Who knew Iceland was just a hedge fund with glaciers? – Thomas Friedman

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The victims of our financial services meltdown are everywhere, including Iceland. While many culprits have been fingered – greed, incompetence, lack of proper oversight – I believe there is one underlying cause that warrants further discussion: Too large to manage and too big to fail. Our remedy for organizations that have become oversized and often dysfunctional is to merge them into ever larger, more unmanageable and less accountable organizations where failure is more likely and catastrophic. The track record of large consolidated oligopolistic entities – airlines, automotive manufacturers, oil companies, Fannie Mae and Freddie Mac, the federal government, high schools – has not been sterling. Yet in spite of failure right and left, our actions, under what are admittedly trying circumstances, are to double-down on this losing hand.

As has been much discussed, when we prop up and even subsidize models that are consistently failing in the marketplace, we ensure not only survival of the un-fittest but we also punish the fit. Smaller, more effective providers will find it very tough short-term to compete against larger providers subsidized by the tax payers. As our leaders are faced with very difficult choices regarding whole industries like financial services and automotive and whole states and cities, it is worthwhile to consider breaking up or pruning large, unwieldy entities rather than automatically embracing a default position of making them larger. It didn’t work out too well for lumbering prehistoric dinosaurs and it unlikely to work for the present-day ones.

What is it about these large entities that leads to dysfunction and failure? While the answer is very complex, there are three fundamental limitations that in my opinion are at the core.

First, power corrupts. Consolidation of whole industries into a couple of complex behemoths in the short-term shifts the balance of power and the apparent advantage from the customer to the provider. However, what this shift empowers is the capability to dictate to the market. Over time powerful leaders devolve toward oppression, stimulating the desire for freedom on the part of those repressed, and eventually rebellion and ultimately overthrow. While we understand this response to oppressive governments, we are only beginning to understand it in oppressive business. Starbucks, once everyone’s darling, now takes on the appearance of the 800 pound gorilla that overcharges for caffeine. The conventional wisdom has been has been consolidate and control in order to gain scale, pricing power and relief from diverse competitors. We now see how that control can corrupt.

Second, consolidation works against mutation and diversity thus stifling innovation. When a plethora of providers consolidate into a handful of survivors, they often reflect the collective wisdom and best practices at a point in time. Accordingly, the ‘winners’ often look quite similar. Over time they benchmark themselves against each other, hire each other’s executives and conform to the same regulations – think automotive manufacturers in Detroit, marching pretty much in lock step. Before you know it you have a set of Stepford twins or triplets who are pretty much incapable of innovation and disruptive thinking. For example, the Mac can operate PC software and the PC apes the look feel of Mac. While standardization offers short-term advantage, innovation is stifled. Elimination of diverse competitor limits the natural selection and evolution that feeds breakthrough. As the world and markets change, the loss of innovation eventually can paralyze growth.

Third, consolidation renders relationships less productive. A Santa Fe-based think tank presents extensive research that smaller schools strengthen relationships between students, their classmates and teachers profoundly impacting achievement. The city of New York has documented similar correlation between small schools and better attendance and graduation rates. There is similar research that shows customer and employee relationships decline in response to mergers and excess size diminishing worker productivity and customer satisfaction as accountability, support, synergy, and innovation wane. Failed relationships ultimately lead to failed organizations.

The fall of the mighty around us is sobering. It causes us to re-evaluate what it means to be successful and secure. Once upon a time a large institution meant success, security, safety and longevity – for us, our money our jobs and our future. But by today’s standards, yesterday’s ‘large institutions’ would be considered small. Put simply, our ability to forge these mammoth institutions has outstripped our competence in managing and leading them.

Yet here we sit investing our diminished wealth in these ‘super-large’ institutions at a time when we have less belief than ever in their competence and competitiveness. A wise person once advised me that when I am in a hole, to stop digging. We are in a hole. How about we find a way to stop digging? Surely we can find ways to break up some of these monoliths rather than mindlessly continuing to kluge them together – and protect the victims along the way without re-committing to a failed future. Has our blindness become too large to manage, our fear too big to avoid failing?

(Column appeared originally in ABA Bank Marketing magazine – January-February 2009)

By ROBERT E. HALL

Not to be reproduced without written permission. All rights reserved. © Copyright Robert E. Hall 2009