Legal Business Blogs

Guest post: What’s your theory of the business?

Year-end is often seen, understandably if somewhat arbitrarily, as a time for reflection. Actually, in my book there’s never a bad time for reflection, so I’ll take an arbitrary peg over no peg.

I hope you share my core belief in the power of standing back for a good, hard, intellectually demanding fresh look – the kind that children would say makes their brains hurt. (As C.G. Jung supposedly said, ‘Thinking is difficult; that’s why most people judge.’

Which brings us to today’s topic: Peter Drucker’s timeless 1994 Harvard Business Review article, ‘The Theory of the Business.‘ In it, Drucker sets out to explain what underlies the familiar phenomenon of companies that have enjoyed long-term success who find themselves ‘stagnating and frustrated, in trouble, and often, in a seemingly unmanageable crisis.’ Here’s what he thinks is going on:

The root cause of nearly every one of these crises is not that things are being done poorly. It is not even that the wrong things are being done. Indeed, in most cases, the right things are being done -but fruitlessly. What accounts for this apparent paradox? The assumptions on which the organisation has been built and is being run no longer fit reality.

These assumptions are what Drucker encapsulates in the phrase, ‘a theory of the business,’ and they have to do with such fundamentals as markets, customers and competitors, values and behaviour, strengths and weaknesses, and what the firm gets paid for. Drucker doesn’t subscribe in the least to the commonplace that when successful firms get into trouble it can be laid at the feet of slackness, complacency, or hubris. Those can all befall firms, of course, but Drucker finds it rarely ‘the relevant or correct’ explanation.

As all too familiar examples, Drucker cites IBM being blindsided by the rise of the PC, and General Motors by first the Japanese and then the fragmentation of the US car market from a predictable staircase of brands driven by rising household incomes in the post-WWII era to a market segmented by lifestyles and car buyers choosing vehicles based on more intangible concepts of self-expression and identification. ‘Put another way reality has changed, but the theory of the business has not changed with it.’

Drucker enumerates what goes into the ‘theory of the business:’

A theory of the business has three parts. First, there are assumptions about the environment of the organisation: society and its structure, the market, the customer, and technology.

Second, there are assumptions about the specific mission of the organisation. […]

Third, there are assumptions about the core competencies needed to accomplish the organisation’s mission.

The environment – society, the market, clients – dictates what the firm can and will be paid for. The firm’s mission determines such critical values as what constitutes quality in the eyes of the firm, what its contribution to society and the economy should be, and what kind of results and outcomes count as meaningful. Finally, identifying core competencies leads to key decisions about where the firm must excel, where good enough is good enough, and where it chooses not to play at all.

Drucker then specifies what must be true for a theory of the business to be valid. It must be:

True, as in accurately reflecting reality in the here and now.

Congruent, meaning the parts have to fit together and complement one another.

Grasped and understood throughout the firm, and vibrantly kept alive (pointedly, Drucker notes that this becomes more challenging as a firm grows and particularly as it seems to move from strength to strength: ‘But as it becomes successful, an organisation tends increasingly to take its theory for granted, becoming less and less conscious of it. Then the organisation becomes sloppy. It begins to cut corners. It begins to pursue what is expedient rather than what is right. It stops thinking. It stops questioning. It remembers the answers but has forgotten the questions. The theory of the business becomes “culture.” But culture is no substitute for discipline, and the theory of the business is a discipline.’

And finally it must be subject to continual testing and validation against reality, because the theory is not ‘graven on tablets of stone, [i]t is a hypothesis.’

Drucker concludes with what’s as close to a call to arms as one is likely to find in management literature:

Some theories of the business are so powerful that they last for a long time. But eventually every theory of the business becomes obsolete.

And here’s a handy test for knowing when the theory becomes obsolete, since they aren’t packaged with sell-by dates: ‘A theory of the business always becomes obsolete when an organisation attains its original objectives. Attaining one’s objectives, then, is not cause for celebration; it is cause for new thinking.’

