Have you heard of the Red Queen effect? The idea draws its name from a vignette in Lewis Carroll’s book, Through the Looking Glass. In the vignette, Alice is chasing the Red Queen in circles that seem to be taking them nowhere. When the two stop running, they are in exactly the same place. Alice is bewildered as she addresses the Queen.
`Well, in OUR country,' said Alice, still panting a little, `you'd generally get to somewhere else -- if you ran very fast for a long time, as we've been doing.'
`A slow sort of country!' said the Queen. `Now, HERE, you see, it takes all the running YOU can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!'
The Red Queen effect is a principle that draws its name from this scene. The principle highlights the speed of change that is required to adapt a business to meet the ever-changing demands of its marketplace. Without such adaptation, businesses cease to exist.
My first introduction to Lewis Carroll’s story of Alice and the Red Queen was when I picked up Eric Beinhocker’s book on complexity economics, The Origin of Wealth. In the book, Beinhocker leverages the Red Queen effect to explain that markets evolve and businesses adapt to meet the market. This simple idea enlightened my thinking about business, strategy, and strategy execution.
At the time (2006), the theory of the Red Queen effect, accompanied by Beinhocker’s thorough explanation of exploring marketplaces, helped me understand the impending demise of Blockbuster and the rise of Netflix. Blockbuster was stuck continuing to improve or “exploit” its business model at a time when it had already reached a peak on the "fitness landscape.”
The fitness landscape is a model that comes from biology which describes the “fitness” of a creature to a particular environment. In the case of this article, we would consider the “fit” of a specific business design to a specific marketplace. The better suited that the design is to the marketplace, the higher the business is found on the elevation on the fitness landscape.
While Blockbuster was fine-tuning its retail video rental and mail subscription model, Netflix had found another peak in streaming video that extended far beyond what Blockbuster was doing. In this way, Netflix was at the base of a much higher peak than the summit that Blockbuster had already crested. Netflix had “explored” the fitness landscape and found a peak that surpassed the peak where Blockbuster was entrenched.
The basis of our efforts as business leaders to exploit and explore changing landscapes relies heavily on resource allocation. This is why the process of planning, the deployment of both financial and human resources against our goals, is paramount to our ability to change in order to meet the evolution of our marketplaces.
Therefore, as we consider resource allocation, we need to take into account the different planning processes that are required to both exploit and explore the fitness landscape.
I would posit that we need to leverage three distinct approaches to financial planning in order to successfully and consistently evolve our businesses. We need to plan for Business as Usual. We need to allocate resources to fund Operational Process Improvements, and we also need to make educated bets, or run a portfolio of experiments, on Net New Innovations. As we go about our planning, whether it be an annual budget or a forecast, we allocate resources to spur on the activity of the firm in each of these three areas.
Blockbuster was focused on Business as Usual and was perhaps preoccupied with Operational Process Improvements while missing out on Net New Innovations. I remain uncertain as to whether they turned a blind eye to streaming video or simply struck out on their own Net New Innovations. In any case, the three buckets remain.
The challenge is that each of these approaches requires a slightly different financial planning process. For Business as Usual, we can use traditional planning to leverage a projected time series from prior periods. We have too much data not to leverage what has happened in the past. However, we need to challenge our numbers with driver-based budgeting and leverage the newer techniques in time series modeling and regression analysis to automate our efforts. There is no reason why the Business as Usual aspect of budgeting and forecasting should not be fully automated in the coming years (it’s what we at Adaptable, LLC are doing).
The next type of financial planning comes from Operational Process Improvement projects. This type of resource allocation is best served by hardcore cost-benefit analysis. Since we have “known” processes within the Business as Usual aspects of our companies, we are simply working to improve these processes by enhancing the value they produce or by reducing the cost to produce that value. Traditional payback and ROI analysis are appropriate here.
Lastly, we have our portfolio of Net New Innovations. The best way to plan these investments is through a stage-gating process in which key success criteria are planned and evaluated every six months or so. In this way, innovations are funded and reviewed systematically similar to the way a venture capital firm would.
The world of Alice and the Red Queen is a current reality, and it is why resource allocation is critical as we seek to swiftly and effectively coordinate the flow of resources toward the areas of our businesses that require change. To avoid becoming the next Blockbuster, we need to be aware of all three types of financial planning that are required to both explore and exploit the fitness landscape. The race is fast and constant, and the path is unknowable. Therefore, planning and connected planning have become a key competency for competitive advantage.
George Veth is Founder & CEO of Adaptable, LLC. A serial entrepreneur, George has founded or co-founded three consulting firms. Most recently, he started and ran Painted Word, a corporate performance management services firm. His domain expertise is in the area of how analytics and resource allocation serve as the backdrop to 21st-century business management.
In 2009, he completed a mid-career degree at the Kennedy School of Government where he studied economic development and social change. He is also Founder and Managing Director of the Mango Fund which is a social investment fund that provides technical assistance and capital to emerging business entrepreneurs in East Africa.
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