WHARTON LEADERSHIP DIGEST 

September, 2006, Volume 10, Number 12 

CONTENTS 

Strategic Decisions:  Distortions and Deceptions

The Consumer at the Heart of Healthcare:  Michael McCallister, CEO of Humana 
 

Strategic Decisions:  Distortions and Deceptions

By Mark Hanna 

Sometimes strategic decisions fail.  Why they fail is a source of debate for academics and practitioners alike.  More and more, behavioral economics – a new field merging the insights of psychology and economics – is providing insights that can help practitioners avoid pitfalls and make better decisions.  In the first 2006 issue of McKinsey Quarterly, authors Dan P. Lovallo and Olivier Sibony use behavioral economics to illustrate various distortions and deceptions that can occur in strategic decisions and what can be done about them. 

Take the case of a harried CEO who relies on the advice of a trusted yet self-interested lieutenant regarding a proposed merger.  If the merger goes through, the trusted subordinate stands to gain by running a larger division and positioning himself or herself as the CEO’s successor.  Unaware that the forecasts are too rosy and the challenges haven’t been sufficiently examined, the CEO and board decide to go through with the merger.  The merger ends in a spectacular loss of value when the anticipated strategic synergies fail to materialize.  

There are both cognitive distortions and deceptions possibly at work here. Distortions can come in the form of over-optimism about the likelihood of success as well as over-confidence about what one knows or doesn’t know about a situation.  Over-optimism can result in unrealistic forecasts, whereas over-confidence can result in an underestimation of risks and challenges. 

Then there are the deceptions – either conscious or unconscious – that can occur at either the individual or group level.  Misaligned time horizons can cause a manager to focus solely on the time horizon for one’s current position.  The manager’s emphasis on incremental innovations with short-term impact may be helpful to that person’s career but be harmful to the corporation’s long-term strategy.  The CEO may be subject to champion bias, which is accepting the evaluation of a proposal more willingly when the proponent is a trusted associate.  The board may be engaging in an unconscious distortion termed sunflower management, which is a kind of collective consensus around a senior person’s presumed opinion.  This consensus can result in an absence of dissent or debate in important decisions.  

These distortions and deceptions can sometimes be intertwined with what behavioral economists call the principal-agent problem.  This phenomenon occurs when the incentives of certain employees or agents are not aligned with the principal’s (company’s) interests, sometimes causing agents to look after their own interests in deceptive ways.  The trusted lieutenant in the case example was motivated to leave certain stones unturned and overemphasize the potential success of the merger. 

So what are leadership practitioners to do?  They can reduce their exposure to these intertwined and harmful patterns by (1) becoming more aware of how biases can affect their decision-making, (2) becoming more mindful of how their past decisions have been made, (3) embedding safeguards into their formal decision-making processes, and (4) encouraging active open-mindedness through a culture of freewheeling debate.  

Note:  Mark Hanna can be reached at markhanna@mchsi.com.  The article is: Dan P. Lovallo and Olivier Sibony, “Distortions and deceptions in strategic decisions,” The McKinsey Quarterly, 2006, (1), 19-29.
 

The Consumer at the Heart of Healthcare:  Michael McCallister, CEO of Humana

Humana Inc. named Michael B. McCallister as its chief executive in 2000.  He had risen through the company’s ranks for 26 years, and since taking the corner office, he has moved the company to focus on its consumers.  With revenue of $14.4 billion in 2005 and 18,700 employees, Humana provides health plans and related services to millions of customers in the U.S. and health care coverage to military personnel and their families.  Forbes magazine named McCallister in 2006 as one of America’s most successful executives in creating shareholder value.  Arranged by Knowledge@Wharton, McCallister is interviewed by Michael Useem, editor of the Wharton Leadership Digest, and Stephen Wilson, Engagement Director for the Conquering Complexity Practice, George Group Consulting. 

Useem: Looking back at how you have grown with the company since 1974, how you lead people and how you’ve led the company, can you offer a couple of thoughts on what it takes now, in year 2006, to lead a much more complex, diverse and much larger enterprise than at an earlier point in your career?

