Creative Destruction: Why Companies That Are Built to Last Underperform the Market--And How to Successfully Transform Them - Hardcover

Foster, Richard; Kaplan, Sarah

Hardcover

ISBN 10: 0385501331 ISBN 13: 9780385501330

Publisher: Broadway Business, 2001

Synopsis

Turning conventional wisdom on its head, a Senior Partner and an Innovation Specialist from McKinsey & Company debunk the myth that high-octane, built-to-last companies can continue to excel year after year and reveal the dynamic strategies of discontinuity and creative destruction these corporations must adopt in order to maintain excellence and remain competitive.

In striking contrast to such bibles of business literature as In Search of Excellence and Built to Last, Richard N. Foster and Sarah Kaplan draw on research they conducted at McKinsey & Company of more than one thousand corporations in fifteen industries over a thirty-six-year period. The industries they examined included old-economy industries such as pulp and paper and chemicals, and new-economy industries like semiconductors and software. Using this enormous fact base, Foster and Kaplan show that even the best-run and most widely admired companies included in their sample are unable to sustain their market-beating levels of performance for more than ten to fifteen years. Foster and Kaplan's long-term studies of corporate birth, survival, and death in America show that the corporate equivalent of El Dorado, the golden company that continually outperforms the market, has never existed. It is a myth.

Corporations operate with management philosophies based on the assumption of continuity; as a result, in the long term, they cannot change or create value at the pace and scale of the markets. Their control processes, the very processes that enable them to survive over the long haul, deaden them to the vital and constant need for change. Proposing a radical new business paradigm, Foster and Kaplan argue that redesigning the corporation to change at the pace and scale of the capital markets rather than merely operate well will require more than simple adjustments. They explain how companies like Johnson and Johnson , Enron, Corning, and GE are overcoming cultural "lock-in" by transforming rather than incrementally improving their companies. They are doing this by creating new businesses, selling off or closing down businesses or divisions whose growth is slowing down, as well as abandoning outdated, ingrown structures and rules and adopting new decision-making processes, control systems, and mental models. Corporations, they argue, must learn to be as dynamic and responsive as the market itself if they are to sustain superior returns and thrive over the long term.

In a book that is sure to shake the business world to its foundations, Creative Destruction, like Re-Engineering the Corporation before it, offers a new paradigm that will change the way we think about business.

About this title

About the Author

Richard Foster is a senior partner and director at McKinsey & Company and the author of the bestselling Innovation: The Attacker's Advantage, named one of the best business books of the year by The Wall Street Journal.

Sarah Kaplan worked at McKinsey & Company for many years, specializing in innovation and technology management. Foster lives in New York City, and Kaplan in Boston.

From the Back Cover

Advance acclaim for Creative Destruction:

"A thoroughly researched, masterfully written, and somewhat frightening explanation of how competitive advantage is built and inevitably erodes. Anyone who is interested in staying ahead of the competition should read this book. It's good."
—Clayton Christensen, Associate Professor, Harvard Business School, and author of The Innovator's Dilemma.

"[Offers] invaluable insight into business building and dealing with the challenge of dynamic growth. Foster and Kaplan get right to the heart of one of today's central themes. An instructive and insightful guide for managers to navigate the twenty-first century."—Jorma Ollila, Chairman and CEO, Nokia Corporation

"It was clear the game had changed, but until this book it was never clear by how much. Creative Destruction will reverberate in corporate boardrooms for some time to come, changing the basic premises of corporate success. There is no doubt that, in order to survive in the future, inspiration can be found in Foster's and Kaplan's book"—Antony Burgmans, Chairman, Unilever, N.V., the Netherlands

"Creative Destruction is a phenomenal book. It reveals what it takes for an enterprise to thrive in the age of discontinuities yet meet the pressures of continuous performance. Wise, sweeping, balanced, grounded in facts and yet highly imaginative, it is unquestionably the best business book I have ever read Countless numbers of CEOs will wish they could have read it sooner—and so will their shareholders."—John Seely Brown, President, Xerox Palo Alto Research Center

"Creative Destruction has clarified for me the challenges of sustaining business success. It is the freshest view of the challenges before us that I have seen. It also shows where we have to change to be successful. Compelling."—Vernon Jordan, Lazard Frres.

