Friday, May 4, 2012

Diversification for everyone?

'Diversification is a good thing. Everyone says so; so it must be true. Anyone who has an investment knows the Sqrt(N)rule:

Take any big thing and break it down into N smaller things. If risks act independently on the N smaller things, then the overall variance of the one big thing is reduced by Sqrt(N)

Variance is surrogate for riskiness: more is not good, generally speaking. The key issue is independence. In the globalized investment markets, what happens in Brazil doesn't stay in Brazil!

And, it doesn't have to be an investment; it could be a project budget. Or a project schedule. Or a work package in the WBS

But, there's a price, at least an indirect price to be paid for diversification. And, by the way, in the governance domain, diversification goes by the name "federalism". That price is inefficiency.

As the one big thing is broken down, overhead is made larger in the aggregate. If it's a WBS breakdown, to get independence you need independent WP managers. More managers means more communications, more ways to miscommunicate, and more times that someone didn't get the memo.

If it's a strategic teaming agreement, every team member is going to want their own project manager. Nobody is going to body-shop their staff. Even General John Pershing, CinC of US forces in France in WW I, refused British and French plans to simply plug the Yanks into the depleted EU ranks.

Of course, that very inefficiency has an upside: the higher more centralized functions have less power and so they are less to be feared and perhaps less autocratic. In fact, to combat autocracy, simply distribute the power. And, the less autocratic is almost axiomatically more capable of innovation. So, there's a lot to be said for diversifying the risk and federalizing the power.

As I'm writing this just as I'm finishing Robert K. Massey'stome "Catherine the Great". As a German born French speaking empress of late 18th century Russia, she was the exception to the rule in many respects. She was an absolute autocrat, but in almost everything else she diversified her risks and ruled successfully for decades. And, she was an innovator, bringing western European knowledge of modern medicine, art, and architecture to Russia. So, go figure!

Post script: for the trivia warehouse: Catherine made John Paul Jones, the acknowleged founding leader of the US Navy, an admiral in the Russian navy for her wars against Turkey. Ole Jones couldn'tt get his flag rank in the USN because there was no flag rank for the navy until the US civil war in the mid-19th century

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