Why Companies Need to Fail

Excerpts from the book Confronting Complexity: X-Events, Resilience, and Human Progress by

John L. Casti

Roger D. Jones

Michael J. Pennock

preface

table-of-contents

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Failure is Always an Option

During the second half of the twentieth century, if you’d asked anyone who was the world’s leading photo-imaging company they would have looked at you like you’d just dropped in from outer space. The answer to that question was so obvious that to even ask the question marked one as a cultural illiterate. Anyone who even faintly understood the term “photo imaging” would have instantly replied, “Kodak, of course.” And indeed it was that obvious. There were no contenders within sight even for second place. Kodak was it. And almost everyone would have imagined that the Soviet Union would collapse before Kodak. But times change, both for companies and for countries. And by 2012 the USSR was but a distant memory—and Kodak was in the bankruptcy courts on its way to oblivion. Perhaps it’s not accidental that the reasons why both the USSR and Kodak collapsed are about the same. So as the story of this chapter is business, not geopolitics, let’s look at Kodak, not the Kremlin.

Strangely, Kodak was not only the chief producer of image technology ranging from cameras to film to industrial imaging products, it was the inventor of almost all the technology that it ultimately transformed into commercial products. These inventions even included the very digital technology that was ultimately Kodak’s undoing. Basically, Kodak didn’t keep up with the digital innovations its patents pioneered. Instead, other firms like Canon and Nikon moved commercialized digital photography, while Kodak remained mired in its analog-imaging culture. At the same time, mobile phone pioneers led by Apple and Samsung added digital photographic capabilities to their phones, removing the need for people to carry a separate camera to capture their “Kodak moments.” Thus ended Kodak’s reign as the name synonymous with photography. But Kodak was far from the first company to come undone as a result of not paying attention to a changing world. So let’s look a bit beyond the simple imaging-based reasons for Kodak’s failure and try to understand the larger lessons at play leading to its corporate demise as chronicled by Koren Simon in her blog Roots of Resilience.

Lesson 1: Lack of a Clear Vision Kodak’s vision statement says it will “help consumers, businesses, and creative professionals unleash the power of pictures . . . ” Compare this statement with the vision statement of Apple: “At Apple, great ideas have a way of becoming great products . . . ” See any difference? In case you didn’t, notice that the Apple vision talks about “great products” that the firm will produce to help their customers. By way of contrast, the Kodak vision says nothing even semi-specific about what it will do to help their customers, only that somehow they will help them unleash the power of pictures. In short, the Kodak vision statement is vague and fuzzy, perhaps because the company was involved in too many different things— cameras, film, film developing, printing, and so forth. The company’s vision did not evoke the idea of a firm that was on top of current technology and would harness that technology for its customers. Instead, it was a vision that offered to facilitate, not lead.

Lesson 2: Lagging Behind the Trend Curve Technology is always on the move, and never more so than today. So even the leading firm can quickly become a follower if it doesn’t keep its eyes and ears open to new trends, looking to see how its existing resources can be deployed to lead the trend, not follow it. The big question here is how did Kodak, the developer of the first hand- held camera, end up lagging other imaging innovators?

 

Lesson 3: Failure to Guard Your Interests As noted, Kodak was the developer (and patent holder!) for much of the digital technology that other firms like Apple, Samsung, Sony, and Fujitsu used to take the lead in the world of digital imaging. Instead of keeping this technology to itself, Kodak licensed it to these firms who then used it to bury Kodak, not praise it. In fact, following Kodak’s filing for bankruptcy these patents were the main asset the corporation still held. And court calendars around the world are still filled with various lawsuits in progress against the leading firms in the digital technology business. If only Kodak had used their own IP and developed it instead of selling it to these other firms, the world of digital technology would look vastly different today at least insofar as who the leading players are.

From the standpoint of the principal themes of this book—social mood, complexity overload, and resilience—the second lesson, lagging behind the trend, is a classical example of complexity overload. Technology was marching on; Kodak wasn’t. As the world of digital technology became increasingly complex, Kodak stuck to what it knew: analog technology, which as far as Kodak was concerned was something simple that they understood. There was no time taken to learn an entirely new way of imaging the world. Unfortunately (for Kodak), the gap reached a breaking point early in the twenty-first century and the road has been straight downhill to the bankruptcy court ever since.

The other two lessons, having a vision that’s too vague and guarding your interests, are more properly matters for the next chapter on resilience. What we can say here is only that the rapid emergence of digital imaging was an X-event for Kodak. But the firm’s inability/unwillingness to roll with that punch instead of trying to resist it sent the firm down for the ten-count. In short, Kodak did not display the kind of organizational resilience needed to see how to deploy their resources in the new environment created by the X-event. That inability turned out to be fatal for the company.

Returning to the question of why Kodak let digital cameras drive the firm into a penny-stock company, it’s useful to consider the observation of Jeff Stibel, formerly a cognitive scientist from Brown and now an entrepreneur who has engineered turnarounds at several companies including Dun & Bradstreet Credibility Corporation. He says, “Once the human mind has set out to do something, or has gotten into the habit of doing something, changing it is very hard.” And it’s not simply that people resist change. What’s astounding is how many companies drive at top speed into the brick wall of corporate disaster. Another turnaround specialist, Thomas Kim of the Turnaround Management Association, says that it’s only when the situation reaches the point that the firm can’t make the payroll or make a loan payment or the cheques start to bounce that the sense of urgency becomes great enough that people become ready to change. But why do they have to wait until the chances to make meaningful change are so small?

