This article appeared in Upside Magazine (December 1992).
Bruce Henderson, the originator of modern corporate strategy and founder of The Boston Consulting Group (BCG), died this summer in his hometown of Nashville, Tennessee. He was 77. I didn't know Bruce that well. Back in the late 1970s, when I was a fresh-faced MBA, happy to be a number-crunching peon at BCG, Bruce was a far-off figure -- the big boss. Whenever I ran into him in the office, I came down with a severe case of cotton-mouth.
But two years ago, after he read the galleys of Bionomics, we began a correspondence and talked for hours about our shared passion -- rebuilding economics with concepts borrowed from evolutionary biology. With the enthusiasm of avid sports fans, we argued over how business strategy, organization design, and public policy would be reshaped by the blending of biology and economics.
Trained as an engineer, Bruce Henderson became fascinated with economic ideas for terribly practical business reasons. Back in the days before he established the discipline of corporate strategy, making the big decisions about a company's long-term future was pretty much a "seat of the pants" affair. The CEO, with perhaps a few senior executives and board members, would sit around and talk until they came up with a plan that seemed sensible. "Bet-your-company" decisions like launching a new product line, acquiring a subsidiary, or shutting down a factory, were made on little more than intuition.
A rigorous analytical approach to making key decisions was impossible, because there were no guiding strategic principles, no theories that could be turned into quantifiable models. Standard economic models existed, of course, but every sophisticated businessman knew that the economists' mythical kingdom of "perfect competition" bore no relationship to reality. To turn corporate strategy into a credible discipline_and consulting assignments that major clients would pay major money for_Henderson had to find a hard link between business and underlying economic forces. Since the realities of business life were not about to change, that meant rethinking the most basic ideas of traditional economics.
Henderson's search began with highly detailed analyses of production costs. Early in his career, while a purchasing manager for a Westinghouse division, he wondered why suppliers who produced their goods in virtually identical factories often put in bids at dramatically different prices. Economic theory said it wouldn't happen. Producers using similar capital equipment were supposed to have similar unit costs and offer roughly the same prices. But economic theory was wrong. In case after case, actual unit costs varied dramatically among suppliers. Henderson didn't know why, but he had zeroed in on the crucial question.
Then, in 1966, shortly after he founded BCG, a study for Texas Instruments' semiconductor division revealed the answer. When TI's unit cost data for a particular part was plotted against the company's accumulated production experience, the cost of the part declined quite predictably. For example, if the 1000th unit off the line had cost $100 to make, the 2000th unit would cost 80% as much, or $80. By the time the 4000th unit was produced, it would cost just $64 ($80 x 80%). Every time cumulative experience doubled, unit costs dropped about 20%. Though it's "old hat" among today's high-tech managers, the notion of predictably declining costs was a radical concept when Bruce Henderson began teaching companies about the "experience curve" a quarter century ago.
During the 1970s, Henderson's concept became the foundation of modern corporate strategy. For the first time, it was possible to explain why building a factory just like your competitor's didn't mean you could match his costs. If he had a head start in experience, you could wind up chasing him down the experience curve. If you both sold at the market price, he'd make money on every unit, while you'd be lucky to break-even.
Once the experience curve was understood, the importance of being the first one to enter a new market became clear. Properly executed, the preemptive strike could mean long-term market leadership and long-term profits. Similarly, the experience curve explained why defending market share mattered. Raising prices to boost short-term profits sold off market share, slowed experience growth, and often handed over low cost leadership to an aggressive competitor. It's a scenario that's been played out hundreds of times as "experience conscious" Japanese competitors have overtaken their "profit conscious" American rivals. Armed with the experience curve, Bruce Henderson was the first one to explain and warn against this suicidal corporate strategy. Without him, many more American firms would have been overwhelmed.
Simply put, Bruce Henderson's experience curve explained how an industry's past shapes its future. Where conventional economics had banished history by blithely assuming that "technology holds constant," Henderson used the experience curve to show how the new insights generated by practical experience were translated into higher productivity and lower costs. Where conventional economics taught the "law of diminishing returns," Bruce Henderson taught the "law of increasing returns." Where mainstream economics taught that marginal unit costs must rise at some point, Henderson proved that marginal unit costs continually fall. That's why companies are always eager for more orders.
In literally thousands of exhaustively detailed studies_in industries as diverse as paper tissues, gasoline refining, life insurance, medical electronics, motorcycles, and microprocessors_he and his BCG colleagues proved that all competitive organizations learn from experience, that there are no limits to productivity.
When the cost/performance potential of a particular technology is nearly exhausted, an industry will shift to a substitute technology and begin a new "experience curve." For example, even as the airlines have shifted from one aircraft technology to the next, their cost/seat-mile has kept falling, opening up air travel to the entire population. By substituting new knowledge for labor and materials, experience-driven innovation keeps pushing costs down. As Henderson put it, when a firm is properly managed, its "product costs will go down forever."
Though he concentrated on the practical problems of clients, Henderson knew full well that the experience curve had undermined the intellectual foundation of mainstream economics. In 1973, he wrote: The experience curve is a contradiction of some of the most basic assumptions of classical economic theory. All economics assumes that there is a finite minimum cost which is a function of scale. This is usually stated in terms of all cost/volume curves being either L shaped or U shaped. It is not true except for a moment in time. . . Our entire concept of competition, anti-trust, and non-monopolisitc free enterprise is based on a fallacy.
By the early 1980s, the lessons of the experience curve led Henderson to shift his thinking beyond the bankruptcy of mainstream economics. He began to imagine a new and far more powerful kind of economics. The realization that organizations are not static machines but complex, dynamic systems that learn from experience, led him to begin seeing companies as living, growing organisms. Following this logic, Henderson began to argue that the competition in the economy's market niches was remarkably like competition in nature's ecologic niches.
Many of his former colleagues thought Henderson had gone off the deep-end with this "biology thing." But instead of retiring quietly and resting on his considerable prestige, he plunged ahead, ready as ever to break the mold, start fresh with a radical concept and explore its implications. In 1989, shortly before his 75th birthday, Henderson published "The Origin of Strategy" the article that would be his last for the Harvard Business Review. In it, he concluded, "Human beings may be at the top of the ecological chain, but we are still members of the ecological community. That is why Darwin is probably a better guide to business competition than economists are." Just as the "experience curve" was scorned for years before being accepted by business school professors, the biologic paradigm will eventually become a core part of the business school curriculum. And, with academic economists, like Stanford's Brian Arthur and Kenneth Arrow, now daring to describe the "economy as a complex, evolving system," there is even some hope that Bruce Henderson's revolution will finally sweep away the nonsense that still passes for mainstream theory. Who knows? If the academics finally grasp how the economy really works, there may even be hope for the politicians. I'm often asked whether the work of the great Austrian economist F.A. Hayek inspired me to write Bionomics. Despite my unending admiration for Hayek, the short answer is no, I'd never read him. Bruce Henderson inspired me to rethink the received economic wisdom. Without his "experience curve," there is no final and fully satisfying explanation for falling costs, rising incomes, and the phenomenon of economic growth. More than anyone else, he made it both possible and necessary for economic thinkers to break free of the static, zero-sum mentality that has gripped the "dismal science" for 200 years. Bruce Henderson gave us the key to "positive-sum" economics. Thanks for the revolution, Bruce.