The Lake Wobegon Effect, the Illusion of Knowledge, and the Principle of Strategic Debate
Daniel Kahneman is an Israeli psychologist and Nobel Prize–winning economist. Among other things, he’s conducted controlled experiments to try to understand how people process information and use it to make predictions. At the University of British Columbia, he conducted an experiment in which 245 students were asked to rate the probability of occurrence of several events. For example, half of them were asked to rate the probability of a massive flood occurring somewhere in North America that would kill more than a thousand people. Then, later in the experiment, some were asked to rate the probability of a massive flood resulting from an earthquake in California that would kill more than a thousand people. The students consistently rated the second scenario as more likely than the first, even though the first scenario (a flood in North America) would include the second scenario (an earthquake and flood in California).
At first, Kahneman dismissed this as the result of statistical naiveté (after all, they were just students). So he conducted a similar experiment with 115 professional analysts employed by research institutes, universities, and various industries. At the Second International Congress on Forecasting held in Istanbul, Turkey, he asked one group to rate the probability of a complete suspension of diplomatic relations between the United States and the Soviet Union. He asked the other group to rate the probability of a Russian invasion of Poland and a complete suspension of diplomatic relations between the United States and the Soviet Union. Like the students, they rated the second scenario (an invasion of Poland and then suspension of ties) as more likely than the first (a suspension of ties), even though the first scenario included the second one. And remember, these were people well versed in probability and mathematics. It was their livelihood. What’s going on here?
The Illusion of Knowledge
The answer is this: we have the tendency to be seduced by statistics and information. The more vivid the information, the more likely we are to believe it. The mind has a problem understanding abstract concepts. It’s much easier to understand concrete things. The students were able to visualize the flood caused by a California earthquake. It was a tangible example wrapped around a believable scenario. The analysts, too, were seduced by the scenario of the Russians invading Poland, making it seem more likely than the more abstract thought of breaking diplomatic ties. Nassim Taleb, the author of the book Fooled by Randomness, says, “As a derivatives trader I noticed that people do not like to insure against something abstract; the risk that merits their attention is always something vivid.”
In business, the same is true. We’re seduced by statistics and mathematics. We love numbers. They’re vivid and concrete. When I worked at H&R Block, the chief operating officer had a three-hole binder that was more than three inches thick. It was filled with thousands of pages of statistics, data, forecasts, and scenario planning. He carried it to meetings and referred to it for most of his decision making. Once I presented a new direct marketing program to him, and he told me that it was interesting but direct marketing doesn’t work in the tax business. He then proceeded to show me dozens of tests and programs that the company had conducted and their poor results. Looking at the data, he was right; direct marketing didn’t work. When I asked him to describe the different campaigns, he couldn’t remember the programs—just the results, the numbers, but not the specifics of the marketing program. After the meeting, I did my own research and found the different programs and realized that what I was proposing was totally different from what had been done in the past. It wasn’t that direct marketing didn’t work, it was that poorly thought out direct marketing didn’t work. The program we implemented increased the customer retention rate by more than 20 percent—a huge win and a new data point for the COO.
You see, data just feels deterministic. It feels scientific, and so it makes us think we have more control than we do. The more detail, the more confidence we have about our understanding. Like Block’s COO, we get lost in the melody of numbers and forget what’s behind the music. Brad Barber, a professor and researcher at UC Davis, calls this the “illusion of knowledge,” which he discovered as he studied online investors. He found that the more information they had, the greater access to statistics, facts, numbers and figures, the greater the risks they were willing to take. Specifically, online investors were more willing to risk their investments than ones who traded over the phone through a broker. The online investors spent inordinate amounts of time going over charts, graphs, and studies, and that convinced them that they had a deeper understanding of the market. It resulted in overconfidence in their stock-picking ability and led to poor performance. Those who switched from using a broker to using online trading experienced a significant decrease in their portfolio performance, while at the same time felt that they had a much better grasp of the market. Go figure, right? I’ve felt it myself: the more data and statistics I have, the more comfortable I feel, the more confident I am, and the more likely I am to miss mistakes and make corrections to my hypothesies.
