Friday, February 23, 2007

The Economics of Strategic Opportunity

Authored by;

Jereker Denrell, Institute of International Business,
Christina Fang, Department of Management The Wharton School and
Professor Sidney G. Winter, Department of Management The Wharton School.

February 2003.

Continuing on with the review of the LEM Working Paper series, Winter et al wrote "The Economics of Strategic Opportunity" to address the interesting topic of how strategic opportunities arise. This article has many worthwhile points and is available here. During July 2006 I also wrote a blog entry on a similar topic from Harvard Business School Working Knowledge series. Review of these three articles is highly recommended.

Winter et al start off their working paper by noting that the ability to earn exceptional returns is contrary to what is assumed to be the instance in business. The Efficient Market Hypothesis assumes that all knowledge is available to all. In the Abstract they write;

"As emphasized by Barney (1986), any explanation of superior profitability must account for why the resources supporting such profitability could have been acquired for a price below their rent generating capacity. Building upon the literature in economics on coordination failures and incomplete markets, we suggest a framework for analyzing such strategic factor market inefficiencies. Our point of departure is that a strategic opportunity exists whenever prices fail to reflect the value of a resource's best use. this paper examines the challenges of imputing a resource's value in the absence of explicit price guidance and suggests the likely characteristics or strategic opportunities. Our framework also suggests that the discovery of strategic opportunity is often a matter of "serendipity" and access to relevant idiosyncratic resources. This latter observation provides prescriptive advice, although the analysis also explains why more detailed guidance has to be firm specific." Abstract
In energy I have seen many people who assume their role and responsibility is to spend the money on exploration and development. The inexperienced assume that the act of doing is all that is required. These people stay in business for the approximate same period of time they have a positive cash balance. On the other hand, I have seen how individuals who are given an opportunity and struggle to lay in wait for the right time, develop sophisticated business strategies, engineering or geophysical ideas that can only be proven through a methodical and painstaking process. A process they have learned through several decades of experience and study. Needless to say, the latter groups are far more successful in any type of financial metric comparison to the former.

I have also written about the reckless acquisitions some CEO's pursue and am reminded of Carly Finorina's failed attempt to acquire PriceWaterhouse Coopers technology group for $19 billion. And the subsequent purchase of these same assets a year later by Lou Gerstner at IBM for $3 billion. Is this luck that provides these people with their enhanced returns? Anyone can spend money, and the amount of money available for any transaction is truly unlimited. Self delusion comes into play and a contagious enthusiasm for the failed theory can support any size of investment or any size bank loan. Because the banker has provided you with the resources to purchase a house, doesn't mean that you do it. How the Efficient Market Hypothesis fails is somewhat based on the discussion that Winter et al write about in this article.

1. Introduction
"Barney sets forth what might be called the "bad news" about resource valuation: in general it is difficult to purchase things for less than they are worth. The interests of both the seller and rivals should stand in the way of such an accomplishment. This paper sets forth the good news about resource valuation: our stance is that "the good news is that the bad news is wrong". (Or at least, the bad news is valid only within it proper sphere.)" pp. 1
"Whether the opportunities seen are actually seized is, however, an important question. We argue that the discovery of a valuable strategic opportunity is often a matter of "serendipity" in the strict sense - not just luck, but effort and luck joined by alertness and flexibility." pp. 1
"To appreciate these points it is necessary to break out of the equilibrium mindset that dominates so much of economic theory - including, of course, the Efficient Market Hypothesis (EMH)". pp. 1
I would also ask how much does time play in making the superior returns. If one is to compete on assets based on the EMH, with its staunch believers, one will be forced to acquire the assets they need at or near the market top. The timing, effort and finding yourself going against the grain are the keys to long term success and exceptional returns. As in my case on this project, I have kept the powder dry and the candle lit and have waited for the puck to arrive, as Wayne Gretzky would say. Now that the puck has landed on my stick, it would take a significant amount of money to purchase a similar strategic opportunity / position / asset. My costs are marginal.

2. Some Fundamentals
"Financial performance and profitability. In the strategic management literature, business success is generally equated with financial performance, and financial performance with "sustained abnormal profitability". pp. 2
And here is the key to a long term competitive financial performance. If the cost of the asset is overpriced at the time of acquisition, the amortization of the assets cost over the life of asset / business will consistently lower the returns realized. Winter et al take this concept further with the following;
"Our view is that net present value - or expected net present value, where risk is involved - is the basic measure of success in the quest for strategic opportunity. It is "basic" in the sense that it stands at the limit set by Einstein's famous dictum that "everything should be made as simple as possible, but not simpler." It is possible to employ more general or sophisticated measures that NPV, and to invoke NPV in more sophisticated ways. It is difficult to make basic economic sense with a simpler analytical apparatus than the NPV concept provides. Hence, our discussion of "strategic opportunity" relates to opportunities for positive NPV undertakings, with merit understood to be measured by the amount of NPV." pp. 3
"In this "basic" economic approach, we set aside some considerations, such as organizational survival, which might make something other than the NPV of an isolated opportunity matter to management. We also set aside more important complications associated with the long term interdependency among opportunities that arise from, and affect the development of, the same set of underlying capabilities and competences." pp. 3
The importance of this discussion is of particular interest in the energy industry. The reason is that almost all metrics of valuation of what is "real" are subjective. As I stated before the costs can be comprised and reflect only the ability to spend money. That does not find or produce oil and gas. Intellectual property is the key asset of an oil and gas firm. The producers capability and capacity to find and produce energy is the key metric. How to value something that is in the ground with many possibles and probables are unknown. What one man sees as garbage, another may see is gold. The subjective nature of the industry leaves the cost based measurements as meaningless. NPV when compared to these historical cost metrics will provide the superior returns that an effective management team provides.
"These consideration do not, of course, rule out a purely cost-based approach to valuation. With some effort it is possible to measure the investment involved in the creation of a particular complex resource, although the result is partly determined by luck. Cost data, however, clearly cannot answer by themselves the question of what the resource is worth. The demand side information is missing." pp. 4
3. Market Completeness and Strategic Search

Not to harp on the theme of the plodding along approach is the better method. The experience of the management staff that are able to "plod" along generally know that they are in a long term battle with the market. A battle for the type of results they know that they can achieve, and at less cost (and higher returns) then other methods. This model of business development is borne of a significant period of understanding and education in essentially the school of hard knocks. This struggle continues unabated irrespective of the monetary success that is achieved. These authors appear to be commenting about what the majority of successful companies have experienced.
"In summary, a realistic appraisal of market systems compels recognition that markets are incomplete, and drastically so in the domain of currently untried activities. As a result, since the value of existing activities may depend on untried activities, it cannot be guaranteed that existing activities are priced correctly. Thus when markets are incomplete, the prices prevailing in an apparent equilibrium do not preclude the existence of valuable unexploited opportunities. To exclude strategic arbitrage, a much stronger condition than market-clearing prices is necessary - we might call it "exhaustive entrepreneurship." It would have to be that for each good, traded or un-traded, there has to be someone who has considered the value of this good in all possible uses. As discussed in the next section, such a condition imposes a massively implausible information requirement on the actors in the system. Moreover, although actors can probably learn to identify the value of some of these resources, we argue that the local and decentralized character of the learning process implies that certain strategic opportunities are likely to remain. The challenges of the learning process also suggest some clues about the likely characteristics of such remaining opportunities." pp. 6
Or, in other words, irrespective of the market dynamics and the quality of the NPV, the strategic opportunities exist despite the market successes and failures. If a market participant eliminates themselves from the game before he / she even tries, then he / she will have lost for certain.

4. Valuation of Complex Resources: The Challenge of Imputation.

When I think of Google, I think of the resource that it provides me. I have 7,000 of maybe the smartest and most competent development and business people, and possibly the top 50 super computers all working actively to provide me with better processed information. A level of, essentially, artificial intelligence that has never before even been imagined. The dynamic that these Google resources provides everyone in business will allow generations of prosperous entrepreneurs. And that is maybe the point, Google's resources are available to everyone and to not use them at their optimal level eliminates you from the business environment of tomorrow.

On the other hand, how the structured hierarchy exists in this environment is of question. If individuals are provided with these opportunities in a fast pace economy, how can the structured hierarchy prosper? It would be my assertion, the longer that businesses exists under the structure of the hierarchy, the harder the change will become and the greater risk of total loss increases. These risks being the market dynamic that Winter et al are heading toward.
"To be capable of accurate calculation of this sort, an entrepreneur would require not only vast computational capacity but, more important, extensive knowledge of the transformation that are possible in the economy. Obviously, in many cases, individuals do not have immediate access to this knowledge. This raises the important question of how resources are valued in incomplete markets. In particular, when and for what types of resources can economic agents, on the basis of search and learning from experience, determine the value of resources and thus the basis of search and learning from experience, determine the value of resources and thus recognize any arbitrage opportunities? Formulated differently: when will the condition of "exhaustive entrepreneurship" be satisfied? Formally, this learning challenge is equivalent to the problems of learning to identify the value function of a large dynamic programming problem without initial knowledge of the set of possible transitions or the costs and rewards associated with each transition." pp. 8
In a nutshell the number and volume of arbitrage opportunities is incalculable. The time to be an entrepreneur and apply these principles exist as in no time in the history of mankind.

5. The Character of Strategic Opportunity.

The Architecture of Strategic Opportunities.

