The Fatal-Flaw Myth
James Surowiecki is among a handful of my favorite journalists; I seek each new essay written by him. Each essay tends to be comparatively brief, but packs a wallop. He writes predominately for The New Yorker magazine, which is where his most recent essay appears. While it is available to all readers (not solely subscribers) on the web, it will remain as such for only so long...
Pay heed!
-- David M Gordon / The Deipnosophist
================================
THE FINANCIAL PAGE
THE FATAL-FLAW MYTH
by James Surowiecki
Issue of 2006-07-31
Posted 2006-07-24
Every other summer, the aerospace industry gathers in Farnborough, England, for a big trade show. At Farnborough last week, there was one thing on everyone’s mind: the plummeting fortunes of Airbus, the European aerospace giant. Airbus is struggling to find customers for the new plane on which it has staked its future, the superjumbo A380, as airlines wonder whether anyone wants to fly on a jet that seats almost six hundred people. The A380s that have already been ordered will be delivered late, thanks to production snafus that may add as much as $2.6 billion to the original development cost of thirteen billion dollars. Airbus’s other big project, the mid-size A350, is to be completely redesigned, at a cost of ten billion dollars. All the while, its sole competitor, Boeing, has been gobbling up business, thanks to its new mid-size jet, the 787 Dreamliner. In the first half of the year, Boeing took almost five hundred new orders for planes, while Airbus took just a hundred and seventeen.
Airbus is a business-world anomaly. It was created in 1970, by an alliance of European countries, in order to break the American monopoly on the commercial-aircraft market, and it’s currently owned by a defense conglomerate in which the French government has a major stake. This connection has helped the company get access to government-subsidized loans, but has also meant that its corporate strategies have been shaped by politics. Now Airbus’s woes are being held up as proof that it is, in the words of one columnist, “a textbook example of how not to run a commercial enterprise.” The Wall Street Journal explained that Airbus was failing because of its “politicized management,” while the Times suggested that Airbus had to decide whether it was a company or a European “employment project.”
There are reasons to think that politics and business shouldn’t mix, but Airbus’s predicament isn’t one of them. What much of the talk about the inherent weakness of Airbus ignores is that, just a few years ago, it was Boeing that looked fundamentally flawed, while Airbus was seen as the future of the industry. Beginning in the late nineties, Boeing’s commercial-aircraft business went into a long and nearly profitless slump. In 2001, Airbus surpassed Boeing in new orders, a lead it maintained until this year. During that period, Airbus’s unusual structure was praised; its insulation from the stock market supposedly allowed it to invest in long-term research and development. Boeing, by contrast, was thought to be trapped in a short-term, cost-cutting mentality, because, as one analyst put it, “the money guys don’t reward long-term thinking and investment.” In 2003, Business Week declared that Boeing was “choking on Airbus’ fumes,” and warned that Boeing’s “slip to No. 2 could become permanent.”
The problem with such prognostications is that they infer basic truths about a company’s prospects from its short-term performance. In fact, present success is often determined as much by context and chance as by fundamental viability. This is particularly true of the aerospace industry, because success is heavily dependent on a small number of big gambles. If you bet right, you look like a genius for a few years, even if the success of your bet was due to factors out of your control. The 787 may now look like Boeing’s salvation, but Boeing built it only after more ambitious plans—for a plane, known as the Sonic Cruiser, that would have been the fastest passenger jet in the air—fell through, partly because of the slowdown in air travel after September 11th. And had Boeing not been in such straits in 2003 it probably wouldn’t have risked the investment required for the 787.
People are generally bad at accepting the importance of context and chance. We fall prey to what the social psychologist Lee Ross called “the fundamental attribution error”—the tendency to ascribe success or failure to innate characteristics, even when context is overwhelmingly important. In one classic demonstration, people shown a person shooting a basketball in a gym with poor lighting and another person shooting a basketball in a gym with excellent lighting assume that the second person hit more shots because he was a better player. This problem is compounded by the tendency to extrapolate big conclusions from small samples, something that behavioral economists call “the law of small numbers.” In the decade or so that Airbus has been a serious competitor to Boeing, this is its first really bad patch, and its difficulties are due mainly to making one bad bet while Boeing made one good one. That’s a minuscule sample size on which to base any kind of conclusion. But this is exactly what we like to do: sports fans assume that a few excellent performances are proof of a player’s underlying ability, while investors assume that a mutual fund’s record over one year is a reliable indicator of the manager’s skill.
Because we underestimate how much variation can be caused simply by luck, we see patterns where none exist. It’s no wonder that management theory is dominated by fads: every few years, new companies succeed, and they are scrutinized for the underlying truths that they might reveal. But often there is no underlying truth; the companies just happened to be in the right place at the right time. In 1999, after all, it was hard to find a business book that didn’t hold up Enron as the embodiment of one important principle or other. Of course, some strategies and structures work better than others, but real meaning emerges only over the long term. Let’s give Airbus a few more years of floundering before we decide that it should be put out of its misery.
Copyright © CondéNet 2006. All rights reserved
"The problem with such prognostications is that they infer basic truths about a company’s prospects from its short-term performance. In fact, present success is often determined as much by context and chance as by fundamental viability."and...
