It’s a constant criticism from the sidelines: Businesses are too focused on the short term, they spend too much energy trying to hit short-term targets and too little time on optimizing long-term results.
As any veteran market watcher might tell you, focusing too much on the long term is just as bad as the opposite. So we need to find Goldilocks’ solutions, happy mediums.
Enter Michael Mauboussin in chapter 22 of "More Than You Know: Finding Financial Wisdom in Unconventional Places." He developed and laid out one such solution for management. Investors might also use it to assess management’s strategy. He wrote:
“The notion that managers should only focus on the long term is nonsensical. Have you ever heard of a company that blew twenty straight quarters but had a great five years? It doesn’t happen; the long term is, by definition, an aggregation of short terms. So what’s the best way to think about managing for the long term in a complex environment?”
One important clue came from Deep Blue, the chess-playing computer developed by IBM (IBM, Financial) for a contest with world champion Gary Kasparov in 1999. The machine won the six-game matchup though brute computing power, as it evaluated 200 million positions per second, and the victory was widely noted as a milestone in the development of computers.
From a strategic perspective, it wasn’t such a big win. That’s because the game of chess is based on a limited number of rules and played on an eight-by-eight board. Add a few more rules, options or a bigger board and the computer can be easily beaten.
As Mauboussin noted, “Since the business world is vastly more complex than any board game, it’s impossible to understand all possible future positions, much less assess them. So success for humans in either chess or business is not about crunching numbers; it’s about developing strategies to achieve a long-term goal.”
Chess master Bruce Pandolfini reported that great chess players have four consistent behaviors that help them win:
- “Don’t look too far ahead”: The great players are thinking just a few moves ahead, not 10 or 15. Thinking too far head wastes their time and energy because that information is very uncertain.
- “Develop options and continuously revise them based on the changing conditions”: Don’t play the first move that pops up in your mind; instead make a note of it, then ask if there might be an even better move.
- “Know your competition”: To join the greats, regular chess players must study their opponents as well as the strategies they are using.
- “Seek small advantages”: Look for a series of small advantages rather than one big advantage. For example, a slightly safer king’s position, plus a half dozen other small advantages, might add up to a winning game.
Mauboussin reminded us that while chess strategies help us get started, there are limits to the analogy. Business is far more complex, and it’s important to remember chess is a zero-sum game (one player’s gain is exactly the same as the other player’s loss). Because business is a not a zero-sum contest, both players can be winners—and often are.
In a complex system, highly variable outcomes can arise out of simple rules. The author added, “Herein lies the key to resolving the tension between the short term and the long term.”
He recommended that companies develop long-term decision rules, but define them broadly enough so that managers can make decisions that address short-term needs as well. Business thinkers Kathy Eisenhardt and Don Sull refer to this approach as “strategy as simple rules.”
Mauboussin described their strategy this way: “They argue that companies, especially in fast-changing markets, should not embrace complex strategies but rather adopt and stick to 'a few straightforward, hard-and-fast rules that define direction without containing it.'”
Eisenhardt and Sull suggested five types of rules:
- How-to rules that explain how a company should execute a process and specify what makes a company process unique.
- Boundary rules should be designed to guide big management decisions, such as which opportunities to pursue and which to forgo.
- Priority rules that will help managers rank the opportunities that they might pursue.
- Timing rules to “synchronize managers with the pace of opportunities that emerge in other parts of the company.”
- Exit rules that provide guidelines for decisions about yesterday’s opportunities.
They went on to suggest a company develop two to seven rules, while observing that young companies normally don’t have enough rules, while mature companies often have too many.
Mauboussin concluded:
“This 'strategy as simple rules' approach is not only strongly analogous to successful chess playing, but it also resonates with other complex adaptive systems. Most important, it puts to rest the nonproductive debate about whether companies should manage for the short or long term. Companies that embrace simple rules can manage both for the next quarter and the next quarter century.”
Conclusion
For investors, Mauboussin’s exploration of the short and long term clarifies at least some aspects of what seems to be a never-ending debate. For investors, it seems we should put our money into companies that manage but do not micro-manage.
As an example of that, I can’t help but think of Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio)’s relationship with the management of Berkshire Hathaway’s (BRK.A, Financial)(BRK.B, Financial) subsidiaries. So long as the managers continue to deliver solid results and don’t do anything foolish, they’re allowed to run their companies independently.
As for other companies, perhaps investors might read annual reports to search for companies that explicitly or implicitly manage according to a small group of flexible, long-term principles.
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