Disruption Big Time

In an excellent post on the Lepore-Christensen fracas, John Hagel draws on Deloitte’s Shift Index to provide some data on disruption. Disruption has increased by a variety of metrics.

One of the metrics in our Shift Index looks at what economists call topple rate – the rate at which leaders fall out of their leadership position. In this case, we focused on the rate at which public US companies in the top quartile of return on assets performance fall out of this leadership position.Between 1965 and 2012, the topple rate increased by 40%.

OK, but the skeptic might reply that this is only about financial performance. Another more significant measure of fall from leadership position is provided by my old colleague and mentor, Dick Foster, who looked at the average lifespan of companies on the S&P 500.  In 1937, at the height of the Great Depression and certainly a time of great turmoil, a company on the S&P 500 had an average lifespan of 75 years.  By 2011, that lifespan had dropped to 18 years – a decline in lifespan of almost 75%.  At the same time that humans are significantly increasing their lifespan, large companies have been heading rapidly in the opposite direction.

Another measure of disruption is executive turnover which has increased.


Some of Deloitte’s work also speaks to the implicit idea in Piketty that capital accumulation is easy. Once someone has capital, Piketty argues, that capital just grows and grows at r>g. Not so, and less so today than ever before. According to Deloitte the return on capital is decreasing and the volatility is increasing. Here’s the return on assets by top and bottom quartile. Even in the top quartile, r is decreasing but it’s easier than ever before to pick wrong and lose your shirt in the bottom quartile.


Lots more of interest in Hagel’s post and in Deloitte’s work.


"According to Deloitte the return on capital is decreasing and the volatility is increasing. Here’s the return on assets by top and bottom quartile. Even in the top quartile, r is decreasing but it’s easier than ever before to pick wrong and lose your shirt in the bottom quartile."

I generally agree with what this post is trying to say, but this statement does not hold water. Just because the dispersion between individual investments is increasing does not mean that the portfolio volatility of returns for the typical investor is increasing. Looking at average VIX levels, there is no clear long term trend indicating that market-wide volatility is increasing. In fact it doesn't even mean that the dispersion of returns across investors is increasing. Investors could be diversifying at a faster rate than investments are dispersing.

The top two charts and discussion are useless. A 40% increase in topple rate is meaningless -- it is consistent with a change in rate from 1% turnover over a decade to 1.4% turnover. Corporations cease to exist in a lot of ways that make the second chart as bad. Merger for example.

Agreed. I'd like to learn what percenatge of the "drop-out" corporations were bankruptcies. I think most of the drop-outs were targets of mergers and acquiisitions.

Outside effing bank regulators, who looks at return on assets? It's mainly return on equity/capital invested.

Also, did D adjust the data for the desultory, economic insanity (dot com bubble/bust, low rates, housing bubble/burst, hundreds of bank failures, great recession, TARP, stimulus, gargantaun Fed $ print, etc.)?

How would you characterize Bear Stearns?

"How would you characterize Bear Stearns?"

Since late 2009, had not given BS a thought.

UST and FRB "bailed out" its shareholders.

It was disparately treated compared to Lehman Brothers; was it not?

I wonder why.

From a January 2009 Joint Statement of UST, FRB, FDIC on Citigrup, pretty much sums it up:

"With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy."

"We will continue to use all of our resources to preserve the strength of our banking institutions and promote the process of repair and recovery and to manage risks. The following principles guide our efforts:
• We will work to support a healthy resumption of credit flows to households and businesses.
• We will exercise prudent stewardship of taxpayer resources.
• We will carefully circumscribe the involvement of government in the financial sector.
• We will bolster the efforts of financial institutions to attract private capital."

September 17, 2008 major money market funds "bust the dollar." So, US Treasury guarantied MMF’s held as of that date - prevented runs and bankruptcies/losses to MMF shareholders.
March 16, 2008 Bear Stearns (garbage assets Fed gty took as collateral) $30 billion sold to JPMorgan Chase which gets to borrow $30 billion from Fed posting Bear Stearns garbage as collateral.
Sept 7, 2008 FNM/FRE (US backed already) placed in conservatorship @ $200 billion plus $1 billion equity
Sept 16, 2008 AIG (discount window line) loan $85 billion; plus $38 billion more - all repaid
Bank of America buys Merrill Lynch for $29/share.
Oct 7, 2008 federal funds rate cut to 1.5%.
SEC temporarily prohibits short selling financials.
Lehman Bros. files for bankruptcy.

