ALASTAIR DRYBURGH

There is an article in the newspaper today about how hard it is for people to find work in depressed parts of the UK. It cites the example of Tracy, aged 46. She has applied for 200-300 jobs, 30 in the past week, but has had no interviews. Maybe, she says, “it’s because I have a lack of training and qualifications.”

Or maybe, on the other hand, it is because she has soft-tissue rheumatism and has to use a wheelchair outside the house. She finds email is the best way to apply for jobs, as holding a pen makes her hands stiffen up. Or maybe it is because retail and construction, the two main staple sources of low-skilled jobs are, in the words of a local official, “so,so  dead in the water.” Or maybe it’s because in Tracy’s area there are 55  people chasing every vacancy.

In spite of all of this, Tracy says “If you don’t get a job, you have only yourself to blame.”

What’s going on here? It’s an extreme case of a very common problem; refusal or inability to acknowledge the role played by circumstances. I certainly don’t blame Tracy for not finding a job, but she does. I have a horrible feeling that she’s just going to keep plugging away, trying to stay positive, blaming herself for her failure,  until she collapses from depression and self-hatred. It’s not a fate I would wish on anybody, but the syndrome is everywhere you look. You see it in people struggling to keep going in a job that just isn’t working for them any more. You see it in companies persisting in markets where they are no longer competitive, or are just dying.

“Staying positive” can, dangerously easily, slide into stubborn devotion to a lost cause. But  its opposite, complete fatalism, is hardly an attractive alternative. What to do? The answer, it turns out, has been around for a while. Here is one of my favourite management thinkers:

“..not to extinguish our free will, I hold it to be true that Fortune is the arbiter of one-half of our actions, but that she still leaves us to direct the other half, or perhaps a little less.”

That makes sense to me. It comes from Machiavelli’s The Prince (published 1532). There’s also some practical advice on how to deal with the fact that the world only partly responds to our actions:

“I conclude therefore that, fortune being changeful and mankind steadfast in their ways, so long as the two are in agreement men are successful, but unsuccessful when they fall out. ”

In summary: be realistic about how much influence you can have on the world. Adapt your plans to the circumstances. Easier said than done, and quite rarely seen.

What’s interesting about Machiavelli is that he is so old he’s actually radically new. He describes the period in which he writes as being characterised by “great changes in affairs which have been seen, and may still be seen, every day, beyond all human conjecture.” Things really mattered then. He was a government official in Florence. After a change in regime he fell out with his new management but instead of being sent on his way with a big payoff he was imprisoned and tortured. Altogether, Machiavelli’s world seems much more like the one we are entering than the one we are leaving today.

You might remember the story of the Hollywood studio who called in a hotshot strategy consultant to tell them how they could do better. After extensive analysis, he delivered his conclusion. “You are investing in too many projects, most of which don’t make much money. Most of your profits come from one or two blockbusters each year. You should only make those.”

You will be able to provide the reply. “This is Hollywood where, famously ‘nobody knows anything.’ Nobody has found a method of producing guaranteed blockbusters. We have to make all those movies and hope that at least one becomes a hit.”

Nobody working today in films, book publishing or the music business would fall for the blockbuster fantasy, but the idea has acquired a new lease of life in new, improved, sexier social-media garb. It’s now called viral marketing.

The idea of viral marketing, worldwide fame at minimal cost, is hugely seductive. The only problem is the one that’s always been there. Many “experts” will try to sell you the recipe to viral success, but the truth is that there isn’t one. In fact, it’s worse than that. There can’t be. Rather than argue with any specific recipe for “going viral”, I’ll show why there cannot be such a thing.

Imagine there were a recipe for certain viral success. Pretty soon, it would itself go viral. There would be millions of viral videos, or emails or tunes out there. Just work out the number of views multiplied by the time taken, and you have everyone in the world spending most of their time watching Youtube videos. This just isn’t feasible. The fact is that any “recipe” becomes self-defeating. At the point that it becomes generally known, it ceases to work. To succeed at the viral game you either need to be lucky or better, even if only very slightly better, than the competition. If it’s a question of being better, the margin of superiority is so thin that it’s impossible recognise before the fact. You only know what’s better once you know what has succeeded. So in that case as well it just comes down to luck.

