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What We Can Learn from the History of Outstanding Corporations
By Christian Stadler
Stanford University Press
Copyright © 2011 Board of Trustees of the Leland Stanford Junior University
All right reserved.
Chapter One THE QUEST FOR ENDURING SUCCESS
There is no such thing as perpetual success.
Life is a constant struggle and we would be fools if we made ourselves believe that some people always succeed. To be honest, life would be dull and boring if we did not face occasional struggles. Success, after all, is a relative experience—relative not only to failure but also to the mediocre and mundane. Overcoming major barriers is part of the fun and makes victory so much sweeter.
For corporations the story is very much the same. At this writing, the world is struggling through a severe financial crisis. This has happened before, of course, and it's a reminder that cycles of boom and bust are endemic to capitalism. A few years ago, following the burst of the New Economy bubble, shareholders, managers, and employees went through similar motions when they became painfully aware that the promise of easy riches remained just that, a promise. What most experienced hands had known all along became obvious to the general public once again: companies that we celebrate one day might stumble and fall before the sun rises again. Armed with natural curiosity, most of us would like to know whether things really have to be that way. Is there the occasional company that avoids or defers this fate? A company our great- grandparents were able to admire? A company we can admire today and feel reasonably confident will be still around when our great-grandchildren grow old?
Brooding on these issues after the completion of my doctoral dissertation, I made a trip to Guildford, a small town an hour outside London, early in 2002. I had been looking forward to this trip, as I was going to meet Arie de Geus, the former head of Shell Planning, who had published a celebrated book on long-lived companies. Arie, I was sure, could answer my questions. But as is often the case with experienced senior managers who move beyond daily operations and reach a certain state of wisdom, Arie raised more questions than he answered. He made it quite clear that we know very little about the long-term development of large organizations. Other than Arie's book, there is only Jim Collins and Jerry Porras's best-selling Built to Last (1994), which concentrates on long-lasting corporations. While their work is on U.S. companies, there is no comparable research on European companies, some of which happen to be older than their American cousins due to the different timing of the arrival of industrialization on different continents. European companies therefore remain generally (or relatively) unexplored, and a detailed analysis of them is bound to add to our understanding of how corporations may develop over time.
I am not sure if it was Arie's intention, but he managed to plant the seed for this book. Although I started to work for a large strategy consultancy in Germany shortly after our get-together in Guildford, the questions continued to haunt me. In the summer of 2003 I finally decided that the subject deserved more than a little thought. I returned to the University of Innsbruck to join the strategy department and set up a team to explore long-term success in Europe. Some of the world's leading experts on the subject, such as Arie, Jerry Porras, and the distinguished (now deceased) historian Alfred D. Chandler, agreed to advise us. With their help we were ready to attack three main questions:
How is it possible for some companies to succeed for more than 100 years?
What distinguishes these companies from others that fall by the wayside?
What can we learn from the experiences of these long-lived companies?
Corporate Landscape in Europe
Before the team felt justified in leaping into the specifics of the project, we wanted to gain an overview of the genealogy of European corporations. How old is the average corporation in Europe? Is there a relationship between success and age? The apparent simplicity of these two questions is misleading. First of all, it is not all that easy to determine exactly what constitutes a company. Some large corporations actually consist of scores, even hundreds, of small companies. In each case where one firm owns a controlling interest in a second firm, we considered it to be one company. There are also companies where a family or an entrepreneur owns a controlling interest in other companies, and therefore what appear to be separate and independent organizations in reality should be considered as one unit. Unfortunately, the structure of the publicly accessible data makes the consolidation of the family-owned firms impossible.
A second issue concerning publicly available data is related to the registration of corporations. Rules in different European countries vary, but in general small corporations run by an individual are not required to sign up in the public registry. This creates a distortion in the data set, as smaller companies are missing.
A third issue has to do with mergers and acquisitions. Following a merger, companies sometimes register as a new corporation. For example, DaimlerChrysler appeared as a new firm after the merger in 1999, although Gottlieb Daimler started with the production of automobiles in the late 19th century.
