Corporate Disease and Darwinism

Stephen DeAngelis

October 14, 2011

Entrepreneur and venture capitalist Luke Johnson believes that large corporations, despite having a favorable business landscape, fail to capitalize on the advantages they have been given. “They have virtually all the assets – money, brands, intellectual property, facilities, momentum,” he writes, “yet their natural dominance is frequently overturned by upstarts.” [“The biggest groups are ill with inefficiency,” Financial Times, 5 April 2011] Johnson insists that “emerging companies, with minimal resources, can defeat huge, established players” because “big corporates fall prey to a number of diseases.” Although I might have chosen a different metaphor than disease, Johnson uses it because his column is about “the pathology” of the ills he sees. He begins his diagnoses of the top ten diseases he sees with continuing support of bad ideas:

“Sunk cost fallacy: the idea that you should throw good money after bad. I have witnessed boards that continued to waste money on doomed projects because no one was prepared to admit they were failures, take the blame and switch course. Smaller outfits are more willing to admit mistakes and dump bad ideas.”

I certainly agree with Johnson about his first diagnosis. To read more about this topic, see my post entitled Killing Ideas as Part of the Innovation Process. In that post, I noted that “Isabelle Royer believes that organizations “need to recognize the role of ‘exit champions’: [individuals] with the temperament and credibility to question the prevailing belief, demand hard data on the viability of the project, and, if necessary, forcefully make the case that it should be killed.” She also recommends that companies be on the lookout for cheerleading squads that continue to support bad ideas as well as recommending that companies establish an early warning system that alerts them that a program is likely to fail. Johnson moves on to his second disease:

“Groupthink: a condition whereby an error is perpetuated thanks to peer pressure, so it becomes orthodoxy. The belief that subprime mortgages were a sound investment was a classic. Virtually the entire finance industry fell for this myth, thanks to the perpetuation of false assumptions, and an unwillingness to break ranks and question the ‘experts’.”

One of the reasons that I favor “what if” exercises is that one of the basic techniques used in them is questioning assumptions. I also favor involving participants from a number of disciplines because they are less likely to fall victim to groupthink than more homogeneous groups. Individuals involved in supply chain risk management processes that utilize “what if” exercises need to ensure that groupthink doesn’t undermine their efforts. Johnson’s third disease involves corporate governance:

“An obsession with governance: increasingly, institutions favor compliance over competence, and box-ticking over practical solutions. I resigned from the board of a Nasdaq-traded corporation because – thanks to Sarbanes-Oxley – the audit committee meetings lasted longer than the actual board meetings.”

Although I sympathize with Johnson, companies know that failing to comply with government regulations can be very costly. I’m not so sure that this is an internal corporate disease as much as a government imposed one. Corporate compliance issues, whether imposed by governments or customers, are not going to go away. That is why Enterra focused its first supply chain optimization solution on dealing with retailer compliance. Johnson continues:

“Institutional capture: the phenomenon whereby management end up running an enterprise for their own benefit, rather than for the real owners. This is also known as the principal/agent problem, and is epitomized by behavior at banks. There, senior executives still think they are entitled to millions of dollars remuneration for an average job. In reality those executives are easily replaceable, while the value and market shares of their banks have actually been built up over decades by many others.”

A form of institutional capture, a side effect of sorts, is that workers have not shared in the benefits of increased productivity (at least in the U.S.) for the past several decades. Even though productivity has risen, in real terms wages have not. This has undoubtedly contributed to the depth of the current recession. Johnson’s fifth “disease” involves in-house politics:

“Office politics: self-destructive infighting for power within large businesses is endemic, and perhaps the biggest value destroyer of all. A brilliant New York Times article last year by an ex-Microsoft executive revealed how the world’s largest software business had a viable tablet PC 10 years ago, which could have pre-empted the smash hit iPad from Apple. But other Microsoft divisions conspired to kill the project because they did not want resources being diverted away from their own imperial ambitions.”

I would have called this disease “corporate silos.” I have written a number of posts about how corporate silos create inefficiencies and prevent companies from achieving all that they could. Read, for example, my post entitled The Curse of Silo Thinking. You can also read more about the New York Times’ article mentioned by Johnson in the post mentioned above [Killing Ideas as Part of the Innovation Process]. Johnson continues:

“Lack of proprietorship: when employees have no effective capital stake in an organization, they tend to be less cost-conscious, and take a more cavalier attitude to waste, personal expenses and the like.”

