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‘How Excellent Companies Avoid Dumb Things’ - New Book

GUEST AUTHOR BLOG by Neil Smith author of "How Excellent Companies Avoid Dumb Things."

How Excellent Companies Avoid Dumb Things, by Neil Smith
How Excellent Companies Avoid Dumb Things, by Neil Smith

We all hear stories about something a company has done that leaves us scratching our heads, wondering "how could they have done that?"

We’re surprised when average companies do something that is so obviously misguided. We’re shocked when it happens at a company known for stellar leadership.

Case in point: the recent hedging loss at JP Morgan Chase .

JPM, known for a nearly unblemished record even during the most recent financial crisis, is now facing a $2 billion dollar loss (and estimates say it could to as high as $4 billion loss) in an investment strategy the company used trying to hedge losses when making large investments.

It is a prime example of how even excellent companies can stumble.

But when companies do stumble in this way, it is usually not deliberate and it is typically not their fault. Does anyone seriously believe that Jamie Dimon, the talented CEO of JPM, wouldn’t have immediately put a stop to the trading if he had known of the potential consequences? In the course of the last 20 years, I have come to realize that every company, no matter its size, industry, or how successful it is, is plagued with the same eight natural barriers which can cause them to do do dumb things. These barriers arise both because of the structure of an organization (structural barriers) and basic human nature ( behavioral barriers.)

It is highly likely that at least two of these barriers came into play in the hedging situation: Management Blockers, and Existing Processes.

JPM was caught unaware by the extent of the hedging lossand did not know the amount of risk that was being taken.

Trusted traders were allowed to be too independent.

When this happens, the Management Blocking barrier can kick into place. Employees act in their own interests and not in those of the company. They become defensive and protective and make decisions based on, amongst other things, their own careers and what will serve them best. Another structural barrier – the Existing Processes barrier – also appears to have come into play. This happens when Existing Processes are falsely trusted and there is no process in place to test or change them. At JPM the Existing Processes for monitoring clearly did not work.

When individuals become very good at what they do, it is very difficult to reign them in. More trust is naturally extend to them, and with that trust comes more authority. The "Management Blocker" barrier can cause people to use that authority to act in their own interests within the company rather than on behalf of the company.

"When a company is among the best in its sector, it becomes harder to detect potential flaws – not because of complacency but because processes and systems appear to be working well." -Author, "How Excellent Companies Avoid Dumb Things", Neil Smith

When people believe an existing process works very well (here, the process in question was risk management) it is very difficult to change that process even when a flaw is spotted. So, flawed processes stay in place, setting the stage for potential catastrophe. The JPM process was clearly flawed but because the bank has been so successful it would have been very difficult to change the process. Risk processes mat have been more focused on protecting the customers’ money, not the bank's capital, which is what the traders used for hedging.

Clearly, JMP is a highly successful bank and Jamie Dimon has been rightly oft-praised for his leadership. And in some ways, it is the most successful companies that are the most vulnerable. When things are going well, there is no sense of impending doom. When a company is among the best in its sector, it becomes harder to detect potential flaws – not because of complacency but because processes and systems appear to be working well.

Every CEO and senior manager should see this as a cautionary tale and take the opportunity to think about how the barriers are showing up in their own companies. Who are your potential Management Blockers? What processes are in place to test and amend your own key Existing Processes?

For every leader it is difficult to question the abilities of trusted managers and processes that have to date been flawless. And yet this is the challenge that must be embraced. The eight barriers encourage misplaced trust. The problem is that unless you are alert to the barriers, it is hard to know that trust is misplaced until disaster strikes.

Neil Smith, CEO of Promontory Growth and Innovation and author of "How Excellent Companies Avoid Dumb Things: Breaking the 8 Hidden Barriers that Plague Even the Best Businesses."

Email me at bullishonbooks@cnbc.comAnd follow me on Twitter @BullishonBooks