In my last post I talked about how unfounded assumptions are at the root of the most dangerous types of crisis. In this one I’ll explore some of the reasons why such severe crises seem to happen more and more often. You need to understand the roots of these crises because responding to a crisis stemming from inside your company is very different from handling one that’s been inflicted from outside. Wherever the crisis comes from, you’ll only be able to handle it if you understand why it happened, and you’ll only be able to prepare if you know why they’re going to keep happening.
Globalization has boosted our productivity and standard of living. But it also leaves us vulnerable – not just because globalized companies rely on suppliers from around the world, but because the fundamental nature of what makes large networks valuable also makes them fragile. These networks rely on the companies within them to specialize in what they do best, and such specialization has profound hidden dangers.
It’s commonplace to say that globalization has made the world a smaller place. Thomas Friedman, perhaps globalization’s most eloquent proponent, has argued in books like Thank You For Being Late, Hot, Flat, and Crowded, and The World Is Flat, that information technology and decreasing barriers to trade have put companies around the world on an even footing. This resulted in supply chain networks that densely interlink companies across the world. Apple, for example, has more than 200 suppliers with more than 800 factories in places ranging from Taiwan to Minnesota. This complex supply chain that allows Apple to maintain very little inventory is a key component of Apple’s almost unimaginable profits.
But how do these complex supply chains generate value? Some comes from moving production to lower cost locations. As much or more, however, comes from the gains from specialization. This idea goes all the way back to Adam Smith, who described in The Wealth of Nations how specialized workers in a pin factory could vastly outperform an equal number of generalist workers. Economic research since then has shown, though, that this key insight explains much of economic growth even today. Globalization allows firms to specialize to an extent they never could if they were contained to a single national market, and many of the gains in productivity come from that increase in specialization.
A specialist is almost always far less adaptable than a generalist.
But specialization also increases risk. The more specialized you are, the better you are at doing one thing, but the worse you become at doing everything else. If conditions change, a specialist is almost always far less adaptable than a generalist. Think about the difference between sprinters and decathletes. Every world-class sprinter is faster than even the fastest decathlete – but these same sprinters would be crushed by even a mediocre decathlete in almost any other event. Specialized firms are sprinters, and today companies compete by building complex networks of specialized suppliers.
It’s not just that these networks are vulnerable to a disruption. They are, of course – we all know that the more single points of failure there are in your supply chain, the more delicate it becomes. But there’s more to it than that. The increased specialization which the complex networks of the modern economy makes possible also makes those failures more likely, precisely because specialization makes them more prone to failure when circumstances change. And when one of them does fail, the same network that makes them valuable conveys the consequences of their failure around the world, disrupting the lives of people and companies that might not have even known that they existed.
As a leader, you are faced with the task of avoiding crises caused by your own mistakes or those of someone inside your organization. You also need to prepare for crises caused by people you’ve never met making choices that you’ve never even had to imagine. In my next and final post in this series, I’ll talk about how the way finance has come to dominate the modern economy makes it even harder for companies to prepare for externally-caused crises, and even more likely that they’ll fall prey to internally-generated ones.