"Creative Destruction is a sharp stick in the eye for corporate conventional wisdom and orthodoxy. Foster and Kaplan have captured the essence of market-driven counterinitiative thinking. A wake-up call for CEOs and investment strategists!"—Joe L. Roby, Chairman, Credit Suisse First Boston Corporation

From the Inside Flap

entional wisdom on its head, a Senior Partner and an Innovation Specialist from McKinsey & Company debunk the myth that high-octane, built-to-last companies can continue to excel year after year and reveal the dynamic strategies of <i>discontinuity </i>and creative destruction these corporations <i>must</i> adopt in order to maintain excellence and remain competitive.<br><br>In striking contrast to such bibles of business literature as <b>In Search of Excellence</b><i> </i>and <b>Built to Las</b><i>t, </i>Richard N. Foster and Sarah Kaplan draw on research they conducted at McKinsey & Company of more than one thousand corporations in fifteen industries over a thirty-six-year period. The industries they examined included old-economy industries such as pulp and paper and chemicals, and new-economy industries like semiconductors and software. Using this enormous fact base, Foster and Kaplan show that even the best-run and most widely admired companies inc

Reviews

In this painstakingly researched, well-documented work, Foster (Innovation: The Attacker's Advantage, 1986) and Kaplan argue that one of the fundamental tenets of American business that a company must be designed to stand the test of time is seriously flawed. Building off the ideas of economist Joseph Schumpeter, who argued in the 1930s and 1940s that capital markets weed out underperformers so that new firms can take their place, Foster and Kaplan contend that once they are successful, companies tend to institutionalize the thinking that allowed them to thrive. However, they say, markets now change too quickly for traditional management structures to keep up. Rather than aiming for continuity, companies should embrace discontinuity, they argue, constructively destroying and re-creating themselves as needed. Aspects of this idea have been proposed for nearly 15 years by authors like Tom Peters and Andy Grove, but Foster and Kaplan's extensive research, drawing on analysis of more than 1,000 companies over four decades, have moved the argument beyond rhetoric. Their prescriptions for forward-looking management increase the pace of change within organizations, open up the decision-making process and relax conventional notions of control are not as fresh as the rest of their argument. But there is no doubt that Foster, a senior partner and director at the consulting firm McKinsey & Co., and Kaplan, a former McKinsey employee who is now a doctoral student at M.I.T., have raised significant questions about how organizations should define long-term success. (May)Forecast: A four-city author tour and print advertising campaign may help attract attention to this book, but it's more likely to be talked about than bought or read.

Copyright 2001 Cahners Business Information, Inc.

The "perennial gale of creative destruction" is a phrase coined by economist Joseph Schumpeter. Although he died in 1950, his name has been invoked regularly during the past year to explain the "gale" of dot.com failures. Foster is a senior partner at consulting powerhouse McKinsey & Co., where coauthor Kaplan worked for many years. They also cite Schumpeter to make the case that companies that fail to reinvent themselves and continually innovate will fall by the wayside. They back their assertion using the McKinsey Corporate Performance Database. It tracks the performance of 1,000 companies in 15 industries over four decades. Foster and Kaplan warn that companies must overcome their inability to change their corporate cultures ("cultural lock-in") and their corporate control systems. McKinsey's data shows that the market's overall rate of change ("discontinuity") will continue to accelerate; the authors stress that companies must "act more like the market" and prescribe ways for doing so. David Rouse
Copyright © American Library Association. All rights reserved

In this new book by two McKinsey consultants, the central question is a very simple one: why do good companies fail? The focus of the book is not so much on corporate continuity as "discontinuity," or companies' constant need to destroy and re-create themselves in order to adapt to changing business conditions. Reflecting a "corporate Darwinism," the authors feel that "destruction is a mechanism that allows the market to maintain freshness by eliminating those elements that are no longer needed." From their research of over 1000 American companies, they show that even successful corporations over time invariably underperform. Examples of companies that chose to "destroy" themselves and reemerge phoenixlike include such well-known names as General Electric, Intel, and Enron. The authors are certainly onto something, but the conclusions aren't all that new. The book comes across as a slick client presentation loaded with graphs, charts, and plenty of business jargon that is often numbing to read. A more satisfying book on this subject is Clayton Christensen's The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail. (Harvard Business, 1997). Not recommended. Richard Drezen, Washington Post/NYC Bureau, New York
Copyright 2001 Reed Business Information, Inc.

