Economist Joseph Schumpeter called waves of industry change “creative destruction.” He argued disruption of the current industry structures and companies built a nation’s wealth. Most economists agree, viewing creative destruction as a necessary ingredient for economic growth.
But Schumpeter was writing in 1942. Is creative destruction still a positive force in today’s world? Or are the benefits of creative destruction more nuanced and the costs far greater than Schumpeter argued?
As I reflect on this question, I observe three types of disruptions to markets: new-to-market capabilities, reshaping of the industry value chain, and consolidation. While all three create winners and losers, the net benefits to society differ.
New-to-market capabilities disruptions include examples like the steam engine, the telephone, the electric bulb, genetic profiling, and personal computers, creating industries that allow us to do things previously impossible. When an entrepreneur brings new-to-market capabilities to an industry, especially ones that solve costly problems or enable major increases in productivity, society wins alongside the innovator.
The second example – reshaping of an existing industry’s value chain – has occurred many times in recent years. Walmart and Amazon transformed retail. Google disrupted advertising. Uber and Lyft are more recent examples of value chain disruption. Consumers, in these cases, benefit through cheaper prices and convenient transport. But by replacing (versus adding to) an industry’s capabilities, dead bodies appear. Uber and Lyft hurt cab and town car business owners just as Walmart and Amazon hurt wholesalers, Main Street business owners, and the employees both treated as family members.
My observation is that when an innovation reshapes an existing industry, it often (but not always) gains its initial scale through some twist of the law, network effect, or another advantage. Uber bypassed regulatory costs and employer contributions to social security. Airbnb bypassed hotel taxes, at least for a while. Amazon did not pay local sales taxes for a long time. Walmart grew to dominate when its scale enabled it to import from China and squeeze manufacturers, increasingly dependent on Walmart’s order size. No other retailer could or (in Sears’ case) chose to do the same. Google dominated advertising, shifting dollars from print media, due to network effects.
Without these advantages, would these industry disruptors have gained the scale that enabled them to invest in yet other advantages? Because of the magnitude and speed of their disruption, my hypothesis is that entrepreneurs and investors gain a lot more value than the consumer, workers, or society at large. The situation is akin to an unfair monopoly – which economists cite as bad for society. Look at America’s wealthiest people (Walmart Waltons, Jeff Bezos, Google founders, etc.) to gain a sense of the wealth that industry value chain disruption creates for the disruptors.
The third and last category contains companies that consolidate industries by acquiring their competition. Health insurers like Aetna are acquiring competitors. Fisher Scientific consolidated the biotech tools and services industry, its most recent move the acquisition of $4B Life Technologies.
Where is the value in this kind of creative destruction? Under the guise of “lowering costs to benefit the customer,” consolidators are often using cash to buy revenue that holds up share prices. This action also increases the value of stock options C-Suite leaders and board members hold. Banking executives made fortunes this way, going from local to regional to national then global banks. Often, when you peek behind the curtain of these consolidated companies, you find that the best leaders of the acquired companies left the organization shortly before or after the acquisition. Innovation skills in the remaining team usually plummet. Does it matter? From society’s perspective, I’d argue it’s a bad thing as large companies have capabilities smaller ones lack, and great jobs are destroyed in the process at a time when we lack enough good jobs. This type of consolidation also contributes to the growing inequality in income, which economists argue curtails our long-term growth.
Schumpeter felt (as did Marx) that creative destruction would eventually undermine capitalism’s institutional frameworks, including people’s support for capitalism. As someone who loves capitalism, I fear some days that Schumpeter was prophetic.
It may not be desirable (and would be impractical) to try specifically to limit this type of economic turbulence. But if society is going to foster more true innovation and value creation, then we should take moves to encourage the development of more new-to-market capabilities and technological innovations over consolidations and abuse of laws. As to monopolies from network effects, we need a stronger FTC.
Do you agree with my assessment?