoring and addressing complexity outside their firms. CEOs must ensure that their companies contribute positively to the system while receiving benefits sufficient to justify participation. Companies that fail to create value for key stakeholders in the broader system will eventually be marginalized (similarly, business ecosystems that do not provide benefits to their members will experience defections). Consider Sony, which brought out its first e-reader three years before Amazon’s but lost decisively to the Kindle and withdrew from the market in 2014. Because it failed to provide a compelling value proposition that would mobilize key components of the publishing ecosystem—authors and publishers—it could offer only 800 titles when its e-reader launched. In contrast, Amazon initially sacrificed profits, selling e-books for less than what it paid to publishers. It also invested in digital rights management to spur the growth of its ecosystem. With the support of other stakeholders, it launched with 88,000 e-books ready for download.

Third, leaders must embrace the inconvenient truth that attempts to directly control agents at lower levels of the system often create counterintuitive outcomes at higher levels, such as the stagnation of a strategy or the collapse of an ecosystem. They must avoid relying on simplistic causal models and trying only to directly manage individual behavior, and instead seek to shape the context for that behavior. For example, questions or simple rules aimed at fostering autonomy and cooperation and leveraging employees’ initiative can be more effective than top-down control in shaping collective behavior.

We have identified six principles that can help make complex adaptive systems in business robust. They derive from our study of features that distinguish dynamic systems that persist from those that collapse or decline. The first three principles are structural; they deal with the design of the system and are broadly seen in nature. The second three are primarily managerial; they deal with the application of the intelligence and intentionality provided by humans. Their key features have been observed in a wide variety of managed systems, from fisheries to global climate control agreements.

A few caveats: Each principle confers a cost and has an optimal level of application; leaders must carefully calibrate how aggressively to implement each one. Furthermore, the principles are in tension with one another; emphasizing one may require deemphasizing another. Leaders must consider how to balance the principles collectively rather than treat the application of each as a unitary goal. For clarity we will illustrate the principles one at a time, but robust systems typically exhibit many or all of their characteristics simultaneously.
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Variety in the units of a CAS allows the system to adapt to a changing environment. Biologically, such heterogeneity explains why many diseases persist despite efforts to eradicate them. The influenza A virus has a high mutation rate and thus a large number of strains. Although we regularly develop resistance to the current common strains, new ones are always emerging. More generally, variation is the stuff of evolutionary adaptation: Heterogeneous components make up the reservoir on which selection acts.

In a business CAS leaders must ensure that the company is sufficiently diverse along three dimensions: people, ideas, and endeavors. This may come at the cost of short-term efficiency, but it is essential to robustness. One obvious starting point is to hire people with varied personality types, educational backgrounds, and working styles. But even amid such diversity, employees are typically reluctant to challenge the dominant business logic, especially if the firm has been successful. An explicit cultural shift and active managerial support may be needed to encourage people to risk failure and create new ideas; indeed, the absence of mistakes is a clear indication of missed opportunities and ultimately of enterprise fragility. Many Silicon Valley firms celebrate productive, or “learning,” failures (think of the mantras “Fail fast” and “Fail forward”), which contribute to their success.

Fujifilm exemplifies robustness through strategic heterogeneity. Its industry faced a crisis in the late 1990s, when digital photography reached the consumer market and quickly eroded demand for photography film. Fujifilm responded with a series of radical reforms to diversify its business—partnering with new companies, investing heavily in R&D, and acquiring 40 firms. What distinguished Fujifilm’s approach from that of the other industry giant, Kodak, was that the firm explored not only obvious adjacencies but also entirely new business areas, such as pharmaceuticals and cosmetics, where it could exploit its existing capabilities in chemistry and materials. It also did so to a sufficient degree. The exploratory efforts and resulting diverse offerings paid off. While the camera film market peaked in 2000 and shrank by 90% over the following 10 years, Fujifilm grew; in contrast, Kodak declared bankruptcy in 2012.

