The Theory Of The Business, by Peter Drucker - 企管

This is an article written by Peter Drucker. This article is the winner
of McKinsey Award. It is one of the classic work of Peter Drucker.

Hope you enjoy it and I am looking forward to your sharing of ideas.


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The Theory Of The Business
1994, Harvard Business Review


Not in a very long time--not, perhaps, since the late 1940s or early
1950s--have there been as many new major management techniques as there
are today: downsizing, outsourcing, total quality management, economic
value analysis, benchmarking, reengineering. Each is a powerful tool.
But, with the exceptions of outsourcing and reengineering, these tools
are designed primarily to do differently what is already being done.
They are "how to do" tools.

Yet "what to do" is increasingly becoming the central challenge facing
managements, especially those of big companies that have enjoyed
long-term success. The story is a familiar one: a company that was a
superstar only yesterday finds itself stagnating and frustrated, in
trouble and, often, in a seemingly unmanageable crisis. This phenomenon
is by no means confined to the United States. It has become common in
Japan and Germany, the Netherlands and France, Italy and Sweden. And it
occurs just as often outside business--in labor unions, government
agencies, hospitals, museums, and churches. In fact, it seems even less
tractable in those areas.

The root cause of nearly every one of these crises is not that things
are being done poorly. It is not even that the wrong things are being
done. Indeed, in most cases, the right things are being done -- but
fruitlessly. What accounts for this apparent paradox? The assumptions on
which the organization has been built and is being run no longer fit
reality. These are the assumptions that shape any organization's
behavior, dictate its decisions about what to do and what not to do, and
define what the organization considers meaningful results. These
assumptions are about markets. They are about identifying customers and
competitors, their values and behavior. They are about technology and
its dynamics, about a company's strengths and weaknesses. These
assumptions are about what a company gets paid for. They are what I call
a company's theory of the business.

Every organization, whether a business or not, has a theory of the
business. Indeed, a valid theory that is clear, consistent, and focused
is extraordinarily powerful. In 1809, for instance, German statesman and
scholar Wilhelm von Humboldt founded the University of Berlin on a
radically new theory of the university. And for more than 100 years,
until the rise of Hitler, his theory defined the German university,
especially in scholarship and scientific research. In 1870, Georg
Siemens, the architect and first CEO of Deutsche Bank, the first
universal bank, had an equally clear theory of the business: to use
entrepreneurial finance to unify a still rural and splintered Germany
through industrial development. Within 20 years of its founding,
Deutsche Bank had become Europe's premier financial institution, which
it has remained to this day in spite of two world wars, inflation, and
Hitler. And, in the 1870s, Mitsubishi was founded on a clear and
completely new theory of the business, which within 10 years made it the
leader in an emerging Japan and within another 20 years made it one of
the first truly multinational businesses.

Similarly, the theory of the business explains both the success of
companies like General Motors and IBM, which have dominated the U.S.
economy for the latter half of the twentieth century, and the challenges
they have faced. In fact, what underlies the current malaise of so many
large and successful organizations worldwide is that their theory of the
business no longer works.

Whenever a big organization gets into trouble--and especially if it has
been successful for many years-people blame sluggishness, complacency,
arrogance, mammoth bureaucracies. A plausible explanation? Yes. But
rarely the relevant or correct one. Consider the two most visible and
widely reviled "arrogant bureaucracies" among large U.S. companies that
have recently been in trouble.

Since the earliest days of the computer, it had been an article of faith
at IBM that the computer would go the way of electricity. The future,
IBM knew, and could prove with scientific rigor, lay with the central
station, the ever-more-powerful mainframe into which a huge number of
users could plug. Everything--economics, the logic of information,
technology -- led to that conclusion. But then, suddenly, when it seemed
as if such a central-station, mainframe-based information system was
actually coming into existence, two young men came up with the first
personal computer. Every computer maker knew that the PC was absurd. It
did not have the memory, the database, the speed, or the computing
ability necessary to succeed. Indeed, every computer maker knew that the
PC had to fail -- the conclusion reached by Xerox only a few years
earlier, when its research, team had actually built the first PC. But
when that misbegotten monstrosity--first the Apple, then the
Macintosh--came on the market, people not only loved it, they bought it.

