Three Management Ideas That Need to Die

Leonard Sherman, Author, If You’re In A Dogfight, Become a Cat! – Strategies for Long-Term Growth

Three Management Ideas That Need to Die

The time to rethink three widely believed, but outdated management ideas is long overdue.

1. There are “good” and “bad” industries

In the late 1970s, Michael Porter’s seminal article on business strategy -- How Competitive Forces Shape Strategy -- established five industry characteristics to explain why some companies are inherently more profitable than others.

Porter advised managers to seek out businesses with strong bargaining power over buyers and suppliers, low threats of entry from similar or substitute products, and minimal competition, giving rise to the notion that there are “good” and “bad” industries, more or less conducive to attractive financial results. 

Take airlines for example, plagued by intense price competition, high structural costs and fickle customers.  Most airlines historically failed to earn their cost of capital, and every major legacy carrier has gone bankrupt -- at least once.  Who would want to enter such a fraught industry? 

But if structurally challenged industries are destined to suffer, how can one explain that Southwest Airlines’ market cap since 1980 has grown more than four times faster than the S&P 500 and more than 90 times faster than the airline sector as a whole?

If a company’s choice is either to enter a poorly performing industry, playing by the same rules as incumbent market leaders, or to stay out of the business entirely, Porter's advice is well taken.  But there’s a third choice: recognizing opportunities to address poorly served customers by playing by a different set of rules.

Southwest Airlines initially focused on passengers who neither valued, nor were willing to pay for a broad range of amenities offered by legacy airlines, instead delivering no-frills, efficient and friendly one-class service.

Similarly, companies like Casper, Costco, Netflix and Warby-Parker have attacked sources of customer dissatisfaction and/or high costs to prove that there’s no such thing as a bad industry, except if you’re an incumbent mired in an outdated business model.

2. The objective of management is to maximize shareholder value.

Perhaps no management principle is preached more dogmatically than that management’s objective should be to maximize shareholder value. 

But this belief has led too many executives to focus on boosting quarterly earnings and stock prices with actions that compromise long-term growth -- a serious problem that’s been getting worse.   

For example, 80 percent of CFO’s recently reported that they would cut R&D spending if their company risked missing a quarterly earnings forecast. Moreover, S&P 500 companies have spent an unprecedented $3 trillion on stock buybacks over the past five years, partly at the expense of R&D, capital expenditures for expansion, workforce training and other value-creating activities.  Share buybacks increase a company’s short-term EPS – that’s just math -- but there is growing evidence to suggest that excessive stock buybacks can undermine long-term value creation.

The real issue here is that maximizing shareholder value should be the outcome, not the driver of management priorities. Corporate strategy should be guided by a customer-centric corporate purpose, a clear articulation of the time horizon for planning, decision-making and capital allocation, and how tradeoffs between stakeholder interests should be resolved. 

As an example, Jeff Bezos’ first letter to shareholders clearly articulated that Amazon would prioritize long-term market leadership over short-term profitability, and that the company would relentlessly focus on customers. By consistently putting customers at the center of Amazon’s strategy and new business development, the company’s market cap has increased almost 1,000X since its IPO.  Customers and shareholders have been exceptionally well served by CEO Bezos’ overarching commitment to a long-term customer-centric corporate purpose. 

3. Mature businesses inevitably decline

Recent research has found that less than 15 percent of Fortune global 100 companies have sustained above-market growth over multiple decades. Does this suggest a Darwinian form of corporate evolution where large corporations are destined to decline?

Those who question the feasibility of long-term growth point to three seemingly immutable marketplace constraints:

  • The law of large numbers, which recognizes that as a company grows, the incremental revenue to maintain above-market growth becomes an ever- larger stretch target.
  • The law of competition, which observes that companies achieving above-average profitability will inevitably revert to industry norms, because superior returns will attract new entrants until profit premiums have been competed away.
  • The law of competitive advantage, which notes that life cycle effects inexorably erode the sales and profits of aging products.

These “laws” are not only flawed, but they could become a self-fulfilling prophecy of corporate failure. After all, if managers truly believe that long-term growth is impossible, they will seek to protect and harvest current assets and customers for as long as possible. But such an approach—playing not to lose, rather than playing to win—only serves to hasten the decline of incumbent market leaders, as Kodak, Blockbuster, Sears and others have painfully discovered.

But there are counter-examples, where businesses have continued to prosper by maintaining the same core values, entrepreneurial spirit and adaptability that led to their success in the first place:

  1. Continuous Innovation, not for its own sake but to deliver...
  2. Meaningful Differentiation, recognized and valued by consumers, enabled by...
  3. Business alignment, wherein all corporate capabilities, resources, incentives, culture, and processes support the firm’s core mission and long-term strategy

Amazon became the fastest company to exceed $100 billion in sales last year following this approach.  Over an even longer term, Johnson & Johnson and 3M are still outpacing overall GDP growth more than a century after their founding.

Long-term profitable growth and shareholder value creation is possible in all industries – good or bad.

About the Author

Leonard Sherman is an Executive In Residence and Adjunct Professor at Columbia Business School. He is also the author of the recently published book, If You’re In A Dogfight, Become a Cat! – Strategies for Long-Term Growth.