Tuesday, January 28, 2020

How Big Business and Big Government get ahead by slowing down the economy

I was saddened to read of the death from leukemia of Clayton Christensen.  He wrote a very influential book titled The Innovator's Dilemma that I posted about years ago:
Clayton Christensen wrote the single most terrifying business book I've ever read. In The Innovator's Dilemma, he says that it's obvious why badly-managed companies go out of business (they're badly managed, duh). He asks a very interesting question: why do well-managed companies go out of business? He says that it's all about managing innovation.

Christensen posits two types of innovation. Continuous innovation (what he calls sustaining technologies) is easy to manage: it's more of what we have, only better. Well managed companies excel at growing sustaining technologies. There are also revolutionary innovations (what he calls disruptive technologies) that change how the game is played. It doesn't matter how much better your buggy whip is, you won't be able to grow your business on that product line.

Companies almost always fail at managing disruptive technology transformations, because they are well managed.  
The entire corporate structure is based on producing and selling at a particular price point. A product that kills your cash cow because it's priced 50% lower probably can't be sold effectively at that company, no matter how brilliantly disruptive it is. IBM sold million dollar mainframe computers. While they certainly knew how to make minicomputers, all the incentives were for them to push customers to bigger and more expensive machines. Minicomputers couldn't become too compelling without undercutting the quarterly sales targets, and so DEC ate IBM's lunch. And then Compaq ate DEC's lunch with PCs.
That's actually a pretty good post, which has stood up well after a decade.  It actually explains a lot about the rise of Donald Trump who is nothing if not disruptive to the well-run establishment political establishment, but that's beside the point here.

But think about innovation, and Donald Trump.  I posted a couple years back about this, too:
What was striking about this was that each industry would exhibit precisely the same growth characteristics. The "S" curve described a slowish initial takeoff, an exponentially rising growth period, and then a slow tailing off. All of these industries followed it in turn: cotton, iron, steel, railroads. What was key to the miracle that occurred between 1720 and 1990 was that as one reached the top of the curve and began to falter, a new industry emerged to drive things forward. Income per capita went from around $450 in what would become the United States (in 1700) to $18,300 in 1989.

In many ways, this seems to be spinning down. More and more industries seem to be in the top flat part of the curve. Fewer new industries are emerging with robust growth to pick up the slack. People look towards the future and do not see a doubling of real per capita national income.
Now go back and think about Christensen's premise: well managed companies excel at managing innovation in the steep and top flat part of that S-curve.  What they don't excel at - because they're well managed - is bringing the next, new S-curve to the market.  You see, the products in that innovation stream very well might undercut their current cash cow products.

So what do they do?  Enter the Regulatory State.  The Government starts issuing all sorts of regulations about this and that, to protect children and kittens and sunshine.  Where do these regulations come from?  Well, a lot of big businesses are happy to help craft these wise and important protections for children, kittens, and sunshine - I mean, who wouldn't?  And along the way the regulations seem to throw up roadblocks to the next set of disruptive technologies.

These new technologies typically come from small companies.  These companies don't have the money to staff up a building full of compliance managers to ensure that the new disruptive products don't kill children and kittens, or block out the very sun itself.
The reason for this is regulation (and its bastard child, litigation). That's the problem. We have buildings full of people that make us stop what we're doing, fill out forms in triplicate, and then wait months or years before we are allowed to pick up where we stopped. Think for a minute what this does. It pushes some of the middle of the S-Curve into the flat part, reducing the overall value of the industry, as resources get sidelined instead of being engaged in production. More damagingly, it pushes the next S-Curve to the right, increasing the time that it takes to bring a new industry online. Most damagingly of all, it possibly completely eliminates some S-Curves from appearing at all, because the risk is too high to attract investors.

It's not the tax rate, it's the regulation rate that's making the economy run down.
This situation is called Regulatory Capture, and is a situation where Big Government and Big Business scratch each other's backs:
A picture is worth a thousand words.
Source: Office of the Comptroller of Currency, as of 31 Dec 2009

The banking system melted down at late in 2008, because weird, opaque transactions like Credit Default Swaps made pricing risk pretty difficult. So what did the shiny new StatistDemocratic administration do? Ensure that these risky transactions are all held by companies that are Too Big To Fail.

As homework and for extra credit, graph the campaign contributions of these same five organizations and their corporate officers by party donated to.
What is ironic (in a funny way) is just how clueless today's young (or old *cough*Bernie Sanders*cough*) socialists are about this.  They think they're really going to stick it to Big Business by having the Government control pretty much everything.  The lack of understanding on display is Epic.

They should read Clayton Christensen.  Rest in peace.


McChuck said...

Nice summary. The graph is telling.

Ken said...

Good summary of the broader implications of Christensen's work.

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