The illusion is compounded by the source of the data. In 1980, AT&T hired McKinsey & Company to forecast worldwide cell phone use by the year 2000. McKinsey is a prestigious consulting firm that hires Harvard, MIT, and Stanford graduates and is a trusted adviser to many Fortune 500 companies. It has a very scientific approach to forecasting that includes extensive (and expensive) surveys and statistical modeling. Using this, it predicted 1 million cell phone users (it was off by several billion). So AT&T decided not to make the investments in infrastructure to support this future business. I’ve seen people take, at face value, any information that comes out of McKinsey, Forrester Research, or other consulting groups without taking the time to understand where the information came from, the circumstances it was gathered in, sample sizes, and how it was interpreted. “Forrester says this about that” is all some of us need to hear. If someone is labeled “an expert,” we tend to believe what he has to say. After my first book was published, I noticed that colleagues tended to want to listen to me more because I was a published author. I had to spend less time explaining my logic and reasoning. My opinion was taken more at face value because I was being labeled “an expert.” Of course, I don’t need to explain the danger in that, do I?
This impression is well illustrated by the story of Linus Pauling. Pauling is one of the few people to have ever won two unshared Nobel Prizes (one in chemistry, the other the Peace Prize). This is a guy with a lot of credibility, the human equivalent of Forrester Research. In the 1970s he became obsessed with the curative properties of vitamin C. He suggested massive doses of it to prevent the common cold and as a cure for cancer. He said, “75 percent of all cancer can be prevented and cured by vitamin C alone.” Because of his credibility, the nation went on a vitamin C–taking kick. I remember my friend Tim Adelfinger taking huge amounts of it and drinking orange juice every morning and trying to get me to read Pauling’s book How to Live Longer and Feel Better. Researchers using double-blind studies couldn’t duplicate Pauling’s findings and warned the public against overuse of the vitamin, but the cautions fell on deaf ears. After all, it was a “double Nobel Prize winner” giving the advice. An expert. Of course, people failed to recognize that he was a winner and expert in chemistry, not in medicine. Unfortunately, he was wrong. And in a macabre footnote, my friend Tim mysteriously died in 1995, before he turned forty years old.
The illusion of knowledge can get the best of us. Even some of the greatest marketers in the world have fallen victim to it. Take, for example, the story of Roberto Goizueta and the epic debacle over New Coke in the 1980s. Goizueta was the brilliant and highly successful CEO of the Coca-Cola Company. During his tenure, he created more wealth for shareholders than any CEO in the history of corporate America (though was later eclipsed by Jack Welch). He also became the first corporate billionaire, the first to amass such a fortune from a company he did not found. The guy was a genius, no doubt.
In the early eighties, he launched Diet Coke, and it became an instant hit. His flagship product, though, regular Coke, was floundering and taking a beating from Pepsi-Cola. Pepsi was running an ad campaign called “the Pepsi Challenge” in which consumers were consistently choosing Pepsi over Coke in blind taste tests. It was a compelling TV spot. Even Coke users were choosing Pepsi in the tests. So Goizueta and his team set out to solve the problem. According to Roberto, his flavor chemist stumbled upon a new formula while he was developing the recipe for Diet Coke. He commissioned a research plan called “Project Kansas,” which consisted of focus groups, surveys, and blind taste tests. The company spent millions of dollars on the project, which concluded that consumers overwhelmingly preferred the new formula to the existing one. Goizueta explained that, based on the data, the company had no choice but to switch recipes and that making the change was “one of the easiest decisions ever made.” He had stacks of evidence to back his decision.
On April 23, 1985, a press conference was held in New York City (Pepsi’s home state) in which Goizueta introduced the new product and announced that the old product would be discontinued immediately. “The best just got better,” he said. Well, from the very beginning, consumers were outraged. The CEO of Pepsi wrote a letter to his employees in which he congratulated them and said, “Coca-Cola is withdrawing their product from the marketplace, and is reformulating brand Coke to be more like Pepsi.”
