Sage Advice

The foremost business thinker of our age tells what is wrong (and right) with the New Economy.

From the August 22, 2000 issue
 Peter Drucker

James Daly

Just as the microprocessor opened up the possibilities of our machines, Peter Drucker opened up our minds. Drucker is the preeminent business philosopher of the 20th century, creating the concept of management as a practical discipline. His intellectual rigor and prescience separate him from the pack of futurists. His great strength is an extraordinary ability to interpret the present, to read the lines in the sand that get to the heart of the matter. In more than 30 books, he has written lucidly on many of the crucial business trends of the past 50 years, identifying the "knowledge society" as the cornerstone of modern business.
 
Today, at 90, he lives in a leafy Los Angeles suburb. He moved there in 1971, expecting to stay for three months. "That’s one reason I don’t teach long-term planning," he says. Drucker swims daily, exhibits obvious pride in the blooming violet flowers of a jacaranda tree, speaks lovingly of his grandchildren. He’s still spry, able to hobble along on a cane as fast as many people can walk and can put down a cooling double espresso in a single gulp.
 
Drucker’s speech is slower now, but his mind no less sharp. His ideas are as important as ever, and he continues to spread them as fast as possible. He has produced a five-part series of hour-long management programs for Corpedia, an interactive corporate learning company. The online programs are animated, colorful, jammed with information and sure to become a touchstone of corporate skills training. Even today, Drucker remains the guru of management.
 
Many of the newer Internet companies are struggling to keep their businesses afloat. What are they doing wrong?
Drucker: I don’t think they are doing anything wrong. They’re just not doing anything right. It’s highly probable that the age in which you automatically got lots of money by calling yourself a dot-com is over. Many of these Internet startups were not startups of business, at all. They were just stock exchange gambles. If there was a business plan, it was only to launch an IPO or be bought. Not to build a business. And sometimes I am rather appalled by the greed of today’s executives.
 
Is it too late to pull out of the tailspin?
Possibly. Venture capital will be increasingly hard to get for many of them. I once worked with a man named Cecil Rose. A financial man. He said that any startup that promises to have profits in less than five years is a phony, but any startup that doesn’t have a positive cash flow in 18 months is also a phony. Now that may be too orthodox today. The fact that some Internet startups take a long time to become profitable is fine. Amazon.com is typical. I am not worried about it. But very few of the Internet startups will have a positive cash flow ever. And that’s not a business.
 
The argument that many of the startups pose is that they are simply buying land while land is cheap. That is, they will spend a lot of money today to build mind-share, and that leads to market share and, ultimately, profitability in the future.
OK, but you can only finance mind-share if you have the cash flow. You had exactly the same arguments in the 1920s, although the term "mind-share" didn’t exist. "Market share" was also an unknown term. The terms are new, but the illusions or promises are old and they were the same in all of the other booms. Typically, the speculative boom precedes the growth of the real businesses by 10 years. The first great speculative boom of our modern economy was with the railroads. The great English railroad boom in the 1830s led to a collapse of many of the first companies in the early 1840s. After that, railroad building began in earnest. The same happened in this country after the Civil War. The railroad boom was in the 1860s. But railroad building, and profit-making, only began in earnest with the transcontinental railroad after the Civil War.
 
Does that 10-year beginnings-to-boom timetable still apply? Do you think it will take a decade before we see the real champions of the New Economy emerge?
Yes. The promise in any new business in any new industry is that you have to buy back every penny you spend. But if you don’t have the cash flow, you must depend on ever growing infusions of new money: Investment capital. If you don’t get what you call "mind-share" translating into market share, you must depend on stock market gains rather then business gains. And that is very, very risky. It makes you exceedingly vulnerable to even the slightest downturn.
 