March 7, 2011 FRB offers $400 billion in loans with MBS collateral

Remember Mobil Oil? That's right, it's gone.

Remember Sun? That's right, it's gone too.

Compaq? Bankers Trust? NYNEX, Bell Atlantic and GTE?

Yep, all those companies were disrupted out of business. Or not, in a world where ExxonMobil, Oracle, HP, Deutsche Bank, and Verizon still exist.


You know, if you had just stuck with Mobil->ExxonMobil I might have nodded my head.

But Sun? It was falling, failing, flailing through the 2000-2009 period. Disrupted is a fair description. Just because Oracle picked up the pieces doesn't change that.

Ditto for Compaq except the disruption started in the mid-90's as Dell and others cleaned its clock (and after it made a horrible decision to acquire DEC). Stockholders were extremely fortunate to be bailed out by the HP offer in 2002, as there really wasn't $24B of value there. (Worse, there wasn't even $10B -- since $14B of the 24B was supposed to be "goodwill.") HP's relationship to Compaq is approximately Compaq's relationship to Digital -- the bagholder for miscellaneous parts left over from the previous company's failure.

Both are fine examples of failed companies.

't was falling, failing, flailing through the 2000-2009 period.'

Fair enough - but to thinks its server/processor business was 'disrupted' by IBM or HP seems a bit 'daneben,' to use a German expression. On the other hand, the collapse of the dot.com economy right around the time Sun did poorly may indicate something was involved other than 'disruption' - after all, Sun was a leading rider of the previous wave of disruption.

'Ditto for Compaq except the disruption started in the mid-90′s as Dell and others cleaned its clock'

Dell simply did the same thing to Compaq that Compaq did to IBM - cut margins/customized to offer customers a cheaper commodity product. Normally, this is not the idea of 'disruption,' but is generally considered a normal process related to efficiency in commodity markets.

'approximately Compaq’s relationship to Digital'

Well, nice to see someone recognize that Digital didn't precisely 'disappear' either.

'Both are fine examples of failed companies.'

Well, Sun is an interesting case (a self developed processor requires serious resources - even Apple seemingly can't afford its own desktop processor architecture these days), and considering that Compaq did better than Amiga (a history so complex it isn't worth getting into here), Gateway (acquired by Acer), or Bell Packard (also acquired by Acer).

I doubt that Amiga (whose video/display architecture remains admirable even today), Gateway, or Packard Bell failed due to 'disruption' either. It is merely that their corpses didn't cost as much to bury as Compaq's. As for Sun - Oracle may have failed in its attempt to create profitable Java disruption through the American legal system, but that was a risk that did not pay a return - something a bit different than failure through disruption per se.

"Corporations cease to exist in a lot of ways that make the second chart as bad. Merger for example".

A lot of people seem to have misinterpreted the original research, including, perhaps, John Hagel, who wrote this:

"In 1937, at the height of the Great Depression and certainly a time of great turmoil, a company on the S&P 500 had an average lifespan of 75 years. By 2011, that lifespan had dropped to 18 years – a decline in lifespan of almost 75%. At the same time that humans are significantly increasing their lifespan, large companies have been heading rapidly in the opposite direction."

The original report referred not to the "lifespan of companies", but the tenure of companies on the S&P 500. That's quite a different thing. When a company drops out of the S&P 500 Index, that doesn't mean that it goes out of existence or "dies". Given the last sentence quoted above which compares to human lifespans, as well as the ambiguous syntax from Hagel, readers here could be forgiven if they got that impression. The New York Times Corporation was dropped from the S&P 500, for example, but that doesn't mean the paper is now written by ghostwriters even though it sometimes seems so.

How can you account for turnover within the SP500?

I thought the SP500 was only from the 1950s?

Reasonable data on equity returns exists since the 1870s. scholars can create similar indices for the periods pre 1950s.

