Failure is all around us. Species, companies, brands and government policies fail. In order to achieve success, we must first understand the pervasive existence of failure. Failure is inevitable, yet necessary to learn and grow. In fact, one will probably experience failure more often than they experience success. Business are no different. Even the large, successful, monopolistic enterprises are not immune from failure. This phenomenon is nearly ignored in its entirety by economists and is viewed almost as an exception to the rule. Paul Ormerod disagrees with failure being categorized as a flaw and argues that it is a natural part of life. In his book, “Why Most Things Fail: Evolution, Extinction and Economics,” Ormerod examines a variety of theories as well as lessons from biology to gain better insight to the nature of failure.
Alfred Marshall is widely regarded as one of the most influential economists of all time and credited with formulating many of the building blocks of modern economics. Early in his career he believed that, like trees, massive corporations would eventually die. He later changed his mind, writing around 1910 that such companies "often stagnate, but do not readily die." He was actually right the first time. They do in fact die. Most of major companies from the 1910’s no longer exist today. They failed somewhere along the line.
Conventional economic thinking has no adequate explanation for failure. It is dependent upon equilibrium, a precise balance between supply and demand, which is static. However, people, society, the economy and the circumstances that shape our decisions and way of life are anything but static. They are in a perpetual state of motion and change. Traditional economic data such as demand, pricing, costs and competitive response often don’t tell the entire story. Any economic development is made up of a combination of countless small decisions which lends itself to a huge amount of uncertainty. The actions and decisions of one party will impact the future decisions and outcomes for all those involved and it is impossible to know how each individual choice will influence the big picture. Economic analysis is nothing more than an attempt to simplify the rather complex matter of managing a business.
“Failure is probably the most fundamental feature of both biological and human social and economic systems.”
The science of biology, especially the study of extinction, provides interesting insights into the phenomenon of failure. The history of life, when examined through fossil records, suggests that extinction is commonplace and subject to some mathematical regularity. Extinctions obey a power law curve, meaning that the frequency with which they occur decreases according to the square of the size. Interestingly enough, the failure rates of companies also fits this same pattern.
Some economists attempt to call upon biology when inferring that evolution is a matter of survival of the fittest, but this is not the case. Evolution is random. Genes do not mutate on their own accord, just as species do not choose how they evolve. The fittest species and businesses only evolve over long periods of time thanks to random mutations and natural selection. The relationships among species are so complex that absolute fitness doesn’t exist. Fitness is relative to a particular situation of an animal or a company and their pending interactions with the environment and relationships with the parties involved. There is not an orderly process that weeds out the weak and only the strongest survive. Species, like companies, emerge, compete and while some thrive, others go extinct as a result of unpredictable, uncertain events. There are many connections that link species together. Predator and prey, for example may seem antagonistic, but the two parties cannot survive without each other. When lynx are scarce, rabbits multiply beyond the environment’s sustainable capacity. As a result, the lynx multiply with the abundance of prey until they severely reduce the rabbit population. Then, the lynx population decreases as there isn’t enough food to sustain itself. This cycle continuously repeats itself, with predator and prey mutually dependent, mutually interacting. Change is constant, but as a whole, balance is maintained.
Species do not generally become extinct due to external shocks (such as the meteor that affected the dinosaurs); rather, extinction is built into the system. As mentioned, a graph of the failure rate of businesses looks like a graph of the extinction of species, and businesses may fail for the same reasons species do because economic systems are almost completely random as well. A nation's GDP and the strength of their economy is a result of millions of small decisions and interactions of the people who make up the society. It is impossible to know how any one individual decision could alter the whole. Many prefer the notion that big impacts must be the result of big causes, but this is not always true. Small causes can lead to big effects.
Conventional economic theory points to external shocks as the ultimate cause for business cycles because the economy “ought to” trend towards an equilibrium.
When modeled with simple rules, however, it is possible to demonstrate complex emergent behavior with regards to extinction events, with endogenous causes internal to the system, rather than external causes (asteroids, floods, climate change).
“Individual behavior is not fixed, like a screw or cog in a machine is, but evolves in response to the behavior of others. Control and prediction of the system as a whole is simply not possible.”
Failure is not unique to business. It exists across many systems. Government policies devised to reduce social inequality have not achieved their goals. In the Western world, social inequality has grown over the past several decades. Global wealth is more equally distributed among countries, but inequality within these countries is widening. Governmental regulations also often distort the evolutionary path of businesses when they try to preserve the competitive marketplace by preventing monopolies when in fact monopolies are healthy for the system.
Furthermore, consider segregated neighborhoods and governments continued attempts to decrease inequality. Despite more than 150 years of social reform, class segregation in Manchester, England remains almost as severe today as it did in 1844. In the US, segregation is based more on race than class. Despite laws, court rulings, affirmative action, the civil rights movement and government programs, segregation and income inequality persists.
The “laws of supply and demand” are taught as basic economics, but things in reality really aren’t that simple. There are always variables. For instance, a crop might be expensive one year due to a poor harvest, then cheaper the next year due to oversupply from a farmer planting more of the crop that had commanded a higher price. The third year, farmers may plant less of the crop due to the low prices in the ‘good harvest’ year, sending prices up again as a result of now less crops in the marketplace. Prices might never reach a classic “supply and demand” equilibrium, but move all around it.
Economics has a lot of uncertainty, yet Marshall outlined game theory that more or less ignores uncertainty and proposes solutions to difficult problems inherent to the interactions between the involved parties. However, these techniques have numerous limitations when applied to real life situations. People often act alone or in groups that align with their own interests, with the purpose of obtaining specific goals. However, with the number of possibilities and variations, it is difficult and often impossible to accurately predict the consequences of the decisions. Even the inventor of game theory, Merrill Flood, gave up on the argument when he realized that people do not always act in a way that would be considered “rational” given the known information.
“The stock-market crash of 1987 shows how small events can have enormous consequences. The immediate causes of the collapse were small, so small...that even with the benefit of years of hindsight they have not been identified with confidence.” Surprises happen even in games that people have played for thousands of years. Few games have been more exhaustively studied than chess, yet discerning the "best" move at any particular point during the game is nearly impossible. The chess grand masters do not insist on finding the best move. They make moves that seem reasonable and unlikely to lead to big losses, in the same way that experimental economics leads us to believe that individuals and firms will behave, but it cannot be known with certainty.
Things fail because of the inherent uncertainties involved in any complex system. Despite our best intentions, outcomes often do not match the desired effects. It is impossible to get around this simple fact and no amount of intelligent analysis will change the situation. Sometimes failure can beneficial. Innovation, evolution and competition are the hallmarks of success and a case can be made that failure is the driving force for all of them.
Tyler Krebeck
Chief Content Manager
January 13, 2020