Before You Read

Discuss the following questions with a partner.

1. What do you think are important concepts that a business owner needs to focus on to make sure their business is and stays successful?
2. What are some reasons a business might fail?
3. Give an example of a business that failed. What caused the business to fail?
4. In what ways do you think business and consumer spending is changing?
5. Skim the next reading. What do you think is the author’s purpose of the text: to inform, entertain, or to persuade? How will that affect the way you take notes on the reading?

Businesses and the Icarus Paradox

Excerpts adapted from the Wikipedia article “Icarus Paradox“, $\ccbysa$

The Icarus paradox is a phrase coined by Danny Miller in his 1990 book by the same name. The term refers to the phenomenon of businesses failing suddenly after a period of success, where this failure is brought about by the very elements that led to their initial success. It alludes to Icarus of Greek mythology, who drowned after flying too close to the Sun. The failure of the very wings that allowed him to escape imprisonment and soar through the skies was what ultimately led to his demise, hence the paradox.

In many industries, extremely successful businesses often face problems maintaining their success. Of the companies in the 1966 Fortune 100, 66 no longer existed by 2006. Fifteen still existed but were no longer on the list, and only 19 remained on the list.

In a 1992 article, Miller noted that successful companies tend to fail because of their strengths and past victories, which causes over-confidence and lulls them into complacency. The characteristics that drove their success such as tried-and-true business strategies, dauntless and self-assured management, and the overall combination of all these elements when done in excess may ultimately lead to declining sales and profits and even bankruptcy. This happens as managers make unwise decisions based on past strategies that they mistakenly believe will always be relevant and companies exploit as much as possible the strategies that contributed to their success, concentrate their focus on the products that launched their brand and become blinded to changes in the external business environment.

According to Miller, success seduces companies into failure by encouraging overconfidence, exaggeration, attribution of credit and blame, complacency, and routine.

Overconfidence

Most successful firms owe their fortune to a unique competitive formula. As the company continues to grow, the manager’s confidence in this winning formula is bolstered. Eventually, the firm ends up focusing only on refining and extending the strategies, products and values that propelled their success. Any other activities are neglected or even discouraged. This may be profitable in the short run as companies continue to specialize and improve in a certain product or strategy, leading to higher efficiency, sales and growth as they develop their competitive advantage in that particular area. In the long run, however, this attitude is unsustainable. They become unable to keep up with the threats of new competitors, changing consumer demands, newly developed business models and changes in the external environment. Some examples are Laura Ashley, Atari, Digital Equipment, Tupperware and Revlon.

Failures in business projects happen all too often. Over 70% of new manufacturing plants in North America, for example, close within the first decade of operations. Around 75% of mergers and acquisitions do not pay off – the acquiring firm’s shareholders lose more than the acquired firm’s shareholders gain. The vast majority of efforts to break into new markets are abandoned within a few years.

Standard economic theory explains the high rate of failures as an inevitable result of companies taking rational risks in the face of uncertain situations. The rewards of a few successes outweigh losses incurred from many failures in the long run. Executives know this and accept the risk. This theory absolves them from blame – they were simply making rational risks, after all.

Lovallo and Kahneman from the Harvard Business Review argue, however, that most of these failures are actually the results of flawed decision making. When predicting the outcomes of risky projects, executives easily fall victim to what psychologists call the planning fallacy. They make decisions based on delusional optimism instead of on rational weighing of gains, losses and probabilities. They imagine successful situations while overlooking potential problems. Consequently, they are overly optimistic and pursue opportunities that are unlikely to succeed.

Exaggeration

Humans have a natural tendency to exaggerate their own talents, so many executives believe they are above average in their positive traits and abilities. This is amplified by the tendency to misperceive causes of certain events and attribute success to their abilities when it might have been out of pure luck.

Credit and Blame

People tend to take credit for positive outcomes and attribute negative outcomes to external factors. A study of letters to shareholders in annual reports, for example, found that executives tend to attribute favorable outcomes to factors under their control, like corporate strategy or R&D (research and development) programs. Unfavorable outcomes were more likely to be attributed to uncontrollable external factors like the weather or inflation. People also tend to exaggerate the control we have over events, not considering the role of luck.

Complacency

There are perils associated with following a certain system, even a winning one, for too long. Clear commitments are required for initial success, but these commitments harden with time and ultimately restrict a firm’s ability to adapt when its competitive environment shifts. As the market environment evolves, the fresh competitive formula that led to a firm’s initial success instead becomes a strict set of rules that control and confine their strategies. Many firms may believe that they don’t need to do anything different from what they have always done to maintain their success. This can lead good firms to go bad, even when executives avoid arrogance and complacency.

Routine

A company’s values unify its people. Strong values can make employees stay loyal, strengthen the bonds between a company and its customers, attract like-minded partners, and hold together a company’s far-flung operations. These entrenched beliefs define how they see themselves and the firm. However, as companies mature, these values may become a strict set of rules that oppress and not inspire. Employees may be punished for suggesting trying something different or not fitting perfectly into the mold.

For example, Polaroid’s employees once prided themselves on the company’s cutting-edge innovations. It valued technological breakthroughs first and foremost. Other business activities such as marketing and finance were deemed unimportant as long as they were technologically up-to-date. Polaroid’s managers then invested heavily in research, without considering changes in the consumer’s tastes. Consequently, sales declined.

Also consider Laura Ashley, who founded her company to defend traditional British values under siege from miniskirts. Laura Ashley’s commitment to traditional values of modesty initially appealed to many women but lost their appeal as more women entered the workforce. The company, however, continued to pursue the old-fashioned designs that represent their fossilized core values, leading to their irreversible decline.

A prime example of the Icarus Paradox at work would be Tesco’s experimental venture into the U.S. market – Fresh & Easy. After making a loss of £1.2bn ($1.8bn), sending Tesco’s net profit down 96%, Tesco decided to finally pull out of the U.S. They failed for several reasons. Tesco opened the chain in 2007 right before the economic recession hit, which severely negatively impacted consumer spending. Tesco also did not expect online grocery shopping to be as popular as it was. In addition, Tesco’s research misjudged the spending habits of their consumer base. While their Metro stores in the UK were popular, there was not enough demand for grab-and-go meals in the US. This is a new concept in the US where, unlike in Europe, most people would usually order take out or cook their own meals. Purchasing such meals are also more expensive for customers than buying groceries and cooking meals themselves. Lastly, In the US, most shoppers only buy their groceries once a week, and they do so in bulk and purchase a large variety of products, while Europeans tend to make more frequent, but smaller trips to the grocery stores.

“It (Tesco) was engaging in hubris, and that brings arrogance. You lose touch with your customers,” said Clive Black, an analyst from Shore Capital in London watching Tesco. He believes that the US market was simply too different from the UK and that Tesco’s aggressive expansion strategy only detracts from their focus in the changing UK market. In Fresh & Easy’s case, Tesco’s confidence in bringing its successful concept of ready meals to the US market contributed heavily to its failure. The intensive marketing required to change people’s daily consumption habits take time and money, neither of which Tesco invested enough of. Tesco was also confident enough to continue to hang on for over 5 years despite indications of possible failure.

CEFR Level: CEF Level C1