Could an early warning system have helped predict our current financial woes?

Much has been said about the causes of the financial crisis to which we are all held captive. Politicians blame each other for the mess, citing varying degrees of under (or over) regulation depending on wind directionality, Wall-Streeters blame avaricious mortgage lenders and profligate home-buyers, consumers blame greedy executives and the politicians beholden to them, and media pundits blame everyone. The interesting question, however, isn’t so much who was to blame, but more, what were the signposts along the way that, had they been identified beforehand, could have helped authorities avert the disaster. In other words, could a unified financial early warning system have helped predict and forestall our current financial woes?

To be fair, foreknowledge of the current crises would likely not have been enough to avert it (excessive systemic risk is purged from markets in one way or another) but surely paying attention to the warning signs (of which there were many) would have allowed governments to shore up soon-to-be faltering banking systems or at least ensure that adequate policy measures were in place that would help to guide the flailing, seemingly haphazard decisions that policy makers have made in the last few weeks.

So what, exactly, would the harbingers of a doomed economy look like, and where would one look to find them? Well for starters at least, historically speaking the major economic downturns have been preceded by a marked uptick in panicky investor behavior. In other words: volatility. Well, you may ask, by the time investors and policy-makers have noticed that volatility is on the upswing, isn’t it likely far too late to take decisive action? That depends upon your definition of too late. To be sure, the tell-tale signs of volatility began appearing as early as July and August of 2007. In fact, the Chicago Board of Trade’s Volatility Index or VIX (often referred to as the Fear Index), began a series of what should have been alarming spikes on mounting concerns about, what was at the time, a growing credit crisis. Granted, increased volatility does not necessarily mean a marked downturn, but had policy-makers created an integrated system of early warning indicators that included volatility monitoring, a VIX spike could have put them on alert.

Remember those Wall-Streeters and bankers who were looking for someone to blame? Well it turns out that they had advanced warning of what was going on in the credit markets and broader economy as well. How, you ask? As we’ve all come to know, inter-bank lending is in many ways the life-blood of our economy. When the credit markets freeze up, banks stop lending to one another (well technically they don’t stop lending, they simply charge prohibitive inter-bank rates which in and of itself is a measure of risk and uncertainty in the overall economy). Often referred to as the TED Spread, the difference between Treasury yields and the London Interbank Offered Rate measures the degree to which banks feel that their peers will default on inter-bank loans, or counter-party risk. In fact, that summer the TED Spread saw a spike to levels it hadn’t seen since the Black Monday crash of 1987. So how far back did banks begin panicking? You guessed it, the same exact time the VIX was spiking towards the end of summer 2007.

These are but two of several examples of potential indicators you are likely to hear about in the coming weeks and months. Again, while any one of these signals doesn’t necessarily mean that an economy is doomed, had the right people, armed with a list of triggers or indicators, been paying attention, policy-makers could have taken steps much sooner. When you think about the hysteria of the last few weeks, the speed with which Secretary Paulson tried to cram the Emergency Economic Stabilization Act of 2008 through congress, the ensuing equity market melt-down, and about the shape of things to come, think about how different things might have been if those who hold the public trust had done their jobs.

On second thought, the really interesting question isn’t what the early warning indicators might have looked like, it’s why our leaders weren’t looking for them to begin with. Truth be told, governments should have begun taking action to quash the mounting crisis more than a year ago.

The Paranoid Still Survive

Ten years after former Intel CEO Andy Grove wrote his best-selling book Only the Paranoid Survive, a report in USA Today (January 31, 2007) suggests a healthy dose of insecurity is still at the heart of CEO success. "I am driven by fear of failure," says Dennis Manning, CEO of Guardian Life Insurance of America, which has annual revenue of more than $7 billion. "It's a strong motivator for me. If I fail, maybe 50,000 people fail with me."

What do CEO's worry about? According to the PricewaterhouseCoopers 10th Annual Global CEO Survey, 37 percent of those CEOs interviewed worry about pandemics, 40 percent about global warming, and 50 percent about terrorism. The overall optimism expressed in the survey is also tempered by other considerations tied to obstacles to growth. CEOs cite the uncertain availability of skilled resources, overregulation, and low-cost competition as impediments to future growth. And, sources of future growth most often cited in the survey include penetrating new markets, M&As, and technical innovation, all areas with higher levels of risk than less venturesome options such as better penetration of existing markets.

