Evolutionary biologists have proven that the more adapted you are in your existing environment, the less able you are to adapt to environmental changes. We blindly cling to “that is the way we have always done it” in defiance of the evidence that this way is no longer relevant to success.
This is the history of business. New ideas, inventions, and business models from the tinkerer in the garage change the world, while rendering obsolete the existing modes of production, infrastructure, and business models. The automobile replaced the horse and buggy, the calculator replaced the slide rule, and the personal computer replaced the typewriter, and so on in a never-ending “perennial gale of creative destruction,” as described by economist Joseph Schumpeter.
“Generally, the leading practitioners of the old order become the victims of disruption, not the initiators of it.”
Werner Sombart (1863-1941) coined the phrase “Creative Destruction”. Joseph A. Schumpeter [1883-1950] made it famous.
Two books highly recommend on this topic: the first by Schumpeter, and the second a biography of Schumpeter:
Capitalism, Socialism and Democracy, Joseph A. Schumpeter, 1942
Prophet of Innovation: Joseph Schumpeter and Creative Destruction, Thomas K. McCraw, 2007
Background on Schumpeter
Schumpeter was to capitalism what Sigmund Freud was to the mind: someone whose ideas have become so ubiquitous and ingrained that we can’t separate his foundational thoughts from our own. There are many mini-narratives in economics: Adam Smith’s “invisible hand,” Thorstein Veblen’s “conspicuous consumption,” Paul Samuelson’s “revealed preference,” Larry Summers, “Nobody ever washed a rental car,” even Ron’s, “surgeons piercing ears.” Schumpeter “Enjoyed saying he aspired to become the greatest economist, horseman, and lover in the world. Things were not going well with the horses.”
Origins of the phrase, creative destruction
He first used the phrase in 1942: “Creative destruction is the essential fact about capitalism. Stabilized capitalism is a contradiction in terms.”
“Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen it its role in the perennial gale of creative destruction; it cannot be understood irrespective of it.”
Economic progress, in capitalist society, means turmoil. Dynamic Disequilibrium. Every day, businessmen feel themselves in a situation that is sure to change presently. They are standing on ground that is crumbling beneath their feet.
“Generally, the leading practitioners of the old order become the victims of disruption, not the initiators of it.”
One problem with creative destruction is the destruction is visible and measurable, but the creativity is not. New ideas hurt people earning their income from old ideas. But if we don’t allow anyone to get hurt, we stay at $3/day. If we allow creative destruction we achieve $137/day, and we can provide a safety net.
The acceptance of creative destruction relieved poverty, not wage regulations or other legislation, or even labor unions. Those preserved poverty by preserving old jobs.
“The capitalist achievement does not typically consist in providing more silk stockings for queens. The Achievement consists in bringing silk stockings within the reach of factory girls in return for steadily diminishing amounts of effort.”
Schumpeter said in a speech to businesspeople: “I’m not into remedies: I am not running a drug store. I have no pills to hand out; no clear-cut solutions for any practical problems that may arise.”
In 1911, Schumpeter laid out five types of innovation that define the entrepreneurial act:
Introduction of a new good
New method of production
Opening a new market
New source of supply of raw materials
Carrying out of new organization of any industry (business model)
Michelin producing radial tires in 1940s ended Akron’s reign as rubber capital of the world, killing off five tire companies (except Goodyear). GM’s innovation in financing is how it beat Ford in market share.
Another book on creative destruction is Openness to Creative Destruction: Sustaining Innovative Dynamism, by Arthur M. Diamond Jr. In it, the author explains two epiphanies he had: Innovative dynamism (ID) can give consumers both lower prices and new goods; and, both consumers and workers benefit. Inevitablists, those who believe innovation runs on autopilot, with the entrepreneur a bystander (if Edison hadn’t invented the light bulb many others would have). But we can be open or closed to innovation, as history has proven. There’s nothing inevitable about it. Bad government and bad policies can shut it down. Chinese culture valued credentialed civil service more than entrepreneurship. Kevin Kelly once argued that innovation is so inevitable that no Marxist could slow it. But under Stalin that’s exactly what happened.
Innovative Dynamism is not inevitable. The entrepreneurs swan song is the best way to predict the future is to invent it. Necessity is not the mother of invention. You are.
The difference between the economist’s vision and the management consultants vision: “Is it necessarily tragic for a firm to die? Why not celebrate what it did or tried to do and move on to new projects pursued by new firms?”
Daniel Kahneman posits “theory-induced blindness” that leads us to see what our theories predict, rather than what is actually in front of us.
Warren Buffet popularized the term moat, shield yourself from the competition, thereby creating a sustainable competitive advantage. The following can create a moat around your business:
intellectual property
Specialized skills or business processes
Exclusive access to relationships, data, or cheap materials
Strong, trusted brand
Substantial control of a distribution channel
Team of people uniquely qualified to solve a particular problem
Network effects or other types of flywheels
A higher pace of innovation
Elon Musk, on a May 2, 2018, Tesla earnings call said: “Moats are lame,” and “If your only defense against invading armies is a moat, you will not last long.” His opinion is that the most important sustainable competitive advantage is creating a culture that supports a higher pace of innovation.
Eastman Kodak Company had all of Buffet’s criteria, but still declared bankruptcy in 2012 after a century of market dominance. And Kodak developed the very first digital camera, way back in 1975! Kodak was even initially market leader in digital cameras too, with a 27 percent share as late as 1999. But it didn’t invest heavily enough in the technology relative to its competitors, the way Intel did when pivoting to microprocessors. Kodak simply wasn’t paranoid enough.
Richard Feynman famously wrote in his 1988 book, What Do You Care What Other People Think?, “I learned very early the difference between knowing the name of something and knowing something.”
George Gilder, author, economist—and Ron’s mentor—wrote of the ultimate conflict in Wealth and Poverty:
In every economy there is one crucial and definitive conflict. This is not the split between capitalists and workers, technocrats and humanists, government and business, liberals and conservatives, or rich and poor. All these divisions are partial and distorted reflections of the deeper conflict: the struggle between past and future, between the existing configuration of industries and the industries that will someday replace them. It is a conflict between established factories, technologies, formations of capital, and the ventures that may soon make them worthless—venture that today may not even exist; that today may flicker only as ideas, or tiny companies, or obscure research projects, or fierce but penniless ambitions; that today are unidentifiable and incalculable from above, but which, in time, in a progressing economy, must rise up if growth is to occur.
This YouTube video complements our show notes and provides a broad overview of creative destruction.
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