Excerpt. © Reprinted by permission. All rights reserved.

Survival and Performance in the Era of Discontinuity

This company will be going strong one hundred and even five hundred years from now.
- C. Jay Parkinson, President of Anaconda Mines, statement made three years in advance of Anaconda's bankruptcy

In 1917, shortly before the end of World War I, Bertie Charles (or B.C., as he was known) Forbes formed his first list of the one hundred largest American companies. The firms were ranked by assets, since sales data were not accurately compiled in those days. In 1987, Forbes republished its original "Forbes 100" list and compared it to its 1987 list of top companies. Of the original group, 61 had ceased to exist.

Of the remaining thirty-nine, eighteen had managed to stay in the top one hundred. These eighteen companies--which included Kodak, DuPont, General Electric, Ford, General Motors, Procter & Gamble, and a dozen other corporations--had clearly earned the nation's respect. Skilled in the arts of survival, these enterprises had weathered the Great Depression, the Second World War, the Korean conflict, the roaring '60s, the oil and inflation shocks of the '70s, and unprecedented technological change in the chemicals, pharmaceuticals, computers, software, radio and television, and global telecommunications industries.

They survived. But they did not perform. As a group these great companies earned a long-term return for their investors during the 1917-1987 period 20% less than that of the overall market. Only two of them, General Electric and Eastman Kodak, performed better than the averages, and Kodak has since fallen on harder times.

One reaches the same conclusion from an examination of the S&P 500. Of the five hundred companies originally making up the S&P 500 in 1957, only seventy-four remained on the list through 1997. And of these seventy-four, only twelve outperformed the S&P 500 index itself over the 1957-1998 period. Moreover, the list included companies from two industries, pharmaceuticals and food, that were strong performers during this period. If today's S&P 500 today were made up of only those companies that were on the list when it was formed in 1957, the overall performance of the S&P 500 would have been about 20% less per year than it actually has been.

For the last several decades we have celebrated the big corporate survivors, praising their "excellence" and their longevity, their ability to last. These, we have assumed, are the bedrock companies of the American economy. These are the companies that "patient" investors pour their money into--investments that would certainly reward richly at the end of a lifetime. But our findings--based on the thirty-eight years of data compiled in the McKinsey Corporate Performance Database, discussed in the Introduction--have shown that they do not perform as we might suspect. An investor following the logic of patiently investing money in these survivors will do substantially less well than an investor who merely invests in market index funds.

McKinsey's long-term studies of corporate birth, survival, and death in America clearly show that the corporate equivalent of El Dorado, the golden company that continually performs better than the markets, has never existed. It is a myth. Managing for survival, even among the best and most revered corporations, does not guarantee strong long-term performance for shareholders. In fact, just the opposite is true. In the long run, markets always win.

The Assumption of Continuity

How could this be? How could a stock market index such as the Dow Jones Industrial average or the S&P 500 average--which, unlike companies, lack skilled managers, boards of experienced directors, carefully crafted organizational structures, the most advanced management methods, privileged assets, and special relationships with anyone of their choosing--perform better, over the long haul, than all but two of Forbes's strongest survivors, General Electric and Eastman Kodak? Are the capital markets, as represented by the stock market averages, "wiser" than managers who think about performance all the time?

The answer is that the capital markets, and the indices that reflect them, encourage the creation of corporations, permit their efficient operations (as long as they remain competitive), and then rapidly--and remorselessly--remove them when they lose their ability to perform. Corporations, which operate with management philosophies based on the assumption of continuity, are not able to change at the pace and scale of the markets. As a result, in the long term, they do not create value at the pace and scale of the markets.