Every big, successful company throughout history, when confronted with
such a surprise, has refused to accept it. "It's a stupid fad and will
be gone in three years," said the CEO of Zeiss upon seeing the new Kodak
Brownie in 1888, when the German company was as dominant in the world
photographic market as IBM would be in the computer market a century
later. Most mainframe makers responded in the same way. The list was
long: Control Data, Univac, Burroughs, and NCR in the United States;
Siemens, Nixdorf, Machines Bull, and ICL in Europe; Hitachi and Fujitsu
in Japan. IBM, the overlord of mainframes with as much m sales as all
the other computer makers put together and with record profits, could
have reacted in the same way. In fact, it should have. Instead, IBM
immediately accepted the PC as the new reality. Almost overnight, it
brushed aside all its proven and time-tested policies, rules, and
regulations and set up not one but two competing teams to design an even
simpler PC. A couple of years later, IBM had become the world's largest
PC manufacturer and the industry standard setter.

There is absolutely no precedent for this achievement in all of business
history; it hardly argues bureaucracy, sluggishness, or arrogance. Yet
despite unprecedented flexibility, agility, and humility, IBM was
floundering a few years later in both the mainframe and the PC business.
It was suddenly unable to move, to take decisive action, to change.

The case of GM is equally perplexing. In the early 1980s -- the very
years in which GM's main business, passenger automobiles, seemed almost
paralyzed -- the company acquired two large businesses: Hughes
Electronics and Ross Perot's Electronic Data Systems. Analysts generally
considered both companies to be mature and chided GM for grossly
overpaying for them. Yet, within a few short years, GM had more than
tripled the revenues and profits of the allegedly mature EDS. And ten
years later, in 1994, EDS had a market value six times the amount that
GM had paid for it and ten times its original revenues and profits.

Similarly, GM bought Hughes Electronics -- a huge but profitless company
involved exclusively in defense -- just before the defense industry
collapsed. Under GM management, Hughes has actually increased its
defense profits and has become the only big defense contractor to move
successfully into large-scale nondefense work. Remarkably, the same bean
counters who had been so ineffectual in the automobile business--30-year
GM veterans who had never worked for any other company or, for that
matter, outside of finance and accounting departments--were the ones who
achieved those startling results. And in the two acquisitions, they
simply applied policies, practices, and procedures that had already been
used by GM.

This story is a familiar one at GM. Since the company's founding in a
flurry of acquisitions 80 years ago, one of its core competencies has
been to "overpay" for well-performing but mature businesses--as it did
for Buick, AC Spark Plug, and Fisher Body in those early years--and then
turn them into world-class champions. Very few companies have been able
to match GM's performance in making successful acquisitions, and GM
surely did not accomplish those feats by being bureaucratic, sluggish,
or arrogant. Yet what worked so beautifully in those businesses that GM
knew nothing about failed miserably in GM itself.

What can explain the fact that at both IBM and GM the policies,
practices, and behaviors that worked for decades -- and in the case of
GM are still working well when applied to something new and different --
no longer work for the organization in which and for which they were
developed? The realities that each organization actually faces have
changed quite dramatically from those that each still assumes it lives
with. Put another way, reality has changed, but the theory of the
business has not changed with it.

Before its agile response to the new reality of the PC, IBM had once
before turned its basic strategy around overnight. In 1950, Univac, then
the world's leading computer company, showed the prototype of the first
machine designed to be a multipurpose computer. All earlier designs had
been for single-purpose machines. IBM's own two earlier computers, built
in the late 1930s and 1946, respectively, performed astronomical
calculations only. And the machine that IBM had on the drawing board in
1950, intended for the SAGE air defense system in the Canadian Arctic,
had only one purpose: early identification of enemy aircraft. IBM
immediately scrapped its strategy of developing advanced single-purpose
machines; it put its best engineers to work on perfecting the Univac
architecture and, from it, designing the first multipurpose computer
able to be manufactured (rather than handcrafted) and serviced. Three
years later, IBM had become the world's dominant computer maker and
standard-bearer. IBM did not create the computer. But in 1950, its
flexibility, speed, and humility created the computer industry.

