The Natural Laws of Business:
How to Harness the Power of Evolution, Physics
and Economics to Achieve Business Success

Author: Richard Koch
Publisher: Doubleday, 2000

Comments:

This is a fascinating book for people who, like me, dropped science after high school and forgot everything about it since. It also provides dividends to business people who can learn from and apply the cross-over of principles.

Synopsis:

A. Darwin’s “On the Origin of Species”

Scientific context

    • Creatures systematically over-produce their young
    • All creatures vary
    • That variation is inherited

Success means fitting the “conditions of life“. If a species is diverse, it can prosper; if it is homogeneous, it is vulnerable. There is no implicit evolution leading naturally to improvements. In nature, “better” means “more likely to survive and multiply”, not be “superior”. Failure is the norm.

Lamarck said that species evolve to survive; Darwin says that species evolve naturally, and the environment decides whether they survive. Ergo, species cannot control their own destiny. If a species (or business) is failing, there are only two solutions: change the environment or change the species (or business).

Business context

A business seeking to own a new market should create a new market segment based upon greater specialization and then own it. Take one market and make it two. It matters not whether the new sub-market is up-market or down-market: the point is it’s different. Address this by identifying a homogeneous sub-market which has different characteristics/needs to the pre-existing market. Then, decide how you can adopt the product offering to have more appeal to this new sub-market. Ideally, this is achieved with no cost increase to deliver the extra value-added. It is even possible to achieve a lower cost structure by eliminating product characteristics which hold no value to the new market segment. Be the first into the new market and set the standards to dominate the category.

Product ideas are more likely to survive and reproduce if they have struggled for life. A successful strategy is to produce a lot of products (offspring) and let the market decide which should survive.

Winners promulgate their success by having a lot of sex: reproducing frequently. Business needs to do the same. New product variants will arrive sooner of later, whether you produce them or someone else does. Scatter new breeds (products) around your core product, to create some insulation from competitors finding inroads. Take your product to other geographic areas. Accelerate product and service improvements. Evolve your products or someone else will do it for you.

It is perhaps counter-intuitive that the successful need to try harder than the unsuccessful, who presumably appear to have more incentive to change in order to simply stay alive. Hoping that the environment will change is the pre-dominant strategy of failing businesses. The right answer is to find a different environment or change the character radically. More likely, you will need to do both, because your existing product or service is unlikely to be an automatic perfect fit with some new market. Changing the environment means different customers, different location, different products or services, different competitors. Changing the character means new skills, new employees, new management, new suppliers and partners.

Failure is the norm: expect it and accept it as an intrinsic part of the process.

B. Fisher’s Fundamental Theorem of Natural Selection

Scientific context

The larger the variance in attributes of a population, the faster the average growth rate of the population. Small variations cause big changes. The species that improves its fit with the environment faster will expand more quickly.

Business context

Above-average improvement in delivering value will be rewarded with above-average growth. This applies both to an industry as a whole and to the individual firms in it.

The Boston Consulting Group identified the experience curve, which said that there is a regular relationship between unit cost and the number of units produced. This suggests that, in the short run, it may be wise to gain market share, even at some cost, as it buys you access to “more experience”, ie more units produced, which will gain you advantage along the experience curve in the long run. This is particularly valuable in new, high-growth markets.

C. Ulam’s Dilemma

Scientific context

This said that no one inside or outside the mathematical profession was qualified to decide which new theorems should survive and which should not. There is therefore no a prioiri assurance of survival of the fittest, and that whatever has survived has proved itself the fittest, post factum. In plainer summary, theories don’t win on their objective merits, but on the results of blind competition.

Business context

Don’t buck the market, even if you think you are right. If the market feedback on your product or service is negative, get rid of it. Accept the market’s verdict.

D. Mendel’s Laws

Scientific context

The law of segregation states that inherited traits are passed on directly and equally by each partner. Rather than blending, traits remain separate… dominant and recessive (to successive generations). The law of independent assortment states that pure chance determines which partner’s traits appear.

E. Gause’s Principle of Survival by Differentiation

Scientific context

Two similar but different species can coexist. Two of the same species will compete until one or both dies. Two competing species can only co-exist if there is more than one scarce resource to compete for.

Business context

You need to be at least slightly different than your competitors, and/or you need not to be competing head-on for the same scarce resource, eg same market segment. Bi-stability means that two competitors can each survive if they are differentiated, or there is more than one scarce resource. For instance, if the market only values one product characteristic, eg price or quality, then you end up either in a never-ending price war environment or you take turns leap-frogging each other’s quality enhancements. A market characterized by co-existence is likely in a stale-mate, where gaining market share will not achieve much financial success. You need to adapt by creating a bi-stable market.

