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Inc.: Is there any one key to that discipline?
Drucker: Innovation requires us to systematically identify changes that have already occurred in a business -- in demographics, in values, in technology or science -- and then to look at them as opportunities. It also requires something that is most difficult for existing companies to do: to abandon rather than defend yesterday.
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The Four Entrepreneurial Pitfalls
Inc.: So many new businesses start out with high promise. They do extremely well the first year or two and then suddenly are up to their ears in trouble. If they survive at all, they are forever stunted. Are there typical mistakes entrepreneurs make but could avoid?
Drucker: There are actually four points -- I call them entrepreneurial pitfalls -- where the new and growing business typically gets into trouble. All four are foreseeable and avoidable.
The first comes when the entrepreneur has to face the fact that the new product or service is not successful where he or she thought it would be but is successful in a totally different market. Many businesses disappear because the founder-entrepreneur insists that he or she knows better than the market.
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Inc.: So, often the entrepreneur is actually succeeding but doesn't realize it?
Drucker: No, it's worse than that. He or she rejects success. You want examples? There are thousands of them, but one of the best is over 100 years old.
A man by the name of John Wesley Hyatt had invented the roller bearing. He made up his mind that it was just right for the axles of railroad freight cars. Railroads traditionally stuffed the wheels of their cars with rags soaked in oil to handle the friction. The railroads, however, were not ready for radical change; they liked their rags. And Mr. Hyatt went bankrupt trying to persuade them otherwise.
When Alfred Sloan, the man who later built GM, graduated from MIT at the head of his class in the mid-1890s, he asked his father to buy him Hyatt's small bankrupt business. Unlike Hyatt, Sloan was willing to broaden his vision of the product. It turned out that the roller bearing was ideal for the automobile, which was just coming to market. In two years Sloan had a flourishing business; for 20 years Henry Ford was his biggest customer.
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Inc.: Good story, but is the rejection of success really all that common?
Drucker: I'd say that the majority of successful new inventions or products don't succeed in the market for which they were originally designed. I've seen it again and again. Novocaine was invented in 1905 by German chemist Alfred Einhorn for use in major surgery, but it wasn't suitable. Dentists immediately wanted the product, but the inventor actually tried to stop them from using it for the "mundane purpose" of drilling teeth. To the end of his days, Einhorn traveled all over the world preaching the merits of novocaine as a general anesthetic.
More recently, I know of a company whose founder created a software program that he was absolutely sure was what every hospital needed to operate smoothly. Well, the hospitals told him they weren't organized the way he assumed. He didn't make a single sale to a hospital. By pure accident, though, a small city stumbled over the program and found it was just what it needed. Orders began to come in from medium-size cities around the country. And he refused to fill them.
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Inc.: Why do entrepreneurs reject unexpected success?
Drucker: Because it's not what they had planned. Entrepreneurs believe that they are in control. That leads to pitfall number two. Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cash flow matters most.
Growing bodies need to be fed, and a business that grows fast devours cash. You have to make constant investments just to keep even with it. This is totally predictable, so getting caught in a cash crunch is totally unnecessary. I have saved more new enterprises than I can remember by simply telling the founder who showed me how beautifully things were going that now is the time to provide for your next financing. If you have six months' to a year's time to provide for your next financing, you can be reasonably sure you'll get it and at favorable terms.
Inc.: Why do you think entrepreneurs have such a hard time grasping the concept of cash flow?
Drucker: They're not the only ones. Warren Buffet once said that if he wants to find out how a company is doing, he doesn't listen to security analysts. They talk profit, which is irrelevant. He listens to bank credit analysts; they talk cash flow. I have yet to see one of the stock market newsletters I get talk about liquidity and the financial position of a growing company. They talk about profit margins and profitability.
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Inc.: Why is that? Is it a product of our business schools?
Drucker: No. Fundamentally, businesspeople are financially illiterate.
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Inc.: Well, let's say the business pays attention to cash flow, gets beyond the cash crunch, and grows rapidly, beyond expectations. What's the third pitfall looming on the horizon?
Drucker: When the business grows, the person who founded it is incredibly busy. Rapid growth puts an enormous strain on a business. You outgrow your production facilities. You outgrow your management capabilities.
