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good to great or just lucky ?
In 2001, Jim Collins presented a landmark study in his book 'Good to Great'. Now, less than a decade later, his conclusions appear to be crumbling to dust. Were these companies not so great after all? What happened to corporate greatness?
In all fairness, Collins' Hedgehog Concept is a great little framework to help pinpoint what business you're really in and if you should be there. What you can be the best in the world at? What drives your economic engine? What are you deeply passionate about?
Most of his other ideas are fine too, certainly when considered 'stand alone'. But put together, we can be safe to say that half of the 11 great businesses he identified are no longer doing so great at all.
Circuit City: Bankrupt
Fannie Mae: Bankrupt / nationalised
Wells Fargo: Needs another $13 Bn
Nucor: Stock and Revenue crash -50%
Pitney Bowes: Stock and Revenue crash -15%
Gilette: No longer independent
What happened... is greatness so easily lost? Is it the credit crunch? Or is something else happening?
Well, consider how mr Collins assembled his list in the first place. He started with 1,435 of what he classified as 'good' companies and identified the 11 (0,8%) companies that became 'great' based on a list of criteria. Amongst the key criteria were a successful CEO transition and stock returns that exceeded general market at least 3 times over 15 years (independent of industry averages).
So he started with a list of almost fifteen hundred fine businesses and found parameters to funnel the list down by over 99%. That's the same as looking at 100 A-grade students and predicting which single one will outperform the others. Would you trust that judgement? Of course not. But why not?
For one, looking at the past provides very little guarantee for the future. Particularly when considering market value of American businesses: the top-20 of largest US businesses refreshes significantly every ten to fifteen years (in Europe it takes a little longer). Some could oppose "but they would have remained great if it weren't for the credit crunch". Well, shit happens, usually unexpectedly.
Second, when setting multiple critical criteria on any sample, the leverage of error is typically large. Either no one passes, or everyone passes. Funneling down 1,435 good businesses to 11 great ones means that 1,424 did not pass. If his combined thresholds were off by 1%, he would have had either twice as many great companies, or none at all. I do not know what the full list of criteria were, but imagine mr Collins used ten different ones, where only 11 companies passed all ten criteria. Blunt calculus: every single one of ten criteria will cull about 140 companies from the pool. Had mr Collins used nine criteria instead, his book would have taken fifteen times as long to write. Had he used eleven criteria, he would have had no book at all.
Last but not least, it appears mr Collins has been fooled by numbers. Fifteen years appears to be long period period to remain successful for any business, seemingly a rigorous criterium with low margin for error. But his sample is huge. Simply by taking a whopping 1,435 companies as starting pool, even when all would have performed modestly there will still be plenty emerging as 'great' at the other end. Could they have simply been lucky?
Consider the following scenario, where every year 10% of the 'good' businesses drops into mediocrity or worse. Any single one of the 1,435 'good' businesses then has a 90% chance of performing on par or better than the 'great' criteria, year on year. After 15 years, a total of (90%)^15 = 20% would qualify as 'great', simply by remaining 'good'. In fact, basic maths show that as much as 28% of the 1,435 'good' companies can slip into averageness every year and still 10 will emerge as 'great' after 15 years (1,435*(72%)^15=10.3). That's a lot of mediocrity.
Let's put this in perspective. There are about 10,000,000 (non-sole proprieter) registered businesses in the US and about 25,000 of them go bankrupt every year. That's 0,25%. Even in the current economic crisis, with that figure shooting up by over 50% to about 40,000 - that's still only 0,4% (although some single bankruptcies have been more spectacular recently). And these are the companies going from 'poor' to 'bankrupt'. So there's over 99% chance any company will still be in business the following year, or not doing poor enough to collapse. I think it's then awfully safe to say that 72% of those doing fine will probably do fine the next year too.
The point to all this? It's all about simple luck - and you only need a little to go from good to great.
© 2009 Costas Papaikonomou
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