How Are You Optimizing?

One of the more popular blog posts on this blog this year was an essay I wrote in March, the title of which was Maximizing Soul. The essay was a lament of sorts about how obsessed we as a society have become about measuring every last thing that we do, and how we have become all about efficiency.

We have become a society of optimization through minimization. We’ve become very good at extracting the very last bit of juice out of a lemon.

That essay was more about society and culture than it was about the economy directly. But more recently, Gulzar Natarajan wrote a blog post making what I take to be more or less the same point, but in the case of the global economy:

The Covid 19 pandemic has underscored the perils with efficiency maximisation at all costs and the importance of resilience. The excessive concentration of manufacturing, especially of critical Pharma products, in China and the supply chain disruptions have provided the most salient reminders. This post discusses the problems of pursuing efficiency at all costs and to the exclusion of all else in case of global manufacturing supply chains.

The title I wanted for today’s blogpost was a bit of a mouthful: “How are you optimizing for whatever it is that you are optimizing for?” I went, instead, with what you see above. But the question I wanted to ask was the one you see in this paragraph.

Say you want to maximize profits (and who wouldn’t, eh?). Three ways you can do this: maximize revenue, minimize cost, or attempt to do both. And Gulzar Natarajan’s point in his blogpost is that the global economy has focused perhaps a wee bit too much on the cost minimization bit – and that we have, in the process, gone a bit too far.

Thanks to business schools and management gurus, it had become articles of faith that businesses should outsource, focus on comparative advantage, specialise functionally, concentrate suppliers and production facilities, minimise inventories, tighten supply chains, contract labour services, minimise tax payout through tax avoidance, and so on. For sure, when done in proportion, all of them have merits and are desirable. But when taken beyond reasonable proportions, they generate distortions.
A common underlying factor behind all these concepts is efficiency. Conventional wisdom has it that their pursuit leads to greater efficiency in some form or other (mainly cost reduction), all of which generally lead to greater profitability, the primary objective of businesses. Therefore efficiency maximisation by pursuing these concepts to their extremes becomes an innate and inexorable dynamic of the market. It does not help that globalisation and advances in information and communications technology and transportation end up furthering these trends. (Emphasis added)

In effect, is blog post is making the point that cost minimization was done at the cost of ignoring the building up of risk:

Businesses and consumers doubtless benefited from these trends. It led to cost reductions which got distributed between higher profits (for businesses) and lower prices (for consumers). A virtuous cycle of consumption, production, and trade led to expansion of aggregate output.
Then the pandemic struck. Lockdowns and quarantines ensued. Supply chains were disrupted. Outsourced suppliers and producers were cut-off or failed to keep their commitments. The lack of diversification at country and company levels among suppliers and producers became painfully evident. Businesses realised that their pursuit of efficiency maximisation and cost reduction had gone too far. (Emphasis added.)

My essay, written in March, tried to argue for maximizing profit by increasing revenue (so to speak), rather than by only minimizing costs. Gulzar Natarajan’s essay, I think, makes a complementary point. If one focuses on minimizing cost by ignoring everything else, there is another problem, that of increasing risks by increasing dependencies on a very small set of ultra-efficient supply chains.

The story in 2022 (and beyond) is going to be one of building more resilient systems. The opportunity cost of this strategy is that these new systems may not be as hyper efficient as the ones that existed pre-covid.

And that Gulzar Natarajan seems to say, is just fine by him.

And I completely agree.

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