How can managers prepare their firms to adapt, whether to a big aggregate shock like COVID or to local market-specific changes?
Looking across the middle market, we see some firms exhibiting agility while others are more like ships struggling to maintain course while being battered by bigger and bigger waves.
Much has been written in the business press about sources of agility. But what does economics have to say about strategies to become more adaptive?
Strategy 1: Move decision-making authority
In a recently-published study, economists examine firms’ performance during episodes of economic turbulence, when product churn (the rate of new product additions and subtractions) or stock market volatility are heightened in a firm’s location and economic sector. Turbulence tends to increase during economic shocks but is also characteristic of high-growth firms and industries during normal times.
The study focuses on the interplay between firm performance and decentralized decision-making authority during periods of economic turbulence. In theory, turbulence could increase the value of local information, benefitting decentralized firms. At the same time, turbulence might create disagreements within organizations about how to respond, and hence a greater need to make tough decisions – a situation in which centralized firms could have an advantage.
The authors use both cross-country and US firm-level data to test these competing theories, and find empirical support for the idea that increased turbulence tends to benefit decentralized firms – in particular, those that have decentralized decision making over outputs and are thus better-positioned to be responsive to changes in local demand.
Strategy 2: Move information
Does this result mean firms should consider decentralizing decision making? Perhaps. But let’s also remember the economic theory that this study seems to support. Taking the theory seriously, it’s all about where, and with whom, critical information lives in relation to decision makers. Decision-making authority should be placed where it can be matched with essential, up-to-date information.
Notice that this does not actually imply firms should decentralize decision making. Consider an alternative and likely complementary strategy: ensure that critical information flows to decision makers. In many cases, conveying information may be easier and/or safer than decentralizing decision-making authority.
Toward a coherent strategy for adapting to turbulence
While localized information is surely important, the various moving parts of any firm are almost never completely independent from one another in terms of their impact on overall firm performance.
Thus, optimal decision making requires two things:
Information must flow in multiple directions regardless of where decision-making authority lies (notice the key here is not data, but actionable information)
Decision makers need to understand and participate in an organizational strategy that maps all essential information into a coordinated set of actions. This requires building intuition for how the decisions of some impact the performance of others, and using tools effectively to coordinate actions across the firm according to the strategy
Over the longer-run, innovations that get actionable information flowing into the hands of decision makers lower the costs of adapting to turbulence and provide opportunities to distinguish permanent vs. transitory changes in market conditions. Such innovations require a detailed understanding of what information is critical, to whom it should flow, and what those decision makers should do with it.
Links to study: Published | Working paper (free)