The Seven Reasons Why All Big Companies Die

There are seven major reasons why all large companies eventually fail:

1. Talent invariably degrades from exceptional to average as companies grow larger (Why All Big Companies Die)
2. As companies get bigger, they use performance management systems to create a sense of fairness. These systems accelerate the transition from exceptional to average (Prince’s 1984 Performance Review)
3. As average employees become the majority, they create social pressures that value mediocrity and crowd out innovative thinkers (Macklemore and Innovation)
4. Larger companies require larger meetings, slowing decision-making and inhibiting unorthodox thinking (Destroyer of Worlds)
5. Scale creates more layers of management. Managers knowingly and unknowingly cultivate mediocrity (Why Bad Bosses Are So Common)
6. Scale creates multiple, competing power centers that force moderating compromises through pocket vetoes (coming soon)
7. Large, complex organizations don’t know what they know, causing all their employees, especially their senior managers, to make bad decisions. (Coronavirus and this post)

This last reason, the reality that larger organizations can’t get the right information to the right people at the right time, may be the most important of all.

Without good information, the very purpose and advantage of a business can’t be fulfilled. Firms, or organizations of any kind, exist to coordinate action efficiently. Coordination requires accurate and timely communication. 

In small firms, accessing the organization’s information is relatively easy. At the Center for RISC, the non-profit I currently lead, I can find out anything we know by simply yelling my question across the room. If we had more than twenty employees, or if we were in multiple locations, that wouldn’t be possible.

As businesses grow, many things are gained, but three very important things are lost between employees: physical proximity, close relationships, and common experiences. All three are critical enablers of communication. If I don’t know my coworkers, if I don’t sit near them, and if we don’t go through many of the same experiences (e.g. go to the same meetings, hear the same conversations, work on the same projects, etc.), I will have very little hope of benefiting from what they know. 

What about technology? Doesn’t that solve this problem? It’s true that most big companies now have large, centralized databases of their documentation, often referred to as “knowledge management systems.” These tools are great, giving everyone easy access to most documents employees have produced. 

But documents are only a tiny fraction of the knowledge contained within an organization. Think about the last meeting you were in. Does a document exist anywhere that successfully captures what happened there? Even the most dedicated note taker will fail to write down the richness of the details, the relevant context, or the observed but unsaid communication. 

In reality, most of any company’s valuable information is inside employees’ heads. With email and videoconferencing, it’s possible to communicate with any of your coworkers, even if they’re located on the other side of the world. This is great, but not all that helpful if you don’t know who to interrogate. How can you know who has the information you’re looking for, or even that such information exists? How will you uncover your “unknown unknowns,” as Donald Rumsfeld used to say?

In large companies, we are all forced to make decisions using poor information, but senior leaders are even more impaired. They not only have a limited view to their company’s collective knowledge, but as I described in my last post, what little information they have is highly filtered and distorted by fearful subordinates. Consequently, the people in the organization tasked with making the most important decisions have the worst information. This is why so many CEOs appear to be so dumb to so many of their employees. 

If moving information around large companies is so difficult, how does our economy work? It’s thousands of times bigger than our largest companies, yet it somehow manages to get good information to millions of decision-makers. The answer is that capitalist economies work well at distributing information because they have two things companies do not: markets and prices.

As the late F.A. Hayek and other economists have noted, prices very effectively coordinate action, and they do so without any centralized decision-making. If a critical oil refinery in Louisiana blows up, the markets will quickly drive up the price of gasoline. Millions of consumers will see that price increase and modify their behavior accordingly, either deferring their gas purchases (if they can), or finding ways to drive less. Producers will likewise respond to the price increase by searching for new ways to increase production at other refineries. Consumers and producers together will do exactly what the economy needs them to do, but without anybody directing them. Most importantly, they will do it without needing to know why gasoline is in short supply. Prices, in that way, are a very efficient means of communication. 

Ironically, companies, the most distinctive and integral building blocks of capitalist economies, don’t work this way. With only rare exceptions, precious resources inside of companies (capital funding, talent, time/attention) are not allocated through any kind of market mechanism. They are centrally planned, and they are “free” in the sense that whatever business unit consumes them will not be charged for it. On the few occasions that they may have to “pay” for such resources, the price is not set in a competitive market, but instead by a formulaic, overhead charge. As such, it is worthless for communication and coordination. 

Large companies operate not like capitalist economies, but instead like the old Soviet Union. Powerful, centralized bureaucrats make all important resource allocation decisions, and they do so with limited and distorted information. They have no prices to guide them, and they can not benefit from the countless bits of hidden, “specific information” that their employees possess. They are doomed to make very serious mistakes, and their companies inevitably suffer the consequences. 

Capitalism solves this problem by replacing its large companies with vibrant upstarts in Schumpeter’s endless wave of creative destruction. This is a great solution for all of us--except those working in the large, sclerotic companies.

The Seventh Law of Large Companies: Large, complex organizations don’t know what they know, causing all their employees, especially their senior managers, to make bad decisions.