Companies can expect to die - unless they innovate!

I commented in my last post about the ways in which organizations are like living systems, and how it can be helpful to anticipate these natural of and change in our organizational life. However, I was taken by surprise by some validation of this from an unexpected source…

I was watching a TED Talk called "The Surprising Math of Cities and Corporations" by Geoffrey West  (a physicist associated with the Santa Fe Institute, a research group focused on multidisciplinary studies of complex adaptive systems).  (Additional references to his work are available at the bottom of this post).   

The title was the first thing that caught my eye, but I became increasingly intrigued as he started to explain some curious parallels between animals, cities and corporations.

Dr West first offers some background, drawing on some of his earlier work.  He had uncovered the mathematical principles that explains an observed relationship that exists between all mammals - the greater the mass of the mammal (think of mice and elephants as two extremes of the scale), the more efficient its metabolism - in a predictable manner.  The elephant is about 75% as efficient as a mouse, relative to its size (this is known as the metabolic scaling theory - a useful introduction is available here).

Source: http://www.thecloudcollective.org/blog/9/blog_intro.jpg

West wondered whether this principle might be found in other living systems, such as cities. After wading through the data, he found that this principle of efficiency and scale does indeed apply.  The basic idea is that doubling the size of a city brings about a 85% increase in certain  infrastructure (e.g. banks, gas stations), rather than the expected doubling - this 15% is known as sub linear growth, and is the basis of the idea of economies of scale.  (An example from the Netherlands is shown in the chart). However, the city research also uncovered that doubling the size of a city brings about a 115% growth in certain 'assets' such as income, number of patents, (and crime!). This super liner growth points to the benefits of growth, the reasons why cities have continued to grow and be successful is that the serve the needs of their inhabitants in ways that smaller towns and cities cannot...

Then West began to ponder whether this principle might apply to that other large social system in which we spend much of our time – corporations. Working with data from thousands of publicly traded companies in the United States (useful because of comparable data), West and his colleagues found that the same scaling theory was evident.

In some ways, this is not surprising. As companies grow larger, they need to become more efficient in their processes and systems.  Companies will see sub linear growth as they achieve economies of scale.

This is the concept inherent in the shift from the Pioneer Phase to the Rational Phase that is described in the Barefoot Guide that I introduced in my previous post.

However, profit per employee (a useful metric for the nature and quality of growth) also follows a sub linear pattern – the larger a company becomes, the more efficient its processes and systems, the lower the profit per employee, as companies invest more and more revenue in managing and maintaining the systems that are necessary to sustain their size.

This raises the key challenge for organizations – their growth will inevitably lead to their decline and death.  The only way out of this predicament is to bring about super linear growth, a route that is often only possible through innovation and disruptive change (this is what cities have had to do in order to maintain their super linear growth).

The difficulty of this is that organizations have become comfortable with their business models, and are often reluctant to change a business model that appears to be working so well for them – after all, it's this very business model that allowed them to grow and be successful in the first place.  Compounding the challenge, it can be very hard to recognize just when the organization has gone over the top of the Growth/Decline curve, and managers are reticent to abandon a business model that still seems to be working for them. 

There is a wealth of interesting research and writing on this theme of confronting a declining business model.  I will explore this further in future posts, as I believe this ability to forecast and anticipate decline, while simultaneously investing in and building new and disruptive business lines is a critical capacity in organizational leaders.

Additional resources on Dr. West's work:

"A Physicist Solves the City" New York Times Magazine

Why Cities Keep Growing, Corporations and People Always Die, and Life Gets Faster  – a conversation with Geoffrey West