The perils of an organisational life cycle. By Leon Gettler
“The discoverer and the inventor are the bane of business. A little sand in the works is comparatively a mere nothing – you just replace the damaged parts, and go on. But the appearance of a new process, a new substance, when you are all organised and ticking nicely, is the very devil. Sometimes it is worse than that – it just cannot be allowed to occur. Too much is at stake.”
John Wyndham, The Day of The Triffids
Innovation and change have always been a conundrum for business. Studies suggest that most businesses are erratic innovators because they hate seeing the new destroy the old. Few are prepared to cannibalise previous investments, brands and systems. Yet without innovation they die. It is one reason why businesses are not built to last.
The noted economist Joseph Schumpeter summed up the problem more than 60 years ago as “creative destruction”. He wrote: “The problem that is usually being visualised is how capitalism administers existing structures whereas the relevant problem is how it creates and destroys them.” Change through technological breakthrough, market forces and economic shifts creates a process of disequilibrium – throwing old, lumbering companies off balance and ushering in nimble entities that change the shape of the economy.
Schumpeter’s creative destruction contains threats and opportunities. For example, when the personal computer replaced the mainframe in the computer industry, IBM was pushed aside by Intel and Microsoft. The corporate world is filled with examples of companies that turned away from opportunities created through disequilibrium. In the 1970s Xerox developed tools such as the mouse and graphical user interface that allowed users to navigate their way through systems. But in the end, Xerox decided not to put these on the market because it made office equipment, not computers.
In 1992, a crew of Apple and Novell programmers were working on a secret project to graft the Macintosh operating system onto an Intel chip, creating a user-friendly alternative to clunky MS-DOS and Windows 3.1 and predating Windows 95. But the project was aborted when its chief backer was poached by the competition and the Apple board got cold feet.
Professor Paul Geroski of London Business School found that growth is impossible to predict because businesses are such erratic innovators. He attributes this to their reluctance to abandon systems they have in place, even if these are not necessarily producing results. His study, The Growth of Firms in Theory and in Practice, found that growth patterns follow a “random walk”. Even if they expected shocks, businesses were struggling to predict when they would happen and were at all at sea preparing for them.
Geroski attributed this to businesses having fixed costs: they could not adequately respond to a problem until they had reached some threshold of poor performance. They tended to tolerate a little deterioration in performance until they were certain the shocks were permanent and important, and would swing into action only when the problem was big enough to warrant change, attacking it in one big hit.
This resulted in large but infrequent and discrete changes in their operations. But as MIT economist Lester Thurow says in his book Creating Wealth: “Successful companies must be willing to cannibalise themselves to save themselves. They must be willing to destroy the old while it is still successful if they wish to build the new before it is successful. If they won’t destroy themselves, others will destroy them.”
Companies that have resisted change have gone out of business. Only a handful anywhere have stood the test of time, but they had to destroy themselves to survive. The roots of the telecommunications giant Nokia go back to Finland’s forestry industry in 1865. The Swedish pulp and paper manufacturer Stora started out as a copper miner more than 700 years ago. The Japanese Sumitomo conglomerate had its origins in a copper-casting shop in 16th-century Kyoto. Only General Electric survives from the original Dow Jones Industrial Average stock index published in 1896. Of those listed on the S&P500 in 1957, only 74, or fewer than 15%, were there 40 years later. Significantly, GE is a reinvention specialist. But not every business is a GE. More significantly, the pace of change has accelerated since the Standard & Poor’s index of 90 big US companies was established in the 1920s. Back then, the turnover rate in the S&P90 averaged 1.5% a year and new members could expect to be there for 65 years. By 1998, turnover in the S&P500 was almost 10% a year. Companies had an average lifespan of no more than 10 years.
A study by Port Jackson Partners found that corporate impermanence was even more marked in Australia. Of the top 100 companies by market capitalisation in 1990, only one third were on the list in March 2002. Arnott’s, Commonwealth Industrial Gases, Pioneer and Normandy Resources were acquired by foreign predators. Local companies were big on acquisitions too. Howard Smith was taken over by Wesfarmers, Ampol merged with Caltex Australia, Smorgon took over ANI and Email, and Advance Bank was hitched up with St George.
Others, including Petersville Sleigh, Adelaide Steamship and IEL, simply collapsed. Then there were those that slipped out of the top100. Some, like Adelaide Brighton and George Weston Foods, seemed to be stuck in low-growth industries. Others stumbled because of poor strategic decisions or lack of imagination.
The most striking feature of the Port Jackson Partners study was the way newcomers developed stronger revenue and earnings, achieved results for shareholders and transformed the market. From 1997 to 2002, they had a shareholder return of 29% a year in dividends and capital gains. In the same time, the survivors achieved only 14%. For those that slipped out, the result was minus 9%.
The story was just as striking in terms of operations. In five years the newcomers achieved revenue growth of 15% a year and earnings before interest, tax and amortisation of 13%. For those that were just hanging in there, the figures were 7% and 6% respectively. The study also points to the way some of the newcomers have introduced innovations that reshaped their industries. Leighton, for example, turned the slim-margin construction industry on its head by competing for jobs on a total-project basis, instead of the old “bid and build”. Flight Centre’s innovations include treating each employee in its network as a net profit centre. Performance incentives are central, and things are kept in-house to maintain the culture.
