Companies: What Are They?
Lecture given at the Royal Society of Arts
January 25, 1995
A.P. de Geus
19.001 1995
Center for Organizational Learning
Massachusetts Institute of Technology
During the 1970's diversification was all the rage among oil companies (and not only oil companies!). But by the early 1980's serious doubts had surfaced in the Shell Group about the wisdom of moving the business portfolio away from oil and gas. Yet, equal doubts persisted about the very long term future in those natural resources. Is there really life after oil, or are we going to return the company to the shareholders? Early 1980's, Shell planners decided (once again) to do some research to see what other companies were doing with their business portfolios. In those days, examples abounded of companies in other industries which were happily revitalising their Profit & Loss accounts by adding new businesses to their existing ones. The Shell planners' study recorded a number of these cases and the report was presented to the Chairman. He was not impressed: 'The companies were nowhere near the size of the Group; the examples were too recent - the diversification moves had not yet stood the test of time". He would be more amenable, he said, if the planners would show him some examples of companies which were older than Shell, were relatively as important in their industry as Shell was in its and which, during their history, had successfully weathered some fundamental change in their worlds such that they still existed today with their corporate identity intact. Surely, an interesting question. Which were those companies? Royal Dutch and Shell T & T are about one hundred years old. So, we were looking for relatively large companies which existed in the final quarter of the 19th century. At the time, tens of thousands of companies already existed the world over. But which ones were still alive today with their corporate identity intact? Some companies only subsist as a name or a brand or an office building. The remnants of a glorious past.
After some research, the examples started coming. There was Dupont, the Hudson's Bay Company, W.R.Grace, Kodak. A handful of Japanese companies trace their origins to the 17th and 18th century and are still thriving today; Mitsui, Sumitomo, Daimanu the department store. Mitsubishi and Suzuki are somewhat younger: they date from the middle of the 19th century. A European company which did meet the qualifications to enter into the Shell study, was overlooked. It is Stora from Sweden. This major paper pulp and chemical company is more than 700 years old and had the character of a publicly owned company from its very early beginnings as a copper mine in Central Sweden. In total, about 40 companies were found of which 27 were studied in some detail. How come there were so few left out of the 19th century population of tens of thousands? And what had the remaining few done to survive? In conclusion, the study team found that these long established companies had a record of adaptation to changing social, economic and political conditions and consumer needs. Each one of them had seen lots of change. We need only think of the times
through which a Stora lived from the Middle Ages to the Reformation into the Wars of the 17th century, the Industrial Revolution and the 20th century with two World Wars in between. Fundamental changes in the external world require fundamental changes in the internal structures of the company to stay in harmony with that world. The history of each of those companies shows that this is what they have done. The internal changes in these successful survivors appeared to have occurred gradually, incrementally and in response to opportunity, or rather, in anticipation of customer demand. This can only mean one thing: these companies reacted earlier rather than later, by foresight rather than by crisis. In modem terms: these companies had been good at "Management for Change" . Are there traits which these survivors share and which could be an explanation of their durability? The sample in the study is small; the documentation more self- congratulatory than reliable. Yet, the study team found some characteristics time and again:
1) Conservative in financing. These companies understood the meaning of money in an old fashioned way; they knew the value of spare cash in the kitty. Theirs was not the wizardry which makes business decisions based on intricate financial deals with other people's money. They had an understanding that money-in-hand meant that they had options at moments which suited them. Capital availability means flexibility.
2) Sensitivity to the environment. The leaders of these companies were outward looking and part of their surrounding world. As a result, they were sensitive to changes and developments in that world. They saw early, concluded quickly; therefore, were able to take action quickly. These companies were mostly connected to their environment in ways which promote intelligence and learning.
3) A sense of cohesion and company identity among employees. In quite a number of the cases, the Shell researchers found a concern and interest in the human element of the company which was somewhat surprising for the times in which their histories played out. This may be one of the contributing reasons for a complementary characteristic of these firms: employees and management seemed to have a rather good understanding of " What this company stood for", or" What this company was about" .And "what it was about" was something with which these people were happy to be identified. Quite often, this value system had been brought in by the founder, sometimes even formalized in a sort of constitution.
4) Tolerance. The Shell team formulated the final characteristic in strangely modem words: Companies which have changed successfully have made full use of decentralized structures and delegated authorities. The companies have not insisted upon a relevance to the original business as a criterion for selecting new business possibilities nor upon a central control over moves to diversify.
It should be remembered that much of the history of these companies played in the 17th, the 18th and the l9th century during which time these values and organisational principles were already applied. However, the common usage of words like "decentralisation" and "diversification" to describe them is relatively recent. I tried to imagine in what terms the leaders, owners and managers in centuries past might have thought about their company policies. One possible reformulating of this last characteristic of our corporate survivors could then be: They had tolerance for activities in the margin.
