Thinking In Bets As Your Company Scales Innovation — Howard Yu

No one can predict innovation despite the eager pundits. They are ones who profess on talk shows without consequences. But it’s business executives who need to live with their own decisions. And you don’t need to look far for examples of perfectly good plans going south.

There was a time when the growth of China’s economy still caught the world by surprise. And that unsatiable demand for energy had people thinking the world’s oil reserves would soon run out. How could you not think so? A barrel of oil sold for $20 in 2001 had crept up to $138 by 2008. That’s when the world’s most valuable companies were Exxon, Shell, and Chevron. They were money-printings machine.

Then what happened? Their market capitalization kept sliding, long before people were demanding non-fossil fuels. It wasn’t renewables that caused headaches for the major oil companies. It was the surge in supply of crude oil. The high price spurred innovations that no one thought were possible: fracking and horizontal drilling. What people thought was a physical limitation turned out to be a business assumption. People had assumed companies would pull oil from the ground, the way they always had. But at over $100 a barrel, every barrel was gold. Innovation soared. Drilling went crazy. The US became a net energy exporter.

Often, the reasons a company wins or loses are outside its own control. Here is a list of examples, things that are outside of management control.

1. Commodity price risks that cannot be hedged away.
2. Changes in public policy, such as service reimbursement rates in healthcare.
3. A sudden speed-up in FDA approval.
4. An increased subsidy for renewable energy or a carbon tax.
5. A tightening of anti-trust rules.
6. Any deregulation or re-regulation,
7. Heightened foreign competition because of foreign exchange manipulation.
8. Intellectual property infringement by rivals.
9. Technological innovation that provides consumers with enough information to bypass intermediaries and distributors, etc.

You get the picture. The list is never-ending. We can talk about the leadership style of a CEO. But in the end, a CEO can’t control all that much. A high-performing team can still be ruined by the uncontrollable. Numerous studies have observed such salient facts. To quantify, individual CEOs, on average, contribute somewhere between 2 and 4 percent of total performance. My colleague Arturo Bris at IMD put it another way: If Apple’s profit margin in 2018 was 38 percent, Tim Cook’s individual decisions would be able to add, or detract, at most 1.5 percent per year. Oops!

So, what’s the takeaway? It’s certainly not defeatism, let alone helplessness. But like all things in life, after a decision is made, the way the future unfolds is always uncertain. The road to a good life is narrow and full of hazards. Any outward success-a good job, a nice house-can’t forestall failures from happening. For a company, what’s needed when making a strategic choice is this: Have a widely shared viewpoint, but fully acknowledge the inherent uncertainty.

This sounds absurdly commonsensical, but most companies exactly do the opposite. Managers go through the most excruciating data analytics based on past history, declare a bold move, align the entire organization for its implementation, and then never look back.

Remember, for every brave move that results in enormous wins, there are countless casualties that pursue the exact same approach. The unlucky companies flame out, and the press won’t report them because these are boring stories. They spent a lot of money on the wrong project. Who’s going to read that? The primary mission of the business press is not to educate, but to generate readership in order to survive.

What this means is companies need to scale their innovation by thinking in bets. And they need to leave a large enough of a buffer to allow things to go wrong in ways they can’t even imagine. Nassim Taleb calls these black swan events. Donald Rumsfeld calls them unknown unknowns.

Start Changing Before You Have To

Only the lazy or the stupid would need an absolute sense of urgency to spur change. Don’t wait until the situation becomes so dire that you need to make your last bet, which must then work out. That’s just an excuse for inaction until it’s too late.

If you prioritize longevity over everything else, eventually a favorable event will happen to you. That’s what card-counting in poker is all about. You can never be certain about a move, and you won’t have perfect information. All you can do is to tilt the situation to your own favor gradually, until you get a lucky break. Real-life business is like a game of poker. Chance favors the prepared, although not always.

So let’s look at a couple of charts to see what thinking in bets would look like.

Imagine you are a business leader in a highly turbulent market, say the technology sector. Maybe half of your product and strategy ideas will work. And that’s if you’re good. Amazon, for one, has had a long list of failures, as I have recounted here before. Upon the disastrous launch of the Amazon’s Fire Phone, Jeff Bezos said:

If you think that’s a big failure, we’re working on much bigger failures right now. I am not kidding. Some of them are going to make the Fire Phone look like a tiny little blip.

