Seeing Your Company as a System

Much-needed guidance on making companies more employee-centered, adaptive, and capable.

strategy+business magazine

by Andrea Gabor

Photograph by Hideki Kuwajima

… No matter how disparate the causes of failure, there is always a common thread: somewhere, somehow, management has let its attention slip. …[Now] is an opportune time to reflect on the leading ideas that have shaped what we know about the management of social systems, particularly corporations, and how to stabilize and improve them.

The recognition that a company is a complex social system and a living community has been an underlying theme of leading management thinkers as far back as the early 20th century. Nevertheless, the machine continues to be the dominant metaphor for business leaders, …

The speed and complexity of the global business environment calls for a new appreciation of a systems-focused view of the world, one that recognizes the interrelationships of people, processes, and decisions — and designs organizational actions accordingly. The intellectual roots of systems understanding … converge around three interrelated assumptions. First, … static solutions that try to lock in any ongoing management solution are likely to become new sources of destabilization themselves. … Second, organizations must have a capacity for widespread experimentation and trial-and-error learning if they are to be self-correcting. Finally, although a systems view requires an understanding of how all the parts fit together as a whole, it also depends on an intimate understanding of the parts themselves. This is because change in any part of the system or in its outside environment — including the other systems to which it is connected — can produce profound ripple effects.

Significantly, these assumptions all recognize the importance of human participation in decision making. … Everyone who works within a system — including suppliers and line workers, designers, and marketers — should learn how the system works, develop their creativity, and apply that creativity to improve the system. …

… The most valuable expertise is understood to be held by those who are closest to any given part of the system. Management’s chief jobs are, first, to facilitate learning, adaptation, and improvement by creating a culture that is free of fear, and, second, to provide the tools and training that employees need to identify problems and opportunities for improvement. And the leaders throughout these companies also practice “mindfulness.” They establish and revise routines that constantly test current assumptions and seek to anticipate future needs, they pay attention to process, and they see continuous improvement as the best way to achieve not only step change but also innovative leaps.

Whole-systems Design

Any effort to cultivate a systems orientation could profitably begin with the work of the late Russell Ackoff, …

Ackoff drew a clear distinction between the machine age, in which companies could assume relative stability and seek optimum solutions to discrete problems, and the systems age, beginning after World War II, a time of growing … complexity. Organizations would henceforth have to deal with “sets of interacting problems” and give up the quixotic search for simple solutions that could be applied consistently. The key challenge, Ackoff said, would be designing systems that would learn and adapt. … [He] said, “Experience is not the best teacher; it is not even a good teacher. It is too slow, too imprecise, and too ambiguous.” Organizations would have to learn and adapt through experimentation, which he said “is faster, more precise, and less ambiguous. We have to design systems which are managed experimentally, as opposed to experientially.” To accomplish this, he laid out a method of interactive planning, … that reflected how key stakeholders would redesign and rebuild a system if it were suddenly destroyed.

[Re-creating the Corporation: A Design of Organizations for the 21st Century] is full of both conceptual tools for organizational redesign and specific practices for developing adaptive and resilient learning environments. … Ackoff describes the use of elected internal boards to give people more control over their decision making, and shows how to set up an internal market for shared services that reflects their real value (or, as he calls it, an “internal market economy”). The overriding theme is the need to avoid any particular management panacea, and instead institute an adaptive, continually evolving design process that (as Ackoff puts it) manipulates the parts of a company “with a primary focus on the performance of the whole.”

Better Thinking and Interacting

Ackoff’s focus on learning is picked up by Peter Senge, … the author of The Fifth Discipline: The Art and Practice of the Learning Organization, which focuses on the need for blending the “behavioral” and “technical” elements of organizations. One underlying premise of the book is that a systems orientation requires individual employees to be open to new ideas and points of view and free of conscious and subconscious prejudices.

“Organizations work the way they do because of how we work, how we think and interact,” writes Senge, … The “best systemic insights don’t get translated into action when people don’t trust one another and cannot build genuinely shared aspirations and mental models.”

Senge identified five disciplines — … as necessary for organizational learning.

1. Systems thinking, which in this case means learning to recognize the forces of acceleration and equilibrium at work in complex systems, how they interact over time, and how to use them to gain leverage.

2. Personal mastery, … tapping immense creative potential by aligning the personal aspirations of individuals with the goals of the organization and a clear view of current reality.

3. Mental models, which are the prevailing attitudes, beliefs, and cognitive habits held within a group that shape its perceptions of the world and how it takes action.

4. Shared vision, which is the collective voiced aspiration that supports the collective pursuit of worthwhile goals.

5. Team learning, which embodies open dialogue with no preconceptions, and other forms of candid, in-depth group activity.

… Senge’s disciplines are fundamentally personal, and require a shift in perspective among individual members of an organization, as well as a collective transformation. …[The] first chapter of The Fifth Discipline offers an excellent overview of the disciplines and how they fit together. Senge’s subsequent book, the collaboratively written The Fifth Discipline Fieldbook: Strategies and Tools for Building a Learning Organization (Doubleday/Currency, 1994), offers a step-by-step guide to tackling the five disciplines. (Disclosure: Art Kleiner, the editor-in-chief of strategy+business, was a Fieldbook coauthor and its editorial director.)