By all means work hard to make your ideas engaging and easy to spread, but be realistic. Viral success would be a wonderful thing, but as a business strategy it’s in the same class as buying a lottery ticket.

This is a recent news story, but it’s typical of many…

Schools are using a range of underhand techniques for achieving better inspection results. When the inspectors visit, they:

• Send troublesome pupils home for disciplinary reasons without recording it as an exclusion;
• Send pupils with special needs home if a teaching assistant isn’t available to look after them;
• Encourage disruptive pupils to stay away while recording them as “authorised absent” or “educated elsewhere”;
• Encourage the parents of difficult children to educate them at home (with the results that you can imagine).

My father gave me another example from the days when computing power was scarce and computing jobs were run overnight. The target for was for 90% of jobs to be run on the night after they were submitted. The operators had devised an effective, elegant algorithm for hitting this target as often as possible: run the shortest jobs first. The unfortunate result of this was that  longest one was always submitted last. Usually this meant that it wouldn’t get  run at all, night after night.

The fact is, any attempt to use a single measure to manage performance will produce gaming, unintended consequences and dysfunctional behaviour.  So what can you do? We need three changes:

1. Don’t try to maximise one measure, balance several;
2. Accept that there is no wholly objective way to meaningful measurement. Some subjectivity will always remain;Stop treating people like mechanistic cogs in a machine.
3. Treat them as intelligent, thinking agents.

Let me illustrate using one of my favourite case studies. I once found a purchasing manager, Laura, about to place an order for four years’ stock of a particular item. This was insane: spending cash on stock that wouldn’t be sold and turned back into cash for four years. Yet, within Laura’s incentive scheme, it made perfect sense. Her task was to get the lowest possible unit price and never to let anything go out of stock. The obvious way to do this was to order in enormous quantities. The fact that the resulting cash outflow nearly bankrupted the company was not her concern (nobody had even explained it to her).

What Laura needed to be doing was balancing three things: unit cost, availability and cash requirement. What she was actually doing was minimising unit cost, in a way that automatically maximised availability but damaged cashflow.  Imagine what would happen if you asked her to take on the balancing act. First of all, it becomes harder to measure performance. “Did you get the lowest unit cost?” is an easy question to answer. “Did you get the best balance between the three things?” is harder. They are different types of question. The first is objective. The second is subjective.  Suppose Laura did say “yes, I got the best balance.” How do you know she is telling the truth? Only she knows. You have to trust her. You have to educate her as to what the company needs. You can’t treat her like a cog in a machine which does exactly what you tell it to do. You have to give her permission to think how best to achieve the goal, and make sure she is motivated to do so.

Now I realise that isn’t good news. The single, objective measure has many attractions. Simple to understand, clear-cut, difficult to argue about..Its only drawback is that it won’t produce the behaviour and the results you want. Sorry, but life is a subjective balancing act. You may as well get good at it.

If you want to hear more about this, it was the subject of the May 2013 teleconference. To hear it, sign up to the series using the link in the box to the right – it’s free. You’ll get a link to the archive, including this one.

I cycle to work about half the time. Recently I noticed that it seemed to be getting harder work, beyond what I would have expected from advancing age and the fact that I live on top of the highest hill in London. After a couple of days of pedalling harder I realized that something was wrong. I had a choice between starting a fitness programme and checking the bike. I opted for the second, and found that a weak spring in one of the brake levers was making one of the brake blocks rub against the wheel all the time.  I fixed that, and the problem was solved.

This is not “Zen and the art of bicycle maintenance.” The point is that very often when we try to make improvements to businesses we focus on doing more of what we need to do, and pay insufficient attention to what is getting in the way. In innovation, for example, we focus on generating more new ideas –  the equivalent of pedalling harder or doing the fitness programme. We don’t pay enough attention to what is getting in the way – the equivalent of the binding brake.