If so many new Net companies are stock market gambles, what about the established old-line companies? How are they faring online?
We all, including myself, greatly underrated the speed at which old businesses have been able to adapt to ecommerce and actually become leaders. Overrated it fantastically, and still do. Let me give you one example: Four years ago I told one of the world’s very large automobile companies they would have to go on the Internet. They listened politely, which means they didn’t throw stones at me. But they thought I was absolutely crazy. Now this same company has started an Internet buying collective and is working with at least two, and probably four or five, other big automobile companies. The buying co-op will turn into a worldwide auctions market, and they are moving very aggressively. But it took four years. And they also still only focus on their own brands, instead of being multibrand as the dot-com people are. Both sides still need to learn from each other.
 
Is it important to be a multibrand organization?
It’s critical. If you are, let’s say, Ford, and you go on the Internet, you sell Ford cars to Ford dealers. If you’re one of the dot-com companies, however, you sell every brand and find the dealer for it. That gives the dot-coms an enormous advantage, but only for the time being. I don’t know which of the big automobile companies is going to realize that its marketing strength enables it to become the seller of all brands and especially of the brands that don’t have the volume. From all I know, they’re all working on it. Give it another six months. They have severe internal problems with these things, however–with dealers, with their own people. They must overcome that.
 
Are there new metrics for success in an Internet company?
That’s a little more than I can answer. A great deal more. But I’m not sure that it will be any different then the traditional metrics. There’s an old grand theory of stock-market valuation that looks upon the value of a stock as the valuation of future gains. There’s a great deal to be said for it. Works very well over fairly long periods of time. And it applies beautifully to the dot-com boom, where the valuation is based on expectations of capital gains. When debt shrinks, the expectations of future earnings become more important and established businesses–but not necessarily large companies only–have a tremendous advantage, because their cost of capital is so much lower. If your cost of capital is based on tremendous stock market gains, then your cost of capital is actually very high if those expectations go down. Still, I do believe that new economics are very badly needed.
 
Such as? What are the most important numbers you’d look at to value a dot-com?
What I think is irrelevant. What matters is that prospective investors will look on these companies differently and that is very clear.
 
What do you think the corporation of the future looks like?
Which corporation? What kind of corporation? Interestingly, the impact of the Internet may be much greater on the nonprofits then on for-profit businesses. And on higher education. The cost of your basic resource, brainpower, is going up fast. It has become very expensive. Technically savvy and innovative people have become unbelievably expensive. They can make all the money they want by remaining independent contractors rather than working for one of the companies, no matter what your stock options are.
 
The impact of the Net on higher education is almost certain to be very much greater than on any business. The average knowledge worker will outlive the average employing organization. This is the first time in history that this has happened. You must have a great deal of knowledge today, and it must often be highly focused. So the center of gravity of higher education is already shifting from the education of the young to the continuing education of adults. Skills in business used to change very slowly. My last name, drucker , is Dutch. It means printer. My ancestors were printers in Amsterdam from 1510 or so until 1750 and during that entire time they didn’t have to learn anything new. All of the basic innovations in printing after the 19th century had been done by the early 16th century. Socrates was stone mason. If he came back to life and went to work in a stone yard, it would take him about six hours to catch on. Neither the tools nor the products have changed.
 
Will this ongoing quest for continuing education affect the structure of the corporation?
Almost certainly. The corporation as we know it, which is now 120 years old, is unlikely to survive the next 25 years. Legally and financially yes, but not structurally and economically.
 
Today’s corporation is structured around layers of management. Most of those layers are information relays, and like any relays, they are very poor. Every transfer of information cuts the message in half. There needs to be very few layers of management in the future and those who relay the information must be very smart. But knowledge, as you know, often becomes obsolete incredibly fast. The continuing professional education of adults is the No. 1 gross industry in the next 30 years, but not in the traditional form. In five years, we will deliver most of our executive management programs online. The Internet combines the advantages of both class and book. In a book you can go back to page 16. In a class you can’t, but in a class there is a physical presence; and on the Internet you have both.
 
