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Streamline Training & Documentation
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Saturday, February 13, 2010
Generating Business Value from IT III: A Case Study
As a way of bringing together the concepts discussed in my two previousposts on generating business value from IT, I'd suggest reading a December 2007 case study (pdf) by Jeanne Ross, director of the MIT Sloan School's Center for Information Systems Research and Cynthia Beath, a professor emerita at the McCombs School of Business of the University of Texas at Austin.
The case abstract gives this overview of the case:
Pacific Life is a diversified financial services company with a history of autonomous business units. Pacific Life had five independent divisions, including Life Insurance, Annuities and Mutual Funds, and Investments. These divisions served different customers and responded to different regulatory and market requirements. Pacific Life executives embrace decentralization as the best structure for capturing excellence in the individual businesses, so they are willing to sacrifice some potential efficiencies. But while they are usually willing to forego the benefits of a more centralized organization structure, they are not willing to assume any unnecessary risks. This case describes how the company governs shared IT services and enterprise risk management to limit its risk exposure while reaping the benefits of decentralization.
Cameron Cosgrove, the vice president for IT in the Life Insurance Division, explains how Pacific Life decides which IT services will be centralized and which will be located in the business divisions:
Where the divisions have IT requirements that are unique to their core business and they need flexibility to have that independence to just GO, we've put those services into the divisions. Where the need is common and can be shared and the consensus is it's a commodity, and competitive advantage isn't really going to be derived from there, then the focus becomes running that service like a utility with low cost and reliability being the drivers — that's what ITS [the group providing IT shared services] is supposed to do for the divisions.
A key part of the decision-making structure is a set of nine Enterprise Architecture Groups (EAGs), whose role, as spelled out in a Pacific Life internal document, is to "create economies of scale, reduce support, maintenance and training needs, improve quality while reducing complexity, and optimize reusability throughout the company." Ross and Beath explain that "EAGs prioritized and scheduled initiatives to improve, upgrade or harmonize ITS's technology assets or services ... [and] secured funding for ITS-related initiatives."
Providing overall guidance is Pacific Life's Information Technology Council (ITC), which approves "the operating budget for ITS, prioritizing any projects that ITS proposed to improve its services, along with other enterprise-wide initiatives that required ITS to make infrastructure investments or process changes." A key responsibility for the ITC is implementation of "policy decisions flowing from Information Security, BCP [Business Continuity Planning], Compliance and Audit and their respective steering committees that had implications for ITS. These policies often drove the need for strategic ITS initiatives."
In sum, "Together the ITC and EAGs generated some of the benefits of IT centralization without centralizing all of Pacific Life's IT assets."
Generating Business Value from IT II: Risk Management
Yesterday's post discussed one aspect of optimizing a company's IT investment, namely, choosing a preferred operating model, which in turn determines IT integration and standardization requirements and, therefore, critical IT and business process capabilities.
MIT's Center for Information Systems Research (CISR), the source of the research on matching IT to a company's operating model, also pushes for careful attention to IT risk management.
Access — providing information to the right people, and keeping it out of the hands of people who shouldn't have it
Accuracy — ensuring information is accurate, timely, and complete
Agility — making needed business changes with acceptable cost and speed
Disciplines for managing risk
Establishing a sound foundation — The foundation is a base of infrastructure, applications and supporting personnel, which is well-structured well-managed and, most important of all, no more complex than absolutely necessary.
Establishing a sound risk governance process — I.e., procedures and policies that provide an enterprise-level view of all IT risks.
Establishing a risk-aware culture — I.e., making sure that everyone has appropriate knowledge of risk, and that non-threatenting discussions about risk are the norm.
Westerman and Hunter provide a list of questions to help managers assess their company's current risk profile. The questions are divided into executive-level and operational-level items. For executives the questions help "convert technical issues into business issues, and IT impacts into business impacts." For operational managers, the questions help in analyzing details of the dimensions and costs of particular risks. Answering the questions ensures that managers at all levels understand "the meaning, potential consequences and relative importance of IT risks."
The questions are organized aaccording to the four categories of IT risk:
Availability
Executive-level questions
Which of our business processes are most dependent on IT?
What consequences are likely if the systems are unavailable?
Operational-level questions
What is the cost of a particular process being down for an hour? A day?
What are our procedures to recover from interruption?
Access
Executive-level questions
What categories of information would be most damaging if released? For example, what is the likely impact of loss or theft of customer data? Product data?
What categories of information are most important for our firm's daily success or failure?
Operational-level questions
How do we control, protect and monitor access to these types of information?
How can we ensure that the right people get access to this information as needed (and then lose access when done)?
Accuracy
Executive-level questions
Which processes and categories of information carry the highest consequences for inaccuracy (e.g., inventory information, financial information, etc.)? What would the firm lose if it could not maintain Sarbanes-Oxley certification, for example?
What constraints has inaccurate or incomplete information placed upon the organization?
What could the firm do if it had better information in some area? For example, how much would the company save if it had better information on global customers?
Operational-level questions
How can we improve the way that we gather or manage these types of information?
How can we create or obtain valuable new types of information?
Agility
Executive-level questions
How well does IT currently deliver on new projects, and what does that mean for what the firm is able to do in the future?
What major strategic changes (new product launches, new geographies, mergers and acquisitions, global cost-cutting, etc.) are foreseeable?