Staying with the way that Google does its business, if we look at this weeks announcement of Google Apps for your Domain, these products provide completely different metrics for the computer user. Microsoft Office has had its way with this market since it dispatched Lotus and Word Perfect to the scrapheap. Now they find that Google Apps will be offered at a fraction of Microsoft's prices. This is the heart and soul of Microsoft's revenues and profits. If at the same time Microsoft experiences similar difficulties on the operating system market. Say if Apple were to provide a better product for far cheaper. Microsoft would have effectively lost the lion share of their revenue and the profits will disappear in rapid fashion. Google has now effectively done this by becoming the worlds largest advertising firm. A business model that is far more resilient and valuable then Microsoft's, in my opinion.

Many might say that Google has been lucky, and there would be general agreement that it was. It is now ten years into their existence and they now have new revenue being generated through the sale of their software and services. One that strikes deeply into the competitive framework of Microsoft and provides better value to the consumer. How could someone be so bold, be so farsighted and be that smart. Well in my opinion Google is, and they got there on the basis of Winter et al's discussion here.
"Based on the above discussion of market incompleteness and the challenge of imputation, it is possible to say something about when and for what type of resources strategic opportunities may be located. As emphasized by Shleifer (2000), any systematic theory of market inefficiency, which simultaneously acknowledges the competitive forces that push markets towards efficiency, needs to answer when and why inefficiencies can occur and remain in the presence of competitive forces and the search for arbitrage opportunities." pp. 9
"The above arguments suggest that part of the answer lies in the complex, combinatorial, character of strategic opportunities. Specifically, it is unlikely that a valuable strategic opportunity can be seized simply by trading in existing resources. It is much more likely that a strategic opportunity can be found if the strategy involves trading in resources whose values are contingent upon one or several other resources being used in a new or different way, including the creation of novel types of complex resources. Unless several other actors have already recognized the opportunity and acted, resource values will not be aligned with the new uses. If these other resources are of an entirely different character or used by a completely different set of firms, identifying such an opportunity can be very challenging. Thus, there can be no presumption that this has already occurred." pp. 10
It is not to say that driving a truck through Microsoft's Office revenues and profits is something that was not considered by many. It is the foresight to see these opportunities and build, over the long term the solution that is necessary. Trading stocks based on the Efficient Market Hypothesis is a fools game, not a business. Building a business with customers and revenues and profits is a long term fight that can only be secured in the discovery of the strategic opportunities that Winter discusses here.
"This does not imply, however, that it would necessarily take a heroic effort to identify such opportunities. If a firm has preferential access to the missing piece of the puzzle, identifying the opportunity might be easy. In general, firms can be expected to differ considerably in the information they possess, even in the absence of deliberate effort to create the sorts of informational advantages that Barney referred to. Such differences in information - and differences in complementary assets - typically imply differences in positioning relative to new opportunities. Thus, in contrast to financial markets where blatant arbitrage opportunities are rare, we submit that the discovery of strategic opportunities is a normal occurrence in the product markets." pp. 10
"As emphasized above, in such situations, strategic opportunities are possible, although not guaranteed. Restated in this way, the argument of Dierickx and Cool suggests a class of resources whose values are very difficult to identify and thus could represent a strategic opportunity." pp. 10
"While such examples of accidental discovery may seem to be unlikely, we argue that the character of strategic opportunities implies that they should be expected in accounts of business success. More precisely, we argue that given that a strategic opportunity is only first discovered after some time, the discovery of this strategic opportunity is likely to have been serendipitous." pp. 11
Serendipity, as I mentioned in July of last year is a good thing. With this project coming up on it's 15th year in May, I have struggled in defining what it is I was trying to do. I started on the basis of the fresh knowledge that the Alberta Governments "Royalty Simplification" initiative would be the opportunity to provide the market place with new and better applications. I quickly promoted Oracle into following my lead and we partnered up. They decided to rename the product Oracle Energy and I was left with relatively angry shareholders. Along came PriceWaterhouse who was unhappy with their partner for Oil and Gas and we had a new deal almost right away. However, Coopers and Lybrand owned Qbyte, the market leader, and their merger with Price Waterhouse left me out of business to say the least. Stumbling as I did into what the optimal organizational structure for oil and gas was the consummate definition of serendipity.

I think that Winter et al are on to something here. I want to go back to an entry that I made late last year about Abraham Lincoln. Ralph Waldo Emerson said something in his eulogy that strikes me as incremental to what Winter et al have been able to state. The quotation is...
"The ancients believed in a serene and beautiful Genius which ruled in the affairs of nations; which, with a slow but stern justice, carried for-ward the fortunes of certain chosen houses, weeding out single offenders or offending families, and securing at last the firm prosperity of the favorites of Heaven. It was too narrow a view of the Eternal Nemesis. There is a serene Providence which rules the fate of nations, which makes little account of time, little of one generation or race, makes no account of disasters, conquers alike by what is called defeat or by what is called victory, thrusts aside enemy and obstruction, crushes everything immoral as in-human, and obtains the ultimate triumph of the best race by the sacrifice of everything which resists the moral laws of the world.' It makes its own instruments, creates the man for the time, trains him in poverty, inspires his genius, and arms him for his task. It has given every race its own talent, and ordains that only that race which combines perfectly with the virtues of all shall endure."
Words to live by. Winter et al take much of this point and clarify it and categorize it in the following:
"Rather, it is likely that the necessary subsystems were only available to or considered valuable by the firm that discovered the opportunity. There are, at least, four possible reasons for this. First, only this firm had the strategic insight into the eventual value of these subsystems. Second, by deviating from existing practice, only this firm had the complementary set of activities that made these subsystems valuable. Third, this firm is "pre-adapted"; it was endowed with the subsystems by its previous history, for reasons unrelated to their application in the new opportunity (Cattani, 2002). Fourth, this firm made a mistake and thought that these subsystems were valuable by themselves even if all reasonable firms would agree that they were not. Although all of these reasons are possible, we suggest that the complex character of the strategic opportunity makes the first reason less likely than the others. Furthermore, although mistakes are not uncommon, we would argue that the second reason and third reasons are the most important." pp. 11

"Overall, this argument suggests that strategy process leading up to the discovery of a strategic opportunity is likely to have had the following characteristics. By deviating from existing practices, perhaps by intentionally choosing an unusual strategy or by necessity due to a lack of resources required to compete in the established manner, a firm develops a set of idiosyncratic resources. Although perhaps not very valuable by themselves, these resources could be used profitably in combination with other resources. By being the only firm with access to these components the firm is thus much more likely to discover the value of this combination." pp. 12

"In a similar way, when a firm has assembled many of the necessary components, it may be able to see that these resources could be valuable if complemented with some others. As a result, the search for the last components will be intentional rather than serendipitous."
The word entrepreneur means a lot of things to a lot of people. Generally it is considered a favourable term and one that is used by most people who do not describe themselves as one. It is not something that one can pick up a book and read about how to become an entrepreneur. It is not something that a college or university can teach. It is something that drives the person to continue the pursuit, irrespective of the costs and consequences. It is a drive to complete some part of their life that is well defined in this paper of Winters. To say that Entrepreneur's are different would be an understatement.
"This characterization also suggests that there may be little to learn from examining the strategic process of successful firms. At least for firms that discovered path - breaking strategic opportunities it is likely that they deviated from established practice by necessity or mistake rather than as part of a plan. To assemble the components required for spotting a path -breaking strategic opportunity, a firm needs to have assembled several components that individually are believed to be of little value. As a result, the firm needs to engage in an unusual amount of exploration. To be motivated to do so, a firm may need to be forced to adopt some of the elements or may need to adopt them by mistake (Denrell and March 2001). If this is so, the strategic opportunities of the most successful firms are likely to have developed through a process that it would be unwise to try." pp. 12
To close out this entry, I want to say this paper really resonates with me and the life that I have lived for the past 15 years. It is a tough and difficult struggle, but one that has defined me as Emerson said. These last few paragraph's display for me that the writers clearly have captured the essence of being an entrepreneur and related it well in these final words.
"...being the first in the know may enable an entrepreneur to create limits to post competition. Thus in this sense, ex post limits to competition may be a direct outcome of ex-ante limits to competition. Several examples of such situations have been outlined in the literature, including investments in over capacity to deter entrants (Dixit 1980) and tying up favorable locations and suppliers (Porter 1980)." pp. 14
"Although this analysis implies that detailed strategic guidance is necessarily specific to the firm and its situation, the notion of serendipity does have some general prescriptive force. While good luck may befall the inert or lazy, serendipitous discovery occurs only in the course of an energetic quest - a quest in which lucky discoveries of an unanticipated kind can be recognized through alertness and then flexiblly exploited." pp. 14
"This perspective on strategy is consistent with a large and growing body of evidence on the relationship of firm attributes to their entry decisions, innovations and other strategic moves, much of it recently reviewed by Helfat and Lieverman (2002) (see also Usselman 1993, Klepper and Simons 2000) In general the evidence shows that opportunities are specific and firms that seize them are usually specifically prepared for them by their "pre-history". This mechanism is the counterpart of "pre-adaptation" in biologic evolution (Cattani 2002). Our perspective is also well aligned with the discussion by (Sarasvathy 2001) about the characteristics of the thought process used by entrepreneurs. Using verbal protocols from experienced entrepreneurs faced with a hypothetical venture problem, Sarasvathy (2001) demonstrated that the thought process of entrepreneurs is more likely to start from the givens of a situation and to proceed by investigating the possible effects and market opportunities that could be created with these means. Goal directed thinking, which a market opportunity was identified at first and the means to achieve directed thinking, in which a market opportunity was identified at first and the means to achieve this opportunity were discussed later, was much less frequent." pp. 15
"The challenge of strategy is the challenge of assessing the opportunities that open to an idiosyncratically positioned actor in a changing environment. For this, the challenge of stock picking provides a poor analogy, because in the context actor idiosyncrasy plays a much smaller role. This assessment is clearly consistent with the central tenets of the RBV, but not with the discouraging words sometimes about resource pricing." pp. 15
Photo: Getty Museum by Troels

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Monday, February 19, 2007

Towards an Evolutionary Theory of Production Part B

In Part A of this secondary research review of Professor Winter's document. Winter raised two important points that provide companies with the opportunities, risks and rewards involved in the theory of production. The two key points were firstly, the production set of possibilities, and secondly the development and deployment of that knowledge. Suggesting that the production methods employed and operational today were based on the less then optimal choices. Winter suggests that today provides an opportune time to revisit the "evolution of production" and I concur.

