Dynamic Simplicity: Are Simple Rules Sufficient for Competing in the Knowledge Economy

Presented at Rendanheyi Silicon Valley Center Seminar

1. “Everything should be made as simple as possible but not simpler” -Quote attributed to Einstein Dynamic Simplicity: Are Simple Rules Sufficient for Competing in the Knowledge Economy? David J. Teece February 18, 2021 Rendanheyi Silicon Valley Center Seminar Copyright David J. Teece

2. My Thesis: The real world business environment is volatile, uncertain, complex, and ambiguous (VUCA). Managers cannot generally escape this… except by accepting government regulation for all… but such regulation would only substitute political for marketplace uncertainty. In dynamic environments simple rules can often help; but they are not a panacea. Strong (high level) dynamic capabilities requires reasoning from first principles… especially with respect to sensing and sensemaking, and also with respect to strategy Copyright David J. Teece 2

3. Eisenhardt’s Simple Rules as I understand them: Small number of guidelines for decision making. Usually context specific. Not overly prescriptive; but nevertheless provide guidelines. Some standard operating procedures can also be simple rules. Copyright David J. Teece 3

4. Eisenhardt and Sull Classify Simple Rules Into Three Types Boundary rules – define the spectrum of acceptable investment and actions Prioritizing rules – which of multiple paths should organization take Stopping rules – when should management pull out of an investment Copyright David J. Teece 4

5. Companies Themselves Often Create Unnecessary Complexity More rules and controls are implemented as firms grow in size. Executive teams must always stay close to the front line team to appreciate the implications of complex reporting requirements. Requests for information often lead to a cascade of reporting work. Simplification in organizational life is almost always a virtue. Too few rules are often better than too many. The virtue of simple rules is (1) they avoid “analysis paralysis” (2) enable faster execution. Copyright David J. Teece 5

6. The Benefit of Simple Rules at Work: Summary Managers can reduce self generated (artificial) complexity by identifying and minimizing (often unintentional) complexity that result from generating edicts and mandates. Simple rules manifested as standard operating procedures economize on bounded rationality and assists efficiency. Copyright David J. Teece 6 But simple rules are only suitable for recurring and identical processes (what elsewhere I call ordinary capabilities)… or possibly lower level dynamic capabilities

7. Simple Rules and Creativity? Rules can become dogma and substitute for thinking. The implicit message with rules is that understanding doesn’t matter. Core rigidities begin to develop. If we never learn to take something apart, we end up trapped in what the world tells us… i.e., trapped in the status quo. When the environment changes dramatically, sometimes the simple rules must not just be modified. The simple rules book must be thrown out/reinvented. When one rejects rules, you are often labelled a troublemaker. But “troublemakers” can sometimes cause us to test the validity of the rule. (C. Nemeth) Copyright David J. Teece 7

8. In Short, Not All Aspects of Management Can Be Modified Into Simple Rules Simple rules reflect some underlying conceptual model. Conceptual models are extremely important tools for organizing and understanding otherwise complex things When we want something to be simpler, we are in essence asking for a more elegant conceptual model. Simple rules economize on bounded rationality… but they don’t eliminate it… and often don’t provide much guidance as to when they are no longer applicable. Copyright David J. Teece 8

9. Following Nobel Laureate economist Koopmans, uncertainty can be classified into: (a) structural (primary) (b) behavioral (secondary) Structural uncertainty is “state of nature” uncertainty… inherent in the environment. Behavioral uncertainty can be defined as that (which is) induced by human behavior and the organization itself. Eisenhardt’s focus on simple rules is more apt for navigating the latter, not the former. Dynamic capabilities is concerned with managing under both types of uncertainty, and particularly the former. Copyright David J. Teece 9 Simple Rules Work Best to Manage Behavioral (And Not Structural) Uncertainty

10. The Dynamic Capabilities Framework Can Lend a Hand The capability hierarchy Ordinary Capabilities : for running the business on its current trajectory Low-level Capabilities : for growing the firm somewhat routinely through M&A, R&D, etc. Dynamic Capabilities : for shifting the trajectory, rethinking the resource base, reshaping the industry Managers with somewhat different skills are needed to support each of these. Copyright David J. Teece 10

11. Dynamic Capabilities Defined The ability of an organization and its management to integrate, build, and reconfigure internal and external competencies to address rapidly changing environments. * * Teece, Pisano, and Shuen , Strategic Management Journal, 1997 Copyright David J. Teece 11

12. Dynamic Capabilities Three main categories of activity* Sensing : Developing and testing a model of the future Seizing : Implementing new business models derived from tested conjectures Transforming : Keeping the organization aligned with evolving strategies Sensing, Seizing, and Transforming should be ongoing and embedded throughout the organization * Teece “Explicating Dynamic Capabilities” Strategic Management Journal , 2007 Copyright David J. Teece 12

13. Simple Rules and the Dynamic Capabilities Low-level Dynamic Capabilities can be assisted by simple rules to provide guidance through choppy seas with enough flexibility to respond to emergencies Higher level Dynamic Capabilities rest more heavily on entrepreneurial management to forge a route into the unknown by reasoning from first principles Copyright David J. Teece 13

