The new Methuselahs

IN SEPTEMBER 2009 Fast Company magazine published a long article entitled “Nokia rocks the world”. The Finnish company was the world’s biggest mobile-phone maker, accounting for 40% of the global market and serving 1.1 billion users in 150 countries, the article pointed out. It had big plans to expand into other areas such as digital transactions, music and entertainment. “We will quickly become the world’s biggest entertainment media network,” a Nokia vice-president told the magazine.

It did not quite work out that way. Apple was already beginning to eat into Nokia’s market with its smartphones. Nokia’s digital dreams came to nothing. The company has become a shadow of its former self. Having sold its mobile-phone business to Microsoft, it now makes telecoms network equipment.

There are plenty of examples of corporate heroes becoming zeros: think of BlackBerry, Blockbuster, Borders and Barings, to name just four that begin with a “b”. McKinsey notes that the average company’s tenure on the S&P 500 list has fallen from 61 years in 1958 to just 18 in 2011, and predicts that 75% of current S&P 500 companies will have disappeared by 2027. Ram Charan, a consultant, argues that the balance of power has shifted from defenders to attackers.

Incumbents have always had a tendency to grow fat and complacent. In an era of technological disruption, that can be lethal. New technology allows companies to come from nowhere (as Nokia once did) and turn entire markets upside down. Challengers can achieve scale faster than ever before. According to Bain, a consultancy, successful new companies reach Fortune 500 scale more than twice as fast as they did two decades ago. They can also take on incumbents in completely new ways: Airbnb is competing with the big hotel chains without buying a single hotel.

Next in line for disruption, some say, are financial services and the car industry. Anthony Jenkins, a former chief executive of Barclays, a bank, worries that banking is about to experience an “Uber moment”. Elon Musk, a founder of Tesla Motors, hopes to dismember the car industry (as well as colonise Mars).

It is perfectly possible that the consolidation described so far in this special report will prove temporary. But two things argue against it. First, a high degree of churn is compatible with winner-takes-most markets. Nokia and Motorola have been replaced by even bigger companies, not dozens of small ones. Venture capitalists are betting on continued consolidation, increasingly focusing on a handful of big companies such as Tesla. Sand Hill Road, the home of Silicon Valley’s venture capitalists, echoes with talk of “decacorns” and “hyperscaling”.

Second, today’s tech giants have a good chance of making it into old age. They have built a formidable array of defences against their rivals. Most obviously, they are making products that complement each other. Apple’s customers usually buy an entire suite of its gadgets because they are designed to work together. The tech giants are also continuously buying up smaller companies. In 2012 Facebook acquired Instagram for $1 billion, which works out at $30 for each of the service’s 33m users. In 2014 Facebook bought WhatsApp for $22 billion, or $49 for each of the 450m users. This year Microsoft spent $26.2 billion on LinkedIn, or $60.5 for each of the 433m users. Companies that a decade ago might have gone public, such as Nest, a company that makes remote-control gadgets for the home, and Waze, a mapping service, are now being gobbled up by established giants.

Buying up smaller companies is usually part of a wider strategy: investing in their proprietary technologies. The tech giants climbed to the top of the pile because they were significantly better than their rivals at what they did. Amazon, for example, offered a choice of millions of books when local booksellers had just thousands. Their success provided them with piles of cash that they could invest in improving their own ideas and protecting them with armies of lawyers, and buying other people’s ideas in the market. Google purchased Motorola Mobility for $12.5 billion in order to acquire the company’s portfolio of patents. These tech giants relentlessly extend their businesses into adjacent areas: thus Amazon expanded from books and retailing generally into internet servers, and Google is expanding into everything to do with information.

In praise of asymmetries

Derek Kennedy, of BCG, a consultancy, says that one of the tech companies’ most powerful defences in the long term will be their ability to combine “asymmetries of information” with “asymmetries of execution”. These companies have unmatched stores of information, as well as an unmatched ability to use that information to reshape their existing businesses or create new ones. Not only do they know what you want before you know yourself but they can also deliver it to you. Companies can use these combined asymmetries to shift into new areas.

The rise of the internet of things (IoT) will give a powerful push to consolidation. Gartner, a research firm, predicts that the number of products connected to the internet will increase from 6.4 billion today to 21 billion by 2020 as companies discover the power of software. The process has already begun. Coca-Cola uses microchips to track the whereabouts of its bottles. Tesla improved its cars’ uphill starts by transmitting a software update. General Electric thinks that the IoT will be the biggest revolution of the coming decades.

The increasing convergence of hardware and software lets companies establish much closer relations with their customers. They can gather up-to-the-minute information on the response to their products and use it to make improvements. They can tailor products to the needs of individual customers. Sonos, a maker of music systems, produces speakers that can tune themselves to the acoustic qualities of the room they are placed in. They can sort out problems before they arise. Diebold monitors its cash machines for signs of trouble, either fixing problems remotely by means of a software patch or sending a technician. They can also branch out into delivering services. John Deere, a maker of heavy machinery, is building sensors for tractors that can receive data on weather and soil conditions, enabling farmers to make more informed decisions on the use of their land.

Older companies such as GE and Caterpillar may well have a fight on their hands with born-digital companies such as Google and Amazon that try to extend their empires into the physical world. But the overall effect will be consolidation. Only companies that can afford to make substantial investments in both the physical and virtual worlds will prosper. And once companies have established strong relationships with their customers, they will have a good chance of keeping them regardless of price. The more that things are connected to each other and to the companies in charge of the networks that control them, the harder it will be for insurgents to get a foothold in the market.

