The current
economic crisis indicates that
conventional risk assessment, rating and management techniques don’t perform
well in a turbulent and global environment. AAA-rated companies and banks have
suddenly failed, demonstrating the limitations of not only risk management
techniques but also the need to re-think the expensive and sophisticated
Business Intelligence and Corporate Performance Management infrastructure that
modern corporations have relied on. But what are the origins of the financial
meltdown that is spilling over into the real economy? Why is the economy
increasingly fragile? We identify three main causes: excessively complex
financial products, globalized financial markets that lack regulations and
usage of subjective computational models that are naturally limited to less
turbulent scenarios.
Models are only Models. No matter how
sophisticated, a model is always based on a series of assumptions. More
sophistication means more assumptions. Classical risk evaluation models,
because of their subjective nature, are inherently unable to capture the
unexpected and pathological events that have punctuated human history, not to
mention the economy. But there is more. Conventional Business Intelligence is
unable to cope with the hidden complexity of a modern global corporation
precisely because it thrives on unrealistic mathematical models. Once defined,
a model is condemned to deliver only what has been hard-wired into its
formulation. However, a difficulty in analysing our
inherently turbulent economy and, more specifically, financial instabilities,
lies in the fact that most of the crises manifest themselves in a seemingly
unique manner. Life very rarely follows a
Gaussian distribution and the future is constantly under construction.
Excessively
complex financial products have spread hidden risks
to every corner of the globe. Their degree of intricacy is such that they are
often beyond the control of those who have created them. Derivatives of
derivatives of derivatives …. The speculative use of such products creates an
explosive mixture. Because of the global nature of our economy, and due to its
spectacular degree of interconnectedness, such products are an ideal vehicle
for creating and transmitting uncertainty.
Uncertain and
global economy. It is because of the laws
of physics that our economy is increasingly uncertain, unstable and
interconnected. This means that it is becoming increasingly complex and
turbulent. Conventional methods that rely on mathematical models are unable to capture
and embrace this complexity, not to mention predict crises. The increase of complexity
is inevitable and globalization is an inevitable consequence of the growth of
complexity.
Complexity is
a fundamental property of every dynamical system.
Like many things, it can be managed provided it can be measured. As for most
things in life, when managed, complexity becomes an asset. When ignored, it
becomes a liability, a time bomb. Because of the laws of physics, the
spontaneous increase of complexity in all spheres of social life is inevitable.
Like for most things in life, every system possesses its own maximum level of
sustainable complexity. Close to this limit, known as critical complexity, it
becomes fragile, hence vulnerable. This is the fundamental reason why each
corporation should know its value of complexity, as well as the corresponding
critical value.
Complexity
can be measured. Ontonix is the first
company to have developed and marketed a radically innovative and unique
technology for rational quantification and management of complexity. Introduced
in 2005, OntoSpace™, our flagship product, is the World’s first complexity
management system. While others struggle with definitions of complexity, we
have been measuring the complexity of banks, corporations, financial products,
mergers, or crises already since 2005. Our complexity measure is objective. It
is natural. No fancy mathematics, statistics or exotic models. A 100%
model-free approach guarantees an objective look at a corporation.
Hidden and
growing complexity is the main enemy of a
corporation. A corporation may still be profitable but close to default. Highly
complex systems are difficult to manage and may suddenly collapse. Excessive
complexity is the true source of risk.
Critically complex systems become almost impossible to manage, hence are
vulnerable and greatly exposed to both internal and external sources of
uncertainty.
Complexity X
Uncertainty = Fragility™. This simple yet
fundamental equation has been coined by Ontonix and establishes the philosophy
and logic behind our technology and services offering. The bottom line is
simple: a complex business process, operating in an uncertain environment, is a
fragile mix. Since the uncertainty of the global economy cannot be easily
altered, in order to operate at acceptable levels of fragility one must
necessarily reduce the complexity of the corresponding business model. Based on
this logic Complexity Management goes beyond Risk Management and establishes a
new underlying paradigm for a superior and holistic form of Business
Intelligence. A technology of the Third Millennium.
Conventional techniques provide
insufficient to insure
against all future contingencies.
There are numerous recent examples of AAA-rated corporations that have
suddenly defaulted or are in serious difficulty. The collapse of the Lehman Brothers
Bank is a prominent case. Based on the
financial highlights of the bank in the period 2004-2008, our analysis has
indicated how a quickly increasing complexity provided crisis precursors, hinting more than
a year before default that the system was in difficulty.
Evidently, the management was unaware that complexity was sky-rocketing as it
is invisible to conventional methods.
The bottom line: manage complexity.