Business heterogeneity is often punished by markets through the “conglomerate discount”—a markdown on the stock price relative to pure-play competitors. However, when a company experiences an environmental shock like the one Fujifilm and Kodak faced, heterogeneity is a key source of robustness.

A modular CAS consists of loosely connected components. Highly modular systems impede the spread of shocks from one component to the next, making the overall system more robust. We see this effect in nature. For instance, occasional local forest fires help maintain modularity by creating areas of lower combustibility. When such fires are artificially suppressed, modularity disappears over time, opening the way for catastrophic blazes that can destroy the entire system.

The performance of Canadian banks during the global financial crisis offers a vivid example of how modularity confers robustness in business. Canada’s regulations mandated less risk-taking behavior than was permitted in the United States, thus minimizing exposure to the complex financial instruments, such as collateralized debt obligations, that created hidden connectivity across U.S. firms and built systemic risk. Furthermore, Canadian banks had a higher ratio of retail deposits, which are generally more dependable than other sources of funding. Thus a weakness in one part of the system was less likely to cause runs in other parts. Finally, the banks had relatively limited investments in foreign assets, which protected them from contagion elsewhere in the global financial system. Thanks to this modularity, Canadian banks emerged from the crisis largely unscathed. None needed recapitalization or government guarantees.

In a business context modularity always brings trade-offs: Insulating against shocks means forgoing some benefits of greater connectivity. Within a company, tight connections across regions or businesses can enhance information flows, innovation, and agility, but they tend to make the company vulnerable to severe adverse events. In the broader ecosystem, integration with other business stakeholders can bolster effectiveness in similar ways, but interdependence also amplifies risk. Because the benefits of risk mitigation are subtle and latent, whereas efficiency gains are immediate, managers often overemphasize the latter.

Despite the trade-offs, modularity is a defining feature of robust systems. A bias against it for the sake of short-term gains carries long-term risks.

In systems with redundancy, multiple components play overlapping roles. When one fails, another can fulfill the same function. Redundancy is particularly important in highly dynamic environments, in which adverse shocks are frequent.

Consider how the human immune system leverages redundancy to create robustness against disease. We have multiple lines of defense against pathogens, including physical barriers (the skin and mucous membranes), the innate immune system (white blood cells), and the adaptive immune system (antibodies), each of which consists of multiple cellular and molecular defense mechanisms. In healthy people these redundant mechanisms act in concert, so when one fails, others prevent infection. AIDS is so deadly because it effectively destroys the second and third lines of defense, removing redundancy. The immune system also shows that multiple principles are usually at play in robust systems: It exhibits not only redundancy but also heterogeneity and modularity of defense systems, and it has feedback loops that permit adaptation.

Businesses often impugn redundancy, treating it as the antithesis of leanness and efficiency. This has led to some disastrous outcomes. In the 1990s, when Ericsson was one of the world’s leading mobile-phone manufacturers, it adopted a single-source procurement strategy for key components. In 2000 a fire incapacitated a Philips microchip plant, and Ericsson was unable to switch rapidly to another supplier. It lost months of production and recorded a $1.7 billion loss in its mobile-phone division that year, which resulted in the division’s merger with Sony.

How can businesses implement redundancy while avoiding prohibitive expense or inefficiency? First, managers should identify the stakeholders—they might be suppliers or innovation partners—on which the business is most dependent. For Ericsson, that set would have included Philips. Next, they should determine the feasibility of creating redundancy to reduce risk. Often this will involve developing new partners, which necessitates careful consideration of the trade-offs involved. Toyota creates redundancy in a highly cost-effective manner. In 1997 a fire at Aisin Seiki, its sole source of P-valves, threatened to halt production for weeks. But Toyota and Aisin were able to call on more than 200 partners and resumed full production in just six days. Although only Aisin had the experience and knowledge for the production of P-valves, Toyota’s tight network of collaborators had, in effect, created redundancy and conferred robustness.

