New economy companies face age-old questions

 

Q: What is the most alarming label that can be applied to a company today?

A: To be called an "old economy" business.

The negative ramifications for businesses designated as "old economy" are serious because investors are switching their capital toward "new economy" companies. As financing moves away from the old economy companies, starved of cash to invest in development, their unpopularity intensifies.

What are the new economy businesses, and why are they so fashionable among investors? Basically, new economy businesses are seen as the wellsprings of innovation and entrepreneurship, the sources of tomorrow's wealth creation. This is a high tech world of constant change and reinvention.

Companies, like software companies, deemed to exemplify the new economy, tend to be knowledge rich, but possess relatively meagre tangible assets. In contrast, old economy companies tend to be tangible asset intensive, in traditional high volume production.

However, a closer examination of these truisms reveals many caveats. How would one classify a pharmaceutical company, or companies like Intel? Their products embody intensive knowledge, but depend on high volume production and economies of scale.

On the other hand, many new economy companies, such as dot.coms are really glorified catalogue companies. They are new economy only in the sense that they utilise the Internet as a medium for marketing, but apart from some entertainment and publishing products, have to resort to traditional physical delivery methods.

There are some parallels between betting repeatedly on the lottery or gambling, and investing in some new economy companies. The wins are spectacular but infrequent. Mostly there are losses. However, unlike the lottery, the stakes are usually high.

All this begs the question about what makes a great company. When the hype and hysteria about new versus old economy dies down - and this is happening already - the answer should be, as always, a company that has a long term future.

It creates value by delivering products and services that customers want to buy, at prices that yield a healthy profit. The new economy comes into the equation because value is often created through innovation and technological discovery. Much of the enthusiasm for new economy companies stems from the fact that most are entrepreneurial start-ups, unsaddled with the historical burdens of more mature companies. Yet, paradoxically, if these start-ups are to realise their growth potential, they will have to face the prospect of taking on the features of established enterprises. This raises a couple of important questions:

Is innovation that brings competitive advantage possible in old economy companies?

Can new economy start-ups avoid the growing pains that entrepreneurial ventures encountered in the past?

According to a model devised by Prof Larry Greiner of Harvard University, some decades ago, companies that survive and prosper go through five stages of growth. The original Greiner model still survives. The model proposes that enterprises experience evolutionary growth, punctuated by a management crisis that provokes revolutionary changes and ultimately brings the organisation into a new evolutionary phase.

The initial phase after the birth of the enterprise is one of creative evolution, depending on intensive informal communication to develop new product and market space. The leader is often a founder owner with excellent technical skills and product knowledge, but maybe little management experience.

At this stage, growth in volume may cause over-trading, inducing a cash-flow shortage that threatens the company's survival. Effective action against these dangers necessitates order, imposed co-ordination and control, moving away from the individualistic inventive culture.

This requires a strong business manager acceptable to the founders who can pull the organisation together. Sometimes the founder is capable of making the transition her/himself - e.g. Bill Gates - but sometimes it requires an outsider - e.g. Steve Jobs's dismissal from Apple.

During the next evolutionary phase, incentives and budgets and a formal impersonal hierarchy are instituted. However, according to Prof Greiner, a crisis is brought on by over-centralisation of the system, as lower level staff who are closest to the markets are torn between following headquarter imposed procedures and taking their own empowered initiatives.

Therefore, decentralisation and delegation are invoked, but eventually a crisis of control occurs. Top management feel they are losing touch with the various business units which are behaving autonomously, perhaps not always for the good of the whole corporation.

Therefore, control is reasserted by installing co-ordination mechanisms, such as formal planning procedures, capital allocation protocols and reward systems designed to encourage identity with the firm as a whole.

This co-ordination phase appears to be the one that is singled out as characterising the worst of old economy bureaucratic companies, when procedures take precedence over problem solving, and innovation is dampened. The organisation is rendered uncompetitive by a red tape crisis.

A resolution of this crisis requires strong interpersonal collaboration, built around a more flexible approach to management. We get project teams and flatter organisations. Rewards are granted on the basis of group performance.

These are the types of companies held up as role models today. It is quite a feat to keep up the spirit of collaborative innovation. But the good news is that this phenomenon is certainly seen in old economy companies. Prime examples are Asea Brown Boveri (ABB), a huge engineering conglomerate, and General Electric (GE).

What crisis awaits companies in this phase? Prof Greiner speculates that employees will become emotionally exhausted by the intensity of teamwork and the constant search for innovative solutions. The secret of successful companies is to avoid regressing and to maintain a challenging milieu where people will continue to grow. It entails a pro-active attitude to creating and recreating competitive advantage to avoid a crisis brought on by inertia and excessive stability.

As to the question of whether new economy start-ups need to go through all the Greiner phases to reach critical mass and collaboration, it is feasible that they do so, albeit at a faster pace. The crises that provoke change occur more quickly in the context of faster growth and shorter product lifecycles than in the past. Examples of companies that appear to be succeeding are Cisco Systems and Sun Microsystems.

Some individuals have had spectacular bonanzas from share trades in new companies that have never made a profit, and probably never will. But then, gambling and speculation can also bring windfalls.

Warren Buffet asserts: "If the business does well, the stock eventually follows." Doing well implies profitable value creation through effective leadership, orchestrating continuous renewal. This is available to old and new economy companies alike. Such companies deserve confidence and support from all stakeholders.