Managing Director & Senior Partner, Chairman of the BCG Henderson Institute
San Francisco - Bay Area
Related Expertise: Corporate Finance and Strategy
The Roman philosopher Seneca famously noted that institutions flourish slowly but fail rapidly. The same maxim applies to businesses. Take for instance Kodak, which was more than a century old when it was near its all-time sales peak in 2005; just six years later, it filed for bankruptcy.
How can companies today, faced with the growing threat of competitive disruption, avoid such catastrophic failure? Forward-looking leaders must avoid being deceived by traditional performance metrics and create new growth options before the path to collapse is unavoidable. Research in other fields, including biology and computer science, offers valuable lessons on when and how a business should innovate in order to maximize its chance of survival.
Businesses, like biological ecosystems, are complex adaptive systems. Many thriving systems are based on positive feedback loops that propel growth. In nature, these may take the form of mutualistic relationships, in which species benefit from each other—for example, bees collect nectar and pollen from plants for sustenance, pollinating the plants, creating more food sources to allow further growth in the bee population, and so forth. Similarly, in business, a desirable new product creates consumer demand, which drives sales, permitting further product entries and investment to grow the market, and so on.
However, systems also face countervailing forces—negative feedback loops—that limit growth. In biological systems, growth may be constrained by the depletion of food or other necessary resources. In business, success may encourage imitators that saturate the market and commodify the product, or disruptors with superior offerings that can rapidly undermine the incumbent’s business. Further, high production levels may cause negative environmental effects or other externalities, eventually precipitating a backlash from regulators or consumers.
Traditional business metrics and strategies tend to reinforce these negative feedback effects. Firms mostly measure themselves by backward-looking metrics like sales and profits, which are lagging indicators of sustainability. And once a successful business model has been developed, companies often become “financialized,” seeking primarily to maximize efficiency and value extraction from core offerings. From this perspective, marginal investments in innovation may seem too risky. Cutting investment, however, reduces the diversity of the company’s growth options, thus creating systemic risk that may be triggered by shifts in demand or competition.
The modeling of complex systems, such as businesses, indicates that for a wide range of plausible parameters, the decline can be much faster than the rise. Furthermore, the dynamics that lead to destruction begin even before sales or profits have peaked. Business leaders must therefore act preemptively—they must invest in innovation even while the existing model is still lucrative.
As most leaders know, the ramp-up speed of new businesses is accelerating in the digital age. Whereas it took Walmart 18 years to reach $1 billion in revenue (the fastest ramp-up in history at the time), it took Facebook only six years and Pokémon Go only seven months. This is a consequence of the low asset intensity and inherent agility of increasingly prevalent digital business models.
What is less often discussed, however, is that firms are also falling more rapidly. Our analysis shows that only 44% of today’s industry leaders have held their position for at least five years, down from 77% a half-century ago.
Thus, preemptive innovation is now more important than ever for incumbent companies. How can leaders effectively pursue such a strategy?
Biological organisms have been competing in complex systems for billions of years and have evolved strategies that enhance long-term success in a continual game against nature, and against others. Their actions reveal useful hints for business leaders on when and how to pursue new options:
Unlike foraging animals, business leaders don’t face a binary choice between exploitation and searching—they can devote resources to both in parallel. But the MVT shows that companies should make sufficient investments in innovation well before their current growth engine is exhausted.
In business, innovation efforts should not be limited to either “big steps” or “small steps.” Instead, firms should leverage both in tandem—big steps to move to uncharted terrain and small steps to uncover adjacent options at low cost—and learn from previous attempts to identify new opportunities.
Business leaders should create variation though experimentation and let the market choose winners, especially when the environment is uncertain. For example, Alibaba rotates a portion of its senior leadership through its various business lines each year, not merely to improve the skills of individual leaders but to combine institutional knowledge from different sources—a form of “genetic recombination” that increases variation and accelerates the firm’s evolution.
The study of algorithms also provides hints on strategies for preemptive innovation. Several types of problems can be solved with heuristics that, while sometimes counterintuitive, demonstrate when and how to pursue innovation.
Much like with slot machines, the true value of potential innovations is uncertain, so it may be tempting to focus on those that promise the biggest short-term payoff. However, to maximize long-run performance, leaders should always preserve some resources to explore alternative offerings, regardless of where their business is in its life cycle.
Similarly, business leaders should start with a wide scope when exploring new innovations and make “big moves” across the space of potential options, refining narrowly with “small moves” only once the best direction is clear.
When making decisions at all levels of the business, leaders should not be afraid to inject some random variation and test the results empirically, rather than relying too much on analysis and intuition to design solutions.
Preemptive innovation is a challenge for incumbent firms: short-term investor pressures can discourage investment, and past success tends to entrench the current business model. But some firms have managed not to box themselves into a corner: approximately 10% of large incumbents are still growing at double-digit rates.
Past performance is a poorer and poorer indicator of future success. In today’s highly complex business environment, failure can come faster than ever—so incumbent firms cannot be complacent. To avoid falling off Seneca’s cliff, it is crucial that business leaders look forward as well as backward, and invest in new sources of growth before the peak of their current models is imminent.
The BCG Henderson Institute is Boston Consulting Group’s strategy think tank, dedicated to exploring and developing valuable new insights from business, technology, and science by embracing the powerful technology of ideas. The Institute engages leaders in provocative discussion and experimentation to expand the boundaries of business theory and practice and to translate innovative ideas from within and beyond business. For more ideas and inspiration from the Institute, please visit Featured Insights.