Do you ever daydream about what could have been?
We all make decisions every day…on both a personal and business level. No matter if they’re big or small, one thing all decisions share is they come with consequences or implications.
This reality bears a connection to the concept of the “broken window fallacy,” or the seen and the unseen.
This concept, or parable, was first promulgated by French economist Frédéric Bastiat in his 1850 essay That Which is Seen and That Which is Not Seen and later in the book Economics in One Lesson by business journalist Henry Hazlitt.
More recently, a graphic style children’s version of the broken window fallacy by economist Dr. Jonathan Newman was released to the world. My husband came across a copy that he gave our son, but after reading it and the grown-up version in Hazlitt’s book, the relevance of this basic economic concept to business decisions became clear.
As briefly as I can, the fallacy goes something like this…
On a bright, sunny day, a baker’s shop is going about its business when suddenly, a young troublemaker throws a brick through the window. As the young man runs away, onlookers gather and begin contemplating the consequences of this event.
The crowd comes to the (erroneous) conclusion that the broken window is really a positive because the glass glazier now has work. The money he earns from replacing the window will be spent with other merchants, who in turn, spend it with others, and so on.
This is the “seen.”
Now it is true that the glazier will take the money he earns from repairing the window and spend it.
But here’s the kicker…
This doesn’t consider the “unseen”, which is where Bastiat’s and Hazlitt’s insights come in.
What could have happened had the window NOT been broken?
Well, before having to repair his window, the baker was planning to buy a pair of shoes from the cobbler next door, or so says the story.
But now the baker doesn’t have the funds to buy the shoes, which represents a loss for both him and the cobbler. It’s true the cobbler would have spent the funds somewhere else.
However, absent the incident, the baker would have a new pair of shoes AND an intact window. Now he only has a repaired window.
The best comparison to this on a grand scale is a natural disaster, like a hurricane.
While it is true that people will be cleaning up and rebuilding, consider this: what vacations, new furniture or appliances, or even a casual meal out would people have bought were it not for the hurricane?
It’s a common misconception shared by a wide swath of the general public, but as Henry Hazlitt put it in Economics in One Lesson:
“No man burns down his house on the theory that the need to rebuild it will stimulate his energies.”
Both of the “what could/would have been” scenarios represent what economists call the counterfactual.
Put a little differently, the counterfactual is the next best course of action, the value of which can be called the opportunity cost.
And here’s where the story gets interesting from both a strategic and day-to-day business decision-making perspective
In a recent article, we explored the budgeting of strategic initiatives, which is one of several “filters” all ideas for initiatives should pass through. Our first budgeting article zeroed in on tangible financial costs.
The “opportunity costs,” or what the company is giving up, is one example of an intangible cost.
Resources are limited and finite, whether financial, human, or equipment…choices must be made, which according to Dr. Newman’s book, is what economics is all about.
Business decisions, be they strategic or operational, are the same way. Really, life itself is about making choices, hence my question at the beginning.
Circling back to our strategic initiative, or decisions around innovation, and even potential risk mitigations.
What often happens, particularly with strategic initiatives, is this:
An executive is dead set on pursuing their idea. In their zeal, they fail to consider the downstream implications of their idea, such as:
- What are the impacts on our people?
- Are any changes needed to our technology – systems, reporting, permissions?
- What implications are there for our customers?
- What do we need to tell, if anything, to our suppliers/vendors?
Or more simply put, they forget to ask this one simple, yet vitally important question:
Is this good for the company?
In the context of opportunity costs and our seen and unseen broken window analogy, it’s about considering what the company is giving up.
We may see the immediate benefit of moving the needle toward our goal or reducing the impact of a certain risk, but was there another initiative or course of action that would have achieved the same result with fewer resources? Maybe the other initiative would have done it in a slightly different manner, which would have cost the company less money but didn’t get the same result.
What did the company give up in exchange for this outcome?
This unseen opportunity cost can also lead to a host of unforeseen consequences on other people and processes, which of course diverts time and attention away from things that really matter to always “putting out fires.”
This article isn’t so much about something new to think about but rather a new way to think about a subject I discuss often. It’s about connecting the theory that drives ideas and applying it in real-world ways, which is exactly how I believe strategy and ERM should be discussed – practically.
This doesn’t always require a formal process, but instead just a quick pause to reflect on the implications of what’s being done.
Taking that pause goes a long way toward ensuring company efforts are not in vain, and that executives, managers, and personnel are not simply going from one crisis to the next. Instead, the company is getting the most bang for the buck for its efforts.
How would you apply the broken window fallacy to your company’s strategic planning, execution, and day-to-day functioning?
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If you or your company’s management are struggling to make risk-informed decisions and want to understand how to harness concepts like this one in an effective (and non-bureaucratic) way, just contact me to discuss your specific situation and potential paths forward!