To expand on this, I am often asked a variant of this questsion: “How can we encourage staff to be more proactive when it comes to chasing business/new ideas. We want us to approach us with any suggestions, we keep pushing the point and are even offering an incentive but it’s not doing the job.”

This is the sort of answer I give.

There are three types of people in any organisation. The first type are the ones who are compelled to innovate – they just cannot stop. If they are lucky enough to find themselves in the right place at the right time then they become Steve Jobs or win the Nobel Prize for physics. If they are unlucky they drift unhappily from one organisation to another, seen as “too disruptive.” It’s unlikely that you have many of these types at your place.

The second type of person is the one who is just allergic to any sort of change or novelty. Whether it is genetic or imprinted in early life they just can’t produce original ideas and find other people’s original ideas deeply threatening. You may well have a few of these types on board. They can be good  people to have around but just don’t expect them to come up with new ideas.

That leaves the third type of  person. These are capable of producing new ideas and putting them into action provided that the environment is right. You almost certainly have some of these around, so if they aren’t coming up with innovations it must be that something is stopping them.  Here are three things to consider, the three things which in my experience are most likely to impede innovation.

Firstly, have you freed up the resources they need? The fact is that innovation takes time, and usually also money. Organisations often forget this, and send a message like  “instead of being at home with your families or down the pub with your friends we want you here trying to innovate for us.” That’s not helpful. You could look at benchmarks from very innovative companies. 3M famously allowed its people to spend 15% of their time doing anything they found interesting. Google picked up the idea and raised the percentage to 20%. How much do you allow?

Secondly, what are the incentives pulling people back to their “day jobs?” I am reminded of the professional firm which realised that it needed to find new clients. The answer was that senior people needed to get out of the office more, attend events and meet new people who could become clients. It’s a very sensible strategy, but it failed because nobody changed the incentives and measurements. Everyone in this organisation was assessed on utilization – the percentage of their time spent on fee-earning work. The immediate effect was that those who most enthusiastically took up the challenge of securing the future of the firm found themselves most penalised for low utilization. Accept that spending time on innovation is going to mean people doing less well on their other performance indicators and that you need to make an adjustment.

Thirdly, you need to find a way of dealing with an almost universal but deeply unhelpful psychological quirk. Imagine a bet; we toss a coin. Heads, I give you £150. Tails, you give me £100. Statistically this is a great bet, but experimenters have found that very few people will take it. That’s  because we don’t calculate outcomes mathematically, we weigh them psychologically. The psychological pain of losing £100 outweighs the pleasure of winning £150, so we decline. Innovation is like this – it’s a series of bets, many of which won’t work out. You could increase the incentives for successful innovation, but you would probably do better to reduce the psychological cost of failure. Try as many things as possible, and lower the stakes on each one. Make it clear that you accept that many new initiatives will fail. Reward good tries rather than successes. Consider, as some organisations do, offering a regular prize for “best new idea that didn’t work.”

Lack of resources and time, dis-incentive schemes, human-standard risk aversion; these are the obstacles. The question isn’t ” how do we innovate more?”  It’s “what’s stopping us?”  Or, if you are the leader, “what am I doing that’s stopping them?”

Nassim Taleb makes this point: a man is driving over a bridge when it collapses. The story in the newspapers is about the man. The real story, however, is about the bridge; what was the structural problem that caused it to collapse?

I would add that there may be another story, bigger still. The bridge was built with a new form of cement that was invented 20 years ago. Several bridges built with this cement have collapsed in the past year. There are thousands of them out there….

There are three levels:

1. What happened?
2. Why did it happen?
3. What does it all mean – is it part of a pattern?

Twitter covers level 1

Newspapers deal well with level 1 and at best touch on level 2

Magazines and books and some blogs make a decent job of level 3.

Take a moment to reflect on your consumption of information, whether about the world at large, or your business. I’d bet that if there is a surplus,  it’s at level 1. If there’s a deficit, it’s at level 3. Which are the underlying trends and patterns that nobody’s telling you about?