 

One reason offered by Michael Hannan and John Freeman in their book Organizational Ecology is that inertia is “in their genes.” In fact, it’s a gene that made many of these companies successful to begin with. The authors argue that companies rarely change their fundamental structural features. Change is risky, since it involves doing something that isn’t already working. They note that even lackluster product lines have some customers. So a company that engages in frequent changes is far more likely to kill itself off with bad choices than firms that resist change.

Hannan and Freeman further argue that in today’s economy accountability and reliability select against constant radical experimentation. A quintessential example of this is McDonald’s, whose most characteristic feature is that their food, décor, and service will be reliably the same wherever in the world you find their store. And the bigger and older the company, the heavier is the selection bias toward stability. Kodak is a textbook example of this phenomenon.

To quote Thomas Kim on the matter of corporate inflexibility, “There are companies that perform reasonably well, and are completely dysfunctional.” Then the market changes. “In companies that we see that hit the wall, that dysfunctional corporate culture really becomes a problem.” And even a dysfunctional culture, once established, is amazingly efficient at reproducing itself. Gabriel Rossman, a sociologist at UCLA, notes that if new entrants simply assimilate to the majority and enter the system slowly, the founding culture can persist over time even if in the long-run they constitute a vanishingly small minority. In sociology, Rossman says this is what’s called “The Founder Effect.” In corporations, it has a different name: “How We’ve Always Done Things.” And now you see how companies fail!

What we see here are two conflicting forces at work: a conservative, inertial resistance to change and herding behavior giving rise to speculative bubbles. The bubbles involve big risks that would not be undertaken using conventional risk/reward, cost-benefit analysis. The bubbles give rise to the X-events we’ve spoken about many times, and ultimately clear out social and economic structures that are no longer functional. This clearing process creates new “econiches” that provide opportunity for entrepreneurs and innovators to offer new products and services. This process is what the Austrian-American economist Joseph Schumpeter termed “creative destruction.” Let’s take a harder look at what he had in mind and try to relate it to the story we’ve told thus far about corporations, business, and economics.

 

OUT OF THE ASHES

The idea of creative destruction as argued by Schumpeter is that the capitalistic system exists in a constant state of ferment, a system continually reinventing itself through the process of innovations regularly destroying existing firms and enterprises and building new ones. While this is perhaps a good elevator sales pitch for Schumpter’s big idea, it is woefully incomplete in a number of ways. For instance, if we take the foregoing description at face value we’d be led to think that innovators simply and inevitably just push aside the established order of things in a kind of “out with the old, in with the new” fashion. The picture that this conjures up is a kind of relentless death of existing firms and the birth of new ones.

A big problem with this picture is that the power structure in most capitalistic societies consists of the political ruling class(es) and the business/financial establishment. As a general rule, the last thing this power structure wants is dramatic, meaningful, lasting change. Rather, it has a vested interest in just the opposite, namely, maintenance of the status quo. The tools at the disposal of the powers that be to maintain the existing systems are enormous, both legislative and financial. This is why it’s no joke to talk about the nonstop “Express Shuttle” between Capitol Hill and Wall Street. It’s not a fiction of a conspiracy theorist’s imagination.

So how does an innovation ever get off the ground when the very social, political, and economic fabric of society is massed against it? The answer is not that the innovations are so spectacular and so irresistible that they overcome all obstacles put in their path. Rather, the innovations move into the main- stream in the same way that a chemical reaction is accelerated by the presence of a catalyst that speeds up the reaction several hundredfold. In the case of the economy, that catalyst that gives life to Schumpeter’s vision of creative destruction is an X-event. In short, some unavoidable, uncontrollable event has to take place that blasts the existing social structure apart. This might be something globally quick and destructive like a world war, a massive earthquake, volcanic eruption, or even global warming. But it may be something more nuanced like a financial crash, an epidemic, or a political revolution. Any of these things can blow away existing structures, creating new “niches” to be filled by innovators with new products and services.

The above picture shows that in one sense, Schumpeter was right. The innovators do replace the existing establishments. But they don’t do it directly; they do it with the essential help of the X-event that creates the niches giving their innovation space in which to develop. So the role of innovators in this picture is to continue to develop their innovations, but also to keep their eyes open for new niches that open up the chance for their innovation to “breathe.” If the timing is not right and no X-event takes place, then the innovation will die on the vine. The innovation will also die if the innovator is looking the other way when the right niche appears. When opportunity knocks, you have to be there to open the door. So when Schumpeter argues that it is entrepreneurs who drive economies, he’s right. But those entrepreneurs don’t do any driving without an X-event to smooth their way.

 

The creative destruction aspect of Schumpeter’s message is what seems to have caught the fancy of the capitalistic class. In their ardor for creation of new ideas and firms, the capitalists ignore the second part of Schumpeter’s argument. That is that as innovation becomes mechanized in corporate labs, entrepreneurs will disappear. The implication of this argument is that the very success of capitalism leads to socialism! That is exactly what happened in Japan. But some argue that in the United States those with an entrepreneurial leaning simply leave their current situation, raise venture capital, and start a new company. If the government creates an environment, legal and financial, that’s favorable to this process, then socialism can be averted.

The philosophy and concepts underlying creative destruction a la Schumpeter are intimately intertwined with the notion of resilience that we’ve spoken about in passing earlier in the book. We’ll defer a discussion of these connections to the next chapter, since resilience will be the piece de resistance for that chapter. But to give just a flavor of how creative destruction and resilience interact, let’s take another look at the way complex systems—and complex companies—collapse.

 

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