Friday, October 08, 2010

Why it's hard for great companies to avoid death

In my previous post, I wrote some thoughts on what is really happening when a great big successful company dies.  I'm talking about the really good, long-term, successful, famous brands like Blockbuster, not the scandal-ridden Enrons that grabbed undeserved headlines galore in their heyday.  The scandal-ridden companies were doomed from the start because faking profits is not sustainable.  But great companies like Blockbuster, with real profits, fantastic operations, fantastic service, and locations galore?  Those are the kinds of companies I'm talking about.  And as promised, I now want to discuss why it seems so hard for great companies to change course and survive the things that get thrown at them.

Ultimately, the answer is seen in my previous post's example about ice companies.  The ice companies simply did not have the necessary skills to compete with refrigerator manufacturers, nor did they have the product to get customers to stop buying refrigerators; consequently, the ice companies became irrelevant.  Similarly, Blockbuster is now irrelevant (and declared bankruptcy), as more and more people opted to watch movies on cable TV pay-per-view, through Netflix, or rent from Redbox kiosks.  And of course, it's going to get even crazier with Google TV, Apple TV, Amazon, and a whole slew of startups you've never even heard of jumping into the game (and of course, the telecoms want a piece of the pie too).

So if a company can't reinvent itself, it won't be able to survive.  The case of the ice companies is special, because no matter what the companies tried to do, it never would have been able to reinvent itself.  When refrigeration came along, people didn't need to buy ice anymore.  Never mind keeping food cold so that it wouldn't spoil, they could just MAKE ice for the heck of it.  Just for fun.  How are you going to sell ice in that kind of market?  And what else could they have done with their capabilities?  Take all their ice saws and labour force and become a logging company?  Maybe.  But I bet you that the logging industry was already at equilibrium.  Most industries are, until something comes from left field and turns it upside down.  And you can bet the ice companies had nothing that could turn the logging industry upside down.

Sad to say, but there's no chance in hell for survival for cases like the ice companies.  Now what about companies that theoretically SHOULD be able to reinvent themselves?    Like Microsoft is a software company, right?  They're in big danger of losing their core bread and butter to companies like Google, Apple, and the like, just through the Internet and smartphone plays alone.  If Google and Apple truly are successful, there will be no need for us to use personal computers anymore, which is really how Microsoft makes all its money (selling Windows and Office).  But at the core, Google and Apple are also really just software companies, they just focus their efforts elsewhere.  OK, and Apple's also a hardware company, but it's not like Microsoft is lacking in this area, since they also have the XBox 360, the Zune, the cancelled Courier, and a bevy of hardware OEM partners with whom they can collaborate.  Why has it been so hard for Microsoft to turn the Internet and smartphones into profitable businesses, let alone dominate those industries?  They've been trying to reinvent themselves for almost a decade, why haven't they been succeeding?  Is it just too early to tell?  Will their efforts bear good fruit, or are they doomed?

Likewise, the questions about Google vs Facebook.  Why have all of Google's social efforts to date not found traction (see Orkut, Friend Connect, Buzz, Wave), while Facebook now looks like it has a real opportunity to make Google irrelevant by essentially integrating the entire Internet into their social network and potentially monetizing it better than Google ever did?  Aren't the two of them really just web companies with a lot of smart programmers?  Heck, Facebook has a ton of ex-Googlers working as employees!  Google was known for having the most PhDs per capita of any publicly traded company; if you work at Google, you're probably really smart.  So why does this seem so hard?

It seems to me that there are three things that prevent a great successful company from being able to reinvent itself and respond to oncoming threats, even if they're able to correctly see and identify the threat that's coming.  OK, there are no doubt more than three, but these three seem to be the biggest factors in my limited mind.

1.  We're making money!  What's the problem?
A company has a fiduciary duty to its shareholders to keep making money.  Especially in today's stock markets that are dominated by short-term traders and hedge funds, companies have huge pressure to keep growing profits in order to keep the stock price up and the shareholders happy.  Furthermore, a lot of executive compensation is focused more on short-term incentives, not long-term.  With that kind of pressure and motivation influencing the people at the helm, it's hard to allocate heavy funds towards investment into the future.  It's easier to invest the money into efforts that will increase market share immediately (eg. increase marketing spend, expand operations), rather than invest into research and development that may never see commercialization.

The fact is, a lot of R&D output never sees the light of day in the market simply because it's so risky and uncertain; nobody can be truly sure about what the market wants and whether the company is inventing a real winner.  Microsoft had major doubts about the Courier, so they cancelled it, despite a lot of excitement from the market.  The iPad actually was not Apple's first stab at tablets.  That honour goes to the Newton, which Apple developed in the late 80s.  It was not exactly a smashing success.  R&D is inherently risky, so the ROI is iffy.  If the ROI is iffy, that's not good for the share price in the short-term.  And short-term share price is what the traders care about, who tend to dominate the stock market much more than long-term investors these days.  This leads to the pressure to avoid investing into R&D unless a company is absolutely sure about what they're doing.  And they can only know what they're doing if they've done it before.