One can argue what the real measure of corporate success is. To be among the first ten in Fortune's 500, or to have the highest Return on Capital Employed are some of the criteria employed today. I presume that staying alive for several centuries in a hard world also qualifies for a high ranking in the corporate league tables. Yet, the Shell planners described these successful corporate survivors in strangely soft terms: "financially conservative with a staff which identifies with the company and a management which is tolerant and sensitive to the world in which they live".
There is nothing in this description about low-cost marketing or the cutting edge of technology, nor about being a high value-added producer. Cleverness in financing is even specifically excluded! That is quite different from the definition which I was taught at Erasmus University in Rotterdam during the early 1950's.
The production of goods and services, so the students were told, takes place in organisations which in our societies are called companies. They produce goods for which other people are prepared to pay a price. Companies produce those goods by trying to find the optimum combination of the three production factors labour, capital and land. These three are substitutable, i.e. Iabour can be replaced by capital. The optimum combination of the production factors is the one at which the company is producing at minimum costs to be sold at maximum price for the maximisation of profits.
To us, students, it was a re-assuring definition. It made a company into a rational thing: the Economic Company. The equivalent of Homo Economicus. Production is a matter of costs and price. These are things you can catch in figures with which you can make calculations. Costs are mostly the costs of labour and capital - the production factors which are interchangeable. That made it sound so controllable: if you have trouble with labour or if it is too expensive, you replace manpower by capital assets. For young aspiring corporate leaders, as many students at Erasmus saw themselves, this description of their future place of work was re-assuring and comforting: rational, calculable and controllable.
When a couple of years later, I entered my first place of work, the Shell refinery near Rotterdam, a slight feeling of discomfort developed quickly. The theories at Erasmus had mentioned labour, but there had been no talk of people. Yet, the real world, the refinery, seemed to be full of them. And because the workplace was full of people, it looked suspiciously as if companies were not always rational, calculable and controllable.
Then, some 20 years later the Shell planners' study painted the picture of companies in very different terms: "struggle for survival, maintaining the institution in the face of a constantly changing world and the need to make fundamental adaptations to that world." Of course, these long term survivors had to control costs, market their products and up-date their technology. But it did not sound as the essence of their corporate being. More as a preliminary or a basic condition to more important considerations of life and death. These companies not only had people who sometimes were uncontrollable or irrational; the companies themselves behaved as if they were alive. As if they were other than economic systems to produce goods with the purpose of maximising their profits. Looking at these two different descriptions of companies, one begins to wonder, whether some companies are "living systems" rather than mere instruments to produce goods and services. In fact, the legislation in my country, of birth has referred to companies as "Persons" since Napoleon's times. The Law distinguishes between natural "persons" and legal "persons" with companies falling under the latter category, . Nor is the law at odds with common parlance. Often, we talk of organised groups of human beings in terms which are closer to the way we speak about human beings than the way we speak about dead objects, like a rock or a sack of grain.
Would it make a difference if we formulate a hypothesis like: "Some or all companies behave like living beings"? Would it change our view about the way in which to manage companies, or would it give an explanation why some companies survive and so many die young? A hypothesis so far removed from the economic definition of companies would force us to have another look at the behaviour of those companies. It may be refreshing. It may, even, give new insights in phenomena that managers have known for a long time. I will not try to argue that all companies are the same. Many companies and many a management behave as if the production of goods and services is indeed a purely economic problem. Other organisations behave more like living beings, trying to survive in adversity What I will try to argue, though, is that management must be acutely aware which type of company they happen to be managing. Management practices which are adequate in one type of companies could do a lot of damage in the other. The reason is that the "companies as living beings' hypothesis looks differently at some basic concepts as- the role of profits and assets,- the amount of steering and control from the top (in decisions like diversification, downsizing or expansion),- the way to create and shape the human community which is the company,- the role of power in decision taking.
I would like to submit for your perusal some of those differences. It would be beyond the scope of this talk to pursue all aspects, but I would like to develop the following three which follow from the Shell study of corporate survivors.
The role of profits and assets.