What does all this mean for strategy and competitive intelligence? Lots. CEO intelligence needs are more complex than ever. Corporate CI practitioners have to maintain vigilance against a wide array of risks, from bird flu to offshore competitors. More importantly, against a wide array of risks, from bird flu to offshore competitors. More importantly, they have to continuously feed their CEO's paranoia. "Healthy doses of corporate insecurity help keep a company fresh and competitive and ensure that the leadership and drive . . . remain active," says Ciena CEO Gary Smith, as reported in USA Today. Intelligence reports and approaches to strategy that harness this paranoia -- by generating plausible future scenarios and corresponding strategy options -- can be highly successful. According to Martin Frid-Nielsen, CEO of telecommunications company SoonR, "Paranoid people often see problems long before their more complacent counterparts. A little bit of insecurity goes a long way to push a company toward perfection, especially when that insecurity resides in the CEO."

A dose of paranoia may be what this troubled economy needs.

Competitive Intelligence Lessons from Frost & Sullivan's 2008 Growth & Innovation Congress

The most interesting learnings from attending this weeks Frost & Sullivan's Global Congress on Corporate Growth are results shared from an annual CEO Survey. The most striking highlights from a competitive intelligence (CI) practitioner standpoint include:

* CEO's number one priority is growth and overwhelmingly agreed that competitive strategy is the most effective growth strategy

* According to the same executives, the number one external challenge to growth is the competitive environment.

That is good news for us because it validates the role CI can play in shaping and executing resilient strategies in light of an increasingly competitive environment. But here is the discouraging news - only 37% of these companies involve CI in developing their firms growth strategy. A major disconnect but unfortunately a reality many of us have grappled with as practitioners and consultants.

Why is CI left out of these discussions? The same stigma that CI is more about data than insight and analysis seem to continue to plague the profession. The burden is on us to change this misperception. Our challenge is not that we can't do the analytical part of the job but instead that in today's economy with constrained budgets and resources, we are pulled in many directions including spending an inordinate amount of time collecting and managing data leaving little room for developing insights and true intelligence.

In light of the economic turmoil we find ourselves in, it will be interesting to watch if the remaining 63% of CEO's are compelled to draw on our expertise out of necessity.

Signaling Complexity

Monitoring corporate signaling practices can and should play an important role in competitive intelligence practitioners’ repertoires.
Changes to dividend policy are often regarded as one of the most salient signaling mechanisms. More often than not, however, organizations will use a suite of signaling techniques tailored to meet the unique environment in which they operate. In other words, industry structure, competitive market forces, and the competition’s intent all play a role in management’s signaling strategies.

And this makes sense. There is real benefit to be had -- such as lowering cost of capital -- from disclosing relevant information about the directionality of an organization’s revenue streams. Fortunately, there exists a delicate balancing act that management must conduct when choosing between the benefits of releasing proprietary information and the associated costs. It is in this balancing act that insight can be had.

For example, consider firms that operate in industries with relatively low entry barriers. These firms are less inclined to rely solely on accounting disclosures as the cost associated with releasing proprietary information likely exceeds costs associated with stock repurchases and/or dividend policy alterations. So what might this mean for an intelligence professional?

For starters, an analyst whose knowledge of an industry is more robust might spend less time poring over SEC filings and annual reports, choosing instead to monitor changes in capital structure and alterations in an organization’s payout policy. Moreover, that same analyst might be more apt to recognize that a voluntary accounting disclosure represents a major signal about the future prospects of the organization, its strengths and weaknesses, or trigger a more detailed investigation.

Similarly, the nature of the competitive environment can play an important role in an organization’s signaling strategies. Firms operating in industries with high concentration ratios (a measure of the relative size of firms relative to their industry as a whole) often have higher political costs and will shy away from signaling via accounting disclosures to avoid government attention. In such cases, analysts would be wise to focus on a firm’s dividend and repurchase policies.

But that’s not all. Consider the insight that might be had from changes in payouts from a firm in a nearly monopolized industry. What might a substantial payout convey about the prospects of the organization, pending regulation, or the industry as a whole? While this question can’t be answered with signaling analysis alone, this new piece of intelligence can add depth and texture to competitor and industry assessments.

Just as an intelligence analyst should pay attention to industry structure and the competitive environment, she should also be wary of her competition’s short and long-term objectives. To be sure, organizations keen on delivering growth tend to re-invest excess capital. What if the proportion of excess capital retained begins to decline? Does that mean the organization anticipates slower growth? Again, the answer isn’t going to be apparent but if our analyst knows that the competition has stated that its goal is to grow for its share-holders, faltering re-investment rates may signal an important and/or deliberate organizational change.