F. Evolutionary biologists and Punctuated equilibrium

Scientific context

Evolution proceeds by long periods of relative quiescence followed by short periods of rapid change. Humans are still hard-wired with the same circuits as our cave forebearers. Seven thousand years is not enough to evolve traits which match our present world. Hunter-gatherers tended to take risks only when their world was falling apart. There is a genetic bias away from risk and to respect for the possessions of incumbents.

The endowment effect suggests that people value more that which they received first.

Drawing from our predecessors, there is a natural capacity for a group to function cohesively, and it is suggested that number is approximately 150 people- the size of a hunter-gatherer clan.

Business context

Larger corporations should divide themselves into workgroups that approximate 150 people.

The first mover advantage gives the first firm into a market a significant defence to challengers. Perceived ownership is what counts. In the face of a threat, management should convince its employees that the firm owns that market, whether this is true or not.

Do not take ongoing risk when things are going badly. Cut your losses and move on.

When taking risks, frame the situation as a mini-emergency. When risk taking is important, form a separate unit to undertake that risk. Make that environment non-threatening and informal.

G. Lewis Carroll’s Red Queen Effect, aka Evolutionary Arms Race

Scientific context

In Through the Looking Glass, the Red Queen has to run as fast as she can, just to stay in place. In evolution, there is constant escalation and improvement in the arms race between predators and prey, but no change in relative position. The fittest prey survive and pass on their superior genetics to the next generation, but so do the fittest predators, so the prey don’t gain advantage.

Business context

Most business plans budget for sales growth. Unless this is a new, high-growth industry, much of that sales growth must come at the expense of competitors, ie actually growth in market share. But if all of the competitors’ plans and strategies are the same, the Red Queen Effect is being ignored.

H. Specialization

Scientific context

Biological research has revealed that the bigger the cells in an organism, the more likely they are to divide the labour. This is also true for societies, e.g. ant colonies.

Business context

Adam Smith’s Wealth of Nations trumpeted the economic advantages of the division of labour. Specialization permitted more “experience” with a task, thus leading to greater skill. It also avoided the downtime in switching between tasks. He suggested that the division of labour is constrained by the size of the market, and also, by transportation and communications.

Ricardo’s Law of Competitive Advantage says that, even when one party is superior at producing both of two products than a competitor, both parties are better off to let the superior one focus on producing the product with which it has the greater relative advantage, and allow the inferior party to produce the other product, with both parties then trading products to satisfy their needs. This is the economic basis for international trade.

I. Newton’s Laws of Motion and Gravitation

Scientific context

Law l – every body continues in a state of rest or of uniform motion in a straight line, unless it is compelled to change that state by a force placed upon it
Law 2 – the change in motion is proportional and directional of the motive force impressed
Law 3 – to every action, there is an equal and opposite reaction

If equal objects collide, they bounce off each other with equal force.

If an object’s motion is disturbed, then there is an equal and opposite disturbance on the other object.

Gravitational force between two bodies is proportional to the product of their masses and inversely proportional to the square of the distance between them. Thus, the closer you are to a large object, the stronger is the gravitational pull.

Business context

The third law is particularly insightful, eg think of political thought: capitalism and communism. In business, the market eventually will respond to a mass-product environment with a call for tailored products, or vice versa.

Competition in business is equivalent to gravity in nature. Just as gravity depresses objects and stops stars from moving in a straight line, competition depresses profits and returns on capital, the extent of which is proportional to the distance and mass of the competitor(s). Mass refers to the power, or size of resources, that a competitor can bring to bear in your market-place. This includes financial strength, management skill, branding, distribution, related-party relationships, etc. Distance refers to the extent to which the competitor is close to your own market-place, including product features, geographic territory, customer niche, market strategy, etc.

A small but proximate competitor may be more dangerous than a larger but distant one.

If you seek strategically to move away from a competitor, you better be sure that you aren’t just moving closer to another one.
Many improvements will not improve your relative position in the long run, they merely will be copied by competitors, and it is the consumer that benefits. Something that provides a competitive lead does not provide long term advantage. A lead is something that connects two competitors. To gain a lead (temporarily), you do things better. It is wiser to pursue a strategy that draws you away from the gravitational force.

J. Einstein’s Special and General Theories of Relativity

Scientific context

The general theory is that acceleration is precisely the same as gravity. Gravitation is the warping of space and time by physical mass. Thus, time is not independent of space.

The special theories show how atomic and subatomic particles work. Nothing can travel faster than the speed of light and light’s speed does not change with the velocity of the observer. Therefore, time and space are not fixed, absolute quantities, but relative. Space, time, energy and mass are all inter-linked.

