Seeking Alpha
Profile| Send Message| ()  
Barely a day had gone by since I wrote a post concerning Toyota's (TM) challenges as they substantially expand their sales volumes and global footprint when I picked up the Saturday/Sunday New York Times only to find that the cover story of the Sunday magazine section was titled "How Toyota Conquered the Car World."

Bottom line: as great as I think Toyota is as a car company and, more importantly, as one of the greatest companies on the planet, I think the story paints a picture of invincibility that is simply not true, and certainly not in light of what we've seen happen to companies such as Microsoft (MSFT), IBM (IBM), Xerox (XRX), Kodak (EK), or even GM (GM) for that matter.

No matter what a company does, as enlightened and forward-looking as it may be, the friction associated with growth and scale takes its toll on creativity, innovation and flexibility. It has to. And it always has. This is where they myopic human mind-set takes hold, structurally erasing from our memories the mountains of historical precedent and data in this area ("But you know, Toyota really IS different..." Yeah, right). I previously wrote a post on this phenomenon called Schumpeter and Search (a really excellent post IMHO that never got the uptake it warranted, probably due to the fact that it was written early in my blogging career and nobody knew of IA. Check it out - it's worth a read), chronicling my perspective on how the tenets of "creative destruction" have systematically toppled some of the greatest companies and brands of bygone eras.

So before we shower Toyota with too many hosannas, consider the following:

The good and bad of legacy. Good for instilling values, bad for rapidly reacting to a changing world. Think about a company like Tesla Motors. Sure, they're "nothing" today relative to a titan like Toyota, but Elon Musk and his team (remember SpaceX and their achievements?) had the ability to start with a clean sheet of paper and build something without the constraints of legacy ways of doing things, managerial hierarchies, etc. This is very emancipating and enables a level of innovation and out-of-the-box thinking that can't be rivaled by the most flexible and foward-looking of corporate behemoths. Think of Google (GOOG) relative to AOL (TWX) and Yahoo! (YHOO). Sure, Google was late on the scene in search. But oh, did they do some damage - and fast - once they arrived. It's nice starting fresh. A company like this could chip away at some of the most innovative aspects of Toyota's R&D programs.

Niche is nice. Toyota, like most corporate multi-nationals, has its attention and resources arrayed across a tremendous breadth of products and markets. Even in the best of cases and with fantastic coordination and communication this is a huge logistical burden that introduces massive friction into the equation. A new entrant that focuses on a narrow but high-value segment of the market, i.e., Tesla and sports cars, which has enormous brand value across an entire product line, can focus like a laser beam on this one initiative and really get it right. Especially when they are introducing a transforming technology which could materially change the way people think about energy consumption while preserving an exciting driving experience. Telsa doesn't need to think about how potential buyers in India will react. Toyota does. This is a luxury that can give a small, nimble company with tons of intellectual capital (think of Google seven years ago) a real jump in their niche of choice, creating a "chink in the armor" that can be more fully exploited after some early wins.

The overwhelming math of coordination. As the number of employees grows and the number of locations in which one is doing business expands, the simple problem of coordination and communication rises exponentially. While strength and consistency of culture can mitigate the effects of this mathematical burden, it simply cannot overwhelm the Law of Large Numbers. Too many nodes. Too many people needing to be on the same page. And this is just for executing well-conceived and detailed plans. This says nothing about continuing to spread and foster innovation. This is one of those areas where small companies have a structural advantage over large companies, and always will. How those small companies take advantage of this is where the magic lies, and in how they make the transition from small to large without losing their unique culture and mode of communication. Think about Google, Google Labs and their attitude towards letting employees take a material amount of their work time thinking, tinkering, dreaming and testing. This is one very powerful and important way in which they've sought to counterbalance the effects of rapid growth. And based upon people I know there, they seem to have done a pretty good job so far. But it is a never-ending challenge.

New paradigms for a new world. This really cuts across the previous points. Given legacy, a broad market focus and a large number of dispersed employees and operations, how does a company really create new models and paradigms, not simply extensions of existing products, methods and mores? Really, really hard. Unless you are a small, nimble company. My guess is that this was the rationale behind a company like Thermo-Electron, which would incubate businesses until they had the mass to stand on their own, at which point they would send them out to compete in the markets. While incubator models have had tremendous problems, Thermo did a pretty good job bridging the gap between idea and commercialization. In any event, the punch line is that if you've got a bunch of smart, highly motivated visionaries, unique ideas, laser focus and a few bucks, you can do something disruptive. It is just that this hasn't been done very often in the auto industry (the DeLorean doesn't count!). But given ventures like Tesla and the amount of money going into cleantech, I've got to think that some pretty innovative, forward-thinking players might well make a dent in the automotive landscape 10-20 years in the future. At least it's possible.

Here are some of the issues I raised in Schumpeter and Search back in August, which I think are directly relevant (and somewhat prescient) to this discussion:

And the beauty of Schumpeter's theory is that it both makes intuitive sense and requires one to ponder history for only a few seconds to come up with several examples that support his thesis, i.e., Xerox, Polaroid, Kodak and General Motors, to name a few. Why does creative destruction occur to companies that are seemingly leading-edge, have vast financial resources and market power and are poised to squash any competitor that stands in their way? Well, a few of the reasons that come to mind include:

1. Success breeds complacency, and by being so happy with yourself you lose the edge and intensity that got you where you are in the first place. This is bad for hard-driving, entrepreneurial people who want the edge and want to win. They lose touch with the company they once knew and the best people leave.

2. Big companies can be less fun than small companies, and the creative and entrepreneurial minds that developed the successful products and paradigms often don't have as much fun or function as well in large, developed bureaucracies. As with (1) above, the most entrepreneurial people will tire of being subjected to extra policies, procedures and processes that serve to inhibit creative thought and follow-through and will eventually leave the company.

3. The prospect of a big payoff is dampened by scale, as the meteoric rise in equity value naturally slows as it becomes harder to grow as fast across a larger base, new competitors enter and make the business less profitable and the equity incentive for employees loses its luster. Again, the best people will want to identify the next challenge and seek the rush and potential payoff of the new new thing.

And these three reasons only address part of the internal environment - how employees are effected when super successful companies get too big and successful. What about the external environment?

4. Arrogance often becomes a fixture of the super successful company, as they begin to believe that they can do no wrong and know what customers want without actually listening to them (I mean, how long were people really going to buy GM cars as long as they said "They'll buy what we build," which was a common refrain within the company during the 1950's and 1960's).

5. Squandered financial resources on either steps to diversify away from one's core competencies, or on irresponsible R&D projects that become "white elephants" and are not subjected to rigorous ROI analysis.

Funny how many times I mentioned GM in the August post. I guess they are simply one of the most high-profile and obvious examples of corporate domination gone badly awry, to the point where their long-term survival is now in question. Now Toyota is a far cry from GM - about as far a cry as one could get - but some of these issues go beyond culture and are a function of legacy, scale and breadth.

This is why I am convinced that while Toyota will solidify its position among the top auto companies for the foreseeable future, it is by no means assured that others may not emerge with lighter organizational structures, more flexible manufacturing environments, and dramatically different technologies and business models that cut into their formidable market share. Markets, as in life, are a marathon and not a sprint, and it is terribly risky to call the winner of a 26.2 mile race (which gets reset at the beginning of every new generation) when one is, say, at the 5 mile point. I am just saying maybe...

TM 1-yr chart:

toyota chart

Source: Toyota Still Hasn't Crossed the Finish Line