The Physics of Business
An interesting take on organizations and growth through the lens of physics
by Justin Jarvinen
The sun is finally shining after a week’s long mid-winter hiatus, so I thought I’d sit down and talk about something that’s interested me for some time: the physics of growth and disruption.
A “corporation” has become generically defined as an entity that produces the same thing over and over again, profitably (one hopes, anyway!). From Latin, the original definition of a corporation is corporare which means to ‘combine in one body’. Today’s legal definition is “a group of people authorized to act as a single entity and recognized as such in law”. Until we start seeing the first wave of fully autonomous AI-powered companies—or distributed autonomous organizations (DAO’s), which use the blockchain and smart contracts to eliminate centralized control—today’s corporations are a collection of humans with specific skillsets and rules that govern how they operate within a single system—an organization.
The bureaucratic state of an organizational system
In 1947, German sociologist Max Weber theorized that in bureaucracies—one of the 3 types of organizational leadership styles he identified (charismatic, hereditary, and bureaucratic)—"Everything runs with machine-like efficiency, and authority and control are exercised on the basis of knowledge.” He also believed that "institutionalized rules and regulations enabled all employees to learn to perform their duties optimally." However, in bureaucracies, the number of people required to do work will always increase by the amount of time available to fill it. This is known as Parkinson’s Law, a theory developed by C. Northcote Parkinson, a Royal Navy historian who observed that the number of people required to do the work would continually rise, whether the actual volume of work increased, decreased, or remained the same. He estimated that a 6% growth rate in any administrative body would eventually lead to a company’s death. This theory is most easily observed when looking at the extreme case of governments: "Since performance is not critical for survival, size is. Therefore, growth becomes an objective because it is an efficient way to secure survival”, according to John Pourdehnad, a renowned organizational theorist with a Ph.D. in Social Sciences from The University of Pennsylvania. Top-heavy management structures, or organizations—particularly startups—with an over reliance on cumbersome administrative functions levy a hefty tax on growth and can quickly lead to restructures or outright failure, according to Gary Hamel, one of the world’s most influential and iconoclastic business thinkers and author of Humanocracy, Creating Organizations As Amazing As The People Inside Them.
Organizational design has long been motivated by the achievement of stability, predictability, and linearity, three principles that run in direct conflict with the fundamental laws of physics which include dominating forces such as ambiguity and change. Examples abound of large companies—you could call them companies in a bureaucratic state—who die because they failed to understand how to manage change and uncertainty. Blockbuster and Kodak are two widely taught examples of this. In fact, since 1955, only 60 of the Fortune 500 listed companies are still on Fortune’s list, in large part, for these very same reasons. Without the unique and nearly limitless access to capital as provided to governments by its tax-contributors, corporations with growth as their primary motivation are predictably destined for bad days. In simple terms, growth tends to slow over time as markets become more mature. Companies in a bureaucratic state are often complacent, rigid, and even become outright resistant to change, as was the case with Kodak. In other words, they get trapped in their traditional and oftentimes over-engineered operational patterns.
Mass is the quantitative measure of inertia. As the mass of a company gets larger and enters the bureaucratic state, its operational inertia becomes greater thus forcing the company to embrace external means of accelerating growth—the force required to effect the desired growth outcome increases as the mass of the company grows and this is why the development of brand new markets and business models needs to play a prominent role in the design of a company’s growth strategy.
Physics as a metaphor for corporations
When you get into it, physics provides a useful metaphor for corporations. A brilliant and somewhat satirical submission to the American Journal of Physics by Dieter Schumacher, Ph.D., actually breaks an organization down into its elementary particles: he calls them Burons. I see an even more appropriate relationship existing between particles and intellectual capital, simply because intellectual capital is elemental to the functioning of a business, and is calculated in economic terms. Intellectual capital, as an output of human capital (along with information capital, and brand awareness) is reflected in the valuation of a corporation. It’s the expertise and knowledge, the ideas, trademarks, patents, and know-how that are unique to the organization. In either example, the organization’s ability to operate, and to cope with externalities, complexity, and change—to be adaptable—comes down to its people and processes: its culture. We can have fun equating people, talents, and mindsets to particles, just as Dieter did, but I’m more interested in the measurement of the ideas and the actions we take that result in the outcomes we seek. At Salt Flats, we’re interested in designing disruptive strategies (or what we call exponential outcomes) that become a force for positive change, whether that change is customer growth, profitability, or the discovery of an entirely new line of business. We call this Vector Transformation and that’s just one of the ways we use physics—its measurement.
Here are some interesting ways we apply our understanding of physics to our innovation practice.
What’s Your Vector?
MATHEMATICS•PHYSICS
A quantity having direction as well as magnitude, especially as determining the position of one point in space relative to another.
