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strategy and business
 / Spring 2004 / Issue 34(originally published by Booz & Company)


Power Laws & the New Science of Complexity Management

For example, the consensus among scientific experts is that human actions have probably affected the world’s climate, and that the environmental and social consequences could be dramatic and costly. For business, and especially energy companies, the risk associated with global climate change is much more immediate. Even in the absence of marked environmental change, a sudden and dramatic change in public opinion alone could have immense repercussions. As Robert Lukefahr and Tim Donohue recently reported in strategy+business, even a 30 percent drop in oil demand “would make development of reserves outside the Middle East — that is, practically all the reserves held by public companies — uneconomical.” (See “Global Warming: Perception Is Reality,” Fourth Quarter 2002.)

Some companies, such as BP, have effectively planned to protect themselves against this extreme risk. BP has diversified its interests and is now the world’s largest manufacturer of solar-powered devices. Meanwhile, it has become heavily involved in natural gas, which produces a relatively light load of greenhouse gases in comparison with other fossil fuels. Many other energy companies have not adopted measures to improve their resilience, and appear to believe — or hope — that the future will unfold slowly enough to allow high-risk events to be dealt with as they happen.

Some firms have learned to capitalize more directly by harvesting the lucrative returns associated with some discontinuities. In many industries, a few products dominate all others in terms of their returns on research and development investment. Think films or books, toys or pharmaceuticals, where many products have extremely low sales, while a few blockbusters reap massive rewards. One strategy in such industries may be to produce a broad spectrum of quick-to-market experimental products, to discover and exploit opportunities presented by market discontinuities.

Capital One, for example, customizes its credit card products by carrying out “experiments” with many thousands of proposed new products each year. Each of these proposed products is “tested” with the help of customer information to rate its attractiveness and potential for producing profits. Most of these new products are outright failures and never get beyond the computer, yet a few succeed, and once in a while, the company achieves a great breakthrough that makes the entire process worthwhile. From 1992 to 1998, Capital One grew from 1.5 million to nearly 17 million cardholders, largely on the back of a single breakthrough innovation, the balance transfer offer, which it introduced in 1992.

This exploratory strategy is similar to that used by a population of bacteria upon entering a harsh environment. Under such conditions, the population will produce a large number of highly mutated offspring. Most will not be viable and, along with the original population, will perish quickly. But a few mutants may hit on characteristics that enable them to thrive in the new environment. Their success will guarantee the continued existence of the population, which has now adapted itself to the new conditions.

Learning to deal with discontinuity requires more than mere diversification or efficient exploration of possible products, of course. It often — if not always — means that individuals and organizations face the difficult task of thinking differently; of breaking habits and questioning long-standing conceptual and cultural commitments. David Snowden, director of IBM’s new Cynefin Centre for Organisational Complexity in Cardiff, Wales, points out that “the entrainment of thinking” is a common problem. Ideas and practices that have proven effective in the past become akin to accepted norms; they acquire inertia, and often for a very good reason. On-the-fly experimentation in the real world is a dangerous thing; hence, we naturally cling to ideas that have worked before. “We do this in order to survive,” says Mr. Snowden.

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  1. Robert Lukefahr and Tim Donohue, “Global Warming: Perception Is Reality,” s+b, Fourth Quarter 2002; Click here.
  2. Randy Starr, Jim Newfrock, and Michael Delurey, “Enterprise Resilience: Managing Risk in the Networked Economy,” s+b, Spring 2003; Click here.
  3. Philip W. Anderson, “More Is Different,” Science, Volume 177, Number 4047, 1972
  4. Robert L. Axtell, “Zipf Distribution of U.S. Firm Sizes,” Science, Volume 293, Number 5536, 2001
  5. Mark Buchanan, “The Physics of the Trading Floor,” Nature, Volume 415, January 3, 2002
  6. Dirk Helbing, “Modelling Supply Networks and Business Cycles as Unstable Transport Phenomena,” New Journal of Physics, Volume 5, 90.1-90.28, July 14, 2003
  7. Anthony Michaels, Ann Close, David Malmquist, and Anthony Knap, “Climate Science and Insurance Risk,” Nature, Volume 389, September 1997
  8. Kai Nagel and Maya Paczuski, “Emergent Traffic Jams,” Physical Review E, Volume 51, 1995
  9. Philip C. Anderson, “Seven Levers for Guiding the Evolving Enterprise,” in The Biology of Business, John Henry Clippinger III, ed. (Jossey-Bass, 1999)
  10. Mark Buchanan, Nexus: Small Worlds and the Groundbreaking New Science of Networks (W.W. Norton & Company, 2002)
  11. Nicholas Dunbar, Inventing Money: The Story of Long-Term Capital Management and the Legends Behind It (John Wiley & Sons, 2001)
  12. Rosario N. Mantegna and H. Eugene Stanley, An Introduction to Econophysics: Correlations and Complexity in Finance (Cambridge University Press, 1999)
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