There are some nasty pitfalls documented by Professor Winter in Part A of this document review. The software being built here for the oil and gas industry must avoid these pitfalls. But, also provide a production set of possibilities and opportunities for the producer to select the optimal solution for the situation at hand. Part B of this paper will discuss Winter's theories on "replication". Or how to deploy the optimal production process across the organization.

3. Replication
Thus, if management wishes to replicate at B the success it is having at A, a first challenge it faces is to devise methods to evoke the transfer of details of which it is unaware, including some of which nobody is aware, and some that represent information that is in various ways "impacted". This is a tall order that can never be filled completely; the gaps in the transfer will be filled by independent re-invention.
It is at this point I need to ask whom does "own" the "production set" of possibilities? Does a specific company or team of individuals? No one? Whom can effectively aggregate, develop and deploy the production set of possibilities. The competitive differentiating factors of the producer are based on its scientific capability, innovativeness and land base. These form what John Seeley Brown and John Hagel classified as an Innovation Management business. A new classification of either Innovation, Infrastructure or Customer Management would apply to all businesses within an industry. I find these theories resonate with my perception of the future. I see the producer filling the role of innovation, software developers providing the infrastructure and therefore these questions are valid. Who owns the knowledge of the production set of possibilities? Who is in the best position for their development, and whom is also responsible for them?

This ownership issue is a very fine point of conflict that will need to be determined through this software development project. The determination may involve whom provides the best solution to the energy industry. A large portion of these points fall within the domain of intellectual property and specifically, Patents. This topic will be discussed extensively due to the sensitive nature of the conflict. The solution to this issue will need to select the appropriate environment to which area (Innovation or Infrastructure) "should" be responsible for providing the definition of the production set and then replicating it from A to B, C,...
The literature of situated cognition points to the fact that the productive knowledge exercised at A exists in an intimate interconnection with the context of activity at A, both in its designed and coincidental feature. Of particular importance here are the "artefact's," tools and / or equipment used in the work (Hutchins 1995; Hutchins and Klausen 1996). In contemporary work settings, crucially important knowledge is often embedded in the equipment, and the local understanding of its functioning is narrowly instrumental. Computers and software are the most ubiquitous and familiar examples of this issue, but there are "low tech" examples as well. The spatial organization of activity at the micro level affects patterns of interaction and communication, and this can affect outcomes in ways that are not fully recognized or understood. (Bechky 2001). pp. 34
This last quote makes it appear that Winter would site the artefact's of tools, equipment have been the traditional area where the knowledge was embedded. In current times the computers and software "are the most ubiquitous and familiar examples of this issue". Possibly denoting where the analysis of this conflict will lead.
In some cases, top management may be totally unaware of the fact that considerations in these various categories are relevant to success. For example, this is inevitably so for procedural details that have been learned without awareness. In many cases, however, it is fairly obvious that the success of an activity depends in various ways on features of its context. Management may understand very well, for example, that the skills and personalities of employees have considerable bearing on the results achieved. pp. 36
Replication in Practice.

Winter has some particular salient warnings in the following quotations. That management may not take these points in consideration at their peril.
The above discussion suggests that replication is potentially quite challenging. It is not necessarily viewed as such, however. Often, management seem to take quite a relaxed attitude toward such challenges. While the relaxed attitude may be justified in some cases, it is arguable that many managers still have a good deal to learn about the subject. Where special circumstances force the issues to management attention, such as the technological peculiarities of semiconductor production (Intel), or MacDonalds' strategic devotion to a uniform customer experience, we do see managerial practices that are consistent with the general picture offered above. The example of Intel's Copy EXACTLY! policy (McDonald 1998) is particularly valuable because it rests precisely on the recognition that there is more productive knowledge implied in achieved high yields than the organization can capture in the form of comprehensive causal understanding of the method in use. pp. 37
And secondly, the exponential difficulty that is evident when interactions are populated with additional options.
This is not at all the case; the point is to control the amount of new learning and problem solving required. Every decision to create a difference between the sites makes an addition to an invisible list of unintended and hidden differences that will occur in spite of the policy. Interaction effects tend to make complexity rise exponentially with the number of discrepancies to be dealt with; it is better to keep the list as short as possible. There will be no shortage of problems to solve. There are several reasons why the problematic aspects of replication often go unnoticed. A basic one, surely, is that exploiting existing knowledge from the original site is rarely an end in itself. pp. 37

4. Production Theory Evolving

One of the competitive advantages of this software offering that differs from SAP and Oracle is the ability to exercise the fact that the costs of goods sold for the second and subsequent copies of the software is zero. This value is being captured by the Energy Industry in a lower cost offering through this development. Industry pays for the developments once. Then pays the associated costs of supporting and improving the application over its life time. Not each time there is a sale, but once and only once. This is where I would assert that these issues being discussed reside for the betterment of the energy industry. Professor Winter touches on these points with the following and final comments:
That knowledge and information are not exhausted by use in a kind of economic magic, a cheerful exception to the manifold scarcities that give the dismal science its name. pp. 39
and
To extend the use of existing knowledge in time and space is not at all the trivial matter it is often made out to be. pp. 39
and
Intra-firm homogeneity of method across establishments is definitely not something that just happens; it is something that happens when managements work hard to achieve it and devote substantial resources to the task. pp. 40


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Sunday, February 18, 2007

Toward an Evolutionary Theory of Production, Part A

Professor Sidney G. Winter, December 2002

With over 2700 words of quotation I am well beyond the fair use doctrine of using Professor Winter's paper. As I mentioned before I will make him whole when I have completed this comprehensive and valuable secondary research. What we have discovered to this point was nicely summarized in the table I published here. The "Production Costs" were assigned to the market with the secondary assignment being to the firm. The topic of discussion at this point is associated with these "Production Costs" however in the form of their interaction and determining the production function. Winter states this nicely in the following quotes, and points to an evolutionary theory of the production process. So the topic of this discussion is deeply related to "Production Costs" although it is more to do with the development of production possibilities based on multiple cost scenarios.
"It should be obvious that evolutionary economics needs to strike quite a different balance. Evolutionary thinking sees questions of production as tightly and reciprocally connected with questions of coordination, organization and incentives. Also, production activity is embedded - now more then ever - in a variety of processes of knowledge creation; theory needs to make room for those links. A major deficiency of the mainstream theory is its isolation from the realities of organizational knowledge. Above all, the evolutionary economy needs theory to address questions of economic change, not the principles of resource allocation in a hypothetical static world." pp. 1
Why we are now discussing the topics of the boundaries of the firm, the Schumpeterian thinking and theory of production is well articulated in Winters argument. What he is essentially saying is the production method chosen may have been selected for other then optimal reasons. That the time frame in which we find ourselves in is an ideal time to readdress these previous decisions, more with an eye to the optimal solution.
"The dominance of the production function apparatus in contemporary mainstream treatments of technological change is also a "Panda's thumb" phenomenon; it reflects the logic of path-dependent evolution (Gould). The apparatus was created and developed for various other reasons, and when questions of technological change came to be confronted it was conveniently available. The inherited apparatus was then extended and supplemented by a variety of formal treatments of technological change, the simplest being the introduction of the multiplicative fact A in the relation Q = Af(x). Negligible attention was paid to the question of whether plausible real-world mechanisms might actually produce knowledge changes with effects that correspond to these formalisms; the formalisms are convenient and hence chosen for reasons other than micro-level verisimilitude. The major investment in building a truly knowledge-based production theory, well-suited to close analysis of the problems of change, was never made. Recently, however, some beginnings have at least been made." pp. 2
Professor Winter provides support for a theory of how the various inputs and outputs of a production process provide an essentially known set of production possibilities. That a production set of possibilities provides a means to provide for a multitude of options in a business. This accurately describes the oil and gas industry. There are many ways to proceed with the drilling and completion of wells, and how the variety of possibilities provides little in terms of a consistent standard manner of interpreting and optimizing production. The scientists and engineers' craft is augmented by the strategic opportunities and issues that the industry face as well. Winter provides this as somewhat of a direction towards a new or "evolutionary theory of the firm".
"It was in introducing this problem that he (Wicksteed 1894 An Essay on the Coordination of the Laws of Distribution) made the notion of the production function explicitly in economic analysis for the first time in the following terms: The Product being a function of the factors of production we have P = f(a, b, c, ...)2. Neither in this statement nor in Wicksteed's subsequent analysis is there any hint that there is anything conceptually problematic about the idea of such a function; it is merely a mathematically explicitly expression of the long familiar idea that if the input quantities vary, the output quantity will vary as well, and in certain characteristic ways." pp. 5