Some consumers began buying old Coke from outside the country, others boycotted the new product, and some even filed a class-action lawsuit (it was dismissed by the judge as frivolous because, he said, he preferred the taste of Pepsi). Then sales began to erode. Within three months Roberto Goizueta was forced to reverse his decision and bring the old formula back, calling it “Classic Coke.” Over the next few years, New Coke dwindled to less than 3 percent of market share, and it died a slow death until 2002, when it was discontinued altogether.
Unfortunately, Roberto Goizueta died of cancer in 1997 before New Coke died of market share, and it became part of his legacy. At the press conference in 1985, a reporter asked him, “Are you a hundred percent certain this won’t bomb?” To which he answered, “As I said, it is the surest move ever because the consumers made it.” If Goizueta can be misled by the data, what hope is there for us? Perhaps some. Henry Ford was once asked about consumer feedback, and he replied, “If I had asked my customers what they wanted, they would have told me faster horses.”
I’m not saying that focus groups and consumer research are useless. They’re not. They serve an important purpose. But, just as with other data, we need to understand their limitations and how they can mislead us if we don’t understand those limits.
The Heisenberg Effect
Werner Heisenberg, a German physicist born in 1901, made important contributions to quantum mechanics, nuclear physics, and the study of matter and radiation. However, he’s probably best known today for his “uncertainty principle,” which has been hijacked from physics and applied to research and data collection. According to Heisenberg, it’s impossible to simultaneously determine the position and velocity of an electron or any other particle with a great degree of accuracy or certainty. By taking a measurement, he said, you change either the position or the velocity of the particle because you slow it down when you measure it. The same thing happens, for example, when you try to determine the air pressure of your car tire; it’s nearly impossible to do without releasing some of the air from the tire and changing the pressure of the tire in doing so. In business research, the Heisenberg effect says that the observer changes the thing he observes.
This is especially true in the case of focus groups, and it’s what makes the data suspect, dangerous, and potentially misleading. You see, the participants are aware of the fact that they’re being observed and recorded from behind a two-way mirror. This completely changes how products, concepts, and services are perceived. It’s like trying to determine your tire pressure; you can’t get an accurate reading. The difference between focus groups and real consumers is that focus groupers think much harder, more deeply, and more logically than they do when they’re not being observed. They don’t want to sound stupid. In fact, most of them think of themselves as product marketers, not as consumers. You can tell from the tone of their voice, body language, and even the pronouns they use to talk about the products. Emotion is often devoid in the focus group setting. It’s very clinical, logical, and filled with “smart” sound bites.
In the real world, consumers are different, and their buying decisions are based more on emotion than on a logical set of criteria. Next time you’re in the grocery store, watch how the person next to you buys things. Very little brainpower is expended; the shopper quickly goes down the aisles and grabs things off the shelf. She doesn’t stop and read the tagline on a product. She rarely compares product features and benefits. Her decision making is more subconscious and emotional. And by taking the emotion out of the experience in a focus group, you change the nature of the decision.
Roberto Goizueta was using data from blind taste tests and focus groups. His subjects were acting like product development managers, not customers. People don’t drink out of a nondescript bottle, they drink out of a branded can. Yet Coke, which had worked so hard to develop its brand, for some reason seemed to forget about that. It seemed to think that brand didn’t matter. The managers were looking at charts, graphs, and data when they made their decision to discontinue a product that had been in existence for a hundred years.
If they had just taken a step back and looked at the situation, they would have realized that there was a logical reason that Pepsi was beating Coke in the blind taste tests. You see, Pepsi is formulated with more sugar. It always had been. It was originally formulated to appeal to kids, and kids like sugar. The blind taste tests had customers taking a “shot” of Cola from a small paper cup (like the one your dentist uses), not drinking an entire can of it. So Pepsi won the taste test because a shot of sugar is more appealing than the blander taste of regular cola. New Coke was formulated with high-fructose corn syrup, so it, too, tasted good in a single gulp because it contained more sugar. But that’s not how people drink cola. Regular Coke drinkers savor their cola; they don’t just take a single shot of it and then fill out a survey or talk to a camera crew. The data Roberto Goizueta was using to make his decision were flawed. The researchers were simulating a customer experience but not doing it in a way that properly mimicked the real experience.
