Lifespans of Firms

Source:

Creative Destruction Whips through Corporate America

Die Another Day: What Leaders Can Do About the Shrinking Life Expectancy of Corporations

BCG Classics Revisited: The Growth Share Matrix

Where Do Firms Go When They Die?

This Is a Fine Time to Be a Big Corporation

Can a company live forever?

 

 

Lifespans of Top companies are shrinking

Richard N. Foster, first in his book Creative Destruction with Sarah Kaplan in 2001, and then in a report in 2012 argues that “lifespans of top companies are shrinking” according to the study on S&P 500 index rotation.

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“61-year tenure for average firm in 1958 narrowed to 25 years in 1980, and to 18 years in 2012, based on a seven year rolling averages.”

“If removal from the S&P 500 is not due to an acquisition [3], it can be a jolt that emphasizes the urgency of turnaround effort or it can be a prelude to delisting and the threat of bankruptcy.”

->” To survive and and thrive,  leaders must “create, operate, and trade” – build new divisions and trade mature ones at the pace and scale of the market without losing control their company. “

“‘creative destruction’, widely credited to Joseph Schumpeter, indicates that economic progress, in capitalist society, means turmoil”

-> “According to Foster, the life span of a corporation is determined by balancing three management imperatives:
1) running operations effectively,
2) creating new businesses which meet customer needs [1]
3) shedding business that once might have been core but now no longer meet company standards for growth and return.” 

<- The problem is that the innovation that is needed to create significant new businesses can often directly conflict with the operational effectiveness of the current business. Under these circumstances large companies slowly fall behind the pace of change of the economy.  [2]

 

A changing Business Environment 

In 2014, BCG revised its famous BCG’s growth-share matrix [4], as the world has changed:

since 1970, when it was introduced, conglomerates have become less prevalent, change has accelerated, and competitive advantage has become less durable. The business environment has become more dynamic and unpredictable, and market share has become less of a driver of and surrogate for advantage.

1. companies face circumstances that change more rapidly and unpredictably than ever before because of technological advances and other factors.

-> proportionately lower numbers of cash cows because their longevity is likely in many cases to be curtailed.

<- companies need to constantly renew their advantage through disciplined experimentation (to invest in more question marks, experiment with them in a quicker and more economical way than competitors, and systematically select promising ones to grow into stars), increasing the speed at which they shift resources among products and business units

2.market share is no longer a direct predictor of sustained performance.

<- new drivers of competitive advantage, such as the ability to adapt to changing circumstances or to shape them

growth-share-matrix_ex1_md_tcm80-162707growth-share-matrix_ex2_md_tcm80-162709

 

Shrinking Life Expectancy of Corporations

“we are in an era of unprecedented technological disruption and change that only the most forward-looking companies will survive.”

To understand how the battle for long-term survival has changed and the implications for both challengers and incumbents, BCG analyzed patterns of entry, growth, and exit for 35,000 companies publicly listed in the US since 1950-2013 —with surprising results.

1.  corporate survival and death

BCG focused on companies exiting the public-company pool —whether owing to bankruptcy or liquidation, merger or acquisition, or other causes (exit years correspond either to the database (compustat) deletion date or to the last recorded instance of income or revenues.), and found is that public companies are perishing sooner than ever before

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Since 1950, the total life span of companies (calculated as the period between founding year and exit year (irrespective of gaps in sales reporting)) and the length of time that their shares are publicly traded have significantly decreased.In fact, businesses are dying at a much younger age than the people who run them.

2.Rising Mortality Risk

Today, almost one-tenth of all public companies fail each year, a fourfold increase since 1965.

スクリーンショット 2016-10-21 15.28.47.png

The five-year exit risk for public companies traded in the US now stands at 32 percent, compared with the 5 percent risk they would have faced 50 years ago.