"It is the production set concept that stands, in contemporary formal theory, for the classical idea of a "state of the arts" or for an "existing state of technical knowledge." Arrow and Hahn concisely say"
"Thus the production possibility set is a description of the state of the firms knowledge about the possibilities of transforming commodities."
"To assume that the production set has certain properties - for example, those that correspond to the linear activity analysis model - is thus an indirect way of imputing analogous properties to the "state of knowledge" that the production set describes. I have proposed here that this indirect approach may be understood as a reflection of the historical development of the theory. In the modern synthesis of the subject, production sets are a fundamental concept, production functions are a derived construct, and marginal productivity schedules are an implied attribute of production functions." pp. 9
It is at this point that Professor Winter opens the doors wide on the possibilities of more. What would happen in oil and gas if all the known methods and procedures that were available and could be immediately quantified to determine the optimal route to pursue the optimal production. I am suggesting here that a large collaboration with in the oil and gas industry, through the joint account, in real time, where I have suggested that the industry capability be determined in terms of the whole industry as opposed to the knowledge and understanding that is currently constrained by the individual or silo-ed companies. That this resource is commanded and controlled within the industry to what I have suggested as the Military Styled Command and Control governance structure. But Winter doesn't stop there, he takes it further to suggest that the limits to production knowledge have been constrained over the years. Hence the potential of yielding greater returns is suggested by Winter in;
Thus it happened that it became much easier for the theorist to describe the logical connection between the production set and the production than to explain the substance of what the production set supposedly represents - a state of knowledge. This neglect of the independent conceptual anchoring of the production set idea has inhibited both the recognition of its limitations and the development of alternative and complementary theoretical treatments of productive knowledge. The following section initiates the discussion of such treatments by exploring the central concept itself. pp. 10
2. The Nature of Productive Knowledge

Dr. Winter begins to deal with the human element of organizations as he discusses what an organization knows. The "learning by doing" and "learning by using" covered in my May 2004 publication provides an understanding of how organizations and people obtain tacit knowledge. Learning is a key competitive tool of the oil and gas industry. Next to NASA, the oil and gas industry is the most scientific business there is. The knowledge contained within each company is massive. How this information is managed could have benefits for the industry, particularly at a time when the expected retirements of senior staff is expected in the 5 to 15 year time frame. The following is a series of quotes that offer some salient criticisms and issues for the oil and gas industry.
However, an important implication of the discussion to follow is that a narrow focus on what goes on in human minds can seriously impede understanding what goes on when organizations produce things. That sort of understanding is the true objective here, and the scope of the term "productive knowledge" is therefore deemed to be expandable as necessary to cover whatever needs to be understood. pp. 11
and
"For engineers, production managers and corporate strategists, the visible face of the validity problem is the question of transferability across time and space. The process worked well today, will it also work well tomorrow? If we build similar facility in a remote location, can we confidently expect that one to work as well? The salience of these questions depends critically on the degree to which the answers seem to be in doubt. When experience seems to confirm the temporal and spatial transferability of the knowledge in use, it quickly acquires a "taken for granted" character. When problems arise, attention is directed to them until they are solved 'for practical purposes." Under both conditions, the judgements made are not those of philosophers or scientists who care about the validity question for its own sake, but of practical people who need to get a job done and have other urgent demands on their attention." pp. 12
Hence the paradox that employees face each day. The motivational and cognitive paradox were discussed in my May 2004 paper. In it, it refers to Dr. Wanda Orlikowski's Model of Technology Structuration which incorporates the motivational and cognitive paradox. Her paper is available on DSpace. We are running the risk of hopping down a bunny trail if we are not careful, however these two paradox are important to refresh our memories.
"Based on extensive studies of user's experience with word processors, Carroll and Rosson (1988) identified two significant paradoxes; The motivational paradox arises from the production bias. That is, users lack the time to learn new applications due to the overwhelming concern for throughput. Their work is hampered by this lack of learning, and consequently productivity suffers. The cognitive paradox has its root in the assimilation bias. People tend to apply what they already know in coping with new situations, and can be bound by the irrelevant and misleading similarities between the old and new situations. This can prevent people from learning and applying new and more effective solutions." (Cox, Delisle 2003)
Professor Winter shifts gears again and immediately begins to discuss the risks of too much change, too many changes without the full recognition of the processes in operation.
While modern thinking may dismiss some beliefs and related practices as plainly superstitious and others as ill-founded, the line between superstition and practical knowledge is oftentimes difficult to draw. pp. 13
and
A striking and well documented example of the issues concerns the role of the water temples in the irrigated rice agriculture of Bali. In the traditional system that had developed over a period of more that a thousand years, the allocation of water among hundreds of farming communities was governed by the priests of the water temples. The temple system was responsive to the variation of rainfall by elevation, seasonally, and from year to year. Implicitly, it dealt with an underlying trade off between the requirements of pest control, which is facilitated by synchronized planting and harvesting among the farms, and the problems of allocation, which is complicated by synchronized decisions. This traditional system was disrupted when the government promoted change in agricultural practices a the time of the "Green Revolution" in the early 70's. The result was a brief period of increased productive, followed by a collapse caused by increasing pest problems and water shortages. Fortunately, the traditional system had been under scholarly examination by anthropologist J. Stephen Lansing, who extended his investigation into a systematic comparison of the ecological consequences and economic effectiveness of the traditional and officially promoted systems. Ultimately - but only after many years - this research led to a reversal of policy and an ensuing recovery of productivity (Lansing 1991; Lansing, Kremer et al. 1998) Professor Lansing commented, "These ancient traditions have wisdom we can learn from."
and
The unifying generalization here is that agricultural production is highly exposed to contextual influences arising in imperfectly understood natural systems of great dynamic complexity. pp. 14
These components need to be dealt with during this software development. If the wrong processes are baked into the software, that would be a disaster. Hence the important role that a user provides in making these developments driven by their collective needs. Dr. Winter provides a real time example in a highly controlled, scientific business, that being of Intel and their change processes.
"A semiconductor factory (a "fab") and its operating procedures can be viewed as an enormous and costly effort to achieve strong "experimental control" on the production process for semiconductor devices, made in the interest of attaining consistently high yields." pp. 14
and
"Elements that might (superficially) appear to be superstitious even appear in codified organizational practice, as in Intel's "Copy EXACTLY" technology transfer policy:
Everything which might affect the process or how it is run is to be copied down to the finest detail, unless it is either physically impossible to do so, or there is an overwhelming competitive benefit to introducing a change. Of course its true basis is not superstition, but a very rational adaptation to the reality that understanding of what does matter is limited." pp. 15
and
"Finally, there is one major consideration limiting the validity of productive knowledge that the examples of agriculture and semiconductor production may not adequately suggest: people are involved. People are also involved as the customers, the consumers, the ultimate arbiters of productive achievement. When the product is corn or computer chips, it may be reasonable to consider that the "experiment" ends when the product appears, and set the customer response aside as a separate problem. But what if the product is education business consulting health care, elder care or day care, entertainment, or just "the dining experience"?" pp. 17
and
Quite rational satisficing principles dictate that investment in the quest for understanding be deferred until there is a symptom of trouble to deal with. When the pace is fast and the competitive pressure intense, such deferral may even involve suppression of ordinary skepticism about the rationale for prevailing ways of doing things. Paradoxically, "practical men" are constrained to be gullible, while high standards of proof are a luxury reserved to certain cliques among the inhabitants of the ivory tower. pp. 18
Distributed Character.

Professor Winter brings up the point that the individual knowledge is one issue, other issues such as work groups, teams, organizations and I am going to suggest clusters, such as Calgary, Houston and Aberdeen, each contain bodies of knowledge that may be both competitive and complementary.
A third distinctive attribute of productive knowledge is that it frequently resides in work groups or organizations rather than in individuals. This is not simply a matter of the same knowledge being held by several individuals, although such common knowledge may play an important role. Neither is it adequately captured by the image of complementary specialized skills being coordinated in the execution often exists only as it is evoked in the actual activity of the group. It is crucially a matter of distributed knowledge, i.e., of complementary parts of the same functional unit of knowledge being held by several individuals and applied in a coordinated way - the coordination itself being a crucial aspect of the knowledge. pp. 22

Accepting the view that knowledge can reside in a group is in this sense a "forced move". Just as practice allows an individual to improve in the performance of a complex skill through improved coordination, so the shared practice of a group permits patterns of multi-person coordinated action to arise, improve and stabilize. pp. 23

In recent years, the fact that productive knowledge often resides in groups rather than in individuals has received increasing attention both from business firms and from scholars outside of the economics discipline. There has been a striking degree of mutual reinforcement between the interest in these issues on the business side, driven by the practical concerns of an increasingly knowledge - based economy, and academic scholarship. pp. 25

To put it another way, it is hard to find a potential barrier to the movement of knowledge that does not function significantly as an actual barrier: national boundaries matter, firm boundaries matter, plant boundaries matter and even within - plant boundaries matter (Dyer 1998). To explicate the functioning of such a complex, multi-level system of distributed knowledge stands as a major challenge for theorists. pp. 28
These last few quotes reflecting the energy industry is not alone in approaching these issues. Clearly the majority of all businesses face similar knowledge and employee retention systems. It appears to me that the level and quality of the research in these specific areas is increasing. However, the difficulty ahead is accurately reflected by the two concepts that Winter has put forward in this paper. The interactions between these cause the complexity of the problem to accelerate in my opinion. The production set of possibilities that an individual, group, organization or cluster has at its disposal is one aspect of how the knowledge is deployed, the problem being where did it come from, how reliable and accurate is it. These issues can best be summed as the underlying issues around tacit knowledge. Its value, difficulty in obtaining and relying upon. The next issue that Winter brings is one of how the capture of tacit knowledge can be replicated throughout an organization or even an industry. That will be discussed in a Part B of this paper.

