Does the Flap of a Butterfly's Wings in Brazil Hurt Management's Credibility in the U.S.?
Everyone has heard of the Butterfly Effect. Most even have a vague understanding of the term's meaning (a small change in a nonlinear system can result in dramatic variances in end results). Few know that it was discovered by accident when mathematician and meteorologist, Edward Lorenz took a shortcut when running equations on his computer in 1961 and entered a number that was slightly rounded. He had assumed the end result would be the same when in fact it was vastly different. This was the beginning of a new field of study in mathematics, The Chaos Theory.
The Chaos Theory has been applied to everything from biology to physics to determine how small changes ultimately affect anticipated outcomes. When applied to how companies and their management teams communicate with stakeholders the relevance is evident. We have seen numerous situations when seemingly minor corporate news events have caused extreme volatility in a stock’s performance – often referred to as Market Overreaction. It can be as innocuous as rain in a remote region delaying an anticipated shipment’s arrival in a different part of the world, or more alarming like a political revolution impacting the oil supply chain. Whatever the event is, it will have an impact on anticipated results…how it is communicated will determine the severity of the impact on management credibility.
For example, a consumer electronics company has a number of variables outside its control it must monitor that could impact the Company’s ability to deliver new products on time to retailers – ultimately effecting revenue, net income, stock performance and shareholder value. There is an expectation as to how a product will perform over its lifecycle but the launch month is most critical to the Company’s anticipated corresponding quarterly results. However, those expectations can be significantly impacted when unusual events affect the supply chain.
Earlier this year, damage to Japanese factories during March’s devastating earthquakes caused a global shortage of silicon wafer production capacity. These silicon wafers are used in the manufacturing of semiconductors and can be found in virtually all consumer electronic products. This shortage caused a ripple effect throughout the industry as companies were forced to either pass along the increased cost to consumers, potential hurting sales, or absorb the costs and erode margins.
For a company like Apple, the decision was easy. They were able to leverage their influence on parts manufactures to obtain supplies in a timely manner and could absorb the increased costs to not affect consumers or partners. However, most companies experienced increased costs and delays in parts which in turn compounded the issues they were facing.
Turning back to our consumer electronics company, the production delay, capacity shortfall and increased costs directly impacted revenue, margins, and net income. While the management team believed the impact would not be felt over the lifecycle of the product’s sales, the short-term implications caused the Company to miss the Street’s expectations for the quarter. The event that changed the end results was obviously outside the control of the management team and as such, they elected to not make any announcement prior to the release of their financial results. Their simple rationale was that they do not provide quarterly guidance.
When the Company finally announced financial results, The Street was taken by surprise and the operational and financial shortcomings, negatively affected management’s credibility with key stakeholders. The perception was that management did not understand the outside events which impact their business. No communications strategy could have resolved the operational or financial impact caused by the earthquakes. However, management’s credibility could have been preserved or even enhanced through timely, transparent communications. Provided that the Company had strong controls and reporting systems in place, management should have been able to identify the extent of the impact the semiconductor shortage and cost increase would have on production and financial results. This information could have in turn been communicated to all stakeholders, enabling all parties to adjust their expectations and position management as credible leaders.
While hindsight is always 20/20, it is important to fully understand the events that affect outcomes and learn how to manage future negative results through more effective communications. Studying the Butterfly Effect and identifying trends enables us to anticipate the elements within a chain of events that impact companies—helping us know when and what to communicate. We do have the ability to influence the outcome of events outside our control in order to enhance a company’s profile and improve management credibility.
