As business leaders, policy makers, the academic community, the media and an outraged public search the rubble of the global economic crisis for clues as to what went wrong, all fingers point to a common perpetrator, poor risk management. But while risk management, or lack thereof, played its part in the disintegration of the world financial system, we contend that another culprit played an even bigger role: complexity, and an inability to cope with it. The unpredictable, unstable, non-linear, and fast-paced nature of the complex interrelationships between nations, firms, and persons that shape the global economic landscape are at the root of today’s risk-management challenges. Hence, these relationships are of central concern to leaders. In these turbulent times, the question becomes: How can business leaders effectively cope with complexity? Complex environments, complex organizations
Complexity is one of the salient hallmarks of the 21st century. It’s evident not only in business, but in every facet of the globalized world in which we live. Countries, economies, and people are more deeply and densely interconnected than at any time in history and these connections are proliferating at a faster pace than ever. Global travel and instant communications magnify the so called “butterfly effect,” whereby a butterfly flapping its wings in Sao Paolo can trigger hurricanes in Shanghai, illustrating how a relatively small event in one part of the world, when amplified in a non-linear fashion, can have catastrophic consequences for another. For example, the recent eruption of an obscure, unpronounceable volcano in Iceland, a tiny nation with only 300,000 inhabitants, resulted in the closing of the entire European air space for six days, losses of approximately two billion USD for the airline industry, as well as billions of dollars in losses for the makers of urgent, perishable, and high-value goods, logistics firms, and tourism operators around the globe. Add to this the loss of productivity for stranded employees and cancelled business meetings and the impact of this relatively small event on the global economy becomes huge.
Professor Martha Maznevski, an Ivey PhD, and her colleagues at IMD1 have identified four main drivers that interact to produce complexity in organizations.Diversity:
From diversity in business models, management systems, and employees to diversity in customers, suppliers, and socio-political systems, leaders must respond to an ever-increasing variety of often-conflicting demands from multiple stakeholders. Investors may demand higher profits while communities demand more corporate social responsibility, just as customers demand lower prices while regulators demand more safety. Take Siemens AG, the global engineering powerhouse. It has operations in 190 countries and over 400,000 employees, and competes in businesses as diverse as energy, healthcare, telecommunications, transportation and financial services. The sheer diversity of Siemens increases the complexity of its operations on a massive scale and presents formidable challenges to its leadership, such as defining strategies, promoting common values, and integrating processes.Interdependence:
Globalization’s deep web of connections has resulted in “small world” effects, shortening the standard six degrees of separation to one or two – local events can easily have global effects through “long-hops.” The intertwining of organizations’ value chains, corporate governance, and financial flows results in exposure to shocks at the periphery that can move to the centre of an organization in rapid succession. As an example, consider the case of Netflix, the online DVD rental giant. With booming sales and profitability over the past five years, it is about to face a major shock to its business model. The United States Postal Service (USPS), struggling with losses, has decided to increase postage rates as well as eliminate Saturday delivery. With Saturday being the biggest delivery day and postage a major cost driver for the Netflix, this move could easily wipe away the firm’s profitability and threaten its existence. Netflix will now have to adjust its strategy to compensate for damaging changes in a critical component in its value chain.Ambiguity:
An overload of information, often with numerous, conflicting data points, makes it hard for business executives to glean insights that can be applied to decision-making judiciously. Coupled with increasing uncertainties and unknowns, causal relationships are difficult to pin down, making it even more problematic to assess the validity of a course of action. The 2003 Columbia space shuttle tragedy is a case in point. The large piece of insulating foam that had shed from the external tank during launch had severely damaged the Orbitor’s left wing. As the Shuttle entered the Earth’s atmosphere, extremely hot gases surged into the punctured wing and melted its aluminum structure. The Shuttle broke up upon re-entry and all seven crewmembers perished. Although the issue of foam strikes had been examined before, ambiguity in the information available led NASA managers to dismiss the threat of the Shuttle’s destruction. Managers defined the foam strike as a maintenance issue for the next flight, not as a safety issue for the current flight. However, management was not clear where the foam had hit the wing and at what speed, and the ambiguity was exacerbated because of poor images from the ground cameras. Nevertheless, management was not concerned about the foam strike – strikes had happened before. Engineers requested additional imagery to form a better or more informed opinion about the damage the strike may have caused, but management cancelled the request, with tragic consequences.Flux:
The unrelenting pace of change that envelops companies, industries, and nations only adds fuel to the fire of complexity. Circumstances that are taken for granted today may become irrelevant tomorrow, often with no advance warning. Consider the case of the music industry. Within three years of its introduction, Apple’s iPod music player gained an audience of 50 million users, a feat that took radio 38 years to achieve. The iTunes music store recently passed its 10 billionth download, and it has come to redefine the value chain of the industry. Flux also brings into focus the impact of speed. Consider a race car driver negotiating curves at double the speed the car was built to handle and the driver equipped to manage. The parallel in business is how well organizations are built to move operations along at high speed and what leaders need to do to manage what may be the scarcest resource of all – time.
