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Interpreting Weak Signals1

By Paul J.H. Schoemaker
Chairman, DSI

“When people stumble onto the truth they usually pick themselves up and hurry about their business.” Winston Churchill

It’s the question everyone wants answered: Why did so many smart people miss the signs of the collapse of the sub-prime market? There were many danger signals about the impending housing bubble and the rampant use of derivatives, as early as 2001. Yet these signals were largely ignored by such financial players as Northern Rock, Countrywide, Bear-Sterns, Lehman, and Merrill-Lynch until they all had to face the music harshly and abruptly. Some players were more prescient, however, and sensed as well as acted on the early warning signals. In 2003, investment guru Warren Buffet foresaw that complex derivatives would multiply and mutate until “some event makes their toxicity clear.” In 2002, he derided derivatives as financial weapons of mass destruction. Likewise, Edward Gramlich warned in 2001, as a governor of the Federal Reserve, about a new breed of lenders luring buyers with poor credit records into mortgages they could not afford.2

So, what separates the prescient few from the hapless? Did the siren call of outsize profits and bonuses, coupled with and the delusional promises of manageable risk, dull the senses? Was their ability to see sooner and more clearly compromised by information overload, organizational filters and cognitive biases that afflict sense-making in all organizations? Economist Robert Shiller of Yale University, a leading housing expert, recently blamed “groupthink” to explain why the Federal Reserve didn’t take the early warning signs of a looming housing bubble more seriously. He and others in the Fed suppressed their growing doubts to conform to the apparent consensus and retain their influence.3 Also, there were cognitive blind spots involved, as former Federal Reserve Chairman Alan Greenspan so candidly admitted in his testimony to Congress: the credit freeze did not fit their mental model of how rational players behave. This kind of market failure was an irrational and impossible scenario. Yet, it happened.

The purpose of this essay is to provide leaders and management teams with proven ways of reducing the chance that they will be ambushed from left or right field by an upstart rival, say, or a destabilizing technology. Our own research and consulting experience suggests nine proven approaches that managers can use to actively surface, amplify, and clarify potentially important weak signals. Figure 1 depicts these complementary methods, which we describe briefly below:


Figure 1. Improving Sense-Making
[click for larger image]

Actively Surface Weak Signals

  1. Tap local intelligence. Insects use a compound lens system, where most of what they see and notice occurs in the eye itself as opposed to the brain. They rely on “localized intelligence” at the level of each eyelet and respond accordingly. Likewise, organizations may wish to drive more of their sense making to local levels. Terrorist networks have demonstrated the deadly power and resiliency of such an approach, using nearly autonomous cells that see and think locally. Or, in a more positive vein, Linux and the open source movement have used local design to build an ongoing global software project.4 From fighter plane cockpits to nuclear power plant control rooms, the key to safety and reliability is to spot problems early and share them among well trained personnel. This requires procedures for real-time cognition and constrained improvisation, so as to bring about flexibility and promptness in highly complex volatile environments. Accessing distributed intelligence takes a culture of alertness and information sharing across multiple social networks.5

  2. Leverage extended networks. A valuable but frequently overlooked way to actively surface weak signals is for executives to query their extended networks to partners, suppliers, customers and others in the firm’s ecosystem. The common element of all these networks is that they extend the eyes and ears of the firm. Different networks tap different zones of the periphery in diverse ways. For example, the R&D departments of Philips and General Electric were greatly helped in their early days by being deeply embedded in external government, academia and customer networks, as well as being connected to other parts of the organization internally.6 Similar results were found in a historical study of Merck and Co., showing how their innovations on biological compounds were related to a “series of complex, evolving networks of scientific, governmental and medical institutions.”7 One consequence of greater organizational participation in extended networks – where many nodes in the network are connected to other networks – is a rapid increase in the number of weak signals received. This problem gets intensified within internet-enabled networks which virtually eliminate signal transmission time and cost. Thus, managers must be selective about which signals and stay within the boundaries of the firm’s absorption capacity.

  3. Mobilize search parties. Senior leaders can identify weak signal areas that merit separate task forces to canvass further. Akin to launching a military search party, scouts explore the terrain and report back what they see. For example, IBM has an on-going capability called “Crow’s Nest” to scan specific zones of the periphery and share insights with top management. The zones areas include such topics as time compression, customer diversity, globalization and networks. The responsibility of the group is to rise above functional and product blinders like a “crow’s nest” on a ship, where lookouts watch for new land, pirates and dangerous reefs ahead. The organization can also outsource some peripheral scanning to outside consultants, who may more quickly factors that could transform the firm’s business. While these outside partners can provide fresh perspectives on the business, the company needs to pay careful attention to coordination to ensure that these “private eyes” are focused on the right areas.

Amplifying Interesting Signals

  1. Test multiple hypotheses. Organizational sense-making is usually driven toward one single interpretation, so new data are force-fit into the existing mental model.8 Managers often have limited tolerance for ambiguity and may be reluctant to devote additional time to develop alternative hypotheses. However, organizations need competing hypotheses to escape the trap of getting stuck on a simple, single view that is wrong. The British Armed Forces and other organizations deploy so-called red teams to accomplish this. The red team is a parallel task force, comprised of senior leaders and support staff, whose only mission is to collect and synthesize information to prove that the current plan is wrong and needs to be changed.9 This team plays the role of the loyal opposition, in the spirit of Alexander the Great who would periodically ask himself how much evidence it would take for him to abandon the current plan.

