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Operations Knit Together Tactics and Strategy

2010/04/12

On this blog, Tom Bigda-Peyton has posted two thoughtful pieces about strategy and tactics.  See Do Tactics Generate Strategy and Do Tactics Generate Strategy Part II.  In today’s post, I’d like to highlight and explore four real-life cases where operations have connected across strategy and tactics to create unintended systemic echoes that have reduced overall success, and that will need significant attention to become sustainably successful.

[Edit note: This update added a link to the term “systemic impact” in the paragraph starting “The point here…”  A prior update deleted “debt” in the last sentence in the paragraph starting “That’s why the SEC and CFTC…” and rewrote the paragraph after that one.]

Here are the four cases in point…

  • New Healthcare bills affect details but leave the basic funding and payment operations intact.
  • New financial regulation ideas leave off the table key bank behavioral impacts only accessible by re-splitting investment and lending operations at banks.
  • New financial regulation ideas for banks and securities markets leave off the table key tools and powers at the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to provide oversight intelligence and rulemaking authority able timely to identify intentional or unintentional game-playing across different security classes and markets.
  • New financial regulation ideas for the credit business leave off the table the basic notion that financial regulatory bodies need to adjust to a consumer regulatory body, not the other way around.

Here’s the policy-making lesson to be inferred:  If you ignore the real-world operations aspect, the strategic-tactical changes to policy are stranded without traction.  They’re cosmetic.  The old ways to say this are either, “Look, ma, no hands,” or “The emperor has no clothes – hah!!”

Here’s how it works.  Follow the money.  This means also follow the daily operations of the firms and agencies that together define the daily rules, behaviors, and work of the participants in healthcare and finance.

The point here is to observe that what participants in an economic sector such as healthcare or finance do on a daily basis defines their ability to succeed over time in their environment.   The core issue for a sector participant is to generate sustainable resources to carry out its activities.  If this core issue is not captured at the operating level when changes are made to the working environment in which the participants operate, then these environmental changes cannot have sustainable systemic impact.

The working premise is that the operational context of participants in an economic sector needs to include knowing that what is done with money, including promises about money and practices related to money, is all subject to behavioral norms that have transaction oversight built into them.  Absent a sector having this operational oversight context, there is nothing to prevent the systemically improper taking of money from people who need the goods and services provided by the economic sector.

Come back to the four cases cited above.  These cases intersect at the operational level.  For example, healthcare funding operations connect with the operations enabled by banking organizational structures.  The operations role becomes the key systemic layer in the design and execution of the framework for strategy and tactics by healthcare subscription firms and major banks.

Consider the money steps involved.  In healthcare, under the new acts, the subscription firms continue to arbitrage the movement of money from demographic groups that need little care to groups that need a lot of care.  Subscription firms make money by designing demographic groups that collectively provide more net cash than is needed by the groups that are net cash users, resulting in some cash being left as revenue to the subscription firms.

Bank operations enter because the subscription firms put the monthly inbound health subscription cash into banks until the subscription firms decide case by case to fund individual units of healthcare activity by providers such as doctors, specialists, and hospitals.  So even though much money is paid out, it sits in the bank for a good while, and this operation keeps on going month after month.  It adds up.

Under the new bills, the providers continue to be paid on the volume of care, not on results achieved, so they continue to operate as cost-plus contractors who get paid for incurring allowed costs until the money runs out.  The providers also resist any real effort in the new bills to move demand for healthcare toward preventive and wellness care because there is more money at the operating level in chronic care and in acute remedial care than in less expensive preventive care.

And the banks like the healthcare subscription process that continues to operate.  Why?  The healthcare subscription process handles about 33.5 percent of the $2.3 trillion spent on healthcare in 2008 (see National Health Expend Data.pdf).  This $770 billion per year is money the banks can lend, or can invest in securities instruments.  Banks make more money on a transaction basis by taking risks in securities investments.  As a result, at the operating level banks tilt these massive bank deposits toward securities investments, not toward lending.

The laws forbidding any one institution from both taking banking deposits and investing in securities on their own account with those deposits or with funds borrowed based on them were repealed at the behest of the banks.  See the 1999 Gramm-Leach-Bliley Act which undid the provisions in the Glass-Steagall Act of 1933 that split commercial banking (taking deposits and making loans) from investment banking (putting money into securities markets).  Key advocates for the 1999 act are participants or direct mentors of the team now guiding the executive branch’s US fiscal and financial policy.