Everyone’s a Knowledge Worker

Widespread employee participation is essential for creating and maintaining learning and adaptive capabilities, but that goal has long been elusive for many companies. …

…“[Knowledge] workers,” whom Peter Drucker first described in 1959 and broadly defined in Management Challenges for the 21st Century (Harper Business, 1999) as people who “know more about their job than anybody else in the organization,” that a widespread recognition of the role of ordinary employees in improving systems began to take hold. …

A narrow definition of knowledge workers, … is articulated by Thomas Davenport. Davenport … wrote, in “Why Don’t We Know More about Knowledge?” a 2004 article in the MIT Sloan Management Review (coauthored with Michael Hammer and Dorothy Leonard), that although “every job requires some knowledge, most would agree that knowledge workers are people with high levels of education and expertise whose primary task is the creation, distribution or application of knowledge.” In contrast, a systems view demands the broadest possible definition of knowledge workers because, at the most elemental level, any employee who connects to a process must have the knowledge to recognize when something is wrong and to sound an alarm.

Employee participation plays an integral role in companies seeking a systems orientation. … [It] lies at the core of one type of company that Karl Weick and Kathleen Sutcliffe, … have studied in depth: high reliability organizations (HROs). These are nuclear power plants, aircraft carriers, and other enterprises that must foster constant mindfulness as a way to avert catastrophic system failures.

In Managing the Unexpected: Resilient Performance in an Age of Uncertainty, … Weick and Sutcliffe describe a culture in which employees engage in the continuous updating and deepening of their understanding of the context of organizational systems, the problems that define them, and what remedies they contain. Mindful organizations, … are characterized by a broadly defined “deference to expertise,” in a setting where “expertise is not necessarily matched with hierarchical position.” … HROs are also capable of seeing weak signals of systemic failure and responding with vigor. To support this capability, such organizations strive for open communication, recognizing that if people refuse to speak up out of fear, this capability will be undermined.

Managing the Unexpected is replete with examples of the importance of mindfulness and imagination at all levels of the hierarchy. … They note the precision and on-the-ground decision making that are necessary to prevent accidents on aircraft carriers operating on the high seas, explaining that because of the sensitivity of operations, junior officers are expected to disregard a captain’s orders when following those orders could jeopardize the crew’s safety. “Rigid hierarchies have their own special vulnerability to error,” write Weick and Sutcliffe. “Errors at higher levels tend to pick up and combine with errors at lower levels, thereby making the resulting problem bigger, harder to comprehend and more prone to escalation.”

Training and Tools

Systems thinkers embrace Louis Pasteur’s dictum that “fortune favors the prepared mind.” …

…Toyota Motor Corporation’s … kaizen philosophy, long associated with the Toyota production system, remains one of the most critically important facets of a systems approach to management. Over a period of decades, it enabled Toyota to achieve its current position as the automaker with the most to lose, in terms of both market share and reputation.

Learning is such an integral part of kaizen — the continuous improvement of every process, every day, at every level of a company —that for many practitioners, training is considered the most important responsibility for any manager. For years, Toyota’s competitive advantage rested on the institutionalization of two interlinked routines, or kata: continuous improvement and coaching. The coaching kata, explains Mike Rother, … author of Toyota Kata: Managing People for Improvement, Adaptiveness, and Superior Results, “is the repeating routine by which Toyota leaders and managers teach the improvement kata to everyone in the organization.”

Rother offers a detailed look at the intertwined layers of routines, processes, and training that define the kaizen approach. …

Achieving kaizen depends on the knowledge and skill of every employee. Thus, writes Rother, “the primary task of...managers and leaders does not revolve around improvement per se, but around increasing the improvement capability of people.”

For decades, Toyota employees, … were engaged in a constant cycle of finding and solving problems, developing and testing new ideas, implementing and codifying new solutions and routines, then starting all over again. … Every Toyota employee was engaged in a constant quest for what Matthew E. May dubbed “the elegant solution” in his book of the same name (The Elegant Solution: Toyota’s Formula for Mastering Innovation [Free Press, 2007]). May defines this solution as “one in which the optimal or desired effect is achieved with the least amount of effort.”

… To explain how managers can apply them more effectively, John Shook, … has written Managing to Learn: Using the A3 Management Process to Solve Problems, Gain Agreement, Mentor, and Lead. This slim, illustrated guidebook offers a worm’s-eye view of A3 diagrams. (An A3 diagram is a single-page document, roughly 11 by 17 inches, that aims to capture a snapshot of an individual process problem and its recommended solution.) “Every issue an organization faces can and should be captured on a single sheet of paper,” writes Shook. “This enables everyone touching the issue to see through the same lens.”