Despite these concerns, it is possible to draw a relatively robust picture of the age of European corporations today. We used the Amadeus database, a platform that aggregates data from local companies, compiling records from public registrars. In 2005 the database listed more than 7 million companies based in Western Europe. Of the total, 2.4 million companies were classified as independent corporations in which no shareholder accounted for more than 25 percent of direct or total ownership. In such a large sample the effect of a family's controlling apparently independent organizations and the new registration of some companies following a merger bears limited statistical significance. The same is true for the sample of 3,139 publicly traded companies. For the 238 companies with more than 10,000 employees and the 154 companies with a market capitalization of more than $5 billion, we manually checked the data and made corrections where appropriate. The only distortion of the data set that might be of significance is the fact that smaller companies are not always required to register publicly and therefore no records are available for those companies. Since a number of scholars have shown that on average smaller companies also tend to be younger, inclusion of these companies would most likely decrease the average age of European corporations.
The average age of companies in Europe is 12.3 years, though this figure may be slightly lower if smaller companies are included. Publicly traded companies fare a little better, as they have weathered the first storms and reached a certain size that provides them with a safety margin against catastrophes. They are 28 years old on average. Large corporations with more than 10,000 employees or a $5 billion market capitalization are 48 years old on average. This makes them almost twice as old as other publicly traded companies.
For starters, these findings are hardly surprising, as no firm begins life as a giant. This is another way of saying that it takes time to grow, and therefore older companies tend to be large. Economic history in fact suggests that markets and industrial sectors become concentrated at least to a certain degree over time, dominated by a small number of major corporations.
More recent studies added another perspective by explaining that mortality rate decreases as size increases and therefore large companies are more likely to survive. In times of poor performance, large firms are able to retrench by reducing the size of their operations. Large companies also have the means to build counter-cyclical units, so that when some are struggling others are booming. In Europe the imminent threat of a hostile takeover, particularly from abroad, also decreases with size. In 2006, when Mittal Steel, a company traded on the London Stock Exchange and owned by an Indian entrepreneur, sought to take over Arcelor, a Luxembourg, French, and Spanish company, it stirred up heated controversy over foreign ownership of "national champions."
Mittal Steel eventually prevailed, as takeovers have become simpler (or more straightforward) due to new European Union (EU) competition policies. Still, there are countervailing examples. In 2006, Germany's EON tried to buy Spain's Endesa, but the forces of national independence eventually prevailed when EON pulled out of the bidding war in early 2007. Also, on a national level the takeover of large corporations is tricky. In the 1970s Standard Chartered, for example, became a takeover target, but the regulator made it clear that it would not grant approval. In Germany large cross-shareholding of big corporations created the often-referred-to "Deutschland AG," which is only slowly starting to falter as efficiency gains the upper hand. Small organizations do not enjoy the same protection by the state and have less room for maneuvering. Once their fortunes decline, they may not be able to cut down their operations or they may not have the financial strength to weather the storm.
Still, even the comparatively long average life span of large corporations is not especially remarkable. Using the analogy that Arie de Geus proposes in The Living Company, we are able to understand how desperate the situation is. Throughout the evolution of the human race, average life expectancy has increased. While the average life expectancy in the Stone Age was around twenty years, modern humans live well into their seventies (78–80 years). According to Guinness World Records, the oldest human being, a French lady named Jeanne Louise Calment, lived to be 122 years old before passing away at a nursing home in Arles in 1997. Assuming that 122 years is our maximum life expectancy, we enjoy around two-thirds of our potential today. In the Stone Age—when living conditions obviously were considerably worse—people were able to reach only 17 percent of this potential.
For corporations, the maximum life expectancy is well above the human potential. The world's oldest family business, Kongo Gumi, started to build and restore temples in 578 in Japan. Europe's oldest business is a winery in France, Goulaine, which set up shop around the year 1000. The oldest corporation run in a more sophisticated way, comparable to large corporations today, is Stora Kopparberg, a Swedish mine that was granted a charter from King Magnus II of Sweden in 1347. Older records allow us to date its first copper mining activities back to 1288. Today it is a pulp and paper corporation and recently teamed up with the Finnish Enso Oyj to form StoraEnso.