What opportunity costs are entailed in missing a product launch (or other strategic move) by a month due to IT issues?
Operational-level questions
How can managers in IT and business units improve project definition and delivery?
What processes, skills and supporting systems are needed to support those changes?
How should the IT foundation change to improve agility?
Once the current risk profile has been identified, using questions such as those above, managers can proceed to implementing the three core disciplines of effective risk management, taking steps that are in line with agreed priorities and previously analyzed tradeoffs.
The Winter 2010 issue of the MIT Sloan Management Review has an excellent article addressing the issue of how businesses can best cope with uncertainty.
Uncertainty concerning events whose probability distribution is known
Uncertainty concerning events whose probability distribution cannot be known
The authors note that even in the case of events with a known probability distribution, it is generally impossible to know when a low probability event will occur. The situation is even more nebulous for the second type of uncertainty, since even the frequencies of possible events are unknown.
Since forecasting in an uncertain world leaves the key question, "When will the Big One hit?" unanswered, the authors argue that a business should de-emphasize forecasting exercises and instead prepare for the future by developing plans for handling various scenarios, including quite extreme, if rare, situations.
The authors recommend a technique they call "future-perfect thinking." They offer this example:
Assume you’re the CEO of a major airline, and in order to formulate your corporate strategy, you need to forecast oil prices for the next five years.
First, imagine that five years have already passed. You’re now able to look back on what happened over that period. It turns out that oil prices have been quite low and stable over the “past” five years, which was a great benefit to the airline (and your career). However, instead of just enjoying that imaginary good luck, explain — or tell the story of — how such favorable circumstances came about. What were the particular economic and geopolitical events that contributed to the low, stable oil prices?
Now, take a second trip forward five years on the time machine. This time, however, when you look back at oil prices, you are exasperated. All you see is mayhem: a period of steep and highly volatile prices that made running the airline almost impossible. Once again, explain what happened. What were the particular economic and geopolitical events that led to that painful scenario?
If you do that kind of exercise a few times, focusing on the realms of your own experience, you’ll start to develop a feeling for different futures and the fact that they are all plausible. ... [T]hough there is no formal technique for converting plausibility into probability, you can use your new insights to develop appropriate risk protection strategies. That is the essence of future-perfect thinking. It involves harnessing the clarity of hindsight to develop more vivid pictures of the future.
The affinity of future-perfect thinking to scenario planning is apparent.
This lecture 24 (pdf) deals with what he calls project uncertainty management, giving credit for his presentation of the subject to Odmund Granli, a Norwegian expert in project management who got some of his training at MIT.
The basic point Prof. Moavenzadeh addresses is the way attention to managing uncertainty, as opposed to looking only at risks — negative eventualities — enables project managers to focus on value creation over the full life cycle of a project.
Uncertainty in this context is defined as the degree of a project manager's
ability to predict the outcome of parameters or foresee events that may impact the project. Uncertainties have a defined range of possible outcomes described by functions reflecting the probability for each outcome.
Uncertainty exists concerning both risks (negative outcomes) and opportunities (positive outcomes), and arises from variability and ambiguity, the latter due, e.g., to values conflicts among project participants.
Prof. Moavenzadeh outlines four types of uncertainty management challenges, one of which, somewhat confusingly, is itself called uncertainty, for which precautionary strategies, such as limiting the range of effects, are appropriate. The other three challenges are complexity, addressed by strategies that reduce the damage potential and limit the overall risk level (e.g., through establishing appropriate standards and procedures); dynamic processes, addressed by strategies that, e.g., reverse adverse trends and break vicious cycles; and ambiguity, addressed through consensus-seeking dialogue of advisory committees, citizen panels, etc.
The bulk of Prof. Moavenzadeh's lecture discusses how project organization and contracts can be structured to optimally manage project uncertainties — both risks and oppportunities. However, since the slides supporting this portion of the lecture are hard to absorb without the benefit of Prof. Moavenzadeh's in-class commentary, I would suggest that someone wishing to learn more read something like Uncertainty Management for Systems Planning and Design (pdf), a 2004 paper by Richard de Neufville of MIT's Engineering Systems Division.
Risk management should be handled on an integrated basis, combining attention to risk financing (e.g., purchase of insurance), loss prevention (e.g., establishing good site security and doing thorough disaster planning), and agreement on how disputes will be resolved.
Take a systematic approach to risk identification. Consider project type and site, project participants, the project delivery method (e.g., design-bid-build), budget and financing, scheduling, legal issues, and political risks (e.g., risk of expropriation).
Aim for a fair allocation of risk. Consider which party can best control each risk, which can best finance each risk, which can best manage each risk, and which can most easily accept the consequences if a particular risk is realized. The outcome of the risk management analysis should be an integrated program that protects all parties.
You need to stay up-to-date on the most economical ways of managing construction risk. Costs can be lowered by investing in loss control and safety programs, providing limited indemnity to contractors, reducing dependence on insurance in favor of risk management, and using controlled insurance programs (see next point).
More and more players in the construction sector are utilizing controlled insurance programs (CIPs). A CIP involves the purchase of the following insurance coverages by one entity (owner, developer, or contractor) for all firms working at the jobsite(s): workers' compensation, general and umbrella liability, professional liability, and builders' risk. The advantages of this approach include cost savings, organized control by the purchasing party, and good PR from the evidence of concern for protecting participants in the project.
