Tag: agile economics

Economic Knowledge Organization

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Transformation is the systemic restructuring of the knowledge production processes and decision-making networks within an organization. While a precise history and understanding of the organization status quo is impossible, it is also foolhardy to begin a transformation without any respect for the system as we find it. Mature organizations adapt over extended periods of time to a unique pattern of decision-making. The individual workers change continuously, so the organization replicates knowledge of the decision-making processes as patterns of behavior increasingly distant from original context. The systemic understanding of the original context for the behaviors becomes separate from the decision-making units performing the behavior. The origin of organizational knowledge becomes increasingly distant from the processes using outdated knowledge.

Maturity produces stability at the expense of adaptability, just as the bones of an adult gain load-bearing capacity at the expense of the trauma-bearing malleability of the bones in a child. Children rarely need to lift heavy objects but frequently fall, while a young father may frequently lift and move heavy objects but falls that might break his adult bones are very rare. The goal here is not to contend that transformation is impossible or that maturity is superior to malleability. Instead, we should recognize from the outset that each have costs and benefits. The first consideration of any disruptive influence must be what purpose current adaptations serve.

We should “start at the beginning” then, and define what an organization is, why it survives, and what it means that it matures. Every organization is a combination of decision-making units that cooperate collectively in the expectation of individual benefit. However, the decision-making unit is neither the collective nor the individual. The totality does not make decisions independent of the individuals comprising it. The individual, though self-interested, never makes decisions in a vacuum. Therefore, the decision-making units within the organization could be pairs of individuals, formally identified groups, or informal teams who act together. Likewise, these individuals are not exclusively participating in the decision-making unit that performs within the boundary of the organization. The knowledge worker might make decisions within the organization as part of a jobsite decision-making unit, as a family-system provider, as an alumnus of a university, or as a thought-leader in a professional community. If we lose ourselves in consideration of the individuals, we may become convinced of chaos and uncertainty, never knowing if cooperative self-interest will optimize the family, fraternity, or career prospects at the organization’s expense. However, as we scale to include larger groups we find that emergent consistencies hold despite these individual differences. The operational “team” follows patterns of behavior even as individuals join or exit. We should thereby place our consideration of the decision-making unit at this “team” level.

The decision-making unit is not the individual, while each of these individuals participate in a multitude of decision-making units. We need not apply a hard constraint to the number of individuals a decision-making unit may contain in practice, though we may say with confidence that one of two constraints limit this size. First, beyond 10 individuals it will become evident that a subset of members is the informal decision-making unit within the formal collective. These leaders must agree or a decision fails, while the remainder provide knowledge but will defer to group decisions. The ability to remain silent altogether increases as the diffusion of responsibility, whether economic, social, or psychological, spreads across a larger collection. Second, beyond 10 individuals, diminishing marginal returns make it increasingly difficult to ensure that each member is producing the maximum effort on behalf of the group. A large formal group then creates informal smaller groups that ensure their own expectations of cooperative effort and protect their own group from outsiders. In the mature enterprise, there typically exists a mixture of formal hierarchy and informal group dynamics. The formal hierarchy develops each time a costly situation makes the benefit of observers that ensure the productivity of subordinates outweigh the cost of trusting individuals to optimize their own productivity. The informal groups that form as decision-making units distinct from the formal hierarchy do so to participate in the spread of beneficial knowledge that the formal hierarchy cannot provide alone.

To answer the question, “Why do organizations form?” we should rely on an economic definition of value creation as the combination of inputs with knowledge. Value increases through many mechanisms, but knowledge is what makes value increase exponentially for a linear increase of inputs. Moreover, this value is subjective but aggregate. The “owners” of an organization do not own much at all, if ownership is the freedom to dispose of inputs according to any desire. For instance, the owner of an airplane is not free to land on an interstate highway, and the owner of a lake is not free to restrict air traffic or the orbit of satellites overhead. Property is not only material, but also intangible. Property ownership is not freedom of disposal, it is the legal privilege to constrain the use of a mutually identifiable resource. Those who form an economic organization do not create property that they may own it and dispose of freely. Instead, they cooperate to constrain and guide the use of resources to maximize value through the addition of knowledge. All value creation is part of a knowledge process. The “owners” of an organization, whether a sole proprietor, partnership, or the shareholders of a publicly-traded corporation, are the residual claimants to any value leftover.

We will adopt the terminology of the “residual claimant” to maintain strict honesty that the organization is not profit seeking nor the owner of property. Each socioeconomic organization is collection of individuals with knowledge, engaging in cooperative self-interest, making decisions that maximize the incremental subjective value of outputs. The residual claimants receive both the profit and the loss of such value-add activities. The residual claimants invest in a production process, but their residual claim at any time boundary exists as a positive or negative return.

Transformation has a clear economic definition with these concepts as a foundation. Transformation is a paradigmatic shift in decision-making processes needed once an organization can no longer attain the knowledge required to maximize value creation. The resistance to such transformation comes from many sources. The benefits of the new paradigm are often unknown while the cost to the individuals that comprise the organization are often high. The changes necessary for one set of decision-making units may undermine the performance of other decision-making units. The benefits of the new paradigm may benefit newcomers, while incumbents rely on the formal and informal networks to resist this challenge to the processes that benefit them.

Management by Spreadsheet? You’re Doomed

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How Bad Operations Management – Capacity Utilization and “Managing by Spreadsheet” – will destroy your company.

Of course, this favorite tactic of ineffective operations managers takes so long to unravel everything you’ve worked for that leadership never figure out what happened. After the laws of economics bring the company to its knees, smaller in revenue and resources, they begin growing again, repeat the same mistakes, and crumble.

My colleagues and I enjoy calling this flawed approach “Management by Spreadsheet” – and it is unfortunate that this is a scenario where leaders rarely learn from history and are proverbially doomed to repeat it.

