Thursday, September 10, 2015

Entropy in organizations and the 4th rule

In today’s post I wanted to expand on a couple of features of my General Theory of the Organization. The first topic had to do with the first law I stated (the fact that in every organization “entropy” –the inverse of the ability to achieve the organization’s goal- increases), and the second had to do with the most typical response to that increase in entropy, the attempt to grow the organization to counter it (which is a part of the 2nd law, that states that the response to such loss of ability is either to stay put, to try to grow or to innovate, the first two responses being always a failure), and why it most frequently backfires. The improvement in the understanding of both laws will lead us to formulate a 4th law I have already hinted at in some previous post.

 1. Revisiting the first law: why entropy increases 

Let’s consider in more depth why it is that with time the ability of an organization to achieve the ends of its members decreases. It can not be a basic law of nature, of course (too complex!), so there has to be an underlying cause. The best explanation for such regularity is actually quite similar to the statistical explanation of the second law of thermodynamics: there are simply so many more configurations where energy is uniformly distributed within a closed system (compared with non-uniform distributions that allow for some work to be extracted exploiting the differences), that with time the system can only evolve spontaneously towards such uniform distribution. Similarly, there are so many more configurations within a closed group that make it less capable to achieve its ends (or within an open one, although if the openness is selective, and allows in only additional members or resources that enhance its ability to grant the members their ends, the ability of the whole group can be enhanced –hence the impulse to grow out of difficulties, which remember was one of only two possible responses to try to counteract entropy and with which we will deal soon afterwards), that it is not surprising that they end up dominating the evolution of the group, as they make it so much more likely that it will evolve along the (much more numerous) paths that degrade its ability.

Now it may be argued that a viable alternative would be to try not to evolve at all, nicely captured in the piece of popular wisdom “if it ‘aint broke, don’t fix it!”. Indeed, a frozen system is not subjected to the second law… until it starts unfreezing (which, btw, takes energy from the environment to achieve a more disorganized state). Applied to an economic organization, the aforementioned viable alternative would be to stick with the proven organizational form (same people, doing the same things, using the same resources, that have allowed them to achieve a certain degree of market dominance, hoping to thus be able to retain it), at least until key persons reach their retirement age and decide to leave (at which point they may even be replaced with people as similar as possible, with the same basic capabilities, same rights and responsibilities, and hopefully able to achieve the same results). Unfortunately, such “alternative” would only be viable in a perfectly stationary economic environment, where consumer’s preferences never varied, new competitors never appeared, recessions never depressed the aggregate demand (thus lowering the overall consumption of most agents), regulations (reflecting heightened public sensibilities) were never updated, etc. Which is to say, It has never happened in reality, at least since the XVIth century (and may be not even then, according to some economic historians the seeds of what would bloom as the traditional Industrial Revolution were planted in the XIV, XIII and even XIIth centuries).

In the real world, once an organization is established and manages to achieve some ends that make it worthy for some individuals to join it, thereby renouncing to some freedom and to some of their resources (hence the “original conflict”, as theorized in this post: original conflict) it starts drawing the attention of people outside it. Even in the best of cases, in a competitive society (i.e. in every single existing society since the dawn of mankind) their success would draw in competitors that will undercut their ability to reach their goals, specially in the case of economic organizations, as those goals are necessarily positional (they are valuable as they signal some meaningful achievement, that stops being meaningful the moment it becomes widespread), and become less attractive as more people attain them and thus lose their strength as status symbols. In more mundane terms, your company that pays you 3,000 bucks a month is a “great place to work” regardless of how many hours it forces you to spend in the office as long as everybody around you is making 2,500 a month. The moment the average salary goes up and catches up with those 3,000 $ (more so if earning that average salary demands a lower time commitment) that same company is just run-of-the-mill (in exactly the same conditions), and if the rest of the job market gets to pay the average Joe 3,500 $ a month, it becomes positively lousy, and they rather do something to reward their employees more competitively or they better seek another occupation (may be as NGO or charity). So paid work is a “red Queen” situation, in which every firm has to stay running just to stay in the same place, as all other firms are equally running to the best of their capabilities.

So essentially, the fact of external competition is what makes staying put a non-option for economic organizations, and what forces them to evolve if they don’t want to lose their ability to satisfy their members’ needs (let’s remember that the main need in such organizations is the need for social status). This fact is confirmed by the different dynamic in competitive and non-competitive sectors: in the former (most private companies in non-regulated markets) the pressure is much higher, the rewards are on average somewhat lower, the turnover is also higher and the rate of change (in all fronts: product change, job content change, relational change in the form of promotions, demotions and reorganizations) is generally more frequent ,whilst in the latter (public service or highly regulated industries like healthcare, education or utilities) the salaries (or benefits that come with the salary) are higher and the rate of change is much slower (governmental departments work today much in the same way as twenty years ago, regardless of some fads to somehow link their pay with “productivity” –between quotes as it is so damn hard to measure). But even in the most protected sectors the inevitability of aging and cognitive decline make the ability of the economic organizations degrade with time, and the dynamics of the less regulated sector exert a constant pressure on them to adapt and improve.