With these four factors at play, as firms intensify the scale and scope of their operations in progressively more complex environments, business leaders in turn preside over progressively more complex organizations. On one level, such mirroring of the environment makes sense – Ashby’s law of requisite variety2 implies that the internal complexity of an organization must equal the external complexity of its environment in order to be effective. The typical organizational application of this law has been to add multiple layers of hierarchy and specialization, with increasingly standardized systems and processes for efficient execution of planned strategies.
However, the above approach is ill-suited to the dynamism inherent in complex environments, where information is often incomplete and ambiguous. Complicated structures and policies that promote a control mindset, where standard operating procedures presume answers to known problems, leave little room for creativity, innovation and the new patterns of behaviour required to solve complex challenges. According to Shari Ballard, Executive Vice-President of Best Buy, “Look at why big companies die. They implode on themselves. They create all these systems and processes – and then end up with a very small percentage of people who are supposed to solve complex problems, while the other 9 percent of people just execute”.3
The demands of competing in a complex landscape require structures and conditions that promote adaptability, learning and creative problem solving, as well as leadership that enables the distributed intelligence of the organization to flourish. We draw insights from organizational learning and improvisation to distill lessons for business leaders on how to enable their organizations to survive and thrive in the increasingly complex business world.Dealing with complexity through organizational learning and improvisation
Given the challenges described above, leaders need to build agile organizations where individuals deal well with ambiguity, reap the benefits of diversity and do so under the pressure of time with a keen awareness of the inter-dependencies in the network in which they operate. Needless to say, this is a very tall order. We look to the fields of organizational learning and improvisation for what it takes to build and lead organizations equipped to deal with complexity.
Some of the best insights come from improvising, where composition and creativity converge with execution, bringing practice and performance together in real time. Improvisation theory was born from work in jazz and theatre in an effort to identify the individual, group and organizational characteristics that provide for both discipline and freedom to take place simultaneously, in order for a goal to be reached in a novel way. We can learn a great deal from improvisation about flexibility and agility in the face of ambiguity and time pressure. Consider jazz musicians, who jam, or work collaboratively to co-create music in real time. This stands in contrast to the orchestral musician working from a musical score with a conductor ensuring the pieces fit together. Or consider the theatre improviser who doesn’t have a script but creates the storyline with the other improvisers. The improvisers have learned to deal with diversity, ambiguity, interconnectedness and flux. In short, they are masters at dealing with complexity, and in being able to do so provide four key lessons that can be applied to business.1. Understand the minimal structures on which you innovate.
In the case of jazz there are melodies that may serve as the minimal structure, whereas in theatre improvisation there are process structures that underpin the performance. One major process principal is “yes anding,” where improvisers are trained to build and develop ideas rather than block them with “buts” or “offers” that shut down the development of the scene. This can happen when an actor tries to seize the moment to elevate himself at the expense of another actor. Rather than operating with minimal structures, businesses often get bogged down with a great deal of outdated procedure, routine and bureaucracy that burden organizations. The lessons for business are to understand the minimal structures that inform the strategy and the minimal structures that inform organizational processes.
Professors Don Sull of London Business School and Kathy Eisenhardt of Stanford Business School4 have suggested that these rules are focused on a few strategically important processes such as what markets to enter, what products to offer and with which partners to ally. These differ from company to company, as each organization has its own opportunity to maximize priorities. Several types of rules and examples of each are mentioned:
• how-to-rules,- delineating the key features of how a process is performed, i.e. Dell splits a business unit responsibilities when a business has reached 1 billion in revenue
• boundary rules – focus on which type of opportunities to pursue, i.e. Lego products must meet checklist of rules, must be fun, high quality, encourage creativity, approved by parents
• priority rules, – ranking of priorities, i.e. Intel allocates production capacity based on gross margin
• timing rules – the pace at which to explore opportunities, i.e. product development cycle must be less than 18 months
• exit rules – when to abandon opportunities, i.e. GE either number 1 or 2 in industry or divest.
