Have you ever noticed that companies bring very similar products to market? Smart phones are the latest craze, with Apple leading the way and rivals including Palm, Samsung, HTC, Nokia, and Google frantically releasing their own copycat versions to get into the mix. The same goes for cars, with the mini-van rage of the 1980s and the sport utility vehicles fad of the 1990s both resulting in vehicles that very closely resembled each other.
This lemming-like behavior can prove disastrous for firms that rush into business endeavors not soundly based on earning a sufficient return on investment. The economic boom and subsequent credit crisis of the past few years is a case in point. The vast majority of homebuilders, casinos, and commercial real estate developers relied on overly rosy growth projections and significantly overbuilt. Banks, including Washington Mutual, Wachovia, and Bear Stearns, made loans to keep up with each other and were ruined by following short-term market dynamics over long-term viability.
In Berkshire Hathaway’s 1990 letter to shareholders, Warren Buffett defined the institutional imperative as “the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.” This discussion was a follow-up to the 1989 letter, which detailed traps within a firm and include: “(1) As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.”
Avoiding the institutional imperative, especially within a firm, is extremely difficult. Buffett’s advice is to work with ethical, trustworthy individuals that are able to run “businesses that possess decent economic characteristics.” His lesson is that right is right even if nobody’s doing it, and wrong is wrong even if everybody’s doing it, which happens to be a phrase that has been credited to an old Texas Rangers cowboy credo.