The duality principle.

Last summer, John Akers, CEO of IBM (the world's largest computer company), was unexpectedly covered in The Wall Street Journal giving a private "kick-butt" speech to some of his managers. He was mad and showed it. Big blue keeps losing market share in all kinds of computers (and software) to a host of companies, and the company has been struggling for some years.

Unfortunately IBM is not an isolated circumstance--reported on a little more dramatically perhaps, but not unusual. Consider that Ed Brennan of Sears is now under heavy board pressure to do something after being passed up by a more profitable WalMart as the world's largest retailer. Sears' core business, retailing, is also a struggle.

Before IBM and Sears, we've watched Detroit lose one-third the U.S. passenger car market to the Japanese--and it is still losing share. Before that, one-half of the U.S. machine tool market was lost to Japan and Germany and whomever, while big steel lost one-half of the U.S. steel market to a combination of imports and to the U.S. mini-mills--are a new kind of steel maker. A combination of large U.S. electronics companies lost essentially all of our consumer electronics market to Japan. Eastman Kodak passed up for whatever reason the entire video age from Japan, and is now struggling, late, to get into the inevitable electronic still camera age, likely from Japan. All this is happening with the maturing of their core photographic film market.

THE HIGH PRICE OF FAILURE

What's going on here? These are big market losses of big companies. Is there something wrong with some of our big U.S. companies? The question is important. We're paying high prices for these failures. With big companies and big markets involved we have an imbalance of foreign trade, destabilization of the world's financial markets, and slow GNP growth-slower for considerable years than either of our two principal trading competitors, Japan and Germany.

If we had achieved the growth rate of Germany for the last ten years (not the higher rate of Japan) there would theoritically be no federal deficit today. There are social issues in all this as well. Little companies come and go all the time--but really big companies, when they get in trouble, cause a lot of social disruption. In some cases--Lockheed and Chrysler in the 70s and 80s--the federal government bailed out companies through loan guarantees because they were so big. With our current S&L bailouts draining out billions in federal cash with more liabilities, we don't need any more big bailouts.

So again, what has been going on with these big companies? What has gone wrong?

What has gone wrong is that these business lost the abilities, vision, and leadership of the long-dead "founding fathers" and replaced it with huge topdown glacial standpat bureaucracies using little or no employee empowerment to help reinvent the business (where many good ideas are found). Nothing was done to prepare for the future.

This is Akers' problem. After decades of roaring success, he and his bureaucracy could not initially believe that his world of mainframes would be under increasing successful attack--both by other mainframe makers (Fujitsu) but more importantly by those ubiquitous PCs, with their ever increasing power, and whose makers have undercut IBM with cheaper prices because they have much lower overheads. Akers has to reduce his bureaucracy to reduce overheads, get some empowered innovators, and compete in the new world. He is now apparently both terrified and mad--late, very late, in the game.

Sears did not believe for a long time that an unknown from Arkansas (of all places) starting little discount stores (Walmart) in small out-of-the-way towns could ever take on Sears with their high overheads and with stores often in the wrong places for growth.

GM (and all of Detroit) could not initially believe that those funny little not-very-reliable cars from Japan in the 60s could do anything in the American market. Japan learned how. Detroit also believed that with their cost structure they could not make little cars and make any money, so they tried to ignore the problem. The rest is history.

The American machine tool industry likewise could not believe Japan could take their market. Japan's first machine tools weren't very sophisticated--"too light and too small for heavy work"--but again Japan learned and now leads with a lion's share of our market.

PROPRIETARY CAPITALISTS

The founding fathers believed in their innovations with passion and vision, and learned the processes of innovation the hard way (with failures). They identified a market need (perhaps not known by the market in the begining), and they developed a product, its manufacturing process, and its market (sometimes a lengthy, iterative, and painful process). They managed their companies in an externalized but hands-on manner and were truly "proprietary capitalists," to use the London Economist term. As their companies grew in size, the founders--or their immediate cohorts of necessity--began to systematize the process of production and distribution. Then when the founding fathers moved on to their reward, many successor managements became increasingly bloodless, administratively or bureaucratically oriented, and operating on the margin with the core business as a given, in a stable world dominated by America.

Increasingly isolated senior management also stood off and didn't get into the pits with the struggling workers as the founding fathers did. The bureaucratic organizations became populated with people, layer on layer, who were taught not to make a decision with any risk--in other words, they coud not innovate. No founding father vision, no hands-on, no empowerment down the ranks to help reinvent the business.

In his new book Narcissistic Process and Corporate Decay, Howard Schwartz describes bureaucracy as a totalitarian narcissistic system run solely from an internalized top. What the "troops" think or have learned is nt integrated. As an example, when the need for some form of change (i.e., innovation) does occur to the top, the ideas for the change come from the top (frequently put forth in seminars by consultants hired on behalf of the top) with no real participation by the "troops". There is little or no consideration of viewpoints of the "troops" regarding the change. It simply does not occur to the top to ask the troops what they think about necesary strategic changes. It is assumed they have nothing to offer. Wrong!

When world competition for the U.S. eventually arose, starting about 25 years after World War II with product innovation or high quality, or both, customers started buying imported alternatives. The rules had changed, but the totalitarian internalized bureaucracies could not cope with change and reinvent their business.

Resources available to successor management were enormously greater than for the founding fathers. But the reinvention of the business, which was so contingent in the first place (to borrow the anthropologist's concept of survival), and which would be equally contingent again, was beyond management. Reinvention takes new founding fathers using empowerment.

