The Theory of the Business

BySoms 2012

“Every organization, whether a business or not, has a theory of the business. Indeed, a valid theory that is clear, consistent, and focused is extraordinarily powerful”.

- Peter Drucker

PROBLEM

• Big companies that have enjoyed long-term success hit stagnation and find themselves in unmanageable crisis despite having experience, best brains, sound policies etc.

• Phenomenon is not restricted to businesses alone but also happens in labour unions, government agencies, hospitals, museums and churches.

EXAMPLES

• According to Drucker this happens because the assumptions on which the organization has been built and being run no longer fit the reality .

• The assumptions that shape any organisation’s behaviour, dictate its decisions about what to do and what not to do, and define what the organisation considers meaningful results.

• These assumptions are about markets, identifying customers and competitors, their values and behaviour.

• Technology and its dynamics, about a company’s strengths and weaknesses. These assumptions are about what a company gets paid for.

Case 1 - IBM• In 1950 IBM was designing SAGE air defense system for early

identification of enemy aircraft.• Univac launched the prototype of first multipurpose computer.

All earlier designs were for single purpose machines.• IBM immediately put its best engineers to work on the Univac

architecture and designed manufactured the first multipurpose computer.

• Three years later IBM became the world’s dominant computer maker and standard bearer. It created not just a computer but a whole computer industry.

• In 1970s IBM was confidently developing powerful mainframe computer into which a huge number of users could plug.

• Apple came up with the first Personal Computer; a grand success.

• IBM accepted the new reality and developed a simpler PC.• Two years later it became the largest PC manufacturer and

industry standard setter.• But mainframe computers and PCs were competitors and

could not co-exist in the same corporate entity so IBM faced problems in optimizing the production of both.

Case 2 - GM• General Motors was once world’s largest and most

profitable manufacturing organization.• Its assumptions were that US market was

homogeneous with stable income groups.• Long runs of mass produced cars with minimum

changes each model year.• Structure of semiautonomous divisions each

focusing on one income segment.• Highest priced model of one division overlapped

with lowest priced model of the next.

• The theory worked for 70 years; GM never suffered losses and steadily gained market share.

• But in late 1970s the market was fragmenting into highly volatile ‘lifestyle’ segments and income no longer remained the only factor of buying decision.

• Also lean manufacturing created economics of small scale and shorter runs and variations in model became more profitable.

• GM tried to patch things over by maintaining the existing divisions that now offered ‘a car for every purse’, automated the long run mass production system but neglected the real growth market – light trucks and minivans.

• End result – confused set of customers, dealers, employees and the management itself.

A theory of the business has three parts:

• Assumptions about the environment of the organization: society and its structure, the market, the customer and technology.

(It define what it is paid for)

• Assumptions about the specific mission of the organization. (It define what it considers to be meaningful results)

• Assumptions about the core competencies needed to accomplish the organization’s mission.

(It define where it must excel in order to maintain leadership)

SPECIFICATIONS OF A VALID THEORY OF THE BUSINESS

1. The assumption about environment, mission and core competencies must fit reality.

(Marks and Spencer decided it was the merchant not the manufacturer who knew the customer)

2. The assumptions in all three areas have to fit one another.

(GM’s core competency-financial control of the manufacturing process and a theory of capital allocations)

3. The theory of the business must be known and understood throughout the organization

(successful organization tends to take its theory for granted and it substitutes discipline with culture)

4. The theory of the business has to be tested constantly.

(Its a hypothesis and it must have the ability to change itself)

PREVENTIVE CARE

• Systematic monitoring and testing of its theory of the business

• Rethink a theory that is stagnating• Take effective action in order to change

policies and practices• Bring organization’s behaviour in line with new

realities of its environment , with its new mission and with new core competencies

1. Systematic and purposeful abandonment – Every three year an organization should challenge every product, every service, every policy with the question, if we were not in it would we be going into it now?

Without that it will lead to lack of resources especially capable people needed to exploit the opportunities when there is a change

2. Study what goes on outside the business especially noncustomers with whom the first fundamental change occurs

eg. U.S. department stores studied their customers constantly but paid no attention to

70% of noncustomers

EARLY DIAGNOSIS

• Theory of business becomes obsolete when an organization attains its original objectives

• Rapid growth is another sign of crisis.It challenges assumptions, policies, and habits

• Two clear signals are unexpected success and unexpected failure whether one’s own or a competitor’s.

Ex: unexpected success of Chrysler by sales of Jeep and minivans is unexpected failure of GM

CURE• To establish maintain and restore a theory

requires not genius but hardwork• It is not being clever but being conscientious• It is what CEOs are paid for• They start out with diagnosis and analysis• They do not dismiss unexpected failure but

treat it as a symptom of ”systems failure”• They do not take credit for unexpected success

but treat it as a challenge to their assumptions

Thank you