This week’s update is written by Oliver Tostevin, an analyst for the Ravenscroft Blue Chip Fund.
Investing in blue chip companies often involves looking beyond the surface to understand the underlying systems that drive their success. One of 2024’s most insightful new books, for me, is Dan Davies’ The Unaccountability Machine, which offers an alternative perspective on the impact that systems control and feedback mechanisms have on economic and business management.
Davies, a former Bank of England economist, has spent years engrossed in the field of cybernetics, which first became a distinct field in the 1940s. In its basic form, cybernetics is the study of control (i.e. steering) of systems – and in particular circular processes where the operation of feedback plays a critical role. The term derives from the ancient Greek “kubernetes”, meaning “helmsman”, i.e. the person steering the boat. As Davies himself admits, it is a huge subject but largely forgotten, Davies hopes to rekindle interest given that cybernetics’ insights are apt for some of the seemingly intractable problems we face today.
Per Davies:
The basic problem is that systems in general need to have mechanisms to reorganise themselves when the complexity of their environment gets too much to bear. But the high-level governing systems of the industrial world – economic and business management – had some defects and blind spots which prevented this from happening. How did that turn into an economic crisis, and then how did it mature into an ongoing political polycrisis?
Davies’ excellent book covers a bit of ground, much of which eulogises the late Stafford Beer, the eccentric figurehead of the cybernetics movement from the 1960s through to the 1990s. For our more curious readers, you can watch the man himself talk about cybernetics here.
As the above quote implies, Davies is interested in institutions, or “decision-making systems” and this is why his book is relevant for us who manage the Ravenscroft Global Blue Chip Fund – all of our holdings are decision-making systems too, and we spend our time studying them.
One of the main thrusts of Davies’ argument concerns what he calls “accountability sinks” – essentially the removal of human agency and the delegation of decision-making to algorithms or rule books. Accountability sinks sever “the connection that’s needed in order for the concept of accountability to make sense” and for information to get to where it needs to be. The classic example is the modern call centre. We’ve all been there – you end up with unhappy customers on the one hand, and on the other, CEOs who can’t figure out why.
Accountability sinks have now permeated the corporate world and come in various guises. Even the modern financial accounting system itself acts as an “information-reducing filter”, having surpassed all other information systems to dominate the modern corporation. Per Davies, the greater the emphasis senior management puts on accounting targets, the greater the filtering effect.
Davies points the finger at the “shareholder value” movement – the modern creed of cost-cutting. To be clear, Davies does not argue in favour of corporate bloat, rather he is saying that when you replace middle managers with rule books, automate processes that shouldn’t be automated or overly rely on outsourcing, you risk cutting off vital information flows. And without a functioning feedback loop, how can you adapt?
As we’ve learnt over the years, the very best businesses are those that have proven their ability to adapt. With the future inherently unknowable, we believe this to be essential, in fact.
If you’ll forgive me, a brief venture into some of the language of cybernetics might be helpful. Beer talked about “variety engineering” as a necessary capability for a functioning organisation: “making sure that every management function is matched, in terms of its information-handling capability, to the kinds of shocks and variety that might affect it”. Such exceptions (“shocks and variety”) are escalated up to the next management level. The upper part of the cybernetic hierarchy is the management of change itself and striking the right balance between too little and too much of it. In Beer’s eyes, an organisation’s final management function is to absorb excess variety through its identity or philosophy – its purpose. It’s unlikely that many businesses discuss cybernetics these days, but it seems to me that many of the better ones have grasped it intuitively.
Take GSK, for example, which is currently held within the Blue Chip fund. The company’s CEO, Dame Emma Walmsley, has long described her role as that of change management – it tends to go unnoticed, but she’s actually very good at it in our view. But it’s not only at the top – GSK has spent the last seven years reinventing its culture too. For example, building a culture of accountability – ensuring that there is a single point of accountability for key decisions. One might even say GSK has set itself up to handle variety engineering on the one hand, and to avoid accountability sinks on the other.
Is it simply academic though? The results say otherwise – we’ve got accelerating revenue, growing margins, a differentiated portfolio and what seems like a long runway for this to continue. And they’ve done it without having to make any large value-destructive acquisitions. In many respects GSK is unrecognisable compared to the business of seven years ago, yet its purpose remains broadly intact.
Investing in blue chip companies requires an understanding of the systems that underpin their success. Davies’ book provides a compelling lens through which to view these systems. As investors, recognising and evaluating these systemic factors can help us identify companies that are not only adept at navigating complexity but also excel in maintaining robust feedback loops and accountability structures. This approach helps ensure that our investments are resilient and capable of thriving in an ever-changing economic landscape.