The Icarus paradox is a neologism coined by Danny Miller in his 1990 book by the same name. The term refers to the phenomenon of businesses failing abruptly after a period of apparent success, where this failure is brought about by the very elements that led to their initial success. It alludes to Icarus of Greek mythology, who drowned after flying too close to the Sun. The failure of the very wings that allowed him to escape imprisonment and soar through the skies was what ultimately led to his demise, hence the paradox.
Overview In many industries, extremely successful businesses often face problems maintaining their success. Of the companies in the 1966 Fortune 100, 66 no longer existed by 2006, 15 still existed but were no longer on the list, and only 19 remained on the list.
In a 1992 article, Miller noted that successful companies tend to fail precisely because of their strengths and past victories, which engendered over-confidence and lulled them into complacency. The characteristics that drove their success such as tried-and-true business strategies, dauntless and self-assured management, signature products and the reciprocal action and overall combination of all these elements when employed in excess may ultimately lead to declining sales and profits and even bankruptcy. This happens as managers make unwise decisions based on past strategies that they mistakenly believe will always be relevant and companies exploit as much as possible the strategies that contributed to their success, centralise their focus on the products that launched their brand and become blinded to changes in the external business environment.
Reasons for failure According to Miller, success seduces companies into failure through fostering overconfidence, complacency, specialisation, exaggeration, dogma and ritual.
Most successful firms owe their fortune to a unique competitive formula. As the company continues to grow, the manager's confidence in this winning formula is bolstered. Eventually, the firm ends up focusing only on refining and extending the strategies, products and values that propelled their success. Any other activities are neglected or even discouraged. This may be profitable in the short run as companies continue to specialise and improve in a certain product or strategy, leading to higher efficiency, sales and growth as they cultivate their competitive advantage in that particular area. In the long run, however, this attitude is unsustainable.
They become unable to keep up with the threats of new competitors, changing consumer demands, newly developed business models and changes in the external environment.
Some examples are Laura Ashley, Atari, Digital Equipment, Tupperware and Revlon.
Overconfidence and complacency Failures in business projects happen all too often. Firms tend to invest too much and too long in activities that are elementally inoperative in its design or concept. Some examples are Merrill Lynch, RBS, AIG, Citibank, Lehman Brothers and Fresh & Easy. Most large capital investment projects come in late and over budget, never living up to expectations. Over 70% of new manufacturing plants in North America, for example, close within the first decade of operations. Around 75% of mergers and acquisitions do not pay off – the acquiring firm's shareholders lose more than the acquired firm's shareholders gain. The vast majority of efforts to break into new markets are abandoned within a few years.
Standard economic theory explains the high rate of failures as an inevitable result of companies taking rational risks in the face of uncertain situations. The rewards of a few successes outweigh losses incurred from many failures in the long run. Executives know this and accept the risk. This theory absolves them from blame – they were simply making rational risks after all.
Lovallo and Kahneman argue, however, that most of these failures are actually the results of flawed decision making. When predicting the outcomes of risky projects, executives easily fall victim to what psychologists call the planning fallacy. They make decisions based on delusional optimism instead of on rational weighing of gains, losses and probabilities. They spin scenarios of success while overlooking potential problems. Consequently, they pursue initiatives that are unlikely to succeed. Research into human cognition has traced this over-optimism to many sources.
Natural tendency Humans have a native tendency to exaggerate their own talents, so many executives believe they are above average in their endowment of positive traits and abilities. This is amplified by the tendency to misperceive causes of certain events.
People tend to take credit for positive outcomes and attribute negative outcomes to external factors. A study of letters to shareholders in annual reports, for example, found that executives tend to attribute favourable outcomes to factors under their control, like corporate strategy or R&D programmes. Unfavourable outcomes were more likely to be attributed to uncontrollable external factors like the weather or inflation. People also tend to exaggerate the control we have over events, discounting the role of luck.
The illusion of control
Managers explicitly deny the role of chance in affecting the outcome of their plans. They see risk as a challenge to be met by their skills, and believe that results are determined purely by actions they and their organisation have taken. In making forecasts, they therefore tend to ignore or downplay the possibility of random, uncontrollable occurrences that may impede their progress towards a goal.