• Hence, the leader’s job is no longer to set the strategy per se but to draw the boundaries within which evolving strategies are able to come forth. Setting simple strategic rules does not imply, however, that tensions in the strategy-making process are resolved. There are still trade-offs to be made as to how to allocate scarce resources. As well, leaders still need to know when to say “No” to emergent strategies that dilute the organization’s uniqueness.
If we look at the players in the financial crisis, we can see that they did not have a clear set of simple rules to guide them. Most banks did not bother to have guidelines for what assets and liabilities to hold on their balance sheets, especially as more and more exotic instruments were introduced in the market. Simultaneously, due diligence rules were given short shrift as it became increasingly difficult to ascertain the end customer. The only simple rule was to grow, at just about any cost.
There are also simple rules about process, and often these relate to the values of the organization. Consider the point made by a WestJet executive who described the freedom of WestJetters (as WestJet employees are called) to resolve customer issues and to create a remarkable experience for the customer or guest. Flight attendants tend to be confronted with challenges for which there is no existing policy or rule (not yet anyway); if all the (potential) challenges and their associated policies are documented it would make for a lengthy manual. Instead, flight attendants are encouraged to use their judgment in creating a remarkable experience for the guest; they are urged to take into consideration the company’s core values. The executives are interested in the intent of the behavior demonstrated by the flight attendants in trying to resolve the challenge. If the challenge was handled properly by the flight attendant, that would be considered as great. If not, coaching will take place and an effort made see if there is (was) a better way to respond to the particular challenge.
2. Design a learning organization that can improvise
For many organizations, a focus on execution, and the resultant bias towards efficiency, has been the bedrock principle. If the creativity and adaptability required to deal with complexity are to be exercised and even maximized, the organization needs to have the capacity to learn and improvise.
There are several elements that have proven troubling for organizations in this regard. At the individual level, dealing with complexity means that individuals need a comfort level with ambiguity and a willingness to learn. As Guy Claxton, author of the book Live and Learn noted, one of the biggest barriers to learning is our resistance to let go of the 4C’s – the desire to be consistent, comfortable, competent and confident. We add a fifth to the list – the desire for control. Protecting and preserving these five C’s is a huge barrier to individual growth and development.
Yet, developing a learning organization means more than having a bunch of capable individuals. It is clear that complexity dictates that the understanding and associated action is a shared endeavor, and that therefore there are critical group elements that underpin organizational learning capability. Many of these are embedded in the simple process rules of improvisers around listening, yes-anding, supporting one another, being accountable to one another and to the joint goal.
However, strong individuals and groups are not enough. As we know, bad organizational cultures beat down even the best employees, and so a key role for leadership is the designing and nurturing of organizational cultures that enable learning and improvisation. Take, for example, openness to trial and error. In order for individuals to be able to improvise effectively, a culture of experimentation needs to pervade the organization. Employees need to be able to feel that they are able to take risks while experimenting and be afforded the chance to make worthwhile and honest mistakes. The leader’s job here is to promote what Professor Amy Edmondson of Harvard Business School refers to as “psychological safety.” In essence this means that no employee is disciplined for asking for assistance or owning up to a mistake. At the same time, psychological safety does not imply a softening of demanding performance goals. On the contrary, in order to truly realize the benefits of psychological safety, accountability for meeting demanding goals must also be present. Thus, as Edmondson argued, psychological safety is “about recognizing that high performance requires the openness, flexibility and interdependence that can develop only in a psychologically safe environment, especially when the situation is challenging or complex.” Once employees feel safe, their self-confidence begins to build and they are more likely to explore new and unfamiliar terrains that may lead to a breakthrough idea. Leaders need to show that they trust their employees to take calculated risks and that failure is indeed a learning opportunity that makes everyone wiser in the long run.
Revisiting the NASA Columbia tragedy, we see that a key issue in the handling of the tragedy was that the engineers who had misgivings regarding the effects of a foam strike on the spacecraft were reluctant to share their views, as many felt that the work environment was hostile to differing opinions. Lacking the psychological safety to speak candidly without fear of repercussions, dissenting engineers kept silent, setting the course for the tragedy to unfold.