This undoubtedly ties in what I wrote above about institutional capture. Lack of proprietorship can lead to lack of loyalty. Good employees are the heart and soul of every business — something we tend to forget in tough times when unemployment remains high. Johnson’s seventh illness involves risk aversion:

“Risk aversion: in most large corporates, the punishment for management failure is greater than the rewards for success. So, rational individuals pursue cautious strategies because they do not want to damage their career prospects. Entrepreneurs often have nothing to lose, and hence are more willing to take the plunge with innovations. Thus a solitary inventor such as James Dyson can beat the rich market leader Hoover because it saw only danger in new technology, while he saw a better vacuum cleaner.”

Washington Post op-ed columnist Robert J. Samuelson writes, “It is becoming clear that the Great Recession has left a deep and possibly lasting scar on the American psyche. From CEOs to ordinary families, we are a nation that is more cautious, more fearful and more risk-averse. This widespread and – so far – indestructible anxiety has hobbled the recovery and helps explain the slow pace of job creation. The economy’s revival depends in part on risk-taking, but risk-taking is in eclipse.” [“How our allergy to risk is hurting the economic recovery,” 13 December 2010] Obviously, Johnson and Samuelson see eye-to-eye on this point. Johnson continues his business illness pathology:

“The burden of history: many older companies have legacy issues such as pension scheme deficits, union contracts, inefficient equipment and so on. By contrast, newcomers can outsource and use the latest technology.”

Frankly, other than declaring bankruptcy and throwing out the past, shedding the burden of history is not easy. Neither management nor labor can stake any moral high ground when it comes this particular subject. I would like to think that companies and unions have learned from past mistakes, but I see little or no evidence of such learning. Johnson next turns his attention to employees:

“Anonymous mediocrities: there is nowhere to hide in a small company – if you can’t deliver, you’re out. But in a large outfit, also-rans can get away with poor work for years.”

Not every employee is going to be a superstar, but all employees should be competent. Johnson is correct that incompetence is easier to spot in small firms. But if middle management is doing their job in large corporations, incompetence shouldn’t be any more difficult to spot than it is in smaller organizations. Johnson’s final topic is about products.

“Commodity products: large companies need large markets, which tend to be mature, more competitive and lower margin. Small firms are happy to sell niche merchandise, where returns are often higher.”

I don’t really see this as an illness. It’s more a fact of life. Surely Johnson isn’t recommending that large corporations break up so that they can sell to niche markets. The best big companies counter this “disease” by segmenting their supply chains; a practice recommended by Gartner. For more on this topic read my post entitled Overcoming the Hype: Making Your Supply Chain a Strategic Weapon. Johnson concludes:

“The deck is stacked in favor of bigness. But, just as the lumbering dinosaurs could not adapt and became extinct, so giant businesses are likely to be less flexible, motivated and focused. The truth is that there are many intangible diseconomies of scale, which means leviathans are often less profitable, and usually much less fun.”

Johnson’s assertion — that “emerging companies, with minimal resources, can defeat huge, established players” because “big corporates fall prey to a number of diseases” — smacks of what is commonly thought of as Darwinism. Morgan Witzel, in a review of the book Darwin’s Conjecture: The Search for General Principles of Social and Scientific Evolution by Geoffrey Hodgson and Thorbjørn Knudsen, writes, that Charles Darwin’s ideas have had a profound impact on “the way we do business. So-called social Darwinism has played an important role in shaping our understanding of economics, markets and organizations.” Witzel continues:

“For example, when discussing business organizations we often speak of them ‘adapting’ and ‘evolving’ to meet conditions in their changing ‘environment’, as if our business organizations were some sort of Galápagos seabird and not large and highly complex institutions.”