Professional insurance (e.g., for architects and engineers in a design firm) presents pitfalls to be avoided, namely low and aggregated limits on coverage. Solutions include obtaining a good certificate of insurance backed by contract requirements, buying project professional insurance on larger projects, and buying owners' protective insurance to increase coverage limits.
If you'd like to see a real-world example of construction risk management (in the public sector), you can visit the California Department of Transportation project risk management webpage.
The Autumn 2009 issue of McKinsey on Finance contains an article by Eric Lamarre, director of McKinsey's Montreal office, and Martin Pergler, a consultant in the Montreal office, that does a good job of elucidating the types of indirect risks companies should include in their risk assessments.
The above graphic illustrates the types risk triggers in the business environment (outer circle) that lead to:
Changes in a company's competitive position
Changes in the company's input costs due to changes along its supply chain
Changes in the health and/or performance of the company's distribution channels
Changes in the ability and/or willingness of customers to buy from the company
The company needs to identify the ways in which risks may cascade from external events to changes in the competitive picture, the supply chain, distribution channels, and customer behavior, and thence to such internal operational and financial factors as productivity, product and service performance, and costs (inner circle).
A complete risk management process will include assessing the likelihood and significance of a range of relevant risk cascade scenarios. Lamarre and Pergler provide well-chosen examples of what this process would look like in practice. An extended example explores how new carbon regulations would affect aluminum producers, both directly and indirectly.
The basic question Williamson has examined in his research is what determines when the market is the best mechanism for handling business transactions, and when the firm is best.
Answering this question required Williamson to investigate what sorts of transaction costs make use of the firm structure — a hierarchical structure — more economical, relative to depending on market dealings.
As the Royal Swedish Academy of Sciences explains in its summary for the public,
... Williamson expects hierarchical organizations to emerge when transactions are complex or non-standard [making it hard to write complete and enforceable contracts], and when parties are mutually dependent. Perhaps the most typical case of mutual dependence is that parties have assets, either physical assets or knowledge, which are only valuable inside a relationship.
For example:
The value of a coal mine in case the owner cannot agree on the terms of trade with a nearby power plant depends on the distance to the second-nearest buyer of coal, which is usually another power plant. Likewise, the value of a coal-burning power plant in case it cannot trade with the nearby coal mine depends on the distance to the second nearest mine. The larger the distances, the greater is the mutual dependence, and — according to the theory — the more likely the mine and the plant are vertically integrated. This is precisely what is observed. When there are other nearby mines and power plants, firms are typically incorporated separately and trade under relatively short and simple contracts. As the distance to alternative trading partners increases, contract duration and complexity also increase. According to one of the studies, a coal-burning power plant that is located next to a coal mine is about six times more likely to be fully integrated than is any other coal-burning power plant.
For further coverage of Williamson's work, touching upon the evidence for the validity of his theory, its policy implications, and how it has been expanded and deepened by other researchers, you can read the Academy of Sciences' Scientific Background (pdf – about six pages each on Williamson and Ostrom).
As noted in an earlier post, when households have increased access to microcredit, one of the impacts can be less use of insurance because microloans make it easier to obtain informal credit in the event of a financial shock.
Last month, Knowledge@Wharton offered an overview of steadily expanding efforts to market microinsurance effectively to poor people in developing countries. As the article explains, micro insurance comprises
risk-sharing products characterized by low premiums and coverage limits [and it] generally covers everything from life and health care to weather, property, agriculture, livestock and catastrophe.
For example, in a pilot program in Bangladesh, a partnership of six NGOs and a local insurance company is offering a product that combines life insurance with some hospitalization coverage. The basic idea is to provide a formal safety net for people who have income, even if small, to protect.
The article discusses the issues participants in micro insurance market need to address, such as making sure the perils covered by property and casualty insurance are relevant for a particular locality. Another key issue is developing a solid partnership among the parties involved — typically, NGOs, micro finance institutions, insurance companies, regulators, and community groups. Last but not least is the issue of educating both the target population and the micro insurance providers.
Why Systemic Risk is Relatively High in the Financial Sector
If you'd like a refresher on the causes of the financial crisis, the Federal Reserve Bank of St. Louis has published an accessible recap in the September/October issue of their Review.
"Systemic Risk and the Financial Crisis: A Primer", by the St Louis Fed's CEO, James Bullard, and two economists at the Bank, Christopher J. Neely and David C. Wheelock, also explains "why the failures of financial firms are more likely to pose systemic risks than the failures of nonfinancial firms," and discusses remedies that have been suggested to better manage systemic risk in the future.
Because understanding what's unique about systemic risk in the financial sector is important for evaluating proposed policy changes affecting the sector, that's what I'll focus on in this post. The whole article is only twelve pages long and well worth a look.
First of all, here's the definition of systemic risk that Bullard, Neely, and Wheelock (BNW) use:
the risk that a triggering event, such as the failure of a large financial firm, will seriously impair financial markets and harm the broader economy.
BNW cite three reasons why the level of systemic risk is relatively high in the financial sector:
Interconnectedness among firms — The volume of inter-firm lending and trading transactions is high, the speed of transactions is rapid, and the "complex structures of many banks and securities firms make it especially difficult for a firm to fully monitor the counterparties with which it deals, let along the counterparties of counterparties." The upshot is elevated settlement risk — "the risk that one party to a financial transaction will default after the other party has delivered."