When the inevitable disaster loomed, or arrived, a time-consuming phased pattern of behavior unfolded. I've lived it and observed it over and over again:

* Denial. "It can't happen. We've been successful for decades and nobody knows what we know. These (new) guys don't know their costs. They'll go broke, their stuff is no good, etc." This phase alone takes some years.

* Slow realization. More years. One can recall the great scene in the movie Butch Cassidy and the Sundance Kid wherein Butch and Sundance are being chased by a posse, which keeps coming and coming. Finally Butch (or maybe Sundance) says to the other, "Who are these people?"

* Fear and terror. Growing loss of market share finally penetrates. The board of directors wakes up and no longer believes the CEO with his "It's going to be better tomorrow" speeches.

* New strategy. Sometimes a new CEO GM went so far as to put an engineer and product man in as CEO for the first time in decades! Write-offs and divestitures start, and several more years go by.

* Mistakes. A lot of thrashing around, with ill-conceived new acquisitions for a quick fix or a capital restructuring. Too many acquisitions don't work. Eastman went out and bought a drug company (Sterling) and will spend a fortune to get into that business. More write-offs and more years.

* More new strategy.

* More mistakes. More write-offs.

I finally survived all this in reinventing Bell and Howell. in retrospect, it took too long, but did use plenty of ideas from within the company. Empowerment was not a popular word in my days--but that is what was used.

BEYOND THE BASKET CASES

The various capital restructurings of the 1980s became the focus of reinventing businesses. We had entered the era of "money capitalism." Many managers had become "money capitalists" and formed an industrial version of a rentier society.

The rentier 80s pass. It didn't all work, and the well-known basket cases are now in front of us. GM, as mentioned above, has possibly started on the path of correction but too many of our basket cases are now in danger of running out of cash. Some will. We can only hope that the boards of directors and their CEOs can survive their own blood bath. One can hope that the boards insist that something other than bureaucratic control and deal making is needed.

Boards must recognize that management of large companies is a duality--operating in the present and preparing for the future. They should read Schumpeter.

The duality of business was first outlined with great force and charm by Joseph Schumpeter in his 1912 book The Theory of Economic Growth. Schumpeter, an Austrian economist, was contemporaneous with John Maynard Keynes, who overshadowed Schumpeter, although today Keynes is largely discredited and Schumpeter is undergoing a modest revival. Schumpeter called the old on-going (bureaucratic) business a "circular flow" operated "on the margin" and innovation "new combinations," the real creator of wealth (Chapters I and II). He first described innovative companies or businesses eventually replacing old dying companies or businesses as the "Creative Destruction of Capitalism."

It is interesting to note that Schumpeter was and is a national hero in Japan (in the same class as Deming). Certainly the recent postwar history of Japan as an innovative nation is consistent with the Schumpeter focus on the "creative destruction of capitalism" with innovation as the true wealth creator. Japan is a Schumpeterian nation.

Management of the duality is not for everybody. To be able to run a bureaucratic company in a mature business and deal with the ambiguities and passions of innovation for the future is a big stretch. The more likely approach is for the board to assume two people or a team to cover the duality and monitor how they get along. Somewhere, with influence at the top, there must be someone with successful innovation in his or her background. These are rare people, and there is no way to reproduce the experiences and trauma of innovation without having done it.

Ongoing mature businesses (the first of the duality) must be run admittedly by a bureaucracy by the numbers to generate cash for reinvesting in the business through innovation (the second of the duality). This, if done right, enables "the creative destruction of capitalism" internally. It takes much patience and fortitude to try early on many possible innovations. Most won't work for diverse reasons. It must be remembered that the successful innovations business was, in its beginning, a remnant of many unsuccessful attempts to successfully innovative. While the successful company in its maturity may have a useful "core competence," it will still have to go through much the same process with which it finally succeeded in its beginning. This takes time, with eventually big money and patience for failure--including that of the board of directors with a struggling CEO.

It would help if management and members of boards of directors would read and absorb the history of innovation to understand that it is not deterministic but highly contingent, and not linear but highly recursive. Ideas for innovation come from strange places and in execution are problematical, and iterative--particularly if one has to eventually replace a core business with anything like its scale.

ACCIDENTAL INNOVATION

The history of innovation is full of initial failure (that is not news), but success came from opportunistic recognition and use of unexpected, unplanned for events (that is news). This seems not widely understood. Louis Pasteur's famous observation, "chance favors the prepared mind," well sumps it up.

Mark Twain unexpectedly popularized the typewriter while it was initially rejected by business. This was not in the original business plan! The Sony cassette videotape player (with original American and German technology) was in the end a failure for Sony because they initially believed it to be a time-shifting device for TV programs with a maximum recording time of one hour. JVC-Mitsushita won by assuming it to be a two-hour device that turned out to play Hollywood's movies. Initial assumptions count introducing new products.

Breaking our sorry pattern of slow new market business reaction with recreation of the innovative, nonbureaucratic abilities of the "founding fathers" is now our national priority for preservation of our economic position. Read Schumpeter, understand innovation, replace bureaucracy with empowerment. Japan does. So does Germany in its own way. There are enough good examples of company reinvention in the U.S. to emulate. There are people in strange places within companies who have excellent ideas--surprising, creative, and challenging ideas. Just ask.

Donald N. Frey is a professor of industrial engineering and management science at Northwestern University and a retired CEO of Bell and Howell. Earlier in his career he was chief engineer for Ford and participated, along with such figures as Lee lacocca, Don Petersen, and Hal Sperlich, on the legendary team that created the Ford Mustang. He is also a member of CE's advisory board.