Smart Companies Fail Because they Do Everything Right - Staying Alive to Scale

Wired has a wonderful interview with Clayton Christensen, author of the tech ninja's bible, Innovator's Dilemma. Innovation is the name of the game in Silicon Valley and if you want to understand the rules of the game this article is a quick and clear way of learning. Everything is simply explained with compelling examples by the man himself.

Just as every empire has fallen, every organization is open to disruption. It's the human condition to become comfortable and discount potential dangers. It takes a great deal of mindfulness to outwit and outlast the human condition. If you want to be the disruptor and avoid being the disruptee, this is good stuff.

He also talks about his new book, The Capitalist's Dilemma, which addresses this puzzle: if corporations are doing so well why are individuals doing so bad?

If someone can help you see a deep meaningful pattern in life then they haven't brought you a fish, they've taught you how to fish. That's what Christensen does. Here's a gloss of his world view changing points:

  • Strength becomes weakness. Successful companies, usually once disruptors, go soft and become sustainers. Sustainers focus on sustaining innovations at the profitable high end of the market, making things bigger, more powerful, and more efficient.
  • Sustainers lose to disruptors. Disruptors create disruptive innovations at the low-margin end of the market. Appearing weak, disruptors aren't initially a threat to sustainers, but disruptive products become better and better over time, overtaking the sustainers and killing them off. Examples: PC, MP3, disk drives, transistor radio, mini mills. Potentially vulnerable: journalism, education.
  • Right becomes wrong. Money example from the disk drive industry: "You could see how, in each generation, an established company would start focusing on bigger, more powerful disks for the top end of the market and then just get wiped out when the lower end of the market found a way to make smaller, cheaper disks, even though those had lower profit margins. It made my thesis. Smart companies fail because they do everything right. They cater to high-profit-margin customers and ignore the low end of the market, where disruptive innovations emerge from."
  • Disrupt yourself. Intel's Andy Grove took the disruption model to heart and decided to cannibalize their own market by developing the Celeron Processor, a cheap and low-performance chip, disrupting Cyrix and AMD, and becoming the highest-volume product in the company.
  • Not what to think, how to think. The idea is to understand the disruption model of evolution and apply it to your own space. Christensen didn't tell Andy Grove how to run Intel, he helped Grove understand how AMD and Cyrix may not look like true competitors now, but that they really could be in a position to bring Intel down. Andy Grove decided what to do with this information.
  • Management is about helping people become better people. It's not about making deals and laying off people and cutting costs.
  • Tax investment capital at lower rates the longer it has been invested. The economy is doing better but jobs are not being created. Part of the cause he thinks is the Doctrine of New Finance: "We’ve encouraged managers to measure profitability based on a return on net assets, or return on capital employed. That encourages companies to liberate their capital, so they invest in efficiency innovations, which means they can make more money with fewer resources." For more jobs we need to encourage greater innovation which means we need to encourage longer term investments. Only investments held more than a year get a lower tax rate and year is very short term. His suggestion is not for the government to pick winners, but to change the tax code to encourage longer term investment by lowering the tax rate as the period of investment increases, perhaps even going negative.

I did little investigation on the tax rate issue, you'll find a couple of related papers at the end of this article. You may remember that we in the US did have a graduated system of capital gains taxes at one time, where short, intermediate, and long term (5 years) gains were taxed at different rates. The idea was to encourage longer term investments with lower tax rates, making riskier long term investments more attractive. That system was removed in 1997 to favor short term thinking.

I'm assuming the "going negative" part of his plan means a tax credit. A tax credit has downsides. It wil be gamed or course. Also, it is ethical for everyone else to pay investors to invest money?

Another suggestion I haven't heard, made by someone I talked to, is to make jobs the measure:

Like long-term capital gains, qualified dividends are taxed at a lower rate. Currently, dividends paid by most all US companies, and even some foreign ones meet the criteria for qualified dividends. If we really want to make job creation a priority, why not tie the qualified dividends to US jobs? Qualified dividends could be allocated based on a company's US workforce compared to its workforce outside the US. This would create incentives for companies to keep the majority of their employees in the US.

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