Firms' high levels of leverage — Financial firms finance a significantly higher percentage of their assets (e.g., holdings of mortgage-backed securities) through borrowing than do typical nonfinancial firms. The upshot is that financial firms are highly vulnerable to insolvency if their assets experience a downward slide in value due, say, to bursting of a real estate bubble.
Financing relatively illiquid investments with short-term debt — For example, commercial banks finance much of their lending, for which maturities are measured in years, by customer demand deposits (checking accounts), which are generally subject to withdrawal at a moment's notice. The upshot of this mismatch between the maturity of assets and the maturity of debt is that financial firms face elevated interest rate risk (the risk of having to pay a higher interest rate as existing short-term debt matures and is replaced with new borrowing) and liquidity risk (the risk of having to raise cash by selling assets during a period when asset prices are depressed, perhaps because buyer confidence is low).1
As BNW explain in a footnote, "Systemic risk constitutes a 'negative externality' in the sense that the actions of one firm harm others. ... Negative externalities are an example of a market failure that may require government intervention to ameliorate." Proposals for changes in the regulatory regime for the financial sector will be under active discussion for the foreseeable future. BNW's article helps laypeople understand the issues and market dynamics that are at the heart of the discussion.
__________ 1 During a financial crisis, lenders may withdraw from the credit markets entirely due to uncertainty about counterparty reliability and solvency, future interest rate conditions, and collateral values. In this situation, which we have seen during the current crisis, new borrowing is effectively impossible.
C.K. Prahalad on Managing in a Volatile Market Environment
You can get an overview of the thinking of C.K. Prahalad (Ross School of Business at the University of Michigan) concerning how firms should gird themselves to deal with a volatile market environment by reading the one-page column he wrote for the September 21 issue of BusinessWeek.
Prahalad's central point is that in today's environment firms must structure themselves so they are able to operate with agility — and they must do so in a way that, however paradoxical it may sound, is compatible with maintaining a consistent strategy.
When you read the column, you will see the steps Prahalad would have firms take to protect themselves from the risks associated with volatility, such as conserving cash, converting fixed costs to variable costs, and focusing on core competencies. I would call particular attention to his comments on the type of human resource management that is required in order to have a flexible workforce:
To better handle the constant project turnover, employees are cross-trained in many different skills. This requires an arsenal of training programs. Employees are regularly tested, and the hallmark of the best of them is the ability to learn quickly.
Having this much flexibility in a staff, and within each staffer, forces these companies to equip their managers with instant access to data on what each employee can do and where they are — physically and in terms of the finish date of their current assignment. All employees know they will be moved from one assignment to another, and in many cases across the world. It becomes the cultural expectation.
There is a clear affinity between what Prahalad is saying here, and the nature of needed employee capabilities and qualities in a "post-Fordist" organization discussed in last Tuesday's post.
On July 22, Knowledge@Wharton published an excellent overview of how scenario planning can help companies maintain a state of preparedness despite the uncertainties that figure so prominently in today's business environment.
My own copy of the article is so heavily highlighted that I know it's something I must recommend reading in its entirety — it's only about four pages. I'll simply highlight two main themes:
Scenario planning is a way of gaining strategic flexibility in the face of an uncertain future.
"... some companies ...have developed a competitive advantage by leveraging scenario planning — first in stimulating discussion about potential outcomes arising from the swirling mix of trends shaping the world, and then in establishing monitoring mechanisms to identify which scenario is starting to unfold. In the end, the major objectives for these companies are to minimize surprises and to consistently anticipate — and act on — major emerging opportunities and challenges, ahead of competitors."
The leaders of a company need to be directly involved in the scenario planning process so that they are forced to examine their assumptions about how the world works and to experience what's involved in analyzing data with an open mind.
The artcle quotes Kristel Van der Elst, head of the scenario planning team at the World Economic Forum: "You end up changing how people think. The long-term benefit is that you open up people's minds ..."
If you'd like to take a look at the sample set of scenarios cited in the article, you can find the paper in question — "Scenarios for the Downturn & Rebound," by Rob-Jan de Jong and Paul J.H. Schoemaker — here (pdf).
Two days ago I wrote a post concerning research studies evaluating microcredit programs in India and the Philippines. Right on cue, today's Wall Street Journal published an article by Ketaki Gokhale that describes how microcredit in India may be moving beyond what the researchers' found — a mixed story of effectiveness in mitigating the effects of poverty — to being positively malign for some communities.
The problems Gokhale describes arise from the shift of microcredit into what is called its "second generation" form. Microcredit began as a substantially philanthropic activity, with financing derived from various non-profit sources. Recently, profit-seeking investors have become actively involved, and a range of risky practices akin to those observed in recent years on a much larger scale in standard credit markets are showing up.
The basic problem is an overabundance of funds available for lending relative to the number of creditworthy prospects for microloans. The plentitude of funds, combined with microlenders' often paying their field officers on a commission basis, makes careless underwriting a powerful temptation. For example, borrowers may be allowed to lie about such matters as the intended use of the loan they're seeking and their existing level of debt.