Several years ago you set down the five dos and the three don’ts of innovation. If you were to create those rules for innovation today, what would they be?
Today you need an organization that is a change leader, not just an innovator. Five years ago, you had an enormous amount of literature on creativity. Most of creativity is the normal amount of hard and systematic work. Fifteen years ago, everyone wanted to be an innovative company, but unless you are a "change leader" company you won’t have the mindset for innovation. Innovation has to have a systematic approach. And innovation is very unpredictable. Look, you have a zipper on your pants don’t you?
 
Last time I looked, yes.
No buttons?
No buttons.
But if you look at the invention of the zipper this is totally irrational. The zipper could not possibly have been a success in the clothing industry. It was invented to close bales of heavy stuff, such as grain, in the port. Nobody thought of clothes. The market turned out to be not where the inventor thought it would be. And this happens time and time again. The first major war fought after the Napoleonic conflicts was in Crimea and it had horrible casualties. It was very important to develop an anesthetic that could be used on the battlefield. One of the first things they came up with was cocaine. It was supposed to be nonaddictive and everyone began using it–Sigmund Freud even. But it was addictive and had to be dropped. Around 1905, the Germans invented the first nonaddictive anesthetic, called novocaine. The inventor spent the last 20 years of his life trying to get everyone to use it. But where was it used? By dental students. And the inventor could not believe that his noble invention could be used for something as mundane as pulling teeth. So the market is almost never where the inventor thinks it will be.
 
No more than 10 or 15 percent of innovations move up to that founder’s wishes. Another 15, 20, or 30 percent are not disastrous, but not successes either. Five years later they’ll say that this is a nice specialty. You know what that means, don’t you? It means you have to wrap it in a five-dollar bill to give it away. Sixty percent are footnotes at best. Timing is also important. An invention may not succeed, but 10 years later someone else does the same thing, but gives it a slight twist and it clicks. Sometimes strategies are more important than the innovation itself. The trouble is that you rarely get a second chance.
 
Do you believe that an organization should be involved in the process of creative destruction, such as that described by Clayton M. Christensen in The Innovator’s Dilemma ?
Absolutely, but this needs to be an ongoing process and it has to be organized. Let me give you an example of a company that I’ve worked with. A fairly big one. A leader in worldwide specialized field. And every three months, a group of people from the organization–younger people, junior people, but never the same people–sits down and looks at one segment of the company’s products, or services, or process, or policies with a question: If we didn’t do this already, would we go into the way we are now? And if the answer is no then the question is what would we do. Every four or five years, that company has systematically abandoned or at least modified, every single one of its products and processes, and especially its services. That’s the secret of its growth and its profitability.
 
A company should be able to eliminate its waste. The human body does it automatically. In the corporate body, there is enormous resistance. Abandonment isn’t that easy, and don’t underrate the effect abandonment can have. It has a tremendous impact on the mindset of the people and the organization. Sometimes a so-called improvement can become a new problem. Of the people and companies I know, 70 percent of the new comes from a slight modification of what already exists. The best example I know is probably GE Medical Electronics. They’re a world leader, but not many of their products have come out of innovation. More have come out of improvement.
 
Any thoughts on the Microsoft antitrust trial?
Antitrust is an obsession of American lawyers, but I have no use for it. Any monopoly holds an umbrella over the newcomers, to be sure, but I am not afraid of monopolies because they eventually collapse. Thucydides wrote years ago that hegemony kills itself. A power that has hegemony always becomes arrogant. Always becomes overweened. And always unites the rest of the world against it. A countervailing power always reacts. A hegemonous system is very self-destructive. It becomes defensive, arrogant, and a defender of yesterday. It destroys itself. Therefore no monopoly in history lives for very long.
 
The best thing that could happen to an old monopoly is to be broken up. If antitrust had not forced IBM to give up the punch card, it would never have become the computer giant. The best thing that happened to the Rockefellers was to be broken up. The Rockefellers were wedded to kerosene. They considered gasoline a fad. By the time Standard Oil was broken up, it was on the decline. The new companies that were focusing on the growing car market, like Texaco, were growing by leaps and bounds. And five years later, the Rockefeller fortune was ten times what it had been before it was broken up.
 