Others are redefining their roles. Wesfarmers has morphed from a farmer co-operative into Australia’s most successful conglomerate. The stevedoring company Patrick is pushing into aviation and rail.
Companies have to be three times bigger than their counterparts in 1990 to make the top 100. They have to be more robust and willing to compete on a global scale.
Australia’s business-creation culture lags behind that of other countries. This has been attributed to poor links between business and education, government inertia, tax policy and the poor availability of venture capital. The study says the US has eight times Australia’s level of per capita funding.
However, it is up to businesses themselves to nurture the skills and ambitions of employees. In the end, the task is about creativity from within.
August 2003: Cover story feature
There is nothing new in the need for business to invent and adapt, so why such an emphasis on innovation now?
There are two obvious answers to the innovation question: product oversupply and disinflation. In many industry sectors there is chronic global oversupply. Productivity gains have not been balanced by rising demand, resulting in a heavy dependence on United States consumers. In the developed world, population ageing is limiting demand growth, and in the developing world, especially Asia, there has not been sufficient wealth distribution to create consumer demand (with the possible exception of China).
The second pressure is price weakness and squeezed margins. Andrew Liveris, president of Dow Performance Chemicals and an expatriate Australian manager, says disinflation (or even deflation, as in Japan) is a 20-year cycle that changes the way business is conducted. “You can’t count on inflation, you have got to point yourself this way. You can do patchwork strategies in the meantime, you can find cheaper ways to make your goods, you can use 6 Sigma technology, which is a very powerful technology to make less errors. You can hit your supply/demand cycle from the right side – in some areas that gives you the ability to raise prices for a temporary period. But the generic answer is that it has to be through innovation – investing in R&D and new business models to break yourself out of the depression cycle.”
Liveris says that in the 1990s Dow more than doubled its revenue with static staff levels – a sharp improvement in productivity – and management layers were cut to six. But this process is nearing its end: to go on achieving sharp improvements, new ways of doing business must be found. The lack of clarity in the debate on innovation is an inevitable side-effect of the vested interests in its pursuit. Scientists lament the lack of funding and interest from business, typically because they are more focused on discovery than creating new businesses, on funding rather than profitability.
Businesses are willing to comment publicly on the need for more collective effort in innovation, but they are unlikely to be illuminating on the detail because such detail can easily compromise their fiercely protected competitive advantage. Academics and consultants are able to make observations about the behavioral and organisational habits that foster or inhibit innovation. Toyota, in being able to implement incremental innovation and “phase shift” innovation every seven years, is an exemplar of innovative practices. But that is all it is, and by the time the methods have been studied and analysed, their relevance is often lost.
What matters is collective effort. Peter Farrell, chief executive and founder of the Australian-based sleep equipment company Resmed, which has developed global markets, is a former scientist and academic who made the transition to business leader. He says there is a much heavier emphasis in the United States on the value of innovation than in Australia. The greatest need is a sophisticated understanding of the relationship between research and development. The habit in Australia is to treat research as a choice between “practical” and “theoretical”. Innovation strategy involves high-quality research and high-quality development.
Keith Williams, chief executive of Proteomics Systems and former professor of biological sciences at Macquarie University, gave up his pension and academic job to start the company. Like Farrell, his tale reveals that universities may create crucial knowledge, but entrepreneurial flair can often be stifled in the university environment.
When Williams and his colleagues left the university they did so with only their knowledge of the field, some discoveries, and research and development routines. Three years later they have a company valued at $200 million. What they had done at the university was pure research on the science of proteins (proteomics) without any obvious commercial applications. After the mapping of the human genome, the business and medical communities want to understand how DNA creates proteins. Proteomics is the most important puzzle in world commerce.
Williams has established several joint ventures and alliances – a characteristic synonymity between the “knowledge economy” and the “network economy”. The list is impressive: the US computer giant IBM, the pharmaceuticals company Sigma- Aldrich, the Japanese engineering company Shimadzu Corporation, and Japan’s largest trading house, Itochu Corporation. The innovation challenge is often shared, with companies choosing to compete only in some areas. This is especially noticeable with chemical, pharmaceutical and agri-science businesses, the global companies relying on outside providers for new knowledge.
For Australian companies, the innovation challenge has two main dimensions. First, it is necessary to measure a company’s better practices against the best in the world. Anthony Pratt, chief executive of Visy in the United States, says this is what opened up opportunities for his company.
The second key to innovation is the sharing of resources, without any loss of competitive impetus. Ifor Ffowcs-Williams, chairman of Cluster Navigators Australia, says business should seek “co-opetition” – a constructive blend of co-operation and competition. His approach is to look for naturally occurring innovation, which is usually in one location, and to catalyse it with specific support. To be innovative it is not necessary to be a highlevel scientist, often it just requires coming from a particular part of the world.
Ffowcs-Williams says: “Biela in Italy has a population of 50,000 and about 200 textile and weaving businesses. Another place in Italy specialises in making socks: there are about 7000 people and 200 firms making over half of Europe’s socks. Doltan, near Atlanta, has a population of 25,000 and makes 45% of the world’s carpets.”
Australia has several innovation clusters, says Michael Burke, managing director of Cluster Navigators Australia. “We have looked at food processing in the north of Melbourne, and there are signs of a successful cluster. We found a concentration of skills around food, and a food research company that no one knew about.”
Ffowcs-Williams says: “All too often the local people are only seen as the delivery point. They are not the delivery point, they are the prime drivers.”