Shook explains the centrality of employee development by following the story of a single employee and his supervisor — with the perspective of each following two parallel columns on every page — as they map out the solution to a single problem, translating production documents from Japanese to English to support the expansion of Acme Manufacturing, … By focusing in minute detail on the mapping of a single problem, he shows how a seemingly mundane process can be fraught with errors, delays, and cost overruns that have system-wide implications, and how a deep understanding of the problem and its causes eventually leads to resolution. He also shows how patient coaching by the supervisor not only helps resolve the problem, but teaches his charge to be a better analyst.

The Deming Connection

The kaizen philosophy, Toyota production system, and similar methods are all closely linked to the work of W. Edwards Deming, the statistician who came to be known as a leading management guru and paved the way for the ascendancy of quality as a management priority. … Deming’s key insight — a deceptively simple yet profound statistical observation about how processes work — offers one of the most practical and important insights into the role that employees play in improving processes and developing a systems approach to organizations.

Deming, … argued that the predictability and quality of all processes are subject to two distinct causes of variation: special causes, which are generally due to a glitch in the system that can be fairly easily fixed, …; and common causes, which are more complex and difficult to isolate because they are systemic. …Treating a systemic problem as though it is a one-time glitch not only makes it less likely that the root cause will be found and fixed, but can cause even bigger problems going forward.

Deming recognized that when it comes to the myriad processes that make up a large system, ordinary employees — including line and maintenance workers, salespeople, and technicians — know the system best. They possess the crucial knowledge that is needed to distinguish between mere glitches and systemic failures and to ensure the predictability of any given process. He argued that a predictable, stable system offers unexpectedly valuable opportunities for improvement and innovation. Companies that rely on outside “experts” to monitor their processes, in lieu of employees with day-to-day experience, lose these opportunities for gain.

In his book Out of the Crisis (MIT Press, 1986), Deming codified his management philosophy in 14 points, which emphasized the importance of a change-friendly culture and participative management, including a work environment free of fear in which employees get the training needed to analyze and improve the system.

Deming’s writing tends to be dense and difficult to read, …The most accessible source for Deming in his own words is his last book, The New Economics for Industry, Government, Education. The first chapter touches on the role of management and the customer, as well as the connection between continuous improvement and innovation. The third and fourth chapters illuminate Deming’s view of systems and the context for thinking about systems within a human organization. “If Japan Can...Why Can’t We?” the 1980 NBC television documentary produced by Clare Crawford-Mason, which is credited with rediscovering Deming’s work and helping to launch the quality revolution in the United States, is a very accessible video introduction to Deming’s ideas — and surprisingly relevant to today’s businesses.

Quantitative Distractions

Any discussion of systemic visions or ideals confronts one final — and profound — hurdle: what H. Thomas Johnson, …refers to as the “quantitative abstractions” that control most companies. “When businesses regard economic activity as if it involves only the manipulation of abstract quantitative variables,” writes Johnson, “they miss what is really happening to the people, the communities, and the natural world that surround them.”

In his books Profit beyond Measure: Extraordinary Results through Attention to Work and People (co-authored with Anders Bröms) and Relevance Regained: From Top-down Control to Bottom-up Empowerment, Johnson outlines how perverse financial incentives and the use of top-down accounting information to control operations ushered in a “dark age of American business history” between the 1950s and 1980s. …

Johnson found that financial systems aimed at achieving short-term, bottom-line results treat the organization mechanistically, as “a collection of independent parts.” … He argues that ignoring the systemic impact of financial decision making is unsustainable in the long run and will yield progressively worse results. Yet, as Johnson wrote in the March 2009 issue of The Systems Thinker, …“the thinking and behavior of almost all business managers in today’s world reflects a world view grounded in the whole-equals-sum-of-the-parts and win-lose competitive principles of 19th-century mechanics, not the systemic, cooperative, win-win symbiotic principles of 21st-century cosmology and life sciences.”

… He argues that Toyota’s performance, unrivaled for close to 50 years — up until about 2000 — could be attributed in part to accounting and financial practices that were consistent with the company’s systemic approach to management. But that changed, wrote Johnson in the February 2010 issue of The Systems Thinker, when Toyota’s top managers “turned away from the thinking that had implicitly anchored its operations to the concrete reality of natural systems in the real world.”

There’s no question that Johnson’s perspective on many issues is controversial. … But his work shows how financial practices can be profitably redesigned with an eye toward participation, increased day-by-day awareness, and shared information, rather than mechanistic control.

All the works mentioned in this guide have been linked to higher performance. Yet their focus on the expertise of ordinary employees remains a hard sell in many companies, because it requires an enormous long-term commitment to training and to local control and knowledge sharing.

Moreover, employee-centered systems organizations need to develop trust — between supervisors and employees and among employees who have to work together to understand and improve the system. Making this work takes skillful management. Indeed, many quality improvement efforts in the U.S. failed because they absorbed rigid process guidelines but failed to build in flexibility.

But it can be done; by now, thousands of managers in dozens of companies have accomplished it. These resources provide a path for others to follow.

