Creative Destruction

Source Articles: McKinsey Quarterly
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SUMMARY:

The first Standard and Poor’s index of 90 major US companies was created in the 1920s. The companies on that original list stayed there for an average of 65 years. By 1998, the average anticipated tenure of a company on the expanded S&P 500 was 10 years. If history is a guide, over the next quarter century no more than a third of today’s major corporations will survive in an economically important way.

When corporate culture kills
How can corporations make themselves more like the market? The general prescription is to increase the rate of creative destruction to the level of the market itself, without losing control of present operations. As sensible as this recommendation is, it has proved difficult to implement.

Cultural lock-in
Cultural lock-in is the last in a series of “emotional” phases in a corporation’s life, a series that mirrors, remarkably, that of human beings. In the early years of a corporation, just after its founding, the dominant emotion is passion-the sheer energy to make things happen. When passion rules, information and analysis are ignored in the name of vision: “We know the right answer; we do not need analysis.”

The causes of cultural lock-in
Why does cultural lock-in occur? The heart of the problem is the formation of hidden sets of rules, or mental models, that once formed are extremely difficult to change. Mental models are the core concepts of the corporation, the beliefs and assumptions, the cause-and-effect relationships, the guidelines for interpreting language and signals, the stories repeated within the corporate walls. Charlie Munger, a longtime friend of and co-investor with Warren Buffett and vice chairman of Berkshire Hathaway, calls mental models the “theoretical frameworks that help investors better understand the world.”

How the markets enable change
Markets, on the other hand, lacking culture, leadership, and emotion, do not experience the bursts of desperation, depression, denial, and hope that corporations face. The market has no lingering memories or remorse. It has no mental models. The market does not fear cannibalization, customer channel conflict, or dilution. It simply waits for the forces at play to work out-for new companies to be created and for acquisitions to clear the field.

Redesigning the corporation for discontinuity
The right of any corporation to exist is not perpetual but has to be continuously earned.
-Robert Simons

The market has pointed the way to a solution. In response to the tension that builds between the potential for improved performance and the actual performance of large businesses in an era of increasingly fast economic change, there are certain kinds of firms-particularly private equity firms-that have demonstrated the ability to change at the pace and scale of the market, and they have earned sustained superior returns for doing so. The two kinds of private equity firms-principal investing firms and venture capitalists-are quite different from each other, but each looks somewhat like the holding companies of the late 19th century. It is possible to imagine that private equity firms will form the seeds of the industrial giants of the 21st century.

The road ahead
Long-term corporate performance has not matched the performance of the markets, because corporations do not adapt as fast as the markets do. This is due to the way corporations evolve, not because of the way they accomplish their day-to-day work. For historical reasons, as we have discussed above, corporations have been designed to operate-to produce goods and services-rather than to evolve. In order to evolve at the pace of the markets, they have to get better at creation and destruction-the two key elements of evolution that are missing.

The point is to let the market control wherever possible. Be suspicious of control mechanisms if they stifle more than they control. Let those who run a business determine the best mix of controls for their business (they know the system best), and shift the burden of integration to the corporate level rather than designing uniform systems that have to be implemented, throughout a corporation, independent of the business. When such changes are implemented, the focus of the corporation will shift from minimizing risk, and thereby inadvertently stifling creativity, to facilitating creativity-and that is what is needed to strengthen long-term performance.

2. Making the most of uncertainty

SUMMARY:

In extremely uncertain environments, shaping strategies may deliver higher returns, with lower risk, than they do in less uncertain times.

Shape or adapt? For years, executives have regarded the question as perhaps their most fundamental strategic choice. Is it better for a company’s competitive position to try to influence, or even determine, the outcome of crucial and currently uncertain elements of an industry’s structure and conduct? Or is the wiser course to scope out defensible positions within an industry’s existing structure and then to move with speed and agility to recognize and capture new opportunities when the market changes?

The different shapes of shapers and adapters
An essential starting point is understanding your alternatives. Shaping and adapting strategies may take many different forms. Shapers generally attempt to get ahead of uncertainty by driving industry change their way. Some, like Qualcomm, aim to increase the probability that a preferred technology or business process will become an industry standard. Others grapple with uncertainty by introducing fundamental product, service, or business-system innovations intended to redefine the basis of competition in an industry: think of the low-price, point-to-point air travel model of Southwest Airlines, Dell Computer’s direct-sales approach, or Netscape Communications’ breakthrough Internet browser, Navigator.

Understanding uncertainty
Whether a company should attempt to shape or adapt depends largely on the level and nature of the uncertainty it faces. To put things simply, when it faces very high levels of uncertainty about variables it can influence, shaping makes most sense. Adapting is preferable when key sources of value creation are relatively stable or outside the company’s control.

Tailoring choices to the four levels of uncertainty
As a rule of thumb for making decisions, then, shaping makes the most sense when uncertainty is high and can be influenced by a company’s actions. To fine-tune this approach, a company must consider ways of varying how it thinks about shaping versus adapting-depending on the nature of the uncertainty it faces. Uncertainty always takes one of four general forms. Understanding which form you face is crucial when you decide whether to shape or adapt.

Other factors
As executives face their shape-or-adapt choices, they must weigh factors beyond the level of residual uncertainty-factors such as the external market environment and the company’s capabilities and aspirations. Shaping strategies, for example, make most sense in markets that offer strong first-mover advantages. One market that may not offer them is Internet-based commerce, which by its very nature invites comparison shopping, thus perhaps undermining one of the most important potential first-mover advantages: brand and customer loyalty. As a result, it isn’t clear yet whether e-commerce shapers such as Amazon.com and eBay have established any sustainable first-mover advantages. Being an e-commerce adapter-replicating good ideas and avoiding bad ones-may offer returns similar to those won by pioneering shapers, without all the risk. Only time will tell.