Evolutionary Models in Business

Evolutionary Models in Business

Evgeny Klochkov

© Evgeny Klochkov, 2022

ISBN 978-5-0051-9258-5

Created with Ridero smart publishing system

Prologue

Special thanks to Oleg Evgenievich Klepikov and Aleksandr Lukich Gaponenko.

Our first meeting with Mr. Gaponenko took place in the lobby of Crowne Plaza hotel in Moscow World Trade Centre in 2017. I was considering enrolling in the Doctor of Business Administration course in IBBA at the Russian Presidential Academy of National Economy and Public Administration, at the moment. Surprisingly, the meeting turned out easy to arrange and proceeded very naturally, despite the fact that I had set very difficult tasks, i.e. to understand and structure the mechanisms of ideology creation and functioning. I was concerned with the realisation that there were really few experts of that profile or at least someone who would have a deep understanding of the area. A couple of days after the meeting, Aleksandr Lukich called and said that he knew a specialist who could help me understand the issue. A few weeks later, I found myself in the office of PSYCHEA, sitting in a meeting room with a glass wall that turned opaque at the press of a button, providing complete privacy. Although I can’t say that it was the only amazing event on that day. Acquaintance with Oleg and the first 1.5 hours of the conversation flew by like one minute. It was a sprint. He fended off all of my ideas and suggestions, explaining it to me that they were far from what I really needed. I got caught up in thought in the evening. For the next 1.5 years, we had regular meetings to discuss my future thesis paper, but even formulating the topic appeared to be a difficult task. Time went by. After each meeting, I took my time to think and came back whenever new ideas or questions would occur to me. Oleg told me not to worry, because as soon as we found the right topic that was really important for me, it would very quickly “pave its way” on paper. Amazingly, he turned out to be right. Suddenly there it was! And on the day that followed another meeting, I just got into the car and made it to the sea to write my paper. It was early spring and the awakening nature was a true inspiration. The entire year that followed passed in formulating the vision that I describe in this book. Well, let’s start!

Introduction

As an introduction to the book, the author offers for analysis two typical cases from the world of Russian business, which reflect the idea of this book. The first case is fairly obvious and lies “on the surface” – the creation of the Sukhoi Business Jet aircraft line. In the early 2000s, the Sukhoi State Corporation decided to diversify its product line and release a civilian aircraft. The stake was placed on the development of a short- and medium-range narrow-body aircraft. In 2008, the first Sukhoi Super Jet made its maiden flight. The company’s management decided to go further and enter the business aviation market. As a result, the Sukhoi Business Jet project was launched. However, while the company faced a number of more or less solvable challenges while creating the Sukhoi Super Jet commercial aircraft, the full-fledged entry into the luxury goods market proved to be an impossible task for the Sukhoi State Corporation. The company has so far failed to go beyond the niche of a producer of goods for the public sector and governments of some friendly countries. It should be born in mind that the company has a significant financial and administrative resource, as well as a very high-quality engineering school of aircraft construction, laid down back in the USSR, which allows it to keep a very high bar in the world arms market. From the technical perspective, some of the modern military aircraft of Sukhoi Group are unsurpassed in terms of their flight qualities and technical solutions. Thus, it is neither financial nor technical components that form the source of the problems of the Sukhoi Business Jet project. From the point of view of the model proposed in this study, Sukhoi Group sticks to the strategies that actually prevent it from entering a new market. If we draw parallels with nature, then the company can be associated with representatives of an arid desert, where resources are scarce, the choice of strategies is very limited, and the toolkit is straightforward. In Sukhoi Group, financing comes from the public budget, and the consumers of the products are also state-financed entities, i.e. the Armed Forces of the Russian Federation or of other countries. The customers’ preferences can be described in a standard requirements specification, and the finished products acceptance is carried out in accordance with an agreed algorithm. Meanwhile, the market to be penetrated in conformance with Sukhoi Group’s plans is governed by completely different laws. Drawing parallels with the animal kingdom, business aviation market players (e.g., Bombardier, Gulfstream, and Embraer, as well as separate divisions of Boeing Business Jets and Airbus Corporate Jets) are prominent representatives of apex predators with complex behavior patterns. Each aircraft is a separate project, implemented for a specific client and customised based on their specific preferences and wishes, the requirements being more exacting, the strategies being more complex, and the product being non-standard. To achieve this level of service, a state corporation needs a completely different nature, structure, a different corporate culture, and a different set of strategies. Sukhoi Group simply does not fit into these rules of the game. The chances of squeezing into this difficult niche using the usual approach are minimum. The only way out would be to create an autonomous market-oriented enterprise operating beyond the rules typical of state corporations.

