FOOL ON THE HILL: An Investment Opinion
How Companies Grow Up

According to Robert Cringely's "Three Waves" theory, companies mature through three radically different types of employees: commandos, infantry, and police. I'd like to talk about the transition from first-wave to second- and third-wave. When is a company a good takeover candidate, and when is a buyout by a Fortune 500 firm likely to turn into a disaster?

By Rob Landley (TMF Oak)
September 13, 2000

This is Part 3 in a series. Part 2, Berkshire's Sustainability, ran last week. Part 1, How a Start-up Evolves, ran in July.

In responding to my first column on Robert Cringely's "Three Waves" theory, which suggests that companies mature through three types of employees -- commandos, infantry, and police -- a Fool named slackler posted the following to the Fool on the Hill discussion board:

"I just read this article, and I can tell you from experience, that is exactly right. I worked for a 12-man start-up from '94-'97, I was the 12th guy. When I left, the infantry was moving in (which is essentially why I left). And, I was one of the last commandos to go. All but one member of upper management had already left. That article was right on!"
As I suggested to him at the time, "This doesn't necessarily mean the company in question is doomed, per se. More that it's a likely acquisition target. Without commandos, the company will probably have trouble diversifying its product line, entering new markets, and reacting to competition. Still, with a profitable product and room to grow in its market, it can continue along its established trajectory for quite some time."

Unfortunately, it's almost guaranteed to top out. Commandos are pathfinders. When you hit the end of the current road, they're the ones that can find a new direction. The infantry play "follow the leader," and when they head off in a new direction they're only going to find anything by blind luck. Most of the time, they'll hit a brick wall, wind up in a desert, or simply end up back where they started. They're good workers, but they need orders.

Infantry MIGHT be able to find new uses for a well-established product in a well-established market; perhaps something on the level of adding off-the-shelf stereo speakers to PC sound cards, circa 1995. If it's a REAL OBVIOUS job with no disagreement about what exactly the right thing is to do, then maybe.

But, trying to get infantry to do a commando's job usually gives you a "Beaches of Normandy" type situation, where you have to throw insane amounts of resources at the project to make any progress. Usually it succumbs to the "too many cooks" effect. You can throw manpower at the second-wave elements of the business, such as sales and manufacturing, which simply get behind an existing idea and push its implementation.

But, when the problem is creative in nature, Brooks' Law applies. (Fred Brooks' classic book on project management, The Mythical Man Month, contained his now-famous statement he directed at software projects: "Adding manpower to a late project makes it later." I'll cover this book in more detail in a future column.)

"Beaches of Normandy" efforts can be made to work, but governments are more likely to use this kind of tactic than corporations. Normandy itself is one obvious example, but so are the NASA moon launches, which actually managed to attract a few commandos to government work. The Moon landing was an extremely compelling project for anybody with a drop of commando blood in them, but it also attracted such a huge horde of infantry that they were able to insulate commandos such as Neil Armstrong and Buzz Aldrin -- and many commando engineers and scientists behind the scenes -- from too much direct contact with bureaucrats, cutting the "red tape" for them.

Usually when a third-wave corporation tries a "Beaches of Normandy" brute force assault on a new market niche, they never even make it out of England. Metaphorically speaking, they spend forever arguing about the design of the boats in committee.

Through a huge investment of resources, a third-wave company can sometimes overcome the inherent inertia of bureaucracy -- remember, that's what bureaucracy is FOR: to prevent change, and get an infantry task force moving -- but they still have no sense of direction. Creative projects run without the participation of commandos usually produce products totally unrelated to what the market wants, like IBM's (NYSE: IBM) PS/2, Microsoft's (Nasdaq: MSFT) BOB, New Coke (NYSE: KO), and 1970s-era American gas-guzzling cars. (Look, fins!) Infantry is good at implementing ideas, but not at coming up with them. Infantry isn't equipped to deal with new territory without clear instructions and, preferably, a map.

A company with no commandos, but a valuable product, is the kind of thing third-wave companies eat for breakfast. They wave money at the owners, buy a controlling interest and, bingo, they have a new product line. Strangely, when this happens it's pretty much good for all concerned.

Second-wave companies that focus on growth for too long tend to stall and crash. Once their market is saturated, they have no idea how to proceed, and do dumb and desperate things trying to squeeze 10% more revenue out of the product than it's prepared to produce. (Raising prices too high is a common way to get customers to abandon your product line. Slashing costs until you kill the quality is another. Bloating a product with unwanted features as an excuse to sell new versions is a third.) Given long enough, this sort of thing will kill the goose that lays the golden eggs.

Third-wave companies know all about maintaining existing momentum: It's what they do. They don't care so much about growth, per se, they care about sustainability and avoiding risk. Their existing product lines produce a steady stream of cash, which they can use to grow by acquisition. They don't have to make product X produce more: They can use the profits from product X to buy a mature but undiversified second-wave company and, boom, they now have product Y with its additional revenue stream. They've managed to grow without having to create anything new.

But, this only really works if the commandos have already left the smaller company. Commandos won't leave while there's still something useful for them to do. When the commandos get bored and leave of their own accord, it's soon time to sell out to IBM, AT&T (NYSE: T), General Electric (NYSE: GE), Xerox (NYSE: XRX), or some other Fortune 500 conglomerate interested in fitting your product line into its overall strategy.

So, if MegaGlobal Inc. comes courting while the commandos are still around, EXPECT A DISASTER. The product still has room for improvement, and if this company doesn't take it to its logical conclusion, its competitors will, quite possibly using the original company's own commandos who still have unused ideas they want to find a home for.

Commandos may try to stick around for a while, out of project loyalty, but it won't last long. Middle management won't let them redesign a successful product from the ground up just because "it could be better." Commandos are loose cannons, and proud of it. Middle management's job is to stop people like them from doing anything unanticipated, which is virtually a synonym for "creative."

So a second-wave company, sans commandos, is ripe to be bought out by a third-wave company or, occasionally, a larger second-wave company intent on becoming a third-wave company. A second-wave company that still has commandos is not a good takeover target. A merger with another second-wave company might be made to work, or might not.

And, when companies skip the IPO and sell out to a large conglomerate, expect some staff turnover over the next year or so -- possibly including the bought company's founder. The amount of turnover might be a good indicator of how well the merger is going to do, but it seems to me to be as much an effect as a cause.