Reprint No. 10210

Author Profile:

• Andrea Gabor is the author of several books, including The Capitalist Philosophers: The Geniuses of Modern Business — Their Lives, Times, and Ideas (Three Rivers Press, 2002). She is the Bloomberg Professor of Business Journalism at Baruch College at the City University of New York.

It Makes Sense to Adjust

Business transformation is now a continuous process that most companies haven’t mastered. Here’s a formula for managing ongoing change.

strategy+business magazine

by Vinay Couto, Frank Ribeiro, and Andrew Tipping

It used to be that a business transformation was a once-in-a-lifetime event, … But if the recent economic upheaval reveals anything, it is that companies of all sizes, in all industries, are operating in a more volatile, less predictable environment, and that change has become a way of life. …

… A review of businesses faced with “burning platforms” (which are enterprise-threatening events) would reveal that most have failed to make the transformation the situations demanded. …

The problem is that most companies don’t have an adequately proactive road map for transformation. Instead, they attempt change on the fly, reacting to business disruption with equally explosive responses that may not be useful six months down the road or even sooner. …[If] an organization prepares for transformation (perhaps when it is not occurring), steering through it is far less difficult.

Each company’s strategy for approaching transformation falls into one of three categories. These categories in turn determine the level of transformation — the timing and the magnitude — that the company can support.

1. Reactive. This is the default transformation strategy; it is minimal, and has become second nature to most seasoned executives. A change in circumstances provokes a short-term response, generally an abrupt shift that requires little cross-company coordination or follow-up. … Problems arise when executives try to apply this approach to situations that call for more sweeping and highly detailed transformation. …

2. Programmatic. This strategy is more comprehensive and is appropriate when major change is required and a company has sufficient lead time. In such circumstances, the company launches a widespread change initiative across the lines of business that are most affected. A cross-functional program office is set up, tactics are identified, milestones are established, executives are assigned to oversight, a communications program is launched, and progress is tracked.

These programs can be effective in dealing with a contained event or threat, such as a new competitor or a new product from a rival, and their potential reward is greater than that of the reactive approach because they are more forward-looking. But as the name of this category implies, the transformation is a program — a systematic, planned sequence of activities designed to achieve specific goals within a specific period of time — and, thus, the outcome takes longer than a reactive transformation.

3. Sense-and-adjust. This is the most long-term and sustainable strategy, … Unlike the first two approaches, sense-and-adjust is dynamic, constantly and consistently smoothing out volatility in areas of business subject to swift and dramatic change, such as research and development or frontline operations like manufacturing and logistics.

Sensing is an ongoing effort to gather and analyze data on current and future business conditions and, more important, translate it into likely outcomes. The sensing process should …synthesize [planning information] with key performance data to form a single “dashboard” of actionable information that can be used by business unit heads or corporate leaders in functions like IT, HR, or marketing.

A high-quality sensing dashboard offers an early organizational indicator of future business conditions. … For example, a business unit head may use a dashboard to reveal unanticipated decreases in either product unit price or volume that could translate to an overall decline in revenue. Or a logistics firm may place its sensing system on alert for changes in pricing and functionality of handheld computers, wireless communications, mapping software, and the like; the goal would be to determine how and when to start applying these technologies to its own business (and to avoid being blindsided by a competitor).

Adjusting is the process of altering business strategies on the basis of sensed outcomes. In this phase, which is done in tandem with sensing, business unit or department heads assess the data to determine possible resource and capability trade-offs. They explore the impact on people, processes, and technology, and then develop a consensus on the plan that is most appropriate for building or maintaining competitive position. In the case of an unexplained drop in unit prices, the adjustment may be an emphasis on marketing, innovation, or layoffs. And if a company has learned that it could outpace its rivals by implementing a GPS system, a slate of new training programs that teach employees how to use the technology may be just as important as purchasing the equipment itself.

As adjustments are made, the sensing capability picks up and continues the cycle, both scanning the horizon for market shifts and monitoring the execution of these strategic responses. Sensing does little good in the absence of adjusting, and vice versa.

The sense-and-adjust approach to change is not the traditional stutter-step strategic planning process in which business units are summoned every six or 12 months to present their take on the market and their performance expectations. The sense-and-adjust process is continuous, incorporating new information and forecasting outcomes and expectations constantly. Companies that have mastered the skills to handle the programmatic approach and have an organization that is reasonably resilient — … are the best candidates for this sustainable strategy….

For some companies, particularly those without the mature planning processes and deep leadership bench necessary to implement a full-fledged sense-and-adjust strategy, a programmatic transformation can offer a clear path toward that goal. …

If nothing else, all companies must recognize that the pace and magnitude of change is far faster and greater now than ever before and that transforming their business is no longer something they can avoid, defer, or out-manage. Even small moves to increase an organization’s sense-and-adjust skills will reap significant and sustainable rewards.

Author Profiles:

• Vinay Couto is a partner with Booz & Company in Chicago. He focuses on global organization restructuring and turnaround programs in the automotive, industrials, and consumer packaged goods industries.
• Frank Ribeiro is a partner with Booz & Company in New York. He focuses on overall corporate transformation and associated capability-building programs to increase an organization’s effectiveness and efficiency.
• Andrew Tipping is a partner with Booz & Company in Chicago. He focuses on large-scale organizational transformation to increase the effectiveness and efficiency with which companies meet customer needs.
• Also contributing to this article were Booz & Company Senior Associate Matthew Siegel and Principal Curt Mueller.