The second case describes a more subtle and complex situation regarding selection of a top manager for a large company. This story unfolded between 2016 and 2019 and involved X5 Retail Group (Alfa Group) and Magnit retail chain. The shareholders of the Magnit chain of stores decided to entice the top manager of X5 Retail Group (Alfa Group) to manage a newly acquired asset, but the new CEO not only failed to repeat the previous success, but also led Magnit to worse results than those with which the activities had been started. As a result, the CEO was removed from the position. The development of the situation looks paradoxical outwardly. In the mean time, it can be assumed that the key mistake must have been the lack of understanding by the new shareholders of Magnit retail chain of the identity of their asset. Let’s study this case in more detail and first define the characters.

Magnit (legal name JSC Tander) is a Russian retail company that owns a chain of food stores. As of the first half of 2019, the retail chain consisted of 19,223 retail outlets and 37 distribution centers. The company’s own fleet of vehicles comprises about 6,000 vehicles. The company’s stores are located in 3,077 settlements in Russia.

X5 Retail Group (X5) is one of the leading Russian multi-format food retailers. The company operates stores in several retail chains: proximity stores under the Pyaterochka brand, Perekrestok supermarkets, Karusel hypermarkets, and stores “within walking distance” under the Perekrestok Express brand. As of the first half of 2019, the total number of outlets was 14,779, and the retailer had 41 distribution centers. Geographical coverage was 7 out of 8 federal districts of the Russian Federation. The transport fleet owned by X5 Retail Group consists of 3,830 trucks.

Thus, both companies are in approximately the same “weight category”. Magnit’s problems became noticeable in 2016, when the chain started lagging behind its main competitor, X5 Retail Group, in terms of growth rate. At the end of 2017, Magnit cedes the leadership in revenue in the Russian market to X5 Retail Group, its net profit getting almost halved – from 54.4 to 35.5 billion rubles. The asset actively falling in price is then bought out by VTB Group in early 2018, Sergey Galitsky, the founder of Magnit, selling 29.1% of the shares. Just a few months later, the VTB financial group resells a part of its stake, about 12%, to Marathon Group, an investment company founded by Aleksandr Vinokurov and Sergey Zakharov from A1.

Following the changeover of its shareholders, Magnit obtains new top management. The position of CEO is offered to Olga Naumova, who until the spring of 2018 led the Pyaterochka chain and achieved very noticeable results in her position. Since 2013, Naumova has been able to accelerate revenue growth and expansion rates, as well as update the stores. While at the end of 2013 the revenue of Pyaterochka stores amounted to 348.39 billion rubles (65% of X5's net retail revenue), shortly before her departure the turnover exceeded 1 trillion rubles (77.8% of the total revenue of the retail group). The number of stores in the chain also increased – from 3,882 to 11,225, which is quite impressive.

The choice of Magnit chain new shareholders in favor of Naumova was absolutely logical: to get a ready-made and highly successful manager from a direct competitor would seem to be a real bargain. The prospects are excellent. A successful top manager has taken the lead. However, something went wrong then. As it follows from its financial statements, Magnit’s revenue grew in 2018 by 8.2% (up to 1.2 trillion rubles), but the company failed to catch up with its main competitor – X5 Retail chain. X5's indicators were growing faster and in 2018 its turnover increased by 18.5% (up to 1.53 trillion rubles). Thus, the gap in turnover between the competitors sharply increased over the year. At the end of 2018, the American investment company OppenheimerFunds, owning 7.3% of shares, withdraws from the capital of Magnit.

To understand the reasons for this outcome, it is necessary to study the history of each of the companies carefully and to figure out their essence. The largest stake in X5 Retail Group belongs to co-owners of Alfa Group, a part belongs to the founders of Pyaterochka and directors of X5 Retail Group, and there are also free float shares. Considering that the majority shareholder is Alfa Group, it is worthwhile to study its essence more closely.

Alfa Group was founded in 1989, and today it is one of the largest private financial and investment consortia in Russia. At the time of the company foundation, the USSR’s legacy was about to be divided, and Alfa Group was being built as a structure ready to actively participate in mergers and acquisitions. It was characterized by posession of a staff of specially trained lawyers specializing in mergers, acquisitions and corporate conflicts, the rigid centralization of power in the management company, the presence of a “trooper” landing in newly acquired companies and taking over their management. Alfa Group was born, grew up and survived as a “predator” in the aggressive environment of the 90s, and X5 Retail Group is a very similar structure. It was created largely through mergers with other structures, absorbing ready-made retail chains and restructuring formats.

