Commitments​, Margins, and Disruption

Once a large company becomes a large corporation, it becomes complacent and slow.  The large company loses its ability to innovate and adapt to changing market conditions and becomes ripe for disruption.  The smaller, smarter, and more agile startups then come in with new, innovative, and immediately superior products and destroy the incumbent companies with their lean methodology.  The large corporation never saw it coming because it was large and stupid.

This is the common belief of why big businesses fail, and David beats Goliath.  But is it true?  Are these large companies big and stupid or is there more to the story?  I would argue that big companies don’t get disrupted because they are incompetent and dumb, but because they are competent and smart.  Well, how could that be?

The large companies have previous commitments that they have made.  They have made commitments to customers, shareholders, suppliers, and employees.  How easy is it to go from an industry where you are making 30% returns and have a dominant position to go into areas that may not be within your immediate circle of competence or may never be truly viable?  The Amazon of today looked very different in 1997 to Barnes & Noble.

At the time, B&N was experiencing record margins and expanding its footprint in brick & mortar retail.  They had built a business with steady growth, attractive margins, and strong relationships with distributors.  E-commerce?  In 1997?  It is easy twenty years later to look back and pose judgment, but how easy would it be in 1997 when you’re business is booming to turn around and disrupt it.

One of the key advantages of new entrants in a market is the ability for them to lower prices.  They do not have the commitments of the incumbents and thus can accept a lower rate of return.  If the incumbent needs gross margins of 30% to maintain their current business and obligations, the new entrant may say they are happy with 20% margins or less to attract customers away from the large company.  The large corporation isn’t going to immediately cut their prices, especially if the new entrant is small and their product is underdeveloped and unsophisticated.

At what point does the large company make a change?  When is it too late?  The only examples of corporations holding off the young, agile competition are by creating their own separately managed companies with a different culture, leadership team, and strong entrepreneurial focus.  One example is the Skunk Works, built by Lockheed Martin*, where a small group of individuals was given a unique project completely outside the conventional business and, in many ways, their job was to defeat the company’s current aerospace business by building faster, stealthier planes.

This is incredibly difficult to do.  For example, Alphabet (formerly Google) has a vast array of subsidiaries focusing on dynamic and exciting new technologies.  However, I have to imagine that the fact that they have Google’s ad business with its steady stream of cash flows and profits to provide into their moon shot programs is organizationally and culturally different than the ingenuity of thousands of startups working in their garages without previous commitments, margins, and obligations.

 

* Great Book on Skunk Works

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