Cleaning the Crystal Ball

How intelligent forecasting can lead to better decision making.

strategy+business magazine

by Tim Laseter, Casey Lichtendahl, and Yael Grushka-Cockayne

Illustration by Lars Leetaru

Peter Drucker once commented that “trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window.” Though we agree with Drucker that forecasting is hard, managers are constantly asked to predict the future … Good forecasts hold the key to good plans. Simply complaining about the difficulty does not help.

Nonetheless, few forecasters receive any formal training, or even expert apprenticeship. … This lack of attention to the quality of forecasting is a shame, because an effective vehicle for looking ahead can make all the difference in the success of a long-term investment or strategic decision.

Competence in forecasting does not mean being able to predict the future with certainty. It means accepting the role that uncertainty plays in the world, engaging in a continuous improvement process of building your firm’s forecasting capability, and paving the way for corporate success. …

… By using the language of probability, a well-designed forecast helps managers understand future uncertainty so they can make better plans that inform ongoing decision making. We will explore the many approaches that forecasters can take to make their recommendations robust, even as they embrace the uncertainty of the real world.

The Flaw of Averages

In forecasting the future, most companies focus on single-point estimates: … [We] often forget that a point forecast is almost certainly wrong; an exact realization of a specific number is nearly impossible.

This problem is described at length by Sam Savage, an academic and consultant based at Stanford University, in The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty (Wiley, 2009). He notes how focusing on an average without understanding the impact of the range can lead to flawed estimates. Better decisions result from taking the time to anticipate the likelihood of overshooting or undershooting the point, and then considering what to do today, given the range of possibilities in the future.

Savage highlights the simple example of a manager estimating the demand for 100,000 units of a product — based on a range of possible market conditions — and then extrapolating that average to produce a profit estimate. … As a result, the profits at an average demand level will be much different from an average of the profits across the range of possibilities. Rather than a simple average, a better forecast would present a wide range of scenarios coupled with a set of potential actions to influence the demand and profitability. …

Reflecting risk in forecasts is a simple concept and one that may seem easy to put into practice, but managers commonly ignore the uncertainties and simply collapse their forecasts into averages instead. … Consider a project with 10 parallel tasks. Each task should take between three and nine months, with an average completion time of six months for all of them. If the 10 tasks are independent and the durations are distributed according to a triangular distribution, chances are less than one in 1,000 that the project will be completed in six months, and the duration will be close to eight months. But using the six-month figure instead offers an almost irresistible temptation; after all, that’s the average input. …

In short, forecasting should not be treated as a game of chance, in which we win by getting closest to the eventual outcome. … Instead, it’s better to use the range of possible outcomes as a learning tool: a way to explore scenarios and to prepare for an inherently uncertain future.

Drivers of Uncertainty

The most useful forecasts do not merely document the range of uncertainties; they explain why the future may turn in different directions. … Just asking “Why might this happen?” and “What would happen as a result?” helps to uncover possible outcomes that were previously unknown. Recasting the driving forces as metrics, in turn, leads to better forecasts.

For example, the general business cycle is a driving force that determines much of the demand in the appliance industry. Key economic metrics, such as housing starts, affect the sales of new units, but a consumer’s decision to replace or repair a broken dishwasher also depends on other factors related to the business cycle, such as levels of unemployment and consumer confidence. With metrics estimating these factors in hand, companies in that industry … use sophisticated macroeconomic models to predict overall industry sales and, ultimately, their share of the sales.

… Whirlpool’s planners use their industry forecast models to focus executive attention, not replace it. The planners present the model for the upcoming year or quarter, describing the logic that has led them to choose these particular levels of demand and the reason the outcomes are meaningful. Executives can set plans that disagree with the forecasters’ predictions, but everyone has to agree on which input variables reflect an overly optimistic or pessimistic future. Even more important, managers can begin influencing some of the driving forces: For example, they can work with retail partners to encourage remodeling-driven demand to offset a drop in housing starts.

Black Boxes and Intuition

As the Whirlpool example demonstrates, mathematical models can help focus discussions and serve as a foundation for effective decision making. Thanks to the increasing power of personal computers and the Internet, we have a host of advanced mathematical tools and readily available data at our disposal for developing sophisticated models.

Unfortunately, such models can quickly prove to be a “black box,” whose core relationships and key assumptions cannot be understood by even a sophisticated user. … Without a clear understanding of the drivers of the model, executives will not be attuned to the changes in the environment that influence the actual results. …

A lack of understanding of the black boxes tempts many managers to dismiss the planners’ models and simply “go with the gut” in predicting possible challenges and opportunities. … Back in the early 1970s, Nobel laureate Daniel Kahneman and his longtime collaborator Amos Tversky began a research stream employing cognitive psychology techniques to examine individual decision making under uncertainty. Their work helped popularize the field of behavioral economics and finance. (See “Daniel Kahneman: The Thought Leader Interview,” by Michael Schrage, s+b, Winter 2003.) Work in this field has demonstrated that real-life decision makers don’t behave like the purely rational person assumed in classic decision theory and in most mathematical models.