  2. Canvass the wisdom of the crowd. To handle the dangers of groupthink or the problem of distributed intelligence (where key information is dispersed around the organization) managers may wish to pay more attention to the grapevine. James Surowiecki, author of The Wisdom of Crowds, summarizes research showing that groups or markets often make far better judgments than individuals. This is particularly true if companies can create forecasting methods (such as Delphi polling) to pool the collective wisdom of an organization without fostering undue conformity. Information flows very quickly through the grapevine when big brother is not watching. One way to avoid collective myopia is to create anonymous opinion markets. For example, in the 1990s, Hewlett-Packard asked employees to participate in a newly created opinion market to forecast its sales. Employees would bet in this market at lunch or in the evenings, revealing through their investments where they thought the sales trend was headed. This market’s forecast beat traditional company forecasts 75 percent of the time. More recently, a division of Eli Lilly asked employees to assess whether drug candidates would be approved by the FDA based on profiles and experimental data, and the internal company market correctly identified the winners from a set of six candidates.10

  3. Develop diverse scenarios. Unfortunately, no method is perfect and uncertainty can never be fully tamed or conquered. Even though the crowd may reveal deep wisdom at times, it will not always divine the future. The consensus can be badly mistaken as Charles Mackay vividly chronicled in his classic 1841 book Extraordinary Popular Delusions and the Madness of Crowds. To challenge the dominant view in your organization, it may be wise to create multiple scenarios about the issues under debate. For example, when a Houston credit union was going gang busters thanks to Enron’s meteoric rise, we asked their senior management team to imagine a scenario where they could no longer rely on Enron for growth and deposits. At first, there was reluctance to develop such an unrealistic and negative view, especially since Enron was their single corporate sponsor. But then some interesting scenarios emerged, ranging from an Enron take-over to more dire scenarios involving trouble for either Enron or the credit union. Later, when Enron suddenly collapsed, the credit union was saved – against the odds according to regulators – because they had taken pragmatic actions to be less dependent on Enron.11 For example, they launched their own e-mail system to communicate with members rather than using Enron’s system. And they opened branches outside the Enron building and had started to admit non-Enron employees in their credit union.

Probing and Clarifying

  1. Seek new information to “confront reality." As Larry Bossidy and Ram Charan emphasize in their book Confronting Reality, the greatest business failures are usually not due to poor management but rather reflect failure “to confront reality.”12 They write about how data-storage company EMC missed key changes in its environment that caused the rapid decline in sales in 2001. EMC’s sales force, speaking mostly with CIOs, was confident that orders were just being delayed. They interpreted the downturn as a temporary blip. But when Joe Tucci was named CEO in early 2001, he began speaking to CEOs and CFOs at customer firms, and found that they were not interested in paying a premium for top performance. Also, they wanted software that wasn’t proprietary since IBM and Hitachi were selling machines that were comparable to EMC’s at a lower price. As EMC’s market share slipped, Tucci rapidly transformed EMC’s business model to focus more on software and services than on hardware, which was becoming commoditized. Once Tucci recognized the new reality, he understood how the company needed to transform.

  2. Encourage constructive conflict. A statue in Helsinki, honoring former Finland president J. K. Paasikivi (1870-1956), is engraved with his motto that “all wisdom starts by recognizing the facts.” This is especially difficult when not all facts are known and subject to interpretation. Constructive, well-managed conflict can lead team members to accept that not everyone sees the facts the same way and that there are multiple interpretations. This in turn will result in better intelligence gathering, a wider exploration of options and a deeper examination of the issues. Unfortunately, the opposite often happens as one insider at Merrill Lynch observed about the leadership team under CEO Stanley O’Neil: “There was no dissent. So, information never really traveled.”13 Leaders can play a key role in managing conflict well; they must allow peripheral observations by team members to enter the discussion. In contrast, more harmonious teams or those managed in autocratic styles are likely to miss crucial information and run the risk of groupthink.

  3. Trust seasoned intuition. Experienced managers often possess far more knowledge than they realize, especially when operating within their domains of expertise. If so, they should learn when and how to trust their hunches. Gary Klein has studied the power of intuition in fast moving environments such as firefighting, medical emergencies and military combat.14 In one study he found that experienced nurses picked up the onset of septic shock in premature infants at least a day before the textbook symptoms appeared and a blood test could confirm the presence of the deadly bacterium. These nurses had learned to be sensitive to weak signals even if the cues varied and the symptoms were weak. It takes many years of experience, with good feedback, to develop reliable intuition. But once it has been honed, intuitive hunches should be viewed as valuable inputs, along with more analytical ones, for the judgment process. Malcolm Gladwell’s book Blink provides many striking examples of thinking without thinking, ranging from truly brilliant intuition to deeply flawed gut feel.15 Sense-making in the face of ambiguity can be enriched by seasoned intuition, to supplement the limitations of more analytical methods, especially when experience runs deep.