Business context

Business must change its mental map of time. In reality, there is no shortage of time; we are awash in it. Very little of what a firm does adds a great deal of value to its customers. Most of the value comes in short bursts, surrounded by deserts of low-value process. Less than 10% of time devoted to any work is truly value-added. The rest is wasted. The high value work takes a small amount of time, and the remainder of time is filled up with low value contribution or delays. Thus, finding time is not the hopeless challenge, but reallocating time to higher value acts is the answer.

Time is the key dimension to achieve success and deliver top value to customers. Measure the time it takes to do things for customers, identifying the processes along the delivery path. Identify procedural and other delays which can be eliminated. Measure the time value that you deliver to customers. Find out how to increase that. Measure customer retention and track it over time, seeking higher values.

Your perspective of what clients want will, by definition, not match what they really want. It will be wrong in proportion to the distance of senior execs from the front line. The answer is to constantly seek your customers’ opinions of what they want and how you and your competitors are doing at delivering that.

K. Quantum Mechanics

Scientific context

Electrons excited by a bombardment of energy may leap instantly from one orbit to another without physically travelling the distance between the two points. When at atom decides to do so, it decides entirely at random. A quantum leap is the smallest change that can be made and it happens unpredictably.

Heisenberg’s Uncertainty Principle states that it is not possible to calculate both the position and momentum of a subatomic particle.

Business context

You can’t predict the outcome of committing a firm resource (a bombardment of energy). There is always a multiplicity of alternatives. Be sure to identify and explore them. Create options. Explore each. Test. Assess.

L. Pareto’s Law: the 80/20 Rule

Scientific context

Pareto studied the distribution of wealth and income across the population and found that a small minority (20%) earned, and owned, the majority (80%). This relationship held across different periods of time and in different geographies.

Business Context

The most popular 20% of your product line may contribute 80% of sales. Those other 80% may be costing you money. The best way to start making money is to stop losing money. Focus on the “vital few” causes, not the “trivial may”. This may require a costing analysis that you presently don’t have, but would profit greatly from developing. Analyze margin by both product and by customer, and attempt to factor in and allocate fixed expenses in these analyses.

This extends to the use of management time. ROME is Return on Management Employed and is a measure equally important to return on capital.

M. Trichotomy Law

Scientific context

Every real number is either positive, negative or zero.

Business context

We focus on the value created and ignore the value subtracted. Every activity, unit or employee that adds value probably subtracts value as well. Executives who provide great contributions, also have negative qualities that require damage control or other limitations. Thus, garnering positive contributions from staff should be viewed equally valuable as removing their negative contributions.

N. Plague Theory

Scientific context

The progress of any disease can be charted fairly predictably by calculating the proportion of the relevant population that has been infected at a few different points in time and then extrapolating. What typically happens is that the proportion infected will grow rapidly and at an accelerating rate, then reach a point of inflection and slow down, and then decelerate, producing an S-curve. If action can be taken to keep the disease below a certain critical level, then it never attains rapid acceleration, and the growth is stunted. The point of rapid acceleration is referred to as the “tipping point“.

Business context

Technological advancements experience this phenomenon, determining whether they whither and die or become successful. What’s important to realize is that committing effort and resources is never directly proportional to results. In the early stages of developing or challenging a market, a terrific amount of resources may be invested with little payoff. But if you can hold on to the tipping point, it will be all downhill thereafter.

Of course, identifying the tipping point is problematic.

There is a lesson here if you are trying to pioneer a brand new market. It is always cheaper to latch on to trends that are already developed by someone else than do the missionary work yourself. You can be tricked and trapped by the success given you by early adaptors of your new product. There will always be a fringe that adapts any particular new thing, but it is another matter whether the market will cross the chasm to mass acceptance. The new idea must be camouflaged as less innovative and be supported by mainstream marketing to have a chance of gaining broad acceptance.

O. The Laws of Thermodynamics and Entropy

Scientific context

The First Law of Thermodynamics states that energy can neither be created nor destroyed: it only can change form. The Second Law of Thermodynamics states that any chemical system will tend toward maximum disorder. Entropy refers to the tendency of things to run down and wear out.

Business context

The natural condition is not equilibrium but entropy. Too much success can make a business arrogant, greedy or lazy. To maintain success requires constant effort.

P. Dorner’s Logic of Failure

Scientific context

People and institutions who proceed with intelligence and care still arrive at disastrous results because they think too linearly in a narrow cause-and-effect analysis. They miss the larger picture of systems implications.

Business context

Pursue several strategies simultaneously. Don’t place all your resources in one grand idea. Create hypotheses and test them. Think in a big picture systems context. Allow and encourage dissenting opinions. Be more circumspect in ascribing causal relationships.

In conclusion, successful businesses exhibit three common traits:

  • They are different from other businesses
  • They make better use of ideas and resources
  • They continually improve, using testing and multiple strategies to secure the first two