Large Companies' Systematic Aversion to Failure

Fail fast and cheap.

It is a key to successful innovation in an uncertain world.  However, large companies have a consistent and strong aversion to ambiguity and the prospect of failure.

Why?

It can be tempting to make dispositional attributions regarding the people who comprise large companies.  "If we could just learn how to become more creative, our company could become more innovative and successful," goes this line of thought.  There is little doubt that becoming more creative, cultivating collaborative capacity, and being more open to Open Innovation can help.  Nevertheless, there is good reason to believe that large companies' aversion to failure is systematic and, thus, resistant to purely dispositional remediation.

What is an acceptable rate of failure?  10%?  90%?  Nassim Taleb provides the answer:

The frequency or probability of [a] loss, in and by itself, is totally irrelevant; it needs to be judged in connection with the magnitude of the outcome.

In other words, for a given magnitude of anticipated success, a high cost of failure means that you cannot fail very often.  Furthermore, the perceived cost of failure at a large company is inherently high:

• Critically, the opportunity cost of a large company is high.  Large companies, by definition, have more to lose than small companies.  For starters, established brands represent an accumulation of trust, and trust is easier to destroy than to build.
• Decision-making cycles are slow at large companies.  Consequently, the commitment of resources tends to occur in relatively large chunks.  Expenditures can mount before somebody can hit the kill switch.
• Hierarchy exacerbates the bias toward commitment escalation.  As a consequence, large companies are more likely to put good money after bad than are small companies.
• Individual benefits and losses may be asymmetric.  Individual decision-makers in a large company can typically assume that she'll have to share the credit for success, but may bear a disproportionate burden of a failure.  Risk aversion is an emotional response that is likely to increase the perceived cost of failure.

Given the high cost of failure, large companies' growth strategies tend to cluster around two scenarios:

• Very high revenue impact—In this scenario, the "size of prize" measured in incremental revenue is relatively large.  Because new, large businesses typically don't spring full-grown from the ground, this scenario typically manifests itself  as an acquisition.
• Low risk of failure—This approach take the form of incremental improvements to, and extensions of, existing products and brands.

Acquisitions are expensive and encourage the development (and subsequent destruction) of redundant manufacturing, marketing, and distribution capacities.  Brand extensions and incremental innovations can dilute brand equity and expose the company to disruptive innovation.  Nevertheless, these corporate behaviors are entirely and systematically consistent with a high cost of failure.

Systematic solutions must be part of large companies' innovation strategy.  Small companies are better suited to exploring the fitness landscape than large companies, because small companies have a lower cost of failure.  They are advantaged in their ability to fail fast and cheap.  On the other hand, small companies are challenged by success: scaling a consumer product company fast enough to hit the market window of opportunity is a daunting challenge.  Large companies have the advantage there.  A systematic approach to innovation mitigates large companies' disadvantages while leveraging its advantages.   The idea would be to incubate products in a small company environment and then facilitate the rapid, and relatively inexpensive, transplant of validated growth opportunities prior to the investment in redundant capacities.  That prescription may be obvious; the trick is in the design of collaborative protocols.