Fast and Slow

Over the past several months my brother has been discussing with me all the books he's been reading on consciousness, habits, brain behavior, willpower, and similar topics in the neuroscience dimension. It's all very fascinating and I have read some of his recommendations, (Willpower) others I put on my Amazon wishlist (check it out here).

Then last week he sent me the email below that I started to think about. It came in at much the same moment as the March issue of Fast Company which happens to be on the topic of the world's 50 most innovative companies. Briefly he makes an analogy between fast and slow brain operation and innovative/entrepreneurial companies. At least that's how I read it. See what you think – my comments are at the end.

'If you haven't read 'Thinking Fast and Slow' by Daniel Kahneman, I highly recommend it. He says that current brain research shows that the brain operates in two modes, the fast, automatic mode that runs without conscious intervention, and the slow, conscious mode where we contemplate and take deliberate actions. Almost all our activity and decision-making is done in the fast mode, but explained to ourselves in the slow mode.

There is an analogy here for business organization. There are two kinds of business:
Type 1. The established business that has discovered a set of activities that brings in more money than they expend, so is consistently profitable. These businesses are low-risk, and depending on the maturity of the market they are in, high reward (developing markets), medium reward (mature markets with weak competition) or low reward (mature, competitive markets).

Type 2. The entrepreneurial business, which is higher risk, not profitable, that is still seeking to find models and activities that will provide reliable income streams. These businesses are high-risk, potentially high-reward regardless of market.

Type one businesses have a lot to lose. If they mess up, they forgo all the income they would have got if they had simply bumped along. For this reason, their correct business philosophy is to establish and maintain processes and procedures that can run in auto-pilot mode, like the fast-thinking parts of the brain. Don't reflect, just do what we did before that we know works. Be very conservative. Make changes only in tiny increments so as to not break anything. Obviously their environment will change, and they must adapt to survive, but their processes should evolve only quickly enough to keep up with those changes, as fast as the changes their competitors make, or if they want to gain market share, maybe a little faster than their competitors. Sudden, big changes, like New Coke, are not appropriate in this kind of business.

Type two businesses don't have anything to break, so the downside associated with revolutionary changes is low, while the potential rewards are high. So for these the correct strategy is to be highly experimental, going all in on new ideas, and abandoning them quickly if they don't work out ('fail fast'). This is analogous to the "slow-thinking," part of the brain, which acts deliberately after conscious planning and contemplation of options, feeling its way through new situations.

An analogy can be drawn here with local versus global optimization. The fitness landscape in an evolutionary system is visualized as a mountain range, where all the creatures creep up a particular mountain by tiny increments, generation by generation, to reach a peak of fitness for their particular niche. The idea is that a little change has a 50/50 chance of taking you closer to the peak, but a huge change is almost certain to take you off the mountain altogether, into some very unfit space where you die. (In Richard Dawkins' words 'however many ways there may be of being alive, it is certain that there are vastly more ways of being dead').

Type 1 companies are there on a mountain, and a steady, evolutionary policy of low risk incremental changes will move them up towards the peak. Like Toyota's lean manufacturing, or any continuous improvement program. But they will only get to the peak of the particular mountain they are on. There may be another mountain adjacent that is way higher (e.g. a bigger, more profitable market). The only way to get there by increments would be to get onto the other mountain. So it's almost impossible.

Type 2 companies on the other hand are motivated to flail around in huge jumps, attempting to identify viable mountains (products/markets/niches), recognize when they land on one, then establish themselves there.

So you need two completely different mindsets, two completely different skill sets, two completely different management approaches to run these two kinds of companies.

That's why when a Type 2 company happens on a scalable, reliably profitable activity, it needs to change – no longer try to be revolutionary, but become a process-driven, by-the-book organization to preserve the winning model. This is done two ways: 1. fire the founders and put in a new CEO, or 2. Sell it to a big established company.

The timing for this is critical. The new company must have achieved a degree of market success, and have established some baseline activities that are proven to be profitable. So don't buy technology companies until their ideas are market-validated.

So now we have a way for a Type 1 company to get over to that other mountain. Overpay for a Type 2 company that has established a basecamp at the bottom, and clean out the old culture, replacing it with a Type 1 culture, then scale the sales.

The great thing about this modus operandi. is that the type 1 company doesn't have to pretend to be any good at innovation. It should shut down all its research efforts and focus only on development. Let all the little startups take the risks; 98 of them will fail and 2 will succeed. Then buy one of those.

This is how Cisco operated in its heyday. It lost its way when it started buying other Type 1 companies like Linksys. This also seems to be how Warren Buffett operates. He is only interested in Type 1 companies.

Apple was a type 2 company under Steve Jobs, and with the succession to Tim Cook, has become a Type 1 company. Don't expect any more internally generated innovation from them. But Apple has a vast cash hoard, and can easily buy innovation with relatively low risk – no need to pick winners before they have obviously won.

Acquirers often talk about how they want to preserve the innovative culture of their acquisition. By this analysis, such an acquisition is doomed.'

My comments:
Looking at the 50 most innovative companies listed in the March issue of Fast Company – at the no 1 spot is Nike. The company was established in 1964. And has the hallmarks of being both a type 1 and a type 2 company – the type 1 elements funding the type 2. The article notes that 'based on interviews with top Nike executives, current and former designers, engineers, and longtime collaborators, reveals four distinct rules that guide this company, that allow it to take big risks, that push it to adapt before competitors force it to change':

  • To disrupt you must go all-in: 'Flyknit isn't a shoe – it's a way to make shoes. … Nike has gone all-in on that bet, building a whole new manufacturing process around the product.'
  • Anticipate a product's evolution: 'three steps ahead thinking is important for any product … if Nike doesn't bet on crazy ideas, its rivals will'
  • Direct your partners: 'successful businesses need to constantly evolve, either through partnerships, new talent, acquisitions – or all three'
  • Feed the company culture: 'That cohesive culture [of stories and secrets] begets tangible benefits, such as talent retention. That self-image is infused into every marketing message … to a public eager to finally be let in on the secret'

Look at the other companies on the list. There are some big, established companies – but not many (20%) – Amazon is in 2nd, Target (a US retailer) in 10th, Google is 11th, Apple is 13th, Samsung 17th, SodaStream 23rd, Ford 27th, GE Healthcare 34th, Corning 36th, Microsoft 48th.

It's interesting that Warren Buffet has just announced that he is going to buy Heinz – not a recent player in the most innovative company lists.

So maybe there are some lessons to be learned from thinking fast and slow about organizations and designing them from that perspective. What's your view?