March 11, 2008

Success Containing The Seeds Of Failure - March 2008

People who should know better, such as sophisticated investors, members of the media, or experts, are always surprised when a successful firm, or for that matter, a successful industry such as financial services, experiences a rapid and severe decline. I am not surprised, because virtually every kind of success contains within it the seeds of future failure. There are four reasons for this.

First, successful companies that achieve a dominant position in a market are most vulnerable to disruptive technologies precisely because they have the greatest stake in maintaining the business model that made them successful. Clayton Christiensen eloquently and cogently discussed this in his landmark book The Innovator’s Dilemma. Thus, even legitimate success can become a trap that prevents a firm from adapting to a threat.

Second, people start to believe that success will continue unabated, and lose sight of its non-sustainability. Companies that are most favored by the investor marketplace are most likely to take a big fall and cause the greatest decline in investor wealth, because investors over-estimate the sustainability of the company’s growth potential. Google has declined from $740 a share last summer to $464 a share the other day, a massive wipe-out of investor wealth, but one which could only occur because of Google’s fabulous success.

Third, success breeds resentment and a desire by other stakeholders to capture all or part of the wealth accumulated by the successful firm. Companies that have amassed a lot of cash and market power are most vulnerable to governmental regulators, political activists who want to capture their wealth for redistribution, or communities that want that cash for social and economic needs. Microsoft just got whacked again by the European Union with a $1.35 billion fine, and Exxon-Mobil, the world’s most profitable company, got hit with yet another multi-billion dollar jury verdict for the Valdez environmental events that occurred almost 20 years ago.

Fourth, there is typically a finite limit to how much growth can be achieved in a given marketplace at an acceptable level of risk. Invariably, firms are driven to continue a particular path of success in a market and they inadvertently gravitate toward unacceptably high risks.

The MSN Money Top Stocks blog recently posted a story appropriately titled “8 Famous Companies that May Vanish This Year.” It demonstrates the risks that come along with great success.

One of the most difficult tasks of a leader, whether he or she is a member of a Board of Directors, a CEO, or a lower-level leader, is to retain a balanced point of view about success. It is tempting only to focus on fixing what is going wrong, but an equal effort needs to be focused on making sure that things are going too well can be sustained in the event of the inevitable attack upon them. Moreover, the leader needs to have robust risk management analysis to understand better when the growth curve is likely to end, and to prepare for its eventual demise.

Alexander Stein, a columnist for Fortune.com, addresses the fury of success in his article “When ‘big’ business becomes ‘too big’”. While the article refers primarily to smaller businesses, it highlights the reasoning behind why success can be “psychologically problematic.”

There is a well-established statistical concept of regression to a mean, which, simply put, means that extreme variability around an expected result of a repeatable process will tend to move back toward the mean or average result over time, and that variability will become less and less likely the more often the process is repeated. Likewise, business success over time becomes less and less likely the longer an organization exists, because many forces come into play to pull it back toward points of failure.

On the flip side of this argument, situations, like days, are “darkest before the dawn.” Very often, times of great failure also create opportunities. Organizations that have just experienced a huge setback have the easiest time mobilizing around change. Businesses or firms that deliver valuable products and services, but are financially strapped, are more likely to receive help than the highly-profitable.

Investors, employees, or members of the public need to temper their enthusiasm to jump on a bandwagon and stay there indefinitely. While a few firms manage to reinvent themselves and never skip a beat over a long period of time, the odds of long-term uninterrupted growth are very low. Companies like Pitney Bowes have to endure these periods of time when other companies get all the buzz, but we eventually attract some investors who have been burned by holding on to the latest hot stock too long.