Maintaining a Healthy Company—Why Do Flourishing Businesses Fail?

From A LECTURE SERIES BY Professor Michael Roberto, D.B.A.

Imagine that you are working in, or maintaining a healthy company. You’re producing strong earnings, and you have competitive advantage over your rivals. I have a harsh truth to share with you. You’re unlikely to still be on top a decade from now.

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Maintaining a Healthy Company Is A Complicated Task

The Kauffman Foundation did an interesting analysis several years ago of the Fortune 500. Fortune magazine, each year, starting back in the 1950s, produces a list of the 500 largest firms by revenue. Now, what the Kauffman Foundation did is look at how many of those firms remain on the list as time transpires.

So they looked at the original list produced in 1955 and asked how many firms remained on the list 30 years later. Well, three decades after the original list was published, about 250 of the original 500 firms were still among the 500 largest firms in the country. In other words, half of the firms were no longer on the list.

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Then the Kauffman Foundation looked at firms that were on the list in 1995 and looked ahead. How quickly did firms fall off the list in the last couple of decades? Interestingly, they found that it took less than 15 years to get to a point where there are only 250 survivors on the list.

Put another way, they examined the turnover, year by year, on the Fortune 500 list, and what they found is, while there have been some fluctuations over time, there’s been, overall, a trend, a steady increase in turnover, over the last few decades among these leading companies.

Only The Paranoid Survive

Image of Andrew Grove
Hungarian-born American businessman, engineer, author and a science pioneer

Some years ago, Andy Grove — the longtime CEO at Intel, wrote a book in which he talked about the notion that only the paranoid survive. He said, as a leader, you have to always be ready to confront new competitive threats and be ready to scan your environment and spot the new, emerging rival that might knock you off. If you’re not paranoid, you won’t stay on top.

Let’s take a look at what’s been happening in just a few industries in recent years.

In the movie-rental business, Blockbuster used to dominate, until Netflix toppled them. In music, we used to go to stores like Tower Records to purchase CDs. Today, we stream music digitally. Most of us, when we’re thinking about traveling to another city, we think about getting a hotel room. And yet, many people today are using Airbnb to find a room that someone is willing to rent for a short period of time.

Only the paranoid survive. In each of these industries, we’ve seen a disruptive threat come and emerge and knock off, or at least threaten, the incumbent players who were so successful some years ago.

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How Do Businesses Sustain Competitive Advantage?

There are four key facts about competitive environments and of the companies that are trying to win in those environments.

Industries vary widely in their profitability.

Warren Buffett once said, when an industry with a reputation for tough economics meets a manager with a reputation for excellent performance, it’s usually the industry that keeps its reputation intact. In other words, if you’re in a really tough business, it’s going to be difficult to make money no matter how smart the management team is, and even if you think you have a great strategy, because frankly, for many years, that business has been one where the fundamental economic forces are causing profitability to be low.

On the other hand, we can find some industries where they’re generating incredible returns on invested capital year after year. So this first factor is really important: Industries vary widely in their profitability.

The industry you’re in matters a great deal.

Sometimes there are forces beyond your control driving your profitability. So if you’re in the newspaper business today as the web continues to grow, no matter how smart your strategy and how capable your management team, your profitability is being driven in large part by greater forces beyond your firm at the industry level.

Competitive advantage is fleeting.

If we look at which industries are really profitable today and then look 5 years ago, or 10 years ago, or 20 years ago, we see the industry structure tends to be much more stable. Is the industry one where a only a few firms dominate? That structure tends to be more stable, but is also apt to change quickly, along with your company’s competitive advantage.

Industry structure varies widely around the world.

We don’t have situations where industries look identical in every country. Yes, we live in a more global world, and yet, industries that look very fragmented in one country may be highly consolidated in others. So be careful when people talk about a global industry.

Yes, global trade occurs, but industries in competitive environments can look very different in different parts of the world for a variety of reasons, stretching from consumer tastes and culture, to government regulation and institutions, and even forms of government.

From the lecture series Critical Business Skills for Success
Taught by Professor Michael A. Roberto, D.B.A., and four others