However, the same assumptions that had helped IBM prevail in 1950 proved
to be its undoing 30 years later. In the 1970s, IBM assumed that there
was such a thing as a "computer," just as it had in the 1950s. But the
emergence of the PC invalidated that assumption. Mainframe computers and
PCs are, in fact, no more one entity than are generating stations and
electric toasters. The latter, while different, are interdependent and
complementary. In contrast, mainframe computers and PCs are primarily
competitors. And, in their basic definition of information, they
actually contradict each other: for the mainframe, information means
memory; for the brainless PC, it means software. Building generating
stations and making toasters must be run as separate businesses, but
they can be owned by the same corporate entity, as General Electric did
for decades. In contrast, mainframe computers and PCs probably cannot
coexist in the same corporate entity.

IBM tried to combine the two. But because the PC was the fastest growing
part of the business, IBM could not subordinate it to the mainframe
business. As a result, the company could not optimize the mainframe
business. And because the mainframe was still the cash cow, IBM could
not optimize the PC business. In the end, the assumption that a computer
is a computer--or, more prosaically, that the industry is hardware
driven--paralyzed IBM.

GM had an even more powerful, and successful, theory of the business
than IBM had, one that made GM the world's largest and most profitable
manufacturing organization. The company did not have one setback in 70
years--a record unmatched in business history. GM's theory combined in
one seamless web assumptions about markets and customers with
assumptions about core competencies and organizational structure.

Since the early 1920s, GM assumed that the U.S. automobile market was
homogeneous in its values and segmented by extremely stable income
groups. The resale value of the "good" used car was the only independent
variable under management's control. High trade-in values enabled
customers to upgrade their new-car purchases to the next category--in
other words, to cars with higher profit margins. According to this
theory, frequent or radical changes in models could only depress
trade-in values.

Internally, these market assumptions went hand in hand with assumptions
about how production should be organized to yield the biggest market
share and the highest profit. In GM's case, the answer was long runs of
mass-produced cars with a minimum of changes each model year, resulting
in the largest number of uniform yearly models on the market at the
lowest fixed cost per car.

GM's management then translated these assumptions about market and
production into a structure of semiautonomous divisions, each focusing
on one income segment and each arranged so that its highest priced model
overlapped with the next division's lowest priced model, thus almost
forcing people to trade up, provided that used-car prices were high.

For 70 years, this theory worked like a charm. Even in the depths of the
Depression, GM never suffered a loss while steadily gaining market
share. But in the late 1970s, its assumptions about the market and about
production became invalid. The market was fragmenting into highly
volatile "lifestyle" segments. Income became one factor among many in
the buying decision, not the only one. At the same time, lean
manufacturing created an economics of small scale. It made short runs
and variations in models less costly and more profitable than long runs
of uniform products.

GM knew all this but simply could not believe it. (GM's union still
doesn't.) Instead, the company tried to patch things over. It maintained
the existing divisions based on income segmentation, but each division
now offered a "car for every purse." It tried to compete with lean
manufacturing's economics of small scale by automating the large-scale,
long-run mass production (losing some $30 billion in the process).
Contrary to popular belief, GM patched things over with prodigious
energy, hard work, and lavish investments of time and money. But
patching only confused the customer, the dealer, and the employees and
management of GM itself. In the meantime, GM neglected its real growth
market, where it had leadership and would have been almost unbeatable:
light trucks and minivans.

A theory of the business has three parts. First, there are assumptions
about the environment of the organization: society and its structure,
the market, the customer, and technology.

Second, there are assumptions about the specific mission of the
organization. Sears, Roebuck and Company, in the years during and
following World War I, defined its mission as being the informed buyer
for the American family. A decade later, Marks and Spencer in Great
Britain defined its mission as being the change agent in British society
by becoming the first classless retailer. AT&T, again in the years
during and immediately after World War I, defined its role as ensuring
that every U.S. family and business have access to a telephone. An
organization's mission need not be so ambitious. GM envisioned a far
more modest role--as the leader in "terrestrial motorized transportation
equipment," in the words of Alfred P. Sloan, Jr.

Third, there are assumptions about the core competencies needed to
accomplish the organization's mission. For example, West Point, founded
in 1802, defined its core competence as the ability to turn out leaders
who deserve trust. Marks and Spencer, around 1930, defined its core
competence as the ability to identify, design, and develop the
merchandise it sold, instead of as the ability to buy. AT&T, around
1920, defined its core competence as technical leadership that would
enable the company to improve service continuously while steadily
lowering rates.

