Friday, June 6, 2008

5 Bad Entrepreneurial Habits

What leads to the downfall of established companies?  In The Essential Drucker: The Best of Sixty Years of Peter Drucker's Essential Writings on Management, Peter F. Drucker writes about five bad Entrepreneurial habits that let small companies leapfrog over the big companies.

The Five Bad Entrepreneurial Habits
According to Drucker, the five bad habits are:

  1. NIH (Not Invented Here)
  2. "Cream" a market.
  3. The belief in "quality."
  4. The illusion of the "premium" price.
  5. Maximize rather than optimize.

The Downfall of Established Companies
Drucker writes how the bad habits let small companies use Entrepreneurial judo:

There are in particular five fairly common bad habits that enable newcomers to use entrepreneurial judo and to catapult themselves into a leadership position in an industry against the entrenched, established companies.

Not Invented Here (NIH)
Drucker writes about the Not Invented Here syndrome:

The first is what American slang calls NIH (“not invented here”), the arrogance that leads a company  or an industry to believe that something new cannot be any good unless they themselves thought of it.  And so the new invention is spurned, as was the transistor by the American electronics manufacturers.

"Cream" a Market
Drucker writes about the pitfall of only chasing the big customers:

The second is the tendency to “cream” a market, that is to get the high-profit part of it.

This is basically what Xerox did and what made it an easy target for the Japanese imitators of its copying machines.  Xerox focused its strategy on the big users, the buyers of large numbers of machines or of expensive, high-performance machines.  It did not reject the others; but it did not go after them.  In particular, it did not see fit to give them service.  In the end it was dissatisfaction with the service – or rather, with the lack of service – Xerox provided for its smaller customers that made them receptive to competitor’s machines.

“Creaming” is a violation of the elementary managerial and economic precepts.  It is always punished by loss of market.

The Belief in "Quality"
Customers only pay for what they value -- they don't care how hard it was for you to produce it.  Drucker writes:

Even more debilitating is the third bad habit: the belief in “quality.”  “Quality” in a product or service is not what the supplier puts in.    It is what the customer gets out and is willing to pay for.  A product is not “quality” because it is hard to make and costs a lot of money, as manufacturers typically believe.  That is incompetence.  Customers pay only for what is of use to them and gives them value.  Nothing else constitutes “quality.”

The Illusion of the "Premium" Price
Drucker warns to watch out for "premium" prices:

Closely related to both “creaming” and “quality” is the fourth bad habit, the illusion of the “premium” price.  A “premium” price is always an invitation to the competitor.

What looks like higher profit for the established leader is in effect  a subsidy to the newcomer who, in a very few years, will unseat the leader and claim the throne for himself.  “Premium” prices, instead of being an occasion for joy – and a reason for  a higher stock price or a higher price/earnings multiple – should always be considered a threat and dangerous vulnerability.

Yet the illusion of higher profits to be achieved through “premium” prices is almost universal, even though it always opens the door to entrepreneurial judo.

Maximize Rather Than Optimize
The fifth bad habit is maximizing when you should be optimizing.  Drucker writes that you need to optimize and move on, rather than maximize:

Finally, there is a fifth bad habit that is typical of established business and leads to their downfall.  They maximize rather than optimize.  As the market grows deep and develops, they try to satisfy every single user through the same product or service.  Xerox is a good example of a company with this habit.

Examples of Optimizing Over Maximizing
Drucker provides a couple of examples how smaller competitors beat the larger company through optimizing rather than maximizing:

Similarly, when the Japanese came onto the market with their copiers in competition with Xerox, they designed machines that fitted specific groups of users – for example, the small office, whether that of the dentist, the doctor, or the school principal.  They did not try to match the features of which the Xerox people were the proudest, such as the speed of the machine or the clarity of the copy.  They gave the small office what the small office needed most, a simple machine at a low cost.  And once they had established themselves in that market, they then moved in on the other markets, each with a  product designed to serve optimally a specific market segment.

Sony similarly first moved into the low end of the radio market, the market for cheap portables with limited range.  Once it had established itself there, it moved in on the other market segments.

Key Take Aways
Here's my key take aways:

  • Just because you aren't the first, doesn't mean it's not a good idea.
  • Go after the low-profit part of the market too, not just the "cream."
  • Customer's don't care how hard it is for you; they only pay for what they value.
  • Beware of "premium" prices.
  • Optimize over maximize.

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5 comments:

Barbara Swafford said...

Hi J.D.

This is a good lesson in learning from others mistakes.

Some companies (large or small) can be quite arrogant and miss out on sales, over price and are being too proud to admit someone else may be doing it better.

In business, I think we can all learn from each other, and by being closed minded, we're only hurting ourselves.

Vered said...

"Customers only pay for what they value -- they don't care how hard it was for you to produce it."

Completely agree with this one, and by the way, in blogging too - often the "best" posts as far as readers go are the ones into which you put the least effort, and vice versa.

Alik | PracticeThis.com said...

3. The belief in "quality." is my favorite.
The cream market is hard for me to accept... Do i challenge Drucker's take? Hell yes. I must be nuts...I followed Tim Ferriss advice and Blanchard's Raving Fan theory - that was very practical and rewarding. Tim and Kenneth call to fire all those customers that demand more maintenance than revenue (usually it is mid and small market). So i did and that was a big change, a positive one in therms of bottom line, the ROI.

or may be i do not understand what Drucker was saying about Creaming the market?

J.D. Meier said...

@Barbara - I'm a fan of learning from everyone. Success leaves clues!

@Vered - I finally understand why this seems to be true. In my recent training, the instructor distinguished between "ballroom" and "conference room" type presentations. In the ballroom, focus on simple messages and nice presentation -- simple consumption. Ballroom is good for the masses to inform or entertain. In the conference room, focus on lots of facts and figures. I think the best posts that hit the best also come from a passionate place, so they're easier for us to write.

@Alik - I'm not sure I entirely get Drucker's point, but I think it's like this -- if you only go for the long shot, you'll miss out on all the perfectly good in between. I actually learned this lesson in fooseball.

Manchild said...

Hello J.D.,

Outstanding! So true. Thank you for sharing this insight post.

Manchild