A symbiotic relationship

Most management gurus have a Manichean view of the relationship between big companies and startups: the more you have of one, the less you have of the other. They also add an evolutionary twist: the more advanced a society becomes, the better small organisations will do in relation to big ones. Gerald Davis, of the University of Michigan’s Ross School of Business, has just published a new book, “The Vanishing American Corporation”, in which he points out that the classic argument for the existence of corporations—that the cost of doing things through them is lower than through the market—has lost its force because advances in technology (of the sort that Silicon Valley has pioneered) have slashed the cost of doing things through the market.

Likewise, he says, limited-liability companies replaced other corporate forms because firms in capital-intensive industries such as steel needed to raise a lot of capital, but software companies typically do not need to raise much money. Mr Davis argues that in future companies are likely to become much more fluid: entrepreneurs can raise money from Kickstarter, rent employees from Upwork, computer power from Amazon cloud and tools from TechShop, register their companies in Liberia and still reach a global audience thanks to cloud computing. There are also ever more ways of organising co-operation; Wikipedia has already produced the world’s biggest encyclopaedia by using volunteers. “The Web and the smartphone allow pervasive markets and spontaneous collaborations at minimal cost. They make institutions like the modern corporation increasingly unsustainable,” he explains.

RocketSpace, which makes its living by looking after startups, at first sight looks like an example of what Mr Davis had in mind. Its basic business is to sell space in its nine floors of offices in the heart of San Francisco, though it does a lot more than that. Starting a company can be lonely as well as gruelling, and working in RocketSpace provides you with an instant network and access to good advice. The company has been so successful that it turns away 90% of companies that apply for accommodation. As a result, being admitted provides instant cachet (former occupants include Uber and Spotify).

But look again, and a more complicated picture emerges. RocketSpace is increasingly acting as a middleman between startups and big companies. The IPO market has shrunk into insignificance; about 90% of today’s successful startups “exit” by selling themselves to an established company. RocketSpace makes that easier by introducing them to the right partners. Big companies outside the tech industry, in turn, benefit from RocketSpace helping them understand the tech world.

The story of RocketSpace suggests that big and small organisations have a symbiotic relationship. Duncan Logan, RocketSpace’s founder, argues that corporations are, in effect, outsourcing some of their tech R&D to the startup world. This is true not only of non-tech companies that do not understand the tech world but also of big tech companies that do some of their R&D in-house but leave some of it to the market to get the best of both worlds. Big companies have much to gain from contracting out their R&D to startups. They can make lots of different bets without involving their corporate bureaucracies. But startups also have a lot to gain by selling themselves to an established company that can provide stability, reliability and predictability, all of which can be hard to come by in the tech world. Big companies have phalanxes of lawyers to protect intellectual property, bureaucrats to make sure that the t’s are crossed and the i’s dotted, and slick marketing machines.

Mr Davis is right that it is getting easier to put together a company from a variety of components, but he is wrong to conclude that big companies are in retreat. The “virtualisation” of some sectors of the economy and the “corporatisation” of others are going hand in hand. Superstar companies try to keep their costs under control by contracting out any functions they regard as non-core. Startups try to reach global markets with the help of platforms such as eBay and Alibaba. The upshot is the development of a multi-tiered economy. The commanding heights of the global economy may be dominated by familiar companies: a premier league of superstars that constantly jostle to avoid relegation, and a first division of less stellar performers that struggle to be promoted. But the lower rungs are studded with large numbers of Mr Davis’s pop-up companies.

If corporatisation and virtualisation can coexist, two of the basic tenets of modern management theory need to be rethought. The first is that corporate man (and woman) is a thing of the past, and that the only way to succeed in business is to turn yourself into an entrepreneur. The reality is more nuanced. Big companies are certainly cutting back on long-term employees. Dan Kaminsky, chief scientist and a co-founder of White Ops, one of RocketSpace’s startups, recalls that, in a previous corporate job, he filled out a form in which a “mid-career worker” was defined as someone who had been in the same post for two or three years. And employment patterns are becoming much more varied. Lawrence Katz, of Harvard, and Alan Krueger, of Princeton, calculate that the proportion of American workers engaged in “alternative work arrangements” (working as freelancers, temporary contractors and the like) increased from 10.1% in 2005 to 15.8% in late 2015.

But big companies nevertheless preserve a core of employees who help maintain a long-term institutional memory and a distinctive culture. Strategy& has been collecting data on the chief executives of the world’s top 2,500 public companies for more than 15 years. The consultancy’s Per-Ola Karlsson notes that more than 80% of these companies’ CEOs are internal appointments. Almost two-thirds of them have spent 12 years or more climbing up the corporate hierarchy. They are drawn from a large cadre of long-term employees who dominate the upper ranks of the organisation and usually outperform external recruits because they have far more company-specific knowledge.

Conversely, entrepreneurship is not necessarily a road to success. Reid Hoffman, the co-founder of LinkedIn, a social-networking company, and author of “The Start-Up of You”, may have made $2.8 billion by selling his own startup to Microsoft, but the coffee shops of San Francisco are full of middle-aged hopefuls scratching a living without a pension.

The second idea that needs overhauling is the transaction-cost theory of the firm formulated by Ronald Coase 80 years ago: that firms are worth having only if they can do things more cheaply than the market can. Since firms continue to occupy a central place in the modern economy despite the enormous advances of the market in recent years, there must be other factors at work. Companies are not just a way of keeping transaction costs to a minimum. They are proof that when people are trying to solve common problems, they are wiser collectively than they are individually. Such collective wisdom can accumulate over time and be embodied in corporate traditions that cannot be bought in the market.