The assumptions about environment define what an organization is paid
for. The assumptions about mission define what an organization considers
to be meaningful results; in other words, they point to how it envisions
itself making a difference in the economy and in the society at large.
Finally, the assumptions about core competencies define where an
organization must excel in order to maintain leadership.

Of course, all this sounds deceptively simple. It usually takes years of
hard work, thinking, and experimenting to reach a clear, consistent, and
valid theory of the business. Yet to be successful, every organization
must work one out.

What are the specifications of a valid theory of the business? There are
four.

1.쨠쨠쨠쨠The assumptions about environment, mission, and core
competencies must fit reality. When four penniless young men from
Manchester, England, Simon Marks and his three brothers-in-law, decided
in the early 1920s that a humdrum penny bazaar should become an agent of
social change, World War I had profoundly shaken their country's class
structure. It had also created masses of new buyers for good-quality,
stylish, but cheap merchandise like lingerie, blouses, and stockings --
Marks and Spencer's first successful product categories. Marks and
Spencer then systematically set to work developing brand-new and
unheard-of core competencies. Until then, the core competence of a
merchant was the ability to buy well. Marks and Spencer decided that it
was the merchant, rather than the manufacturer, who knew the customer.
Therefore, the merchant, not the manufacturer, should design the
products, develop them, and find producers to make the goods to his
design, specifications, and costs. This new definition of the merchant
took five to eight years to develop and make acceptable to traditional
suppliers, who had always seen themselves as "manufacturers," not
"subcontractors."
2.쨠쨠쨠쨠The assumptions in all three areas have to fit one another. This
was perhaps GM's greatest strength in the long decades of its
ascendancy. Its assumptions about the market and about the optimum
manufacturing process were a perfect fit. GM decided in the mid-1920s
that it also required new and as-yet-unheard-of core competencies:
financial control of the manufacturing process and a theory of capital
allocations. As a result, GM invented modern cost accounting and the
first rational capital-allocation process.
3.쨠쨠쨠쨠The theory of the business must be known and understood
throughout the organization. That is easy in an organization's early
days. But as it becomes successful, an organization tends increasingly
to take its theory for granted, becoming less and less conscious of it.
Then the organization becomes sloppy. It begins to cut corners. It
begins to pursue what is expedient rather than what is right. It stops
thinking. It stops questioning. It remembers the answers but has
forgotten the questions. The theory of the business becomes "culture."
But culture is no substitute for discipline, and the theory of the
business is a discipline.
4.쨠쨠쨠쨠The theory of the business has to be tested constantly. It is
not graven on tablets of stone. It is a hypothesis. And it is a
hypothesis about things that are in constant flux-society, markets,
customers, technology. And so, built into the theory of the business
must be the ability to change itself.

Some theories of the business are so powerful that they last for a long
time. But being human artifacts, they don't last forever, and, indeed,
today they rarely last for very long at all. Eventually every theory of
the business becomes obsolete and then invalid. That is precisely what
happened to those on which the great U.S. businesses of the 1920s were
built. It happened to the GMs and the AT&Ts. It has happened to IBM. It
is clearly happening today to Deutsche Bank and its theory of the
universal bank. It is also clearly happening to the rapidly unraveling
Japanese keiretsu.

The first reaction of an organization whose theory is becoming obsolete
is almost always a defensive one. The tendency is to put one's head in
the sand and pretend that nothing is happening. The next reaction is an
attempt to patch, as GM did in the early 1980s or as Deutsche Bank is
doing today. Indeed, the sudden and completely unexpected crisis of one
big German company after another for which Deutsche Bank is the "house
bank" indicates that its theory no longer works. That is, Deutsche Bank
no longer does what it was designed to do: provide effective governance
of the modern corporation.

But patching never works. Instead, when a theory shows the first signs
of becoming obsolete, it is time to start thinking again, to ask again
which assumptions about the environment, mission, and core competencies
reflect reality most accurately -- with the clear premise that our
historically transmitted assumptions, those with which all of us grew
up, no longer suffice.