…[Our] brains seek out patterns. … Though critical in evolutionary survival, this skill can also lead us to see patterns where they do not exist. For example, when asked to create a random sequence of heads and tails as if they were flipping a fair coin 100 times, students inevitably produce a pattern that is easily discernible. The counterintuitive reality is that a random sequence of 100 coin flips has a 97 percent chance of including one or more runs of at least five heads or five tails in a row. Virtually no one assumes that will happen in an invented “random” sequence. …

Our tendency to see patterns even in random data contributes to a key problem in forecasting: overconfidence. Intuition leads people to consistently put too much confidence in their ability to predict the future. As professors, we … challenge [our MBA students] to predict, with a 90 percent confidence level, a range of values for a set of key indicators such as the S&P 500, the box office revenues for a new movie, or the local temperature on a certain day. If the exercise is done correctly, only one out of 10 outcomes will fall outside the predicted range. Inevitably, however, the forecasts fail to capture the actual outcome much more frequently than most of the students expect. Fortunately, the bias toward overconfidence diminishes over time as students learn to control their self-assurance.

History Matters

Although Peter Drucker fretted about looking out the rear window of the car, in reality too many forecasters fail to examine history adequately. Consider the subprime mortgage crisis. In 1998, AIG began selling credit default swaps to insure counterparties against the risk of losing principal and interest on residential mortgage-backed securities. …

At the end of the fourth quarter of 1998, the delinquency rate for U.S. subprime adjustable-rate mortgages stood at just over 13 percent. By the end of the fourth quarter of 2008, this rate had almost doubled, to an astonishing 24 percent. … Although a 24 percent default rate seemed unprecedented to most bankers, a look back beyond their own lifetimes would have indicated the possibility. In 1934, at the height of the Great Depression, approximately 50 percent of all urban house mortgages were in default.

That is why looking back at past forecasts and their realizations can prove so valuable; it can help prevent overconfidence and suggest places where unexpected factors may emerge. Recently, researchers Victor Jose, Bob Nau, and Bob Winkler at Duke University proposed new rules to score and reward good forecasts. An effective “scoring rule” provides incentives to discourage the forecaster from sandbagging, a proverbial problem in corporate life. … By assessing forecasting accuracy, the rules penalize sales above the forecast number as well as sales shortfalls. …

… A recent survey by decision analysis consultant Douglas Hubbard found that only one out of 35 companies with experienced modelers had ever attempted to check actual outcomes against original forecasts — and that company could not present any evidence to back up the claim. …

Wisdom of Crowds

… Journalist James Surowiecki presented the case [for conventional wisdom] in his bestseller, The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies, and Nations (Doubleday, 2004). Furthermore, research into forecasting in a wide range of fields by Wharton professor J. Scott Armstrong showed no important advantage for expertise. In fact, research by James Shanteau, distinguished professor of psychology at Kansas State University, has shown that expert judgments often demonstrate logically inconsistent results. For example, medical pathologists presented with the same evidence twice would reach a different conclusion 50 percent of the time.

The old game of estimating the number of jelly beans in a jar illustrates the innate wisdom of the crowd. In a class of 50 to 60 students, the average of the individual guesses will typically be better than all but one or two of the individual guesses. …[That] result raises the question of why you shouldn’t use the best single guesser as your expert forecaster. The problem is that we have no good way to identify that person in advance — and worse yet, that “expert” may not be the best individual for the next jar because the first result likely reflected a bit of random luck and not a truly superior methodology.

For this reason, teams of forecasters often generate better results (and decisions) than individuals, but the teams need to include a sufficient degree of diversity of information and perspectives. …

Group dynamics can produce a different sort of challenge in bringing together a team; … Typically, a dominant personality steps forth and drives the process toward his or her predetermined view, making little or no use of the wisdom of the crowd. In The Drunkard’s Walk: How Randomness Rules Our Lives (Pantheon, 2009), physicist and writer Leonard Mlodinow describes a number of research studies that show how most people put too much confidence in the most senior or highest-paid person. …

Culture and Capability

To become proficient at forecasting, a company must develop capabilities for both achieving insight and converting that insight into effective decision making. The firm need not seek out the star forecaster, but instead should invest in cultivating an open atmosphere … that brings to the fore a more complete picture of the expert knowledge that already resides in many of its existing employees.

The resulting culture will be one in which managers recognize and deal with uncertainty more easily; …

In the end, overcoming the problems and traps in forecasting probably requires the use of all of these approaches together, within a supportive culture. …

… Too many managers dismiss the inherent uncertainty in the world and therefore fail to consider improbable outcomes or invest sufficient effort in contingency plans. The world is full of unknowns, even rare and difficult-to-predict “black swan” events, … Overreliant on either their intuition or their mathematical models, companies can become complacent about the future.