 2. Why grow? (hint: it’s NOT human nature) 

Since the beginning of my professional career (remember it was in consulting, where the pressure is much higher than in other areas of the economy) I’ve been baffled by the obsession with growth. In my company of 15 years we were relentlessly focused in achieving “double digit growth” (10% or above) regardless of the conditions of the market. The world economy was contracting in the throes of a full blown recession? Damn the torpedoes, we had to deliver 10%. We were in the midst of a major reorganization, forced to change the name of our brand and to redefine the compact between the firm and its employees (by redefining the professional career that had been promised to every one of them when they joined)? Fuggedaboudit… go back to the street and sell, sell, sell! In the end, how good a professional you were was measured almost exclusively by how much you could contribute to the growth of the company. Can you convince your client of how superior the services we provide are (regardless if they truly are or not)? Can you identify further “needs” that would justify selling him a new project (or an extension of the current one)? Can you gain his trust so we gain some competitive advantage over our competition in the next sale? If the answer is yes, yes and yes you have a brilliant career and are more than welcome to stay, if there are minimal doubts in any of them… Houston, we have a problem. Not that it was in any way irrational, those exuberant rates of growth were absolutely crucial for the company to survive, given its dependence on a clear career path to reward the foot soldiers it relied upon to stay in business (that career path had to compensate for salaries that were, on a “job content” basis, never that competitive to begin with, so what made it attractive was the possibility to reach those positions faster than anywhere else…).

What troubled me back then (and still troubles me today) is that a) there is no way every company within an economy can grow above the rate of the aggregate (that would be a “lake Wobegon” situation, where all kids were famously taller and more intelligent than average) and b) even if every company pushing to grow above average were somehow possible (and didn’t end up in ever greater concentration by absorption or destruction of those companies that failed to keep up with the accelerating path), a social system entirely based upon growing rates of growth is not sustainable (as a part of that growth relies on the non renewable consumption of depletable resources). However, far from that obsession with growth being a peculiar quirk of that single company(an obsession that instead of subsiding has only gotten worse with time, regardless of the lack of success in achieving it and the necessary downgrades of the original target), what I’ve learned as my professional life has progressed is that it is very widely spread malady, to the point that barely an organization is free from it. In a sense, it is what lays at the core of the Marxist critique of Capital as a system trying to senselessly trying to perpetually expand the productive capabilities of society (of the “multiple capitals” that were required to compete against one another, even if each was in a monopolistic situation, for the system to keep on moving) just for the sake of expansion itself. Imagine a conversation between NC, a nondescript capitalist (in the Marxist sense) and NHB, a normal human being:

-        NHB: so why are you putting so much effort and attention in ensuring this year you produce 10% more merchandise than last year?

-        NC: well, so I can sell it and bring in a 10% more revenue!

-        NHB: and what do you want that extra revenue for? Will you live a 10% more luxuriant life?

-        NC: I wouldn’t dream of such folly! With that 10% I will rebuild my worn fixed capital, get a bit more, buy more raw material and hire more labor, so next year I will produce not 10, but 20% more (actually, 22% more) than last year!!!!

-        NHB: I see, which will probably also require a 22% more effort and toil from you, and seems just as irrational (doing something idiotic is not turned less idiotic by being repeated year after year)… what would be wrong with producing the same as this last year?

-        NC: Everything! Mi colleagues in the Plutocrat’s Club would put me to shame, as they are all growing their businesses like crazy; My wife would abandon me as I couldn’t afford a bigger soapbox at the opera and a new, bigger, mink coat for her; My competitors would increase their market share at my expense and, having more sold units between which to distribute their fixed costs would undercut my price and finally drive me to bankruptcy!

