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WHEN I WAS IN GRADE school, I remember a field trip to a highflying local company called Prime Computer. At the time—it was the 1980s—Prime was a Fortune 500 company with a popular line of minicomputers and a runaway stock. Today, Prime is long gone and barely remembered. A Wikipedia page is about all that remains.
For a long time, I didn’t understand this. How could a company so successful simply cease to exist? Prime, of course, isn’t alone in this phenomenon. The same thing happened to Blockbuster, Borders, Compaq and many others.
I didn’t learn the answer to this puzzle until many years later. In his book The Innovator’s Dilemma, Harvard professor Clayton Christensen provided this counter-intuitive explanation: When successful companies fail, it’s because of their success. What happens is this: As a company’s success grows, it pours its energy into doing more of what made it successful in the first place—building the next iteration of its product, then the next and then the next.
But as the company does this, its focus becomes more and more inward. And when it does that, it ignores the proverbial entrepreneur in the garage—the upstart competitor who is able to look at things with fresh eyes and thus develop something completely new.
Christensen died in January. It occurs to me that his concept of the innovator’s dilemma has special relevance today, as we struggle with the effects of the coronavirus. At its core, Christensen’s warning to companies was that they need to avoid being too narrowly focused.
This advice is also valuable for other spheres of life, including personal finance. Below are three specific aspects of personal finance where I believe you can incorporate Christensen’s thinking.
1. Investing. I often advise against stock-picking. The stock market’s behavior this year helps explain why. At its lowest point a few weeks ago, the S&P 500 was down 34% from its Feb. 19 peak. But that was just the average.
Across companies, there was—and continues to be—wide disparity. Airlines, hotels and cruise lines, as you would expect, fared much worse than average. American Airlines, for example, dropped 64%. Meanwhile, other companies performed far better. Amazon lost just 12%. Pharmaceutical companies, which are on the hunt for a coronavirus vaccine, actually saw their stocks rise. Companies in the videoconferencing business have also done very well.
Why am I mentioning this? Christensen’s point was that companies run into trouble when they ignore upstart competitors. But the reality is, competitors are just one of the many unpredictable factors that impact companies and their stocks. Today’s public health crisis is the latest example.
Looking back over the past 20 years, we’ve also experienced war, terrorist attacks and a financial panic. They each came out of nowhere and each impacted different stocks in different ways—some positive, some negative. This, in my view, is yet another reason to favor index funds over individual stocks or actively managed mutual funds. It’s just too hard to know what the future will bring.
To be sure, a few hedge fund managers have been proudly trumpeting their foresight in shorting stocks this year. But there’s a reason you can count these managers on one hand. For most people most of the time, it’s impossible to predict what’s coming.
2. Household finances. Later in his career, Christensen co-authored a follow-up book, The Innovator’s Solution, to help companies avoid becoming the next Prime Computer. While there was no silver bullet, he provided more than a dozen recommendations. His overall message: Never rest and never accept the status quo. While these may sound like platitudes, there are many ways to apply these ideas to your finances. Got more free time during this work-from-home period? Here are some specific steps:
3. Financial planning. Many people are asking why the world wasn’t better prepared for today’s pandemic. After all, in recent years, we’ve seen SARS, Ebola and other outbreaks. And, of course, there’s Bill Gates’s now-famous warning from 2015.
So why didn’t we see this coming? One explanation: Our attention is too fragmented. With the 24-hour news cycle, Facebook, Twitter and so forth, it’s awfully hard to focus. This applies to our personal finances as well. With limited hours in the day, it’s very hard to spend time considering risks that seem outside the realm of the probable.
What’s the solution? Again, it might sound like a platitude, but you should think more broadly and consider a wider range of outcomes. In an interview, Christensen offered an important insight: “For whatever reason, the way they designed the world, data is only available about the past. When you teach people that they should be data-driven and fact-based… in many ways we condemn them to take action when the game is over.”
Christensen’s point is well taken: When planning your financial future, look beyond recent experience and look beyond what the experts are saying. Have not just a Plan A, but also a Plan B and a Plan C. Hopefully you’ll never need them. But it should help you to sleep easier, no matter what the future brings.
Adam M. Grossman’s previous articles include Under Pressure, Unpleasant Surprise and Keeping Busy. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.
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It appears there are as many ways to go out of business as there are to succeed. I worked for a company that was publicly traded, but the controlling interest was held by two families. Eventually one of the family generations wanted their money out and the company was sold. It was “merged” with the other company and disappeared completely. Eventually the company that they merged with was purchased, and that name disappeared. A little later that company was purchased. I think I was bad luck for those companies…
Don’t always agree with Jim Collins, but he wrote a whole series called “Good to Great” – including Built to Last and How the Mighty Fall. See: https://www.amazon.com/gp/bookseries/B07NZX6SFG/ref=dp_st_0066620996
However, turnover or “creative destruction” is actually the norm, it is the exception when a firm can sustain excellence. Only 12.2% of the Fortune 500 companies in 1955 were still on the list 60 years later in 2015, and nearly 88% of the companies from 1955 have either gone bankrupt, merged with (or were acquired by) another firm, or they still exist but have fallen from the top Fortune 500 companies (ranked by total revenues). Although it is only five years later, even fewer from the list of 1955 remain today.
See: https://www.aei.org/carpe-diem/fortune-500-firms-in-1955-vs-2015-only-12-remain-thanks-to-the-creative-destruction-that-fuels-economic-growth/
Great and very timely article.
“Many people are asking why the world wasn’t better prepared for today’s pandemic.”
So true in glorious hindsight. 🙂
I think the answer is the same as why the vast majority of people take their social security payments too early and why Dr. Quinn saw everyone of his retirement patients take the lump sum instead of the higher present-value annuity. It’s the same reason high levels of disposable income often lead to conspicuous spending rather than unseen saving.
I think we’ll be pretty well prepared for the next pandemic for a few years until this thing becomes old news. Voters will then resume rewarding politicians that fund the urgent over the necessary.
Markets and viruses have less to do with our troubles than ourselves. On the other hand I’ve been very encouraged by so many Americans doing their part to end this pandemic – thank you! 🙂
Good article. While I agree that companies often fail because they stick to what made them successful, sometimes they simply can’t compete with new technology. A classic example, albeit not in a major industry, is how electronic calculators rendered slide rules obsolete. Slide rule makers were obviously in no position to have developed the calculators that spelled their end. Even when they have the resources to innovate, dominant companies may lose out simply because there is no guarantee that their dominance will carry over to the market for a new disruptive technology–classic case is Barnes and Noble’s Nook versus Amazon’s Kindle.
That said, Christensen’s How Will You Measure Your Life? is a classic that never failed to make a significant impact on my MBAs.