Sunday, May 22, 2011
According to Professor Stanley Schwarcz of Duke University, a financial crisis can be thought of as having a number of categories. He calls them the 3Cs and the TOC; conflict, complacency, complexity, and a type of ‘tragedy of the commons’. I suggest that these categories are similar to those found in our organisations, which are simply a micro-cosmos of larger global business and financial networks.
As an industrial engineer, the most important of these for me is complexity. In business engineering – where change is engineered into an organisation – one finds complexity in supply chain networks, business application systems, product portfolios, and customer segments. Everyone understands the concept of complexity intuitively; but being able to measure it and act on it – that seems to be impossible!
In general, complexity causes similar problems in organisations, irrespective of the industry, size, or type. These problems are, in essence, that:
• Complexity keeps stakeholders from gaining an adequate understanding of the organisation that would allow it to operate efficient and effectively.
• It increases the amount of information that needs to be processed in order to understand the organisation fully.
• Complexity in the lower level sub-activities that support the organisation’s value chain and supply chain can lead to unanticipated problems.
• It can hide unrelated events – that is, non-linear cause-and-effect behaviour is not seen by management.
• It can hide the actual risk embedded in the layers of business activities, becoming even more critical if there is limited time to assess all possible outcomes and risks.
• It can hide fraud in the organisation.
• Complexity creates critical hubs in the system that can allow rapid crises contamination because of many intra-related relationships.
• Intra-related relationships are created through information technology, communication systems and social networks; and information can be transmitted rapidly through these systems, causing an exponential ripple effect of events.
So we see that the modern organisation has evolved into a complex system with many non-linear cause-and-effect relationships. Simply trying to manage this complexity through traditional methods can produce unforeseen failures and crisis within the organisation, reducing profits and decaying shareholder value.
Complexity management is a dynamic property of any system. It functions because of relationships in the system (structure), and uncertainty (entropy) in these relationships. To manage it in our organisations, we need to identify, measure, and quantify both the structure and the entropy; or else it will always remain a matter of speculation. How we deal with this new-found insight into complexity to ensure enough robustness in the organisation requires another discussion on organisational change capabilities.
Many arguments about the financial crisis call for the establishment of governmental entities to monitor and intervene in the financial markets, to pre-empt another crash. Similarly, organisations need to define their own role and responsibility for dealing with complexity in the organisation. One could argue that this rests with the strategy or finance units; but I think that the ideal vehicle should be the unit that deals with risk management. Its task should be to measure and report on the complexity within the organisation. However, how to understand and deal with it must be a standard point of discussion between the executives of the organisation as part of the business model.
In 1998, in The Collapse of Complex Societies, Joseph Tainter argued that, early in the system cycle, the value of complexity is positive – that is, it creates more than it requires to be created. He found that societies collapse because, as stress increases in the system, it becomes too inflexible to respond. It is not that the system doesn’t want to respond: it cannot. The whole system becomes a huge interlocking system that is unlikely to respond to any change.
Collapse is nature’s last remaining method of simplification. And that is exactly where the risk lies for an organisation’s stakeholders! Complexity management is a crystal ball into the organisational problems; rather than ignoring it, executives need to find ways to measure it, analyse it, and act on it !
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