Focus groups can be useful. Since consumers are more focused and so putting more thought into what you tell them, they can be good places to test the understanding of a concept. According to the Union of Concerned Scientists, the average consumer is exposed to more than three thousand commercial messages a day. They come in the form of television ads, radio commercials, billboards, print ads, banner ads, pop-ups, Google keywords, and a myriad of other things. We are bombarded with messages. In order to get through the clutter, your business concept needs to be easy to understand. A complex or confusing concept is destined to fail, and this is a good use of a focus group. If those in the focus group don’t get it, those on the street aren’t going to get it either.
Surveys are also subject to the Heisenberg effect. The only information you get from one is people’s opinion under survey conditions. Like focus groups, they take the emotion out of the buying experience and people tend to answer questions using logic and reason. The questions themselves can be misleading or even “leading.” I’ve found myself subconsciously trying to design a survey to get the answer I’m looking for (an example of the “confirmation bias”).
There are more problems with surveys, focus groups, and consumer research, far too many for us to go into here. My point is that they’re not always what they appear to be and that you need to be careful. Just because a “fact” is in a report or tabulated on a chart doesn’t mean that it’s right. After all, who’s in the focus group? Who’s taking the survey? And why are they taking it? Put simply, the data is skewed by those who are willing to take part in the survey. It strikes me as absurd that the CEO of Coca-Cola made multibillion-dollar decisions based on insights gleaned from a group of people who took a survey because they wanted a coupon, twenty dollars, or the chance to win a Caribbean vacation.
We can never really trust the sample in any piece of research. Many leaders know this, so they use their own experiences to make strategic decisions. That’s fine as long as they understand that they’re working with a single data point. Let me explain, because that can be just as misleading as other forms of research.
The Allure of a Single Data Point
A good story is loved by most of us, and it leaves an indelible impression. I have a hard time remembering the Pythagorean theorem, but I can easily recall the exchange between Darth Vader and Luke Skywalker when Darth revealed that he was Luke’s father. Stories are easy for us to memorize, in part because of the causal connections a good story uses (that’s the way our mind is wired to work). One thing is connected to the next thing. One thing after another. That’s the same thing that Kahneman observed. The more vivid the information, the more apt people are to remember it and consider it more likely. A California earthquake causing a fatal flood is more concrete, more dramatic than just a flood anywhere for any reason. It’s the drama that makes the impression and sears stories into our minds.
In business we use stories, too. We interact with a customer, and this makes an impression on us. We have our own experience with the product, an experience that tends to trump any other understanding we have of our market. It’s those personal experiences that have a great impact on us. For example, when I was the CEO of Preferred Capital, I would still make sales calls and I developed my corporate strategy, in great part, from my experiences from these encounters. I couldn’t help it. If I talked to a customer who was really interested in a deferred-payment plan, I’d start devising new corporate strategies based on my personal experience with a single customer.
When I was at H&R Block, there was a takeover of the company and a new chairman was elected to the board of directors. Richard Breeden, a former head of the Securities and Exchange Commission, became the leader of Block and wanted to make changes. I remember, among other things, that he was concerned with the $100 million advertising campaign we were just about to launch. The ads were a play on the successful “got milk” campaign. The objective was to combat the relentless attack by TurboTax, which was dramatically taking market share from us. Our campaign was based on the slogan “At H&R Block, you got people.” Breeden’s concern didn’t have anything to do with the strategy, the quality of the commercials, or the execution of the campaign. No, it was a concern over grammar and something his elderly mother told him. Mrs. Breeden, Richard told us, was a former schoolteacher, and she told her son that she was offended by the improper use of grammar in the “You got people” slogan. It should be “You have people” not “You got people.” I’d be embarrassed to tell you how much time was spent discussing this point.