Such an outcome is okay and accepted because what was lost on the Fire Phone was offset by Amazon Web Services (AWS), which earns tens of billions of dollars. And yet, thinking in bets doesn’t mean having a rosy lens. It means seeing the world with a range of outcomes. You need a strong viewpoint about where the world is probably heading, while at the same time, acknowledging the existence of wild cards that can overturn everything. Choices can later look dumb, despite considerable deliberation.

If this sounds paradoxical, it is. It is exactly this kind of paradoxical thinking that propels success under great uncertainty. That’s why “only the paranoid survive” in the IT industry, as so vividly told by the late Intel CEO Andy Grove. It takes an inner insecurity that propels a CEO to become forever vigilant. Being vigilant means that you do everything to prevent disasters despite having a strong viewpoint on how the future will look based on your best educated guess.

That’s why you build in a buffer for the worst-case scenario.

And that’s exactly how those who thrive in the very turbulent IT industry look compared to incumbents from other, more predictable sectors.

Just a few words about how we came up with this graph and what it means. At IMD, we like to analyze company behaviors using large amount of data. For instance, if we try to understand the attitude of a company, we stay away from self-report surveys. They are too easily swayed by any one-off event with too few data points. Instead, we take in years of articles from The New York Times, the Financial Times, the Wall Street Journal, and other standard-bearer business publications, together with a company’s own press releases. We feed all of them into an algorithm. It then matches key words to understand the dominant sentiments or concepts that shape how the public comes to understand the company.

This method is not perfect. But it’s an analytical approach more reliable than an annual survey filled out by a small panel of people.

What you saw on the graph is the industry average. Now you can play with the interactive graph here.

On the vertical axis, we measure certainty. To what extent are companies from the sector are certain about the direction of change? It should come as no surprise. Twenty years of exponential growth in computing power have left the IT sector in no doubt about how connectivity and A.I. will continue to shape the world. Similarly, media-whether it is print or broadcast -has been shaped by the Internet since the ’90s, with the now-forgotten AOL and its lesser cousin, Yahoo!

The horizontal axis measure how much a company focuses on the upside of a situation or worry over its risks. What’s interesting is that those who harbor a strong viewpoint about the future are not necessarily blatantly optimistic. Instead of thinking about the future as something they have control over, instead grossing over the potential pitfalls, tech companies-especially those who survive and thrive in our sample-are ones that obsess over disasters. They try to minimize downside. In other words, they make changes ahead of time because they can see what lies ahead. But they, for the most part, make small bets at first, instead of committing to some irreversible move, like a mega-merger that puts the whole firm at risk. Finally, they build buffers in cash.

Silicon Valley always loves making small bets to create big wins. That’s why it’s always making changes ahead of time and disregarding industry boundaries. That’s why when Apple, Google, Amazon, and Alibaba are entering other industries like auto or finance or healthcare, investors often think other industry incumbents are in trouble. It’s not because industry incumbents can’t fight back, but because they don’t have the winning outlook to compete.

Being paranoid, tech giants are also obsessed with building buffers. They hoard cash for the rainy days. And so when times are lean, they have the most staying power. When no one has resources to buy cheap assets during downturns like the pandemic period, they snatch talents from others and build an even stronger foundation. And if something goes south, they have enough cash to ride out the miscalculation. So they are around a bit longer and hope for another black swan in their favor. Below is one cash-hoarding behavior and why tech companies are using it.

But then again, probability thinking is as useful in leading a business as in our personal lives.

Thank you for reading-stay well.

Yours,

P.S., Sometimes a bad strategy can lead to good outcome only because of dumb luck. And during those times, managers may learn the wrong thing by looking at results alone. Any examples you have seen where executives draw erroneous conclusions? Or ways that a company can avoid inaccurate conclusions so that it can become smarter over time? Share your thoughts with us. We always love to hear from you.

This article has been co-authored with Angelo Boutalikakis, a Research Associate at IMD’s Center For Future Readiness.

Originally published at https://www.howardyu.org.