1) A theory of the business outlines key assumptions about the environment, mission, and core competencies of an organization. 2) Examples are provided of IBM and GM, whose original theories became outdated as realities changed, leading to stagnation. 3) For a theory to be valid, its assumptions must fit reality, be consistent internally, and be understood throughout the organization. The theory also must be constantly tested and updated.

1. The Theory of the Business
By
Soms 2012

2. “Every organization, whether a business or
not, has a theory of the business. Indeed, a
valid theory that is clear, consistent, and
focused is extraordinarily powerful”.
- Peter Drucker

3. PROBLEM
• Big companies that have enjoyed long-term
success hit stagnation and find themselves in
unmanageable crisis despite having
experience, best brains, sound policies etc.
• Phenomenon is not restricted to businesses
alone but also happens in labour unions,
government agencies, hospitals, museums
and churches.

4. EXAMPLES

5. • According to Drucker this happens because the
assumptions on which the organization has been built
and being run no longer fit the reality .
• The assumptions that shape any organisation’s
behaviour, dictate its decisions about what to do and
what not to do, and define what the organisation
considers meaningful results.
• These assumptions are about markets, identifying
customers and competitors, their values and behaviour.
• Technology and its dynamics, about a company’s
strengths and weaknesses. These assumptions are
about what a company gets paid for.

6. Case 1 - IBM
• In 1950 IBM was designing SAGE air defense system for
early identification of enemy aircraft.
• Univac launched the prototype of first multipurpose
computer. All earlier designs were for single purpose
machines.
• IBM immediately put its best engineers to work on the
Univac architecture and designed manufactured the first
multipurpose computer.
• Three years later IBM became the world’s dominant
computer maker and standard bearer. It created not just a
computer but a whole computer industry.

7. • In 1970s IBM was confidently developing powerful
mainframe computer into which a huge number of users
could plug.
• Apple came up with the first Personal Computer; a grand
success.
• IBM accepted the new reality and developed a simpler PC.
• Two years later it became the largest PC manufacturer and
industry standard setter.
• But mainframe computers and PCs were competitors and
could not co-exist in the same corporate entity so IBM
faced problems in optimizing the production of both.

8. Case 2 - GM
• General Motors was once world’s largest and most
profitable manufacturing organization.
• Its assumptions were that US market was
homogeneous with stable income groups.
• Long runs of mass produced cars with minimum
changes each model year.
• Structure of semiautonomous divisions each
focusing on one income segment.
• Highest priced model of one division overlapped
with lowest priced model of the next.

9. • The theory worked for 70 years; GM never
suffered losses and steadily gained market share.
• But in late 1970s the market was fragmenting
into highly volatile ‘lifestyle’ segments and
income no longer remained the only factor of
buying decision.
• Also lean manufacturing created economics of
small scale and shorter runs and variations in
model became more profitable.

10. • GM tried to patch things over by maintaining
the existing divisions that now offered ‘a car
for every purse’, automated the long run mass
production system but neglected the real
growth market – light trucks and minivans.
• End result – confused set of customers,
dealers, employees and the management
itself.

11. A theory of the business has three parts:
• Assumptions about the environment of the
organization: society and its structure, the market, the
customer and technology.
(It define what it is paid for)
• Assumptions about the specific mission of the
organization.
(It define what it considers to be meaningful results)
• Assumptions about the core competencies needed to
accomplish the organization’s mission.
(It define where it must excel in order to maintain
leadership)

12. SPECIFICATIONS OF A VALID THEORY
OF THE BUSINESS
1. The assumption about environment, mission
and core competencies must fit reality.
(Marks and Spencer decided it was the merchant
not the manufacturer who knew the customer)
2. The assumptions in all three areas have to fit
one another.
(GM’s core competency-financial control of the
manufacturing process and a theory of capital
allocations)

13. 3. The theory of the business must be known
and understood throughout the organization
(successful organization tends to take its
theory for granted and it substitutes
discipline with culture)
4. The theory of the business has to be tested
constantly.
(Its a hypothesis and it must have the ability
to change itself)

14. PREVENTIVE CARE
• Systematic monitoring and testing of its
theory of the business
• Rethink a theory that is stagnating
• Take effective action in order to change
policies and practices
• Bring organization’s behaviour in line with
new realities of its environment , with its
new mission and with new core
competencies

15. 1. Systematic and purposeful abandonment – Every three
year an organization should challenge every product,
every service, every policy with the question, if we
were not in it would we be going into it now?
Without that it will lead to lack of resources especially
capable people needed to exploit the opportunities
when there is a change
2. Study what goes on outside the business especially
noncustomers with whom the first fundamental
change occurs
eg. U.S. department stores studied their customers
constantly but paid no attention to
70% of noncustomers

16. EARLY DIAGNOSIS
• Theory of business becomes obsolete when an
organization attains its original objectives
• Rapid growth is another sign of crisis.It
challenges assumptions, policies, and habits
• Two clear signals are unexpected success and
unexpected failure whether one’s own or a
competitor’s.
Ex: unexpected success of Chrysler by sales of
Jeep and minivans is unexpected failure of GM

17. CURE
• To establish maintain and restore a theory
requires not genius but hardwork
• It is not being clever but being conscientious
• It is what CEOs are paid for
• They start out with diagnosis and analysis
• They do not dismiss unexpected failure but
treat it as a symptom of ”systems failure”
• They do not take credit for unexpected
success but treat it as a challenge to their
assumptions

18. Thank you