Posted on Strategy Freek: June 11, 2009 1:56 PM
The economist Jovanovic wrote, about a quarter of a century ago, "efficient firms grow and survive; inefficient firms decline and fail". What he meant is that the market is Darwinian; it will rule out the least efficient firms, with habits and practices that make them perform comparatively badly, and it will make sure efficient firms prosper, so that only good business practices prevail.Yeah right.
When you look around you, in the world of business, one sometimes can't help wonder where Darwin went wrong…How come we see so many firms that drive us up the wall, how come we see silly business practices persist (excessive risk taking, dubious governance mechanisms, corporate sexism, grey suits and ties to name an eclectic few), and how come so many—sometimes well-educated and intelligent—people continue to have an almost unshakable belief that the market really is efficient, and that it will make the best firms prevail if you just give it time?
That's because the logic is not entirely wrong. The market is Darwinian, and the firms with the highest level of "fitness" are the ones most likely to prevail. However, our Darwinian view of business is also so incomplete and simplistic that I am unsure whether it would make Mister Charles Robert Darwin cringe, burst out laughing, or pull the hairs from his famously bulging beard in agony. Darwinian mechanisms—or market mechanisms if you prefer—namely work at different levels. And sometimes they conflict. Let me explain.
Some business practices, like the ones mentioned above, will actually reduce the fitness levels of the firms that adopt them, and make them less efficient, yet they persist. That's because these practices have a fitness level of their own. They survive just like viruses survive among humans. The flu kills many thousands of people every year, and at first glance it seems a slightly flawed strategy of this virus to kill one's host, yet it persists. Why is that? That's because it spreads quicker than it kills. It doesn't matter much, for a virus, that it reduces the fitness of its host, as long as it jumps to someone else before the host snuffs it! And in a way that is what bad business practices do too. They spread easily and kill slowly and stealthily.
Moreover, the flu doesn't kill everybody that gets it; it often just makes them perform worse. And that is what bad practices do too. Just like an extremely lethal virus dies out—because it kills its host before it can spread—terrible business practices also never quite see the light of day. It is these stealthy, annoying, nasty, creepy, sneaky, and irritating, pains-in-all-sorts-of-bodyparts practices that tend to persist. They don't kill instantly, but gradually wear a firm down.
And there is another advantage to that—for the practice that is. Firms don't quite know that the practice is bad. Very bad practices are easy to spot, so nobody adopts them, but not these ones! They're like a sneaky virus—you catch it before you realize it, and the negative effects only become apparent in the long run.
An example you say? Well, take the management quality standardization scheme ISO 9000 and apply it in a very innovative industry. Research—by professors Benner from Wharton and Tushman from the Harvard Business School—has shown that ISO 9000, in the long run, can have a severe negative impact on a firm because it hampers innovation. Yet, the short-term benefits are clear; adopting ISO 9000 often comes with some good reputational effects, an immediate increase in customers, and satisfied stakeholders. However, the negative effect on innovation, in the long run, may outweigh all of this.
Nevertheless, firms adopt the practice because they do see the short-term benefits, but are quite unaware of the long run detrimental stuff. To managers in charge of improving their firms' performance now, the practice seems attractive because they noticed that companies in other industries (perhaps not so reliant on innovation) benefited greatly at the time they adopted it, many of the firm's competitors are currently adopting it, and they all see a surge in customer applications too! Of course it looks attractive!
Moreover, once we start to suffer from a shortage of internal innovation, many years will have passed, and no-one quite realizes that the creeping troubles were originally triggered by the adoption of the ISO9000 practice a long time ago. The practice gets adopted by many many firms and continues to persist, despite the fact that everybody would be better off without it.
The same may very well be true for quite a few of our popular governance mechanisms, the practice of excessive risk taking as we saw it in investment banking, many forms of performance management systems, and certainly for corporate sexisms, and pin-striped suits with purple ties on hot summer afternoon. It is not that Darwin is wrong—and the mechanisms he discovered do not rule our markets—it is just that they're just as difficult to shake off as a common cold. And that they are just as annoying.