One might expect particular types of company, such as new entrants in the technology sector, to account for most of the observed shift. Surprisingly, however, our research shows that the surge in mortality risk is widespread: 

There are no safe harbors. Mortality risk grew relatively uniformly across all sectors of the economy.  [6]

Neither scale nor experience is a safeguard. Mortality risk also grew for companies of all sizes and ages. [7]

3. Why it happens

In the economic and venture-capital-funding booms of the mid-1980s and mid- to late-’90s, many smaller and younger companies entered the public markets.

-> These companies (less than 10 years old and had less than $50 million in sales) had a more than 25 percent higher risk of failure compared with the average company—likely owing to poorer quality (a lower bar for entry), few buffers against failure (lack of resources), and intense peer pressure (the smallest companies faced the highest competitive density).

–>> Those that endured grew into serious competitors for incumbents, driving up the death rate among medium-size and large established companies, which were often unable to react quickly enough to the disruptions wrought by these smaller upstarts.

—>>> Surviving incumbents then began to react by acquiring small-to-medium-size companies, again driving up exit rates in this segment while stabilizing turnover among large companies. [8]

4. A Growth-Endurance Trade-Off

BCG observed a surprising relationship between revenue growth and mortality:  accelerated growth correlates with shorter life spans, whereas companies with more moderate growth face the lowest risk. (This correlation holds true across the entire period of analysis and remains significant even when controlling for factors such as age, size, industry, and profitability.)

But,

+ Over the period of our analysis, the average cumulative profits of public companies declined at an even sharper rate than corporate life spans.

-> rather than achieving their full potential in less time, the contraction of corporate life spans, on average, diminishes long-term value creation. Longer-lived companies thus appear to create more value than fast-growing, short-lived ones.

 

Publicly-traded firms die off at the same rate regardless of their age or economic sector

Log sales of some 30,000 U.S. Companies 1950-2009
(controlling for inflation and GDP growth)

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This picture credited by Marcus Hamilton and Madeleine Daepp partly proves some assumptions BCG made above.

<- The relatively rapid growth of smaller companies near the beginnings of their lifespans account for the ragged lower portion of the chart, as well as the relatively steep initial sales increases. As companies reach maturity, their sales tend to level off.

Looking at a database of 25,000 companies from 1950 to 2009, they found that publicly traded companies die off at the same rate, regardless of the firm’s age or what sector it’s in. In their dataset, they found that most firms live about 10 years and the most common reason a company disappears is due to a merger or acquisition.

(However, the problem here is that they are only doing with listed time. Firms may take long time until going listed, and different industry may vary significantly. And can we simply recognize companies merged equally as being demised or perished?)

 

Fortune 500 story

Researchers Dane Stangler and Sam Arbesman have some different ideas by examining annual turnover in the Fortune 500 list, the first of which was compiled in 1955.

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The number of companies leaving (and entering) the Fortune 500, which ranks the largest corporations by revenue, rose through the 1980s and 1990s, but is down since.

 

-> Stangler and Arbesman cite several historical studies that seem to show that this stuff comes in waves. The 1920s was a decade of high turnover in the ranks of the country’s 100 largest corporations; the 1940s saw very low turnover. Then again, turnover in a list of the top 500 or 100 companies isn’t the same as the average corporate life expectancy. It could be that the long-run trend there is in fact downward.

-> Big companies have been doing a better job of sticking around and thriving since 2000. Meanwhile, broader “business dynamism” research based mostly on U.S. Census data shows that, on the whole, bigger, older companies control more of economic activity than they did not just 15 years ago but also 40 years ago.

->>Big companies have gotten better at adapting to technological change, or that the particular technological changes we’re currently experiencing favor the big over the small?

see more on firm turnover rate and competition

 

Can a company live forever?

It is perhaps unsurprising that the country where people live the longest is also home to some of the oldest companies in the world.

<- In Japan, there are more than 20,000 companies that are more than 100 years old, with a handful that are more than 1,000 years old, according to credit rating agency Tokyo Shoko Research.

->  1. Professor Makoto Kanda, who has studied shinise for decades, says that Japanese companies can survive for so long because they are small, mostly family-run, and because they focus on a central belief or credo that is not tied solely to making a profit.

