AIG And Outsourcing Portfolio Strategy

The government bailout recipient AIG recently dismissed McKinsey, management consultants who were undertaking work called ‘Project Destiny’ to layout a roadmap for the business. Some details are here. The rationale was apparently to take the work in house in order to reduce costs.

It raises some interesting questions about to what extent strategy can be outsourced, and whether the cost of this outsouring outweigh the benefits. In this case, internal politics may also be at play as the new CEO looks to impose his own agenda.

An interesting principle behind this is the cost of information. For example, if I stood to win $5 on a coin flip, and had to call heads or tails. Then the expected value of that wager to me is $2.50 ([$5 x 50%] + [$0 x 50%]). But if I had a way of knowing exactly what the outcome of the coin flip would be with certainty I would be willing to pay up to an incremental $2.49 for that information (if accurate) because I would be certain to get $5, rather than the expected value of $2.50 if I had no knowledge on whether it would be heads or tails.

This is to some extent the situation AIG is in, they have tremendous uncertainty around their business, it is not clear how the value of their assets and liabilities might change over time.  Their market cap has been fluctating in approximately $1-5B range so far this year, suggesting the market isn’t sure either. How much should AIG pay to improve their knowledge? That question is itself a large consulting project.

They have clearly decided that the incremental gain from the information McKinsey could provide is too great. In reality, cashflow issues might have impeded, what could have been an otherwise financially desirable decision.

Topics such as portfolio outsourcing as discussed in more detail in my book on Strategic Project Portfolio Management.

5 responses to “AIG And Outsourcing Portfolio Strategy

  1. Would you not pay up to $4.99 for the information if you stand to win $5?

    • Think about how well you’d do without any information. In that case you have a 50% shot at making $5, so that’s worth $2.50 to you on an expected value basis. Since you have that already, any new information you receive must put you in a better position than that $2.50 outcome you get for free, with no information. That’s why the value of knowing the outcome with certainty is up to $2.49 ($4.99-$2.50).

  2. On a one-time game you still might be willing to pay up to $4.99 because you might value a certain $0.01 more than a 50% chance of $5. I did however originally miss the nuance about the incremental value, so fair enough I’ll concede that on this blog post your mathematics skills are superior. Your position is a little less secure on the punctuation and spelling in the first line though :o)

  3. You’re right I’m assuming people are risk neutral, which makes the numbers easier, but likely doesn’t hold in reality. That’s for pointing out the typos, I’ve corrected those.

  4. We shouldn’t go too far with the analogy here. I think the main point here is about strategic control. If there is a new CEO in town, and there is, then that guy was not brought in to either toss coins or keep the lights on. He was brought into get ahold of the critical information and then to place a new set of informed bets. An in this case, by bet I mean investments. They are not the same thing.

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