There is also an issue of interest rates, which Gokhale reports are generally in the 24% - 39% per annum range. Once borrowers take out a loan at a high rate, if they do not put the funds to use to generate sufficient income to pay off the loan, they can find themselves in a spiral of indebtedness similar to that which afflicts many users of payday loans in the US.
Finally, there is a religious element to the story. Many Muslim borrowers in Ramanagaram, the city in southern India where Gokhale did much of her reporting, have stopped paying on their loans in response to direction from their mosque imams, who object to "the overindebtedness of the community, and the strains it's putting on family life." Gokhale reports that these complaints are viewed by some as a smokescreen for trying to disempower women, who are the majority of borrowers. This revolt against honoring loan agreements is spreading to other communities.
The Efficacy of Microcredit in Promoting Business Growth and Alleviating Poverty
In severalpreviousposts I've discussed microcredit. These posts have all looked at programs that combine provision of credit with training in managing a small business and the revenue it generates. The key issue is how much impact these programs have on business size and on the standard of living of the people and communities involved.
Now some further research on the efficacy of microcredit in alleviating poverty and promoting business growth has come to my attention, thanks to The Economist, which published a one-page article on the subject in their July 18 issue. Two studies are described:
An investigation of the impact of access to microfinance in Hyderabad, India. The study compared low-income neighborhoods that were added to a bank's microfinance market area with low-income neighborhoods that were left out of the market area. Assignment of neighborhoods to the treatment and control groups was random.1
An investigation of the impact of access to microfinance in the Philippine provinces of Rizal and Cavite and in the Manila area. As in the Indian study, this Philippine study used randomizing to address the problem of self-selection, i.e., the problem that the most entrepreneurial individuals are the ones most likely to take advantage of microcredit, and providers of microcredit favor markets where such individuals are concentrated.
In the Philippine case, it was individual credit applicants who were assigned randomly to the treatment and control groups. Those in the treatment group received loans, while those in the control group did not. All of the applicants in question were of marginal creditworthiness, so bank loan officers, not privy to the nature of the experiment, accepted (with a few exceptions) their computer system's decree as to whether or not a particular applicant should be approved, even though the decision was, in fact, random.2
Neither of the two microcredit programs was bundled with client training.
The Hyderabad study's findings, based on a survey done 15 to 18 months after the launch of the program, suggest that
microcredit does have important effects on business outcomes and the composition of household expenditure. Moreover, these effects differ for different households, in a way consistent with the fact that a household wishing to start a new business must pay a fixed cost to do so. Existing business owners appear to use microcredit to expand their businesses: durables spending (i.e., investment) and business profits increase. Among households who did not own a business when the program began, those households with low predicted propensity to start a business do not increase durables spending, but do increase nondurable (e.g., food) consumption, consistent with using microcredit to pay down more expensive debt or borrow against future income. Those households with high predicted propensity to start a business, on the other hand, reduce nondurable spending, and in particular appear to cut back on "temptation goods," such as alcohol, tobacco, lottery tickets and snacks eaten outside the home, presumably in order to finance an even bigger initial investment than could be paid for with just the loan.3
The authors of the study note that it is
somewhat hard to assess the long run impact of the program. For example, it is possible that in the longer run those people who are currently cutting back consumption to enable greater investment will become significantly richer and increase their consumption. On the other hand, the segment of the population that increased its consumption when it got the loan without starting a business may eventually become poorer because it is borrowing against the future, though it is also possible that they are just enjoying the "income effect" of having paid down their debt to the money-lender (in which case they are richer now and perhaps will continue to be richer in the future).
Also
microcredit ... appears to have no discernible effect on [children's] education, health, or women's empowerment [decision-making concerning household spending, investment, savings, and education]. Of course, after a longer time, when the investment impacts (may) have translated into higher total expenditure for more households, it is possible that impacts on education, health, or women's empowerment would emerge. However, at least in the short term (within 15-18 months), microcredit does not appear to be a recipe for changing education, health or women's decision-making. Microcredit therefore may not be the "miracle" that is sometimes claimed on its behalf, but it does allow households to borrow, invest, and create and expand businesses.
The Philippine study also used surveys to assess microcredit impacts. The surveys were conducted 11 to 22 months following an applicant's entrance into the experiment, and yielded these findings:
Individuals assigned to the treatment group did borrow more than those in the control group.
The marginally creditworthy microentrepreneurs who received credit shrank their businesses relative to the control group. The researchers suggest that this was a result of deciding to lay off employees who were not very productive. "[T]reated microentrepreneurs used credit to re-optimize business investment in a way that produced smaller, lower-cost, and more profitable businesses."
A rise in business profit does not translate into income and consumption changes. E.g., there were no significant effects on two key measures of consumption: food quality, and the likelihood of not visiting a doctor due to financial constraints. This could be due to the combination of increased business profits and decreased outside employment (with an increase in school attendance and perhaps related expenditures), thus leading to no change in total household income or consumption.
The treatment group reported increased access to informal credit to absorb shocks. This informal credit reduced the incentive to acquire formal and informal insurance.
There was some evidence that expanding access to capital (credit in this case) increases profits for male, but not for female, microentrepreneurs. Males seem to use the increased profits to send children to school; there is a concomitant decrease in household members employed outside the family business.
