Practice Productive Paranoia (Avoid the 5 Stages of Decline)

The first step in being built to last is don’t die. The only mistakes you can learn from are the ones you survive. Every company is vulnerable to decline. There’s no law of nature that the most successful companies will inevitably remain at the top. Any can fall and most eventually do. Entrepreneurs who build great companies differ from less successful comparisons in how they maintain hypervigilance in good times and bad. Leaders who navigate turbulence and stave off decline assume that conditions can unexpectedly change, violently and fast. They obsessively ask, “What if? What if? What if?” By preparing ahead of time, building reserves, preserving a margin of safety, bounding risk, and honing their discipline in good times and bad, they handle disruptions from a position of strength and flexibility. Productive paranoia helps inoculate organizations from falling into the 5 Stages of Decline that can stop the flywheel and destroy an organization. Those stages are (1) Hubris Born of Success, (2) Undisciplined Pursuit of More, (3) Denial of Risk and Peril, (4) Grasping for Salvation, and (5) Capitulation to Irrelevance or Death.

Researchers have identified a cluster of anomalies that corrupt this process and lead to suboptimal allocation decisions. Among the most pernicious …

• DEFEND WHAT’S YOURS. Leaders tend to be territorial about the resources they control and are typically reluctant to share money and talent with other units, even when the returns might be higher.

• THE RICH GET RICHER. The biggest units in a multibusiness company tend to get more than their fair share of capital, not because they offer better returns, but because the leaders of these businesses have more political clout.

• GOOD MONEY AFTER BAD. Executives tend to overinvest in struggling businesses in hopes of turning them around. Research shows that in most cases, returns would have been higher if the money had been invested in less troubled units.

• SHARE THE PAIN. When cash is short, executives tend to cut spending across the board rather than protect high-priority areas.

• IT’S WHO YOU KNOW. Senior leaders with strong internal networks typically win more resources than leaders who are less well connected, irrespective of the merits of the particular business case.

• HOME IS WHERE THE HEART IS. Senior executives are less likely to defund or divest a business in which they worked earlier in their career.

• PRETTY IT UP. In competing for funds, business unit leaders have an incentive to inflate the merits of their investment proposals. These distortions are often difficult for corporate-level executives to ferret out.

• MORE OF THE SAME. Funding decisions are often made relative to last year’s budget. Every business or product line gets pretty much what it got the year before, plus or minus a few percentage points.

I was also told that a brand-new CEO shouldn’t be trying to make huge acquisitions. I was “crazy,” as one of our investment bankers put it, because the numbers would never work out and this was an impossible “sale” to the street.

The banker had a point. It’s true that on paper the deal didn’t make obvious sense. But I felt certain that this level of ingenuity was worth more than any of us understood or could calculate at the time. It’s perhaps not the most responsible advice in a book like this to say that leaders should just go out there and trust their gut, because it might be interpreted as endorsing impulsivity over thoughtfulness, gambling rather than careful study. As with everything, the key is awareness, taking it all in and weighing every factor—your own motivations, what the people you trust are saying, what careful study and analysis tell you, and then what analysis can’t tell you. You carefully consider all of these factors, understanding that no two circumstances are alike, and then, if you’re in charge, it still ultimately comes down to instinct. Is this right or isn’t it? Nothing is a sure thing, but you need at the very least to be willing to take big risks. You can’t have big wins without them.

Disruptive technologies, Christensen had observed, often grew out of hobbyist communities. They were developed using “bootlegged resources” in which “off-the-shelf components” were redeployed for something other than their intended purpose. They started out wonky but rapidly improved along attributes of performance that established players ignored.

But even once you had absorbed this lesson, it wasn’t easy to implement. Pursuing niche markets cost profits, making investors question your sanity. This, too, Christensen had foretold: “One of the reasons managers at established firms find it difficult to serve emerging markets is that their investors and customers tell them not to.”

That was the real secret of The Innovator’s Dilemma, which readers often missed. It was not a book about how to succeed; it was a book about how not to fail. Christensen’s book wasn’t a how-to for start-ups but a counterinsurgency manual for senior managers at stagnating firms. Thirteen years in, Huang felt that Nvidia was at risk of becoming such a firm, and it was as much paranoia as optimism that led him to pursue the mad-science market.

Successful bidders for objects whose true value is unknown routinely turn out to have paid too much: they won because they were the most optimistic. When there are few publicly held shares in small companies whose success or failure is hard to predict, these shares are more likely to be held by people who overestimate their value than by people who underestimate it. Most such investments fail, but the losses might, though need not, be offset by occasional spectacular gains. The market value of a security is often a poor guide to the value likely to be created in the business over the long run.