But it’s not Richard’s fault. We all do the same thing. We use our personal experiences, an interaction with a customer, a story we hear, or something our elderly mother said to construct our understanding of the marketplace. The problem is, these are all single data points and a single data point doesn’t indicate a trend, doesn’t give us a feeling for the market, doesn’t reinforce any hypothesis. They’re good to illustrate a point. They’re good for clues and looking for things to explore. But they’re not good for decision making, and they’re dangerous when we base our strategy and tactical execution of a single data point. Not only was Mrs. Breeden a single data point, she was probably a poor data point because she wasn’t a target H&R Block customer.
So where does this lead us? We can’t rely on data. We can’t rely on experts. We can’t even rely on our personal experiences. What’s a manager to do? The answer lies in two places. One is cultural, the other procedural.
The Adaptive Management Culture
A culture is a set of shared attitudes, values, and practices that characterize the organization. It’s the responsibility and a reflection of its general manager and the group as a whole. The GM sets the tone; the group picks it up and practices it. An adaptive management culture is one that has several different—and contrasting—attitudes that allow for the evolution of a business model.
The first is the paradox of confidence and paranoia. Climbing in high mountains, for example, requires a paradoxical balance between self-assurance and self-suspicion. When I arrived in Alaska to climb Mount McKinley, I pulled the lead guide aside and confided in him that I was afraid of heights. He laughed and told me, “Good, me too.” He then went on to explain that it was healthy to have a fear of heights, that it kept you aware of the dangers that surround you on a big mountain like McKinley. Those without fear, he told me, tend to be nonchalant and are the ones who will unrope in dangerous places or walk too close to a corniced snow cliff and fall to their deaths. Those with a true fear of high places never lose their awareness of danger and so never let their guards down. At the same time, climbing requires confidence, the willingness to step out onto a ledge with coolness and self-assurance. In order to create the maximum friction between your feet and the slope, you have to position your body parallel to the pull of gravity. This means that on steep slopes you actually have to push away from the slope in order to maintain friction. At first blush, it seems counterintuitive; your tendency is to want to lean into the slope and grab on to it, to “hug” it, but that only decreases the friction and makes you more susceptible to slipping. Climbers call it “trusting your feet,” and it requires a lot of confidence, especially when there’s a thousand feet of nothing below you. Mountaineering is an interesting blend of paranoia and self-assurance.
The same is true for an adaptive management culture. Your team needs to implement with confidence, while at the same time be wary of their forecasts, hypotheses, data, and the tactics they use to solve their problems. You have to develop a split personality, constantly looking for mistakes and reasons to doubt while at the same time trusting your feet. One is so you can see opportunity, the other is so you can see the barriers to that opportunity.
Mark Zuckerberg does this naturally; it’s part of his psychological makeup. He’s very confident while, at the same time, apprehensive. During the early years of Facebook, even after he received venture capital funding from Accel Partners, he was still working on other business ideas, Facebook garnering only half of his time. “Early on,” Zuckerberg is quoted in The Facebook Effect, “I viewed it as a project. I wasn’t superinvested in it because it wasn’t clear to me it was going to be this huge thing. I was like ‘Yeah, this is pretty neat. It’s not the end-all be-all, but it’s cool.’” Sean Parker, his business partner, said, “Mark was actually very rational about the low probability of building a true empire. He had these doubts. Was it a fad? Was it doing to go away? He liked the idea of Facebook, but he was willing to pursue it doggedly, tenaciously, to the end. But like the best empire builders, he was both very determined and very skeptical.” Even as the idea took off, he still hedged his bets. He was working on another company called Wirehog. Wirehog was a peer-to-peer content sharing service, like Napster, except you could share content—music, video, text files—only with your social network, people you knew. In 2004, his Facebook business partners began to complain that he was spending too much time on Wirehog. But Zuckerberg was skeptical; he knew that Face-book was a good idea but didn’t totally trust himself on how the concept would play itself out. So he continued to develop Wire-hog as his backup plan even as Facebook was growing by leaps and bounds.
