Faculty Feature: Dr. Clif Petty - Essential Hazards

I love football.  But I hate to see football players injured.  And therein lies the problem.

One second I am cheering a leaping catch by a wide receiver, and in the very next second I am hushed at the sight of the receiver lying motionless on the turf.

At a visceral level I often feel a connection to the injured player.  One day when I was a teenaged football player I was running with the ball on a wet field.  I spun around to avoid a tackle, and then began backpedaling to keep my balance.  A defensive back was coming full speed toward me, and he lowered his head just as I began backpedaling.  We collided hard.  He ended up with a cracked helmet.  I ended up with three broken vertebrae and a two-month sentence in a hospital bed.

Football certainly involves speed and agility, even grace.  However, at its essence football is a violent struggle between teams, and violent collisions between players.  Spectacular tackles make the highlight reels at least as often as shifty running.  But as public concern grows over concussions and other serious injuries resulting from football collisions, those responsible for the game have begun to consider how they might reduce the risk of serious injury.  The NFL has issued new rules aimed at eliminating the most dangerous types of collisions.  Equipment companies have designed new helmets and other protective gear.  And many coaches have developed new training methods and safeguards.  But are these efforts on target?  To what degree is it really possible to make a violent game safer?

I believe many people are wondering something similar about business these days.  Business is competitive.  Many markets are high speed and full contact.   So is it possible to make business safer for stakeholders?  When hazards are essential—in the sense that they lie close to the very nature of a business—can we protect stakeholders without losing something of the basic character of business?

Consider the case of financial services.  Financial services firms compete to attract and retain clients.  Clients demand attractive investment returns and, sometimes unrealistically, protection from risk.  Financial service providers did not dream up derivatives in order to make mischief.  Most derivatives were created to “thread the needle”—to boost investor returns and hedge risk.  Similarly, bankers did not develop non-conventional mortgages as weapons of mass destruction.  Although today we mostly consider them toxic, mortgage bankers designed these loans to meet particular borrower profiles.  When used responsibly these derivatives and exotic mortgages posed no noteworthy risk to borrowers or lenders.

Financial services firms compete aggressively to design new investment instruments and credit vehicles, and to hedge risks.  And ultimately these firms compete to attract and retain the most profitable client relationships.  This competition is essential, and at the same time, potentially hazardous.  Derivatives are reliable tools for hedging risks, but they become dangerous when they are de-coupled from their original purpose, or when used for highly leveraged speculation.  Non-conventional mortgages work well when the lender retains the loan (and risk), or when sold and securitized in a manner that is transparent and well regulated.  But when lenders play hot potato games with credit risk what once looked like an innovative mortgage product may begin to take on the form of a financial Frankenstein.

Bankers are not the only ones who face this essential nature vs. core hazard conundrum.  Consider the case of the electronics industry.  At its heart the electronics industry is a two-chamber powerhouse of high-tech product development and efficient global supply chain management.  Companies like Apple and Samsung manage vast networks of component makers and assemblers.  The engineers and designers in these companies develop the next big thing, and then pass along the production specifications to the ninjas of supply chain and contract manufacturing.  Apple and Samsung specify thousands of component parts to arrive just-in-time to feed their massive assembly operations.  The obvious outcome for customers is a continuous flow of powerful and convenient devices available at reasonable prices.  But the amazing synchronicity of innovation and cost-effective manufacturing is also tied to distinctive hazards.  International contract manufacturing may lower cost, but it also increases the risk that contractors will cut corners on worker safety and health.  This intense technology race also creates enormous temptations to cheat.  Corporate espionage and theft of intellectual property are costly and pernicious hazards.

So what can be done to better manage the essential hazards, those that lie at the very heart of an industry or market?

First, businesses should identify and give highest priority to these fundamental hazards.  Essential hazards should receive top priority in setting corporate policy, and companies should lobby for best practices with regard to industry association guidelines and government regulation.  It is often easier and more attractive to set policy for issues that are tangential to the company’s core business, or for those that happen to be politically or socially popular.  But sophisticated policy with respect to a company’s charitable giving does not compensate for oversights with respect to worker health in its assembly operations. A financial services firm should first (and continually) grapple with policies related to the management of risks and the responsible creation and marketing of financial products and services.  Electronics firms should squarely face the challenges of global contracting and related safety and health concerns ahead of other matters.

Second, setting policy for essential hazards should be viewed as an ongoing project and championed by executive leadership.  It is best to view this area of policy in a manner similar to that recommended by the total quality management movement.  In other words, corporations should continually improve policy with respect to essential hazards.  Rather than merely setting policy, firms should work to continually improving policy.  Policy guidelines are clearly important, but measuring performance and strengthening it over time are equally important.  The need for a continuous improvement approach to policy is particularly important for those competing in higher-speed and more dynamic markets.

Finally, it is important to recognize that essential hazards are tied to the legitimacy of an industry or area of business practice.  Despite the current level of public concerns about concussions, it is hard to imagine U.S. football losing its charter, or for that matter losing a significant portion of its social and political support.  Business legitimacy is similarly robust in many cases.  But this should not blind us to the fact that poor management of essential hazards may lead to sudden waves of regulation, punishing litigation, and/or widespread loss of stakeholder support.  Responsibly managing essential hazards is deeply challenging, but it may also be the most crucial aspect of protecting the heart and soul of business.