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Volatility Is Good For You

Volatility Is Good For You

It has become an article of faith that economic and political predictability are a good thing for the economy. Indeed, there are explicit links made between the discount rates applied to national foreign debt and the erratic or placid nature of the respective operating environments.

Much has also been written about 'dancing on the edge of chaos', not all of it entirely coherent. The message is, however, that there is a border between shambles and frozen, locked-in states, and it is in this area that fruitful change occurs.

There are curious parallels between ecology and business. Commercial frameworks seem to tend towards monopoly, unless regulated. Ecologies tend to a static, 'climacteric' state. There is a supposedly fundamental law of ecology which states that, at equilibrium, the number of co-existing species cannot exceed the number of limiting resources. If Michael Porter were to re-write this rule, it would probably say that there can be no more types of firm in a marketplace than there are defensible rent barriers inherent in it. (Or distinctive competencies, or whatever your favourite guru prefers.)

This gives rise to the so-called 'paradox of the plankton': that despite this law, very many species do, in fact, co-exist. In a paper* in Nature, the answer is spelled out. It is to do with chaotic cycling. That is, species populations will exhibit chaotic fluctuations when their members compete for three or more separate resources. This generates a constantly changing environment, with which many species can each individually find temporary, relative advantage. Complex populations of this sort are resilient, insofar as they can react quickly to any external change.

Accept a degree of instability

Monocultures fail absolutely, whilst diverse systems fail piecemeal, with others queueing to fill the vacancy. If, as a citizen, therefore, you want an adaptive and stable economy, then you should accept a degree of instability as the price of pluralism. If, however, as an employee or a shareholder, you want the secure performance of one particular firm, then you will seek absolute external placidity, in which this firm can proliferate (or, again, fail absolutely, or be subject to predation). Shareholders can diversify away this risk so long as corporations themselves remain diverse. The recent wave of benchmarking (etcetera) has tended to drive firms to resemble each other ever-more closely, and - I would suspect - to entrain their earnings and to homogenize their options.

Large corporations, however, embody some capacity to diversify risk, provided they are prepared to accept some diversity. They are relatively slow to sense the changing external environment, and yet slower to respond to it. (cf. the Economist article, Fear of the Unknown, pp. 89-90, 4 December 1999). They can compensate for this by maintaining 'plankton', diverse potential responses which will emerge organically as the challenges themselves change. This does not require an integrated, conscious response, just many independent, coherent but different responses.

It is worth noting that markets value firms chiefly for their intangibles, and that the explicit trade in intangibles in the US has risen from USD15 bn to USD100 bn in seven years. Implicit acquisition of assets such as IPR and 'connections' may have driven much of the M&A surge, however. It is the capacity to organise knowledge and the knowledgeable, to create joint relationships and to deploy the new infrastructure of the information age - a myriad of partners, routes to market, subcontractors - which are likely to be the defining characteristics of success. It is easy to see where the room for improvement exists, but it is hard to redesign formal, unique approaches to the ill-defined and the intangible. With regard to the early stages of such projects, therefore, the best solution may be to try many solutions, and to emphasise the one that seems to work at present. Pluralism and apparent inefficiency may be the strongest prescription for success.

(* Nature 402 pp. 407-410, November 1999)

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