There was no evidence that increased access to credit improves subjective well-being — optimism, calmness, lack of worry, life satisfaction, work satisfaction, lack of undue job stress, decision making power, and socio-economic status. To the contrary, there was some evidence of a small decrease.
In sum:
"... increased access to microcredit leads to less investment in the targeted business, to substitution away from labor and into education, and to substitution away from insurance (both explicit/formal, and implicit/informal) even as overall access to risk-sharing mechanisms increases. Thus although microcredit does have important — and potentially salutary — economic effects in our setting, the effects are not those advertised by the "microfinance movement." Rather the effects seem to work through interactions between credit access and risk-sharing mechanisms [e.g., access to loans from family members] ... . At least in a second-generation setting [in which microcredit is provided by profit/sustainability-seeking institutions], microcredit seems to work broadly through risk management and investment at the household level, rather than directly through the targeted businesses. [emphasis added]
Also:
... treatment effects [e.g., on business profits] are stronger for groups that are not typically targeted by microcredit initiatives: male, and relatively high-income, borrowers... The overall picture of our results also questions the wisdom of targeting microentrepreneurs to the exclusion of consumers/wage earners. ... [O]ur findings highlight that money is fungible. Entrepreneurs do not necessarily invest loan proceeds in their businesses. Limiting microcredit access to entrepreneurs may forgo opportunities to improve human capital and risk-sharing for non-microentrepreneurs.
The Philippine researchers' concluding note is that "household financial arrangements in developing countries are complex ... [so] it is important to measure impacts on a broad set of behaviors, opportunity sets, and outcomes. Business outcomes are not a sufficient statistic for household welfare, nor even necessarily the locus of the biggest impacts of changing access to financial services."
3 "Among those who did not already own a business a year ago, the following characteristics predict the decision to become an entrepreneur: whether the wife of the household head is literate [a proxy for willingness to defer consumption], whether the wife of the household head works for a wage [which will reduce the return to opening a business], the number of prime-aged women in the household [also a proxy for willingness to defer consumption], and the amount of land owned by the household [a proxy for initial wealth]."
The President of the New York Fed on Lessons Learned from the Financial Crisis
On June 26, William C. Dudley, the President and CEO of the New York Fed, spoke at the annual Bank for International Settlements conference in Basel, Switzerland. His topic was lessons learned from the financial crisis we've experienced over the past two years.
Since Dudley's remarks, as posted at the New York Fed website, are clearly organized, and only about 4½ pages in length, I'll simply recommend that you read through them. To whet your appetite, here, slightly edited, are the summary recommendations with which Dudley concludes:
Do a better job understanding interconnectedness. This means changing how we oversee and supervise financial intermediaries.
Change the system so that it is more self-dampening.
Improve incentives.
Increase transparency.
Develop additional policy instruments. For example, we might give a systemic risk regulator the authority to establish overall leverage limits, or collateral and collateral haircut requirements, across the system. This would give the financial authorities the ability to limit leverage and more directly influence risk premia, and this might prove useful in limiting the size of future asset bubbles.
Inventory of Proposed Causes of the Financial Crisis
Reports produced by the Congressional Research Service (CRS) at the Library of Congress are not routinely made available to the public. I agree with OpenCRS that this is an unsatisfactory state of affairs. Until such time as the policy changes, anyone wanting to have a look at material from CRS is dependent on a site such as OpenCRS, or on making a special request for a particular report to a member of Congress.
A timely example of a CRS report that has made it into the public domain is "Causes of the Financial Crisis" (January 29, 2009) by Mark Jickling, a Specialist in Financial Economics at CRS.
Jickling explains the purpose and structure of his report in the summary with which it begins:
While some may insist that there is a single cause, and thus a simple remedy, the sheer number of causal factors that have been identified tends to suggest that the current financial situation is not yet fully understood in its full complexity. This report consists of a table that summarizes very briefly some of the arguments for particular causes, presents equally brief rejoinders, and includes a reference or two for further reading. It will be updated as required by market developments.
Jickling's table enumerates twenty-six causal factors that have been proposed by various analysts and commentators:
Imprudent mortgage lending
Housing bubble
Global financial imbalances (e.g., China's accumulation of vast amounts of US Treasury debt instruments)
Over-the-counter derivatives (about which information concerning risk exposures is limited)
Fragmented regulation
No systemic risk regulator
Short-term incentives
Tail risk (i.e., risk associated with extremely rare, but not impossible, events)
Black Swan theory (i.e., the notion that the financial crisis is due to such an extremely rare confluence of factors that trying to guard against future repetition would require unduly onerous new regulations that would very seriously inhibit growth)
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In the June 2009 issue of the Harvard Business Review, Roderick M. Kramer, a professor of organizational behavior at the Stanford Graduate School of Business, explains a concept that he refers to as "tempered trust." This is an attitude toward trusting people that is prudent, rather than being either unduly credulous or unduly suspicious.
Kramer argues:
We can never be certain of another's motivations, intentions, character, or future actions. ... That said, there is much that you can do to reduce the doubt — in particular, by adjusting your mind-set and behavioral habits.
Kramer offers seven rules for tempering trust:
Know yourself. Ask yourself what your disposition toward trust is.
Someone who tends to trust people too readily must work on improving his/her ability to interpret the cues people send out, bearing in mind that just about "any indicator of trustworthiness can be manipulated or faked."
