When 'creative destruction' destroys more than it creates

The following post originally appeared on the Harvard Business Review Blog Network.

When changes in the natural environment accelerate, so do the extinction rates of the Earth's creatures. It happened to the dinosaurs and again to many species during the Ice Age. Many scientists believe we may be entering another such period.

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The same happens in business, and we are clearly entering a period where the extinction of the slow, the inflexible and the bureaucratic is about to happen in record numbers. 

My colleagues and I at Bain & Company have been tracking this for 40 years, and we have never seen companies losing their leadership positions as quickly as they are today. A list of the top 20 banks today contains only seven that were on the list a decade ago. A similar pattern hold for airlines. And for telecom. And for many others.

Some of this, business historians might say, is simply due to what Joseph Schumpeter called "creative destruction" — a desirable culling of businesses that can't keep pace. But try telling that to the tens of thousands of workers laid off in just the first six months of this year by once-dominant companies in the electronics, computer and mobile telecom industries.

Would shareholders of Kodak — which had some of the earliest digital photography technology — agree that its destruction made evolutionary sense, or would they echo Harvard Professor John Kotter's remark that it was the result of "complacency"? Did it seem "creative" to Nokia shareholders when the company missed the smart phone wave despite having some of the early technology?

We have been studying companies that seem to be able to endure and adapt for longer periods of time, and have come to the conclusion that the extinction of once-great innovators is less often caused by technological or market evolution, and more often by self-inflicted wounds and slow cycles of decision and adaptation.

Unlike dinosaurs, which had no conscious way to adapt to rapid changes around them, companies and CEOs have a choice. They can focus and simplify their organizations. Or, as happens all too often, they can pursue complex strategies that beget complex organizations and complex processes until they grind to a halt like a Rube Goldberg machine.

It is this complexity, my colleague James Allen and I report in our new book Repeatability, that is the "silent killer of profitable growth," and the greatest inhibitor of adaptability.

Repeatability was based on a three-year Bain & Company study of enduring profit and relative competitive ability to adapt in a world of increasing velocity and uncertainty. Consider these three statistics from our ongoing analysis:

  1. Nearly two-thirds of companies now destroy value. Of the 70,000 companies with market data available, more than 42,000 earned shareholder returns (dividends + stock price appreciation) below inflation. Of course, the 'great disasters' of the past two decades were part of this list, such as Vivendi, General Motors, and AOL/Time Warner. But next to those there were thousands of relatively small companies that simply failed to create any value for investors. And those small companies add up: altogether, they destroyed $16 trillion.
  2. Only 9% of companies achieved even a modest level of sustained and profitable growth. In the past decade, the percentage of companies achieving even 5.5% real revenue and profit growth and earning their cost of capital has steadily declined. Yet almost every business aspires to do this.
  3. Just 100 companies accounted for $10 trillion in net returns. Although most companies failed to earn returns that beat inflation over 20 years, all of the companies we studied combined returned $19 trillion (above inflation) over 20 years. Remarkably, just 100 companies generated more than half of that amount.

So how did the top 100 create such astonishing returns?

About 25 of them did so thanks to the commodity bonanza that unfolded during the last two decades (for example, the price of a barrel of oil has risen from $20 in 1992 to about $100 today).

But among the rest, the majority produced those returns thanks to what we call a Great Repeatable Model. American Express, AB InBev, Larsen & Toubro, Hankook Tire, Toyota, Olam — all are companies that found a way to replicate their success again and again. Although some lost their way temporarily, all are characterized over the long term by their simple focus on their historic core, which allowed them to continuously grow their profit pools, and tap into new ones.

What can executives learn from these 100 companies? We see four key lessons:

Build an intolerance for excess complexity. Root it out wherever you find it. Markets change; technology evolves. But it is internal complexity that turns companies into lumbering dinosaurs.

Compete for the long term. Stock markets might seem capricious, but in the long term, shareholder returns closely track operational performance. "We are willing to be misunderstood for long periods of time," says Amazon CEO Jeff Bezos.

Focus on your greatest strengths. Focus on what you have that others don't, not on what others have that you don't. It is no accident that one of the most amazing business turnarounds in history — Apple — was triggered by a simplification of the product line (four products), the R&D pipeline and even the organization.

Make strategy a search for a Repeatable Model that can replicate and adapt your greatest successes again and again. Most of the 9% of companies that achieved sustained profitable growth over a long period are distinguished by their simplicity and focus — and their ability to react faster than their competitors because of it.

Chris Zook is co-head of the Global Strategy Practice at Bain & Company. He is co-author, with James Allen, of the upcoming book: Repeatability: Build Enduring Businesses for a World of Constant Change (HBR Press, March 2012). He is the author of Profit from the Core and an author and co-author of numerous other books and HBR articles, including The Great Repeatable Business Model, published in HBR in November 2011.