I recall reading in a finance book by Zvi Bodie that though diversification decreases company specific risk, the risk of a portfolio going to zero never decreases, and in fact, statistically, the longer you hold such a diversified portfolio the greater your chances of hitting zero (which makes sense if you think about it: it's like exposure to a radioactive material, the longer the exposure, the greater the chance, however small, of something bad happening to you).

As for AlexT's post, it's just your typical "convergence as time increases" artifact, meaning that as time progresses companies catch up faster, competition increases, capital deepening occurs and you get more turnover. Average is Over. How to cure this? Simply allow greater monopoly, via stronger patents and IP protection, something AlexT would never condone, but it works to "break through" to the next level. Also Piketty's book discusses real estate and its monopoly power, not necessarily public shares.

Although the kind of things that make a diversified portfolio go to zero are the kind of things where you have bigger worries than your portfolio.

That r is chronically low is not news and doesn't conflict with Piketty's thesis (that r > g): both r and g are low. Indeed, it's low r that has induced owner's of capital to seek higher returns through speculation, a development that has added to financial instability.

Christensen's theory of disruption was a theory of technological innovation. Lepore's response focused on the validity of this theory of disruptive innovation. Now with Hagel's and Tabarrok's blog posts, the goalposts are moved, and we find ourselves talking about "disruption" more generally instead of technological innovation. It isn't remotely clear how CEO turnover relates to technological innovation.

Hagel's blog post also seem to suffer from a narrative fallacy. It is not a weakness of Lepore that she isn't out there pushing her own poorly supported theory. "Explaining trends" is something you do when you value neatly-trimmed, coherent worldviews over true appreciation for the complexity and uncertainty inherent in the economy.

Yeah, Christensen's theory is (or was in the original paper) specifically about cheaper, initially worse technologies superseding established better technologies. Hagel is equating disruption with change in general, which isn't relevant to Christensen's theory.

Typically shallow post from Alex Tabarrock. Sorry but Lepore's essay still stands - the chart above does not talk about whether this turnover is due to technological distruption or other factors such as mergers. Lepore's criticism basically focused on the very weak evidence Christensen had for building his distruption theory (hypothesis) and this post does nothing to overturn this criticism. I don't recall Lepore arguing companies don't dissapear from the market.

'According to Deloitte the return on capital is decreasing and the volatility is increasing.'

And yet, oddly, not a single billionaire has decided to get out of the business of getting richer, whether it be self-made men like Gates, Buffet, or Branson, or old money like that of the du Pont family.

To quote from Forbes - 'One of the longest-running fortunes in American history belongs to the du Pont family, who rank eighth with a fortune of at least $15 billion. The du Ponts trace their ancestry to Pierre Samuel du Pont de Nemours (d. 1817), a French Physiocrat, who survived the Revolutionary Terror by immigrating to America in 1800.'

And to further quote from that socialist rag - 'Many family fortunes have grown faster than inflation over time. Example: The descendants of John T. Dorrance, the chemical engineer who invented a canning process for condensed soup that used half as much water, shaving production costs by a third.

Dorrance died in 1929 with an estimated fortune of $150 million, or $1.9 billion in today’s dollars. After 80 years of growth in the value of Campbell Soup shares and decades of hefty dividends, his heirs enjoy a combined net worth of $11.5 billion, implying an annualized return on inheritance of 5.6%–2.3% above inflation.' http://www.forbes.com/2009/12/03/americas-richest-families-walton-rockefeller-dupont-business-billionaires-families.html

This kinda screams "survivorship bias." Is there a good dataset somewhere of very rich families as of, say, 1900, so we can see what happened to their riches?

The article linked gives several examples, and of course it screams 'survivor bias' - which was the point of Forbes attempting to determine 'America's Richest Families'.

But for the benefit of those who don't like reading Forbes style socialist claptrap, here is an excerpt which illustrates how survivor bias works -

'In compiling the list of America’s Richest Families, Forbes scoured biographies, financial filings and our extensive database of well-heeled individuals past and present. The list represents an eclectic mix of families who play an active role in the companies their relatives built, living entrepreneurs who have showered their families with the spoils of their success and old-money families who live off of trusts created decades ago.

