Creative Destruction: An Economic Analysis - Essay Example

CREATIVE DESTRUCTION: An Economic Analysis II Analysis Creative destruction conceptualized by Schumpeter in early1950s was likened to “industrial mutation” as something biological that is inevitable in a corporate lifetime. As an economic reality, Schumpeter posited that it represented the process of incessant destroying old ones giving place to new ones in a systematic manner. And that it is a never ending process in capitalist economies (Schumpeter). The reality of creative of destruction has been voiced by the U.S. Federal Reserve Board’s chairman Greenspan (2003) characterizing it as “continuous scrapping of old technologies to make way for the new” in the consumers’ relentless search for “low product prices and high quality”. However, Richard Foster and Sarah Kaplan posit that it is possible “to successfully transform” the “companies that are built to last but underperform the market” (Foster and Kaplan). Dick Foster and Sarah Kaplan (2001), in their excerpt demonstrate the fact of creative destruction from the first index of Standard and Poor (S & P) which listed 90 major US companies as of 1920 could not retain all of them for more than 65 years. And in 1998, the S&P 500 conceded that no company could stay in the list for more than 10 years. In 1917, Forbes listed 100 largest companies of the U.S. It relisted its “Forbes 100” in 1987 which did not contain 61 companies of the original list. And out of the remaining 39, 18 companies such as Kodak, DuPont, General Electric, Ford, General Motors, Procter & Gamble and twelve others survived the series of crises from the Great Depression, inflation shocks due to oil crisis in 1970s to technological innovations of the recent past. The authors expect that by the next quarter century, only one third of today’s corporations will have survived with economical success (Foster and Kaplan). The authors of the book introduce concepts like “cultural lock-in”, “continuity”, and “discontinuity”. The surviving companies just managed to exist but did not perform in that they earned for their long-term investors 20 % less than market averages with the exception of General Electric and Eastman Kodak though Kodak has since fallen. Foster and Kaplan argue that no company has ever performed better than market as their strong conviction as they hold the view that “markets always win” in the long run as per the “McKinsey’s long-term studies of corporate birth, survival, and death”. Continuity: The reality is continuity (not mere existence) in the strict sense of the term is not possible since markets retain them only till they are competitive and reject them the moment they stop performing. Managements that follow the philosophy of continuity cannot keep pace with changes taking place in the markets with the result the corporations cannot match value creation at the rate markets create in the long run. New companies such as Intel, Amgen and Cisco have accomplished superior performance at least for some time far better than the longest surviving companies. The process of creation and removal of corporations from the markets have been characterized by Schumpeter as “the gales of creative destruction”. In order to survive the process of creation, the corporations’ the managers need the energy or time to match with that of market. Just as markets, corporations should also be able to manage the process of creative destruction. The norm for the capital markets is to create and destroy over time in greater scale so that greater wealth-building is realized. The S & P 500 index has already shown in 1998 that average life time for a corporation to remain on the list is ten years. Discontinuity: The authors argue that life expectancy of seventy years for corporations’ best performance no longer exists. In fact Drucker in 1969 (Drucker) wrote in his book “The Age of Discontinuity” his arguments only to be soon overcome by tumultuous events of 70s which were the repeat of 1930s. Very few companies came forward to risk their capital or the managers’ careers on the basis of Drucker’s philosophies. In retrospect, waves of changes have been happening since 1920s; first one was the moving over to rebuild the consumer infrastructure from the military buildup immediately after World War II when the nation witnessed many new companies entering the economy. Some of them are Owens-Corning, Textran, and Seagram during 1940s and 1950s. The second wave started in 1960s when there were governmental initiatives in defense and aerospace. At this time, one-decision stock “buy once and never sell them” ruled the day. It turned out to be a bubble that burst in 1968 when the New York Stock Exchange had reached 1000. It reached again to that level only in early 1980s. By the end of 1990s, the age of discontinuity had arrived as prophesied by Drucker. If it is any guide, by 2020 the S & P will have listed companies that survived for not more than ten years. Importance/applicability of those concepts. The discontinuity is not an unexpected phenomenon, It had been lurking for a long time as the cause of fundamental economic forces. They are ever increasing business efficiency, steep decline in capital costs. The shift from goods to services saw drastic reduction interaction and transaction costs. They were mostly due to information technology advancements, high labor productivity as a result of technology advancements and advanced management methods. Further, capital markets efficiency increased due to the accuracy and transparency of data on corporate performance. Enhanced national liquidity as a result better performances of the U.S. companies in terms of their profit making and preference shown towards U.S. securities in