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Wednesday, February 14, 2007

New working papers from Harvard.

Two documents that are directly on topic of this blog were recently published at Harvard University. Both have been co-authored by Associate Professor Andrew McAfee of Harvard University. As I subscribe to his blog, readers should be fairly familiar with his work if you follow the "Google Reader My Starred Items" list on this blog, there is also a convenient RSS Feed.

The new working papers are entitled:

Electronic Hierarchies and Electronic Heterarchies: Relationship Specific Asset and the Governance of Inter-firm IT

Authored by: Professor Andrew McAfee, Harvard Business School, Marco Bettiol, University of Padua, and Maria Chiarvesio, University of Udine.

Scale without Mass: Business Process Replication and Industry Dynamics

Authored by: Erik Brynolfsson, MIT Sloan School, Andrew McAfee, Harvard Business School, Michael Sorell, Harvard Business School, Feng Zhu Harvard Business School.

I am adding these two working papers to the LEM Working Paper series review of Dosi, Winter, Langlois and others. As these working papers are current, I will be reviewing them right after the document that I have started now entitled "Toward an Evolutionary Theory of Production".

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Tuesday, February 13, 2007

Growing pains - transitioning to a sustainable energy economy.

This excellent video is part of the MIT Museum Soap Box series sponsored by the MIT Energy Research Council. I wrote about the first installment of this presentation here, and this video goes off in two completely different directions. These new directions provide prescient discussion on key issues of the day. At one hour and thirty five minutes it is a worthwhile review. This presentation is primarily with Professor John B. Heywood who is the Director of the Sloan Automotive Laboratory and Co-Director, Lab for 21st Century Energy, and Professor Stephen Ansolabehere. John Durant, Director of the MIT Museum is the moderator of this presentation.

The introduction provides the standard fare comment that greenhouse gas emissions is the major issue of today. My opinion regarding green house gases is based more on the inability to grasp how humans could be responsible for the alleged damage. Raised during the time when the risks of the ice age was returning, I place as much weight on the frantic calls to reduce green house gases at any cost, as I do on the ice age returning. If you aggregated and assigned a square meter to each and every human on the face of the earth they would fill an area of approximately 50 square miles. Green house gases from this concentration of people is a bit of a stretch for me. However, this video has changed my opinion on the whole global warning issue.

Professor Heywood starts with the desire to change the title of the topic to "Making our energy use less unsustainable." Noting the discussion of the previous MIT energy related video was how much energy is produced today, and how the alternatives to coal, oil and gas pale in comparison to our current demands. Unsustainable for two reasons. The scale of our energy use, and the way we use energy is very efficient. The problem is the scale and growth in our demand shows a further unsustainability of our energy use. Dr. Heywood notes three areas that may provide value in approaching these problems.

  • "Conserve needs to be a good word"
  • "Improve mainstream technology to reduce demand."
  • "Finding new ways to produce and consume energy."

All these points seem to be a reasonable approaches to the problem. Professor Heywood then notes that new technology will not "save us". Commenting that technology will have a role but that it is a false wish and a hope to expect that technology will provide a magic bullet. Growth is making the energy problem more difficult each day. Growth being the growth in demand, growth from economic activity, growth from population and industrialization.

In my mind I have to ask why has the Segway not caught on? The ability to travel 20 km at up to 20 km / hour for the cost of a little under $1.00 in electricity is an obvious solution to the problem. When given a hammer, a child will hammer at everything in sight. Why does everything have to be solved through the auto industry? Is the car necessary for all that we do, or could there be alternative means to get around? I sometimes think that the world should have invented the Segway before they developed the car. Nonetheless the device is fast and efficient and is cheaper then transit, it must be one of those acceptance issues.

Professor Stephen Ansolabehere begins his commentary and notes that the existing known global coal reserves provide energy for 300 to 3000 years. Coal can also be the worst in terms in CO2 emissions. We have this as the issue in which the abundance of coal is a cost of pollution that is not taxed. What Dr. Ansolabehere means by this is that the cost to produce one unit of energy values coal at $1 per unit, nuclear at $2 per unit, and solar is at $5 per unit. A carbon tax would deal with raising the coal costs to be uncompetitive to solar so that investment in solar can be made to reduce the reliance on coal. This makes sense to me. It does not make sense to attach a carbon tax to the oil and gas industry. These products are less damaging then coal and the reserve life does not last nearly as long. (50 years by most estimates). Oil and gas would also benefit in its development in the same manner as solar would with a carbon tax.

Professor Ansolabehere then notes the scale at which the public is willing to pay for a carbon like tax. Noting that the average home heating bill in the U.S. is $100 per month. He states that his tracking the U.S. attitude to solve global warming is assessed at $14 / month a number of years ago, and currently this has been raised to $21 as global warming has become the number one concern. There is a very clear disconnect with people on how serious the issue of the global warming issue is. Yes my grammar is correct, in order that a carbon tax effect a change to the alternatives would require the costs of the average home heating bill to skyrocket by several hundred dollars. What the global warming issue needs is more people that don't want it in their back yards.

I am also concerned that this may lead to a carbon tax be assessed on the oil and gas producers. This is a critical time for oil and gas as we bridge the easy and cheap production of the 20th century with the costly and difficult 21st century. An assessment on the industry will only slow down the research, exploration and development. Not a choice that anyone wants to truly consider. As I believe any assessment can not be on the producer level. The competitive advantages of a country are dependent on the low costs of energy. The tax should be at the consumer level, which indirectly reduces energy demand.

So how has this video changed my opinion? I would now support a carbon tax on coal users to the point where research and development, and use of alternatives could be done profitably. If people are willing to pay extra to heat their home, and coal is the devil in these details, they must be the solution. To tax the oil and gas industry as the Canadian government is now suspected to be doing as early as March will have no effect on the reduction of green house gas emissions, but will have a remarkable effect in making our energy problems worse.

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Monday, February 12, 2007

Greg Papadopolous of Sun Microsystems.

In what is dubbed as "Sun Analysts Summit 2007," Sun Microsystem co-founder and Executive Vice President of Research, Dr. Greg Papadopolous makes his presentation entitled "Redshift: The Explosion of Massive-Scale Systems. This presentation should be viewed by most users of computers today. An important video that details where the demand for computer processing is coming from, and where the solution to satisfying those demand resides. At 46 minutes it is a worthwhile review. So much of what I expect in this oil and gas software development project needs to be addressed from the hardware side. The demand for processing of an entire segment of the oil and gas industry is not something that can be taken likely. Recall that we have selected Sun as our key vendor for their support of the Java platform. This extends to Sun's Niagara Chip set, Solaris their Operating System, their Grid Computing offering, Crossbow their virtualization offering and finally the Java Programming Language.

Starting off with "Project BlackBox" which is a standard shipping container that provides substantial computing performance in one "BlackBox". Two rows of 19' standard racks, with each rack capable of housing 42 units of servers, blades and / or storage devices. The cooling of 200 kw of processing is the defining capacity of a project Blackbox. One should ask what / who would need to use such a large unit? That is the purpose of this talk. Many of these systems will be used by the market, and most importantly this software development project will use BlackBoxes in order to host the application for the oil and gas industry. The system we will be using will be owned and operated by Sun Microsystems and hence provides not only the solid reliability, performance, and availability of computing power but also the security that each producer knows their data is as secure and as confidential as possible.

"Red Shift" is a leading observation of Sun's marketplace of computing. The costs of computing is halving each year, yet the demands continue to grow. Where is this demand coming from? Core Enterprise demand has been satisfied by Moore's Law for a number of years. Dr. Papadopolous says that Band Width is the key driver to the current and future increases in computer processing demand. Band width has grown exponentially from 56 kilo-bites of analog capacity in 1995, to now 10 Gigabit Ethernet being available today. This band width is fueling an increase in the number of devices that are networked. It is clear that the proliferation of these devices assumes that processing is centralized in one location. This Band Width related demand is consistent with the technical vision I noted here, and the proliferation of IPv6 related devices. I agree with Dr. Papadopolous that the computer demand in the future will be difficult to satisfy.

Bandwidth is driving the increased demand for computing in far greater volumes then what Moore's Law provides. In addition to the conventional business market, the High Performance Computing market makes the demand for computing processing insatiable. Papadopolous notes demand from small and midsized firms that are using hosted services like Gmail, Salesforce.com and other web applications is a trend that he suspects will be showing up soon in large firms as well. Running an email server is an arduous task for any and all users. Aggregating the demand for email in the hands of large service providers provides economies of scale and better application functionality over the long term. A variety of customers are beginning to realize Service Oriented Architectures are the most effective and efficient means of managing these services.

