The Land of Giants

The quest for immortality - Chapter 0

The notion of whether this is the most transformative period in human history is an argument for futurists and historians. Frankly, it’s not a very interesting argument; we’re alive now so it’s grandiose to believe this is the case. What I find most interesting, and I may be alone here, is how businesses cope with this change.

As we enter a new techno-economic paradigm there will be greater Creative Destruction (“the industrial mutation that incessantly revolutionises the economic structure from within, incessantly destroying the old one, incessantly creating a new one”). This is the ‘essential fact of capitalism’ according to Schumpeter. As Alfred Chandler noted, entrepreneurship plays a critical role in the process of growth and development. However, managers play an equally important role in amplifying those innovations.

‘The quest for immortality’ is my attempt to apply some heuristics, some rules of thumbs, for creating sustainably successful businesses. This will be a series of posts exploring a range of topics and, ultimately, trying to understand if it is possible to survive the process of Creative Destruction.

Collectively, the four stages identified by Carlota Perez (irruption, frenzy, synergy and maturity) result in Creative Destruction.

Research by Foster and Kaplan found that, on average, an S&P 500 company is now being replaced about once every two weeks. 89% of companies listed on the S&P 500 in 1955 no longer exist, and the average lifespan of S&P 500 companies has fallen from 61 years in 1955 to 17 years in 2015. Firms are not just disappearing but struggling to compete. Between 2000 and 2009, the revenue of over half of publicly traded firms with a market capitalisation of greater than $1bn shrank by 10% or more in one of those years.

These numbers paint the picture that new competitors are killing off incumbents, which then go the way of Blockbuster or Kodak. However, whilst there is an element of truth to this, it is does not truly reflect what is happening.

In the last twenty years, the number of publicly traded companies in the US has fallen 50%, from 7,322 in 1996 to 3,671 in 2016.

The average age of a listed company has risen 50%, from 12 to 18 years. The average market cap has risen over 105%. There is a growing case of ‘winner takes all’. According to Bain & Co, just one or two players in each market earned (on average) 80% of the economic profit. It is not that new insurgents are disrupting the market but the growth of incumbents that has had the biggest impact to date.

Despite the hype of disruption new challengers are struggling to shift incumbents. Five-year survival rates for newly listed firms have declined by 30% since the 1960s, according to research from the Tuck School of Business at Dartmouth College.

The biggest winners in the last twenty years are incumbents that have seen off competition and created greater barriers to entry. In the words of Warren Buffet, they have established economic castles protected by unbreachable moats.

Having to compete with these behemoths is one reason why companies are staying private longer. The median time to IPO has risen from 4 years in 1999 to 11 in 2014, according to Bain & Co. When Amazon went public in 1997, it was worth $300m, twenty years on it is worth over $450bn. Is it feasible a company of that size could grow into a giant in the public markets today?

Drawing on Andrew Lo’s theory of adaptive markets, companies are living organisms, competing to survive. Organisations have adapted to their environment. During the management revolution and the early days of the internet, scale and efficiency provided many companies with a competitive advantage. Many of these firms exist in highly competitive, high-velocity oligopolies. In these environments, the ability to change continuously is a core capability of successful firms (perhaps elephants can dance after all).

However, there is an argument that actually little has changed in the last twenty years, relative to what is expected in the coming decades (after all, we were promised flying cars and got 140 characters). This relative stability has allowed companies to create massive empires and explains why many truly disruptive start-ups are vertically integrated (think Tesla or Monzo).

As the research from Credit Suisse highlighted, companies are larger and older today. Though this has led to higher profitability and greater market caps, it arguably also makes change harder. The winners of the past have shown a great capacity to adapt. However, many believe that the rate and scale of change will make it increasingly difficult to keep pace. As Chris Zook and James Allen state in The Founder’s Mentality, it is the inherent paradox of business. ‘Growth creates complexity. Complexity is the silent killer of growth’.

What does this concentration mean for the process of Creative Destruction and the visible hand? For entrepreneurs and managers?

Digital — A new dawn

According to 8VC, the ramifications of this new techno-economic paradigm have yet to be realised: ‘The vast majority of the economy has yet to be transformed by the IT revolution — we are nowhere near the exhausted, fully-saturated markets of Perez’s ‘maturity’ phase’.