Galápagos seabirds might take umbrage at the thought that they are not “highly complex” organisms, but Witzel’s point is that we can take the “living organism” analogy too far. She explains:

“When, during the recent crisis, many companies failed, it was easy for us to explain this in Darwinian terms. These failed businesses were weak: according to the law of ‘survival of the fittest’, they had been selected out. The business world is a jungle, a harsh environment in which only the strong can adapt and survive. Or so our thinking often goes. But do these ‘Darwinian’ notions about business have any real grounding in Darwin’s own theory? According to Geoffrey Hodgson and Thorbjørn Knudsen, the answer is largely no.”

That’s a crushing blow for anyone who likes to use Darwinian analogies! Fortunately, Witzel goes on to write, “Darwin’s theories can be extremely important in helping us to understand how organizations, institutions and markets change.” She insists that “rather than picking bits out of the Darwinian corpus and adapting them to suit our own purposes – or to fit our own preconceptions – we need to look at his theory as a whole.” Based on the title of Hodgson’s and Knudsen’s book, you’ve probably ascertained that it “is not a book about business.” Witzel insists, however, that “it is a book that business people should read in order to understand business.” She explains:

“It is a scholarly and profound work of relevance to all the social sciences, and there are times when the lay reader will be glad for the glossary thoughtfully provided at the end of the book. Its primary value for the business reader is to expose some of the fallacies connected with Darwinism that have grown up over the years, and re-examine our ideas. … Economists and business gurus have stressed ideas such as competition and individualism, to the point where ‘survival of the fittest’ has become something of a mantra. As a result, key Darwinian ideas such as mutual aid, sympathy and co-operation have often been ignored by later writers on business and economics. The authors remind us of these overlooked theories, and challenge the idea that Darwinism offers such easy solutions as ‘survival of the fittest’ in any case.”

Mutual aid, sympathy, and cooperation don’t sound very much like business terms; but, in more and more articles about business (especially articles about supply chains) you do hear terms like collaboration and trust. Witzel continues:

“Darwin’s theory rests on three simple principles: variation, selection, and replication or inheritance. Of the three, it is inheritance that has received most attention in recent years thanks to advances in genetics. And in business we sometimes talk of organizations as ‘inheriting’ characteristics in the same way that people do, or having an ‘organizational DNA’ as part of their cultures. But as the authors point out, this is a fallacy. Organizations do not have genes, nor is their method of evolving comparable to replication. There is, they say, no comparison between org­anizations and people on this level. Instead, when we consider how organizations change, we need to look at all three principles: the variation in types of organization, the factors for why some organizations work better in some environments than others, and then how organizations change and grow.”

Some of the corporate illnesses discussed by Johnson were actually descriptions of why small organizations function better than large organizations in certain environments. Whereas Johnson might recommend treatment, Witzel might recommend understanding. She continues:

“Competition exists, of course, … but it is only one factor out of many. One key lesson from this book is that we need to consider more closely how businesses interact and depend on each other, even when they are also in direct competition. Rather than seeing markets as arenas for combat, we should consider them as complex systems, with companies linked together through that system. Recognizing, perhaps, that businesses need to think less about competition and more about co-operation, the latter might offer better prospects for long-term survival. More generally, we need to remember that markets and businesses are infinitely more complex than we like to think they are. The authors do not shy away from complexity; indeed, they hint in the conclusion that we need more of it in our thinking about business.”

Some of this new thinking is already being implemented. Japanese automakers had to cooperate in the months following the natural disasters there. Blogger Michael Koploy wrote in one of his posts, “The ‘secret sauce’ of many supply chains is their connections, relationships, and deals with suppliers. Ironically, the Japanese Big 3 of Toyota, Honda, and Nissan were forced to share these secrets and work together to help assist the auto parts suppliers affected by the earthquake and tsunami.” [The Post-Tsunami Supply Chain All-Stars | Who Recovered the Fastest and How? Software Advice, 15 July 2011]And the Consumer Goods Forum, an international group of retailers and manufacturers, insists that “shared supply chains are coming in the not-too-distant future.” [“Companies to Test ‘Shared’ Supply Chain in Europe,” SupplyChainBrain, 31 January 2011] Witzel concludes that Darwin does have something to teach the business world; but, to learn the right lessons “one needs to understand the whole theory in order to see how evolution really works.” The bottom line for both Johnson and Witzel is that nothing in this world remains static. Change is inevitable. Understanding what needs to be changed and how to do it is what is going to determine which companies die and which companies thrive.