Future growth through Creative Destruction

Companies that once revolutionized and dominated new industries – for example, Xerox in copiers or Polaroid in instant photography or KODAK in films have seen their profits fall and their dominance vanish as rivals launched improved designs or cut manufacturing costs (lowering their own costs allows them to charge lower prices to customers, thereby drawing customers away from less efficient competitors who eventually close their doors or move into other products where they are able to find a cost advantage).

Wal-Mart is a recent example of a company that has achieved a strong position in many markets, through its use of new inventory-management, marketing, and personnel-management techniques, using its resulting lower prices to eliminate the profitability of older or smaller companies. Just as older behemoths perceived to be juggernauts by their contemporaries (e.g., Montgomery Ward, Kmart, Sears in the U.S.) were eventually undone by nimbler and more innovative competitors, Wal-Mart faces the same threat. Just as the cassette tape replaced the 8-track, only to be replaced in turn by the compact disc (which is now being undercut by MP3 players), the seemingly dominant Wal-Mart may well find itself an antiquated company of the past. This is the process of creative destruction.

In fact, successful innovation is normally a source of temporary market power, eroding the profits and position of old firms, yet ultimately succumbing to the pressure of new inventions commercialised by competing entrants. Creative destruction is a powerful economic concept because it can explain many of the dynamics of industrial change: the transition from a competitive to a monopolistic market, and back again. It has been the inspiration of endogenous growth theory and also of evolutionary economics.

Creative destruction can hurt. Layoffs of workers with obsolete working skills can be one price of new innovations valued by consumers. Though a continually innovating economy generates new opportunities for workers to participate in more creative and productive enterprises (provided they can acquire the necessary skills), creative destruction can cause severe hardship in the short term.

There are numerous types of innovation-generating creative destruction in an industry:

• New markets or products
• New equipment
• New sources of labor and raw materials
• New methods of organization or management
• New methods of inventory management
• New methods of transportation
• New methods of communication (e.g., the Internet)
• New methods of advertising and marketing
• New financial instruments
• New ways to lobby politicians or new legal strategies (though many economists would argue that this last is not a genuine example of creative destruction, so much as an example of using force of government to prevent more innovative or lower cost competitors from selling to one’s customers)