The Blue Line Imperative

The Blue Line Imperative:
What Managing for Value Really Means

Kevin Kaiser, S. David Young

What it’s about

Written by myself and my INSEAD colleague and friend, David Young, this book describes our interpretation of the principles of finance and how those principles are an embodiment of the principles of physics. The essential premise is that all life forms require energy to continue to be a life form, and, because energy is in finite supply in the universe (subject to clarification as we improve our understanding of the universe and its ‘laws’), then life forms were imbued from the earliest days with an ‘awareness’ of this scarcity of energy and thus an ‘awareness’ and a ‘behavioral imperative’ to adjust behavior according to the opportunity cost of this energy. Moreover, as the life form which occupies this planet has evolved from its beginnings approximately 4 billion years ago to the present, it has ‘passed along’ this ‘awareness’ to all of its components (each and every individual self-replicating cell possessing the ‘code of life’, along with, perhaps, those with the code but lacking the capability of self-replication). In our interpretation, while there are many components of this one life form (such as a liver cell in your liver, or a skin cell on a whale, or a leaf on a carrot plant, or a bacteria floating on the ocean, each and everyone of those is a descendant of, and a component of, the one global life form. With this understanding, any investment of energy is viewed relative to the portfolio ‘owned’ by this global life form, and thus the opportunity cost of any investment is assessed from the perspective of the other opportunities available to this global life form, rather than the other opportunities available to whichever individual component appears to be deploying the energy. In other words, to understand whether the use of energy by a liver cell, or a human, or a company, is value creating, we must ask from the perspective of the global life form rather than from the perspective of the individual entity. Essentially, this is a way of saying that the global life form can select which components (which cells, complex organisms, or corporations) get to have access to energy, in the same way that the human body will make a similar determination if it finds itself submerged in freezing water and needs to determine to which components of the human body it will allocate its scarce energy as it tries to buy time for rescue from the frigid conditions.

With this understanding, interpretation, and perspective, we then connect to the principles of finance which posit that the required return on any investment must be assessed based on the riskiness of the investment project relative to the fully diversified portfolio. In this theory, the fully diversified portfolio is a theoretical portfolio which contains all productive assets on the planet (or off of it, but accessible to the life form on the planet). It seems to us that this perspective matches remarkably well to that of seeing all life as components of a single, global life form. And thus, we consider this required return on any given investment to be simply a reflection of the physical reality faced by the life form which is ‘aware’ that energy is scarce and each allocation must be considered in relation to all other opportunities available to this global life form. This is precisely what the estimates used in modern finance are trying to capture.

With that in mind, it isn’t a surprise to learn that each human, or any other individual component of this global life form, has an instinctive awareness of this required return and thus has an automatic, instinctive ‘sense’ of whether any investment is ‘good enough’, a.k.a., value creating from the perspective of nature, or not. It also explains why humans are quick and visceral in their reaction to deviations from this required return - interpreting returns which are well above the required return (for the given riskiness of the project) as being evidence of expropriation, theft and/or some other form of 'deception’, and interpreting returns which are well below this required return as evidence of exploitation and abuse. As we posit, humans (and dogs, and other animals which appear to have a sense of ‘right and wrong’) use the word ‘fairness’ (in the English language, or its counterpart in other languages), to refer to allocations of energy and resources which don’t violate this evolutionary principle, and unfairness as those allocations which appear to violate it. When they see evidence of unfairness, this leads to a loss of trust in the system (processes or leadership or other elements of the system) behind the allocation of energy that the allocation is consistent with the health and well-being of the organization (or organism). As a result of this loss of trust, they will perceive the organization (or organism) as doomed and will stop contributing to its ongoing existence (by being engaged, innovative and enthusiastic in supporting its ongoing practices) and will simply show up to receive a paycheck and will wait to be told what to do. As a result of this behavior, all learning will slow down, and eventually stop, and the organization will become an non-learning, non-innovative, value destroying entity sliding towards its demise.

Based on this, we describe a value creating organization as one in which people perceive fairness to be present (meaning they perceive value creation to be the norm in the organization which they interpret as evidence that the organization is honoring the laws of nature which require resources are allocated to those projects whose returns are at least equal to, or above, the opportunity cost of capital as assessed from the fully diversified portfolio’s perspective, such that the global life form will tolerate the organization’s ongoing existence), and therefore they trust the leadership and processes behind the allocations of energy, and thus they maintain their engagement and willingness to support and contribute to the ongoing entity through problem-solving and engagement. As a result, we propose that the pillars of a value creating organization are (1) Fairness, (2) Trust, and (3) Learning.

Why I like it

I like it because it represents my best effort, driven and supported by David, to put to words and publish my understanding and interpretation of the principles of finance and the imperative of value creation as it connects to the existence of the organism in an evolutionary world in which the laws of phsyics, and the scarcity of energy, must be taken into account.