So what does all this have to do with financial and credit market regulation and the operations of those firms?  The operations fit together as follows…

Since the early 1980s, the bulk of gains in earnings by workers have gone into healthcare costs, either employer-paid or individual worker-paid (see NYTimes/ A Decade with No Income Gain).  As workers continued to buy goods and services, they began to borrow to make ends meet.  This fit nicely with the 1978 Supreme Court bankrate ruling that lets banks apply nationwide the laws of a state of domicile.  This ruling means laws in, for example, California, Delaware, South Dakota, and Tennessee, which have almost no rate limits, apply US-wide.  From an operations perspective, it’s no surprise that these are favored states for incorporating bank credit card units, resulting in US-wide rates exceeding 20 or 30 percent, plus fees.  And because bank operations since 1999 as noted above include deposits, personal loans, and securities investing, these joint cash operations force fed the bank machine.

So now you come full circle for the systemic role of operations that knit together strategy and tactics.  Healthcare subscription deposit flows, plus revenues from personal and mortgage loans made for volume not quality, plus revenues from funding derivative securities (derivatives are securities whose value depends on the market prices of designated other securities) that acted as insurance policies against declines in the value of securities built on packages of poorly regulated personal and mortgage loans, all combined to boost bank profits to some 40 percent of all US corporate profits (see The Atlantic Magazine 2009/05 The Quiet Coup).  And then it all came tumbling down as the combined operations kept pushing healthcare money and credit card cash flow into a profitable but unsustainable securities-based insurance operation that purported to guarantee packages of excessive credit card debt and bad mortgage loans.

That’s how operations can connect systemically but negatively across strategies and tactics that at each step of the way can independently look like winners.

That’s why the SEC and CFTC need the authority to require all derivatives to be listed, quoted, and traded on exchanges with transparently reported clearing and settlement operations that are subject at least to self-regulation that itself is subject to active and integrated oversight and surveillance by the SEC and CFTC.  See the SEC’s Market Oversight Surveillance System – MOSS – killed by securities exchanges and brokerage firms back in the early 1980s under SEC Chairman John S. R. Shad, former vice chairman of E F Hutton and Co.  The goal, actually achieved during large-scale beta operation of MOSS in 1981, was daily to capture trading irregularities and systemic operating imbalances across equity and options markets, rather than to react with long time lags and limited market operations information.

And the credit card sector needs regulation by an independent consumer financial protection agency (CFPA) that defines a framework for all personal credit lending and rates so that private credit operations can conform to reasonable consumer standards when extending consumer and mortgage credit.  The financial sector regulators then need to set up a framework that forbids operations at any one bank from combining deposit and loan operations with high-paying but risky securities investment operations, and that requires banks to exercise due diligence in underwriting, offering, and selling securities including derivatives related to the consumer credit and mortgage business.  The CFPA should have independent authority to define credit rules in the public interest and for the protection of consumers.  The clear example is the SEC’s operation as an independent agency under the Securities Acts.  The SEC works in the public interest and for the protection of investors with other agencies such as the Federal Reserve, but does not give them veto power over the SEC’s actions.  Similarly, bank and other financial market regulators need to track the CFPA’s framework regarding consumer financial protection matters, not vice versa.

One other item.  Operations already exist in the healthcare subscription sector so that healthcare subscription firms can be paid to administer, but not fund, the transactions between patients and providers funded by large self-insured employers.  This will allow baseline healthcare funding sources, i.e., disintermediated employers and employees in the aggregate, to focus on longer-term preventive and wellness care.  As populations become healthier, these positively structured operations will induce a cut in demand for chronic and acute care, and an increase in overall US workforce competitiveness and value (and take-home pay).  This focus on overall patient health and outcomes will reinforce healthcare payment operations that are not based on payments for each step in a course of care addressing the life of the patient.

This discussion brought to light the key role of operations in assembling strategy and tactics.  The cases across healthcare and finance aimed at achieving and sustaining everyday personal health, as well as at achieving sustainable financial health.  Through their connected operations, both kinds of health either can pull down together, or can pull up together.  It’s unhealthy for framework operations to pull in opposite directions, and based on recent US experience with pulling down together, pulling up together looks preferable.

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