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Published: August 15, 2011

 
 

How to Prevent Self-Inflicted Disasters

All too often, companies unintentionally create their own worst crises. With a little awareness of your organizational DNA, you can avoid that fate — and the headlines that go with it.

During the last few years, a number of well-publicized “black swan” events — highly destructive calamities that seemingly come from out of nowhere, and that are diverse enough to include oil rig explosions, automobile recalls, major production delays, financial meltdowns, and at least one phone-tapping scandal — have had immense negative effects on the companies involved. When you look in more detail at these crises, you often find that they were self-inflicted to some degree. An overly aggressive production schedule may have driven employees to disregard or downplay the company’s safety or risk prevention procedures. Internal staff may have warned their peers about potential dangers, but those warnings never made it to the top of the company. Decision makers may have ignored, misunderstood, or even suppressed bad news, in a way that ultimately backfired. After the event, the leaders of the company often have to admit: “We did it to ourselves.”

The unintended consequences associated with a self-inflicted black swan can be devastating. They include negative publicity; huge, sudden costs; lost revenues; lawsuits and criminal judgments; and regulatory penalties. Analysis of the stock prices of companies that suffered such events in 2009 and 2010 in the oil, automobile, aircraft manufacturing, and financial-services industries shows that within two months after a visible self-inflicted crisis, an average of 18 percent of shareholder value was lost, relative to the S&P 500. Moreover, stock price performance continued to diminish over time: On average, shareholder value came down 33 percent within a year.

Self-inflicted black swans have occurred in many industries in widely varying circumstances, but always with one common factor. Although the initial trigger appeared to be an exogenous event, the critical decisions were largely under the control of management. Typically, a number of people within the company knew about the situation and saw the potential downside in advance; if this knowledge had been acted upon with diligence and in a timely manner, the problem could have been prevented. Often, these companies had formal procedures in place designed to avoid these precise risks, but the procedures were routinely ignored or bypassed by employees.

How could companies that knew better fall into these traps? Because the perception of risk diminishes over time. It’s not unlike the dangerous habit of texting while driving. Imagine that one day under pressure, you send a text message while behind the wheel, and nothing bad happens. You promise yourself that you won’t do it again, but the pressures continue, and you start to make a habit of it. A few months go by with no mishap, and you come to believe that the “no texting while driving” rule shouldn’t apply to you. You are one of those favored people who can successfully multitask without much risk. But when you’re feeling lucky is just when you’re most likely to cause an accident. Companies that get into similar habits — overlooking or sidestepping their risk management practices — are similarly primed for a self-inflicted black swan.

For example, more than one oil and gas company has been informed at some time by subcontractors of the potential for a severe explosion. Mitigation measures have typically been at hand to rectify the problem, but because implementing them would temporarily halt the operation, leading to lost revenue, the manager of the oil rig is under pressure to find some way to cover over the problem. If everyone else involved in the rig tacitly accepts this decision, even though it contradicts official company policies, there might well be an explosion within months.

Similarly, at the outset of the global financial crisis, some people within banks and insurance companies were warning of the declining standards for securitized mortgages, CDOs (collateralized debt obligations), and other high-risk investments. But others had strong incentives to ignore these warnings — not just the formal motivators such as pay, but equally powerful informal incentives such as the traders’ fiercely felt need to outperform others. In the U.K. voicemail hacking scandal, the news media had a similarly strong competitive motivation: to scoop rival publications. The institutions that survive unscathed tend to be those that maintain informal commitments to back up their formal rules on safety and integrity.

 
 
 
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Editor’s note: This article is part of a body of management theory and practice called organizational DNA. Take our new online survey to see your own organizational DNA profile — and gauge, among other things, how well equipped your company is to prevent and mitigate self-inflicted crises. Click here for the survey and more information.
 
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