Consider, for example, the 2002 dock strike on the West Coast of the U.S., which disrupted normal shipping in ports from San Diego to the border with Canada for a couple of weeks. A survey conducted by the Institute for Supply Management shortly afterward found that 41 percent of the respondents had experienced supply chain problems because of the strike — but only 25 percent were developing contingency plans to deal with future dock strikes.

We can train our intuition to offer a better guide in decision making. To do so, we must be aware of our biases and remember that all models start with assumptions. Engaging a diverse set of parties, … forces us to articulate and challenge those assumptions by seeking empirical data. …Rather than seeking the ultimate model or expert, managers should adopt the axiom cited by General Dwight D. Eisenhower …“plans are nothing; planning is everything.” A good forecast informs decisions today, but equally important, forces us to consider and plan for other possibilities.

Reprint No. 10202

Author Profiles:

• Tim Laseter holds teaching appointments at an evolving mix of leading business schools, currently including the Darden School at the University of Virginia and the Tuck School at Dartmouth College. He is the author of Balanced Sourcing (Jossey-Bass, 1998) and Strategic Product Creation (with Ronald Kerber; McGraw-Hill, 2007), and is an author of the newest edition of The Portable MBA (Wiley, 2010). Formerly a partner with Booz & Company, he has more than 20 years of experience in operations strategy.
• Casey Lichtendahl is an assistant professor of business administration at the University of Virginia’s Darden Graduate School of Business. His research focuses on forecasting and decision analysis.
• Yael Grushka-Cockayne is an assistant professor of business administration at the University of Virginia’s Darden Graduate School of Business. Her research focuses on project management, strategic and behavioral decision making, and new product development.

Relocation in retirement takes careful financial, logistical planning

Employee Benefit News

By Wayne Hanson, SPHR, CEPF

May 24, 2010

For employers that offer retirement planning advice, an important topic for advisers to raise with employees is the possibility of relocating after they retire.

A recent Del Webb survey shows that 42% of today's 50-year-olds plan to relocate, compared to 36% of 50-year-olds in 1996. Further, about 50% of those considering relocation plan to move to a different state, while 25% plan to move to a different city within the same state.

Employees need to concretely plan - not just carelessly ponder - for a relocation following retirement, and shouldn't pack the moving van without considering a number of key factors, including the cost of living and health care.

A 2009 Fidelity Investments survey of 502 married couples found that only 38% report making decisions about their retirement finances together. Moreover, many couples don't agree on such basics as what type of lifestyle they expect to have in retirement.

Different retirement phases

Future retirees also must understand that their retirement needs may differ from one phase of retirement to another. At first, many retirees will be eager to travel, pursue hobbies or volunteer without restriction. In a recent article at CNNMoney.com, this was called the "go-go stage," …

However, retirees inevitably move from the "go-go stage" to the "slow-go stage" - still on the go, but not as often, the site reported.

The third stage, the "no-go stage," is the point at which physical/mental limitations prevent retirees from sustaining the active pace of the previous stages.

The different stages of retirement will impact where a retiree spends their money and how much they spend. Keeping the different stages of retirement in mind will be beneficial to current employees in retirement planning, whether the focus is finances, lifestyle or where to live.

Outside of the obvious considerations such as cost of living and health care, there are many other important considerations, including family. The serious health condition of a family member may be reason not to relocate or at least to postpone a scheduled relocation.

Social supports

One of the biggest fears with relocating is not being able to develop friendships in a new place. …

Other important considerations for employees nearing retirement who are considering relocation include:

* Can you afford the occasional trip back to your old hometown for significant events such as family reunions, funerals, weddings or the birth of grandchildren?

* If you need part-time work while in retirement, what are the employment prospects in your new city?

* Does the increased probability of natural disasters, such as hurricanes or earthquakes, in the new location cause concern? Have you actually experienced the off-season weather?

* Are amenities such as grocery stores, shopping areas, airports and public transportation convenient in the new location?

* Have you looked at your tax strategy? …

* What are the crime statistics in the new location?

* Have you spent ample time in the new location to ensure it really is a good fit? …

* What is the economic, employment, social-service, and health care spending climate?

Just as marriage should not be entered into lightly, neither should relocation occur without a thorough analysis of all important factors. …

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Contributing Editor Wayne Hanson, SPHR, CEPF, is an HR consultant with a special interest in financial literacy. He has provided support to the private sector in a number of different capacities.

The eyes have it

Employee Benefit News

By Kathleen Koster

April 5, 2010

As employers strain to emerge from the economic doldrums, vision benefits may come into focus for those who want to keep health care costs down by providing another avenue toward preventive care.

Employers that see the forest for the trees recognize the importance of providing access to routine eye check-ups, while those that don't could find themselves clouded by lost productivity and expensive health care claims. …

The Bibb County Board of Commissioners in Georgia understands first-hand the imperative of offering vision benefits.

