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(originally published by Booz & Company)


Lessons from Failure

After crunching the numbers, the researchers found that organizations achieving success in exploitative activities, which merely reinforce the value of existing beliefs and processes, don’t learn much. Companies with above-average industry performance persisted with the same strategies, so that the routines that once afforded them success over their competitors constrained them in acquiring and developing new processes. Their performance faded over time.

The analysis also showed that firms learn valuable lessons from successful exploratory activities, because these ventures result in new knowledge that can be encoded and utilized by the firm.

But failures in exploratory activities are a costly waste when they don’t result in new information that can be distilled and used by the firm. Even relatively modest exploratory failures cost each firm about $192 million a year in expected cash inflows, the researchers calculated, an amount that declines over time. (Mutual funds base their varying fees in part on the size of the portfolios they manage, and the smaller inflows imply a loss of millions of dollars in potential revenue.) And because exploratory failures are “less core” to the business’s established identity, the authors argue, they can be more easily written off by managers, which limits the potential for drawing lessons.

But failure at exploitative activities can boost organizational learning and firm performance, the researchers also found, because the breakdown of established routines hits at the very heart of the business. Firms therefore react with more urgency to such problems and nip them in the bud. In the study, firms that failed at the familiar quickly turned things around: The authors write that each exploitation failure generated substantial new revenue for the firm going forward.

The findings apply less to extreme “disasters” than to more modest failures or near-misses, the researchers note. And there is a limit to what can be learned overall: Firms with the greatest diversity of experience — those that engaged in several different types of exploration and exploitation, to varying degrees of success and failure — actually performed much worse than others, the paper found. The researchers posit that too much tinkering in too many different areas can mean any knowledge gleaned is never fully incorporated and thus does not inform future projects. Instead, organizations need substantial experience in a given area to develop effective routines.

Bottom Line:
The effects of prior success and failure on future performance are linked to the nature of the experience — whether it involved breaking new ground or reinforcing the status quo. In exploring new territory, success is far more beneficial than whatever lessons can be learned from failure. But when it comes to established routines and processes, initiatives that end in failure can often provide more of a long-term boost to organizational learning and performance than those that are initially successful.

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