Creating and Sustaining Process Improvement

In 2001, the California Management Review published an article by Nelson Repenning and John Sterman, “Nobody Ever Gets Credit for Fixing Problems that Never Happened.”  Its subtitle is used as the name of this posting.

It might seem paradoxical to leverage the ideas presented within it to think about the nature of process at an asset management firm, since the examples provided are related to manufacturing.  But the theories put forth by the authors can also illuminate the processes involved in knowledge-based work.

(In addition, analysts and portfolio managers who are trying to understand the companies they follow will find some simple concepts to apply in their research work, especially the trade-off between temporary upticks in results and more lasting benefits that come with true improvements in process.)

Let’s start with a summary of the ideas themselves before some thoughts about how they relate to asset management firms.

Improvement loops

Referencing the many management theories that come and go — and which don’t seem to live up to their promise in practice — the authors identify the nub of the problem:

Most importantly, our research suggests that the inability of most organizations to reap the full benefit of these innovations has little to do with the specific improvement tool they select.  Instead, the problem has its roots in how the introduction of a new improvement program interacts with the physical, economic, social, and psychological structures in which implementation takes place.

The article has a series of graphics that build on one another to demonstrate what they call “the physics of improvement.”  At the root of it is a choice:

The performance of any process can be increased by dedicating additional effort to either work or improvement.  However, the two activities do not produce equivalent results.  Time spent on improving the capability of a process typically yields the more enduring change.

While it often yields the more permanent gain, time spent on improvement does not immediately improve performance.

The “work harder” loop and the “work smarter” loop operate at different speeds and “the greater the complexity of the process, the longer it takes to improve;” plus, “investments in capability can be risky.”  Another loop — the reinvestment loop — tends to reinforce the chosen path, resulting in a virtuous circle when capability is being added to good effect and a vicious circle if “work harder” is always the default direction.  When that happens, shortcuts are taken; they “are tempting because there is often a substantial delay between cutting corners and the consequent decline in capability.”

When things deteriorate, those in charge are prone to an attribution error, blaming the people rather than the system and making decisions that are counterproductive:

What starts as an erroneous attribution about the skills, effort, and character of the workers becomes true.  Managers’ worst fears are realized as a consequence of their own actions.

Inattention to the underlying problems and the lack of a culture of continuous improvement cause shortfalls in process over time.  Here’s the authors’ stylized summary of the problem:

Operations and distribution

As mentioned, the article focuses on physical production and the throughput of a system, which isn’t immediately obvious as an analogue to an investment process.  But it fits well with operations and distribution, the two other main components of an asset management firm.

In each, if understaffing is an issue (and/or if inadequate technology is), the dynamics are very much as described in the article.  When things aren’t getting done on time or in the right way, the tendency is to blame the people and not the system.  (Work harder!)  That inclination is exacerbated in the many organizations where there is a wide cultural divide between the investment staffers and everyone else.

Investment process

While the notion of throughput is less obvious on the investment front, it does come into play.  For example, if an analyst is supposed to cover a hundred stocks — and to meet the firm’s requirements for models, earnings estimates, and ratings on them — that’s already a very challenging assignment if there is to be any real original research done.  When that number goes higher because other analysts leave or new issues need to be covered, a difficult load becomes even more challenging.  (Work harder!)

But the larger point when it comes to investment process is that it is often too static.  Much of that is because there’s a belief that “consistent and repeatable” is marketing gold — but also because innovation in methods is not a high priority among investment professionals.  (A recent tweet asked, “If you’re working at investment fund, do you have an R&D function?”  There absolutely should be one and not just for investment research and decision making, but for operations and marketing too.  Yet such efforts at innovation are relatively rare.)

That J curve in the upper right of the image above can be daunting — unless it’s just what you do on a regular basis.  If change is a way of life for the firm — and why wouldn’t it be, given that the markets are complex adaptive systems? — then the J curve is barely noticed given the rolling increases in capability that are flowing through.  But if stasis is the model, then the near-term hit on the way to working smarter seems bigger than it probably is.

All of this is complicated, of course, by the noisy nature of markets and the difficulty linking outcomes to process.  It’s not like monitoring the production of widgets; the feedback is not immediate and it is always murky, making it easy to avoid making needed changes.

Given the marked declines in most asset classes this year, revenues are down and firms are tightening their belts.  Often that happens first in the areas of operations and distribution, triggering those throughput issues identified in the article.  Eventually, there may be cutbacks on the investment side too.

The other thing that happens at times like these:  It’s easy to set aside those R&D ideas as some fanciful stuff that was thought about when times were good, when they are actually the seeds of competitive advantage for the firm going forward.

Continuous improvement means that you keep at it when others stop.