The 27 companies of the Shell study are examples of companies that have as their main driving forces their own survival and the development of their potential. With their age varying between 100 and 700 years, their history shows that these companies are in business, any business, so long as it helps them to continue being a viable work community. Over their long lifetime, each one changed its business portfolio at least once, some of them several times. Dupont de Nemours started out as a gun powder manufacturer, became the largest shareholder of General Motors in the 1930's and is nowadays mostly into specialty chemicals. Mitsui' s founder opened a drapery shop in Edo (= Tokyo) in 1673, went into money-changing and converted into a bank after the Meiji Restoration in the 19th century. The company added coal mining and towards the end of the 19th century ventured into manufacturing. The first written mention of Stora in Dalecarlia, Central Sweden dates from 1288. In those days it was a copper mine. During the ensuing 700 years new activities were added which replaced the old "core" business. The company moved from copper to forest exploitation, to iron smelting to hydro power and nowadays to paper and wood pulp and into chemicals. Each one of these portfolio changes, in hindsight, seems to be Herculean, but for the people running these enterprises in those days they may well have been gradual and almost imperceptible at the outset. Yet, they demonstrate a flexible attitude vis-a-vis the business which the company happens to be doing at any moment of time. At some stage these companies may have been thinking of themselves as bankers. A later generation, however, became manufacturers. Such changes in the business can not come about without an attitude versus assets which sees the latter not as the essence of their business, but as a means for living.Like any company, they need to make profits from the business which they happen to be doing to stay alive. However, neither the business, nor the profits from it are their main driving force. They need profits in the same way as any living being needs oxygen. It is a necessity to stay alive, but it is not the purpose of life. Another way of putting this fundamental difference is to say that if AVIS were one of those work communities, it would think about its business as "renting cars to exist".
That is quite different from the "economic" company which is in a business which it uses to make profits or to maximise shareholder value. For such a company, this business is the essence of life and profits are its purpose: an economic company "exists to rent cars". The maximisation of profits and capital (asset) value leads to thinking that the present asset base is the essence of the company. That the company's purpose in life is to exploit this particular set of assets. In a crisis they will scuttle people rather than assets to save their" Balance sheet" (which statement quite appropriately only records physical assets!). The logical climax of this thinking would be that "we will liquidate the company and return the remaining value to the shareholder, whenever the oil runs out". However, companies are rarely returned to the shareholders. Corporate suicide is uncommon amongst living companies. Their purpose in life is survival and the development of potential. They can not accept that a set of assets would determine the life or death of the institution.
The amount of steering and control from the top.
When one contemplates the immense portfolio changes which the surviving living companies have introduced over time, one can not escape the apparent contradiction that, recently in the 1970's, many companies learned that diversification is a dangerous route to take. The lessons were so painful that, nowadays we are right in the middle of a reaction to the diversification movement. Stick to your knitting, back to basics and concentrate on the core business are the fashionable business policies. Yet, we see these strong indications that to survive beyond the next major technological, political or social upheaval in the world at large, a company must be able to change completely its business portfolio away from what at some moment in time is its core business. An explanation for this apparent contradiction lies undoubtedly in the manner in which portfolio changes came about in our corporate survivors over the centuries. The changes were mostly gradual, incremental and in anticipation of customer needs. New business was not required to be relevant to the original business and above all, there was no central control over the diversification. Certainly, one should add, the
diversifications were not initiated from a central control point, as seems to have been the case with so many of the 1970's diversification moves. Earlier we called this management practice of little steering and control from the top "a management attitude of being tolerant towards activities in the margin".
Tolerance is a measure of the openness of a system. It is the extent to which a company is open, "is tolerant" of new and different people and open to new and different ideas ( the Oxford Dictionary: "the disposition to be patient with the opinions or practices of others").
Tolerance levels are different between different companies. Some companies are highly tolerant of new people, new ideas and new practices and some companies are definitely not. Both low and high tolerance have a place in business, depending on the environment in which the company is working, or rather, depending on the amount of control that the company has over its environment.
Low tolerance needs a degree of control over the environment but it is efficient.
A management policy of low tolerance needs two basic conditions to be fulfilled: the company should have some control over the world in which it is operating and this world should be relatively stable. The stability is desirable to allow the company the time to find the equilibrium between its internal efficiency and the external world. In such a world, a company can go for maximum results with minimum resources. To allow it to achieve its goal of minimum resources, the management will also have to exercise a high degree of control over all internal operations. In these companies there can not be much room for delegated authority and freedom of action.
A company may be lucky and live and die in a world with a market for its products which happened to be stable. However, for any company living for more than a few score years the world will change from time to time. When that happens, the company has a choice: - it can change the world back to what it was or to a more acceptable form. Alas, this is usually not in the power of a private company. It may be, or may have been, the prerogative of State monopolies to arrange for rules and regulations which keep the outside world more or less under control. Private companies must rely for survival on the other response which is - to change itself and adapt to the changing world.
