The COVID-19 pandemic and the unprecedented business conditions that have come with it have forced every company to take a hard look at which parts of itself are robust and necessary and which parts are not. It seems odd to talk about innovation in that context, as most people believe it to be additive, more about building for the future than surviving the present.
Unsurprisingly, at High Alpha Innovation, we would tend to disagree. Innovation should be about building for many futures, not just the ones that are good for business. Periods of crisis, in which our failures of imagination are widely shared and clearly shown, are perhaps the best time to reexamine these efforts.
In this series, we’ll examine why companies underestimate the possibility of certain events and how they can create more resilient futures through systematic startup partnership and creation.
Why our models fail
For two weeks in November of 2018, the Camp Fire ripped through Northern California, leaving 85 dead and 11,000 ruined homes in its wake. It’s not altogether surprising that such a deadly, costly fire should occur in some of the most fire-prone territory in the US. And yet, the stakeholders most familiar with the possibility and the danger failed to account for either one.
Decades of effective fire suppression, coupled with the infrequency of large fires, convinced residents to cut back funding for fire prevention in the name of budget austerity. PG&E, the power provider to the region, also curtailed tree trimming near its lines, and “no longer anticipated the need” to take extreme fire prevention measures in 2018.
That year, Paradise, California received approximately 3% of its average rainfall, and on November 8th, all those factors converged. The firefighting resources of the Western United States were stretched to their limits for two weeks dealing with the most expensive fire in California history.
Emergent behaviors can appear when a number of simple factors operate in an environment to form more complex collective behaviors. Forest fires are a perfect example; tree density, wind speeds, air moisture, ground moisture, slope combine to produce an effect more than the sum of its parts. Because emergent behaviors follow power law distributions -- large fires are exponentially less likely to occur than smaller fires -- we are tempted to imagine that they will never happen. And so we, like those entrusted with protecting the people of Paradise, California, are taken off guard.
Corporations can learn powerful lessons from the Camp Fire, and many have by weathering crises of their own. They have seen how an indiscriminate insistence on efficiency and cost cutting can cripple the ability to respond to a crisis. COVID-19 represents many failures of that system with population growth, globalization, and economic complexity combining with pandemic to create unprecedented business conditions. Companies that have spent years avoiding volatility, resolutely rooting out the risk of small fires, are finding themselves ill prepared to deal with the big fire that has arrived.
How then to respond? Little at the corporate level can be done to avoid emergent effects, and management cannot and should not discard entirely the push for capital efficiency that has driven shareholder value for the better part of 50 years. But corporations should expand the set of futures for which they’re prepared.
Human brains love a normal distribution curve, and risk management groups over the past several years have increasingly based their probability assessments on that bell curve, allowing for only a certain amount of volatility in stressors and outcomes, a certain spread of futures. You can’t run a business if you’re paralyzed by fear, so the practice is useful to a certain point, but it’s also untrue.
Businesses don’t live on normal distribution curves. In a static system at long-term equilibrium, timelines are infinite, and over a sufficient number of observations, normal curves emerge. But ours is a complex world; it’s constantly changing. And the more complex an ecosystem is, the more likely it gives risk to emergent effects. Our normal distribution curves have much fatter tails than we realize.
Innovation planning in corporations often begins with the question, “What is going to change in the future?” We find it more useful to ask “what won’t”. Normally distributed scenario analysis will almost certainly be proven wrong. Complexity will give rise to events that models can’t predict. Companies that imagine more futures are more likely to thrive than companies that imagine fewer.
Unless corporations or humans become immortal, we will always live in a fat tail world. The least we can do is admit it.Then we can start to build companies that will thrive in it, by preparing for a range of unknowable, unpredictable futures.
See part 2 for an explanation of why companies are so fragile, and what to do about it