So I think the best thing that could happen to Microsoft is to be broken up into several pieces. I do not think Bill Gates would agree with me, but then Mr. Rockefeller did not agree either.
 
He fought the breaking up of Standard Oil to the very last minute. AT&T fought it until it became clear that it was hopeless. The same with IBM and old man Watson, whom I knew very well. Not the man who built IBM but his father, who had the vision of the computer as early as 1929 but when reality came in a danger to punch-card business did everything to kill the computer. And the antitrust suit enabled his loving sons to ease the old man out. These were clients of mine. Friends of mine.
 
One of the seminal books that you wrote was The Age of Discontinuity . If you were to revisit that today, in this age of accelerated change, what would you write?
I don’t know, because I haven’t read that book for 30 years. I don’t read my old books, I write new ones. But I would put much more emphasis on demographics, much more emphasis on globalization. Much more emphasis on the Internet, particularly on business-to-business ecommerce. What the new economy or new society will look like you can’t predict, but you can see certain trends and some things I believe you can anticipate.
 
In the last 40 or 50 years, economics was dominant. In the next 20 or 30 years, social issues will be dominant. The rapidly growing aging population and the rapidly shrinking younger population means there will be social problems. Because of manufacturing advances, production will increase exponentially. Employment is disappearing. Blue collar employment and the share in manufacturing of gross national product is going down. We came out of World War II with farming still employing 25 percent of the work force, and producing some 20 percent of the gross national product. It is down to 3 and 5 percent now. And manufacturing is in the same direction, but maybe not going that far down, if you translate manufacturing goods prices into stable dollars. They have been going down at least 1 to 2 percent a year since 1960.
 
How does one manage successfully in this time of dramatic change?
It is very tempting to manage only for the short term, but very dangerous. One of the things managers have to learn, and very few of them have, is to balance short term and long term. I would say the unique accomplishment of CEO Jack Welch of GE has been that he has been developing the tools for keeping an eye on the financial short term–and by that I don’t mean six months but three years–but he has a very strong, strong emphasis on developing people long term. Call it a mind power strategy. This came fairly easy to GE because GE in the 1920s developed a sound and modern financial strategy and it was one of the very first companies in the 1930s to develop a human resources strategy. So these are all GE traditions. Jack Welch has put this balance to the forefront of his business. He gets monthly reports on each of his 167 businesses, I am sure, but he makes people investments for seven years ahead.

How do you turn transition to an advantage?
By looking at every change, looking out every window. And asking: Could this be an opportunity? Is this new thing a genuine change, or simply a fad? And the difference is a very simple: A change is something people do, and a fad is something people talk about. An enormous amount of talk is a fad. I have an old friend and he is an important man at a big institution. I think he was being accused of never changing anything. He has a very prosperous, very successful organization, and he said buying a book about change is much cheaper than changing anything. You must also ask yourself if these transitions, these changes, are an opportunity or a threat. If you start out by looking at change as threats, you will never innovate. Don’t dismiss something simply because this is not what you had planned. The unexpected is often the best source of innovation.
 
Remember that many transitions may be meaningless for a particular business. They may be exceedingly meaningful for some other institution, but for us they are meaningless. They don’t change our market, they don’t change our customers, they don’t change our technology, and the large part is just things they talk about at conferences. So most of the things are not for us. You may read about these changes in Business 2.0 , and it’s very interesting and I put a sticker on it and have all of my people read it. And they discuss it. And I will remember it even, and five years later, yes, maybe I do something. It becomes part of my instrument kit. So you just watch out at every window.
 
What do you believe is the future of business on the Internet?
I think it’s too early to speculate about ecommerce. One never knows how a new distribution channel will change what is being distributed and how customer values will change. If ecommerce takes only a relatively small part of the total consumer business, (and it may take a fairly large part), it will have a profound impact, and force existing distribution channels to change radically.
 
