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Creative criticism

Josef Schumpeter’s idea that entrepreneurs drive the economy fails to understand the power of established family firms.
A tired old brontosaurus or a great family business?

Picture a tired old brontosaurus, big and unwieldy, tottering about the savannah. Now picture a bunch of little voles scampering about under his feet, leaping in to pinch his food every time he reaches down with his weary head. Before long you’ll be imagining the big lizard biting the dust while the voles dance a victory jig. That’s a pretty good way to sum up Austrian economist Josef Schumpeter’s theory of creative destruction. In the economy old businesses are the brontosauruses, and entrepreneurs are the voles.

According to an essay entitled Schumpeter Inc in a book called Megatrends – written by a bunch of crystal ball-gazing Economist writers – creative destruction will be one of the most powerful forces in the economy in the coming decades. Big is over. Small and nimble is where it’s at. There are several reasons. The internet lets small, creative businesses from out-of-the-way places compete with multinationals in New York or Berlin. The developing world is full of new, untapped markets where innovations like small cars and cheap private healthcare might flourish. Smart methods of payment could shake up banking, people will demand more flexible working patterns, undermining the traditional structure of the company. And so it goes on. Disruption is everywhere. Nothing will remain the same.

After reading this it’s tempting to throw your hands up in the air, pack in your job and go and launch a start- up. It’s especially chilling for family businesses, which are in many cases exactly the sorts of lumbering Leviathans that are supposed to be most at risk. How can they hope to survive in this disruptive new world? Don’t despair. It’s fashionable to get hot under the collar about entrepreneurs, but family businesses still have a lot going for them. For a start, businesses that plan on zooming into the Middle East, Africa or even China can’t rely on stable, peaceful markets. German Mittelstand companies with long-term relationships in Western Europe are not sexy, but their customers aren’t likely to become embroiled in civil wars or seismic social change.
The whole idea of creative destruction is exaggerated. Schumpeter fans often talk about technology firms as the paradigm of creative destroyers. And it’s true that Facebooks and Googles can become giant-killers. But there are few industries where geeks in a garage can destroy a behemoth.

Van Oord, a sixth-generation Dutch company, is Europe’s go-to firm for dredging – a vital job that keeps ports open and goods flowing around the world. The Odebrecht family has been building dams in South America for decades. What sort of start-up is going to come along and creatively destroy their business?

Anyway, the next big thing rarely lives up to the billing. While the share price of tech companies rise on average by 32% on the day of their IPO, most have negative returns after three years. Despite its huge valuation, Facebook has still not fully explained how it plans to make the money to justify it. Hype is sometimes justified, usually not.

Small = beautiful?

Schumpeter thought that “small is beautiful”. Maybe. But big is powerful, especially when it’s backed by a state. China Mobile has 600 million customers; 80% of the value of China’s stock market is in state-backed businesses. The Russian state controls 181 businesses, while Malaysia’s state- owned oil company Petronas occupies a snazzy 88-storey skyscraper in Kuala Lumpur. They aren’t looking over their shoulders.

Family businesses are actually well-placed to deal with all this 21st-century disruption, if it actually happens. After all, the older they are the more upheaval they will have managed before. The 20th century in Europe was hardly a time of calm prosperity, but very many rode the storms. They are good at it. Old businesses are not always stuck in the past – the Rothschilds did nifty things with bonds two centuries ago, and no doubt do nifty things with credit default swaps these days. Carol Ryan, of the Family Business Consulting Group, talks about the “ambidextrous company” which has a core business but also a separate, innovative wing.

Sixth-generation American family firm Huber started off making ink, but now makes cosmetics, flame retardants and engineered woods. Pfeifer, a 15th generation German business, switched from making rope after World War II and now is a massive wire manufacturer. Tata is big in steel and software, but also owns Tetley tea. Diversification breeds stability.

Fleet-footed

It’s tempting to be impressed by fleet- footed start-ups, but tried-and-tested relationships matter. “Family firms invest in building their social capital and as such can enjoy the advantages of customer, employee and supplier loyalty, which is often lacking in non-family firms when the chips are down,” says Penny Webb of family business consultancy Familias & Co.

Families that have been working together profitably for generations are hardly going to suddenly switch overnight to some upstart. These networks of firms are specifically designed to ride out cyclical wobbles.

Those who yearn for creative destruction have a strange view of the economy. The Megatrends article talks about businesses being switches in a system. But economies are not like circuitboards. They are complex, layered networks that involve complicated human relationships. Decisions are made by human beings, and they are motivated not only by profit, but also by loyalty, friendship and sometimes tradition. Economies are imperfect, but they muddle along. They are, if you want another simile, more like families.

Behind all this talk of creative destruction there’s a deterministic survival-of-the-fittest metaphor at work – those voles always win. But another animal comparison might be better. Many young animals have scary-looking colouring that try to persuade you that they are more dangerous than they are. Often, though, they are no match for a wilier, more mature competitor.

Comments

Hazelhurst offers an interesting but rather limited interpretation of Schumpeter's theory of creative destruction. He almost gets it right when he praises the impressive track record of the Rothchild's and Hubers' re-invention of their businesses through the introduction of new products and services. Both examples he offers are of "self-administered" creative destruction -- for every new product and service there was a commensurate divestiture of old antiquated products and services and a shifting of invested capital.

The fact remains that some families are highly adept at managing their emotional sentimentality for their products and services. They do this by destroying their market leading positions through innovation and self imposed obsolescence and thereby out-flank the small nimble entrepreneurial start-ups. This takes leadership, self-awareness and introspection. In a peculiar way, Hazelhusrt ends up defeating his own argument by praising the very economic concept that has been the secret for longevity of most family firms.

Simply stated, Schumpeter viewed firms as a paradox; the harder they work to destroy themselves, the longer they last. The corollary of course is a firm that practices a form of self-admiration and nostalgia for the past -- a fatal elixir that has destroyed a staggering amount of family wealth.

Tom Deans Ph.D.
Author of Every Family's Business
www.EveryFamilysBusiness.com

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