-        NHB: so there really is no way out, and it is nobody’s fault. The system really forces you to produce commodities for the market (pieces of merchandise that are circulated with the sole purpose of being exchanged for a greater amount of capital than what it took to produce them) in ever increasing amounts, the limits of the Earth’s non renewable resources be damned, the need for pursuing interests other than making money be damned, the impoverishment of the workers and the deadening monotony of their specialized work be damned

-        NC: Yup, that pretty much sums it up. As Kurt Vonnegut put it, “and so it goes”

So there is indeed a strong push towards growth in economic organizations (that, remember, have no way of further “degrading” by adopting lower level needs), but it is not rooted in human nature, but in the social system based on commodity production (where even in the service sector we can consider the worker time as a commodity which he exchanges in the market for money which he will mostly reinvest to keep on selling it at ever higher intensity to “get ahead”). This is what we would expect if the ultimate reason that made people join (and stay within) economic organizations were to improve their social status. By definition social status is relative, and I can only improve mine if somebody else loses his. As I can assume everybody else is pursuing the same end (and everybody else’s win would be my own loss) the only rational choice for me is to keep trying harder. The form that “trying harder” takes, when the group from which I extract my social status has a constant “status density” is to use more of it, to make it bigger so the total status I extract by belonging to it also grows. That would be the link that connects individual decisions (“I will work harder”, “I will spend more hours at work”, “I will force my peers to strive harder to increase production” and so on) with the overarching social structure, as I find explanations that only rely on some “metaphysical” feature of said structure overly unconvincing (as I complained about in this post: critiquing the critiquers).

 3. Putting it all together: the 4th rule

So I consider the following statements to be solidly grounded:

-        the degradation in the ability of each and every organization to achieve its goals is real, and more marked the more competitive the market in which it operates is

-        given the innate resistance to change of human beings, the spontaneous response to such degradation is to try to grow the organization, which in economic ones translates to an increase in the amount of goods or services produced (regardless of the potential demand for them)

We have also seen that in a capitalist economy everybody is indeed engaged in that “grow production at all costs” mentality (funny that for most of their history such was also the case in socialist economies, but the lack of effective coordination between agents –as a centralized state is unable to perform such feat- led to their stagnation and final collapse, apparent enough since the 70s of the last century), and precisely because everybody is trying to grow, it is very unlikely that such strategy may succeed, leading to a “red queen” situation.

So in most organizations, specially the economic ones (devoted to the improvement of the social status of their members), people are asked to do more and more to grow the organization, as that is seen as the only means to at least keep whatever level of satisfaction they have achieved, but that increased effort is rewarded at best with the maintenance of the status quo (and at worst with a gentler loss of it). That surely doesn’t predispose any member towards magnanimity and love of their fellows in struggle. Now imagine the possibility for a change comes your way, and you see two options. If you choose option A, if it turns out right it may imply a noticeable betterment of your circumstances (an increased achievement of whatever your collective goals are); if it turns out bad things would get worse, and it would be clear that it was your fault. As the outcome is uncertain, let’s assign to the first outcome (good) a probability of A.G%, and the second outcome (bad) a probability of A.B%, and let’s quantify the benefit of the first outcome as A.X (measured in units of pleasure, or monetary units, or level of achievement of whatever end the organization pursues) and the loss of the second outcome as A.Z (which should be a negative value).  Now let us suppose that option B (the alternative to A in the original choice) is certain to produce some loss (let’s quantify it as B.Z), but such loss (here is the catch) can be blamed on somebody else.

The expected value of the option A is (or should be if we were entirely rational beings) the difference between the values of the possible outcomes weighed by their probability of happening:

Value A = A.X * A.G% - A.Z * A.B%

And the expected value of B is the (remember, negative) value of its certain outcome:

Value B = B.Z ( < 0)

So we would expect people to choose A over B whenever

Value A > Value B =>  A.X * A.G% - A.Z * A.B% > B.Z

And of course, B being negative (being less than zero) the previous inequation obtains every time that

A.X * A.G% > A.Z * A.B%

That is, every time that the expected value of the positive outcome exceeds the expected value of the negative one, people should choose to go with option A.

As any experienced operator can attest, nothing of the sort happens. When faced with such a choice 99% of people, 99% of times will go with option B, regardless of how negative B.Z turns out to be, regardless of how fantastic the potential outcome (A.X) appears to be, regardless of how more likely (A.G%) it is than the alternative, and regardless of how comparatively mild (A.Z) or unlikely (A.B%) that alternative is. As I formulated it in a previous post: “if there is a choice between a doubtful benefit and a certain loss of which somebody else can be blamed, ten times out of ten people will choose the second option”  .

There are a number of reasons why the rule obtains, based on some popular tenets of folk psychology (most of them explained in depth in Kahneman’s Thinking Fast and Slow), from loss aversion (that makes us assign an inordinate probability to the chances of a bad outcome) to confirmation bias (that makes us to see as more likely that people, specially those we are not very fond of, will mess up things regardless of our best intentions). However, I’m going to leave it at that, as for my present purpose it is enough to justify the next step in my research: why it is of paramount importance to have clear hierarchical lines traced as part of the organization’s definition, and responsibilities fully spelled out, so people know where they stand and what is expected of them, and can not resort to the universal “is somebody else’s fault” line of defense. 

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