I think one high probability guess is a system that uses ecommerce to sell and a physical location to deliver. That is already being developed very rapidly in Japan. Ito-Yokado is probably the world’s largest retailer today. And they own, among other things, the Japanese 7-Eleven stores. Japan has 10,000 7-Elevens. Increasingly, they have deals with all kinds of suppliers where customers buy online and pick up at the nearest 7-Eleven. Because a central problem of ecommerce is delivery.
 
The delivery has to be local. That is fairly easy if you sell books. Books have an enormously high value-to-weight ratio. There is almost no product except diamonds that has a ratio as high. They are very easily shipped and, true, they can be damaged, but they’re fairly sturdy. All over the world transportation costs of books are artificially low. They are subsidized heavily. In this country, the best guess is that it costs the post office four times what it charges. So books are easy, but tractors aren’t quite that easy. And perishables are hopeless. So I would say there is high probability that you will see develop a system in which selling is online and delivery is in a physical location. At Japanese 7-Elevens, the online pickup system already accounts for about 40 percent of what the store sells. The 7-Eleven gets a small commission but it costs them nothing, it’s pure gravy. So I think that is one of the likely things. Other changes are also profound. Because for the first time selling, making, and delivery are separated. The center of power has been shifting to distribution now for 50 years. That’s accelerated several orders of magnitude. How many manufacturing plants will survive? Not many. But so far the distributor has squandered that power. The distributors already have the brands, but only a very few of the very big manufacturers have brands that have real standing in the consumer market.
 
In other areas, the design of a product, its manufacture, marketing and servicing will become separate businesses. They will be owned by the same financial control but basically run as separate businesses. Ford is considered a manufacturing company, but they don’t manufacture anything. They assemble. Which is a radical break with the mass-production concept. So the changes are very profound and very deep and very long lasting. And we are just beginning to understand what it all means.
 

Books by Peter Drucker

Drucker has written some 30 books in a writing career that spans seven decades. They fall into three broad categories: management studies, socioeconomic political studies and collections of essays. Here are some of the most important:
 
• The Future of Industrial Man (John Day)–His second book, published in 1942. Had a considerable impact, and along with his first book, The End of Economic Man (John Day) in 1939, helped establish him as an insightful political scientist.
 
• Concept of the Corporation (John Day)–Drucker’s epochal work. An in-depth study of General Motors published in 1946 and one of the only corporate studies of lasting intellectual merit. Combines social ideas with the practical observation of what actually happens inside a profit-driven corporation.
 
• The Practice of Management (Harper & Row)–Defines his groundbreaking theory of Management by Objectives, a technique to improve individual and group performance in which managers at every level of an organization have measurable goals that fits the overall goals of the corporation. In many ways, The Practice of Management created the management book craze.
 
• The Age of Discontinuity (Harper&Row)–Published in 1969, this book was decades in advance of conventional thinking. Drucker spotted three discontinuities in technology and industry, the world economy and government. Introduced the concept of the knowledge worker.
 
• Innovation and Entrepreneurship (HarperCollins)–Tackles innovation as a discipline that can be taught and learned–the sources, nature, and symptoms of which can be studied. Remains the best manual on the practice and principles of entrepreneurship.
 
• Adventures of a Bystander (Harper & Row)–A charming account, ending in the late 1970s, of a life and career of intellectual distinction and lasting importance.
 
• The Effective Executive (Harper & Row)–Focuses on personal effectiveness. The individual’s companion guide to the organization’s Managing For Results. Published in 1985.
 
• Managing For Results (HarperBusiness)–A how-to book that expands on the theories of Managing by Objectives and how they can be made meaningful in the world outside the corporation.
 
• Management Challenges for the 21st Century (HarperCollins)–His most recent book. Continues his acute analysis of changing forces in management.
 
• Managing Oneself and Others (www.corpedia.com)– A series of five online programs on modern corporate management techniques. Colorful, insightful, and ultimately indispensable.