Here we pause for a moment to celebrate the almost surreal originality and intellectual power of Peter Drucker: He was 85 years old when he wrote those words. (He would live another 11 years.) How many 25-year-olds, or 45-year-olds, truly believe that attaining one’s goals is the occasion to start thinking anew? I warned you at the beginning that this kind of profound reflection can be intellectually taxing.

Now let’s jump ahead nearly 20 years to the 2011 HBR article, “When Your Business Model Is in Trouble,” an interview with Columbia Business School Professor Rita Gunther McGrath. Early on, she’s asked what are the warning signs that a business model is running out of gas:

The first clear stage is when next-generation innovations offer smaller and smaller improvements. If your people have trouble thinking of new ways to enhance your offering, that’s a sign. Second, you hear customers saying that new alternatives are increasingly acceptable to them. And finally, the problem starts to show up in your financial numbers or other performance indicators.

Now, I’m not going to put words in your mouth, or thoughts in your head, but do you find that (a) your lawyers have trouble thinking of ways to improve what they do; (b) clients are directing some work to non-traditional providers; and (c) it’s getting harder and harder to move the financial performance needles? Sorry; we can just keep moving right along here.

What should firms worried about the durability of their model do about it? The Professor is not offering cheap solace (emphasis mine):

There’s always very early evidence that a business model is in trouble, but it usually gets ignored or dismissed. That’s because at most companies the people at the top got there because of their success with the current model – so they have very few incentives to question its durability. So you get a denial reaction initially, followed by desperate attempts to eke just a little more time out of the existing model.

As an example of a business model with staying power, she cites markets with ‘customer stickiness’, particularly subscription-based models, and barriers to switching; a close second is to provide a ‘platform’ – think Microsoft Windows in its heyday. To be avoided are markets where the customer ‘buys something once and is done.’ Ahem.

Drucker cites two ‘preventive’ techniques for avoiding business model obsolescence: The first is what he calls ‘abandonment’ but what is probably more familiarly thought of as ‘zero-based’ activity management. Every three years or so, he recommends asking of every single service or product the firm offers whether it would be offered again today if not already in the portfolio. Seriously. In the vernacular, this is known as reinventing yourself before the other guy does it to you.

Second, Drucker implores you to talk to non-clients. It’s devoutly to be wished that your clients like you, but what about the overwhelming majority of businesses and individuals that are not your clients at the moment? What do they want? How do they get their legal needs met?

McGrath also has a recommendation that echoes our writing suggesting law firms look at setting aside a tiny percentage of their revenue (1/4 of 1%?) for R&D:

You need a portfolio of opportunities. I believe in investing in several options: Some will pay off, and some won’t. Some of them might be mutually exclusive. Verizon, for example, knew that landline telephones were disappearing. A lot of companies would have just milked that business for the cash cow that it was, but Ivan Seidenberg took out investments in four or five mutually exclusive networking technologies and let them run until it became clear which one would be dominant. Then he invested heavily in that technology and shut the others down. Most companies don’t do that.

If you’ve read this far, you would be making a reasonable assumption to assume that I’m implying Law Land should take heed because I believe its “theory of the business” is approaching obsolescence.

Not so. Well, not exactly.

I write at year-end, on this conventional occasion for reflection, because I hope one of your New Year’s resolutions, Dear Reader, is to begin taking less for granted.

To exercise your brain’s higher analytic functions (taxing as it can be, if pursued conscientiously) with greater rigor. To make fewer assumptions. To treat the status quo as just one of an almost infinite variety of “status’s,” and not first among equals. To be on alert. To be nimble, agile, responsive, far-sighted. If Drucker’s thesis does or will soon apply to Law Land, you’ll be lapping the field. If it doesn’t or won’t soon, I still will guarantee you a richer intellectual, moral, and personal life.

Happy New Year.

Bruce MacEwen is the president of Adam Smith, Esq. You can read his blog here.