Monday, July 23, 2007

On "Management by Data"

Today's Wall Street Journal contained an article by Scott Thurm entitled, "Now, It's Business By Data, but Numbers Still Can't Tell Future."

As I began to read the piece, I was hopeful that it would herald a general trend toward more competent, aware, and quantitatively-sensitive management by more senior executives in US large-cap companies.

Mr. Thurm writes, in part,

"The success of enterprises as diverse as Harrah's Entertainment, Google, Capital One Financial and the Oakland A's has inspired case studies, books and consultants promising to help executives outpace rivals by collecting more information and analyzing it better.

There is much to be said for the approach. Guided by Chief Executive Gary Loveman, a former Harvard Business School professor, Harrah's rethought customer incentives, adjusted slot-machine payouts, and poured money into hiring and retaining top-notch employees. Its shares are up more than fourfold in the past decade and the company has agreed to a $17 billion buyout by private-equity firms.

Google has outdistanced Yahoo, Microsoft and others by tweaking both its Internet-search algorithm to provide better and faster results, and its formula that determines what ads are displayed alongside search results. This virtuous circle draws both more Web surfers and more advertisers.

In many cases, analyzing data would be an improvement over prior management techniques, which Stanford business professor Robert Sutton derides as "faith, fear, superstition and mindless imitation." Mr. Sutton is co-author of "Hard Facts, Dangerous Half-Truths & Total Nonsense," one of several recent tributes to the data-driven enterprise."

So far, so good. Then, Mr. Thurm states,

"Running a complex enterprise can't be reduced to a spreadsheet, however. Even the most detailed statistical analysis has limitations, as Mr. Sutton acknowledges.

For one, conditions may change, rendering the analysis misleading....

The tension between the short term and the long term is familiar to managers. Other research suggests that quality-focused approaches may reduce defects, but hamper innovation.

That helps explain why companies seem invulnerable one minute and aimless the next. For a decade, Dell captured an increasing share of sales and profits in the PC industry by mastering supply-chain logistics. But Dell couldn't diversify its business, making it vulnerable once Hewlett-Packard matched its expertise.

The real trick, then, is to combine these skills, gaining advantage by analyzing today's problems while looking creatively for tomorrow's opportunities."

At this juncture, I became pretty disappointed with Mr. Thurm's article. After initially acknowledging the value of data-driven management, whether it be marketing, operations, competitive, or environmental data, he rather quickly began to give reasons why it's not enough.

Of course it's insufficient to just analyze data and manage in light of it. What Mr. Thurm, and most other business writers, continue to fail to acknowledge is Schumpeter's original observations concerning the fragility and impermanence of any company's dominance of dynamic, attractive markets.

I will further add, from my proprietary research, that diversification generally spells mediocrity.

Thus, the fundamental reality that is so frequently missed, including in Mr. Thurm's article, is that even the best management of a great business is fated to earn consistently superior returns for a limited time period. I've argued elsewhere as to why my preferred metric is consistently superior total returns, so I won't repeat them.

Suffice to say, it's simply unrealistic to expect any one firm to use one, or more, management approaches to sustain its consistently superior return performance. That takes a mix of good management, plus innovation. Historically, firms simply do not continue such performance even for a decade.

Success typically creates its own competitive reaction, if not environmental and legal/regulatory ones.

Thus, Dell's weakness was not failing to diversify, but simply succeeding so well for so long. To have done less would have brought another consistently-superior performance-ending scenario into being.

Despite Mr. Thurm's contention that "the trick" is to balance current management and future opportunities, it's not a trick at all. It simply exists so rarely, if at all, as to be practically impossible.

Thus, the point of his article becomes more about noting another management fad, rather than a serious, philosophical revelation that even the best managerial schemes cannot forestall Schumpeter's fundamental observation: that businesses exist in shifting sands of competitive and environmental contexts which prevent them from enjoying consistently superior performances without innovation. And to which I would add, few successful firms innovate sufficiently radically to move them beyond the developing trap of their current, consistently superior performances, while successfully adapting to the new innovations to continue their current performances.

It's nice to read about how some firms have successfully used data to manage themselves in ways which earn consistently superior returns. It's dispiriting to read yet another business column which suggests that companies can achieve perennially consistently superior return performance, if only they would combine the right mix of managerial tonics.

That's just not how business has worked, nor, due to the nature of humans operating them, are ever likely to work in the future.

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