Early attempts to chronicle inherited money reveal the difficulty of preserving wealth over generations. In 1939, financial journalist Ferdinand Lundberg published an expose of inherited wealth using tax returns released by Congress under the Revenue Act of 1924. Of the 60 families he identified, only four qualify for our list.

The 25 families on our list are worth a combined $418 billion. Given the stance of secrecy often adopted by American aristocracy, all of the net worth figures should be considered “at least” estimates.

Of the 25 families we’ve identified, 44% owe their fortunes to companies founded in the 19th century. Another 36% trace their wealth to businesses started in the first half of the 20th century. Three companies– Stryker Corp. , Estée Lauder and Fidelity Management and Research–were founded in 1946.'

And another point about survivor bias - these days, we tend to sneer at someone who just happens to inherit a share of a 500 million dollar fortune. We set our standards much higher than that, in the age of the Waltons and Kochs and Albrecht brothers (Aldi US and Trader Joe's, for the more provincial readers - Europeans are already familiar with the retailer). After all, the sons of Theo Albrecht - Berthold and Theo Jr. - have a wealth of merely 14.4 billion dollars, again according to Forbes.

Somehow, I doubt either of those heirs of merely half a family's business (Aldi has an interesting structure) are worried about the return on their capital, or doubt that they will have at least a few billion dollars to pass on to their children.

And yes, time for personal anecdotes - I actually know the grandchild of someone who is not quite a billionaire, and is not quite in the top 100 richest Germans. He has not given any of his wealth to his children, or his grandchildren. If by wealth you mean shares in the company, or trust funds involving 7 digits. He believes that his family needs to accomplish things on their own, without being given large amounts of money. On the other hand, what is a few hundred thousand euros when something requires it? Like a large apartment - or a job with the family company. The scale changes at that level, something I first noticed at GMU as a student, where one of the people I worked with was connected to a Tidewater family in the oil business, among other things - she too was expected to work to pay her rent as a student, but when she moved, her family sent a person best described as a servant with a van, to handle the work - just what your family does to help out, right? She will never make a list of the richest Americans - but it is extremely unlikely she should not be considered less than part of the 1%, based on her family's resources, even if her actual income never rises to that level.

Apart from survivor bias, these are the sorts of problems that arise when attempting to determine family wealth. Families are not the same, and the measures one uses for 'wealth' may be too inflexible. For example, all of the people mentioned above will always have access to the very best health care that money can buy, at a global level - that access is not reflected in any single family member's personal wealth, however. This applies most distinctly to children, one must note.

Picking through the rubble, I came across this:

"Early attempts to chronicle inherited money reveal the difficulty of preserving wealth over generations."

Why you hate Piketty bro?

And yet, strangely, about half of the 25 richest families in America trace their wealth back to the 19th century, according to the notably hard left Forbes magazine. Which just might mean that relative positions have changed, not that the wealthy are actually poor. For example, the Ford family was apparently quite poor in 2009, not even making the list - if one uses the standard that owning three percent of a company with a profit of $2.7 billion and revenue of $118.3 billion is a sign of poverty. Apart from whatever else those poor, poor Ford family members may own - probably a couple of run down mansions, a few pitiful trust funds, and some tax free accounts (admittedly, set up with far more skill than Mitt Romney's were).

As this is a putatively libertarian web site, this probably is the best place to note the passing of another member of the old money which ever so coincidentally seems to have influenced the last decades of American politics, even if the Mellons may not be as rich as other people on the Fiorbes family list - 'An heir to the Mellon banking, oil and aluminum fortunes, the Pittsburgh-based Scaife spent hundreds of millions of dollars of his estimated net worth of $1.4 billion to counteract what he called “the liberal slant to American society.”' http://www.washingtonpost.com/national/richard-mellon-scaife-billionaire-famous-for-attacks-against-bill-clinton-has-died/2014/07/04/9e2fcace-458c-11e3-bf0c-cebf37c6f484_story.html

Of course, it's the creation of the investment partnership (private equity, hedge funds, etc.) that has allowed the wealthy to pool their capital and seek higher returns, induced by the combination of so many heirs sharing the wealth and (as noted in my first comment) a depressed r. Unfortunately, they have sought a higher r through speculation. Economists have been studying the correlation between a depressed r, a depressed g, increased speculation, the financialization of the economy, increased inequality, and financial instability for many years. Not all economists care to observe the correlation.

