For years, Joseph and I tried to give each other credit for that line until we finally realized it came from a mutual friend. Regardless of the source, it's an important concept. More often than you might think, companies will find themselves, at least for a while, with relatively idiot-proof business models (usually involving underserved markets or niches with IP walls or other high barriers to entry). This can be a problem, particularly if the models were stumbled on or the people who developed them have left the company (both of which also happen more often than you might think).
These companies are especially vulnerable to what Warren Buffett calls “the institutional imperative.” You should read the whole essay but I found this passage particularly sharp (via DeLong).
My most surprising discovery: the overwhelming importance in business of an unseen force that we might call “the institutional imperative.” In business school, I was given no hint of the imperative’s existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn’t so. Instead, rationality frequently wilts when the institutional imperative comes into play.
For example: (1) As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.
Institutional dynamics, not venality or stupidity, set businesses on these courses, which are too often misguided. After making some expensive mistakes because I ignored the power of the imperative, I have tried to organize and manage Berkshire in ways that minimize its influence. Furthermore, Charlie and I have attempted to concentrate our investments in companies that appear alert to the problem.
Another aspect of the issue is that we talk about government needing to act more like a business but we complain about waste in government. Businesses make bad investments all the time. Governments do too but that becomes more obvious when they are supposed to be acting like a business.
ReplyDeleteExample of the former: the MBTA in MA bought rail cars from Boeing back in the 1980's. These didn't work well. Among other problems, they had A/C units on the bottom, which meant they stopped working. This resulted in a dedicated part of a facility that would adapt 2 train cars a week by putting new A/C units on top. Mistake. And the same kind of mistake companies make but it's held up as an example of government inefficiency. (As for business examples, ever been in new construction?)
And when government acts as a business, it can't write off investments like companies can. Take Harrisburg PA and its incinerator. Looked like a good business move, but it wasn't.
I would add to Jonathan's comment that we have a process for failed business' to go bankrupt. It's unclear that we have (or want) a mechanism for public sector bankruptcy.
ReplyDeletePerhaps the most important reason why government can't be expected to work like a business is that businesses are free to choose what products and services to provide and which markets to serve.When one part of the business becomes unprofitable, they have the option of simply dropping it and going elsewhere.
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