Strategy to prevent systemic failure

Applying group-think and sell-by date concepts in business

LAST time I discussed whether lack of board diversity was the cause of group-think and failure as a result. My view is that lack of diversity per se does not create group-think, though board dynamics do.

Dominant CEOs and chairmen are often highly successful people and it is this track record of success that makes it hard for independent non-executive directors to challenge them.

Yet challenge constructively they must because strategies have sell-by dates and so recipes for past success can become guarantees of future failure – at its worst, manifested in systemic failure.

For 20 years, Jack Welch followed an immensely successful growth strategy of milking General Electric’s (GE) industrial businesses to invest in the faster-growing financial services sector – to the point where banks complained GE had an unfair competitive advantage as a financial institution because of its AAA rating resulting from being classified as an industrial company.

Their successful lobbying stopped GE continuing to grow in financial services. Welch’s successor Jeffrey Immelt took over a company whose growth engine was in neutral, having to face the problem that the industrial businesses were short of new products because not enough had been invested in research and development (R&D).

Turning that R&D deficit around took years of cash-consuming investment with no immediate payoff. So it is hardly surprising that compared with the Welch years, the Immelt years do not seem stellar. Yet Immelt’s problems were of Welch’s making.

I am sure that it must have been very difficult for independent directors to challenge Welch’s strategy and argue that his drive into financial services was unwise – all the more so since the strategy was lauded in business schools and written up in top-selling management books.

Group-think does not just happen within the board – conventional wisdom is just another form of groupthink and directors on GE’s board from diverse backgrounds would have been influenced by what they had read.

In the case of GE, the strategy sell-by date was caused by continuing with it for too long. Perhaps this is what Toyota is facing at the moment. For decades, its strategy has been astonishingly successful. It reached global No. 1; it had an unparalleled reputation for quality; it taught the world “Lean Manufacturing” – how to make not just cars but anything with concepts such as “Just In Time”, “Kaizen” and quality circles.

It was the low-cost leader in its industry that also managed to differentiate itself with luxury models such as Lexus, disproving Michael Porter. It was hugely cash rich, so that it could almost be regarded as a bank. Such a track record of continued success must have been immensely hard to question, regardless of whether the board had the diversity recommended by The Economist or not.

“If it ain’t broke, don’t fix it” is just another way of describing group-think and of failing to recognise that strategies do have sell-by dates.

In Toyota’s case, its chase for market share may have led it to drive down supply chain prices just that bit too far, outsourcing to one new factory in a new country too many, where its cardinal principle of quality was not adequately understood.

Sharing platforms across models, sourced from all over the world only amplified any glitch so that one defect affected millions of models across the range, damaging the brand across the board as opposed to being containable in just the affected model.

Just as it will take GE time to recover from going past its strategy sell-by date, it may also take Toyota longer than people realise because unwinding what has been done so well for so long is really difficult, if that is what it has to do to recover its reputation.

That brings me to systemic failure, often the result of group-think on a board with diverse backgrounds – though the groupthink here is of a different kind – the kind that caused the global financial crisis.

This is group-think caused by the herd instinct: the argument that if other people are doing it and making lots of money, then we should be doing it too. This may not be sound thinking, but it reflects the pressure boards of financial institutions were under from shareholders and analysts when their results were being compared with other companies that were in opaque derivatives.

When one or two institutions behave irresponsibly to make supernormal returns, it does not threaten the system (the famous “free rider” problem in economics), but for all to do so will cause the system to collapse.

That is what happened with subprime, collateralised debt obligations and credit default swaps, termed “dancing” by Chuck Prince, then CEO of Citigroup, when he explained that everybody was on the dance floor as was Citigroup – the trick being to get off before the music stopped – i.e. before the strategy had gone past its sell-by date.

The writer is CEO of Securities Industry Development Corp, the training and development arm of the Securities Commission.