14. Reasoning From First Principles (Not Simple Rules) is Critical for (High Level) DCs: Break down a complicated problem into basic elements and then reason from the ground up. Used by Aristotle and by Elon Musk and Charlie Munger Allows managers to cut through the fog of shoddy & inadequate reasoning to see opportunities that others miss Aristotle: “In every systematic inquiry where there are first principles, or causes, or elements, knowledge results from arguing knowledge of these” Copyright David J. Teece 14

15. “People’s thinking process is too bound by analogy to prior experience… you have to build up the reasoning from the ground up… from first principles.” Elon Musk, 2015 Musk reasons out his plan of action and adjusts based on what he learns. Musk says “It’s the difference between being a cook and a chef. Cooks practice routines; chefs innovate.” Copyright David J. Teece 15 Elon Musk’s (Tesla, Space X) Approach to Deep Uncertainty is to “Reason From First Principles”

16. Haier Has Strong Dynamic Capabilities Chairman Zhang most likely reasoned from first principals as there were no simple rules around… they all had to be invented Relying on the microenterprise model simplifies decision making and avoids many stultifying rules. Copyright David J. Teece 16

17. Rendanheyi is an Enabler of Haier’s Dynamic Capabilities 1 Interview with Zhang Ruimin, June 19, 2017, MIT Sloan Management Review with Paul Michelman, p.7 “The micro-enterprises … are very entrepreneurial and very good at identifying, developing and seizing new market opportunities…they are very self organized.” 1 “Self organize” is a simple rule. 17

18. Rendanheyi and Dynamic Capabilities Both Adopt a Holistic Perspective 1 Interview with Zhang Ruimin, June 19, 2017, MIT Sloan Management Review with Paul Michelman “We tend to look at things from a holistic perspective…so we are applying traditional holistic thinking to our management.” 1 Adopting a holistic perspective requires more than simple rules… it requires dynamic capabilities. 18

19. Consider the elements of R. Rumelt’s Strategy Kernel: Diagnosis Guiding policy Coherent actions Simple rules can sustain a strategy and help construct a guiding policy. But there is much more to strategy than policy. “Create value, capture value” and “navigate obstacles to progress” are not simple rules. Copyright David J. Teece 19 Simple Rules and Strategy?

20. Appendix Copyright David J. Teece 20

21. By Allowing for Ease and Speed in Decision Making, Simple Rules Assist Dynamic Capabilities by Avoiding: The rigidity and burdensomeness of complex rules The chaos and confusion of no rules at all Copyright David J. Teece 21 With uncertainty, one never has the full information and a simple rule that is “good enough” lets one make a decision, learn, pivot, and move on.

22. The Cook v. The Chef The chef is the trailblazer that reasons from first principles. He knows the raw ingredients and how to combine them. The cook uses a recipe (simple rules) and reasons by analogy. A good chef has dynamic capabilities; a cook only has ordinary capabilities… or at best low-level dynamic capabilities. Copyright David J. Teece 22

23. Ways to Reason by First Principles: Socratic questioning – asking why why why ? Explain the foundations of your thinking Examine consequences and implications Challenge assumptions Look for evidence Consider alternative hypothesis Question the question Copyright David J. Teece 23

24. Reasoning From First Principles 1. Removes the clutter of conventional thinking and allows one to think anew. It’s hard work… which is why so few people do it. 2. Is necessary when you are: a. doing something original b. dealing with complexity c. managing “wicked” problems Conclusion: Simple rules are not an Occam's razor for tech sector decision making. You still need dynamic capabilities! Copyright David J. Teece 24

25. With “wicked” problems, you make progress by reasoning from first principles, and thereby hopefully breaking the mold… and reframing the problem. Reasoning by analogy is easier, e.g. tigers don’t change their stripes. Therefore, neither tigers nor people can change. While it’s easier, it’s often wrong. Copyright David J. Teece 25

26. Winter Eisenhardt Helfat et al. Teece “zero order” or “zero level” - the 'how we earn a living now' capabilities: producing and selling the same product, on the same scale and to the same customer population   “operational” – enables the firm to perform ongoing tasks for making a living “ordinary capabilities” - administrative, operational, and governance-related functions that are necessary to the execution of current plans “first order” – new product development or the opening of new outlets (A “dynamic capability” enables a firm to alter how it currently makes its living; definition also implies “reliable patterned behavior”) “dynamic capabilities” - organizational and strategic routines by which managers alter their resource base—acquire and shed resources, integrate them together, and recombine them—to generate new value-creating strategies. Examples: product development, TMT decision making, replication, resource allocation, coevolving, patching, knowledge creation, alliance formation, M&A. Defined and assessed relative to the resources they change, not to firm performance “dynamic capabilities” – the capacity of an organization to purposefully create, extend, or modify its resource base. The function must be repeatable and can be reliably executed. “low-level DCs” or, in one paper, “microfoundations” - processes for forming external partnerships or for developing new products. They consist of (often idiosyncratic) routines that are employed less often than the routines of ordinary capabilities. Microfoundations allow the firm to integrate, reconfigure, add, or subtract resources “higher order” - investments in organizational learning to facilitate the creation and modification of dynamic capabilities for the management of acquisitions or alliances   “dynamic managerial capabilities” - the capacity of managers to create, extend, or modify the resource base; can also change the external environment “dynamic capabilities” - activities and assessments that channel other capabilities and resources so as to maintain external fitness. Copyright David J. Teece 26 Terminology Table Greg Linden and David J. Teece, Feb 2021