Joseph A.

Schumpeter
"Creative Destruction"
From Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig. pub. 1942], pp. 8285:
Capitalism, then, is by nature a form or method of economic change and not only
never is but never can be stationary. And this evolutionary character of the
capitalist process is not merely due to the fact that economic life goes on in a social
and natural environment which changes and by its change alters the data of
economic action; this fact is important and these changes (wars, revolutions and so
on) often condition industrial change, but they are not its prime movers. Nor is this
evolutionary character due to a quasi-automatic increase in population and capital
or to the vagaries of monetary systems, of which exactly the same thing holds true.
The fundamental impulse that sets and keeps the capitalist engine in motion comes
from the new consumers, goods, the new methods of production or transportation,
the new markets, the new forms of industrial organization that capitalist enterprise
creates.
As we have seen in the preceding chapter, the contents of the laborer's budget, say
from 1760 to 1940, did not simply grow on unchanging lines but they underwent a
process of qualitative change. Similarly, the history of the productive apparatus of
a typical farm, from the beginnings of the rationalization of crop rotation, plowing
and fattening to the mechanized thing of todaylinking up with elevators and
railroadsis a history of revolutions. So is the history of the productive apparatus of
the iron and steel industry from the charcoal furnace to our own type of furnace, or
the history of the apparatus of power production from the overshot water wheel to
the modern power plant, or the history of transportation from the mailcoach to the
airplane. The opening up of new markets, foreign or domestic, and the
organizational development from the craft shop and factory to such concerns as
U.S. Steel illustrate the same process of industrial mutationif I may use that
biological termthat incessantly revolutionizes the economic structure from within,
incessantly destroying the old one, incessantly creating a new one. This process of
Creative Destruction is the essential fact about capitalism. It is what capitalism
consists in and what every capitalist concern has got to live in. . . .
Every piece of business strategy acquires its true significance only against the
background of that process and within the situation created by it. It must be seen in
its role in the perennial gale of creative destruction; it cannot be understood
irrespective of it or, in fact, on the hypothesis that there is a perennial lull. . . .
The first thing to go is the traditional conception of the modus operandi of
competition. Economists are at long last emerging from the stage in which price
competition was all they saw. As soon as quality competition and sales effort are
admitted into the sacred precincts of theory, the price variable is ousted from its
dominant position. However, it is still competition within a rigid pattern of
invariant conditions, methods of production and forms of industrial organization in

particular, that practically monopolizes attention. But in capitalist reality as

distinguished from its textbook picture, it is not that kind of competition which
counts but the competition from the new commodity, the new technology, the new
source of supply, the new type of organization (the largest-scale unit of control for
instance)competition which commands a decisive cost or quality advantage and
which strikes not at the margins of the profits and the outputs of the existing firms
but at their foundations and their very lives. This kind of competition is as much
more effective than the other as a bombardment is in comparison with forcing a
door, and so much more important that it becomes a matter of comparative
indifference whether competition in the ordinary sense functions more or less
promptly; the powerful lever that in the long run expands output and brings down
prices is in any case made of other stuff.
It is hardly necessary to point out that competition of the kind we now have in
mind acts not only when in being but also when it is merely an ever-present threat.
It disciplines before it attacks. The businessman feels himself to be in a
competitive situation even if he is alone in his field or if, though not alone, he
holds a position such that investigating government experts fail to see any effective
competition between him and any other firms in the same or a neighboring field
and in consequence conclude that his talk, under examination, about his
competitive sorrows is all make-believe. In many cases, though not in all, this will
in the long run enforce behavior very similar to the perfectly competitive pattern.
(pp. 82-85)

Opinion

Introspective -- By Calixto V. Chikiamco

By

Disruption!
To Joseph Schumpeter, the Austrian economist and author of Capitalism, Socialism, and
Democracy, the most prominent feature of capitalism is "creative destruction," a process by
which innovating entrepreneurs drive growth by upending the old order.
Whereas Marx portrayed capitalism as "exploitative" and characterized by periodic crises,
Schumpeter celebrates the dynamism of capitalism. In other words, in capitalism, disruption is
the name of the game.
Who can dispute that disruption is around everywhere today?