In the mean time, Magnit could hardly claim to be a predator. The founder of Magnit did not plan to participate in the division of the USSR’s inheritance and was building a family company. The key positions were held by the people close in kinship or in values, and the project developed mainly based on organic growth. Avoiding capital cities, clearly saving on store interiors, Magnit focused on efficient logistics and ensured low prices for goods on the shelf. Magnit went through cost optimization and fine-tuning of internal processes, not resorting to takeovers of competitors. On completing the transaction with VTB Group, its founder S. Galitsky left the business, having by the time of the sale already accumulated a number of systemic contradictions, including those related to the resignation of Vladimir Gordeichuk, a key partner and CEO of CJSC Tander. Olga Naumova, invited from X5 Retail Group to the position of CEO, inevitably encountered a completely different nature of the business. Despite the fact that she came from a direct competitor, X5 Retail Group, Magnit chain was a completely different entity.

Olga Naumova and her team found themselves at the head of a company, which was developing within the framework of the strategy of survival in the regional market. It is obvious that the management of such a company involves completely different principles and a different approach than the ones applied with X5 Retail Group. When looking at the situation through the proposed paradigm, it becomes clear why at the beginning of 2019 a new position of president appeared at Magnit, which was taken by Jan Dunning, former Lenta’s CEO. As the RBC news site wrote: “In the new configuration, Naumova will continue to be responsible for the entire work of the company, while Dunning will deal with strategy and interaction with shareholders.” However, a few months later, at the end of June 2019, Olga Naumova left the company. As a result, Magnit suffers significant losses and changes its position in the competition from the leader to the one having to catch up. Due to the drop in the capitalization of the retailer, shareholders lose billions, while X5 Retail Group continues increasing its turnover.

Thus, in the above examples, we see that the different natures of the companies impose different restrictions on their development, which leads to the fact that application of some traditional approaches to the development of the company leads to failure. Despite the external similarities of the two companies, i.e. the same market, the same specificity, and equal weight category, they turned out to have a completely different essence, which in the end gave completely different results.

For a predator, some losses in fights with opponents are commonplace, and the company has the skills to replace the lost competencies. X5 Retail Group quickly replaced the top manager that left, regrouped and, without unnecessary hype in the media, showed concrete results – an increase in the revenue and capitalization, as well as capture of an even larger market share. Meanwhile, Magnit, which had an excellent start in the form of a state bank as a shareholder and a top manager from a competitor, was unable to reach the potential.

It is obvious that Olga Naumova, a native of the clan of predators, having joined the new company, found herself in a very unexpected environment for herself. They hardly prepared for the seizure of new territories and battles with opponents. Obviously, all the available tools were not formatted for the Alfa-Group style of operation. Instead of adapting her own role, the new director decided to remake the entire company to what she was used to, trying to change the nature of the company. This is confirmed by the announced new development strategy, including rebranding. However, changing the nature of a business structure is a task that requires a long time and significant inner changes. That said, one shouldn’t forget about the environment, where the race for market leadership did not stop for a moment and the resources of both companies were being actively spent to maintain the pace. Accordingly, any complex operation carried out “on the fly” has a low chance of success.

There is a number of similar examples in the world of business, the positive or negative results of which, when viewed through the proposed model, become understandable and logical. For instance, the outcome of the Skolkovo Technopark residents performance on the international market, the development of the Aurus car project, attempts to purchase the Brazilian company Embraer by Boeing, the purchase of Tiffany by the LVMH holding, and many other cases.

The study substantiates that the cases considered and similar ones have the same nature and similar reasons underlying the resulting consequences. The range of problems to be solved within the framework of this study will be formulated as follows: why do even large companies with substantial resources make big mistakes? How can one take into account factors that cannot be identified by using the classical approach and traditional business models in the process of taking complex strategic decisions?

The answer to these questions lies in the special view of business structures described and justified in this study. The object of the study is to create a new model of business vision, as well as to develop recommendations for the model application. The work was based on classical principles and models that are already known and have proven themselves in practice. These are Charles Darwin’s Theory of Evolution, genetic algorithms, Spiral Dynamics, the Rainforest model of the Silicon Valley from V. Hwang and G. Horowitt, the Blue Ocean Strategy of W. Kim and R. Mauborgne, Corporate Lifecycle Model from Dr. I. Adizes, C. Christensen’s Jobs-to-be-Done concept, R. Dilts’ Pyramid of Logical Levels, the T.O.T.E. Model, Carl Jung’s theory of archetypes, the Propaganda concept from E. Bernays, D. Ariely’s Predictably Irrational, PSYCHEA model of O. Klepikov and A. Murazanov.

The synthesis of these models makes it possible to create not just another model, but to formulate a novel outlook on the existing models and tools in the field of management, which are of a mechanistic nature. The new model takes into account not only mechanistic relations, but also organic, social, and psychological relationships. It enables prediction of the competitors’ behavior and gives understanding of their capabilities and development potential. The study is structured according to the principle of describing classical theoretical models, identifying their principles of operation and interconnection with each other, analyzing practical examples, and then the final practice-oriented model for entrepreneurs and managers is proposed and described in stages.