McCallister: I might disappoint you if I told you that I'm not sure it's any different.  Although there are a number of different tactical things you have to do given the scale, scope and complexity of what we are today versus what we once were, to me the principles have always been the same: You find the best people you can. You get a clear direction for the company. You delegate the right work to the right people, and then you get out of their way and let them do it while holding them all accountable for their performance. I know that's right out of Management 101, but that's what you do. Given the complexity of the business we're in today there are a number of tactical ways you have to go about doing those simple things I described, but I think at the core they're all the same.

We've had to deal in more of a team environment than we once did. When  Humana was a hospital company the business operated as individual, local units with as  many centralized activities as we could manage. As we tried to integrate health insurance and hospitals, it became more regional, or at least metropolitan‑wide. When we went into being a pure employee benefits company in the mid‑nineties, our structure became much more centralized because insurance is a financial institution more so than healthcare. The way we operate and run Humana has transitioned. We're more data‑driven today than we once were and we have more challenges relative to applying technology in an effective way. Many of the agenda items are different, but the core principles of how you manage the enterprise are the same.

Useem:  I’ll build on that with two related questions. Looking back again on your career, were there one, two, or maybe even more individuals who, as you developed your own style, your own approach to leadership, served as mentors to you – even if they didn't use the term themselves?

McCallister: I've been asked that question many times over the years. I've worked for and been around a lot of really good people, but I've never been able to point to one person after whom I modeled how I do things. I've been careful to watch other people in a work environment, and I came to the conclusion early on about the sort of style I was going to have. I'm not sure it's something you can always drive yourself . . . . it's a compilation of what I've seen around me over time and deciding for myself what I liked and what I didn't, what worked and what didn't. Sometimes what I didn't like was quite effective, so it's not as if I took all the winners and regardless of the process, kept them. I believe there are a number of ways to get to an answer or result. You can choose your path.

Useem: You have made hundreds of major decisions along the way. Could you pick out one of your more difficult decisions and just talk about it: What went into it? How did you reach the decision? What does it take on your part to make a good and timely decision?

McCallister: Well, I'll pick one that we made not too long ago. When we decided to set the strategy for this company after I became CEO in 2000, one of the most important decisions we ever made was to organize and drive this company around the simple premise that the consumer had to be at the heart of healthcare. Now there's a lot of talk around that idea today. Six years ago there wasn't anybody talking about it and there weren't many people going down that path. If you think about healthcare and the way it operates and has for a hundred years – very paternalistic, no information – it's a mother and father "may I" kind of environment. To have the consumer at the core of how it's organized seems so simple and seems so right – except when you talk to healthcare people, who think it's crazy. That decision was a big one and has really guided everything we've done for the last six years with varying levels of success. . . .  What’s particularly gratifying is that the rest of the industry has now decided they're going to go down this path, too. We get the benefit of having been at it for a while, and we also take pride in the fact that we may have helped nudge the industry toward consumers.

Useem: What prompted that decision at that time? And, to whom did you turn for guidance or counsel?

McCallister: I didn't turn to anyone on the outside. After thinking about it myself, I engaged a handful of Humana’s key people and together we tried to figure out where we were going to take the company, how we were going to fix it and change it. Those key people had an incredible mix of knowledge from both in and outside the industry, and quite frankly there wasn’t much going on outside that would have led us down the consumer path.

 We were trying to answer a very, very big question: "What would it take to rationalize healthcare and the cost of healthcare in the US?" We started putting down everything that's been tried, everything that's failed, everything that's worked – there haven't been too many things that have worked. When we started listing the history of it, all the various components, all the various approaches that people have tried to apply over many, many years, it quickly became clear that the one thing no one had ever tried was to get the consumer at the heart of this. But it didn't start with, "We think the consumer's great. Let's a make a case for it." It was the other way around. We looked at a blank sheet of paper and asked ourselves, if we’re going to try to do something about the cost of healthcare and health insurance, how do we do it?

Useem: It's hard to put particular time points on this, but – start to finish – was this a deliberation on the inside that took place over six months? A year? How much of your own time did you focus on this before you finally said this is a "go?"