MIT Sloan defines digital disruption as ‘changes in the competitive environment, resulting from the use of digital technologies by new market entrants or established competitors in ways that undermine the viability of your product/service portfolio or go-to-market approach.’

In the age of digital disruption it is now possible for technology to lead to a techno-institutional leap, overcoming structural and economic obstacles. Technology changes much faster than formal governing institutions, and therefore, it can help entrepreneurs to start new businesses. The question remains, can incumbents leverage new technology and undertake true digital transformation, or to what extent are they restricted by complexity, legacy thinking and path dependency.

The graph below shows the media attention to ‘Disruption’ versus ‘Digital Transformation’.

I like to think this represents a proactive approach by organisations, reacting to the digital revolution/Industry 4.0/The Second Machine Age — call it what you will. Doing nothing is the most dangerous approach to the future success of the organisation.

Research from Citigroup found that over the past two decades, technological disruption affected approximately 10% of global public companies by market capitalisation. In the coming decade, up to 47% of global companies could face pressure to adapt to some form of technological disruption.

There are two principal ways firms are responding: relying on M&A and developing a multitude of strategies.

The growth of M&A is more dramatic in recent years when excluding non-tech buyers.

Research from Vermeulen and Barkema found that acquisitions can revitalise an organisation and decrease inertia, enhancing the viability of its later ventures and ultimately foster long-term survival. Acquisitions can be another way for organisations to administer shocks to their systems, making them more adaptable in the long run. Wal-Mart will certainly hope this is the case with its latest acquisition, Jet.com for $3.3b, following the previous spin out of its own e-commerce business in 2000 and then acquiring Kosmix in 2011 for $300m.

The sheer number of acquisitions also highlights the need for organisations to develop new capabilities as they are no longer capable of exploiting existing resources.

The combination of a range of technology advancements is having a compounding effect on the impact of change. Companies have responded by taking a fragmented approach. Everything needs a strategy, whether it’s a cloud strategy, a mobile strategy, or a data and analytics strategy. Even a digital strategy that looks across a range of technologies is misguided. A company should have one strategy, which answers the following questions:

· How will we create value?

· How will we deliver value?

· How will we capture value?

New digital technologies are fundamentally changing the answers to these questions.

I believe there are three interdependent elements of digital transformation, each of which I will explore in the following post (Chapter 1).

· Reimagining products/services and customer engagement

· Developing a new operational backbone

· Lowering the cost of change

The rules of the game have changed. Digital technologies are creating completely new value propositions, invalidating many of the trade-offs that companies are built on and changing the economics of an organisation.

Robert Smith, founder of Vista Equity Partners; “We are truly in the early stages of the fourth industrial revolution. There is a digitisation of every single industry on the planet, and ultimately that will lead to the digitisation of every single company in one way, shape, form or another.” However, as stated by Freek Vermeulen of LBS, the change will not be uniform across all industries.

Chapter 1 will explore the impact of ‘digital disruption’ and the three elements of digital transformation.

Numbers

1. Foster and Kaplan, https://www.innosight.com/wp-content/uploads/2016/08/creative-destruction-whips-through-corporate-america_final2015.pdf, 2015

2. Credit Suisse, https://research-doc.credit-suisse.com/docView?language=ENG&format=PDF&sourceid=em&document_id=1072753661&serialid=h%2B%2FwLdU%2FTIaitAx1rnamfYsPRAuTFRGdTSF4HZIvTkA%3D&mkt_tok=eyJpIjoiT1RZMk5HWTNZV0l3T1dGbCIsInQiOiJONWhqeWtHU0pnXC9oYTYxY2lvazZHTitQa1daSFBEQ3NHU1Q5dmxvWGdmMUFZVTBoRHdETmEycWdIYlkrckNQeUxKaG1ybDExWkdqUmlMYmUyKzVjXC9HcXlSUVZlR0srVThucFA5YlhhNEltMVZzVUR6azhwckszSG5nWjFTYUEwIn0%3D, 2017

3. Bain and Company, http://www.bain.com/publications/articles/firm-of-the-future.aspx, 2017

4. Citigroup, http://uk.businessinsider.com/citigroup-report-on-disruptive-innovation-2017-1, 2017

5. KPCB, http://www.kpcb.com/internet-trends, 2016