When we think about risk, we tend to think about risk and reward. That’s only part of the picture, though. Consider this classification, and you’ll probably find that you are avoiding good risks and not even realising that you are taking some bad ones.

Type 1: The Horseburger

This is the sort of risk which, when you are lucky, produces a small benefit. It also produces a small benefit if you are mildly unlucky. When you are seriously unlucky, though,  it produces a catastrophic loss.  It’s called the horseburger after the recent horsemeat in beefburger scandals.  The supermarkets were gradually pulling down the price of meat products, until somebody decided they could only meet the price by introducing tainted meat. For a while, nobody noticed. Then someone did, and the castastrophe happened. This type of risk could also be called the BP Texas City Refinery. It’s managers were tasked with reducing costs by 25%. They did this by cutting back on maintenance, repairs and replacement of worn-out plant. It worked for several years, until there was an explosion which killed 15 and injured 170.

The danger of the horseburger risk is that we see the regular small benefit but are blind to the catastrophic risk lurking out of sight, waiting to happen. We don’t actually feel as if we are taking a risk at all.

Type 2 – Convex

The point about the convex risk is that the gain when you are lucky is greater than the loss when you are unlucky. An example would be for me to toss a coin. If it comes down heads, I give you £150. Tails, you give me £100. This is a good bet, but researchers have found that very few people will take it. The reason is that we don’t calculate outcomes based on probability, we weigh them based on psychology. The psychological pain of losing £100 weighs more than the pleasure of winning £150.

There’s a real cost to this psychological bias. Imagine that every day you are offered this bet, and every day you decline. But imagine yourself ten years hence – by saying no each day you have said no to an amount of around £90,000.

Type 3 – 50 Shades of Grey

This one takes its name from the self-published book sensation of the same name. It could equally well be called the Harry Potter, Lady Gaga or the Rolling Stones. If you are unlucky, you have a small cost – you don’t sell anything. If you are moderately lucky, you still don’t sell anything. If you are hugely lucky, you sell in the millions and become fabulously rich.

This is a great risk to take, provided that you aren’t depending on it to pay the bills. Only very, very few attempts succeed, and nobody has found the formula that guarantees success.

Type 4 – Sausage Machine

This one works like a sausage machine, because it’s very predictable. You put the meat in the top, turn the handle and sausages come out. Twice as much meat, twice as many turns produce twice as many sausages. Three times the meat, three times the turns, three times the number of sausages.

This is a good sort of risk to take provided it produces enough. You know that if you put in the hours you will get the result. For a dentist, the result is a good income. For someone on the minimum wage, the result is a meagre existence on the edges of society.

Putting It All Together

Here is a  plan for putting this classification to work:

1. Overcome the psychological bias against convex risks and take more of them. Do this by taking a broad view – not of each individual risk,  but of all the risks you take over a week, month or even year;
2. Eliminate the horseburger risks you probably don’t even know you are taking. Any time you do something to reduce costs or raise efficiency, ask yourself where (not whether, where) this increases the catastrophic risk and make sure that that risk is properly managed;
3. Build a sausage machine that produces a base income without taking up all your time and capital;
4. Use the time remaining to experiment with potential “50 Shades of Grey”s. Do this only if you find it fun, and don’t kid yourself that the odds of success are better than 1,000,000:1.

One day, the Devil was bored and decided to ascend to Earth for some fun, setting himself up as Professor Woland the investment guru. His disciples had huge success – they were almost invariably the most successful of all managers following whichever index they chose. Occasionally they blew up, but those unfortunates were soon forgotten.

It was only after several years that his secret came out. Once a year he would invite his disciples to a game of russian roulette. He played fair with a ten-chamber revolver so nine  times out of ten they survived, and were rewarded with superb performance. One time out of ten.. complete blowup, personally as well as professionally.

