Classic: Corporate Inefficiency, Risk Aversion

This post was originally published on August 22, 2011.

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Risk Aversion comes in many forms -- from the rank and file laborer who fails to see any commensurate reward for sticking her necks out; to the professional who throws safety factor on top of safety factor effectively preventing almost any project from gaining altitude; to the manager who hesitates to take even modest risks because she realizes success is shrugged off as “expected” while failure is punished.  In the large company, risk aversion typically permeates every corner of the organization and has a central role in propping up conventional wisdom and preventing change.

What causes this risk aversion in large organizations?  At the individual level, I see it as a survival skill, and one that is fairly rationally applied.  In a corporate culture which largely ignores success but punishes failures (which, based on personal observation, describes most of them), the scales are heavily tilted in favor of conservatism.  And while each person has a personal risk-taking profile that also factors into their decisions, allowing even the most risk-averse organizations to make some progress although often at the risk taker’s expense, in aggregate the large corporate environment often generates a culture that encourages the taking of a million small chances, but very few that actually have a chance to make a difference.

This behavior is rooted in corporate politics -- the celebration of mediocrity (happy, friendly, much-admired mediocrity, but mediocrity none the less), the shrugging off of successes as if they were expected as a matter of course, and the visible punishment of failures.

A hot/cold car

Many years ago I worked on an engineering project for a customer located in Germany.  The project, one which had lingered for many years without any employee willing to take it on, involved solving a “temperature stratification problem” in the air conditioning system of the customer’s top end automotive product.

Yeah, it was risky, and being ignorant of such things and plainly overconfident, I volunteered for the job.

The tricky part of the project was that I couldn’t make any changes to any other part of the vehicle as it was already in production.  And besides that, the design of this particular AC system had been done by one of our competitors.

Other than that, it should have been easy!

My predecessor in the job had refused to take this risky project, but at the time I was young and unaware of how dicey the project actually was.  So, like a fool, I went forward, devoting considerable “after hours” time working on it.

Naively, I hoped that solving this “unsolvable” problem would be a major boost to my career.  That perhaps we would even capture the business from our competitor.  That I would receive high praise.  And maybe a promotion.

After several months of work, I came up with a fix that could be implemented in the existing product envelopes at a minimal cost.  I’d won.

Then I waited for my reward.  And waited.  And waited.

Nothing much happened.  I didn’t understand it at the time, but my success produced a collective yawn from my superiors.  They expected this kind of “success” as a matter of course.  Of course, if I’d failed, I would have instantly become damaged goods.

Such is the norm in most large companies.

The punishment of the innocent

Many years later, I spoke to another engineer in another company about a high-risk project he’d been assigned, and one that had damaged his career.

The project involved relocating a very large piece of recently purchased, used production equipment.  The machine hadn’t run for several years, and it was massive and ancient.

Once it arrived at the new location, one problem after another surfaced causing delays, cost overruns, and disappointing projections of how the machine would operate even after it was operating.  In this process, the original justification for the project was destroyed and senior management began their inevitable search for the guilty.

That search should have led right to the door of the executive that sponsored the project, but because he was powerful and high in the organization, blame instead fell to my engineering acquaintance.

As other members of the management team (and the engineering team) watched this drama unfold, the net effect became obvious – nobody in either group would be stepping forward to recommend another risky project anytime soon.

A few additional comments on failures

Every organization has ‘em.  Some are the result of an inaccurate estimate of required resources.  Others are caused by incorrect assumptions, a failure to properly predict competitive response, or simply proposing an idea that can’t be physically accomplished.  A few fail because external circumstances unpredictably change during the project’s development.  Another cause of failure is moving forward with unclear goals or targets.  In my experience, the least common failure source is a lack of effort or foolish mistakes – yet most large companies treat every failure as if it was caused by this last category.

Failure as a learning opportunity

Failure should be a part of the track record of every manager.  Show me a manager who claims to have never produced a failure, and I'll show you one that is either a liar or one who is clinging to someone else's coattails.  Failure is evidence that effort is being made to stretch and grow the capabilities of the organization.  Failure represents an opportunity to learn.

When an organization regularly sacrifices employees at the altar of failure, the message gets across to the survivors pretty quickly -- take few and limited risks.

So why do large companies do this?  And since the tone is set at the top, a better question might be:  Why do chief executives seem to have such an intolerance of failure?

The role of owners

I imagine it is because their bosses -- the board of directors, and ultimately the shareholders – are also intolerant of failure.  As is often expressed in the investment community – people pay for results, not effort.  Most CEO's appear to manage their subordinates exactly the way they are managed by their superiors.  In this process, they impose the same expectations on their management teams as investors impose.  Such behavior stems from a belief system with a few critical underlying precepts.

1.  Employees are largely interchangeable parts, and by-and-large can be easily substituted for one another.

2.  There are a few superstar employees out there, and everybody is chasing them.  Populate your organization with a few of these people, and large scale success will be yours.

3.  If an employee makes a large, visible mistake, they are clearly not a superstar.  If they occupy a superstar-type position, they should immediately be traded out for a future draft pick.

Investors clearly believe these precepts (as can be seen by the intolerance they demonstrate for less than perfect performance).  Board members have bathed in this environment for the bulk of their careers.  CEO's clearly drink the same Kool-aid or they aren't hired.  Even managers get their initial indoctrination into this belief system by carefully observing those higher on the corporate ladder.

The expectation is communicated subtly.  Generally, a board doesn’t say to the CEO "Don't take any big risks -- we don't want any big failures".  Instead, the messages are deciphered by observing what is rewarded and what is punished.  The same is generally true at lower levels inside the company.

I suppose the ultimate question is -- are those precepts correct?  This is a subject for another day and another blog post.

Why smaller is better

In the small company, risks are an everyday part of running the business.  And since the owner is putting his or her own personal assets on the line with each substantive decision, she has no one to blame to but herself if things go wrong.  There is no advantage to conducting a search for “who shot John.”  Blame-gaming, as it occurs in large corporations, is simply a waste of time and energy.  And while this doesn’t prevent an insecure owner from trying to cast blame elsewhere, it definitely happens less with a small employer than with a large corporation.

In the small company I own, I’m not interested in discovering who was responsible for a mistake, I’m interested in learning from it.  We never conduct searches for the guilty, although we do regularly look for what when wrong and try to correct it.

At this same company, we recently lost a significant chunk of business.  And while there were some hints that things might be a bit off track, we didn’t pick up on these hints and react by putting in place a plan to offset it.  When the disaster occurred, I was stunned.  But I wasn’t worried about determining who “should have been watching out” for this issue, because we all should have been watching.  Instead, we will learn from the error and try to make sure a similar problem doesn’t occur again.

Summary

Small companies are not inherently less risk averse than a large corporation, but in practice they almost always are.  Small companies certainly have fewer institutional barriers to taking risks.  That being said, the risk profile of the business is highly dependent on the risk-taking profile of the owner, which ranges across a broad spectrum of behaviors.

A small company with less risk aversion than their corporate competitors, are likely to gain an upper hand by outflanking their larger, more risk averse rivals.  And while it doesn’t afflict every large company, risk aversion is yet another significant source of large company inefficiency that helps level the competitive playing field.

Posts in the “Corporate Inefficiency” Series (Chronological Order)

Posts in the “Behaviors Managers Hate” Series (Chronological Order)

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