The second is the paradox of being theoretical and practical. Your business model needs to be grounded in a hypothesis, which means you’ve got to be theoretical and philosophical. At the same time, you’ve got to turn your theory into practice. Strategy is very theoretical, while tactics are very practical. I introduced the concept of concurrent thinking to help you develop these somewhat conflicting traits. Robert Oppenheimer, the father of the nuclear bomb, is the epitome of these contradictory attitudes. He had a deep understanding of the theory behind the bomb and then ran parallel projects to make it a practical reality. He hired experts in weaponry, learned the practical nature of bomb making, and then applied them to this new type of weapon. He spent as much time with the mechanics and engineers as he did with the theoretical physicists. That’s how he was able to align the bomb strategy with its implementation. He realized that the detonator, for example, was just as important as the processing of the fuel rods. Like Steve Jobs, he was often accused of micromanagement, but that was because he was trying to drive the theory into the practice. That, after all, is the ultimate responsibility of a leader.
These are the values of an adaptive management culture, and there’s a process we can use to help drive them into our psyche.
The Principle of Strategic Debate
Last year, I took my eighteen-year-old daughter and five of her friends on an RV trip to the hills of southern Utah and the canyons of northern Arizona. Among other places, we visited Zion National Park, Bryce Canyon, and Lake Powell. We culminated our adventure at the Grand Canyon. On the last night there, we got up at three in the morning and started down the Bright Angel trail to the bottom of the inner gorge and the Colorado River. Standing on top, when you look down, you perceive a gaping hole, but as you descend, the canyon walls slowly appear to change. By the time we reached the Colorado River, the walls had transformed into a huge mountain range. It seemed as though we were in a valley, not at the bottom of a pit. That’s because your point of view, where you stand, changes your perception of things. And let me tell you, at the bottom of the Grand Canyon, the walls look a lot bigger than they do from the top.
Intellectual points of views are just as dramatic as physical ones. In the book Six Thinking Hats, Edward de Bono uses a hat metaphor as a clever and memorable way to describe the practice of changing your viewpoint. For example, he calls a negative viewpoint a “black hat” and a positive viewpoint a “yellow hat.” We need to adopt both viewpoints—positive and negative—in order to evaluate our business model as we implement. We have to teach ourselves to consciously see things both ways. What are we doing right? What are we doing wrong? What’s working? What isn’t? Smart climbers look for the barriers, the obstacles, while at the same time scanning the mountain above and looking for a gap, a notch in the peak, a weakness in the mountain, opportunities to reach the summit.
The same is true for you and the judgment of your business model. You need to sense the opportunities that lie in the business, in your subject, even if they’re not the original opportunities you foresaw. As you begin implementing, you’re like a structural testing engineer; you put a load on the idea and see if it has any strength. The structure may fail, but there may be a part of it that’s strong that can be used elsewhere. That’s an opportunity.
The best way to do this is to encourage constructive debate among yourself and your team members. This needs to become part of your corporate culture. Too many companies frown on dissent and so discourage debate. This is dangerous. It’s like a climber who has no fear of heights and so isn’t conscious of the big drop right behind him and casually steps off to his death. Debate is how we overcome the psychological bias that perseverance creates.
Our business model is based on a hypothesis for solving a series of problems. The strategic debate is either a formal or informal process in which one person argues that our hypothesis is right and supports it with evidence, while the other person argues that the hypothesis is wrong and supports it with contrary evidence. This process helps us to determine the effectiveness of our business model, find its weaknesses, and take advantage of its strengths.
Bill Gates encouraged debate at Microsoft. In the Gates biography Hard Drive, the authors say, “they expected to be able to challenge Gates. In fact, he wanted them to argue with him. His confrontational style of management helped Microsoft maintain its edge, its mental toughness. It made those who worked for him think things through. These are qualities that continue to distinguish Microsoft to this day. It is a culture that never gives employees a chance to get complacent because as they do, someone is going to challenge them. Gates was not afraid to change his mind if someone made a convincing argument.”
Steve Wood, one of the first programmers to be hired by Microsoft, added, “Bill is not dogmatic about things. He’s very pragmatic, he can be extremely vocal and persuasive in arguing one side of an issue, and a day or two later he will say he was wrong and let’s get on with it. There are not that many people who have the drive and the intensity and entrepreneurial qualities to be that successful who also have the ability to put their ego aside. That’s a rare trait.” It’s a trait that you and I need to emulate.