Dr. Papadopolous notes that what he calls "Redshift" is a move to massive scale. Where scale and efficiency are available and afford-ably provided to users, when the users need them, wherever they may be. Sun believes RedShift will be redefining to the computing industry. Coporate strategies regarding Red Shift are of two possible scenarios. First Sun could be disintermediated such as what Google is doing in building their own servers. Or alternatively, follow the Sun school of thought that high levels of engineering are needed to build systems for today and the long term future. This latter strategy is also where strong integration of both software and hardware engineering is needed. "Efficiency and Predictability at massive scale are as Mission Critical to Redshift as Remote Access Servers (RAS) has been to the core enterprise."

Papadopolous is keen to differentiate what he means by the "Commoditization of computing" is not the "Commoditization of computers." The engineering of complex systems is necessary in this "RedShift" era. The cobbling together of many single core systems will only provide so much value. The approach of providing the City of New York with electrical power generated by a series of portable generators is inefficient, impractical and costly. This is the analogy he draws between what Sun is providing with their services and what many of the smaller service providers are doing.

Speaking on the Sun offering Papadopolous notes that computing infrastructure consists of three things. And to Sun's credit they have been able to integrate these components and provide commoditization of computing in an efficient manner.

  • Core Services and Platforms
  • O/S Instances
  • Base HW Plant (Server, Storage and Switches)
Base Hardware Plant.

What had happened in the past 20 years to distill the microprocessor down to a single chip is today what Symmetrical Multi-Processing (SMP) systems are being codified into one chip. That which was a full rack of servers in 1997 is contained on one Sun Niagara chip. Providing lower costs in almost any metric of computing power.

Taking these concepts further, Neptune, Sun's next processor will contain a 10 G Ethernet card embedded in the chip.

Operating System Instances

Solaris, Sun's open source operating system, Crossbow their operating system virtualization tool, and Java which is integrated into Solaris. "The Java RTS (Real Time Systems) + Solaris = Real time Application Server". With real time results, providing a solid application system performance that mirrors and exploits the value of their hardware. It is my opinion that both Apple and Sun's futures are brighter based on their ability to integrate their own operating systems on their own and x86 hardware. Companies such as Dell, IBM and HP are unable to compete in this arena due to their inability to provide the integration at this high level.

NetBeans which is the open source version of Sun's development tool is one of the best Integrated Development Environments (IDE's) available today. BlackBox as mentioned above defines the shape of Sun's very bright future.

Core Services and Platforms
  • Identity and Security
  • Procedural languages and scripting.
  • Service Oriented Architecture and Web 2.0
  • New Clients.
Finally Dr. Papadopolous notes a key component of Sun's open source business model is that "Open Source" does not apply to the binary or run time application. The Binary requires the use and service contract with the in this instance. Genesys will be paying for the use of Solaris and Java services, support and use agreements. This is in addition to the processing power purchased by the hour off the grid. All in all an excellent video, one that provides a vision of the future of computing.

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Thursday, February 08, 2007

John Seeley Brown on MIT Video

John Seeley Brown talking about "Re-learning Learning - Applying the Long Tail to Learning" on MIT Video. The video is on the longish side at 1:43 minutes, however, it is time well spent. Along with John Hagel III, John Seely Brown was instrumental in defining the web services paradigm for business. I wrote about their thinking at the time on the subject.

Speaking in the context of change, Brown suggests the "speed of acceleration" of change means that little or no skills will be able to sustain their value over a moderate to long period of time. A new approach to learning requires people to adopt the attitude that an inventory be conducted to determine where new skills are needed, each year. In support of new skills Brown also suggests that we find successful learning models. Differentiating between "learning about" and "learning to be" with the latter being the more difficult of the two.

Dr. Brown notes that a good example of "learning to be" is the open source software development model. I have to agree with his comment as it is a strong model of organizational learning. Brown calls it a "distributed cognitive apprenticeship platform". The most popular culture in the digital generation has come back to a "building, tinkering and participatory culture". This last comment in line with Sun Microsystems and its CEO talking about the "Participation Age". In the future I will discuss in-depth the methods that software is developed under these open source models. It is what we will be using on this development and it is rather complex and interesting development model in terms of its methods and processes.

Brown comments that this "learning to be" is usually more amateur then professional with the point that passion is what drives the people in the open source model to build better systems. This passion leading to the rise of the Amateur Class. For almost no amount of money users can participate at high levels in science and business ideas. Professionals and amateurs are working together today. The tools by themselves are not sufficient. What is needed is the passion of the users to make things happen.

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Wednesday, February 07, 2007

Where we're at.

This past month we seem to have travelled quite far in terms of the optimal organizational structure for producers. A summary table of the concepts and roles of each component would help to provide clarity of all the issues we have discovered and discussed. This table recalls the basic premise of this work being the Joint Operating Committee, and adds to it the work of Langlois, Foss, Winter and Dosi. As this research is ongoing and the table would be considered subject to adjustment in the near future. However, I think it currently provides the oil and gas worker with an understanding of where the roles of the firm and market begin and end.

I have separated the various areas of responsibility and frameworks into either the Market or Firm. Within each construct I placed the "P" as the item being a Primary role or "s" as being a secondary role within in the market or firm. Each category / construct can then be seen to provide the separation of responsibilities, the boundaries of the firm and the division of duties.

ConstructMarketFirm
Joint Operating CommitteePs
Military Styled Command and ControlsP
Transaction CostssP
Production CostsPs
InnovationPs
Routine, compliance and accountabilitysP
ResearchsP
DevelopmentPs
Financial FrameworkPs
Legal FrameworkPs
Cultural FrameworkPs
Operational Decision Making FrameworkPs


P = Primary
s = secondary

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Tuesday, February 06, 2007

Towards a Neo-Shumpterian Theory of the Firm.

Professor Sydney G. Winter is the Deloitte and Touche Professor of Management at The Wharton School of the University of Pennsylvania. The Wharton School consistently ranks as one of the best business schools on the globe. I have read Professor Winter's works before, particularly in combination of the work that he has co-authored with Professor Giovanni Dosi. The title of this article stood out in terms of a good follow through on Professor Langlois' theories.

In the abstract, Professor Winter provides a little more focus in to the theme of this research;
"Schumpeterian analysis requires an intuitively appealing and realistic conceptualization of the distinction between routine and innovative behavior, and in particular, a conceptualization relevant to complex organizations and complex tasks."
Which leads me to ask, is Professor Winter stating that innovation can be handled by the Joint Operating Committee, and "routine" tasks handled by the Military Styled Command and Control Structure? This role definition helps to understand the division of labor and the barriers of the firm in assigning tasks. However, I would state that these classifications are both right and wrong. The role of the Military Styled Command and Control Structure (MSCC) is not limited to compliance and routine. The most important aspect of the firm is well represented in the case study of Chrysler by Thomas H. Davenport and John C. Beck in "The Strategy and Structure of Firms in The Attention Economy." (This document is behind a paid wall but you may be able to find elsewhere. It is in the March / April 2002 Ivey Business Journal.)
"One example, of both a problem and a solution, is the Chrysler division of DaimlerChrysler. In the early 1990's, it shifted to cross-functional "platform teams" that managed the entire process of developing a new vehicle. Over all, these teams worked well, producing both successful new car designs and shorter development cycles. But the functional organization that had focused attention on producing and maintaining technical skills was no longer in place. Soon, technical experts found themselves working not with others of their ilk, but with manufacturers, marketers and financial experts on cross-functional issues. The result? A recurrence of quality problems that Chrysler had previously solved. The company is now attempting to turn some of its attention to increasing functional and technical knowledge by organizing "Tech Clubs," so that engineers in specific domains of car development can meet with each other and exchange ideas. In general, matrix structures such as these create attention problems; our innate focus on hierarchy and threat / reward does not match well with situations where it is not clear which dimension is the primary one. But Chrysler's Tech Club approach, a kind of "stealth" matrix, avoids this problem by giving only informal legitimacy to a second dimension of structure. It's important to understand that the balancing act here is not about power, but rather about attention; Chrysler needs employees to stay focused on the process of developing new vehicles, but not forget about enhancing their technical skills. The Tech Club structure seems to get that balance just about right." pp. 52
Just as Chrysler needed to redeploy "Tech Club's" to recapture the engineering capability that was no longer being developed in the "platform teams". And it would probably be safe to say the engineering capability atrophied under Chrysler's revised organizational structure. For oil and gas I see the potentially similar atrophy of earth sciences and engineering capabilities by leaving the Joint Operating Committee (JOC) as the only organizational construct and relegating the Military Styled Structure to "routine" tasks. The scientific capability and the strategic land base of the producer are two of the primary areas of responsibility that those members of a producers MSCC are providing. The nature of the MSCC is about the "firm", and the JOC is about the "market" to relate them back to the discussion around Professor Langlois' theories. Professor Winter takes these concepts to the next step with this quote.
"But the edge of production set is the edge of an abyss so far as technical knowledge is concerned: We there encounter the Great Unknown. When an attempt is made to introduce the phenomenon of technological change into this conceptual scheme, the theorist is almost forced to try to play the new game by the old rules. This means that certain production possibilities are suddenly extracted from the Unknown and added to the Known. There is ordinarily no analysis as to why particular possibilities rather than others should be thus discovered, and considerations of mathematical convenience determine, by default, the path of technological development is such a theoretical world." pp. 3
The oil and gas industry is not static. We are entering a time where the demands of the engineers and geologists is accelerating at a ferocious rate. Innovation will straddle both the JOC and MSCC organizational constructs. How much of these capabilities, innovation capabilities and scientific capabilities, are captured, managed, enhanced, tested, and redeployed within the JOC and MSCC? What I want to do here is ensure that the "routine" tasks of "transaction costs" and accountability are not the only responsibility of the MSCC. I would suggest the MSCC is the "research" and the JOC is the "development" in the traditional Research and Development classifications. This is an overall objective of this re-organization of the industry, to enhance the speed, innovativeness and capability of the producer and the industry. Professor Winter adds some more problems and opportunities to these concepts;
"But "knowing how to bake a cake" is clearly not the same thing as "knowing how to bring together in one place all of the ingredients for a cake". pp. 4
and
"Just to have a label, let us call this level of discussion of a technique the conceptual level as distinguished from the operational level discussed earlier. Two points should be made about it." pp. 6
Here we have a clear definition of the roles within the various organizations. Are you able to bake a cake, or know how to build a kitchen for the Chef to bake many cakes? Do you know how to drill a well, or do you know how to advance the science of geology and engineering? Professor Winter continues with some additional issues regarding the capability and ability of staff within these classifications.
"When a corporation president whose experience is in finance succeeds one who started as a production engineer, the technique that the corporation is using changes even before the new president makes his first phone call: The same procedures are now embedded in a new frame of experience and analogy." pp. 6
and
"Knowing your job' in such an organization is partly a matter of having the necessary repertoire of actions, and partly knowing which actions go with which incoming signals. Each individual has some ability to perform a considerably larger set of actions than are called for in his job, but to the extent that "practice makes perfect" he will acquire superior skill in the ones actually called for. [The man who graduated as a chemical engineer becomes gradually specialized first in petroleum refining and then in those particular aspects of particular refining methods that are central to his job.] As emphasized previously, a large part of any individuals conceptual understanding of his job consists of images of other peoples' jobs." pp. 7
Within the producer there will be those that are practiced at drilling wells effectively and those that conduct research effectively due to the nature of their jobs and previous experiences. The cultivation of two separate and disparate "types" of employees is not necessarily new, it is necessary that these be clearly differentiated within the producers JOC and MSCC. The interactions and communications between employees and particularly between the two organizational constructs is answered here:
"Any single individuals conceptual understanding of the firm in its entirety is mainly at an extremely abstract and aggregative level." pp. 7

