Mortality is an often overlooked fact of corporate life. But what are the warning signs? Gary Hamel examines why good companies hit the buffers.
I grew up in Michigan, so the bankruptcy filing of General Motors strikes close to home. There was a time when GM made more than half the cars sold in the United States. But now, what was for decades the world’s largest industrial company, is a ward of the state. GM’s failure isn’t the result of one spectacularly ill-conceived decision – the company didn’t jump off a cliff. Instead, it meandered into mediocrity, one small short-sighted step at a time. Like a two-pack a day smoker, GM committed suicide in degrees.
Dodgy quality, a toxic labour environment, incoherent brand identities, clunky power-trains, adversarial supplier relations, and subterranean resale values – these were the chronic symptoms of a management model that regarded profits as the game rather than the scoreboard, that valued financial finagling over inspired engineering, and elevated MBA-types to rule over car guys.
A scant eight months ago, GM’s then-chairman, Rick Wagoner boasted that his company was “ready to lead for 100 years to come” – a comment that could only have been made by someone who was either naively optimistic or hopelessly delusional.
Ever since I can remember, GM’s defenders have been arguing that the company was making progress; and they were right. GM has been getting better for a very long time – but it’s been forty years since it was the best. The Chevrolet Malibu and Corvette ZR1, the Buick Enclave and Cadillac CTS-V are exceptional cars by anyone’s standards. Problem is, they are even more exceptional when judged against the persistent ordinariness of GM’s other products. For years, excellence at GM has been an aberration, rather than an all-consuming passion.
Coast-to-coast
A company can coast for a long time when it starts with a dominant share of an enormous and hard-to-penetrate market in the world’s largest economy – but given enough time, and enough incrementally myopic decisions, it will eventually run out of momentum.
GM is not the only company that’s sputtering right now. Motorola, Citi, Nascar, Starbucks, Sony, United Airlines, EMI, Kodak, Alitalia, Sprint Nextel, the New York Times, Unilever, AOL, and Chrysler – these are just a few of the businesses that seem to have lost their mojo. Truth is, every organisation is successful until it’s not – and today, there are a lot that are not.
How does this happen? How do yesterday’s icons become today’s also-rans? How does excellence degrade? What are the causes of corporate dysphoria? These are important questions. When an organisation stumbles badly everyone loses: shareholders, employees and customers. Through the years, I’ve seen a lot of companies lose their way. Here’s how it happens.
First, gravity wins. There are three physical laws that tend to flatten the arc of success. The first is the law of large numbers. We all know that it’s a lot harder to grow a big company than a small one. To grow a $40 billion company by 25 per cent requires the creation of ten new billion-dollar businesses. To grow a $40 million company by the same percentage requires only one new $10 million business. In business as in biology, big things grow slower.
Then there’s the law of averages. No company can outperform the mean indefinitely. During the last five years of Jack Welch’s tenure at GE, the company’s market value grew from just under $140 billion to more than $400 billion. To maintain that torrid pace, Jeff Immelt, who took over from Welch in September 2001, would have had to grow GE’s value to more than $1.2 trillion dollars by mid-2006 – and that was never going to happen. As you lengthen the relevant timeframe from one year to five and then to ten, the probability of out-performing the average rapidly approaches zero. In the long-run there are no growth companies.
Lastly, there’s the law of diminishing returns. The pay-off to any programme
focused on revenue growth or margin enhancement tends to shrink over time. Top
line growth slows as markets mature, and productivity growth slows as the knife
scrapes closer to the bone. Over time, it takes more and more effort to produce
less and less in the way of incremental returns. While these three laws aren’t
as unyielding as gravity, they’re tough to overcome – and few companies manage
it.
Second, strategies die. Like human beings,
strategies start to die the moment they’re born. While death can be delayed, it
can’t be avoided. Autopsies reveal three primary causes of death.
Clever strategies get replicated. Hewlett Packard ultimately learned how to make computers as cheaply as Dell. JetBlue took a chapter out of Southwest Airline’s playbook. Cialis and Levitra intruded on Viagra’s turf. And Facebook built on the social networking model pioneered by MySpace. While some strategies are harder to imitate than others (particularly those that yield network effects), most can be decoded by dedicated rivals.
Venerable strategies get supplanted. Digital cameras made film obsolete. Downloadable music deflated the market for CDs. Skype allowed its users to sidestep expensive tariffs. And online news aggregators hollowed out newspaper profits. Sometimes newcomers improve on an existing strategy, but occasionally they shoot it out of the sky.
Profitable strategies get eviscerated. The Internet has produced a dramatic shift in bargaining power – from producers to consumers. Armed with near perfect information, customers are able to batter down prices on just about everything. For many companies, well-informed customers are now a bigger threat to margins than well-armed competitors.