As an evolutionary thinker, you will find that debating adds depth to your thinking and is the perfect venue and meeting place for positive and negative viewpoints. A formal debate consists of four things: a proposition (idea), issues (unsupported claims), arguments (claims supported by logic), and evidence (facts used to support claims). Understanding these things develops the structure of your thoughts. Study them. Debate yourself. Take both sides of the issues. Argue. Challenge. Defend. Ask yourself: What are the issues, arguments, and evidence that work to endorse my strategy? Then ask: What are the issues, arguments, and evidence that work to damage the viability of my strategy?
A word of caution: Winning an argument with someone doesn’t mean your ideas are sound. Victory is prejudiced by factors other than logic and reason. Steve Jobs can easily out-argue me or refute my ideas in a board meeting or panel discussion by virtue of his reputation, position, and personality. Likewise, my daughter can beat me in an argument by turning on the tears. He who shouts the loudest or cries the hardest can often triumph in a debate. So beware; that doesn’t mean the idea, or pieces of it, aren’t valuable just because you’ve lost an argument.
Few companies do this better than General Electric. Debate and challenge are an integral part of its corporate culture. Earlier this year, I was hired by GE Energy to provide input to its head of strategic planning so that he could debate Jeff Immelt, the CEO. The problem we were working on was distributed energy generation. In the United States today, we generate electricity by means of a centralized grid, and the energy business models support this solution. However, as the technologies for solar, wind, and other renewable sources become more efficient, they may change the way we generate electricity and we may shift from a centralized grid to a distributed system in which consumers and businesses generate their own electricity. We used the techniques in this book to develop various scenarios in which business models evolved from the current centralized ones to distributed ones. The CEO and the head of strategy then had a series of debates on the ones they thought to be most likely and then used the scenarios as inputs into their strategic planning process.
The Principle of Strategic Debate states that most large organizations demand blind adherence to the corporate mission statement and corporate plan. This kills the ability to evolve. Adaptive managers encourage dissension and debate, and this creates a culture intent on improvement. Some of them, like GE, even make it a formal part of their management process. I suggest you do the same.
The Nine Adaptive Management Processes
Culture is also reflected in the processes management uses to run its business. Some of the adaptive management processes may be part of your current culture; others may be new. Let’s do a quick review and summary of the processes outlined in this book and how you might integrate them into your current business. There are nine key processes, which are based on the principles I introduced in the first chapter. Together they form the overall process of adaptive management. Some of them are subprocesses of others. Some of them are completely independent. When, where, and how you use them depend upon your own corporate culture and your current planning and implementation processes. I won’t suggest an order. I think it’s better for you to take them and integrate them in a way that works for your organization, be it a five-man shop or a Fortune 500 company.
The first is the scenario planning process. This is our form of forecasting. Business operates in a chaotic environment, one in which unforeseen events can trigger unforeseen changes in the environment. Backward reasoning, the hindsight bias, and the confirmation bias all make us think that we are better at forecasting than we really are. We overcome these biases by developing multiple scenarios and using them as inputs into the long-term strategic planning process. It depends upon your business model and the maturation of the model, but this should be an annual process.
The second is a tactical inventory process. Tactics are the things we do to solve problems. An annual or semiannual cataloging of our solutions brings tactics into focus and creates tactical awareness among both employees and leaders. Remember, the inventory includes the tactics we’re currently using as well as a list of possible new tactics. In my first book, Borrowing Brilliance, I suggest a methodology for developing new ideas that is easily adapted to this process. Put simply, it is a three-step process: defining the problem, looking at industries with a similar problem and borrowing the solutions, then making new combinations to come up with new ideas. For example, when I was working for GE Energy, we studied the problem of centralized versus distributed business models. That forced us to study other industries, such as the computer industry, which started as a centralized processing model (mainframe computers) and then evolved to a distributed model (the personal computer) and now looks as though it may evolve back to a centralized model (cloud computing). We also looked at corporate farming (centralized) versus organic farming (distributed) and noted the different tactics that drove their evolution. We then used this material, these tactics employed by other industries, to construct an inventory of new tactics that GE could use to evolve its business model in anticipation of the coming evolution. My other book will give you more tips and techniques for developing this inventory.
