“The greatest shortcoming of the human race is our inability to understand the exponential function.” ― Albert A. Bartlett
In a classic paper titled ” What Business Are You In?” by Theodore Levitt (HBR), argued that companies are focussed on the |product | and that was their shortcoming. If one looks around nature is The | Ecosystem Architect |. From a single cell organism to whole species, every members is a prosumer (Producer + Consumer) in an ecosystem. Every relationship is symbiotic. Every interaction leads to equilibrium.
However as you look around you see in business the classic management theories have and continue to fail the very executors of their learning. “Business Model Warfare – The Strategy of Business Breakthroughs” by Langdon Morris at the Ackoff Center for the Advancement of Systems Approaches (A-CASA),The University of Pennsylvania, highlighted what seemed startling to almost everyone who read the report. The study highlighted the rate of mortality of businesses which is quite mind boggling when you look at the numbers of effect of causality.
Fortune 500:A study by planners at Shell found that by 1983, ..That’s an average mortality rate of 12 companies per year, or one per month. (http://www.innovationlabs.com/BusModelWarfare.pdf)
Forbes 100: In 1917, from the largest 100 US companies. By 1987, 61 of those companies no longer existed. Over the seventy year span, in other words, an average of about one company per year disappeared.
S&P 500: The S&P 500 list provides a third reference point. In 1957, the S&P listing of 90 top companies was expanded to 500. By 1997, only 74 of the original 500 companies remained, an average mortality rate of more than 10 per year.
The cause is that | skills | of people running businesses, are logarithmic, while change is exponential. So the vast majority of executives of incumbent businesses have logarithmic skills (supply chain, accounting, business management, etc.). The upstarts have exponential ecosystem skills (interdisciplinary skills such as design, mechanism design algorithms, behavioural and decision models, etc.). The result is that the people running business with logarithmic skills cannot compete with the folks with exponential ecosystem skills. The result. The logarithmic companies have an extremely high mortality rate.
I term this the Ecosystem Skill Differentiation Law
Ecosystem Skills change exponentially, while traditional skills change logarithmically. The effect is Exponential Decay of logarithmic companies.
Capability: |Majority| of managers, executives, boards and investors possess Logarithmic skills.
Causality: Logarithmic skills enable the rate of change to only look at logarithmic thinking and vocabulary (ownership, mindset, conglomerate, valuechain, leverage capital to grow, processes, committees, systems, supplychain, asset building, balance sheet building, etc.)
Behaviour: What is the “change” that can be acquired, copied, stolen or partnered or leveraged by government support/policy, in the the hope leap to “Exponential” capability or stifle new entrants.
Effect: Race to the Bottom. Spend everything to win or value erosion behaviours such as high dividend payouts and stock buybacks.
To understand behaviour of logarithmic executives there are examples too numerous to discuss and share here. We look at startling behaviours of sample companies.
From the report ” Living beyond their means: ˜Cash flows of five oil majors can’t cover dividends, buybacks” states that
“publicly traded oil and gas firms, collectively rewarded stockholders with $536 billion in dividends and share buybacks since 2010, while generating $329 billion in free cash flow over the same period. The companies made up the $207 billion cash shortfall—equal to 39 percent of total shareholder distributions—primarily by selling assets and borrowing money.”
At the same time, these oil companies as a portfolio continue to underperform benchmark indices for over a decade.
Look at the airline companies. The results are no different. JETS (https://etfdb.com/etf/JETS/#etf-ticker-profile) an ETF with over $3.9B in AUM which racks an index of companies involved in the air travel industry, including airline operators, manufacturers, airports and terminal services, is a broad representation of the companies involved. The result over a 10 year period of performance as a benchmark is no different from the oil majors.
Would you work for a logarithmic company whose behaviour of executives, boards and investors are predictably irrational and lead to value erosion? The chance is that most do!
Or the telcos of the world. Logarithmically run and distribute value, but do not capture value. However ecosystem player do. The result is that the among the most indebted companies are telcos. Everyday people get up and ask. Why are we not generating returns in the telco business. The answer lies with the people and skills asking the questions.
- . methods of |classification of a business | by industry are inaccurate.
2. Over 99% of all employees/skills/boards/investors have | Logarithmic Skills |and see Exponential `Decay in ROI/ROE
3. Exponential Ecosystem Technologies are | Unbundling | every logarithmic business/skill
4. Models are based on |RISK| and not Uncertainty
•Statistical pricing and risk-forecasting models played a significant role in the build-up to the crisis • •they gave wrong signals, underestimated risk, and mispriced collateralised debt obligations
5. | Behaviours |of Person & Machine are not part of a today’s models
6. Exponential Technologies are not logarithmic skills (ex: language coding skills), they are | interdisciplinary |
So what’s next?
A Very simple heuristic. Companies/Countries where you see an average of around $475/hr. revenue per employee have EET skills. Companies where you see an average of around $10 to $30/hr. revenue per employee have logarithmic skills.
In the post pandemic world the clear dichotomy between who scales and who adapts to continue is based on a very simple understanding of what are Exponential Ecosystem Skills and Logarithmic `Skills.
Look ahead: Founders/CXOs/Employees/Investors with Exponential Ecosystem Skills lead Return on Time, Capital & Equity battles
In today’s world we see common technology being mentioned such as AI and Machine Learning. If you look back in time the same happened in the 80s with automobile manufacturing in Japan with Robots. AI & ML will replace the factories of $10 – $30/hr. and ,multiply the scale by a factor of x, but is not an EET. On the other hand am EET such as Computational Mechanism `Design algorithm(s) such as auction models can create, capture and distribute value across multiple ecosystems simultaneously. That is the difference, er exponentially.
Thus investors looking for the next big thing will see more than 98% of all their investments suffer from exponential decay. The cause being the businesses are based on logarithmic thinking.