MEDIA PERSPECTIVES - November 12, 2014

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Efficiency and Fragility
By: Jaffer Ali

Americans have discovered the fragility of life, that ominous fragility that the rest of the world either already experienced or is experiencing now with terrible intensity.
--Jose Saramago, Portuguese Nobel Prize Winner

In science, mathematics and systems analysis, more and more is being written about "fragility". In fact, the brilliant Nassim Taleb's next book is on this very topic. With our financial bubbles and torrid pace of change, it is no wonder that this term is entering into the lexicon of business and entrepreneurship. We are all searching for ways to survive chaos and an uncertain landscape.

An interesting study was done comparing the human brain with financial markets. Brain activity was graphed and its topology compared to the peaks and valleys of the stock market. The similarities were striking, but I believe their differences even more instructive. More on that in a bit.

There is a relationship between efficiency and fragility that has eluded observers for years. Is it the case that the more efficiencies are brought to bear, the more fragile the system? Or is there a point where the cumulative benefits of efficiency cross a threshold and become more susceptible to "black swans?" We already know that quantitative advances can lead to qualitative changes. I recognized this while losing my hair over the years. Eventually the quantitative loss of hair crossed a threshold... and voila, I was bald!

Back to market efficiencies and the brain. You see the financial markets' ability to take in information were deemed more efficient than the brain in processing information. The brain, while being less efficient, has redundancies built into it. If one part of the brain is damaged, it is these redundancies that allow for the brain to keep working. The body is replete with redundancies by the way.

But the drive for efficiency eliminates redundancies by definition. In business, the drive for efficiencies also eliminates human redundancies. This is one reason the digital economy has not been a great net employer. Efficiencies created in the digital ecosystem eliminate more jobs than they create. This was one of the points in the recent NY Times piece called The Facebook Illusion.

The elimination of redundancies creates more fragility. So when we see overly optimized, efficient systems with increasing complexity, we also are witnessing an increase in fragility. So what? As systems become more fragile, they can break quite suddenly and with little warning.

It may be the case that the drive for ever increasing profit margins works to increase fragility. What do I mean? Increasing profit margins usually requires more and more efficiencies... more optimization. This means less "slack" in a system. Less redundancies. This is when a company is in peril that may not be immediately apparent. A company's fragility often remains hidden until a black swan shows up at its doorstep.

I am not suggesting mindless inefficiencies need to be part of systemic planning. I am saying that carefully planned inefficiencies in the form of redundancies and slack can help withstand stressing events... from brain traumas to business calamities.

We practice the above. We introduce "slack" in areas like customer service for our e-commerce division. If we ran 100% efficiency, we would never be able to handle spikes. We cross train so multiple people know each other's jobs. Cross trained people may not be able to function as efficiently as those specializing in the tasks, but we get through vacations and handle unpredictable work flows.

There are two more elements that increase sensitivity to fragility; size and centralization. It is now commonplace to speak of "too big to fail" but in reality, as our corporations became larger and larger, they were (and are) subject to increasing fragility. The metaphor for this is a camel fully loaded and one places a single extra piece of straw that breaks its back. Our corporations are becoming "fully loaded" and just waiting for the piece of straw to break its back.

And as our political system and corporations become larger, they also are becoming more centralized. We needed to get something notarized at our bank (JP Morgan-Chase) and they had to call HQ in New York to notarize a simple document. That is centralization. We switched banks the next week to a local bank...

Why does centralization create sensitivity to fragility? When mortgages are not decentralized, local conditions are subservient to central decision making. Rules that can be applied across the nation become a "one size fits all" solution. A bad rule propagates nationwide... and thus is subject to exponential risk. Decentralized decision making can equally lead to bad decisions but the harm is localized instead of increasing exponentially.

Centralization and efficiency are the rationalized twins of large systems. They go hand in hand. When things are going well, the benefits are easy to see. But when the black swan comes calling, the costs are disastrous for the system.

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Original Article: Efficiency and Fragility

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