Given the pain of making internal structural change and given sufficient power to force the outside world in a mould which suits the company, the temptation will be irresistible to do the latter. The European PTT's and to some extent the European national airline companies, still today, give us regular demonstrations of the latter behaviour. But also private enterprise in many countries have comfortable arrangements, associations, clubs etc. which make for a nice, warm environment in which these companies are operating. The banking and insurance industries in most European countries, not all that long ago, were good examples. So are many of the professions. Of late, certain political and technological developments, or simply the urge to grow, have tempted many companies out of their national environments. The European Union is one such political development. Technology pushes the telecommunication industry world-wide. PTT's begin to think about international business. Local banks and insurance companies realise that either they move out and try to live in other countries or the foreign world will move in on their national patch and start destroying their local arrangements. By moving into new and "foreign" territory or, inversely, by seeing the outside world move into their own territory, many companies discover that the old means of influencing the environment to one's own benefit either do not exist anymore or that they are not allowed to use them as they were used to. When that happens, the world around these companies becomes unpredictable, more difficult to know and almost certainly more changeable.
In a changing and uncontrollable world, any company with the desire to survive over longish periods would be ill advised to rely on a management policy of high internal and external controls. The Shell study showed that the successful survivors created internal space and freedom to cope with a world of changes which they had no hope to control. They had management policies of high tolerance to people and ideas, both from the inside as from the outside.
High tolerance is wasteful of resources. High tolerance is wasteful of resources, but adaptable to a changing environment over which the company has no control. Moreover, high tolerance is the way to a gradual renewal of the business portfolio without having to resort to diversification by topdown "diktat". The way this works may be illustrated by an example which many of us experience every year: in Spring we have to make a choice between low tolerance and high tolerance when we face the job of having to prune our roses. In the extreme, the choice between pruning the roses hard or pruning them long depends on the result we want to achieve in summer. If the gardener wants to have the largest and most glorious roses of the neighbourhood, she will prune hard. She will reduce each rose plant to one max. three stems, each of which she will reduce to two or three buds. The plant is forced to put all its available resources into its "core business". We may expect to see in June some sizeable flowers to dazzle the neighbours. However, in an unlucky year, if we get a severe night frost in late April or early May, the rose plants may suffer serious damage to the limited number of shoots which were left on the plant. Worse, if the frost, or a visit of the deer or a sudden invasion of green fly is really serious, we may not get any roses at all this year. Or loose the main stems or the whole plant! Pruning hard is a dangerous policy in an unpredictable environment. So, if we know that we live in a spot, where nature may play a trick on us and, especially, if we want to have roses, year after year, we will leave more stems on the plant and leave more buds per stem. We will not have the biggest roses in the neighbourhood, but we have enhanced the chances that we will have roses, not only this year, but also next year. But there is more to this management policy of high tolerance. Pruning long also achieves a gradual renewal of the portfolio. By leaving young, weaker shoots on the plant, we give them the chance to grow and to strengthen, so that they can take over the task of the main shoots in a couple of years' time. A tolerant pruning policy achieves two ends: - it makes it easier to cope with unexpected environmental changes, - and, secondly, it works towards a gradual restructuring of the plant. The policy is wasteful of resources, because the extra growth buds will take resources away from the main stem. Yet, it is a policy which is better indicated in an unpredictable environment which we do not control. Historically, diversification by tolerance for activities in the margin has a better track record than diversification by dictum!
The way to create and shape the human community of the company
This is the third area, where managerial behaviour is quite different between economic companies and self perpetuating work communities. The fact that living companies want to survive for periods much longer than the lifetime of any individual, requires a different managerial attitude to the shaping of the community. There are companies that are like puddles of rain water a collection of rain drops nun together in a suitable hollow. From time to time, some more drops are added, but when the sun shines and the temperature heats up, the puddle starts evaporating. Puddles of rain water can not stand much heat. Puddles are relatively stable surroundings. The drops stay in the same position most of the time and some of these drops never seem to leave the puddle. The drops are the puddle.Other companies are like rivers. A river is a permanent feature in the landscape. Come rain, come shine, the river may swell, it may shrink, but it takes a long and severe drought for the river to disappear. One difference between a puddle and the river is that the drops of water which form the river are different at any moment in time. Long lasting companies provide for a succession of new water drops by which the puddle transforms into a river. A river is also more turbulent. The water drops change position all the time and, finally, they run out into the sea. The river lasts many times longer than the drops of water which shaped it originally.
A company will become a river by the introduction of continuity rules. What are continuity rules?
Continuity rules are the personnel policies which ensure that there is a regular supply of new human talent entering the company. The numbers that enter are determined by the definition (or re-definition) of the company: Who are We and How many of Us are there or do we want to have? Recruitment is not done, simply to replace a member of the staff who has left for whatever reason. Time will have to be taken into account in terms of generations of managers and employees. And so will ideas about the desirability to grow or reduce the community, or to keep it stable over time.