Look at Microsoft.  HUGE money into R&D every product cycle to make new versions of Windows, Office, and all their other products; the ROI is correspondingly huge on that stuff.  Microsoft has admittedly ridden this wave really well, but they can afford to do it because it's what they know and understand; they know how to succeed in making good operating systems and office suites.  Unfortunately, these stable franchises serve markets that may be bypassed and made irrelevant by web plays and smartphone plays.  The fact is, they haven't been able to do anything to reinvent themselves to stop relying so much on Windows and Office sales.  That's the key, isn't it?  If your core bread and butter is about to be destroyed, don't you want to start making something different instead before it's too late?

Stable franchise R&D is reliable and easy while the market lasts.  Meanwhile, innovative inventive R&D is hard, risky, and difficult.  But traders and shareholders don't understand this, so they simply punish Microsoft the way the only way they know how: they hate on the stock price.  It's easy for a business consultant or investment banker to throw around some numbers and make recommendations.  It's entirely another thing for the company to execute on those recommendations, when they're not only technologically complex, but also something the company has little experience doing.  The unfortunate thing is that while the trades and shareholders punish the company if it deviates from profit growth, severe deviation may be necessary just to invest heavily into changing the company's direction.  Shareholders want to have their cake and eat it too.  That's perhaps an unfair challenge, but also a fact of life for big successful companies.  Of course, all those traders end up jumping back on the bandwagon if a company manages to survive the fire and release something new that turns its fortunes around.  But they'll get off just as quickly, they're not there for the long-term.

2.  We just don't know how to do this!
Each company has its own strengths and weaknesses.  The challenge is when a threat hits a company's weakness so hard that they can't get back up, especially if the company's weakness was previously considered a strength.  Look at the ice companies again.  Completely flatfooted and unable to respond to Freon.  Everything that the ice companies were good at did nothing to help them compete against refrigerator companies.  Where the ice companies had large manual labour forces to harvest, cut, and transport large blocks of ice, refrigerator companies required quality chemists and engineers.

But what about companies that essentially hire the same kind of labour force and invest in similar capital infrastructures?  This is where I think the Google vs Facebook fight is quite interesting.  Both companies are filled with extremely smart people, both companies are primarily Internet plays, and Facebook even has a ton of former Googlers working for them.  So why does it look like Facebook really actually now poses a big threat to Google, and why does it seem like Google has failed at every attempt to respond?

Part of it is just how the company is structured.  For example, Microsoft is good at shipping and selling packaged software, but the big growth market that is the Internet isn't about packaged software.  But perhaps an even bigger part is culture.  Google's full of really smart people who have made a fantastic search engine that essentially operates by itself.  In fact, most of their products operate by themselves.  Most of their products sell themselves too.  There is very little visible effort on high-touch customer service or sales because it's not needed for most of their stuff.  The proof is in the disaster stories when Google has to deal with rare real customer problems:
The worst part is that once I realized that Gmail was failing, I quickly paid, but Gmail took a full 21 hours to restore my service, bouncing me off scores of social networks and mailing lists, and denying my inbox's existence to all of my friends and professional connections on Twitter, LinkedIn, Facebook, and email itself.

The awesome thing about this incident is that it showcases all of Google's weakest pointsas a creator of user-facing applications.

Google simply isn't structured to handle high-touch human interaction, because they've had all their super smart programmers create automated systems that rely on stable infrastructure, algorithms, and simple aesthetics to guide users and customers.  Customer service is simply not necessary, and as a corollary, it could perhaps be said that Google as a company does not understand the emotive aspects of humanity.

On the other hand, you have a company like Facebook that is built from the ground up to be all about human relationships:
"The naive solution is to do something like Friend Lists," Zuckerberg says. "Almost no one wants to make lists," he continues. He's noted this before. "The most we've ever gotten is 5 percent of people to make a list. It's pretty brutal to have to do this every single time." He then went into the algorithmic solutions. These are helpful, Zuckerberg says, but it's also really easy to get these wrong, he notes. There needs to be a social solution, Zuckerberg says.
This philosophy seems to have fulfilled Zuckerberg's original vision of taking real life and allowing it to proliferate and integrate online.  That's created a really sticky product that people keep coming back to, and they spend time there, both consuming and creating content.  There, inside the closed garden that Google can't access for indexing and monetization.  So Google is trying to build their own cooler and better garden with all the tools and tricks in their bag, but they've invested too much into their current operational model and ways to tear down the house and start from scratch.  Meanwhile, Facebook's closed garden turns out to be a Trojan horse for doing a reverse takeover of the entire Internet if they have their way with Facebook Connect, the Like button, and so on.