It is among the relatively new entrants to the economy--for example, Intel, Amgen, and Cisco--where one finds superior performance, at least for a time. The structure and mechanisms of the capital markets enable these companies to produce results superior to even the best surviving corporations. Moreover, it is the corporations that have lost their ability to meet investor expectations (no matter how unreasonable these expectations might be) that consume the wealth of the economy. The capital markets remove these weaker performers at a greater rate than even the best-performing companies. Joseph Alois Schumpeter, the great Austrian-American economist of the 1930s and '40s, called this process of creation and removal "the gales of creative destruction." So great is the challenge of running the operations of a corporation today that few corporate leaders have the energy or time to manage the processes of creative destruction, especially at the pace and scale necessary to compete with the market. Yet that is precisely what is required to sustain market levels of long-term performance.

The essential difference between corporations and capital markets is in the way they enable, manage, and control the processes of creative destruction. Corporations are built on the assumption of continuity; their focus is on operations. Capital markets are built on the assumption of discontinuity; their focus is on creation and destruction. The market encourages rapid and extensive creation, and hence greater wealth-building. It is less tolerant than the corporation is of long-term underperformance. Outstanding corporations do win the right to survive, but not the ability to earn above-average or even average shareholder returns over the long term. Why? Because their control processes--the very processes that help them to survive over the long haul--deaden them to the need for change.

The Reality of Discontinuity

This distinction between the way corporations and markets approach the processes of creative destruction is not an artifact of our times or an outgrowth of the "dot.com" generation. It has been smoldering for decades, like a fire in a wall, ready to erupt at any moment. The market turmoil we see today is a logical extension of trends that began decades ago.

The origins of modern managerial philosophy can be traced to the eighteenth century, when Adam Smith argued for specialization of tasks and division of labor in order to cut waste. By the late nineteenth century these ideas had culminated in an age of American trusts, European holding companies, and Japanese zaibatsus. These complex giants were designed to convert natural resources into food, energy, clothing, and shelter in the most asset-efficient way--to maximize output and to minimize waste.

By the 1920s, Smith's simple idea had enabled huge enterprises, exploiting the potential of mass production, to flourish. Peter Drucker wrote the seminal guidebook for these corporations in 1946, The Concept of the Corporation. The book laid out the precepts of the then-modern corporation, based on the specialization of labor, mass production, and the efficient use of physical assets.

This approach was in deep harmony with the times. Change came slowly in the '20s, when the first Standard and Poor's index of ninety important U.S. companies was formed. In the '20s and '30s the turnover rate in the S&P 90 averaged about 1.5% per year. A new member of the S&P 90 at that time could expect to remain on the list, on average, for more than sixty-five years. The corporations of these times were built on the assumption of continuity--perpetual continuity, the essence of which Drucker explored in his book. Change was a minor factor. Companies were in business to transform raw materials into final products, to avoid the high costs of interaction between independent companies in the marketplace. This required them to operate at great scale and to control their costs carefully. These vertically integrated configurations were protected from all but incremental change.

We argue that this period of corporate development, lasting for more than seventy years, has come to an end. In 1998, the turnover rate in the S&P 500 was close to 10%, implying an average lifetime on the list of ten years, not sixty-five! Drucker predicted the turning point with his 1969 book The Age of Discontinuity, but his persuasive arguments could not overcome the zeitgeist of the '70s. The '70s were, for many managers, the modern equivalent of the 1930s. Inflation raged, interest rates were at the highest levels since before World War II, and the stock market was languishing. Few entrants dared risk capital or career on the founding of a new company based on Drucker's insights. It was a fallow time for corporate start-ups. As the long-term demands of survival took over, Drucker's advice fell on deaf years.

The pace of change has been accelerating continuously since the '20s. There have been three great waves. The timing and extent of these waves match the rise and fall of the generative and absorptive capabilities of the nation. The first wave came shortly after World War II, when the nation's military buildup gave way to the need to rebuild the consumer infrastructure. Many new companies entered the economy at this time, then rose to economic prominenc...

Edition details

• Publisher: Broadway Business
• Publication date: 2001
• Language: English
• ISBN 10: 0385501331
• ISBN 13: 9780385501330
• Binding: Hardcover
• Edition number: 1
• Number of pages: 384