"By far the most important coordinating and organizing force is the invisible interlocking structure of mutually consistent expectations held by the various members of the organization: Each correctly expects that he will receive familiar signals from the others, and will respond in the familiar ways" pp. 7
These last quotes emphasizing the tacit interactions that are so prevalent in today's organizations. Dr. Winter then quotes directly from Schumpeter;
"It is easy to see that the characteristic of being in a higher rank, the function of superintendence in itself, constitutes no essential economic distinction. The mere circumstance that ranks one worker above another in the industrial organization, in a directing and superintending position, does not make his labor into something distinct. (p.20)"pp. 8

"But we see at once that the necessity of making decisions occurs in any work. No cobbler's apprentice can repair a shoe without making some resolutions and without deciding independently some question, however, small." (p. 20) pp.8

"... insofar as individuals in their economic conduct simply draw conclusions from known circumstances -- and that indeed is what we are here dealing with and what economics has always dealt with -- it is of no significance whether they are directing or directed. (p. 21)" pp.8

"The data which have governed the economic system in the past are familiar, and if they remain unchanged the system will continue in the same way. (p.22)" pp.8
Winter then comments on the difficulties of how these definitions are understood by the "worker" as classified as the "manager" and "entrepreneur".
"In short, the manager of a firm, when the economic system is in an equilibrium circular flow, is just another guy who knows his job in a firm full of people who know their jobs. The firm in equilibrium knows the technique it is using because it is using it, and has been for some time past." pp. 8
and
"Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it. (p.85)" pp. 9
Walking along this road will be difficult. The changes that are being realized and instilled within this software that we are developing will initially provide comfort to few. Change is a difficult and necessary action that is being driven, I suggest, by societies demands for energy, and peoples need to be "less" burdened by the demands of their work. I wrote extensively in the "Plurality" document about Dr. Anthony Giddens and Dr. Wanda Orlikowski and their structuration theory and model of structuration here. Review and familiarity with these theories will help to understand the role of change.
"The general emphasis in Schumpeter's work is, of course, on the entrepreneurial phenomenon in its most pure and dramatic form, where single individuals provide the leadership needed to bring about drastically new ways of doing things. But he does occasionally point out the essential continuity between these instances of dramatic innovation and the smallest sort of adaptation, to changing conditions." pp. 9

"Moral: Sometimes an innovation involving substantial technological novelty is much less costly and difficult than a change which, by standards external to the firm, is simple and commonplace. Viewed from inside the firm, technological novelty is only one among several reasons why an attempt to change techniques may involve large and unpredictable costs." pp. 10
Professor Winter moral provides some evidence that we are traveling the shortest route through these changes. I believe so. How much change the development and use of these systems brings about is unknown, however, the directness of our objectives helps in making the journey shorter, and potentially less painful. Professor Winter goes on in the document to note some principles of Neo-Schumpeterian Theory.
1) Contrary to the received theory of the firm, no sharp distinction can made between techniques known to the firm and those that are unknown. There is, instead, a quite continuous gradation from highly routine behaviour, to highly innovative behaviour. pp. 11
2) Relativity to existing routines: the only techniques which may appropriately be considered "perfectly known" to the firm are those it is actually performing, and has been performing repetitively. Furthermore, if we revert to the metaphor of Figures 3 and 4, the steepest part of the percent known curve is reached very quickly as the firm departs from its existing routines. Costs and uncertainties pile up rapidly for all but the most minor departures from well worn paths - even when the new direction is one already taken by other firms. pp. 11
3) A new method of production is a minor departure from an old one the the extent that (a) the repertories represented by the individuals currently in the firm contain the relevant skills, in roughly the right amounts, and (b) only minor "rewiring" is needed in order to create the interlocking system of signals and expectations that will evoke the appropriate actions at the appropriate time, (c) the relationship between the new technique and the old is correctly conceptualized by most individuals - so that planning for the change can go forward under largely correct premises as to who is capable of what. Similarity of list of ingredients may be a useful proxy variable for some of the considerations, but it is not a fundamental aspect of the closeness of one technique to another." pp. 11
4) Just as the fragmentation of knowledge in the firm makes innovation difficult and the consequences of attempted innovation unpredictable, nor does it tend to frustrate the economist who wants to predict the lines that innovation will take. The firm gradually "learns" a new method of production, vast numbers of details of the routines established will be determined by considerations that play no part in ordinary economic calculus, and may in addition be unknown to most of the firms managers, let alone to the observing economist. Not infrequently, decisions with quite major consequences for the firms future economic transaction will turn on such considerations. "Mere mangers" may behave predictably, entrepreneurs (and the organizations led by them) do not especially if the prognosticator directs his attention only to the economic influence on behavior. " pp. 12
Finally, as with Professor Langlois, I have abused the fair use of Professor Winter's copyright. As with Langlois, I am in contact with Professor Winter to determine what is required to make him whole under this phenomenal document. He leaves with a conclusion that resonates with my thinking of where we are headed too, and to a large extent why;
Thus a neo-Schumpeterian theory of the firm would be a historical theory in the sense that significant differences among firms would be regarded as historically determined; it would be a dynamic theory because only in the context of such a theory can the traditional problems of price theory be confronted anew, and, ideally, it would be probabilistic -- the existence of a multiplicity of unobservable factors that shape firm behavior would be explicitly recognized. Clearly, the program is an ambitious one, involving conceptual, theoretical and empirical questions of great difficulty. Success in building a new theoretical road can not be guaranteed, and the easier choice is to walk the old one. The question is how long are we prepared to content ourselves with a theory that is simple at the price of being simplistic. pp. 11
Photo Courtesy Kaley Davis

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Monday, February 05, 2007

Breakthrough ideas for 2007

The online version of the February 2007 Harvard Business Review contains the "HBR List". Which is described as their "Breakthrough Ideas for 2007". Upon reviewing the material I would have to concur. The authors alone are worth the price (apparently free).

Several of the Breakthrough Ideas that I am interested in include:

Algorithms in the Attic

The article starts off with its summary concept:

"For a powerful perspective on future business, take a hard look at mathematics past. As computing gets ever faster and cheaper, yesterday’s abstruse equations are becoming platforms for tomorrow’s breakthroughs. Companies in several industries are now dusting off these formulas and putting them in the service of new products and processes."
In Partnership Accounting I noted the complexity of the algorithm used to calculate the operations in oil and gas could be modeled in the current programming languages and particularly Java. This Harvard article is similar in terms of what the processing power and algorithms of past advanced maths could be used to form new business models and opportunities.
The Leader from Hope;

"Hope is good thing, maybe the best of things, and nothing good ever dies." Is a quotation from the movie "The Shaw-shank Redemption". This Breakthrough Idea is the controversial use of hope in a changing environment. The article states clearly;
If you are an executive trying to lead an organization through change, know that hope can be a potent force in your favor. And it’s yours to give.
And I see absolutely nothing wrong with that sentiment.