On the lifespan of companies: How are mergers handled? Certainly, lots of successful upstarts in many industries get swallowed by large incumbents. Should this be considered the end of their lifespan? I'd like to see these before-after comparisons conditional on various minimum threshold sizes of book value of assets or something similar.

Poorly? Don't the majority of mergers and acquisitions end up being net losses?

It's interesting to read this post in conjunction with the recent post on the supposed 'wage premium' for public sector works. A way to read an increasing 'topple rate' is as an increase in opportunity in the private sector. A very long 'average lifespan' on the S&P 500 implies the best way to get to the top of a company is to work there a very long time. If corporate lifespans are getting shorter, the top positions open up more frequently which means that all positions have greater upside potential, which implies a lower wage rate may be an acceptable trade off.

In contrast the public sector does not have a dramatically different 'topple rate'. If 30 years ago there was a small town that had someone doing the tax collections, today that small town is probably still there with a person doing tax collections. There is sometimes mergers or downsizing that happens in the gov't sector, but not much. Cities and states grow or contract in population typically very slowly. They don't blink in and out of existence in a blink of an eye the way companies can. Hence the public sector 'wage premium' might be an illusion. Higher wages offset lower upside opportunity in one sector while the other sector offers higher upside opportunity in exchange for lower starting wages.

The firm age seems like a better metric than executive turnover, because executive compensation has risen so dramatically--they can earn their fortunes and retire much more quickly than ever before.

It's not clear to me that the graphs on asset returns says anything. For one thing, inflation has declined over that era, so some decrease in r could just be a lower premium on inflation risks. But more importantly, it's not clear to me that there actually is a decline in either graph. The top quartile shows only a tiny decrease--how robust is this? A few more years of data and the trend might even slope upwards. The bottom graph purports to show a huge decline in returns, but this looks like it's just due to a very strong bias caused by the tech bubble of the late 90s--again, it's quite possible that the trend will simply level out as more data comes in. Neither graph appears to contradict Piketty's thesis that r is constant, much less that r>g, especially when you consider that average growth rates actually have declined over that time frame.

Disruption, bah.

How many of these fads have to come and go before everyone starts to ignore them?

The source data is listed as Compustat, so these are presumably accounting returns of assets.I don't see in Hagel's description where he explains whether these are returns on assets at market value or at book value. Further, anyone who has done much work with the Compustat data set will know that the number of firms covered is not stable. A combination of smaller, newer firms having greater access to public capital markets and better data coverage by S&P causes the Compustat universe to shift dramatically in the direction of very small firms. Graphs like those shown in Figure 22 would be more meaningful if they were drawn only from the S&P 500. Even then, there may be shifts in the taste of the index selection committee at S&P to favor younger and faster growing firms to make their index "sexier".

Much more detail is needed to render these data interpretable. The story appears plausible, but no one should mistake this sort of thing for research.

Responding to specific arguments with general observations is a classic obfuscatory tactic. In her New Yorker piece, Lepore makes a series of logical and evidence based critiques of Christensen's case studies. In his response, Christensen largely ignores these details; he makes an array of points that support his theory, but fails to grapple with the opposition. Hagel does the same thing in his blog post. Because Lepore's victory in this exchange may be viewed as a triumph of traditional, long-form journalism, it provides support for her skeptical attitude towards disruptive innovation.

On second read, my first comment was unfair to Christensen and Hagel. They do engage with some of Lepore's specific criticisms, and since she indulges in an unhealthy amount of generalization, her critics can hardly be faulted for falling into the same trap. Still, I think the broader point is accurate.

For example, Lepore contends that K-Mart's failure, Seagate's profitable disk drive business, Bucyrus's enduring success, and TD Bank's lucrative refusal to embrace cutting edge financial instruments, undermine the theory of disruptive innovation. Maybe she is wrong, I don't know, but these are key parts of her argument. As far as I can tell, none of them are addressed by Christensen and Hagel. Both authors seem quite confident in their perspectives, so why the unwillingness to fight in the weeds?

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