the capital markets were also the reasons. Not to be left behind were the improved fiscal management of the Government, reduction in corporate taxes and an efficient size of Federal Reserve. These were the forces that helped emergence of big corporates like Microsoft whose real assets is just 1 % of its market value. Dell Computer had no assets. And it was possible to start internet startups with no capital at all. The new and upgraded technologies have contributed about $20- $ 40 trillion in additional sales. The savings through productivity improvements can result in market value that is worth several trillions. New entrants have taken advantage of these improvements and they will be in the fore-front for the next twenty years. Those who cannot will be acquired or merged as a logical conclusion of their inability to keep pace. By 2020, S & P 500 list will be occupied by companies that are unknown today. They will have mastered the art of creative destruction unlike companies of the present. The authors argue that continuity has to be given a go-by by the companies so that they mimic more like present day markets characterized by creative destruction among corporations. The creative destruction should henceforth happen within corporations so that there is perfect alignment between performances of individual corporations and the overall performance of the market they are operating in. It is however not very easy to achieve. It is due to the conflict between the nature of existing operations and the ability to accommodate new ideas to flourish. The implementation will mean in sacrificing traditional assets, new channels of distribution, resorting to dilutive acquisitions. Cultural lock-in The inability to survive creative destruction is also due to cultural lock-in the corporates finds themselves fastened to as a result of their long-standing convictions. For example, in order not to cannibalize Aspirin leadership of Bayer, Sterling Drug did not introduce non-aspirin pain reliever drug (Panadol) in the United States. Bayer was ultimately acquired by Kodak because of its refusal to give up aspirin leadership. Sterling drug became actionless out of its anxiety to retain its past culture. The problems standing in the way of surviving creative destruction are cultural lock-in and obsession with continuity. Bureaucracy is another impediment as corporations advance in their age as a form of rational decision making guided by the past events or data. Rational decision making has proved to limit the business potential. There is anxiety to protect existing businesses and corporations do not want to discard old and established products in order not to usher in product cannibalization. Cultural lock-in is due to the adherence to “hidden set of rules or mental models”. Corporations find it extremely difficult to depart from their past due to fear of customer conflict, shareholders’ resistance or rejection and market reaction. Convergent thinking is another factor that only enables practicing of continuity. It believes in focusing on problems that are obvious so that solutions could be found quicker. But converged thinking is suited to only “handling small and incremental changes”. Divergent thinking on the other hand helps manage discontinuity. It broadens the focus i.e the decision making context. This method attempts to arrive at questions in the right manner so that answers are reached in the quickest possible time. The three skills of conversation, observation and reflection (COR) are present divergent thinking. Early warning systems fail in the mental models of corporations due to people being silenced or literally killed in their efforts. For example, Abbot Laboratories, a leader in the medical diagnostics and test equipment was disturbed by the Government’s introduction of Medicare and Medicaid in 1970s. The CEO effectively managed to silence three potential successors who wanted to change strategy, as a result. III Synthesis Corporations need to be redesigned to keep pace with discontinuity. Success lies not in perpetual existence but continuous earning. Corporations should take the cue from the markets itself. Just as markets have the ability to change or respond, the firms should also change at the same pace and scale of the markets. Some of the new firms have in fact outperformed markets in the last three decades mainly because of their organizational design. The design has shown them way of operating at the highest levels of efficiency. They have assumed discontinuity as the norm and braved the forces of creative destruction. In the process, firms do not keep their acquisitions for ever. Rather they focus on value creation in the short term. Redesigning of the corporations should be to evolve quickly in the same scale and pace of the markets to achieve improvement in long-term performance. Works Cited Drucker, F Peter. The Age of Discontinuity : Guidelines to our changing society. U.S.A.: Transaction Publishers , 1998. Foster, Dick and Sarah Kaplan. "Creative Destruction." The McKinsey Quarterly 3 (2001): 41-51. Foster, Richard and Sarah Kaplan. Creative Dsetruction: Why Companies That are Built to LAst Underperfrom the Market- And How to Successfully Transform Them. New York: Currency/Doubleday, 2001. Greenspan, A. "Remarks before the World Affairs Council of Greater Dallas in Andersen Esben Sloth, Druid and IKE (2004) The Process of Creative Destruction: From Vison to Mesurement and Evolutionaty Exploration." Washington D.C.: Federal Reserve Board, 2003. Schumpeter, J.A. Capitalism, socialism and democracy in Andersen Esben Sloth, Druid and IKE (2004) The Process of Creative Destruction: From Vison to Mesurement and Evolutionaty Exploration . 3. New York: Harper, 1950. Read More