Ever got full marks on an EW, felt confident and got a much lower mark in the next? You’re not alone. This struggle to maintain a success-streak can be seen on a corporate and even national scale. Of the companies that were in the Fortune 100 in 1996, 66 of them ceased to exist by 2006. Only 19 companies were still on the list 40 years later. This effect gets its name from the ancient Greek myth of Icarus who plummeted to his death after flying too close to the sun. The paradox lies in the fact that it was the breakdown of his very wings that allowed him to escape imprisonment that led to his demise.
An explanation for why businesses fail to maintain success may be that they stick to a unique formula that made them affluent in the first place. As a firm continues to capitalise on this strategy, the manager’s confidence in this formula grows. This confidence will mean the company will focus on refining the products that propelled their initial success and neglect other improvements. This may be lucrative in the short run as continued specialisation leads to higher levels of efficiency and sales growth. However, in the long run, this approach isn’t sustainable because firms won’t tackle the threats of new competition, changing consumer preferences or shifts in the macroeconomic environment. Without adapting to these prevailing market forces companies will fail to remain competitive and retain their market share.
A real-world example where corporate complacency has led to the downturn of a successful company is the decline of Hindustan Unilever (HUL) in the Indian laundry detergent market in the 1970s. HUL not only created the market for synthetic detergents in India but also popularised its use in rural villages. By 1985, Nirma, a brand fabricated from the backyard of a young chemist, outstripped HUL, accounting for 28% of sales revenue compared to HUL’s 23%. What caused HUL’s demise was its underestimation of the threat posed by Nirma. Nirma’s products were priced less than HUL’s by 14 rupees per kilogram. Consequently, low-income consumers in rural areas were more willing and able to pay for Nirma’s products and Nirma’s dominance in rural markets soon translated to dominance in the entire synthetic detergent industry. Seeing as HUL’s initial target market was middle-income-earners, the company failed to reduce the price of its products, hoping the source of their success would continue to reap benefits. Ultimately, HUL lost its market share to Nirma.
Not only do corporations as a whole fail to adapt but individual executives also play a part in many companies’ downturns. Humans have a proclivity to overestimate their own ability due to either an ignorance of their genuine capability or a chronic self-belief. This can be seen in a study conducted on letters to shareholders in annual earnings reports. The study found that executives are likely to attribute a positive outcome to their own actions, such as R&D schemes. Conversely, undesirable results were attributed to exogenous factors such as inflation or obscure weather aberrations. Therefore, executives may be making biased decisions when trying to maintain their company’s prosperity. They continue implementing their own initiatives, failing to see that their strategies are curbing their firm’s success and leading to their company’s downturn.
Anchoring can similarly be particularly harmful when firms pursue major capital projects after having capitalised during a prosperous period. Anchoring occurs when agents base their decisions on a reference point and adjust their choices relative to it. This concept is exemplified in a study of 258 infrastructure projects by the American Planning Association, which showed that actual costs of these projects were on average 28% greater than estimated costs. Furthermore, research by Rand Corporation found that half of the chemical-processing plants they surveyed produced less than 75% of their design capacity. The underestimation of resources needed for such projects may result in executives failing to assign sufficient contingency funds to account for possible delays and problems. If underfunding reduces the capacity of such infrastructure, return generated by these projects could be negative and cause companies’ profits to decline. The source of this bias stems from executives proposing plans that highlight the positives and ignores the downsides. This then encourages them to anchor their decision around the idea that the project should be undertaken.
From overconfidence to over-reliance on technology, understanding the limitations of our decision making outlined by the Icarus Paradox is integral for successful companies to remain successful. Failure should, therefore, be used as a tool to adjust policies to meet the ever-changing consumer preferences. The importance of mitigating the temptation to act complacently after a period of success has been identified by Bill Gates: “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” One for all of us to learn from.