Essay on Decision Loops – Part 1

In 1928 a young, brilliant mathematician named John van Neumann, devised a theory that would affect economic and military thought for many years to come. The theory that Neumann developed was based upon several observations he made during a game of poker. The first observation was that wining and losing was the interdependent on all players. A wining strategy was not solely based upon a single player’s strategy – but rather the product of all the player’s strategies. In order to devise a winning strategy, Neumann had to account for other player’s strategies, assuming that each player’s objective was to win the game. From these observations Neumann developed what became known as game theory and he applied the theory to economic markets. Previous economic models used traditional neoclassical economic assumptions that a seller and buyer acted solely on the mission to maximize their gains. A seller is looking to maximize profit and a buyer wants the maximum value for capital spent. The contribution that Neumann made was to define a seller and buyer as a transactional unit that was dependent upon each other, but not necessarily to achieve maximize profits and value for capital.

Game theory became a sensation in 1944 when Neumann and Oskar Morgenstern co-wrote The Theory of Games and Economic Behavior. This book is a 642-page tour de force on game theory and its application to economic models. To be of value, the models, derived from using Neumann’s game theory require precise mathematical values. If the values are subjective, it can lead to false results. In terms of economic models, applying game theory to markets in which social behavior must be quantified requires an understanding of utility. Utility is a measurement of satisfaction. People’s actions are governed either by the drive to increase utility or the satisfaction of their condition in the context of all information. Aristotle called this the pursuit of leisure time. Beaumarchais measured utility in the motivating power of the eternal Figaro. It has been argued that utility is an inaccurate value, as people tend to compartmentalize decisions, or pass on decisions that promote the long-term state in favor of the short-term gain. A component of the measurement of utility is diminishing marginal utility, which states that the more one has, the less difference an additional unit of utility will make. In terms of market share, if a company has 83% market share and they gain two or three points of market share; it has marginal utility value on the company. Conversely if a company had one percentage point of market share and they gain three or four points of market share, it has significant utility value to the company.

The end of the Second World War was heralded as a triumph for science and technology. The power of the atom had been demonstrated and the industrial power of America was crowned the Arsenal of Democracy. After America entered the war in 1941, a group thought leaders were recruited from the Harvard Business School (HBS) to the Pentagon to form a new organization. This group was called the Statistical Control Office of the Army Air Corps and it is important because it was the beginning of the fusion of new age business strategy, neoclassical economics and the strategy of war. The Stat Control Office as it became known, was established with the mission to apply the management techniques and quantitative economic theories developed at HBS to war effort. The objective of the team was to find methods to improve the overall efficiency of the war effort through analysis of production, logistics and warfare. The group helped coordinate the collection of statistics, the interpretation of statistics and the development of models that revealed methods to improve productivity of manufacturing, logistics and combat operations. They were especially skilled at improving the combat efficiency of U.S. strategic bomber commands. Strategic bombing entailed complex logistical supply chains and the coordination of aircraft and analysis of results. The mission of strategic bombing was to destroy the production capacity of a nation-state to wage war. It was assumed that business people who have an understanding of logistics and the means of production would be of value to strategic bombing. The emergence of the atomic age post the war was intellectually focused on atomic bombs, reasons for their use, means of delivery and impact on the battlefield. There was a natural fusion between the old Stat Control Office methods, the RAND Corporation and the military strategy adopted by the U.S. for the first fifteen years after the end of the Second World War. One of the major contributions that the Stat Control Office created during the war was a methodology called operational analysis that defined the state of best-expected return given a set of conditions. This is a military term for framing. Financial people frame investments; military people provide operational analysis to frame the expected of the state of return for combat operations.

A short aside to this essay, here is a link to post on Taylorism. I think the work principles around Taylorism are fine for the modern industrial production line, but I am on record as saying it an inhibitor to adoption of agile IT and over the long-term the industrialization of IT will result in the monocultures of IT being abandoned like the blast furnaces of old.

Taylorism has been a fundamental foundation of the post-19th century modern company. We see that it is deeply embedded in our daily life with the message of “do your job” and job specialization. A hundred years after the introduction of Taylorism, there has been an anti-Taylorism movement developing. From a high level, the thinking within the anti-Taylorism field is about the reduction of the separation that exists between conception and execution. Anti-Taylorism thinkers embrace broadening of skills sets away from siloed specialists. Work teams have autonomy and co-determination empowerment to make decisions and accelerate the business. That is the specific change I witnessed at the customer mentioned above. We had been engaged with the conception (architecture and technology) side of house, but we could not get investment from the operations side of house.

After the war, during the late 1940s and into the in the 1950s, game theory became a driving force in place called the RAND Corporation [see, The Wizards of Armageddon, by Fred Kaplan, 1983]. Originally funded by the Air Force, the RAND Corporation played a prominent role in thought leadership in defense related strategies post the Second World War. RAND figured prominently in the development of America’s cold war strategies and game theory became a basis for many of their early studies on various strategies and their outcome. In 1947, Albert Wohlsetter and his wife Roberta published an internal RAND paper that included an application of Neumann’s game theory was well as adaptation of operation analysis by Edwin Paxson called systems analysis. At RAND, systems analysis exploded across the organization and became a fundamental element of the thought leadership provided by RAND across all intellectual domains to which the organization contributed. Systems analysis answered the question of given the mission, what are the characteristics required by something or someone to accomplish the objective of the mission. In an organization dominated by mathematicians, systems analysis was broadly accepted as true science.