I understand, knowledge workers are expensive and variability of demand for their brilliance as spending on payroll rises is a terrifying prospect.

But I promise you this: The moment you attempt to control variability in capacity utilization for your individual allocable resources, you have signed a death sentence for your knowledge-worker-dependent company.

Why? A focus on capacity utilization sends a clear message to employees that there is nothing more important than the time they spend actively engaging in the most important function on their job description – which you probably put right on that spreadsheet. Every individual will now maximize their own workflow and they will do it at the expense of the overall system.

How? This emphasis tends to be set squarely on the “run” phase of each worker’s process. For example, a developer now has the clear message that optimizing for time spent coding is the only expectation from leadership. When an individual worker in a complex process optimizes their own capacity utilization, there are a number tactics they pursue:
– Isolation from other workers rather than collaboration.
– Dependency on other workers to complete the planning, setup, and validation portions of their workflow, decreasing quality and overall value-add.
– Demand to receive ever-larger batches of work to increase the amount of time they can work uninterrupted.
– Increasingly large-batch output, increasing cycle time and decreasing quality.
– Increased external locus of control as anything outside their large-batch run-phase focus is not their “job” anymore.

As a dog returns to his proverbial vomit, so also the operations leader focusing on capacity utilization will do everything in their power… To make this situation EVEN WORSE. (S)he will add capacity to alleviate bottlenecks.

The complex system in which individual processes optimize their own run-phase process inevitably puts immense stress at a single point in the system. Whether one person or an entire department, capacity utilization management will create one crisis after another due to bottlenecks. The individual (or team) who becomes the bottleneck becomes overwhelmed and will wave every red flag they have as high as they can.

And leadership, who put them in this painful situation, attempts to save the day with additional control over capacity – by adding NEW resources at the bottleneck.

Of course, because variability of demand was the original problem, this means capacity bottlenecks will emerge in each subsequent silo in the system over time. Typically, this does not happen within the course of one project so no one can see it except the leader who is making the bad decisions in the first place.

In software development, where resources are extremely expensive and in short supply, this has horrible consequences – many projects can stall at the same bottleneck due to the lengthy cycle time of “talent acquisition”. Companies make hiring decisions in a state of crisis, when they are least likely to consider the long-term impact of the decision for their payroll or company culture.

At first, this leads to increasingly expensive hiring decisions with the fallacious assumption that resolving this one bottleneck will balance out the system. Then, due to variability in demand and increasing batch size and feedback cycle time, other bottlenecks inevitably emerge.

This is when leadership starts doing things that make alarms go off for everyone – suddenly, because the operations tactics have made payroll expense more of a burden than ever, the company stops hiring expensive resources out of panic and begins taking the cheapest body they can throw at the bottleneck in the shortest time.

You will see your first major walk-out of your most important resources begin.

In a state of denial, a capacity utilization manager will see this as a windfall, since payroll just went down. A systems view sees this is the beginning of the end, because the ratio of people with the most historic commitment, highest barriers to exit, and longest legacy of contribution to company culture – to those who are cheap and new and willing to leave any timeout – has just shifted drastically.

If you haven’t realized it yet, that spreadsheet is lying to you and it is pushing you toward financial crisis.

The truly sad thing is that some portion of executive leadership – sometimes all of them – actually believes things are getting better. More numbers and more spreadsheets translate to “we’re doing the best we can with a hard situation.” So the capacity utilization advocates survive the crisis that follows, because they have the spreadsheet that pacifies the misled leaders. The focus stays on utilization, bottlenecks, and talent acquisition, continuing the downward spiral.

Of course, you’re also no longer leading the same company as when you started tracking capacity utilization of allocable resources – whatever cross-functional teams composed of collaborative contributors you had are gone. Sometimes, an entire functional unit has turned over, leaving you with a group that was forged in the mold of large-batch, long queue, high cycle time work.

A few bad projects and damaged customer relationships later and that variability of demand combined with the additional capacity from less effective resources create a perfect storm. A small but perfectly manageable drop in demand and every individual can no longer maximize their capacity utilization.

Panic ensues.

Your most expensive resources probably start looking for another job because they see very clearly that the marginal return on their weekly payroll just tanked.

The second walk-out occurs at this point, continuing to strain relationships with existing current customers while placing the occasional project in crisis as another resource is taken from their silo and expected to hit the ground running.

Revenue is still falling, so low performers are sought out and “unnecessary” benefits are reduced. Fire a couple sales people here and a few testers over there because they can’t easily prove how they add value. Replace your talent acquisition rep. Anyone that was never a bottleneck, in fact, is expendable – but you’ll start with anyone you can get away with firing so that you don’t have pay out accumulated vacation or other obligations.

I assure you that the entire company sees that this fierce loyalty to “managing by spreadsheet” has resulted in the destruction of everything that made your company an awesome place to work. Everyone is now looking for a job.

Because the system has been trained against responsiveness to demand variability, it only takes a few more waves in the natural ebb and flow of demand to make you desperate enough to layoff anyone who is too expensive for their contribution at the exact moment of desperation. Anyone who was holding off on leaving the company due to timing or a sense of pride in “finishing what you start” will now also actively look for a job.

Now that you’ve shrunk to the point that less managers can “manage” the spreadsheets, you fire them, too.

Congratulations, you have basically destroyed everything you had worked to achieve with your company.

Unfortunately, many companies do not not learn their lesson, never ask the right questions, continue their flawed approach, and repeat the cycle of growth and collapse until the reputation for mismanagement makes it impossible to continue the vicious cycle.

If you are at any stage of this debacle, it’s not too late. The same internet upon which you found this post was built based on scientific principles from economics and queuing theory that can save your company.

Send me a message to find out how.