Butterflies in New Mexico
By Norman R. Augustine

The world community does not seem prepared to accept panglobal authority in the face of panglobal crises.

With schools, sporting events, and many businesses shut down in an attempt to slow the spread of coronavirus with “social distancing,” many companies are scaling back or entirely eliminating in-person shareholder events and transitioning to virtual meetings instead.

During my decade as a CEO of what became Lockheed Martin, I kept a card on which I had listed the 10 worst things I could think of that could happen to our company. I occasionally referred to it to assess how well we were positioned to avoid, or at least respond to, disasters writ large. My list included such unthinkables as a major factory destroyed by a tornado, a competitor making an existential technological breakthrough in our major product line, one of our products causing a catastrophic failure of a human spaceflight, a corporate aircraft crash with key members of the management team aboard, a massive penetration and collapse of our computer systems, and other draconian nightmares (but no COVID-19).

Two of the 10 things on my list actually happened.

One was a surprise hostile takeover of our company by another firm that possessed ample assets but little experience managing a major aerospace business such as ours. This incident occurred late on my predecessor’s watch, while I was on the executive committee. Our antagonist rapidly accumulated some 70% of our stock and thus owned us lock, stock and barrel, as the saying goes. Under the strong leadership of my predecessor and a remarkable board, we managed to survive and prosper. The strategy our firm employed was a simple one: Quickly buy a majority of our new owner’s shares before they could stop us! The result was that we literally owned each other. Then we offered to sit down and talk. Our antagonist firm did not survive.

The other crisis occurred when the Soviet Union suddenly collapsed and took down with it much of the U.S. aerospace industry. Within a few years, that industry would lose 640,000 employees and nearly three-fourths of its companies would cease to exist. Our firm had a reasonable strategy, albeit not entirely for the right reason.

As it happened, the former director of the U.S. Arms Control and Disarmament Agency and I had been writing a book on national security. We became convinced that the U.S. defense budget would soon precipitously decline due to the approaching end of the Reagan defense buildup, abetted by the severe financial pressures that seemed about to consume the Soviet Union. Although we never anticipated the Soviet Union altogether collapsing, our company’s strategy was to accumulate cash before the crisis hit (we referred to it as our powder magazine) and wait for opportunity to appear.

Indeed, the crash came, and soon quality aerospace companies could be purchased for 25 cents on the revenue dollar, compared with dollar to dollar a year or so earlier. Notably, it was only this unusual circumstance that enabled Lockheed Martin, founded from all or parts of 17 different companies, to have been created. As Winston Churchill said, “Never waste a good crisis.”

Arguably, the most tortuous type of risk with which to contend is that where the probability of occurrence is extremely low, but the consequences of the potential outcome are extremely large. Presumably the public is comfortable dealing with such circumstances: It buys lottery tickets.

Paralleling all this, philosophers and mathematicians point to chaos theory, where nonlinearities, discontinuities and instabilities morph to produce monumental (usually bad) outcomes. The canonical question such theorists cite is, “Can a butterfly flapping its wings in New Mexico create a hurricane in China?” Or, in more contemporary terms, “Can a microbe in Wuhan cause New York City to shut down?” The answer turns out to be yes.

Turning to the matter of directing and managing under such circumstances, there is a Swedish proverb that says, “Every ship has a great captain in calm waters.” Jack Welch, more pragmatically, asks, “Does he get back on his horse?” Unfortunately, it is very easy for leaders to neglect the six-sigma black swans that lurk around the balance sheet. After all, they are unlikely. Should a leader spend time worrying about draining the swamp when surrounded by alligators?

Once, as a government employee, I was testifying before a congressional committee on behalf of the U.S. Army and sought to include financial reserves in the budget request for a huge new helicopter that was then in prototype development. One of the members asked, “What are you going to spend your reserves on?” Apparently unhappy with my explanation that the Army didn’t know, because that was the nature of reserves, the congressman asserted, “Mr. Secretary, we have lots of people appearing here who know what they want money for.” Congress canceled the program.

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Self-confident boards and CEOs dealing with highly unlikely events that bear potentially dire consequences would be well served to recall Churchill’s admonition shortly before the outbreak of World War I. Stating the popular view of the time, he said, “War is too foolish, too fantastic, to be thought of in the 20th century… Civilization has climbed above such perils. The interdependence of nations in trade and traffic, the sense of public law, the Hague Convention, liberal principles … have rendered such nightmares impossible.” After a brief pause Churchill concluded his remarks, saying, “Are you quite sure? It would be a pity to be wrong.”

In today’s era of dog-eat-dog control of overhead rates and just-in-time inventories, wherein tires for a new car arrive at the assembly plant a moment before the vehicle is to roll off the factory floor, can boards of directors really be expected to stockpile “rainy day” funds and other assets? If it is for the plausibly foreseeable — say, a major snowstorm or hurricane — many observers would say yes. But if it is to cushion the impact of a large asteroid hitting the Earth, most (dinosaurs notwithstanding) would say no.

Managements can be expected to prevent, or at least contain, many butterfly events, such as the tree that fell across a powerline in Ohio a few years ago and put much of the Northeastern United States and neighboring Canada in darkness for days. But part of the challenge is that black swan events are fiendishly complex, with many hidden subtleties and interconnections. Electrical engineers refer to these as sneak circuits.

A friend of mine tells of the extensive effort the telecommunications firm he was leading undertook to prepare for hurricanes that occasionally ravaged their area. They stockpiled poles, wire, concrete, bucket-trucks and more. But when the big hurricane struck, their response was stopped in its tracks by the shortage of daycare centers. Yes, daycare centers. With schools closed as a result of the storm’s damage, a large number of workers had to remain at home to care for their children, resulting in a badly depleted workforce at the most critical moment. This was ultimately resolved by enlisting retiree volunteers to help staff daycare centers.

In the case of black swans that attack one individual company, the appropriate action would seem to be to undertake reasonable internal preparations, and to purchase insurance from a reliable provider to cover the rest. In the case of black swans that nest more broadly than a single company, even large insurers or conglomerates probably won’t have the resources to provide protection and will therefore include force majeure escape clauses in their coverage. This is where governments must step in to take preparatory measures and lead recovery efforts. It is, for example, unreasonable to expect individual hospitals to maintain large inventories of empty beds, but governments should maintain surge capacities of such critical assets. Noteworthy in this regard, panglobal crises demand panglobal leadership — although the world community does not yet seem to be prepared to accept such authority.

When viewed in retrospect, perhaps the COVID-19 tragedy will have provided the incentive for the world to take more seriously such matters as climate change and the massive human migrations that result; to take reasonable actions to neutralize an asteroid on a collision course with Earth; to ask whether it makes sense to invest 18% of the GDP on healthcare but only one-tenth of 1% on biomedical research; to address the economic and human consequences of widespread use of shoulder-fired missiles and drones against commercial aircraft — and more.

Now on my 85th trip around the sun and having participated in over 500 board meetings of Fortune 100 companies and numerous gatherings of smaller firms seeking to become Fortune 100 companies, I sometimes am tempted to believe that I have seen it all.

I would be very wrong.

Norman R. Augustine is the retired chairman and chief executive officer of the Lockheed Martin Corp., the nation’s largest defense contractor, and a former undersecretary of the Army. He is a former member of the board of directors of ConocoPhillips, Black and Decker, Procter & Gamble and Lockheed Martin, and has served on a number of private company boards. He is a member of the Directors & Boards editorial advisory board.

2020 Second Quarter

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