McCallister: At the hundred-thousand-foot level it didn't take too long to agree the consumer was the way to go. Then we started bringing it down to fifty thousand feet and said, "All right, if the consumer's going to be the core of what we think, then what are the next steps we take to make that happen?" That took longer, probably more like a year in the making. Some great things came out of all those conversations. It's not on our strategy page, but as soon as we decided that the consumer was where we wanted to be it was clear we were going to have to be an innovator as well, because it was going to take some innovations in the industry to bring the consumer to the center. –Innovation is a core component of making that happen.

Useem: In focusing on the consumer, you in a sense opened up a Pandora's box. Every consumer has a slightly different set of needs, and so inherently the universe becomes more complex, more diverse. How have you coped, managed, and led when you've invited greater complexity into the way you do just about everything?

McCallister: First of all, one of the faults in all of healthcare as far as I'm concerned is an attitude that everyone's the same. A lot of the solutions around health insurance and healthcare tend to be "one size fits all." I would stipulate that the consumer world is very complex, that people need and want different things. For an employer or any buyer of insurance to pretend that they know what all their people need is outrageous. I start with the underlying principle that consumers are different. They all need different things and they want different things, and it's interesting that the rest of the economy responds to that every single day.  Consumers drive everything – except in healthcare, where people try to do top‑down to these folks. I'll stipulate that it's complex, stipulate that maybe it's more difficult to meet a consumer where they are, but that's exactly what has to be done if you're going to engage consumers. If you don’t get down to their individual level and meet their needs, find what they're going to respond to, the chance that collectively they're going to change anything is zero.

Useem: Has this in any kind of material way affected the way you run your office or the way you work with your top team?

McCallister:  It’s made the company's head spin, because you have people in two different camps. You have people in the old camp of the business, those who believe we have to do better at what we've been doing. Then you have those who are ready to go down a different path and try to find a different way. The friction between the two can be significant, and generates another level of complexity in what was already a complex business.  The real trick there is to separate the good complexity from the bad complexity: get the picture that if you're going to respond to consumers and try to meet them where they are it will generate some complexity, but try to stay away from what's not important and what consumers won't pay for.

Useem: Are there other companies, or even other industries, that provided some thinking through, some guidance, or some models for what you're doing now?

McCallister: There are probably some components from a number of places. I'll give you one: Dell computer has done a nice job of managing complexity and delivering complexity people will pay for. Although they provide a lot of selections, there's less complexity there than most people would think. There are any number of consumer products and other consumer brands where they have done things you never would have dreamed of on the backs of consumers. Starbucks is a great example. Who would have thought you could have sold consumers that kind of coffee? They responded to some need that was yet unidentified.

I can probably go on and on, but I looked at technology from the standpoint of its importance. Even in 2000 it was clear that people were going to do significant transactional work over the Internet, that people were going to seek out information on the Internet and they were going to use the Internet for comparisons and for better pricing on products. That was a big piece of this. Just imagine the information flow that would be necessary in healthcare to get people engaged and empowered. It's crucial that the Internet be the core process for that., All of the Internet companies that were responding to consumers were  decent models to look at, certainly from an information-flow perspective.

Useem: If someone from another industry or another company in the same industry came to you and said, "Mike you've been through it. Are there a couple pitfalls to be avoided?" – are there lessons that you would pass on to them?

McCallister: One that comes to mind, quickly, would be that in an era of technology expansion and explosion like we have today, I think any business in any industry really has to carefully achieve a level of standardization – things necessary to fully maximize the technology uptake and productivity gains that are potentially out there. That was pretty natural in our business, because we have such high transactional work. I think you’ve got to quickly connect the process orientation with the application of technology.

Useem: On the pitfall side, is there anything that you would have done differently or would tell someone, "Watch out for this going forward?”

McCallister: If you try to make any significant changes to your business or in your industry, you better get a backbone, because critics will come out of the woodwork. Be ready to withstand a fair amount of criticism from those who believe differently.

Useem: With complexity comes a focus on a more diverse terrain that takes up more time, more energy. In getting new products to the market and new services out there, how has this increasing focus on the consumer – and all the complexity that it has brought – affected your ability to be innovative and still come up with great solutions to the problems that consumers face?