-> 2. Local factors could be another key to their success. Shinise focus primarily on the Japanese market, from Kikkoman’s products to small sake manufacturers, and they benefit from a corporate culture that has long avoided the mergers and acquisitions that are common among their Western counterparts.

Although there are exceptions to every rule, the most important factor for survival is an emphasis on innovation and reinvention.

-> However, innovation for the sake of it is not the goal, It is a focus on “little bets” that helps companies grow and keep up with the competition.

–>> Innovation in general is not always easy, however, especially for publicly listed companies that must balance the concerns of capital markets and shareholders, who demand quarterly profits and who are not necessarily interested in decades-long research projects.

Yet even if a company can innovate and conditions do remain favourable, immortality does have its downsides.

For instance, there is no real proof that age makes a company any more profitable than younger companies. On the contrary, evidence from the stock market actually suggests that age could be a hindrance.

Of the 74 or so companies that have stayed in the S&P 500 for more than 40 years, only a dozen or so have managed to beat the average, according to a study by consultancy McKinsey.

 

 

[1]

“companies that have embraced the “create, operate, and trade without losing control” strategy include IBM, GE and Johnson & Johnson. Each of these companies create, often by buying smaller companies in the market that are poorly positioned to expand their products internationally. They also free up capital by divesting business units at the same time–all while maintaining control of their margins and returns.”

[2]

“How fast do we have to change to maintain our position within our industry?” The pace of change varies by industry. That said, if one’s industry is changing more slowly than the pace of change in the economy, that industry itself will experience gradual “fade’ and often replacement by lower cost international competitors. Doubters only have to think about the steel, auto or paper businesses to find examples.

[3]

“mergers and acquisitions tend to increase when the economy is growing, leading to higher returns on equity.

When the market for deals and IPOs is depressed, as it has been for several years, demand for creative destruction builds up. This pent-up entrepreneurial energy and demand for deals typically gets unleashed when the economy is stronger.”

[4]

“The matrix helped companies decide which markets and business units to invest in on the basis of two factors—company competitiveness and market attractiveness—with the underlying drivers for these factors being relative market share and growth rate, respectively. The logic was that market leadership, expressed through high relative share, resulted in sustainably superior returns. In the long run, the market leader obtained a self-reinforcing cost advantage through scale and experience that competitors found difficult to replicate. High growth rates signaled the markets in which leadership could be most easily built.

Putting these drivers in a matrix revealed four quadrants, each with a specific strategic imperative. Low-growth, high-share “cash cows” should be milked for cash to reinvest in high-growth, high-share “stars” with high future potential. High-growth, low-share “question marks” should be invested in or discarded, depending on their chances of becoming stars. Low-share, low-growth “pets” are essentially worthless and should be liquidated, divested, or repositioned given that their current positioning is unlikely to ever generate cash.”

[5]

BCG used Compustat’s database (1950 to 2013) for our core data set and then matched companies with the S&P Capital IQ database to obtain additional data points. The data set includes foreign companies listed on US exchanges. 

[6]

Only the past decade saw a slight divergence in outcomes: traditionally stable oligopolies (such as the oil and gas industry) recovered the most, while mortality remains high in more dynamic industries (such as technology).

[7]

While smaller companies have always faced greater risk, even the largest companies are now facing higher exit rates. Company age only began to affect exit risk in the first decade of the 2000s, when turnover plateaued for older companies but continued to grow among younger ones.

[8]

Take the example of Compaq Computer. Founded in 1982, it went public and shot to success extremely fast. Unlike many of its peers (Altos Computer Systems, Corona Data Systems, Eagle Computer, and Osborne Computer), Compaq survived into the ‘90s, establishing itself as a serious threat to incumbents in the computer industry. Among the much older and larger incumbents it disrupted was DEC, which was sold to Compaq in 1998. Another giant, HP, saved itself from the same fate by buying up Compaq after the company struggled through the dot-com collapse. 

 

 

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