A key feature of complex adaptive systems is that we cannot precisely predict their future states. However, we can collect signals, detect patterns of change, and imagine plausible outcomes—and take action to minimize undesirable ones.

The Montreal Protocol, which established global rules for protecting the ozone layer, illustrates these capabilities. Scientists from many countries came together to analyze the human health impacts of ozone layer depletion by chlorofluorocarbons and propose interventions. Because the atmosphere is a complex adaptive system, the precise impact of human activity couldn’t be predicted. Nevertheless, by presenting rigorous evidence of the potential consequences of further degradation, the scientific community built a consensus for action. The United Nations called the protocol “perhaps the single most successful international environmental agreement to date.” Nature does not allow us to predict the future, but it can reveal enough for us to avert disasters.

In business systems few things are harder to predict than the progress and impact of new technologies. But it can be worthwhile to actively monitor and react to the activities of maverick competitors in an effort to avoid being blindsided. Companies that do this follow a few best practices. First, if they are incumbents, they accept that their business models will be superseded at some point, and they consider how that may happen and what to do about it. Second, they understand that change often comes from an industry’s periphery—from start-ups or challengers who have no choice but to bet against incumbents’ models. Third, they collect weak signals from the smart money flows and early-stage entrepreneurial activity that constitute those bets against their models. Fourth, they practice contingent thinking: Rather than posing the unanswerable question of whether this or that company or technology will succeed, they ask, If the maverick’s idea worked, what would be the consequences for us? Finally, they take preemptive action against such threats by replicating the idea, acquiring it, or building defenses against it.

The consumer optics firm Essilor, which has grown its top and bottom lines at double-digit rates in a mature low-growth industry for the past several decades, exemplifies this approach. “Technology is critical but unpredictable, and we can’t control it or do it all ourselves,” CEO Hubert Sagnières told us. “But we can scan systemically for threats and opportunities, jump on them decisively, and build capabilities to exploit them.”

This approach led Essilor to acquire Gentex in 1995, making it the world leader in polycarbonate lenses. It also enabled the firm to access and exploit digital-surfacing technology, which had been identified as a major strategic threat some years earlier, by acquiring Johnson & Johnson’s Spectacle Lens Group in 2005. A major competitive threat was neutralized, and an $8 million business operating at a loss was turned around and grown into a $50 million operation with 35% margins.
While heterogeneity provides the variety on which selection operates, feedback loops ensure that selection takes place and improves the fitness of the system. Feedback is the mechanism through which systems detect changes in the environment and use them to amplify desirable traits. The fact that selection occurs at the local level implies, paradoxically, that some lack of robustness at lower levels may be necessary for robustness in the larger system. That is, the system must destroy order locally to maintain its fitness at higher levels.

In nature, mutation and natural selection—the variation, selection, and propagation of genes that contribute to reproductive success—is an autonomous process. In business the analog is a predominantly “managed” activity. The variation, selection, and propagation of innovations happen only when leaders explicitly create and encourage mechanisms that promote those things. In fact, mainstream management thinking, as taught in many business schools, may actively suppress the intrinsic “variance” and “inefficiency” associated with iterative experimentation. Yet the cultivation of this adaptive capability is now essential for companies that may have managed themselves for decades using only analysis and planning.

How can a company implement the process of iterative innovation?

First, it must detect the right signals from across the organization. This is not trivial. There is always some distance between the local actions of an employee or a business unit and the macrolevel outcomes they produce. We often don’t know which behaviors are worth strengthening and which should be discouraged. Still, frontline employees have valuable information that typically isn’t transmitted and amplified. Leaders need to engage with those employees to discover innovations that could improve robustness. That’s why Japanese manufacturing managers often go to the gemba (the “real place,” such as the factory floor) to glean fresh and rich information. By interacting directly with employees there, they can identify challenges and innovative solutions visible only at the local level.