On the other hand, a person who is good at reading cues, but still hesitates to form trusting relationships, needs to develop more receptive behaviors.
Start small. Take incremental steps, with further steps contingent on reciprocity. This way, you control the risk that the other party will exploit your good will. On an encouraging note, Kramer advises that "Salting your world with lots of small trusting acts sends a signal to others who are themselves interested in building good relationships ..." This leads to more positive interactions.
Write an escape clause. Kramer argues, "With a clearly articulated plan for disengagement, people can trust more fully and with more commitment."
Send strong signals. Kramer emphasizes the importance of sending clear and consistent signals of your interest in dealing with people who will trust you and be trustworthy themselves. He says, "Most of us tend to underinvest in communicating our trustworthiness to others ..."
The signals need to be unambiguous so that you attract other tempered trusters, while deterring predators, who need to recognize that you are not someone to be trifled with. The idea is to develop a reputation for fair dealing with those who reciprocate, and for retaliating strongly, but proportionately, against those who violate your trust.
Recognize the other person's dilemma. Kramer points out that "the people we're dealing with confront their own trust dilemmas and need reassurance about whether (or how much) they should trust us. Good relationship builders are proactive at decreasing the anxiety and allaying the concerns of others."
Look at roles as well as people. Kramer explains, "A person's role or position can provide a guarantee of his expertise and motivation" even when we have not had the opportunity for personal contact with the individual. "Role-based trust is trust in the system that selects and trains the individual."
Remain vigilant and always question. Kramer's admonition is to keep one's due diligence concerning others' bona fides up-to-date. Admittedly, this can feel awkward because it involves regularly checking up on people with whom you have an established relationship of trust.
The Treasury Board of Canada Secretariat has developed a tool that organizations can use to assess their degree of maturity in practicing results-based management. The graphic below summarizes the model on which the tool is based.
The Managing for Results (MFR) model, with its five supporting elements
In addition to the "pivotal characteristic" of Using Results to Manage, the MFR model includes five supporting elements (whose definitions have been edited in the list below):
Commitment to results — Focus on organizational leadership and its support for MFR, on the implementing capacity of the organization, on reinforcement of the values of MFR, and on the inclusion of MFR in evaluating managers' performance.
Questions to ask:
To what extent is your organization using results information to manage and adjust ongoing operations, strategic plans, policies and resources?
To what extent is there tangible support from management for building and strengthening MFR practices?
To what extent is MFR-related training available to managers and staff throughout the organization?
To what extent do the appraisal systems in your organization relate individual accomplishments to outcomes?
To what extent do your organization's values and ethics reflect a focus on outcomes?
Results-based strategic planning — Results should be linked to high-level organizational objectives and should guide design of operational processes. Managing for results should also be linked to risk management.
Questions to ask:
To what extent is there a linkage between immediate and intermediate outcomes and the organization's strategic outcomes?
To what extent are horizontal initiatives reflected in your organization's strategic plans?
To what extent is risk management systematically practised in your organization and linked to outcomes?
Operational/business planning — Focus on performance expectations and how these align with the organization's outcomes. The expectations should include outputs and outcomes, wherever possible.
Question to ask:
To what extent does your business plan specify organization-wide performance expectations that are clear, concrete and time-bound?
Measuring results — Data collection should include outcomes, not just inputs, activities and outputs. Measurement should be linked to planning and reporting, and cost should be integrated with results measurement. Note that the evaluation role is also a key part of the development of a measurement strategy.
Questions to ask:
To what extent do you measure outcomes?
How easy is it to relate these measurements to financial measures? How often is this linking done?
To what extent is evaluation integrated into the management of programs and policies?
Reporting on results — Focus on the integration of external reporting with actual practices and results within the organization.
Questions to ask:
To what extent are the results data used for internal managing and for external reporting?
How consistent is the information used for managing with the information reported externally?
The assessment tool is essentially a rubric that describes five levels of maturity, which the Secretariat refers to as transition stages:
Awareness
Exploration
Transition
Full implementation
Continuous learning
The self-assessment tool is available in MSWord and pdf formats.
For a straightforward approach to allowing employees scope for exercising their intelligence and creative talents, while controlling risks associated with empowerment, you can look to the "levers of control" framework put forward by Robert Simons, a professor at Harvard Business School.
Simons recommends adopting four types of control system so that employees can "initiate process improvements and new ways of responding to customers' needs — but in a controlled way." The four types of control system are:
Diagnostic control systems — The traditional approach of checking performance against plan by monitoring critical performance outcomes, such as sales and profits.
Belief systems — Communication of your company's core values and its mission in a way that inspires employees' commitment and motivates them to "search for new ways of creating value." Simons notes, "In the absence of clearly articulated core values, [employees] are often forced to make assumptions about what constitutes acceptable behavior in the many different, unpredictable circumstances they encounter."
Boundary systems — Ground rules for operations, and limits on the types of opportunities that employees are allowed to pursue. Simons argues that empowerment only works if you refrain from making lots of rules about what employees must do, and instead specify what they may not do. For instance, departures from ethical behavior should be clearly verboten. A company will probably also want to specify types of business it does not want to get involved in (perhaps because of lack of needed competencies), and/or types of customers it does not care to serve. Simons argues, "Boundary systems are especially critical in those businesses in which a reputation built on trust is a key competitive asset."