What, then, needs to be done? There is a need for preventive care --
that is, for building into the organization systematic monitoring and
testing of its theory of the business. There is a need for early
diagnosis. Finally, there is a need to rethink a theory that is
stagnating and to take effective action in order to change policies and
practices, bringing the organization's behavior in line with the new
realities of its environment, with a new definition of its mission, and
with new core competencies to be developed and acquired.

Preventive Care. There are only two preventive measures. But, if used
consistently, they should keep an organization alert and capable of
rapidly changing itself and its theory. The first measure is what I call
abandonment. Every three years, an organization should challenge every
product, every service, every policy, every distribution channel with
the question, If we were not in it already, would we be going into it
now? By questioning accepted policies and routines, the organization
forces itself to think about its theory. It forces itself to test
assumptions. It forces itself to ask: Why didn't this work, even though
it looked so promising when we went into it five years ago? Is it
because we made a mistake? Is it because we did the wrong things? Or is
it because the right things didn't work?

Without systematic and purposeful abandonment, an organization will be
overtaken by events. It will squander its best resources on things it
should never have been doing or should no longer do. As a result, it
will tack the resources, especially capable people, needed to exploit
the opportunities that arise when markets, technologies, and core
competencies change. In other words, it will be unable to respond
constructively to the opportunities that are created when its theory of
the business becomes obsolete.

The second preventive measure is to study what goes on outside the
business, and especially to study noncustomers. Walk-around management
became fashionable a few years back. It is important. And so is knowing
as much as possible about one's customers--the area, perhaps, where
information technology is making the most rapid advances. But the first
signs of fundamental change rarely appear within one's own organization
or among one's own customers. Almost always they show up first among
one's noncustomers. Noncustomers always outnumber customers. Wal-Mart,
today's retail giant, has 14% of the U.S. consumer-goods market. That
means 86% of the market is noncustomers.

In fact, the best recent example of the importance of the noncustomer is
U.S. department stores. At their peak some 20 years ago, department
stores served 30% of the U.S. nonfood retail market. They questioned
their customers constantly, studied them, surveyed them. But they paid
no attention to the 70% of the market who were not their customers. They
saw no reason why they should. Their theory of the business assumed that
most people who could afford to shop in department stores did. Fifty
years ago, that assumption fit reality. But when the baby boomers came
of age, it ceased to be valid. For the dominant group among baby boomers
-- women in educated two-income families -- it was not money that
determined where to shop. Time was the primary factor, and this
generation's women could not afford to spend their time shopping in
department stores. Because department stores looked only at their own
customers, they did not recognize this change until a few years ago. By
then, business was already drying up. And it was too late to get the
baby boomers back. The department stores learned the hard way that
although being customer driven is vital, it is not enough. An
organization must be market driven too.

Early Diagnosis. To diagnose problems early, managers must pay attention
to the warning signs. A theory of the business always becomes obsolete
when an organization attains its original objectives. Attaining one's
objectives, then, is not cause for celebration; it is cause for new
thinking. AT&T accomplished its mission to give every U.S. family and
business access to the telephone by the mid-1950s. Some executives then
said it was time to reassess the theory of the business and, for
instance, separate local service--where the objectives had been
reached--from growing and future businesses, beginning with
long-distance service and extending into global telecommunications.
Their arguments went unheeded, and a few years later AT&T began to
flounder, only to be rescued by antitrust, which did by fiat what the
company's management had refused to do voluntarily. Rapid growth is
another sure sign of crisis in an organization's theory. Any
organization that doubles or triples in size within a fairly short
period of time has necessarily outgrown its theory. Even Silicon Valley
has learned that beer bashes are no longer adequate for communication
once a company has grown so big that people have to wear name tags. But
such growth challenges much deeper assumptions, policies, and habits. To
continue in health, let alone grow, the organization has to ask itself
again the questions about its environment, mission, and core
competencies.

There are two more clear signals that an organization's theory of the
business is no longer valid. One is unexpected success -whether one's
own or a competitor's. The other is unexpected failure--again, whether
one's own or a competitor's.