Conclusions

There is a major difference between taking in signals and actually realizing what they mean. Managers as well as organizations tend to see the world in a certain way and start to confuse their mental maps with the territory. Weak signals that don’t fit are often ignored, distorted or dismissed, leaving the company exposed. The other risk firms face is that managers waste time chasing meaningless clues. Managers should look at their organization’s recent history to see which type of error is more prevalent and then redress any imbalance as needed.

In any given week – especially lately - the popular press is full of examples where managers missed weak signals. Considering the prevalence of such cases, we sought to identify the deeper challenges as well as some practical, proven remedies. The major problem, in our view, is that managers are insufficiently aware of various cognitive and emotional biases that can cloud their judgments when interpreting weak signals. When ambiguity is high, we can easily torture the weak data until it confesses to whatever we want to believe. To counter these insidious tendencies, managers must cultivate deep and broad awareness of their biases, as well as deploy practical mechanisms for organizational triangulation. Both of these tacks will require leadership as well as the mastery of various tools to combat the pernicious filters that so often obscure and distort important weak signals. In a fast-moving marketplace, none of us can afford to miss what we are seeing.

Notes

 1Adapted from “Making Sense of Weak Signals” by Paul J. H. Schoemaker and George S. Day, MIT’s Sloan Management Review, Spring 2009 (forthcoming).

 2Edmund L. Andrews, “Fed Shrugged as Subprime Crisis Spread,” New York Times (17 December 2007). Paul M. Barrett, “Wall Street Staggers” Business Week (29 September 2008), pages 28-31, and Nelson D. and Schwartz and Vikas Bajaj. “How Missed Signs Contributed to a Mortgage Meltdown,” Wall Street Journal, 19 August 2007.

 3Robert J. Shiller, “Challenging the Crowd in Whispers, Not Shouts,” New York Times, (2 November 2008), Page 5

 4How organizations can maintain high reliability of performance in complex environments is addressed in Roth , Emilie, Multer , Jordan and Raslear , Thomas, “Shared Situation Awareness as a Contributor to High Reliability Performance in Railroad Operations”, Organization Science, 2006 ; Vol 27 ; Part 7, pp. 967-987; see also Karlene H. Roberts, “Some Characteristics of One Type of High Reliability Organization,” Organization Science, 1990.

 5Karlene H. Roberts, “Managing high reliability organizations,” California Management Review, 1990; GA Bigley, Karlene H. Roberts, “The incident command system: High-reliability organizing for complex and volatile task environments,” Academy of Management Journal, 2001; Edwin Hutchins and T. Klausen “Distributed cognition in an airline cockpit” Cognition and Communication at Work, 1996; Karl E. Weick and Karlene Roberts, “Collective Mind in Organizations: Heedful Interrelating on Flight Decks,” Administrative Science Quarterly, 1993.

 6F. Kees Boersma, "The organization of industrial research as a network activity: Agricultural research at Philips in the 1930s," Business History Review, volume 78, 2 2004, pp. 255-272; F. Kees Boersma, "Structural Ways To Embed A Research Laboratory Into The Company: A Comparison Between Philips And General Electric 1900-1940," History and Technology, volume 19, 2 2003, pp. 109-126.;

 7M. W. Dupree, Networks of innovation: Vaccine development at Merck, Sharp & Dohme, and Mulford, 1895-1996; book review by Galambos,L, Sewell,JE," Business History, volume 39, 4 1997, pp. 185-187.

 8A classic philosophical treatment of different approaches to gathering and interpreting information is C. West Churchman’s classic book The Design of Inquiring Systems, NY; Basic Books, 1971.

 9Personal communication with Sir Kevin Tebbit, former Permanent Secretary of the Armed Forces, United Kingdom of Great Britain; also, see Bose, Partha (2003), Alexander the Great's art of strategy. New York: Gotham Books, Penguin Group (USA) Inc.

 10From brief discussion of book in Wired. http://www.wired.com/wired/archive/12.06/view_pr.html.

 11For more detail on the case see Paul J. H. Schoemaker, Profiting from Uncertainty, Free Press, 2002.

 12Larry Bossidy and Ram Charan, “Confronting Reality,” Fortune October 18, 2004, pp. 225-229, excerpted from Confronting Reality: Doing What Matters To Get Things Right, Crown Business, 2004.

 13“Thundering Herd Faltered and Fell”, New York Times, Sunday Nov. 9, 2008, p. 9

 14Gary Klein, Sources of Power, MIT Press, 1998; also see Robin M. Hogarth, Educating Intuition, University of Chicago Press, 2001.

 15Malcolm Gladwell, Blink: The Power of Thinking Without Thinking, Little, Brown. Unfortunately, Gladwell did not articulate well the conditions that favor intuition which typically requires vast experience in stable domains with repeated and accurate feedback. For a critical review of this book see Hogarth, R. S. and Schoemaker, P. J. H., Book Review of Blink, Journal of Behavioral Decision Making, Vol. 18, 2005, pp. 309-318.

 

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