In life, death can come as a shock. In business, it never should. With the right metrics, strategy decay is largely predictable, though few companies bother to track it. And while a doddering granddad can’t abandon his decrepit body for a young and vital one, a company can – at least in theory. Companies die when they can’t escape the grasp of a dying strategy.
Third, change happens. Think of the number of things that have been changing at an exponential pace: the number of genes sequenced, the number of devices connected to the Internet, the number of mobile phones in the world, CO2 emissions, the amount of bandwidth available globally, and the production of knowledge itself. In the past, there were many things that protected incumbents from the gale-force winds of creative destruction, including regulatory barriers, technology hurdles, distribution monopolies, and capital constraints. But in most industries these bulwarks have been crumbling. Discontinuities undermine old business models and create opportunities for newcomers. So not only do strategies die, they die quicker than they used to – and that’s a fact. Over the past few decades, product- and technology-based advantages have become more fleeting. (This point is elaborated in Richard D’Aveni’s work on hypercompetition.)
At the same time, the correlation between current and future earnings performance has become progressively weaker. Using more than three decades of data, my MLab colleagues calculated the year-to-year correlation in earnings performance (using a moving seven-year band) for every company in the S&P 500. Over a thirty-two year span, the average correlation in annual earnings dropped from 75 to 46 per cent.
Fact is, most businesses were never built to change – they were built to do one thing exceedingly well and highly efficiently – forever. That’s why entire industries can get caught out by change – industries like big pharma, publishing, recorded music, and the major US airlines.
In a world where change is shaken rather than stirred, the only way a company can renew its lease on success is by reinventing itself root and branch, before it has to – a feat that even the smartest companies have trouble pulling off.
Fourth, success corrupts. The seeds of failure are usually sown at the heights of greatness – that’s why success is so often a self-correcting phenomenon. The dynamics work like this:
Once a company becomes an industry leader, its employees, from top to bottom, start thinking defensively. Suddenly, people feel they have more to lose from challenging the status quo than upending it. As a result, one-time revolutionaries turn into reactionaries. Proof of this about face comes when senior executives troop off to Washington or Brussels to lobby against changes that would make life easier for the new up and comers.
Years of continuous improvement produce an ultra-efficient business system – one that’s highly optimized, and also highly inflexible. Successful businesses are usually really good at doing one thing, and pretty much cr@p at everything else. Over-specialization kills adaptability – but this is a tough trap to avoid, since the defenders of the status quo will always argue that eking out another increment of efficiency is a safer bet than striking out in a new direction.
Long-tenured executives develop a deep base of industry experience and find it hard to question cherished beliefs. In successful companies, managers usually have a fine-grained view of “how the industry works,” and tend to discount data that would challenge their assumptions. Over time, mental models become hard-wired – a fact that makes industry stalwarts vulnerable to new rules. This risk is magnified when senior executives dominate internal conversations about future strategy and direction.
With success comes bulk – more employees, more cash, and more market power. Trouble is, a resource advantage tends to make executives intellectually lazy – they start believing that success comes from outspending one’s rivals rather than from out thinking them. In practice, superior resources seldom defeat a superior strategy. So when resources start substituting for creativity, it’s time to short the shares.
Finally, success breeds arrogance. Caretaker executives who’ve never been entrepreneurs and have never built something out of nothing, are prone to view success as an entitlement, rather than the result of innovation, gut-wrenching decisions, and perseverance. Isolated from the bleeding edge of change by subservient minions, they start believing their own speeches. Unlike Andy Grove, Intel’s former CEO, they aren’t perpetually paranoid. Instead, they’re naively confident, and therefore prone to under-estimate threats and discount new competitors.
Back to the car business. Many years ago I had the opportunity to sit in on a meeting between W. Edwards Deming, the revered quality guru, and a group of US auto executives. Already in his 80s, Deming supported himself on a podium while he unleashed a stinging attack on what he saw as Detroit’s septic management practices. Deming argued that contrary to the prevailing views in Detroit,Toyota and Honda weren’t gaining ground because they were state-sponsored and disinterested in profits. Rather, their success was the product of a single-minded devotion to product quality and a well-trained and highly motivated workforce. At the end of the censorious lecture, a timid manager raised his hand. When, he wondered, would his company catch Toyota? Deming grunted with distain, lowered his chain, and shot back, “What, you think they’re standing still? You may never catch up.” His point: In a world filled with hungry new competitors, leadership, once lost, might never be regained. Dr. Deming died in 1993. In the years since, the penalties that must be paid for denial, nostalgia and arrogance have climbed ever higher – a fact that GM’s managers, employees and shareholders have learned to their sorrow.