Chapter 1. Theoretical Models

In December 2019, during the plenary session at the “100 Steps to a Favorable Investment Climate” conference, an important thesis about the future of business was aired by Konstantin Polunin, a partner of Boston Consulting Group (BCG): “Companies will determine their right to exist in terms of the cumulative systemic effect rather than in terms of return for shareholders”.

In recent years, it is often suggested in the professional community that the study of complex, self-generating, self-organizing, nonlinear, and adaptive systems will become the most relevant in the 21st century, the main meaningful goal of the organization and its mission (rather than the self-preservation of the company) being the key factors to these systems. The new paradigm will view business structures not as organizational models, but as living organisms. The solution to the task of building the next generation structure will lie more in biology and psychology than in engineering and finance. But in order to understand this thesis, it is worthwhile to study more closely what it can be based on, what theoretical models may underlie this assumption. The book will describe the models that form the basis of the hypothesis that it is much more effecient and far-sighted to perceive business as a living organism.

1.1. Types of Cooperation Models

To begin with, some starting point should be determined, and the idea described in the book Reinventing Organizations by F. Laloux shall serve as a basis. The book comprehends the accumulated experience of human cooperation models, which reflect the mankind development history and consciousness development level, and presents a novel idea that can describe the existing complex interrelationships in more detail than generally known concepts. Organizations as models of cooperation between people are always bound to the currently dominant people’s worldview and consciousness development stage. Each time humanity as a species changed its method of world cognition, it grew to new, more effective types of organization. At the same time, such growth did not occur evenly, evolution proceeded in leaps and bounds, like transformation of a caterpillar into a butterfly. Each rise to a new stage of self-consciousness opens up unprecedented abilities and opportunities for humanity, and each new stage of development endows a new model of organization.

Let us consider the following models of organizations in today’s business environment. The companies are divided based on the principle of the underlying organizational structure, and for the convenience of distinguishing them, each is labelled with a color in compliance with the ideas of F. Laloux.

Family Business

Business is built according to ethnicity or family ties. The management style is manual control. The decision-making body is often comprised of a family members council, with the leader serving as a chairman of the council and announcing decisions. In such a business, the role of the leader does not imply autocracy, but rather is to coordinate opinions, lead and control the wealth of the family. For these companies, healthy social relationships in the group are more important than production schedules. The leader’s life belongs to the family where he serves the clan, and not vice versa. The use of awards in the form of reward for individual achievement in such organizations is unlikely, since the reward separates good workers from the rest of the group, i.e. from the family.

Small Business, Startups (Red Organizations)

This business is characterized by the presence of strong personalities who quickly find themselves at the top of the power pyramid. Leaders in such organizations show a high level of energy, take risks, are ready to fight “for territory”, while being able to create innovations and challenge the system. Thinking in this case is formed by the opposites, creating a black and white picture of the world, and in the end everyone is divided into winners and losers. The management style is maintained at the level of manual control. Leaders show tough hegemony in decision making. There is no planning in these companies, since the stake is made on achieving immediate results. Red Organizations are well adapted to cope with chaos, but they are not fit to create complex results in a stable environment where planning and strategy development are possible.

Formal Hierarchies (Amber Organizations)

The overall structure is established in the form of a rigid pyramid with a cascade of formalized orders from bosses to subordinates. In such companies, processes and procedures are very tightly regulated, which leads to a flourishing bureaucracy. Rule-making authority is associated with a social role rather than a strong personality, thus creating stable organizational structures that are sustainable and capable of large-scale development. Notable examples of Amber Organizations are government agencies, the church, and the army. Authority is comparable to a priest in vestments or a general in uniform, and it doesn’t matter what kind of person he is – the form determines the authority. The distribution of remuneration is carried out in accordance with the position and length of service. Each element of the organization understands its exact location and has to act according to the rules of the system. The outlook on life in such structures is static, i.e. there are unshakable laws that divide things into right and wrong. If members of the organization do the right thing, they will be rewarded, and should their behavior fail to conform to the accepted norms, members of the group breaching the established code of ethics may be rejected by the community.

Companies of this level have an understanding of causation, which allows to reproduce past experience and leads to creation of a planning system. Planning and implementation of plans are strictly separated. The thinking takes place “above”, the execution is done “below”. Management is based on the principle of “give orders and follow up”. The philosophy of the Amber Organizations suggests that employees are mostly lazy, dishonest, need supervision, they need to be monitored and told exactly what is required of them. New ideas, individual achievement, critical thinking, and self-expression are not encouraged. Human resources are virtually completely interchangeable. Order and stability – subordination, formalized internal processes, and clear rules – reign in these companies.