The weakness of systems analysis is the broad assumption of theoretical facts. In real life, outcomes are usually different then those projected by models and conjecture. In the early 1940s, the collision between systems analysis and operational analysis was plainly visible. The projected affect of weapon systems created by RAND was not in line with the operational analysis from data collected during the Second World War. Paxson and others eventually concluded that people do not always act in accordance with the mission – they are not always logical. People make decisions based on other criteria and often that decision-making criterion is occurring in real time. It is at this point that we begin to pick up the elements of behavioral economics.   People who subscribe to behavioral economics attempt to augment future projections by compensating for human behavior. The theory is that people are prone to cognitive dissonance, irrational behavior and anchor behavior.

The system analysts of the Pentagon took two paths post the Second World War. A group of them soon found their way into the fabric of corporate America and most notably the Ford Motor Company. This group included Charles (Tex) Thornton, Arjay Miller and Robert McNamara [see, The Whiz Kids, John Byrne, 1993]. Those who remained in the service of the defense industry of America soon found they had plenty of work ahead. As the Cold War intensified, it became an assemblage of ideological, scientific and economic warfare. The RAND Corporation played an important role in shaping the defense related strategies of U.S. In their history we can find many examples of the problem of inference, survivorship bias and applications of game theory, counterforce, systems analysis, mutually assured destruction and the Nash equilibrium. The purpose is highlight three broad trends that emerged from the thought leaders at RAND. The intellectual environment at RAND helped establish a position of thought leadership that (a) set forth a predominance of reliance upon system analysis and mathematics, (b) which was countered by the use of game theory to inject elements of social behavior into intellectual thinking and (c) these disciplines created as part of national defense found their way into private sector through the use by economists and business leaders.

There is a cyclical wave between the social sciences and the hard sciences. At times one is in favor and the other is out of favor. The decades after the First World War and before the Second World War were dominated by social sciences. The Second World War hastened the rise of science and mathematics and the decline of the social sciences. This rise is due to the process, operational analysis and hard science investments (e.g. B-29 Program, Manhattan Project) that emerged from the war and was promoted by thought leaders at RAND. What started from the working levels of government and the private sector eventually gained positions of leadership by the 1960s. At RAND, for a time the social sciences were viewed as inferior by the hard science leaders. Mathematics was the only hard proof that utilized concise logical to draw precise conclusions about the past and enabled a prediction of the future. Game theory played a prominent role in the development of strategies for the military and drove assessment of the bomber gap, the missile gap and eventually collapsed inward as a result of endogenous risks created by the inferred conclusions.

This was not the first time that pursuit of natural sciences was held in higher regard then the social sciences. During the 19^th century, Auguste Comte promoted a view that societies operate according to the laws of nature, thus understanding the laws of nature then facilitates and understanding of societies and negates the need for the social sciences. This thought movement became known as positivism. It can be broadly defined as a scientific study contained to the facts and the relations between the facts present to derive a viable understanding and observation. Positivism is an early attempt at game theory, systems analysis and rational expectations.

As the thought leaders inside RAND played out various cold war game theories, a concept called counterforce was developed. Counterforce was originally pioneered by Bernard Brodie and inserted into the public domain in a January 1954 article in Foreign Affairs [see, Nuclear Weapons: Strategic or Tactical, January 1954]. John Kaufmann further developed the concept of counterforce as a strategy option to a Soviet invasion of Western Europe. The idea of counterforce was not to massively destroy the Soviet Union, but rather destroy the ability of the Soviet Union to wage atomic war by destroying their military forces. Until this time, U.S. military strategy was focused on the massive destruction of every aspect of the Soviet Union using atomic weapons. Counterforce did not have official adoption as a U.S. military strategy option until the election of John F. Kennedy as President and his selection of Robert S. McNamara as Secretary of Defense (i.e. SecDef).

When McNamara became SecDef in January 1961, one of the key members of the Stat Control Office returned to the Pentagon and a position of intellectual leadership within the defense establishment of the U.S. This is important because McNamara had been honing his skills at the Ford Motor Company since the end of the war. Upon returning, he was trust into an intellectual battle between the branches of the armed services that wanted more weapons, more money and believed that any conflict with the Soviet Union would result in a massive atomic exchange and the analysts at RAND and other places who were advocating opposing views. When McNamara reviewed the Single Integrate Operational Plan (SIOP) for response to escalating tensions with the Soviet Union, he was terrified by the singularity of the plan and limited options. It assumed many worse case scenarios about the Soviet threat and provide a single war plan involving a massive atomic strike on the Soviet Union. When he was given the Kaufmann briefing on counterforce, McNamara found an intellectual solution to system wide problem. Counterforce provided options for the U.S. atomic strategy. It provided a means to control spending and moved the intellectual thinking away from absolutists such as Herman Kahn. This started the departure of U.S. defense thought leadership away from the objectives of making atomic war winnable and survivable.

Counterforce was interesting because it altered the operating assumptions of the U.S. war plans that had been based on precise mathematical analysis of the blast radius and destructive force of atomic weapons. The analysts at RAND had studied the bomb damage assessment reports from the Second World War to infer and project the destructive capacities of atomic weapons. As part of the Gulf War One and Two, bomb damage assessment reports would go mainstream as part of the technology revolution and would play a prominent role in the media coverage of both wars. Vietnam became the ultimate showcase of counterforce strategy. The U.S. strategy was never to win the war, but rather to deter North Vietnam aggression and destroy their military forces without destroying the social infrastructure of nation-state. Counterforce failed because people do not act rationally. The North Vietnamese people were operating under a different set of principles. Counterforce was originally promoted as a game theory analysis of Soviet and U.S. war plans. It concluded that a strategy based upon destroying the military capacity of the Soviet Union to engage in an atomic war and generally avoiding destruction of their cities, would change their military strategy and force them to pursue a cessation of hostilities favorable to the U.S. The endogenous risk to strategies derived from game theories is that people do not act rationally.