Search engine giant Google, on the other hand, is an exemplar of creating the right balance between psychological safety and accountability for high performance. For example, engineers are allowed to devote 20 percent of their time to projects of their own choosing, with no approval needed by upper management. If these projects turn out to be unviable, there are no negative repercussions for the employee. Google has developed several successful products as a result this policy, including Google Suggest, AdSense for Content and Orkut.3. Build expertise and real-time communication
Improvisation research reveals that the greater the level of expertise, the better the improvisation. There is a caveat, however. Expertise actually drives out improvisation, since individuals and organizations tend to revert to old patterns rather than consider whether new approaches are required. Yet, when they do engage in improvisation, expertise is critical. Real-time communication is also essential. Real-time communication means that individuals have access to the right information when they need it. One of Wal-Mart’s strengths has been the use of information technology to help them understand customer needs, and get the products on the shelf when they need it. They know customers tend to buy more Pop-Tarts in serious storms so they can track weather patterns and ship products to where they need to go. The ill-fated Apollo XIII mission, in which a sudden explosion of one of the oxygen tanks endangered the lives of three astronauts on board, forced Mission Control in Houston to improvise solutions with materials already on the spaceship, i.e. plastic bags, duct tape, etc. to deal with the ongoing challenges posed by this unanticipated event. At the same time, NASA ensured that it had the expertise in the room to solve the complex problem with unorthodox yet practical solutions.
In contrast, the 1949 Mann Gulch fire in Montana is an example of how the lack of expertise and real-time communication hampered an improvisational solution that could have saved lives. Faced with a rapidly expanding fire with 30-foot flames moving at 610 feet per minute, the foreman of a group of firefighters realized that they could not outrun the flames that were relentlessly advancing. He then improvised a solution: He started an escape fire, and lay in the ashes of the burnt ground while the wall of flames scorched the earth around him. At the same time, he yelled at his crew to drop their tools and do the same. No one did, as this astonishing act had never been been part of their training and the sound of the intense fire made it difficult for others to properly understand the intructions. Instead, they all ran for the nearest safety point, a ridge, as they had been trained to do. Sadly, only two members were able to reach the the safety point, while 13 other perished in the fire. The foreman, who had improvised on the spot, survived unscathed.
CEMEX, one of the leading construction materials companies of the world, with over 50,000 employees, uses these principles to create order out of chaos in its home market, Mexico. Using the latest in information technology, including computers and GPS units in all their ready-mix delivery trucks, each truck operates as independently as possible – cruising Mexico’s notoriously unpredictable roads as an autonomous agent, waiting for orders. There are no fixed schedules. Instead there is real-time data of customer orders, production schedules, traffic reports, even weather reports that allow operators to make decisions on the spot as to where to deploy resources. The objective of the drivers is to deliver within a twenty-minute time window, otherwise the customer receives a twenty percent discount. The results: 98 percent of deliveries occur within this time frame, whereas before only one-third of orders were on time in a three-hour time window.4. Distribute leadership
In most large organizations leadership is designated and responsibilities are assigned by hierarchy – there are top, middle, and line managers, with prescribed roles at each level. Top-level managers fulfill resource allocation duties, while middle managers are controllers, and operational managers, implementers. Improvisation, on the other hand, teaches us that individuals take the lead at different times, though the lead is collectively owned. Clearly there is a top leadership role, namely to be the prime promoters of trust and purpose, while middle-level managers take on more of a coaching role, and line managers become entrepreneurs. At each level there needs to be a sense that leadership is shared; that is, leadership is conferred on the individual with the critical skill set, know-how and capabilities for a specific challenge. Adopting this approach can be a difficult adjustment for leaders who have been taught that their job is to manage and lead. After all, that’s how they became successful leaders! Leaders need to acknowledge that they cannot know everything. In certain situations they serve their people better by listening and accepting their expertise.
Leadership in this context, regardless of role, needs to act as an enabler of spontaneous action. Leaders need to serve as catalysts for bottom-up interaction by promoting empowerment at all levels. Hence, power is diffused through the system and blunt authority is pushed aside in favour of collective influence. John Brown, former CEO of BP observed:
“If you named a boss, you’d have an organization and a hierarchy, and hierarchies – or, more specifically, the politics that accompany hierarchies – hamper the free exchange of knowledge. People are much more open with their peers: they are much more willing to share and listen, and much less likely to take umbrage when someone disagrees with them (…) It might sound like fantasy, but I truly consider myself only the first among equals in the top management team”.5
The product design firm IDEO, headquartered in Palo Alto, California, arguably one of the most innovative and successful design firms in the world, embraces the notion that everyone working on a design project is equal. Its multi-disciplinary design teams, which count Apple, Procter & Gamble and Research in Motion among its blue chip clients, choose project leaders based not on title or tenure, but on who is most capable of facilitating the group’s efforts for that particular project. No one in the project team is allowed to censor the ideas of others – everyone is encouraged to keep building on what others have proposed until a mutually acceptable solution is found. At the end of the project, success is shared equally amongst all members.