"People are generally bad at accepting the importance of context and chance. We fall prey to what the social psychologist Lee Ross called “the fundamental attribution error”—the tendency to ascribe success or failure to innate characteristics, even when context is overwhelmingly important ... investors assume that a mutual fund’s record over one year is a reliable indicator of the manager’s skill."Context and chance are one thing (two things?), but a historical perspective is yet another. Surowiecki shows his readers why that is crucial as early on as his third paragraph.
Pay heed!
-- David M Gordon / The Deipnosophist
================================
THE FINANCIAL PAGE
THE FATAL-FLAW MYTH
by James Surowiecki
Issue of 2006-07-31
Posted 2006-07-24
Every other summer, the aerospace industry gathers in Farnborough, England, for a big trade show. At Farnborough last week, there was one thing on everyone’s mind: the plummeting fortunes of Airbus, the European aerospace giant. Airbus is struggling to find customers for the new plane on which it has staked its future, the superjumbo A380, as airlines wonder whether anyone wants to fly on a jet that seats almost six hundred people. The A380s that have already been ordered will be delivered late, thanks to production snafus that may add as much as $2.6 billion to the original development cost of thirteen billion dollars. Airbus’s other big project, the mid-size A350, is to be completely redesigned, at a cost of ten billion dollars. All the while, its sole competitor, Boeing, has been gobbling up business, thanks to its new mid-size jet, the 787 Dreamliner. In the first half of the year, Boeing took almost five hundred new orders for planes, while Airbus took just a hundred and seventeen.
Airbus is a business-world anomaly. It was created in 1970, by an alliance of European countries, in order to break the American monopoly on the commercial-aircraft market, and it’s currently owned by a defense conglomerate in which the French government has a major stake. This connection has helped the company get access to government-subsidized loans, but has also meant that its corporate strategies have been shaped by politics. Now Airbus’s woes are being held up as proof that it is, in the words of one columnist, “a textbook example of how not to run a commercial enterprise.” The Wall Street Journal explained that Airbus was failing because of its “politicized management,” while the Times suggested that Airbus had to decide whether it was a company or a European “employment project.”
There are reasons to think that politics and business shouldn’t mix, but Airbus’s predicament isn’t one of them. What much of the talk about the inherent weakness of Airbus ignores is that, just a few years ago, it was Boeing that looked fundamentally flawed, while Airbus was seen as the future of the industry. Beginning in the late nineties, Boeing’s commercial-aircraft business went into a long and nearly profitless slump. In 2001, Airbus surpassed Boeing in new orders, a lead it maintained until this year. During that period, Airbus’s unusual structure was praised; its insulation from the stock market supposedly allowed it to invest in long-term research and development. Boeing, by contrast, was thought to be trapped in a short-term, cost-cutting mentality, because, as one analyst put it, “the money guys don’t reward long-term thinking and investment.” In 2003, Business Week declared that Boeing was “choking on Airbus’ fumes,” and warned that Boeing’s “slip to No. 2 could become permanent.”
The problem with such prognostications is that they infer basic truths about a company’s prospects from its short-term performance. In fact, present success is often determined as much by context and chance as by fundamental viability. This is particularly true of the aerospace industry, because success is heavily dependent on a small number of big gambles. If you bet right, you look like a genius for a few years, even if the success of your bet was due to factors out of your control. The 787 may now look like Boeing’s salvation, but Boeing built it only after more ambitious plans—for a plane, known as the Sonic Cruiser, that would have been the fastest passenger jet in the air—fell through, partly because of the slowdown in air travel after September 11th. And had Boeing not been in such straits in 2003 it probably wouldn’t have risked the investment required for the 787.
People are generally bad at accepting the importance of context and chance. We fall prey to what the social psychologist Lee Ross called “the fundamental attribution error”—the tendency to ascribe success or failure to innate characteristics, even when context is overwhelmingly important. In one classic demonstration, people shown a person shooting a basketball in a gym with poor lighting and another person shooting a basketball in a gym with excellent lighting assume that the second person hit more shots because he was a better player. This problem is compounded by the tendency to extrapolate big conclusions from small samples, something that behavioral economists call “the law of small numbers.” In the decade or so that Airbus has been a serious competitor to Boeing, this is its first really bad patch, and its difficulties are due mainly to making one bad bet while Boeing made one good one. That’s a minuscule sample size on which to base any kind of conclusion. But this is exactly what we like to do: sports fans assume that a few excellent performances are proof of a player’s underlying ability, while investors assume that a mutual fund’s record over one year is a reliable indicator of the manager’s skill.
Because we underestimate how much variation can be caused simply by luck, we see patterns where none exist. It’s no wonder that management theory is dominated by fads: every few years, new companies succeed, and they are scrutinized for the underlying truths that they might reveal. But often there is no underlying truth; the companies just happened to be in the right place at the right time. In 1999, after all, it was hard to find a business book that didn’t hold up Enron as the embodiment of one important principle or other. Of course, some strategies and structures work better than others, but real meaning emerges only over the long term. Let’s give Airbus a few more years of floundering before we decide that it should be put out of its misery.
Copyright © CondéNet 2006. All rights reserved
posted by David M Gordon | 3:39 AM
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