Being a top manager, in charge of setting strategy, really isn’t easy. Managers make decisions today that will influence their company’s performance for years to come. But they don’t know how those decisions will pan out, or how their competitors and customers will respond.
To counter this, educators and advisors tell firms and their executives that they should benchmark against the best and learn from others, and have “agility” so that they can quickly change course dependent on what works or not.
Having examined the impact of various strategic decisions and practices, and after interviewing senior executives, I now fear that managers make erroneous decisions and, what’s worse, are unable to correct their flawed courses of action.
1. The short-term trap
The first problem, which makes managers unable to understand the consequences of their strategic decisions, is that often, choices have different long-term and short-term effects. Managers usually understand the short-term consequences of their decisions fairly well but can’t foresee the long-term impact. In fact, even several years later when they are experiencing the negative effects, managers often find it difficult to grasp what causes their troubles, owing to the large time gap between cause and effect. As a result, they continue their faulty course of action.
I noticed this clearly when (together with Mihaela Stan from University College London) I studied clinics in the UK In-Vitro Fertilisation (IVF) industry, which are obliged to publish the percentage of successful births resulting from treatment. To increase success rates, many clinics prefer treating ‘easy patients’, seeing short-term results shoot up, but long-term performance flatten. By contrast, the clinics with ‘difficult patients’ learn far more in the long-term, seeing success rates rise. The ‘easy-patient’ clinics deprive themselves of such learning opportunities and see lower success rates than their more inclusive peers.
Managers must grasp the relationship between cause and effect; by avoiding more challenging IVF patients, performance results lagged behind. If the effectiveness of a particular strategy is measured solely on its short-term effects, it could be wrong in the long run.
2. The knock-on effects trap
A similar problem appears when a particular strategic decision, aimed at improving one part of the organisation, its business model or value chain, has unexpected consequences in another part of the firm.
Let me give an example. Large, R&D-intensive firms often have two separate internal functions that deal with patents: one for patent applications (filing) and another for patent enforcement. Nowadays, firms choose to outsource the patent filing to reduce costs and improve delivery.
What happens? As research by Markus Reitzig, Assistant Professor, Strategy and Entrepreneurship at London Business School showed, when patent filing is outsourced, the performance of the enforcement function decreases substantially. During filing, the firm learns about its competitors and how to anticipate their actions, so the enforcement function suffers without this internal exchange of information: after all, how can it attack its competitors proactively with such a knowledge gap?
Look out for the indirect effects that are difficult to foresee. Remember that organisations are complex systems with many parts: when problems materialise in one part of the firm, it’s often difficult to understand that the root of the trouble originates from another corner.
The observation error trap
The third reason why managers often misjudge the effectiveness of particular strategies and practices I clearly observed when doing research in the Chinese pharmaceutical industry, together with my PhD student Xu Li. In this industry, there is a belief that innovators – those engaged in new drug development – outperform non-innovators. This is not true. Over 10 years, on average, non-innovators outperformed innovators.
How come industry insiders have such misconceptions?
It is true that a few innovators in the industry performed exceptionally well. However, much more often, innovators were disastrously unprofitable. By contrast, the profitability of the non-innovators was much more evenly distributed. It’s easy to notice the very top performers in any given industry and only pay attention to them, thus creating the misconception that innovation on average enhances profitability.
The misconception that innovation spurs on profitability is a common observation error. If we do not observe the entire spectrum of firms in an industry, and we do not pay attention to the variance in performance figures, a strategy’s benefits can be overestimated.
What to do?
Traps like these can cause managers to seriously misjudge the effectiveness of their strategies. Misconceptions emerge because managers – like the rest of us – struggle to accurately foresee long-term results, have trouble recognising complex knock-on effects, and fail to observe the performance of all firms in their industry. These factors point to the relevance of academic research on management practices. As you may have noticed, all aforementioned examples stem from academic research on various strategic practices.
Relying on simple observations of your own performance and the performance of your competitors often renders incomplete and biased information; thorough academic empirical research can reveal unexpected patterns and consequences of different business strategies, helping firms and their managers to make more effective choices.
As a manager: what can you do to avoid the traps?
- Pay explicit attention during the decision-making process.
- Think through possible long-term effects, potential indirect consequences, and differences in variability.
- Do not rely on simple observations, they will not suffice.