An emerging hotbed of user centered innovation (Danish Research Unit for Industrial Dynamics and Danish User-Centered Innovation Lab)
The Danish Government's 2005 strategy for the next 4 years states that, “strengthening user-driven innovation" is a national priority. In response, a group of researchers from Copenhagen Business School in Denmark and MIT Sloan School of Management in the US - supported from Danish Ministry of Economic and Business Affairs – now establish the Danish User-Centered Innovation Lab.
I will be paying close attention to this Danish initiative. This is a topic that suffers from a lack of research, however, it is new and extremely important. This software development project will hopefully develop many of the positive attributes of this worthwhile research.

Here comes XBRL;

This Breakthrough Idea article notes SEC's Chairman Christopher Cox's initiative to use the XBRL reporting language. This is directly in line with what I had written on this blog back in May 2006. The XBRL technology will be truely revolutionary, just as the Harvard Business Review notes.
"All this undoubtedly sounds too good to be true to managers who are rightfully jaded after decades of false promises that the next IT silver bullet is (this time, really!) just around the corner. So what makes XBRL different? Unlike all past technological developments, it doesn’t come in a wide variety of proprietary flavors, like ERP systems, operating systems, and customer relationship management systems, to name just a few. XBRL is an open-source standard that was developed by an international public consortium of nearly 500 organizations from 27 countries, including companies, investors, analysts, auditors, regulators, and aggregators of financial data, such as Standard & Poor’s. (For more background, see www.xbrl.org, the standard’s official Web site.)"
Innovation and Growth, Size Matters; (A future research Field)

An interesting theory has been put forward here, one that I will be picking up as an area for future research. "Superlinear" growth could help to attain the metrics in performance that the industry needs. The individual energy industry clusters, such as Calgary, could potentially benefit from the knowledge that innovations can be leveraged from size.
"Though our research has focused on cities, the social and structural similarities between cities and firms suggest that our conclusions extend to companies and industries. If so, the existence of superlinear scaling that links size and creative output has two important consequences: First, it challenges the conventional wisdom that smaller innovation functions are more inventive, and perhaps explains why few organizations have ever matched the creativity of a giant like Bell Labs in its heyday. Second, it shows that because organizations and industries must apparently innovate at a continually accelerating rate to avoid stagnation, economizing by reflexively cutting R&D budgets and creative staffs may be a dangerous strategy over the long term."
The best Networks are really Worknets; (A future research field)

Building off of Metcalfe's Law which is essentially N Squared and applying it to a situation where-in a business collaborates at a large scale. Noting there is incremental value beyond what is aggregated. Something that is intuitively understood, but never quantified.

In Defence of Ready, Aim, Fire;

How the open source software movement succeeds and provides value to business.
"This presents a conundrum for business. Clearly, firms can’t just start trying everything. Management overhead is real, and the costs of failure can’t simply be laid at employees’ feet. As a result, open system–like innovation must necessarily continue independent of any firm’s ability to either direct or capture all of the value. Some companies’ product lines or employee structures may not allow radical experimentation, but smart managers will look for ways to take advantage of this sort of broadly distributed effort. In environments where organizations can reduce the cost of failure by farming out a problem to individuals—who may be induced to participate solely by the chance to learn new skills or to gain the respect of peers—we can expect open systems to make increasing inroads into standard commercial efforts."
The folly of Accountabilism;

There would be little to doubt that the need for accountability has escalated significantly in the past decade. This article deals with many of the related issues that stem from the abundance of accountability in business today. It's concluding comment accurately captures the issue;
"Accountabalism tries to squeeze centuries of thought about how to entice people toward good behavior and dissuade them from bad into simple rules by which individuals can be measured and disciplined. It would react to a car crash by putting stop signs at every corner. Bureaucratizing morality or mechanizing a complex organization gives us the sense that we can exert close control. But grown-ups prefer clarity and realism to happy superstition."
Seven out of twenty of these articles are directly related to the work being done here. Two provide new material for future research and one is a rich resource on the topic of user centered innovation.

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Friday, February 02, 2007

Mondrian Code Review.

Guido von Rostrum, who wrote the Python scripting language, is also an employee of Google. Guido has been with Google for a little over a year and is presenting his Mondrian Code Review project. The development of Mondrian is what he has done with his 20% time that Google pays him to do the things that interest him. Mondrian Code Review fills a nice hole in most IDE (Integrated Development Environments) and is a natural extension of the standard concurrent version systems, like Subversion, the choice of this development project. With the variety of projects that Google is involved in, the tool would provide real value. A real value for any large software development project.

I have reviewed many of the videos that MIT produces and it is a source that never fails to inform and entertain. Google on Google video looks to me to be as high a quality of source of useful videos. This review provides the petroleum user with a window on the methods and procedures of how software is built in an open environment.

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Thursday, February 01, 2007

How Open Source Projects Survive Poisonous People.

Google has had the capacity in the past few years to draw in many of the pioneer's and industry leaders to work for them. Two of these people, Ben Collins-Sussman and Brian Fitzpatrick are leaders in the open source world. Both have worked on Subversion which is the version control system used on this project. Of note, Google hired them to implement Subversion through out their product line, and in the process giving the tool the most significant test I could imagine.

The experiences they refer to throughout the presentation are based on work done for both Subversion and Apache. The topic of discussion focuses on how to avoid the toxic or poisonous people that can infect an open source project. The most important aspect of any contribution is to ensure that the team is not drawn down by people not reviewing the archives. Contributions have to be incremental to the work that has been done, not reiterating what has already happened.

The presenters open with their 4 areas of concern.

  1. Comprehension
  2. Fortification
  3. Identification
  4. Disinfection
The resource you are trying to protect is the Attention and Focus of the user and development community. Keeping disparate groups from losing focus and spending their attention in the wrong areas will lead to project failure. The methods to guard against these incidents is highlighted in their video. The first note is that poisonous people can;
  1. Distract.
  2. Emotionally drain your community.
  3. Cause Needless infighting.
You need to avoid paralysis.
  • People can derail forward progress by people being.
    • Perfectionists.
    • People obsessed with process.
    • Even nice guys can do this unintentionally.
    • The perfect is the enemy of the good.
The presenters then bring up the analogy of "Painting the bike shed". Which was an analogy that was used in the development of BSD Unix. The analogy goes; a nuclear plant that was needed to be built was progressing as good as it could. The entire development then stalled to determine what color the bike shed should be painted. The debate then ground to a halt on both the bike shed and the nuclear plant. Here the authors noted "The amount of discussion on a feature, is inversely proportional to their value. And is noted to be one of Parkinson's Law's.

Fortifying against the threat.

Politeness, Respect, Trust and Humility are necessary in an open source project. All of the deficiencies that the presenters had experienced originated from these 4 points.

Have a Mission, where do your want to go. Limit your developments scope. Define the project so that future requests can be classified as "its on our list of things to do" or "its not"

Mailing lists are a critical tool of the open source project, etiquette should be monitored and enforced. Review of the archives, don't let users disrespect any previous conversations by not reviewing the archives. A few more of their points include;
  • Design documentation.
  • Bug fixes.
  • Document Mistakes. (Ensures that travels down dark alleys are limited and not repeated.)
  • Code Changes (Change Log)
  • Code Collaboration policies. Email is the key to participation.
  • No powerpoints.
  • Do big changes on branches for easier review. (Be generous on creating branches.)
  • Spreading the "bus factor" so that developers move around alot. (Bus factor is how many people need to get hit by a bus before the project fails.)
  • No names on top of source code files. (Makes people nervous) Everything is owned by everyone. (Cuts the pettiness.)
  • Have well defined processes.
  • Releasing Software
    • Backport Bugs
    • Test and release tarballs.
  • Accepting and reviewing patches.
  • Admitting new committers
  • The community founders establish the culture.
    • The culture becomes self selecting.
    • Voting is a last resort
      • A healthy community should rarely need to vote.
Identifying poisonous people.

Communications Annoyances
  • Uses silly nicknames
  • Uses multiple nicknames in different media
  • Overuses Capital letters.
  • Uses excessive punctuation.
  • Acronyms are used.
General lack of a clue as to what is going on.
  • Unable to pick up on the mood.
  • Doesn't understand common goals of the community.
  • Asks incessant questions.
Hostility
  • Insults the status-quo.
  • Angrily commands help.
  • Attempts to blackmail.
  • Attempts to deliberately rile people .
  • Makes accusations of conspiracy.
Conceit
  • Refuses to acknowledge the opinions of others.
  • Makes sweeping claims.
  • Usually about the projects future success.
  • Re-opens topics that are long settled.
  • Without reading the archives.
Lack of Cooperation
  • Willing to complain but not help with anything.
  • Unwilling to discuss design.
  • Too insecure to take criticism.
Disinfecting your community.
  • Is this person draining attention and focus?
    • If so, is the person really likely to benefit the project?
  • Is this person paralyzing the project?
  • Is the dispute likely to finish soon?
Don't...
  • feed the energy creature.
  • give jerks purchase.
  • engage them.
  • get emotional
Do...
  • pay attention to a newcomer.
    • even if they're annoying at first.
  • extract a real bug report if possible.
  • know when to give up and ignore them.
  • know when to forcibly boot them from community.
Summary
  • Comprehend:
  • Preserve attention and focus.
Fortify:
  • Build a healthy community.
Identify:
  • Look for tell tale signs.
Disinfect:
  • Maintain calm and stand your ground.
And finally, the presenters put a special emphasis on decision making. All decisions can be discussed off-line, no decisions made without the documentation in the email lists. The reason why and what alternatives will show up in the archives and contributors can see the reasons and justification for the previous decisions. All of these excellent points will form a major part of the code of conduct that will be one of the first deliverables from this community.

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