Second, the organization must translate those signals into action. This may seem self-evident, but large companies often find themselves unable to implement this crucial second step because it may require diverting resources from the dominant product or business model and perhaps allowing underperforming products, businesses, and employees to fail more quickly. James Cannavino, IBM’s chief strategist in the early 1990s, notes that strategic planners were aware of the rise of PCs and the increasing importance of software long before the company faced a crisis. But the mainframe business was so profitable that they weren’t inclined to translate their insight into a definitive shift to personal computing. Ambidexterity—the ability to simultaneously run and reinvent the company—requires effective feedback loops and is critical to robustness in changing environments.

Tata Consultancy Services operates in the technology services space, which is characterized by unpredictability in both the technology itself and its application by large organizations. Recognizing that it needed to optimize for adaptability, the firm instituted its 4E model of experimentation—explore, enable, evangelize, and exploit. TCS explores by placing many small bets and scaling them up or down on the basis of market feedback. The strategy is enabled by heavy investments in analytic and knowledge management capabilities. Successes are evangelized within the organization, thereby enabling TCS to fully scale and exploit them. The company has had spectacular results, growing from $20 million in revenue in 1991 to $1 billion in 2003 and more than $15 billion in 2015. Its rise reflects an ability to rapidly adapt in a dynamic sector where many large rivals have faltered.

This is not to say that the tighter the feedback, the better. If the feedback cycle becomes too short or the response to change is too strong, the system may overshoot its targets and become unstable. For example, financial regulatory systems tend to swing between overregulation and underregulation, making equilibrium impossible. As with the other principles, calibration is essential.

In society, complex adaptive systems require cooperation in order to be robust; direct control of system participants is rarely possible. Individual interests often conflict, and when individuals pursue their own selfish interests, the system overall becomes weaker, and everyone suffers. This is the quandary of so-called collective action problems: Individuals lack incentives to act in ways that benefit the overall system unless they benefit in immediate ways themselves. Trust and the enforcement of reciprocity combine to provide a mechanism for organizations to overcome this quandary. (Indeed, this was key to the success of the Montreal Protocol.)

The Nobel laureate Elinor Ostrom studied situations in which users of a common-pool resource, such as a fishery ecosystem, are able to avoid the “tragedy of the commons,” whereby public resources are overexploited to the eventual detriment of everyone involved. Her insight was that trust, along with variables such as the number of users, the presence of leadership, and the level of knowledge, promotes self-organization for sustainability. It allows users to create norms of reciprocity and keep agreements.

To leverage the power of trust, leaders should consider how their firms contribute to other stakeholders in their ecosystem. They must ensure that they are adding value to the system even as they seek to maximize profits.

Novo Nordisk’s approach to new markets illustrates how this can work. Let’s look at the firm’s entrance into the Chinese market for insulin. The company established a Chinese subsidiary in the early 1990s, well before there was widespread awareness of or established treatment protocols for diabetes in China, or even many physicians who could diagnose it. Novo Nordisk built relationships with other stakeholders in diabetes care, establishing partnerships with the Chinese Ministry of Health and the World Diabetes Foundation to teach the medical community about diagnosis and management, and facilitating more than 200,000 physician training sessions. It also reached out to patients through grassroots campaigns and developed support groups to establish itself as more than just a provider of insulin. Finally, it demonstrated its local commitment by building production sites and an R&D center in China.

These efforts not only developed the market—they built trust between the company and other stakeholders. And they paid off. Novo Nordisk now controls about 60% of China’s enormous insulin market. Making a clear commitment to other stakeholders and the social good enhanced the robustness of the firm and strengthened the broader CAS in which it is nested.

Rising corporate mortality is an increasing threat, and the forces driving it—the dynamism and complexity of the business environment—are likely to remain strong for the foreseeable future. A paradigm shift in managerial thinking is needed. Leaders are used to asking, “How can we win this game?” Today they must also ask, “How can we extend this game?” They must monitor the changing risk environment and align their strategies with the threats they face. Understanding the principles that confer robustness in complex systems can mean the difference between survival and extinction.

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