At the same time that Japanese automobile imports had Detroit's Big
Three on the ropes, Chrysler registered a totally unexpected success.
Its traditional passenger cars were losing market share even faster than
GM's and Ford's were. But sales of its Jeep and its new minivans -- an
almost accidental development -- skyrocketed. At the time, GM was the
leader of the U.S. light-truck market and unchallenged in the design and
quality of its products, but it wasn't paying any attention to its
light-truck capacity. After all, minivans and light trucks had always
been classified as commercial rather than passenger vehicles in
traditional statistics, even though most of them are now being bought as
passenger vehicles. However, had it paid attention to the success of its
weaker competitor, Chrysler, GM might have realized much earlier that
its assumptions about both its market and its core competencies were no
longer valid. From the beginning, the minivan and light-truck market was
not an income-class market and was little influenced by trade-in prices.
And, paradoxically, light trucks were the one area in which GM, 15 years
ago, had already moved quite far toward what we now call lean
manufacturing.

Unexpected failure is as much a warning as unexpected success and should
be taken as seriously as a 60-year-old man's first "minor" heart attack.
Sixty years ago, in the midst of the Depression, Sears decided that
automobile insurance had become an "accessory" rather than a financial
product and that selling it would therefore fit its mission as being the
informed buyer for the American family. Everyone thought Sears was
crazy. But automobile insurance became Sears's most profitable business
almost instantly. Twenty years later, in the 1950s, Sears decided that
diamond rings had become a necessity rather than a luxury, and the
company became the world's largest -- and probably most
profitable--diamond retailer. It was only logical for Sears to decide in
1981 that investment products had become consumer goods for the American
family. It bought Dean Witter and moved its offices into Sears stores.
The move was a total disaster. The U.S. public clearly did not consider
its financial needs to be "consumer products." When Sears finally gave
up and decided to run Dean Witter as a separate business outside Sears
stores, Dean Witter at once began to blossom. In 1992, Sears sold it at
a tidy profit.

Had Sears seen its failure to become the American family's supplier of
investments as a failure of its theory and not as an isolated incident,
it might have begun to restructure and reposition itself ten years
earlier than it actually did, when it still had substantial market
leadership. For Sears might then have seen, as several of its
competitors like J.C. Penney immediately did, that the Dean Witter
failure threw into doubt the entire concept of market homogeneity-the
very concept on which Sears and other mass retailers had based their
strategy for years.

Cure. Traditionally, we have searched for the miracle worker with a
magic wand to turn an ailing organization around. To establish,
maintain, and restore a theory, however, does not require a Genghis Khan
or a Leonardo da Vinci in the executive suite. It is not genius; it is
hard work. It is not being clever; it is being conscientious. It is what
CEOs are paid for.

There are indeed quite a few CEOs who have successfully changed their
theory of the business. The CEO who built Merck into the world's most
successful pharmaceutical business by focusing solely on the research
and development of patented, high-margin breakthrough drugs radically
changed the company's theory by acquiring a large distributor of generic
and nonprescription drugs. He did so without a "crisis," while Merck was
ostensibly doing very well. Similarly, a few years ago, the new CEO of
Sony, the world's best-known manufacturer of consumer electronic
hardware, changed the company's theory of the business. He acquired a
Hollywood movie production company and, with that acquisition, shifted
the organization's center of gravity from being a hardware manufacturer
in search of software to being a software producer that creates a market
demand for hardware.

But for every one of these apparent miracle workers, there are scores of
equally capable CEOs whose organizations stumble. We can't rely on
miracle workers to rejuvenate an obsolete theory of the business any
more than we can rely on them to cure other types of serious illness.
And when one talks to these supposed miracle workers, they deny
vehemently that they act by charisma, vision, or, for that matter, the
laying on of hands. They start out with diagnosis and analysis. They
accept that attaining objectives and rapid growth demand a serious
rethinking of the theory of the business. They do not dismiss unexpected
failure as the result of a subordinate's incompetence or as an accident
but treat it as a symptom of "systems failure." They do not take credit
for unexpected success but treat it as a challenge to their assumptions.

They accept that a theory's obsolescence is a degenerative and, indeed,
life-threatening disease. And they know and accept the surgeon's
time-tested principle, the oldest principle of effective decision
making: A degenerative disease will not be cured by procrastination. It
requires decisive action.

Reprint 94506

~~~~~~~~

By Peter F. Drucker

Peter F. Drucker is the Clarke Professor of Social Science and
Management at the Claremont Graduate School in Claremont, California,
where the Drucker Management Center was named in his honor. This is
Drucker's thirty-first article for HBR.


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