The biggest groups are ill with inefficiency
By Luke Johnson
Published: April 5 2011 22:51 | Last updated: April 5 2011 22:51
The paradox of large organisations is that they have virtually all the assets – money, brands, intellectual property, facilities, momentum – yet their natural dominance is frequently overturned by upstarts. How is it that emerging companies, with minimal resources, can defeat huge, established players?
The answer is that big corporates fall prey to a number of diseases, the pathology of which I describe below:
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● Sunk cost fallacy: the idea that you should throw good money after bad. I have witnessed boards that continued to waste money on doomed projects because no one was prepared to admit they were failures, take the blame and switch course. Smaller outfits are more willing to admit mistakes and dump bad ideas.
● Groupthink: a condition whereby an error is perpetuated thanks to peer pressure, so it becomes orthodoxy. The belief that subprime mortgages were a sound investment was a classic. Virtually the entire finance industry fell for this myth, thanks to the perpetuation of false assumptions, and an unwillingness to break ranks and question the “experts”.
● An obsession with governance: increasingly, institutions favour compliance over competence, and box-ticking over practical solutions. I resigned from the board of a Nasdaq-traded corporation because – thanks to Sarbanes-Oxley – the audit committee meetings lasted longer than the actual board meetings.
● Institutional capture: the phenomenon whereby management end up running an enterprise for their own benefit, rather than for the real owners. This is also known as the principal/agent problem, and is epitomised by behaviour at banks. There, senior executives still think they are entitled to millions of dollars remuneration for an average job. In reality those executives are easily replaceable, while the value and market shares of their banks have actually been built up over decades by many others.
● Office politics: self-destructive infighting for power within large businesses is endemic, and perhaps the biggest value destroyer of all. A brilliant New York Times article last year by an ex-Microsoft executive revealed how the world’s largest software business had a viable tablet PC 10 years ago, which could have pre-empted the smash hit iPad from Apple. But other Microsoft divisions conspired to kill the project because they did not want resources being diverted away from their own imperial ambitions.
● Lack of proprietorship: when employees have no effective capital stake in an organisation, they tend to be less cost-conscious, and take a more cavalier attitude to waste, personal expenses and the like.
● Risk aversion: in most large corporates, the punishment for management failure is greater than the rewards for success. So, rational individuals pursue cautious strategies because they do not want to damage their career prospects. Entrepreneurs often have nothing to lose, and hence are more willing to take the plunge with innovations. Thus a solitary inventor such as James Dyson can beat the rich market leader Hoover because it saw only danger in new technology, while he saw a better vacuum cleaner.
● The burden of history: many older companies have legacy issues such as pension scheme deficits, union contracts, inefficient equipment and so on. By contrast, newcomers can outsource and use the latest technology.
● Anonymous mediocrities: there is nowhere to hide in a small company – if you can’t deliver, you’re out. But in a large outfit, also-rans can get away with poor work for years.
● Commodity products: large companies need large markets, which tend to be mature, more competitive and lower margin. Small firms are happy to sell niche merchandise, where returns are often higher.
The deck is stacked in favour of bigness. But, just as the lumbering dinosaurs could not adapt and became extinct, so giant businesses are likely to be less flexible, motivated and focused. The truth is that there are many intangible diseconomies of scale, which means leviathans are often less profitable, and usually much less fun.
Copyright The Financial Times Limited 2011