"We didn't realize different diseases and potential health issues can be detectedduring a vision exam," says JennyBurdeshaw, Bibb County Board of Commissioners. "However, one of our employees found out he was diabetic when it was detected during hiseyeexam. He wasput on insulin within a week.That experience alone helped us change our thinking,andas a result,we now offer vision benefits to our employees.We want our employees to be healthy, and we believe getting regular eye examsis anotherway tonot only check your visual health, but to check on your overall health." …

"A vision plan tends to be a very highly regarded, yet very low-cost benefit. That's why vision insurance is one of the few products that has actually increased in popularity," says Jeff Spahr, staff vice president of vision and voluntary services at WellPoint.

For the most part, employees want vision benefits, as almost half of consumers without vision benefits are interested in obtaining them, according to Anthem's Specialty Trends Report. Yet, only half of all employers offered access to vision benefits in 2008, and employer contributions are declining, according to the report.

Perhaps if the remaining employers knew that, according to the Vision Council of America, vision disorders account for more than $8 billion in lost productivity, they would be more apt to offer vision benefits. In fact, uncorrected vision can decrease employee productivity by as much as 20%, finds the VCA Vision in Business Report.

VCA also discovered that employers stand to gain as much as $7 for each dollar spent on vision coverage. Further, a quarter of employees surveyed agree that having their vision checked and corrected would increase their productivity at work, reports a WellPoint survey.

Vision benefit plans can also serve as a gateway to employer wellness programs. VSP, for example, estimates they can funnel over 60% of people in vision plans into preventive care.

"You can't start managing people until you get them into preventive care. So, for every dollar that gets spent on eye care services, we're able to return back to an employer increased productivity and medical costs savings of about 94% through increased productivity on the job because they're healthier, lower turnover among those employees and lower overall medical costs," says Melody Healy, director of product strategy and integration at VSP.

Offering vision benefits, or at least making them available for purchase, "is an integral part of prevention," she concludes. "The vision benefit is a very good way of engaging people to start their path to wellness."

High value, high savings

Including vision care in a company's benefit package is a significant aspect in encouraging holistic health care. …

"The eyes are one of the few spots on the body where there is an unobstructed view of the circulatory system. Diseases like diabetes or arterial sclerosis can be picked up through a vision exam," he says. "The sooner that we can get folks into the system, especially with diabetes, where 20% to 30% don't know they have the condition, the greater impact we can have on reduced cost of care and improved quality of life as well." …

In fact, VSP® Vision Care helps save its customers nearly $3 billion annually on health care and human capital costs associated with the treatment of chronic diseases detectable via an eye examination, according to a study undertaken by Human Capital Management Services, Inc. on behalf of VSP.

The study showed that VSP client-companies are realizing these savings for the early detection of diabetes, hypertension and high cholesterol in the first year alone, directly related to health plan, disability and employee termination costs. …

Hear no communication, see no benefit

Andy Mechavich, senior manager of compensation and benefits for LECG/SMART, encourages employers to design their vision plans to cover preventive exams at 100% "to entice people to go and get their eyes checked."

Mechavich stresses communicating the advantages of vision care in the context of wellness. Even though 76% of employees are enrolled in their employer's vision benefit, nearly half of U.S. employees with access to a vision benefit through their employer aren't taking advantage of it, finds a recent employee survey conducted by Harris Interactive on behalf of Transitions Optical, Inc. …

Further, employees have limited knowledge of what their vision plan can do. Nearly 25% of employees who don't enroll in their plan say it's because they don't have vision or eye health problems. Only 21% of those questioned in the Transitions Optical survey select diagnosing or managing chronic disease as a reason for enrolling.

Likely contributing to the problem is lack of, or sparse, communication about vision benefits. …

Says Spahr: "Everything is in place for employees to use [vision benefits]; it's that gentle nudge from the employer that can really make a difference."

Tips for preventing, reducing computer eye strain

Encouraging vision eye check-ups is especially important in the digital age, when employees are constantly squinting at their Blackberries and working for hours in front of computer screens.

According to the American Optometric Association, nearly 90% of those who use a computer at least three hours a day suffer from vision problems associated with computer eye strain.

Symptoms of computer vision syndrome, according to VSP, include:

Blurred vision or a delay in focusing when shifting focus from the computer screen to objects farther away.

Feeling like there's something in your eyes, or burning/stinging and inflammation.

Eye discomfort.

Headaches.

VSP and AOA offer the following suggestions for mitigating the negative effects of computer eye strain:

Blink often. It washes your eyes in naturally therapeutic tears.

Follow the 20-20-20 rule: At least every 20 minutes, take a break to refocus your eyes by looking at something 20 feet away for 20 seconds, minimum.

Keep bright overhead lighting to a minimum. Use blinds and a screen instead to reduce monitor glare. Try to keep lighting off to the side.

Keep your monitor at least 20 inches from your eyes. The center should be about 4 to 6 inches below your eyes.

Enlarge the font size on your PDA or smartphone screen.

Ask your doctor to prescribe a pair of glasses that will make your eyes comfortable for viewing the computer screen.

Get an annual eye exam, letting your doctor know that you work on a computer.