If a company's already been doing business a certain way for a long time, and that's how they've been successful in the past, how can you expect them to just reinvent themselves?  When professional sports teams perform poorly for too long, the only way to get it back on track again is to clean house, bring in new management and new players with a new philosophy, and grow them into a new cohesive unit.  But that's easier to do over a few years with a team that has maybe only 30 players and management personnel of maybe 10 people.  A company with thousands of employees spread around the world?  Tad more difficult, wouldn't you think?

3.  We hate change!
Don't believe any company that says that change is one of their core values.  This couldn't be further from the truth.  They might have the fancy plaques on the wall, but it's a myth.

Back when I quit my job to do startup stuff and run a software consulting company, I wanted to call the company Change Agent Solutions.  Catchy, no?  We'd be able to go into companies, align and streamline all their systems and processes, and turn them inside out for the better.  We'd have a cool James Bond chic feel.  My partner was adamantly against the name.  "People hate change," he emphatically stated.  I thought it was just that one company, after getting jaded with corporate politics and people's unwillingness to do crazy things.  After getting a ton more experience under my belt, I realize he was right.

People have jobs, like their jobs, and will fight tooth and nail for their jobs.  Even if they hate their jobs, they will do anything to keep their jobs because the jobs will put food on the table for their families at home.  Despite all the stress and politics that come with work, jobs are a source of self esteem, income, and fulfillment.  Furthermore, people are lazy, stupid, short on time and money, or just already enjoy what they are doing.  I can't see any other explanations for why retraining is so difficult for a lot of people.  You don't see salespeople becoming tradespeople.  You don't see financial analysts working to become actuaries.  You don't see assembly line workers deciding to become computer programmers.  People in general aren't good at mind-bending, inside-out, upside-down, revolutionary change.

Those who are unionized to have collective bargaining agreements with their employers are on a whole other level.  The unfortunate thing is that if a company is hit from left field by a competitive threat totally unexpected, and the company has no way to respond to it, the company has almost no ability to do what the union wants (i.e. guarantee jobs at a desirable wage rate).  If any ice companies had unionized (although I don't think unions were yet popular back then), those unions and employers would have been powerless to save the jobs of those employees.

With this whole attitude against change, which may exist for whatever reason, companies find it extremely hard to change, even if they see big threats coming. When I worked in telecom, one of the operations managers told me how they kept telling their employees since the 90s how the Internet was coming and was going to fundamentally change their business.  They hit the message home all the time every year.  Except it didn't happen.  I can only imagine how many employees eventually started tuning out the message.  But eventually it happened, and fortunately, a lot of telecom companies figured it out and successfully reinvented themselves to become broadband ISPs and wireless carriers instead of just traditional phone companies.  They were darn lucky that providing Internet service can use the same labour force as providing phone service.  And that cell towers need to run on telecom infrastructure.  And that so many wireless carriers were available for acquisition.

Some companies like the telecoms are able to organically change themselves for future success, but many aren't so lucky.  Other companies try to change by acquiring companies that will become the core of their new business.  That's how Nortel Networks was able to successfully transition itself from becoming a manufacturer of traditional telecom equipment to a manufacturer of high-capacity network switches.  They simply bought out Bay Networks, and they were no longer Northern Telecom; Nortel Networks was one of the new Internet darlings.  It was unfortunate that their customers over-invested in fibre and then could buy no more when the Web 1.0 bubble popped.  It was also unfortunate that Nortel ended up trying to fix the whole mess through financial manipulation scandals.  But it's a good case study on how a single acquisition was able to transform an entire company for a better future.

Other companies are not so good at acquisitions.  If a company acquires another company, it's not simply a case of crunching spreadsheet numbers and estimating a positive ROI.  If there is no place for the acquired company in the acquiring company due to poor cultural fit, politics, or operational structure, the acquirer will experience no value and end up vomiting the company back out (see eBay's purchase of Skype) or swallowing the bitter pill of wasted money (see Google's purchase of Jaiku to compete with Twitter).  Even worse is if the acquired company feels they aren't given a fair shake, so they leave the company to try on their own again (see Google's purchase of location startup Dodgeball, the founder's frustration with making it work inside Google, and his eventual departure to found Foursquare).

Real change is hard, and that's why big successful companies can't respond well to unexpected threats that come out of left field.  In fact, the bigger the company, the harder it is, simply due to the company's size and momentum.  Complexity for anything increases with scale, and that especially includes large, complex, set-in-their-ways organizations, operations, and labour forces.

UPDATE:  My final post on this subject.  Well, for now anyway.  :)