Your organization—the people and processes who make and market your products, or provide your services—is moving in a direction. The market measures this movement in terms of key performance indicators (KPIs) such as revenues, profits, growth rates, earnings, relative performance, same-store sales, and much more. Used in the mid-90’s by IBM and Apple, and since by scores of large companies seeking to accelerate growth, or to blunt external disruption, “Dual Path Transformation” enabled companies to evolve down two distinct paths:
Transformation A bolsters the legacy business by leaning into a company’s strongest competitive advantage and innovating around it.
Transformation B seeks brand new markets and business models. Done together, each with equal importance, the Dual-Path strategy “Strengthens today while building for tomorrow”.
Mentioned in the previous section, we apply a process we believe is more appropriate for disruptive innovation: we call it Vector Transformation. Salt Flats measures alignment with and potential value of every signal against a quantified motivation m. (i.e., increase earnings per share by 10%). Motivations are plotted alongside a current-state baseline (Vector 1) and enable us to measure a signal’s potential performance against that baseline. When developed, these innovation alpha signals affect Vector Transformation, a similar concept to Dual-Path with a key distinction being an improved view into the risks, costs, and other tradeoffs and variables that enable us to hit m and improve company performance on that measure. We’ve become recognized as a leader in Vector 2 where our outcomes are typically brand new business models that leverage a company’s strengths or knowledge to service the needs of brand new markets. And sometimes the winning signals are disruptive and need to be built entirely outside the organization!
In either case, vectors are an ideal way to measure the relative performance of a strategy against a baseline KPI.
Scientific method
MATHEMATICS•PHYSICS
A method of procedure that has characterized natural science since the 17th century, consisting in systematic observation, measurement, and experiment, and the formulation, testing, and modification of hypotheses.
Just like scientists, everything we do is rooted in experiments designed to validate (or invalidate) a hypothesis with empirical data. We generate signals which are ideas that have the potential to become solutions and answer the question: “What needs to be true” for this signal to achieve its associated m? Our objective is to validate or invalidate signals until we find a winner by building prototypes, engaging the marketplace, and applying data analytics.
In our innovation practice, we’ll typically generate dozens or even hundreds of signals, but our framework enables us to quickly progress the best ideas through win states using a rigid process of experimentation. The oscillatory middle of our framework represents the experiments and validations that eventually become an exponential outcome as illustrated in the image below.
Asking questions, challenging assumptions, and reframing so that unknowns become known are just some of the ways our innovation framework is similar to those used in the scientific community. We typically achieve this innovation enlightenment via the assembly of large, diverse groups of people —what we call Collective Intelligence—and challenge the group to discover far beyond the ability of any one individual contributor.
Diffusion
SOCIAL SCIENCES•PHYSICS
The diffusion of innovations theory describes the pattern and speed at which new ideas, practices, or products spread through a population. The main players in the theory are innovators, early adopters, early majority, late majority, and laggards.
In 1964, Everett Rogers, a professor of communication studies, popularized the Diffusion Theory of Innovations in his book Diffusion of Innovations. Rogers proposed that five main elements influence the spread of a new idea: the innovation itself, adopters, communication channels, time, and a social system. This process relies heavily on human capital and is aligned with my belief above that “intellectual capital—as an output of human capital—is elemental to the functioning of a business”.
When pursuing the implementation of an alpha signal, we need to develop an equally keen understanding of the market and how our solution will be communicated so that we can model our expected rate of diffusion (or, in startup terms, traction). Most early-stage growth strategies are designed using a formula based on this theory which you can see reflected in the image below.
As a startup achieves momentum and moves beyond early adopters and into the early and late majority portion of the market, it starts to become a measurable force that’s now recognized by a large incumbent. This is the stage where most acquisitions happen because their size and rate of growth can positively impact the larger organization. “Grow fast or die” is a mantra held by many successful startup founders and it leans into the notion that speed is your advantage and success is predicated on working your way through the early stages of diffusion before someone else does. Second mover advantage applies here but we’ll talk about that in another post.
By applying physics, you gain a clearer view of the future.
By applying physics, you gain a clearer view of the future.
Innovation is extremely difficult. However, understanding physics—even if only conceptually or metaphorically—gives corporate leaders, particularly the ones in strategy and innovation, a fresh understanding of how natural internal and external forces are at play. Physics helps separate foundational from superfluous and can quickly lead to more efficient processes and improved decision-making.
The world we live in and the market we occupy grows more complex by the day. And yet, understanding physics allows us to see clearly: everything has its relationship to everything else and the outcome of new ideas and decisions can be far more predictable once you look at those ideas through the lens of physics.
In my next post, I’ll introduce you to Arc Of Innovation™, our proprietary innovation framework, and how we use Game Theory to take predictability to an entirely new level.
