On the Eve of Destruction?

Book: Creative Destruction: Why Companies That Are Built to Last Underperform the Market -- And How to Successfully Transform Them
Authors: Richard Foster and Sarah Kaplan
Publisher: Currency
Price: $27.50

Who's the poster boy for this postmillennial, hyperspeed, shock-a-minute economy? Why, that would be Joseph Alois Schumpeter, the Austrian-born economist who died in 1950. He was the "gales of creative destruction" guy who observed that a market economy ensures growth by allowing new, better companies to topple the old. In his own day, his notion played second fiddle to John Maynard Keynes's "general theory." Now Schumpeter's da man.

Consider this: Of the companies that comprised the Standard & Poor's 500 index in 1957, just 74 were still on the list in 1997. Destruction to go! Even more startling: Of those 74 survivors, just 12 outperformed the index over that 40-year period. "The corporate equivalent of El Dorado, the golden company that continually performs better than the markets, has never existed," write Richard Foster and Sarah Kaplan, authors of Creative Destruction: Why Companies That Are Built to Last Underperform the Market -- And How to Successfully Transform Them. "In the long run, the markets always win."

Foster, a McKinsey & Co. senior partner, and Kaplan, who has since left McKinsey to study at MIT, pored over 38 years of results from 1,008 companies in 15 industries. This effort, they say, took them a decade and the assistance of more than 50 McKinsey colleagues. (Does it take that many to change a lightbulb?)

Here's what they found: Companies that are "built to last" (note the dig at Jim Collins's 1994 classic) can't possibly sustain competitive advantage. The very characteristics that help organizations survive -- processes and systems that allow for order and control -- ensure that organizations will underperform the market. "Corporations are built on the assumption of continuity; their focus is on operations," Foster and Kaplan write. "Capital markets are built on the assumption of discontinuity; their focus is on creation and destruction."

The business world is discontinuous and becoming more so. Dramatic declines in capital costs, the increasing efficiency of capital markets, and the rise in national liquidity, Foster and Kaplan write, will force more economic disruption in the next two decades than ever. "The survivors will have to be masters of creative destruction -- built for discontinuity, remade like the market."

That is, to sustain advantage, organizations will have to emulate market behavior. The market is fearless. It abandons subpar performers. It welcomes innovation from the periphery. And it is completely flexible, unconcerned by threats of cannibalization, channel conflict, or earnings dilution. Companies, likewise, "must stimulate the rate of creative destruction through the generation or acquisition of new firms and the elimination of marginal performers -- without losing control of operations."

Most companies don't do that because they're trapped by their own success, plagued by "cultural lock-in" that prevents them from changing even in the face of clear market threats. Managers, rewarded for what was important yesterday, grow satisfied with operational excellence and incremental innovation. Harvard professor Clayton Christensen made the same point in the 1997 hit The Innovator's Dilemma (Harvard Business School Press) -- but let's face it: That book, rooted in a gray study of disk-drive manufacturers, was tough to wade through. Foster and Kaplan offer a much better read.

How can companies combat cultural lock-in? Some attempt simultaneous large-scale internal creation and destruction. Corning Inc., for example, experimented throughout the 1980s with investments outside its core consumer-goods business. It invested heavily in optical-fiber technology, a completely new arena. Eventually, it sold the consumer division, which had accounted for 50% of sales. "Corning has a bright future based on the assumption of discontinuity, not the comfort of continuity," Foster and Kaplan conclude. "So far, Corning has been a master of the game."

Likewise, private equity firms have created a model that places creative destruction above managing operations. Venture-capitalist company Kleiner Perkins Caufield & Byers, leverage-buyout firm Kohlberg Kravis Roberts & Co., and the recent explosion of incubators identify orders-of-magnitude opportunities. All of them apply strict rules dictating the life of their investments and expected returns; and they operate in a highly decentralized fashion, retaining control over operations through clear contracts.