The Industrial Revolution was “as much about process innovations that reduced waste and increased productivity as it was about the application of new technologies,” wrote Roger Martin in a recent Harvard Business Review (HBR) article, - The High Price of Efficiency. Martin is professor and former dean of the Rotman School of Management at the University of Toronto, as well as an accomplished writer.
The belief that efficiency is fundamental to competitive advantage has turned management into a science, - taught in every business school on the planet, - whose objective is the elimination of waste, - whether of time, materials, or capital.
“Why would we not want managers to strive for an ever-more-efficient use of resources?,” asks Martin. Of course we do. But, an excessive focus on efficiency can produce startlingly negative effects. To counterbalance such potential negative effects, companies should pay just as much attention to a less appreciated source of competitive advantage: resilience, - “the ability to recover from difficulties - to spring back into shape after a shock.”
“Think of the difference between being adapted to an existing environment (which is what efficiency delivers) and being adaptable to changes in the environment. Resilient systems are typically characterized by the very features - diversity and redundancy, or slack - that efficiency seeks to destroy.”
What’s wrong with a relentless focus on efficiency?
A relentless focus on efficiency can lead to serious problems. The article discusses three in particular, - intense concentration of wealth and power, elevated risks of catastrophic failures, and potential abuses of power.
Industry consolidation is increasing. The trend toward consolidation and growing size is evidenced by a few worldwide statistics: 10% of public companies generate 80% of all profits; firms with over $1 billion in annual revenues are responsible for 60% of total global revenues; and the rate of mergers and acquisitions is more than twice what it was in the 1990s.
The trend is particularly prominent in the US: 75% of U.S. industries have become more concentrated in the past 20 years. In 1978 the 100 most profitable firms earned 48% of the profits of all publicly traded companies combined; by 2015 the figure had risen to 84%. In 1994, 33% of GDP was generated by the 100 biggest companies; by 2013 the figure had risen to 46%. The five largest banks now account for 45% of all banking assets, up from 25% in 2000.
Digital technologies, - the Internet in particular, - have played a central role in the rise of global, superstar firms. Over the past few decades, the Internet has arguably become the most innovative platform the world has ever seen. It has transformed many of our every-day activities, including the way we work, shop, learn, bank, listen to music, watch films and deal with government. At the same time, the Internet’s universal reach has led to increasingly powerful network effects and to a new kind of platform business dynamics.
Scale increases a platform’s competitive advantage. The more products or services a platform offers, the more consumers it will attract, helping it then attract more offerings, which in turn brings in more consumers, making the platform even more valuable. Moreover, the larger the network, the more data is available to customize offerings to user preferences and better match supply and demand, further increasing the platform’s global reach and overall efficiency.
As a result, a small number of companies have become category kings, dominating the competition in their particular markets. “The resulting business environment is extremely risky, with high returns going to an increasingly limited number of companies and people - an outcome that is clearly unsustainable.”
The Risk of Catastrophic Failures. But, if consumers benefit from the low prices, increased choice and convenience brought to them by super-efficient, Internet-based companies, why should anyone object? The problem, argues Martin, is that very high concentrations increase the risk of catastrophic failure, as he illustrates with an example from agriculture, - monocultures.
In agriculture, a monoculture refers to the practice of growing a single strain of a high yield crop or raising a specialized, fast growing livestock breed in a farming system. Monocultures are widely used in industrial farming to increase the scale and efficiency of their operations. However, continuous monoculture can lead to a buildup of pest and diseases. If a disease strikes for which they have no resistance, it can quickly wipe out an entire population of crops or livestocks.
Something similar could happen to a company or economy too dependent on a few, highly efficient processes and business models.
Power and self-interest. “Given that people operate substantially out of self-interest, the more efficient a system becomes, the greater the likelihood that… the goal of efficiency ceases to be the long-term maximization of overall societal value. Instead, efficiency starts to be construed as that which delivers the greatest immediate value to the dominant player.”
For the past several decades, maximizing shareholder value has been the key objective of many companies. But, as a number of experts, including Martin, have pointed out, maximizing shareholder value can encourage company executives to take actions that will raise the price of their stock in the short term, both satisfying investors and increasing their own stock-based compensation. This can lead to reduced payrolls, cutbacks in R&D and lower capital expenditures, all taken in the name of reducing waste to increase the price of the stock. But the gains come at a cost, to laid-off employees and their communities, to long term investors and to the company’s very future.
In a well-functioning, dynamic market such an unwise move would open the door to increased competition from both existing companies and new entrants. But this doesn’t work if power is concentrated among a handful of players, whose dominant positions make it very difficult for competitors to break through. “And sometimes power becomes so concentrated that political action is needed to loosen the stranglehold of the dominant players, as in the antitrust movement of the 1890s.”
The Value of Resilience
In a fast changing, unpredictable economy, companies face a growing number of potential disruptions to their best laid strategies, including technology advances, global competition, and turbulent markets. As noted in a 2016 HBR article, The Biology of Corporate Survival, companies are disappearing faster than ever before. “Public companies have a one in three chance of being delisted in the next five years, whether because of bankruptcy, liquidation, M&A, or other causes. That’s six times the delisting rate of companies 40 years ago… Neither scale nor experience guards against an early demise.”
Biological systems have long been an inspiration in the study of complex systems. High resilience in the face of an uncertain, changing environment is the essence of evolutionary biology and natural selection. Similarly, business resilience, is fundamental for a company to withstand major disruptions and survive an unpredictable, turbulent future.
To help achieve a better balance between efficiency and resilience, Martin offers a number of recommendations:
Limit scale. “In antitrust policy, the trend since the early 1980s has been to loosen enforcement so as not to impede efficiency… We need to reverse that trend. Market domination is not an acceptable outcome, even if achieved through legitimate means such as organic growth… Our antitrust policy needs to be much more rigorous to ensure dynamic competition, even if that means lower net efficiency.”
Introduce friction. “In our quest to make our systems more efficient, we have driven out all friction. It is as if we have tried to create a perfectly clean room, eradicating all the microbes therein. Things go well until a new microbe enters - wreaking havoc on the now-defenseless inhabitants… Rather than design to keep all friction out of the system, we should inject productive friction at the right times and in the right places to build up the system’s resilience.”
Promote patient capital. “[L]ong-term capital is far more helpful to a company trying to create and deploy a long-term strategy than short-term capital is… we should base voting rights on the period for which capital is held. Under that approach, each common share would give its holder one vote per day of ownership up to 3,650 days, or 10 years. If you held 100 shares for 10 years, you could vote 365,000 shares. If you sold those shares, the buyer would get 100 votes on the day of purchase.”
Create good jobs: “In our pursuit of efficiency, we have come to believe that routine labor is an expense to be minimized. Companies underinvest in training and skill development,… what if we designed [jobs] to be productive and valuable?… A key but counterintuitive element of the strategy is to build in slack so that employees have time to serve customers in unanticipated yet valuable ways.”
Teach for resilience: “Management education focuses on the single-minded pursuit of efficiency - and trains students in analytic techniques that deploy short-term proxies for measuring that quality. As a result, graduates head into the world to build (inadvertently, I believe) highly efficient businesses that largely lack resilience… For the sake of the future of democratic capitalism, management education must become a voice for, not against, resilience.”
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