Seeing the economic stream of an endeavor
Most people work for the private sector, which cannot exist without profit - Larry Elder
Every endeavor is, at its core, an economy. Scarcity, choice, and consequence shape the work long before strategy decks or roadmaps appear. The endeavor’s long-term survival depends upon a pipeline of worthwhile pursuits, respect and trust of its customers, and effectiveness in:
discovering and building relationships with customers
managing the resources used by activities in development, production, and operations
organizing these activities into effective flows
providing the means to accomplish those activities quickly and efficiently
evaluating and improving how this work is being performed, and
enhancing the effectiveness of running the business overall.
Even the owner of a lemonade stand needs to attract seed money to cover pre-launch expenses; once launched, enough capital must continue to be attracted to warrant continued investments in labor and materials for operating expenses. In parallel, the means of production must be established, maintained, and evolved at a steady pace for growth to occur; at a minimum, one must ‘break even’ for mere survival, which is never a satisfying experience.
Herbert Simon, computing's first economist, describes the steep path this involves in his book, Sciences of the Artificial:
The idealization of human rationality is enshrined in modern economic theories, particularly those called neoclassical. These theories are an idealization because they direct their attention primarily to the external environment of human thought, to decisions that are optimal for realizing the adaptive system’s goals (maximization of utility or profit). They seek to define the decisions that would be substantively rational in the circumstances defined by the outer environment.
Economics exhibits in purest form the artificial component in human behavior, in individual actors, business firms, markets, and the entire economy. The outer environment is defined by the behavior of other individuals, firms, markets, or economies. The inner environment is defined by an individual’s, firm’s, market’s, or economy’s goals and capabilities for rational, adaptive behavior. Economics illustrates well how outer and inner environment interact and, in particular, how an intelligent system’s adjustment to its outer environment (its substantive rationality) is limited by its ability, through knowledge and computation, to discover appropriate adaptive behavior (its procedural rationality).
The question of maximizing the difference between revenue and cost becomes interesting when, in more realistic circumstances, we ask how the firm actually goes about discovering that maximizing quantity. Cost accounting may estimate the approximate cost of producing any particular output, but how much can be sold at a specific price and how this amount varies with price (the elasticity of demand) usually can be guessed only roughly. When there is uncertainty (as there always is), prospects of profit must be balanced against risk, thereby changing profit maximization to the much more shadowy goal of maximizing a profit-vs.-risk “utility function” that is assumed to lurk somewhere in the recesses of the entrepreneur’s mind.
In real life the business firm must also choose product quality and the assortment of products it will manufacture. It often has to invent and design some of these products. It must schedule the factory to produce a profitable combination of them and devise marketing procedures and structures to sell them. So we proceed step by step from the simple caricature of the firm depicted in the textbooks to the complexities of real firms in the real world of business. At each step toward realism, the problem gradually changes from choosing the right course of action (substantive rationality) to finding a way of calculating, very approximately, where a good course of action lies (procedural rationality). With this shift, the theory of the firm becomes a theory of estimation under uncertainty and a theory of computation—decidedly non-trivial theories as the obscurities and complexities of information and computation shift.
This distinction between substantive and procedural rationality gives us a vocabulary for this reality: leaders rarely optimize in the abstract; they navigate constraints, partial information, and shifting terrain. When we acknowledge this, the fog lifts. We stop pretending decisions are puzzles with correct answers and start treating them as investments made under uncertainty.
Navigation must intelligently juggle priorities across the many demands which compete for those resources; as Herbert Simon describes:
How well one thing substitutes for another cannot be determined by how similar they are in physical characteristics, or indeed, by any purely objective criteria. Economists define substitutability in terms of people’s subjective preferences as revealed by their overt behavior. If a rise in the price of coffee causes people to buy more tea, then economically speaking, we can say that they are substitutes without having to investigate the chemical or physical characteristics of either...
Simple as all this is, it goes completely counter to rhetoric that is often heard, and sometimes heeded, about the urgent need to “establish priorities” either nationally or in a business or other organization. At the instant that such rhetoric is uttered, there may indeed be an urgent need for more of one thing at the expense of something else, but it is only a matter of time before the changing proportions of the two things change the relative urgency of adding more of each. Categorical priorities ignore this fact, unless they are very flexible and reversible-in which case they are not really “priorities.” But because sober analysis seldom has the appeal of ringing rhetoric, priorities often do get established and outlive the necessities that gave rise to them.
Value being ultimately subjective, it varies not only from person to person but from time to time with the same person and varies also according to how much of the given good he already has. Obviously, a man in the desert dying of thirst would sacrifice much more for a glass of water than he would in his home, with water available from his faucet. In short, even for the same individual, the value of water can vary from virtually everything he has down to zero-or even below zero, since he would pay to have water taken away if his basement were flooded...
While an individual or an economy may appear at first to be weighing the subjective value of a good against its objective cost, ultimately what is being weighed is the subjective value of one good against the subjective value of another good. Faced with identical technology and resources setting the limits of what is possible at a given time, different combinations of goods may be produced, according to the subjective preferences of the decision makers, whether those decision makers are consumers, central planners, or royalty...
This prioritization thus requires business intelligence of sufficient fidelity and relevance for the above to occur across many stakeholders, empowering all to act in the business's interests as well as their own. The importance of this information is highlighted by Lawler, Mohrman and Ledford in their landmark 1995 publication, Creating high performance organizations:
Without (..) information about business performance, it is difficult for individuals to understand how the business is doing and to make meaningful contributions to its success. In addition, participation in planning and setting direction is impossible for employees to make good suggestions about how products and services can be improved and about how work processes in their area can be done more effectively. It is also difficult for employees to alter their behavior in response to changing conditions and receive feedback on the effectiveness of their performance and that of the organization. In the absence of business information, individuals are usually limited simply to carrying out prescribed tasks and roles in a relatively automatic bureaucratic way.
Where in your current work are you still assuming perfect information - and what would change if you treated that space as an economy instead of a puzzle?
Before we can manage work effectively, we have to see it clearly. Once we recognize that every decision is an economic choice, the next question becomes: how do these choices accumulate into the shape of an organization? That’s where portfolios - and the bets inside them - begin to matter.