Interactive control systems — The "formal information systems that managers use to involve themselves regularly and personally in the decisions of subordinates." In practice, this means regular face-to-face discussion between senior managers and subordinates to assess emerging information and new ideas that may or may not indicate a need to revamp the company's strategy and action plans. Managers are looking to "identify specific vulnerabilities, opportunities, and the source of any problems that require proactive responses." The sorts of questions to explore are What has changed since our last forecast? Why? What are we going to do about it?
Note that the combination of belief systems and boundary systems effectively define the domain within which employees are encouraged to actively seek profitable innovations.
Elizabeth Warren on the US Treasury's TARP Strategy
An earlier post called attention to Elizabeth Warren's video talk on modernizing financial regulation. As a follow-on, below is the video released today in which Warren, in her capacity as chair of the Congressional Oversight Panel monitoring the Treasury's Troubled Asset Relief Program (TARP), introduces the panel's April report, titled "Assessing Treasury's Strategy: Six Months of TARP."
In the video, Warren talks about the pros and cons of three approaches to dealing with bank failures — liquidation, receivership, and subsidization. She also explains the four criteria by which the panel is judging the Treasury's performance in using TARP funds to restore stability to the banking sector — transparency in the presentation of bank accounting statements, assertiveness (decisiveness) in addressing failing institutions, accountability of bank management, and clarity concerning what the government is doing and why.
Having had the unsettling experience of working with a strategic planner at a large company who had a remarkably unenterprising approach to competitive analysis, I was glad to see the helpful advice Kevin Coyne and John Horn offer in an article published in the April issue of the Harvard Business Review.
Based on their experience at McKinsey (Coyne is an alum now teaching at Emory University's Goizueta Business School, Horn is a consultant at McKinsey's Washington DC office), and on a survey of some 1,825 senior executives at a cross-section of companies, Coyne and Horn offer a practical approach to competitive analysis that requires careful thought, but is not onerous in terms of the amount of information that needs to be gathered and processed.
Specifically, Coyne and Horn address the issue of how to go about taking account of likely competitor reactions to a "major initiative." A major initiative was defined in their survey as a move at the strategic level, i.e., a move "with 'the potential to significantly affect' the [survey] respondent's view of her company's competitive position." Two types of initiative were considered: a product or service innovation, and a change in pricing.
The Coyne-Horn approach involves answering three questions concerning a major initiative:
Will the competitor(s) react at all? Coyne and Horn found that 17% of their respondents answered No when asked if they had responded to a competitor's most recent major initiative.1
Your answer to this question will be Yes only if you answer Yes to all four of the following subquestions. If any of the answers is No, you are done; you don't need to proceed to questions 2 and 3.
Will your rival see your action? Coyne and Horne found that only 23% of the managers they surveyed learned about a competitor's new product or service early enough to respond prior to the market launch. Only 12% learned about a price change in time to take pre-emptive action.
Will the competitor feel threatened? Coyne and Horn suggest that if the competitor can stay on plan in the face of your initiative, they very possibly will keep on doing what they're doing rather than adjusting to the new state of play.
Will mounting a response be a priority? Coyne and Horn point out that the competitor may be disinclined to shift its attention from its current activities to react to your move.
Can your rival overcome organizational inertia? Coyne and Horn suggest that if substantial changes in strategy and/or established processes would be needed to mount a response, the competitor may very end up ignoring your move (at least until the pain resulting from the changed market situation compels a response).
What options will the competitor actively consider? Coyne and Horn found that only 25% of companies that examine ways of responding to a competitor's major initiative consider more than three options. Also, the options considered tend to be "the most obvious ones: matching a price change or introducing a me-too product."
Which option will the competitor most likely choose? Coyne and Horn argue that, as a rule, the competitor will choose the option "that is most effective (according to his analytic technique) within the constraints of his trade-off between short-term and long-term pain."
To apply this rule, you need to consider two subquestions:
How many moves ahead does your competitor look? Coyne and Horn found that "fewer than 10% of the managers surveyed looked at more than one round of response by more than one competitor."
What metrics does the competitor use? Coyne and Horn suggest deriving an answer to this questions by asking the related question, "What measure would have led my competitor to his recent decisions?" They caution that any "long-term" metrics (e.g., "long-term" market share) be evaluated in light of the fact that only 15% of companies look more than 4 years out when assessing the likely "long-term" costs and benefits of options under consideration.
Once you've arrived at your answer to Question 3, you're ready to
mimic your adversary's decision-making process by applying his metrics and analytic techniques (including the rounds of competition) to the options you think he will look at in order to see which one (or ones) seems best.
To carry out this final step in the competitive analysis, you need to attain an understanding of
the patterns the CEO or relevant executives have displayed in prior decisions ... Talk to people who have worked with those executives and learn about the units they have led. Look at the history of the competitor's other units as well.
The Coyne-Horn approach is practical and doable because it focuses "on understanding how a competitor actually behaves rather than on the theory of how everyone should behave." The above summary outlines what you'll find in the article, but reading the whole piece is highly recommended.
__________ 1 Coyne and Horn emphasize that there is significant variation in competitor behavior across locations and industries. Therefore, the average responses reported in the article are suggestive but are not represented as applying precisely to any particular location or industry.