Newspapers are being disrupted by the Internet, film photography is being disrupted by digital
photography, postal mail is being disrupted by e-mail and texting, music CDs are being disrupted
by file sharing, landlines are being disrupted by mobile phones, voice calling is being disrupted
by Skype and other Internet-based services, and pretty soon, fuel engines will be disrupted by
electric vehicles.
While I was in college, all the engineering students had to have slide rules. Then the slide rules
went the way of the dodo bird, replaced by scientific calculators. Recently, I stumbled on
www.wolframalpha.com, a Web site that has been described as a "computational engine." I guess
even now the engineers themselves are being disrupted.
Nothing much is safe from disruption. Even doctors are finding this out. Open-heart surgeons are
being disrupted by cardiologists doing angioplasty while a new breed of cardiac surgeons are
using minimally invasive robot-assisted heart surgery.
Disruption and competition can come from anywhere, not just from ones direct competitors.
Kodak, of course, was and is being disrupted by Canon, Nikon, Pentax, and the "usual suspects"
in the digital film world. However, guess who are the biggest sellers of digital cameras to the
public? The mobile phone manufacturers.
Ive previously written about how the Aboitizes shipping business got disrupted by budget
airlines on the passenger side and RoRo ships on the cargo side. Who knew that the Aboitizes
would be competing with Alfred Yao and Lance Gokongwei?
I have a few other examples: Eyeglass manufacturers had only each other as competition. Then
came the contact lens manufacturers. But can corrective eye surgeons wielding the disruptive
technology of laser surgery qualify as competitors? The technology may not be mass market
now, but it could still affect the demand for eyeglasses in the future.
Likewise, car manufacturers will face severe competition and disruption in the near future and
competition will not come from any existing car company. This is because of the global push
toward "clean engines" and electric vehicles.
Theres a huge barrier to entry in the car industry because producing todays fuel combustion
engines with its array of computers that intelligently coordinate the engine requires huge capital.
Not so with electric vehicles, where the barrier to entry is low. This is why a battery
manufacturer like Chinas BYD has been the recipient of a Warren Buffett investment and is seen
as an emerging force in the automotive industry.
The corporate graveyard is littered with corpses of companies disrupted by technology: Visicalc
(spreadsheet software), Wang (word processors), Smith-Corona (typewriters), Kaypro
(computers), Polaroid (instant photography), etc. Disruption in the personal computer storage
industry has been fierce: 5.5-inch floppy disks replaced by 3.5-inch floppy drives replaced by
CDs and DVDs and flash drives.

Still, its possible for an industry to "reinvent itself" in the face of disruption. Moviehouses were
supposed to die with the advent of the Betamax and the VHS. They didnt. Instead, cinemas got
"reinvented" as multiplexes in malls. Although the stand-alone theater has died (I remember
Avenue, Galaxy, and Lyric in the old days), it has been reborn as multiplexes in Powerplant Mall,
Megamall, etc.
Mechanical watches were supposed to have been disrupted by digital quartz technology, but
clever positioning as luxury timepieces has enabled their Swiss manufacturers to survive and
thrive.
What accounts for the accelerated pace of disruption and creative destruction? Globalization is a
factor. Barriers to entry, usually government imposed, have fallen away in the wake of WTO and
free trade rules. I remember a time when the Board of Investments used to mandate "measured
capacity," which is a way of restricting competition and dampening innovation.
In many more countries, anti-trust is accepted government policy. An insurgent company with a
disruptive technology stands a better chance when monopolies are prevented from exercising
predatory behavior.
But the biggest factor may be that theres much more capital going around looking to finance the
next Google, Apple, or Amazon. Savings from pension funds are going to venture capitalists who
finance disruptive companies. Amazon.com, for example, disrupted traditional bookselling with
its online bookstore. It was financed by Kleiner, Perkins, Caufield, and Byers, a VC firm. .
Stock markets are also doing their part. Companies with a potential to disrupt an industry and
make lots of money for their investors are getting higher P-E (price earnings) multiples -- and
therefore cheaper cost of capital -- than tradition-bound companies with stable incomes.
Microsoft has a lot lower P-E than Apple although the former makes much more money.
Creative destruction or constant disruption, however, has a downside, apart from the capital
values that are destroyed in the disrupted company. Labor suffers, particularly those whose work
involves specialized skills. What if you were a linotypist in the old printing presses? Or the
machine operator of lathe machines being replaced by CNC (Computer Numerical Controlled)
machines?
This is why we must develop innovative social policies involving lifelong education and
retraining, portability of pensions, and other types of social insurance. Furthermore, we must
rethink our bankruptcy laws to facilitate a companys exit from an old industry and its possible
reincarnation with new technology.
Unless societies become communist, disruption will be a way of life. We must learn to live with
it.