The point of the parable is that it isn’t hard to boost performance by taking on risks which are rare, but devastating when they do occur. Woland’s disciples had a 73% chance of a three year run of superb performance, and a 59% chance of five years, before the odds finally got them. It’s why one wiser than usual observer commented of a particular star hedge fund operator “if you gave me a list of top performing funds I’d expect him to to be on it. If you gave me a list of funds most likely to blow up I’d expect him to be on that, too. “  There is also the perverse consequence that at any given time the most successful performer is likely to be the worst – the one with the greatest amount of hidden “hope-it-won’t-hit-me-this-year” risk.

This isn’t just a parable for the investment markets, either. The same manoeuvre is depressingly common elsewhere. It’s the real story of many cost-cutting programmes. We cut costs and see a benefit immediately. We don’t usually account for the increased risk that our cuts create. The most egregious example is the BP Texas City refinery in 2005. Years of cost reduction through reduced maintenance and repairs resulted in a literal, not a metaphorical blowup – an explosion which killed 15 and injured more than 170.

Ultimately it’s just an application of the “no free lunch” principle. When next you do something to boost returns, stop and think what additional risks you are taking on.

(This was written as a column for Management Today several months before the great horse-burger scandal, but you can see that the same mechanism is being used).

Accounting shenanigans are beside the point. Multi-billion dollar  writeoffs are irrelevant. Whatever the truth of HP’s allegations about manipulation and misrepresentations in the Autonomy deal, they were right to do it. This may seem an outrageous assertion, but stay with me. By the end of this piece I may or may not have persuaded you, but we will have shed light on two very important principles of business which are often overlooked.

Principle Number 1: there are three reasons for doing things, and getting a return on investment is the weakest of the three.

Let me explain with an example. Years ago, I worked in an internal consultancy unit at Pearson who owned Alton Towers, the UK’s leading theme park. Alton Towers submitted a large capital expenditure request for a new rollercoaster ride. Pearson’s Group FD threw the proposal at us and asked us to say what we thought he should do. As we worked through it, a difference of approach emerged. Some of us thought that there should be a return on investment calculation, but others held that that was beside the point. This investment was a cost of staying in business. If you want to maintain your position as the country’s leading theme park, then at least every other year you need to offer the public something new; bigger, faster scarier than they have ever seen before. You can debate whether you could get the same impact for less money but the real question is not “should we do this?” but “how do we afford it?”

Apply this logic to HP. They are a hardware business, and the hardware business doesn’t seem to offer much of a future. If they want to stay in business they have to transform into something very different. A software and services company is the most likely candidate, and there aren’t that many sufficiently large acquisitions available. In this case the status quo is not an option, so what else do you do?

But, you will argue, it’s a pretty long shot. They are not IBM. Quite true, but that brings us to the second principle:

Principle Number 2: If you did the right thing then, you have done the right thing now.

This might seem hard to grasp, but poker players and traders completely understand it. You calculate the odds, assess the options to find the one with the best expected value, and place your bet. Sometimes you still lose; that doesn’t mean that you made a mistake, only that you can’t eliminate the element of luck. Sociologists who study risk perception also get this idea; they call it the “s**t happens” principle. HP’s bet on Autonomy may have a low prospect of success, but it does at least offer a hope of transformation and is probably better than anything else available.

If I have a criticism of HP management, it’s not that they did the wrong deal, or did it at the wrong price. It’s the lame way in which they have defended it. Rather than making feeble (and patently implausible) statements like “we relied on audited accounts, what else can you do?” they should be asking shareholders something like “Given that we’re on the fast track to oblivion at present, we have to do something. What else do you suggest?” Then they should forget the blame game, call off the lawyers and start concentrating on managing their new operation. HP is a transformation story or it’s nothing. The odds are against it, but the game isn’t over yet.

Kate Swann transformed the fortunes of retailer WH Smith over ten years. She turned losses of £135m into profits of £106m. Gross margins rose by an incredible 15%. The share price rose from £2.50 to £6.50. She did this by losing (emphasize by losing, not despite losing) 35% of turnover. She didn’t fundamentally change the experience of shopping at WH Smith. It was, and remains, an uninspiring place to shop (I’m being polite here).

