How Drucker Thought About Complexity
Throughout his life, Peter Drucker strived to understand the increasing complexity of business and society and, most importantly, the implications for how we can continue to create and deliver value in the face of complexity. I have long been influenced by Drucker's work. In the 1960s and 1970s, he was already anticipating some of the implications of the Big Shift just beginning to emerge: the transition to an information economy, the centrality of knowledge work, and the transformative impact of digital technology on all types of work.
Around that time, two forces coincided, each amplifying the disruptive capacity of the other. First, the deployment of the digital microprocessor and packet-switched networking marked the beginning of the rise of the digital infrastructure that would eventually span the globe, driven by exponential performance improvements in computing, storage, and bandwidth technologies. Digital technology unfolded on top of a second force that had been building for a few decades: a global movement in public policy towards economic liberalization which was systematically reducing barriers to the movement of goods, money, people, and ideas across the boundaries of nations and industries.
The combination of these two forces created enormous opportunities but also enormous challenges. They have systematically and significantly eroded barriers to entry and movement on a global scale. The result is relentlessly mounting performance pressure. Evidence of this pressure is starkly captured in the return on assets (ROA) for all public companies in the US since 1965. Over this period, there has been a sustained and dramatic erosion in performance: ROA has collapsed by 75 percent.
As the effects began to play out in the '70s and '80s, Drucker wrote extensively about the need for management practices to change. He knew that as the nature of work transformed and the pace of change increased, existing management practices, not to mention worker skill sets, would quickly become outdated and fail to meet the needs of the coming information economy. The widespread erosion of ROA confirms that our management practices and institutions are struggling to respond to the relentless pressure. Why haven't they responded more effectively?
The vast increase in the complexity of the economic and social landscape over these decades offers at least a partial explanation. There are many ways to think about complexity, but one key dimension is the degree of connection and interaction among participants. Thanks to the forces described above, we are more connected on a global scale than ever before. Not only are there more connections among more people, the speed of interactions has increased significantly, so that even small events in remote areas can propagate quickly, setting off cascades of events that evolve beyond anyone's expectations. Witness the grassroots political movements that are increasingly shaking up "stable" political regimes around the world. Power laws with spiky heads and very long tails progressively crowd out the familiar bell curves that made life seem predictable.
In this environment, we must re-examine the basic assumptions that drove our business success in the past, starting with the most basic question of all: why do we even come together in institutions such as firms? Almost 80 years ago, Ronald Coase won the Nobel Prize in Economics for an essaythat suggested that we do this for the sake of scalable efficiency — it costs less to coordinate activity within a firm than across independent entities. At the time, this was a remarkably accurate description of the rationale driving the emergence of large corporations around the world.
But times have changed. As the complexity of our environment increases, we need to step back and reassess this rationale. The cost and difficulty of coordinating activities across entities, on a global scale, is far lower now. The pace of change is accelerating and the degree of uncertainty increasing. Perhaps a new rationale will be required to drive institutional success in the future. Perhaps we need to move from a rationale of scalable efficiency to one of scalable learning — designing institutions and architectures of relationships across institutions that help all participants to learn faster as more participants join.
Drucker didn't quite frame it in these terms, but perhaps we need to expand our focus on innovation beyond the narrow frame of technology and product innovation. If we are to successfully adapt to the escalating complexity of our environment, we need to invest more time and energy in exploringinstitutional innovation. In his later writings, Drucker began to explore the periphery of this idea through several themes that are equally relevant to our current perspective:
- The importance of lifelong learning in a rapidly evolving information society
- The need to decentralize organizations around employees — viewing them as assets capable of expanding growth rather than as fixed costs to be eliminated — and to move away from standardized and tightly-specified process flows
- The need for institutions to focus on building capability around core strengths — one of the reasons he was an early proponent of outsourcing as a way to simplify operations and to focus management on what really matters
- The importance of focusing on the dynamics of evolving economic and social processes rather than on static equilibrium models.