Kongo Gumi, Goulaine, and Stora Kopparberg are very rare creatures. For several reasons, a more realistic potential life expectancy for corporations is somewhere between 200 and 300 years. First of all, international trade and industrialization started to gain momentum in the 18th century. Modern production methods started in Great Britain and spread to continental Europe and North America. Second, most of the older organizations were not able to function in the new age of capitalism, and third, new legislation such as the Royal Charters provided a new legal framework for corporations to flourish. A number of surviving companies from the early days of capitalism formed exclusive clubs. Membership in the British Tercentenarians Club, for example, is open only to firms that have been trading continuously for at least 300 years while also retaining links to the founding family. The club, founded in 1970, currently has 11 members.
A similar club in France, Les Hénokiens, has 40 members that boast at least 200 years of history.
If 300 years is used as the potential life expectancy of a firm, the average European corporation reaches an embarrassing 4 percent of its potential, while large corporations reach 16 percent. In terms of potential longevity, companies therefore remain in the Stone Age. Even more worrisome is the fact that there is no sign of improvement. More than 10 years ago de Geus and his team calculated an average life expectancy of 12.5 years for European and Japanese corporations. While mortality rates have continuously declined in the course of human evolution, there is no indication of similar improvements for corporations in the past decade. Around 10 percent of all companies disappear each year.
If one subscribes to a Schumpeterian logic of creative destruction, it may seem that this is the natural course of business life, as new entrants arrive and incumbents disappear. From the perspective of theory the pattern seems plausible, although it comes with costs. In some cases, such as Lehman Brothers, Enron, Worldcom, and Tyco, shareholders lose substantial investments. This has wider implications if life savings and pensions evaporate and the drama of the hour obliges public officials to step in while at the same time forgoing tax revenue previously provided by the company and its employees. In other cases, when companies are taken over, the situation may be quite different. Studies show that shareholders of the takeover target in many cases receive a premium, while shareholders of the bidding company usually have to book losses. The synergies that the merger is supposed to generate are hard to realize. Different corporate cultures turn integration into a substantial issue, and all too often the share price eventually falls.
Meanwhile, for employees the situation is generally bleaker. Theory tells us that finding a new assignment should present little challenge as long as new jobs are being created elsewhere. In practice, however, finding work often involves dislocation and the uprooting of lives. Families may break up when economic needs force one parent to move while the second one stays behind to avoid a change of schools for the children. Arrangements that seem unavoidable at the beginning have the potential to cause irreversible harm to individuals and families. Entire communities face declining prospects and difficult transitions.
An additional consequence of the destruction of a corporation is the loss of tacit knowledge and company-specific capabilities that may not be transferred to new settings. Negative effects are certainly less drastic when companies disappear from the statistics by being taken over. Staff might be able to carry on in their jobs with limited disruption. To deliver on promised cost savings, however, management often resorts to layoffs—in which case employees once again find themselves on the receiving end.
For a national economy as a whole, the negative effects of disappearing corporations might also be more pronounced than expected. One of the relevant questions revolves around location. If a corporation ceases to exist, it is unlikely that new jobs will be created in the same region. Even in the case of a takeover, a location move sometimes falters. For a large corporation this situation can also cause great damage to suppliers. Their alignment to the needs of their former customers—in terms of location, products, and processes—makes the acquisition of new customers a challenging task. In fact, many suppliers also pull up roots when their major customers move.
Despite all the negative effects of premature corporate death, there would still be some sense in this painful reality if new companies were more efficient, if they could guarantee higher returns for their shareholders. Unfortunately, a century of economic research has not been able to come up with a conclusive answer to this question. While some economists support Schumpeter, others argue that companies build up capabilities worth their preservation. An analysis of a sample of 3,207 companies in Europe shows that on average, younger firms display higher performance (measured by total shareholder return, or TSR). This, however, is gained at the price of higher volatility, and thus higher risk for investors. The median performance tends to be better for older firms. Older companies that have proved themselves in the past and possess both the capital and the experience to avoid major mistakes are a safer bet, so to speak, but they offer less hope of major gain.
Excerpted from Enduring Success by Christian Stadler Copyright © 2011 by Board of Trustees of the Leland Stanford Junior University. Excerpted by permission of Stanford University Press. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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