I long ago realised that to understand a business I would learn much more by talking to people involved in day-to-day operations than the chief executive. They represented “what is really going on here?”.
My empirical research drew on a database that enabled us to relate perceived market position to return on capital employed. We discovered, to no one’s surprise, that high cost with low quality was not often a successful strategy. And low cost with high quality yielded the highest profits. Of course it did. But were you better off with low cost, low quality, or high cost and high quality, or being stuck in the middle with medium quality and medium cost? All produced similar returns.
A product offering is very rarely a sustainable source of competitive advantage because it can readily be imitated. What really matters is enjoying a competitive advantage in the market position you choose — and that typically involves matching your market position to the distinctive underlying resources and capabilities of your business. Waitrose, Aldi and Lidl are not the beneficiaries, and Tesco and Sainsbury’s not the victims, of any verity of business strategy other than the eternal one; the best strategy is to be good at whatever it is you do.
You have described economics and business as the last bastions of modernism. What do you mean by that?
I think they are the last bastions of the idea that you can redesign the world in accordance with a rationally designed blueprint. Modernism in the twentieth century went through areas such as art, architecture and the humanities with the idea that we could rethink everything from the ground up and that we understood enough about the world to do that. I’ve come to believe that we don’t. But people still think they can analyse and structure economies as if they were a mechanical system and that they can do the same in business. So in the same way that Le Corbusier said – wrongly – that a house is a machine for living in, it exemplifies the idea that a business or an economy can be structured from first principles in the same way.
The more I learned about economics, the more I discovered a landscape that is surpassingly strange. Like the land of Mordor, it is dominated by a single theoretical edifice that arose like a volcano early in the 20th century and still dominates the landscape. The edifice is based upon a conception of human nature that is profoundly false, defying the dictates of common sense, before we even get to the more refined dictates of psychology and evolutionary theory. Yet, efforts to move the theory in the direction of common sense are stubbornly resisted.
First, Hayek’s vision of the economy as a complex evolving system was less readily rendered in mathematical form than the Walrasian paradigm that dominated economics in the late 20th century.
The union of political liberalism with Hayek’s economic liberalism – laissez faire– has proven to be an unhappy marriage. It is no surprise that some of those who have fared worse during the last quarter century of right wing resurgence are attracted to xenophobic nationalism and intolerance. In the early 21st century it is not ‘big government’ that is the threat to liberal values. Ask yourself: where are they key liberal ideas of tolerance, the rule of law, and defense of the weak against the strong more secure today: the Nordic countries (where governments comprise half of the economy) or the U.S, where Hayek’s political vision has been widely embraced?
Hayek rightly insisted that the question of how best to organize society could not be answered in abstract terms but required instead historical and empirical comparison. I wonder if he might today – on empirical grounds – reconsider his view that a larger government role in the economy is a threat to liberal values?
Second, the market, as Hayek says, processes information and on that basis, determines, for example, the best way to organize production. But applying this logic shows that hierarchical economic planning may not be such a bad thing at least when combined with markets. The boundary of the firm – how big it will be – is determined by the answer to the question, should this component be produced inhouse or purchased? But this is also the boundary between organizing things according to the market or according to the hierarchical structure of command that has led capitalist firms to be termed (ironically) as ‘mini-planned economies.” The ‘verdict of the market’ in this case is that both markets and hierarchies have a place in the economy! DSW: That’s a great point, but it can be elaborated along very interesting lines! I’ve been delving into the business literature a lot lately, and “command and control” often doesn’t work at the firm level either. A single firm requires the same protections against disruptive self-serving behaviors that Ostrom demonstrated for common-pool resource groups with her core design principles. Also, for a single firm to adapt to change, it needs carefully orchestrated variation-and-selection processes rather than a centralized plan. However, your larger point is well taken: a firm remains a “mini-planned economy” even if not organized as command and control.