Anchoring In making forecasts about a project, executives and their subordinates typically have a preliminary plan drawn up by whoever proposed the initiative, which is then adjusted based on market research, financial analysis or their own professional judgement, before deciding how to proceed.
This process has some serious pitfalls, however. The initial plan tends to accentuate the positive because as a proposal, it was designed to make the case for the project as compelling as possible, thus skewing the subsequent analysis towards over-optimism.
Anchoring can be especially pernicious when it comes to forecasting the costs of major capital projects. Executives often fail to build in enough contingency funds to cover overruns because they are anchored to their original cost estimates and do not sufficiently adjust them to account for possible delays, problems and expansions of project scope.
A study by Rand Corporation found that the construction costs of 44 chemical-processing plants owned by major companies such as 3M, DuPont and Texaco are, on average, more than double the initial estimates. Furthermore, about half produced less than 75% of their design capacity and a quarter produced less than 50%. Most plants had their performance expectations permanently lowered and the owners never realised a return on their investments.
Competitor neglect In making forecasts, executives tend to focus on their own company's capabilities and plans and are thus prone to neglect the potential abilities and actions of rivals. Again, this results in underestimation of negative events such as price wars, overcapacity etc.
This is particularly destructive in ventures to enter new markets. When a company identifies a rapidly growing market well suited to its products and capabilities, it often rushes to gain a beachhead in it, investing heavily in production capacity and marketing. However, attractive pro forma forecasts of financial results that motivate this expansion rarely account for other competitors also targeting the same market. As all these companies invest at the same time, supply outstrips demand and the new market quickly becomes unprofitable.
Organisational pressure Each firm has a limited amount of time and capital to be invested into new projects. There is intense competition for this time and money as individuals and units jockey to present their own proposals as being the most potentially lucrative. There are thus large incentives for these individuals and units to accentuate the positives in predicting outcomes. As a result, it ensures that forecasts used in planning are overoptimistic (which later distorts all further analysis). Also, it increases the odds that the projects chosen for investment are the ones with the most over-optimistic forecasts, and hence the highest probability of disappointment.
Other organisational practices also encourage over-optimism. For example, senior executives tend to stress the importance of stretch goals for their business units. This may increase motivation, but it also leads to unit managers further skewing their forecasts towards improbably rosy outcomes. Additionally, organisations may discourage pessimism, which is perceived as disloyalty. Other employees shun the bearer of bad news. Suppressing pessimistic opinions while rewarding optimistic ones will cripple an organisation's ability to think critically and analyse objectively.
Dogma, ritual and specialisation There are perils associated with following a certain system, even a winning one, for too long. Clear commitments are required for initial success, but these commitments harden with time and ultimately constrain a firm's ability to adapt when its competitive environment shifts. As the market environment evolves, the fresh competitive formula that led to a firm's initial success instead becomes a rigid set of rules that dictate and confine their strategies. This dynamic can lead good firms to go bad, even when executives avoid arrogance and complacency.
To win in the market, executives must make a set of commitments that together constitute the organisation's success formula. A distinctive success formula focuses employees, confers efficiency, attracts resources, and differentiates the company from rivals. Five categories of commitments comprise the success formula:
Strategic frames: What we see when we look at the world, including definition of industry, relevant competitors and how to create value. Processes: How we do things around here entailing both informal and formal routines. Resources: Tangible and intangible assets that we control which help us compete, such as brand, technology, real estate, expertise, etc. Relationships: Established links with external stakeholders including investors, technology partners or distributors Values: Beliefs that inspire, unify and identify us.
Although commitments are essential for initial success, they tend to harden over time. Initial success reinforces management's belief that they should fortify their success formula. With time and repetition, people stop considering alternatives to their commitments, and take them for granted. When the environment shifts, a gap can grow between what the market demands and what the firm does. Managers see the gap, often at an early stage, and respond aggressively to close it. But their hardened commitments channel their responses into well-worn ruts. The harder they work, the wider the gap becomes. The result is active inertia.
According to Sull's paper in 1999, active inertia – an organisation's tendency to follow established behavioural patterns – encompasses and details the ways success can eventually breed failure.
Frames become blinders Strategic frames are the mind-sets that help managers evaluate how and what the business is doing, judge the market they are operating in, determine the importance of each segment of customers and decide on how to best increase the value of their firms.