Sunday, October 17, 2010

Mandelbrot’s Legacy: Strategy in Extremistan

By Dr. Suhaib Riaz.

Benoit Mandelbrot passed away at the age of 85 a few days ago (Oct 14, 2010). He epitomized the cross-disciplinary and relevance-focused scholar like few others. While Mandelbrot’s work has had applications across the sciences and social sciences, the implications of his ideas for the field of Strategic Management are rarely considered.

One exception is the work of his co-author and protégé, Nassem Nicholas Taleb, who gives due credit to Mandelbrot for shaping his own thinking. Taleb’s extension of Mandelbrot’s ideas has several implications for us. Central to these is the contention that the social science world is not Mediocristan, i.e. one that can be captured by Gaussian probability distribution, but rather Extremistan, where more Mandelbrotian ideas of fat-tails and fractals apply.

Taleb’s is perhaps the only recent work to take Mandelbrot’s ideas close to Strategy scholars, as close indeed as an article in a recent Harvard Business Review issue. To get a feel of the Extremistan we are talking about, where most of Strategy operates, look at Taleb’s examples in the HBR article, which are also reported in the “On Robustness and Fragility” section added to the new paperback edition of his book, The Black Swan. What exactly does Extremistan mean and what does it do:

“It causes winner-take-all effects that have severe consequences. Less than 0.25% of all the companies listed in the world represent around half the market capitalization, less than 0.2% of books account for approximately half their sales, less than 0.1% of drugs generate a little more than half the pharmaceutical industry’s sales – and less than 0.1% of risky events will cause at least half your losses.” 
Note the implications of this for (organizational) performance, which is core to the very definition of the Strategic Management field:
“Because of socioeconomic randomness, there’s no such thing as a “typical” failure or a “typical” success. There are typical heights and weights, but there’s no such thing as a typical victory or catastrophe.” 

This is something Strategy scholars should sit up and take notice of. The dominant methods in Strategy research are still based on the Gaussian assumptions relevant only to Mediocristan. The majority of strategy scholars rely on regressions, which originated in fields of study where all phenomena approximated (or were heavily assumed to follow) Gaussian distributions. Simply put, our tools are not up to the phenomena our field deals with.

I believe this means that Strategy has to be looked at afresh as a field, not confined to Mediocristan, but rather like several other social and economic phenomena, from Extremistan. The lack of recognition of these issues is not just a problem in the world of academia, but also in industry, where current practices and organizational structures typically don’t apply Extremistan ideas:
“Such disparagement of negative advice makes companies treat risk management as distinct from profit making and as an after thought. Instead, corporations should integrate risk-management activities into profit centers and treat them as profit generating activities, particularly if the companies are susceptible to Black Swan events.” 
Recent events related to the global financial crisis have given Mandelbrot’s ideas a new life, even as he himself passes away leaving us a rich legacy. His maverick nature, cross-disciplinary work, and focus on relevance also meant that his home base remained in practice and it was not till his last decade in life that he actually took on a full time professorial appointment!

This is perhaps an opportune time for fresh thinking on how his ideas might apply further to Strategic Management, both in academia and practice.

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