Linear thinking in a cyclical world

May 1, 2005 By    

Many of us incorrectly view the world as neat, clean and predictable. We often will take bits of information and conclude in our minds that a particular trend will continue for years to come.

 Carl Hughes
Carl Hughes

For instance, if it takes you 20 minutes in heavy traffic to go one mile you may think at this rate you would get home sometime the following day. Yet practical experience tells us that even where traffic is the worst, commutes don’t extend into the next day.

Exaggerated thinking? Perhaps, yet the influence on our judgment is real. What happens is that we are taking bits – or data points – of information and falsely assuming that they will continue in a straight line off into the distance.

This linear approach to the world is also observed in a more global perspective. In the early 1980s it was assumed that we would never return to the low interest rates of the 1950s and 1960s. Economists rationalized that conditions in the U.S. financial markets were so different that there no longer existed an interest rate cycle. In the mid-1980s we were certain that crude oil was heading to $100 per barrel.

In a matter of months from those predictions, crude oil fell to the teens and we have just experience the lowest interest rates since Eisenhower was president.

The propane industry gives us a great example of this linear thinking. String just two mild winters together and most of us think our storage and delivery capabilities are overbuilt. Have a strong, sharp, cold winter that catches us off guard, where we scramble to find supply, and the industry will sprout rail terminals and enormous storage facilities like dandelions in the spring. Not one in 10 of these projects would be supported by objective financial analysis.

The problem with linear thinking is that our judgment is blurred, and therefore our decisions become impaired. We want to over-react to the most recent data points because we don’t acknowledge that the real world changes constantly and is anything but linear. Even as we view the activity in our individual businesses that at times appear to be treading water, forces are working – never in a linear, straight-line method.

Explaining cycles is very difficult, while predicting them is near impossible. It is our need for predicting and forecasting that leaves us with only straight-line thinking.

Dangers of linear thinking

Another problem with linear thinking is that it ignores the fact that the world is very clearly cyclical. We see it in weather; we see it in returns of former fashions and in the fortunes of political parties.

Economists have long identified cyclical trends in business and finance. Despite the obvious facts that our world is cyclical and has historic upturns and downturns, we still seek trends and hang on to them way too long. Intuitively we believe that we can take a trend and distill a truth that will predict the future – most always a straight line. It’s as if we believe that cycles don’t exist and we want to prove them away.

If the forces that drive our business – weather and wholesale supply costs and lesser factors like interest rates and housing starts – clearly have cyclical characteristics that ebb and flow over time, why does it make sense to start the next year’s plan based on last year’s experiences?

How can you run your business successfully amidst all the uncertainty? Here’s a few tips:

  • Don’t overreact to last year’s experiences.
  • Always consider a multi-year plan that takes into consideration the cyclical nature of your business environment.
  • Don’t attempt to forecast the future.
  • Build options and flexibility into your business to ensure it will perform under all types of conditions.

The most successful companies have a horizonal approach to business and simply will not let the latest trend throw them off course from their anticipated destination.

Carl Hughes is vice president of business development for Inergy LP. He can be reached at 816-842-8181 or by email at Chughes@InergyServices.com.

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