What is the magic, if any, behind 2 + 2 = 8? Well, the story is that if you try make it happen it usually won't work. To put it in John Kay's words "goals are most likely to be achieved when pursued indirectly." Obliquity is the name for this. What does it tell us about businesses and the goals they shoud be pursuing?
The current fad is for businesses to concentrate on maximizing shareholders value. Metrics have been crafted that supposedly measure the failure of success in achieving this target. They are called EVA, CFROI etc... The theory behind it is that, other things being equal, focussing exclusively on shareholders captures every dimension of the corporation anyhow. But is it that simple? Is it carved in stone that this rational managerial framework outperforms a more holistic managerial approach.
John Kay has a nice metaphor to show that the devil lies in the details indeed, that of the US National Parks Service. One duty of this governmental body is to ensure that forests are not destroyed by their greatest enemy, namely fire. The stated goal of the Service was once that of zero tolerance towards fires. Every outbreak would be fought and extinguished. The resulting fire statistics turned out to be exactly the opposite of what was expected: More fires rather than less fires. Why? Because forests (like corporations) are a complex system. Indeed, allowing some small fires to burn is a good way for making sure that bigger fires won't have much combustible undergrowth left. Hence, instead of having forest rangers enforcing the zero fire target, letting them judge what to do depending on the current environment was a far better option. Rather than putting an optimization goal (that of a fire numbers minimized to zero) at the forefront, an adaptation (holistic) approach was in the end privileged.
The adaptative approach is especially relevant in an environment where small differences in the beginning can make big diffrences in the end. The common example that springs to mind is that of the butterfly whose flapping wings in Africa may trigger a storm weeks later in the Carribbean! Complex systems are typically non-linear and so has become the modern business world. Our modern societies have migrated from economies of perspiration to economies of inspirations. Does this make a hell of a diffrence? Yes it does! The economics of ideas is far more subtle and complex than the economics of hard assets. Indeed, ideas are very different from hard assets, they are non-rival: Your using the Pythagorean theorem does not preclude me of using it. Ideas are also partially excludable. For instance, a copyright or a patent gives you the right to charge for the use of your idea, or in case you can't to sue. The non-rivalrous feature of ideas gives them an atypical cost structure. Indeed, a good that is rivalrous must be manufactured each time it is sold. A non-rivalrous good, such as an idea, requires a significant fixed cost of production for the first unit and a very small marginal cost for the future units. Think of Microsoft's Windows. They charge you a lot for something that a "small" marginal cost. The only way to recoup the initial outlay is to deviate from competitive pricing (price=marginal cost), to charge above marginal cost and to create a rent. This is where increasing returns to scale kick in and where the winner may indeed take all: 2 + 2 = 8!
Question is then: How does this happen before you're dead? Santa Fe Institute W. Brian Arthur calls for an understanding of the differences between what he calls Alfred Marshall's world and the increasing returns world. Alfred Marshall, a leading British economist (1842-1924), lived in a world of bulk production, of perspiration and of diminishing returns, namely a world where the trend was towards "normal" profits in the equilibrium for all entrepreneurs. As Marshall showed in his Principles of Economics , optimization tools are prime candidates to get a concise picture of such a world. The increasing-returns world is a significant departure from Marshall's world. This is a world were things tend to wander off, where things that get ahead, get further ahead, where things that get down, get further down. A popular example of this in the Internet is network effects. The outcome of such a world are now well-documented: Imperfect competition, chaotic marketplace, unpredictability, lock-in, winner take-all and..... "fat profits for the winner (2 + 2 = 8)".
How do people, corporations behave in such a world? Should they optimize à la Marshall, strive for the maximization of some metrics such as EVA or rather shoot for more holistic approaches à la forest rangers? Well, it seems to me that the best option you can go for in a complex world (which is a mixture of Marshall's and increasing returns') is to develop a strong sense of adaptation. Physicist Murray Gell-Mann, author of The Quark and The Jaguar writes "whether putting together a business plan for a new venture, refining a recipe, or learning a language, you are behaving as a complex adaptative system." After all, when you look at earthquake or floods, rather complex phenomena indeed, it is hard to predict them but easy to avoid building your house in an earthquake or flood prone area.
The increasing returns world is truly a world of obliquity, psychology, perspiration and inspiration, cognition and adaptation. Economists do not say otherwise when they say that the economics of ideas call for a move away from perfect competition.
To make hits happen, to reach the 2 + 2 = 8 arithmetic, single metrics such as EVA, CFROI, whatever their sexiness, won't do. Worse, they'll more often than not push you in the wrong direction and defeat the whole purpose you had in mind in the first place. Complexity calls for humility. Catch-all single metrics are simply too arrogant!
That's why, as you can imagine, I keep wondering what is going to make this blog a real hit!