Ms Swann is now, justifiably, one of the UK’s most highly regarded retailers. What she did was utterly simple, but at the same time utterly confusing. The confusion is apparent in this Guardian piece about her. The headilne says she achieved success by “going against the grain.” Then the caption to the photo says she “favours the old retail adage that….” In a way, both of these are true. The method she used is as old as the hills and pretty much guaranteed to produce dramatic improvements with low risk. Yet actually applying it goes against the grain for most businesses.

So what did she do that is so powerful, and so confusing? It is almost embarrassingly simple. She looked at the numbers and observed two things:

1. CDs and DVDs offered very poor margins, while books and stationery offered good margins;
2. High street locations made less money than railway station and airport locations.

The plan of action was thus clear. Stop selling CDs and DVDs and use the space for higher-margin products. Actively seek out new railway station and airport locations. It really was as simple as that.

But, you ask; if it’s as simple as that, why don’t more people do it? Most organizations would benefit from understanding where they make their money, but very few take the time to find out.

There are three reasons:

1. Not understanding how to do it. The work naturally falls under the remit of the finance department, and everyone assumes that they know how. The fact is that most finance people don’t know how to do this sort of work. They have the basic number-crunching skills, but something is missing. It’s like musical ability; if you are a good guitar player you know 75% of what you need to know to play the violin, and could learn the violin much more quickly than someone who had never played anything, but there are still things you need to learn. When it comes to profitability analysis, there are also things you need to unlearn. The main things to be unlearned are concern for accuracy, consistency and comprehensiveness (now you see why it can be hard).

2. Violating rules of thumb. Much of the time we operate according to rules of thumb. These rules guide us well, except when they don’t. Ms Swann’s old adage was  “sales are vanity, profits are sanity.” It’s an excellent principle, as she demonstrated. The trouble is that it conflicts with an even more basic principle. This one is never explicitly stated, which makes it even more powerful. It’s “sales are hard-won, you mustn’t walk away from them. ” When these two principles conflict, most of the time the second, more primitive one wins.

3. The old familiarity=security principle. Worked great in the stone age, not such a great principle now. There’s an ancient part of our brain which doesn’t care whether a new state looks better or worse than the current one. If it’s new, it’s threatening. Emotionally, we are pulled towards the status quo.

Once you understand the obstacles, you can see why it is so hard to do the obvious, simple thing. If you would like to find out more about how to do this,  listen to the free telephone seminar next week. You can register here.

Recent appearances before the Commons Select Committee were striking, above all else, for the exceptionally high ratio of heat to light generated. Beyond the rhetoric, however, there is a very important lesson about modern retailing, and quite possible about other businesses as well.

There is little value in running physical operations like shops or warehouses. Value is in brands and systems.

To explain what this means, consider one of the questions asked to Starbucks: “How can you be telling HMRC that you are making no money in the UK, while telling your shareholders that you are doing well there?” In fact, there is no contradiction.

Imagine that Starbucks had no presence here, and that you were a large organisation with expertise in running coffee shops. You approach Starbucks and offer to run their UK operations. They say, “Fine. You run the shops, according to our model. You pay us a royalty for the brand and our systems, and buy all the coffee from us. ” This is a nice deal for Starbucks as they are making a royalty of 4-6% on everything you sell, plus a normal profit on the sale of coffee beans. It’s not a good deal for you, though. Once you have paid the royalty and bought the beans, you will struggle to make money. Starbucks’s profits accrue in the Netherlands and Switzerland.

The same applies to Amazon if you substitute “running a warehouse” for “running coffee shops.” Warehousing is the only thing Amazon does in the UK, and it is not profitable. Profit comes from the brand and the very clever systems. These were created outside the UK, operate outside the UK and don’t get taxed in the UK.

The apparent paradox arises because these businesses are global and tax systems still national. That’s not a problem that can be solved in a hurry, but understanding why that is tells us something very important about the developing economics of business.