The third is the learning process. Every year we put together a formal strategic plan. It’s based on a forecast (the most likely scenario), a set of problems, and a hypothesis for solving them. Before we begin the new planning process, we need to stop, review the plan from the previous year, and ask ourselves: What have we learned? What have the data of implementation taught us? Do we need to adjust our theory? If so, how? I like to consider this a separate process from the construction of a formal plan because it is often overlooked. This is how we get smarter. It also humbles us and helps to overcome the hindsight bias. It’s healthy to admit you’re wrong.
Defining problem(s) is the fourth process. We’ve spent a lot of time in this book discussing the problem and its relationship to corporate strategy (it is the strategy), so we don’t need to repeat it here. The point I do want to make is that leadership needs to define the hierarchy of problems so that line managers can make adjustments to the plan as it unfolds without having to be micro-managed by the CEO. Without a clear understanding of what problems we’re solving, we get “feature creep”—our line people start solving other problems that undermine the solving of our primary problem. At Intuit, Quicken was designed to solve a checkbook-balancing problem, but over time the line managers started solving other problems and so the software became loaded with so many features that it became difficult to balance a check-book with it (hence the term “feature creep”).
The fifth is the strategic alignment process. Using the concept of concurrent thinking, we try to perceive how all of our tactics fit together and form our overall strategy. It’s part bottom-up process and part top down. I introduced the concept of tactical briefs as a technique, a process itself, to facilitate the alignment of strategy and tactics. A tactical brief is like a creative marketing brief and describes how each particular tactic works to solve the specific problem it’s designed to solve as well as the problems above it, including the primary problem that determines the overall strategy. For example, at Wal-Mart, a tactical brief would include a description of how a particular tactic helps to drive down the shelf price of the various products Wal-Mart sells.
The sixth is the strategic planning process. This is the formal process of writing your strategic plan. Writing is important because it educates you and your team. It helps you understand the holes in your logic (if there are any), and it helps you define the cascading objectives for the organization. Remember, it’s those objectives that give your managers the ability to solve their problems creatively. Most important, it helps you define the metrics and dashboards your managers will use to implement the strategy. Of course, we now know that the plan is obsolete as soon as we print it. But that’s okay, right?
Tactical optimization is the process we use for implementation. We measure the effectiveness of our tactics by monitoring the metrics (using the dashboard). When a tactic becomes more effective, we try to make it even more effective by hypothesizing why it is so. When a tactic becomes less effective, we also ask why and try to determine the reasoning. This ultimately leads to the optimizing of our tactics and so our business model, while at the same time it teaches us what works and why it works. Some business models (such as online or direct marketing) are better suited to optimization than others, but this is a process than can be applied to most models.
The alteration process is a subset of both the planning process and the implementation process. We need to set aside time to consider both strategic alterations (questioning whether we are solving the right problem or asking ourselves if there is another problem we could be solving with the resources and tactics we’ve perfected) as well as tactical alterations (which leads us to both the tactical optimization process and the tactical inventory process).
The ninth is the debating process. This should be both a formal process and an informal one. It’s okay to challenge our forecasts, theories, and means of implementation. In fact, it’s encouraged. That doesn’t mean that we should be in a constant state of argument; we still need to make decisions and make things happen. We need to step with confidence, trust our feet the way a rock climber does, while at the same time be wary and even paranoid of what’s just around the corner. Making this part of our process is a step, no pun intended, in this direction.
Adaptive management tells us that when things work, we should pour it on, the way a general reinforces his troops when they break an enemy line. When they don’t work, when they begin to degrade, we need to ask ourselves: Why? Is it the tactic itself that’s worn out, or is it something else? Is there a problem with our strategy? Is there a problem with our underlying hypothesis? It’s these questions and the process for answering them that are at the core of adaptive management.