At WestJet, employees at all levels are urged to think alongside management about how to reduce costs and enhance guest satisfaction. For example, the ground crew noticed that the absence of external sight gauges to read the water level of the potable water tank that supplies the aircraft with water led the crew to always fill the tank, regardless of its destination. The extra water added weight, thereby increasing fuel burn and emissions. The crews’ suggestion to install an external sight gauge allowed the crew to determine how much potable water was used on a specific flight or route, hence decreasing costs as well reducing emissions. In contrast, General Motors, once the most highly successful automotive company in the world, lauded its centralized leadership and tightly controlled processes as cornerstones of its success, not realizing that these practices were inhibiting its employees’ capacity to learn and innovate in the fast-changing automotive business.Final thoughts
The insights gained from organizational learning and improvisation are good management practices in and of themselves, but in the face of complexity, learning and improvisation are paramount in dealing with the ambiguity, diversity, interconnectedness and flux.
We began this article by pointing out that complexity was a big factor in the financial crisis. The global financial system has many of the signature features that produce complexity. First, over the last several decades, the scale and interconnectivity of the international financial system have grown dramatically. With such dense connections, the financial network has a “robust-yet-fragile” quality. A bigger network diversifies risk, but denser connections make contagion easier. Shocks to the system are either absorbed or amplified, depending on the “tipping point” – the failure of Lehman Brothers could be argued as the final tipping point that made the previously robust system so fragile. . Second, the diversity of the network increased substantially, with more and more players entering the game of buying and selling risky assets, and new product lines being offered constantly to satisfy the need to grow revenues and market share. With so many securities and so many clients, keeping track of emerging danger zones became more difficult. Third, the increased diversity and interconnectedness created more ambiguity, with exact information becoming difficult to assess. For example, Bank A could be dealing with Bank B on insuring securitized loans, which are priced according to their risk. However, Bank B could have counterparties, each of whom in turn could have counterparties, making it impossible to price the risk. Fourth, the global financial system has been changing rapidly in recent years. New financial products are introduced with lightning speed, and new forms of financial intermediaries such as hedge funds were created almost overnight and with little regulation.
These four factors combined to produce massive complexity into the world financial system, overloading the network to the point of collapse. Dealing with the dynamic complexity in the high-velocity, inter-related, ambiguous and diverse business landscape requires the adoption of new approaches to building and leading organizations. The greatest shifts that need to occur are in the mental models that have dominated business thinking – the “silo mentality” that views organizations as the sum of their distinct parts. It requires business leaders to think in cross-enterprise terms, across the entire set of networks that comprise its value chain, where interconnectivity blurs boundaries both within and outside the organization’s borders.
In complex environments, leaders need to have the fortitude not only to tolerate but to thrive when balancing on the edge of stability and instability, where improvisation and experimentation provide the best chances of success. It is not easy, however, to maintain this balancing act. In times of crisis, the natural tendency is for people to fall back on their proven expertise and routines, rather than take a chance to build on their expertise with a novel approach.
In the final analysis, coping with complexity is not about predicting the future or reducing risk. It’s about building the capacity, in yourself, your people, and the organization, to adapt continuously and learn speedily, in order to maximize the chances of seizing fleeting opportunities.
1. Maznevski, Martha, Steger, Ulrich and Amann, Wolfgang. Managing complexity in global organizations. Perspectives for Managers, IMD, No. 141, February 2007
2. Ashby W.R. (1958) Requisite variety and its implications for the control of complex systems, Cybernetica 1:2, p. 83-99.
3. Cunha, Miguel Pia E. and Rego, Armenio. Complexity simplicity simplexity. European Management Journal, Volume 28, Issue 2, April 2010 pp. 85-94
4. Eisenhardt, Kathleen M. and Sull, Donald N. Strategy as simple rules. Harvard Business Review (January 2001) pp. 107-116.
5. Cunha, Miguel Pia E. and Rego, Armenio. Complexity simplicity simplexity. European Management Journal, Volume 28, Issue 2, April 2010 pp. 85-94
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Reprint from Ivey Business Journal
[© Reprinted and used by permission of the Ivey Business School]