McCallister: Two big issues to me. We organized a separate innovation group because I believed it was going to take that, given the fact that we were an old company that had been around a long time,. We were going to require some separate people to be innovative because it wasn't going to come naturally elsewhere. That generates another couple of issues. One is that the innovative types aren't always caught up in what's actually doable, so a natural friction ensues. It's not just a question of what's actually doable from the standpoint of building out and delivering something, but what the market will eat, so to speak, as well as the execution of some of the innovative things that can come up. It's hard in a company that's fighting over resources to fund innovation, especially if it doesn't have short-term payback, because the people who are trying to make the trains run on time every day get a little frustrated with that burning of resources.  But you have to get committed to some level of burn to keep an innovative engine going.

Wilson: One of the impacts of product-service complexity is it can impair execution service levels. So as you go towards consumer‑driven healthcare, what are the implications for the back office for execution, and how would rate the overall industry in that regard?

McCallister: I think we in the industry allow our complexity to be the wrong kind at the wrong place. We allow our customer-employers to drive complexity as opposed to letting consumers drive it, which is the right way. Our industry has poorly controlled bad complexity relative to the historic sales model to employers. I think we're early in figuring out exactly what complexity we're going to be able to manage and put in front of consumers directly. . . . we'll have to see how that plays out. I think the complexity that we manage, tolerate and make good at the consumer level has big potential. Ongoing complexity in the back office from an old model is absolutely non‑value-added.

Useem:  Could you just identify an example or two that brings out the difference between a consumer‑driven need as opposed to an employer‑driven need? How have you worked with that difference?

McCallister: Employers are trying to satisfy the health insurance needs of lots of people in one fell swoop. That causes them to go with a “lowest common denominator” concept. In other words, what would it take to satisfy as many of these people as I can possibly satisfy? It's just that simple, and the driving force there will be, “What will it take for me as an employer to have everybody feel pretty good about working here?” Which is important, because no one wants to lose people over benefits.

On the other hand, if you go to a consumer-driven model, you're letting the individual consumer decide what their blend of risk tolerance is, what their economics are, the type of things they want from health insurance, how important different levels of benefits are for them – in the context of their overall family environment. I could have two employees standing next to each other: One just won the lottery, and the other one is barely making ends meet. As far as their relationship to me goes, they're doing the same job and making the same money. It's as simple as letting the individual decide the coverage, off of short-term versus long-term economics – the risk tolerance they have, versus an employer trying to do it on a broad basis for a lot of people.

Wilson: What is the role of management in this industry, particularly in driving innovation? What's keeping complexity at bay?

McCallister: You have startup companies that are totally innovation‑driven. That's pretty straightforward and pretty simple. We've had companies in our space that just stayed consistent with their old approaches, and that's pretty simple. The trick is when you start putting them together and managing all of the organizational implications, as well as having a reasonable focus: What are you all about as a company, and how are you going to approach the market? We've been through all those issues and difficulties and we continue to get better at it. . . . I think that management's job is to balance all those horses, keep the organization pointed in the right direction. Senior management has to be the leader relative to driving innovation, because they have to make the organization feel comfortable with it.

One of the things we've tried to develop around here is a learning organization. When we first started that process, I got reactions like, "I don't know what you're talking about – a learning organization?" And so we worked on that over the last few years and developed it. We've come a long way. I think that goes hand-in-hand with innovation. Innovation requires people to learn different things – it requires a culture built around the idea that learning is OK. I think we've come a long way there.

Useem: Looking ahead to the next couple of years, what do you see as one of the bigger challenges coming along for you, personally, either inside the company or as your own market changes?

McCallister: Well, I have a big piece of work in front of me as we speak, and it's specific to the Medicare program. We are a major player in the expansion of the Medicare program, so we have millions of new customers. Inside a highly politically charged business we have a big job to execute on the concept of consumer engagement because the Medicare program essentially operates as a retail consumer business on a scale we've never seen in our industry. We have a wonderful opportunity in front of us to take much of what we've been trying to execute relative to consumer engagement, information, the use of technology, etc., and apply it to a very large, new business. That’s very exciting. We hope to take these ideas much further down the path with this population over the next couple of years.