THE SIMPLE REASON MOST COMPANIES CAN'T HANDLE MAJOR CHANGE

Albrecht Enders and Andreas Konig, 06.10.09, 04:30 PM EDT

Not just individual businesses but whole industries fail when the paradigm shifts. Here's why.

Apple and other PC manufacturers took over the computer industry from giants like IBM in the 1980s. Southwest and other no-frills airlines drove traditional aviation companies into bankruptcy in the 1990s. Toyota and other Asian car producers slowly but surely brought the U.S. automobile industry to its knees beginning in the 1970s. The pattern repeats itself over and over again: A throng of small, seemingly powerless start-ups introduce discontinuous innovations into an industry, and they manage to knock not just one or two but all the established players from their pedestals.

Why do entire industries stumble when confronted with discontinuous change? That is one of the most intriguing questions in management research.

Psychological studies have shown that people confronted with uncertainty tend to look to others for cues on how to behave. The psychologist Robert Cialdini calls this phenomenon "social proof." Social proof helps to explain some of the most startling paradoxes in human behavior. For instance, bystander apathy: The larger the crowd of bystanders at the scene of an accident, the more likely no one will help the victims. Social proof theory tells us that everyone hesitates to help because each individual in the group imitates the behavior of all the others. If everyone else is passive, each bystander will erroneously pick up a signal that there is no emergency.

Social proof also exerts its power in the business world. Security analysts deciding whether to invest in specific stocks have been shown to base their decisions largely on what their peers do. Cialdini explains in his book Influence: Science and Practice: "If a lot of people are doing the same thing, they must know something we don't. Especially when we are uncertain, we are willing to place an enormous amount of trust in the collective knowledge of the crowd."

Managers trying to figure out how to react to new situations don't pick just any companies in their industry to follow. They typically look to their most successful peers, who have repeatedly proved their ability to make the right decisions in the past. In other words, they engage in benchmarking. Usually this is wise. Managers rightly assume that those with the most successful track record have the best information and base their decisions on deep understandings of situations.

However, my colleague Andreas König and I, working with established companies, have observed that when fundamental changes occur, looking to others within one's industry, especially market leaders, can be a recipe for the demise of everyone in the industry. This is so for two reasons.

First, social proof in response to radical change can lead to bystander apathy just like that at an accident scene. Incumbents confronted by discontinuous change hesitate to adopt new technology, because they interpret the nonresponse of others as a sign that the new technology isn't worthwhile. Ultimately, the entire cohort fails to respond to the change. We talked to many owners of brick-and-mortar bookstores, for instance, who explained that they had waited too long to react to the rise of online retailers such as Amazon ( AMZN - news - people ) because their competitors weren't responding either.

Second, market leaders are especially unlikely to adopt discontinuous innovations because they have become risk averse protecting the success they've already had. Also, they have the most to lose if sales of their existing, highly profitable products are cannibalized by the new products. And so as lesser players engage in benchmarking and follow the industry leaders, the entire crowd of established players fails to adopt radical change.

What are the implications of these observations? We all live in a world of frequent radical change now, so we must constantly rethink who we look to, and under what circumstances. Most of the time, benchmarking against our main competitors or best-in-class in our industry makes sense. But in times of radical change, it is likely to lead straight to collective failure.

Therefore, we need to learn to look to players outside of, as well as within, our own industries. Only if as decision makers we adopt a broader perspective will we be able to leverage the benefits of benchmarking during times of continuous change and avoid the traps of social proof under discontinuous circumstances.

Albrecht Enders is a professor of strategy and innovation at IMD, the global business school based in Switzerland. He teaches In the Orchestrating Winning Performance program. Andreas König is an affiliate research fellow at IMD.