On the other end of the scale, continuity rules will stipulate that there is a fixed moment of retirement for each and every member without exception. River-type companies are the opposite of that old cartoon which shows the Board table surrounded by 12 geriatric individuals nodding slowly to the Chairman who is proposing to extend the retirement age by one more year! Strict exit rules make for a sharper realisation by the incumbent management that they are only one link in a chain. Leadership becomes stewardship. You take over from somebody, you hand over to somebody else. In the mean time, you try to keep the shop as healthy as you got it, or make it just a little bit healthier. Strict exit rules are good for humility.
Companies which are seen as learning, living beings demand not only different thinking about recruitment, but about other aspects of Human Relations as well. The emphasis shifts first of all to the question:- Who is Us? In other words who belongs to the institution, who shall we let in and who is only part of the surroundings?
The definition of Self, who we are and who belongs to us, usually, is quite restricted and the process of entry of new members is highly selective. Clarity on these points is an absolute requirement for the living work community. Without it there is no continuity. Without continuity, there is no mutual trust between the community and its individual members. Without trust there is no cohesion and no community. This thinking is quite different from the Human Relations practices required in an economic company. In the latter type of company, the role of Human Relations is one of finding the right people to fit the asset base of the company. People are cogs to fit a hole, or "hands" to serve the machines or "brains" to make the right type of calculation or do the most promising research. The numbers to recruit are determined by the need for a capacity to produce the foreseen demand for the company's products. If the company has more demand than it has capacity, it admits new people (and machines). Consequently, when it has less demand, it reduces capacity by letting people go. Also, the type of people, the company will admit or fire is mostly defined in terms of "skills"; "We need 250 metal bashers", or "We have a surplus of paper pushers". In this reasoning we do not hire or fire people, only "skills", hands or heads. The mutual obligations between company and individual are those of "delivering the skill against the payment of a remuneration"; an agreement usually concluded under the umbrella of the country's social legislation or of some collective labour agreement.
In the hypothesis of the learning, living institution the admission or dismissal of people takes place under considerations which are more comparable to the care which is taken when admitting new members to a club or a trade union or a professional body. Good care is taken that the new members carry the right (professional) qualifications, but equally good care is taken that there is a certain harmony between the member and the institution. Member and institution share certain values and purposes and aim to harmonise their respective long term goals. Also, admission is not a capacity question. In the learning, living company, capacity questions are addressed via the outside world, not by increasing or decreasing the membership. A shortage of capacity will lead to more sub-contracting of people who are not members of this particular work community. In Italy, Benetton does only a minor part of its manufacturing with its own people (some years ago only about 20%), meaning that it does a lot of sub-contracting. That is an effective way of acquiring capacity in a competitive industry with fluctuating demand. Benetton admits relatively few members to the inner core of its work community.
In conclusion, every management group has a choice. Many people in the business world may not want to create a work community. It is perfectly legitimate for anybody to want to create a corporate machine with the sole purpose of earning a living for that person or for her family. However, to make this choice has consequences. There is no free lunch. The approach of entrepreneurs and family businesses to structure, processes, staff and decision power will have to be different from the ones which apply to the living community. People who want economic companies have fewer options in their managerial practices. In their companies only a small group of people qualify to be "one of Us". All other people recruited to contribute to the corporate efforts become attachments to somebody else's money machine. Their relationship will necessarily reflect it. They are outsiders, recruited for their ''skills", not to become full member with all rights and obligations. Skills are sold for money and money is not a sufficient harmoniser between corporate goals and individual expectations. Loyalty will be lower and, as a result, the levels of trust are lower. The fact that there is no commonality of goals and low-ish levels of trust require a strengthening of hierarchical controls to make the money machine working effectively and efficiently. The conditions for effective mobilisation of all the available brain capacity are reduced. When the business grows somewhat, some new members will (have to) be admitted to the inner core of the founder, her immediate or extended family and possibly some old friends - i.e. the real, very small group "who belong". A critical point arrives when the succession of the inner-community will have to be addressed. The absence of continuity rules or the reliance on the next generations of the family for corporate continuity will make "ships that-pass-in-the-night" out of many of those money machines. This, in its turn, will be understood by potential recruits of such companies. People will allow themselves to be recruited, but do so with their eventual exit in mind. In short, economic companies not only have a difficult life in a changing environment that they do not control. Also, in their internal management practices, they have to overcome considerable obstacles to make it to the top of the class and to make it into the next generation.