Tuesday, May 15, 2012

When Giants Fail: Christensen and measuring the wrong thing.

There's a lovely article in last week's New Yorker (firewall) about Clayton Christensen, the famous Harvard business theorist. Best known for his 'Innovator's dilemma' idea, he looks at how lower quality products like minimill rebar in the steel industry repeatedly disrupt established companies.

I hadn't seen before (or had forgotten) his explanation of why established companies often let it happen. It was because managers had come to measure success in the wrong way. "Success was now measured not in numbers of dollars but in ratios", he says. It was about IRR or RoI or margins.

So companies had a tendency to exit low-margin businesses, even if the absolute value of profits was high. And they could not see it was a problem, even as low quality products, like Toyota Cars and transistor radios, steadily got better and devoured their businesses from below.

That was why he called it a church: it was an encompassing orthodoxy that made it impossible for believers to see it was wrong.
This reminds me of the more general problems with measuring the economy in terms of GDP, as we discussed here. But it is a more general problem than national income accounts. We've over applied and overused income as a concept, at the expense of assets, contingent risks and liabilities, and other aspects of the good life.

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