Unfortunately, these are not hard and fast rules. Careful judgement must be exhibited when conducting signal analysis and individual data-points are not likely to yield epiphanous insight. Nevertheless, these examples illustrate two things. The first is that monitoring the suite of corporate signaling efforts can play an important role in garnering insight on the competition. Importantly, however, these examples also illustrate that signal analysis can be much more valuable if it is paired with complementary analytical techniques, industry and competitive awareness.

William J. Dragon
Will is a Senior Consultant at Outward Insights, a Boston-area strategy and competitive intelligence consulting firm. He can be reached at wdragon@outwardinsights.com.
© Copyright 2008 Outward Insights

Fly Swatting and Competitive Strategy

Recent findings from a Cal Tech research study, published in the journal Current Biology, and reported today by the BBC, reveals interesting parallels between the neurological make-up of houseflies and effective competitive strategy.

According to the BBC report, researchers think that the fly's ability to avoid being hit by a flyswatter is due to its fast acting brain and an ability to plan ahead. High speed, high resolution video recordings showed that the insects quickly work out where a threat is coming from and prepare an escape route.

"Most people will have experienced the frustrating experience of carefully attempting to swat a fly, only to swing and miss while the intrepid insect buzzes off to safety. The research suggests that the best way of swatting a fly is to creep up slowly and aim ahead of its location," the BBC reports.

The article goes on to note that over the years there have been different theories put forward to explain the fly's uncanny ability to outwit human attempts to swat them, but the research says it is about quick-fire intelligence and good planning. Specifically, the researchers discovered that, long before the fly leaps, it calculates the location of the threat and comes up with an escape plan.

Any strategic planner frustrated at his or her company's inability to best a nimble competitor can empathize with unsuccessful human efforts to swat flies. What sets leading companies apart? A fast-acting, nimble nature, sound planning, and an uncanny ability to spot threats before they impact their interests. As with the fly, quick-fire intelligence and good planning are required if any company is to develop keen instincts and an uncanny ability to avoid threats and leap to a new, safe position.

Leaping Over the Intelligence – Decision Gap

We all know, intuitively, that competitive
intelligence isn’t really intelligence unless it is actionable.
If a piece of intelligence doesn’t compel a decision-
maker to take action, we are told, it is just another piece
of information. But what constitutes action? And,
what is the process by which competitive intelligence
prompts a decision or strategy that is implemented and
subsequently managed? Frequently, even companies
that possess world-class competitive intelligence
functions struggle with turning credible, insightful,
actionable intelligence into a clear strategy, decision, or
course of action.

Why is good intelligence often not incorporated into
strategic plans or operational decisions? The problem, I
believe, rests with reluctance among management to
clearly define the role it expects intelligence to play in
company decision-making, to define key decision
components that are influenced by intelligence, and to
track progress against them.

Too often, strategic planning is an exercise in
reaffirming what is known or comfortable, or what has
worked in the past. Similarly, decision implementation
is often an exercise in executing what has worked
before. Companies are hard-pressed to take new, bold,
and decisive action even when all the intelligence
“signals” point to the wisdom of pursuing a new course
of action.

The identification of an issue champion can help. This is an
individual in a decision-making or leadership role whose corporate
function is most impacted by the intelligence. For the
issue champion to successfully act on new intelligence,
the CI manager must brief him or her on the content of
the intelligence, and discuss the implications for the
company and for his or her function directly.

What other solutions can help to mitigate the gap between intelligence and action?

Why Now Is the Time To Take a Closer Look at Scenario Planning

September is a common strategic planning time for many companies. With fall just around the corner, this is a good time to begin thinking about maximizing your strategic planning process. If your planning process is not fostering collaboration among corporate and business-unit managers, nor making best use of best practices -- two conditions that improve planning process outputs, according to a recent McKinsey & Company survey -- scenario planning may offer a solution.

Scenario planning helps organizations envision a future very different from the present and develop concrete strategies that ensure success in a number of different possible futures. Companies also develop specific, measurable indicators that provide an early warning of what the future may bring, and the opportunity to start preparing today. In doing so, scenario planning encourages that managers from different parts of the company collaborate to offer their unique insights about the external environment. It also facilitates the consideration of prevailing environmental trends, likely competitor behavior, and external threats -- planning best practices executives say they wish they could follow more judiciously.

Let us know if your firm incorporates scenario planning into the annual planning process.