Why Companies Fail (Part II)

By Gary Hamel

Published June 08, 2009 on WSJ

In my last post I identified three things that can turn leaders into laggards: the practical difficulties of sustaining above-average performance, the natural obsolescence of once-vital strategies, and the corrosive impact of discontinuous change. Now let me add a forth: success corrupts.

The seeds of failure are usually sown at the heights of greatness - that's why success is so often a self-correcting phenomenon. The dynamics work like this:

Once a company becomes an industry leader, its employees, from top to bottom, start thinking defensively. Suddenly, people feel they have more to lose from challenging the status quo than upending it. As a result, one-time revolutionaries turn into reactionaries. Proof of this about-face comes when senior executives troop off to Washington or Brussels to lobby against charges that would make life easier for the new up and corners.

Years of continuous improvement produce an ultra-efficient business system - one that's highly optimized, and also highly inflexible. Successful businesses are usually good at doing one thing, and one thing only. Over-specialization kills adaptability - but this is a tough to trap to avoid, since the defenders of the status quo will always argue that eking out another increment of efficiency is a safer bet than striking out in a new direction.

Long-tenured executives develop a deep base of industry experience and find it hard to question cherished beliefs. In successful companies, managers usually have a fine-grained view of "how the industry works," and tend to discount data that would challenge their assumptions. Over time, mental models become hard-wired - a fact that makes industry stalwarts vulnerable to new rules. This risk is magnified when senior executives dominate internal conversations about future strategy and direction.

With success comes bulk - more employees, more cash and more market power. Trouble is, a resource advantage tends to make executives intellectually lazy - they start believing that success comes from outspending one's rival rather than from outthinking them. In practice, superior resources seldom defeat a superior strategy. So when resources start substituting for creativity, it's time to short the shares.

Finally, success breeds arrogance. Caretaker executives who've never been entrepreneurs and have never built something out of nothing are prone to view success as an entitlement, rather than the result of innovation, gut-wrenching decisions and perseverance. Isolated from the breeding edge of change by subservient minions, they start believing their own speeches. Unlike Andy Grove, Intel's former CEO, they aren't perpetually paranoid. Instead, they're naively confident, and therefore prone to underestimate threats and discount new competitors.

These aren't the only things that can turn leaders into also-rans, but they're the ones I've encountered most often.

In future blogs, I'll share some ideas about how a company can inoculate itself from these dangers. One quick suggestion: Treat every belief you have about your business as nothing more than a hypothesis, forever open to disconfirmation. Being paranoid is good, becoming skeptical about your own belief is better.