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How Companies Evolve

When considering the three waves that companies pass through, it's important to remember that the third wave is not synonymous with stagnation or decline. While third-wave growth might not be as dynamic as earlier-stage development, it doesn't have to mean a company is simply waiting to die.

For a look at the third wave done right, check out Berkshire Hathaway(NYSE: BRK.A). It's a third wave company managed and run quite well. Warren Buffett has assembled a collection of predictable, sustainable businesses like See's Candy and GEICO that produce consistent profits year after year.

The mandate of each business unit at Berkshire is to continue doing what has worked well in the past, while the job of upper management is to invest those profits in whatever new endeavors will produce the greatest additional revenue streams in the future.

Growth by acquisition is normal for third-wave companies, and there's nothing wrong with that. See's Candy has been a West Coast based operation for decades, and it makes a boatload of money every year without having to expand into new territory. Buffett has the option of investing money in See's to push into fresh markets and muscle out the competition but has not chosen to exercise it.

Instead, "Berksure" has used the profits from See's to grow Berkshire as a whole by buying profitable and predictable future revenue in the form of businesses like Dairy Queen. Warren Buffett simply considered buying Dairy Queen a better investment than reinvesting the money in an existing business unit. Berkshire Hathaway is not a dying shell: It's a thriving and growing business surrounded by opportunities.

Healthy third-wave companies grow by acquisition all the time, often making headline news. General Electric(NYSE: GE) bought NBC television. IBM(NYSE: IBM) bought Lotus Development. These are just two examples of the hundreds of businesses purchased each year by third-wave companies looking for a place to invest the profits from their existing business.

When these companies have cash to spend, they invest it in a "sure thing" -- or at least the most stable and predictable investment they can find: an existing, healthy, and profitable business. Even when third-wave companies are still capable of forwarding second-wave, or growth-stage, agendas within their individual business units (such as IBM's growth of its services division), they're still attracted to predictability and love acquisitions for this reason.

They can see what they're getting, they know exactly what they're paying for it. And they know what they're buying is already a success, as long as they can avoid screwing it up.

Author Eric Raymond once noted that executives at Fortune 500 companies aren't primarily motivated by increasing profits, but by reducing risks. This is what third wave companies are all about. The first wave is about creating something new. The second wave is about exploiting the opportunity to grow. The third wave is about holding territory. Once the pioneers have found the place and the settlers have made it livable, the farmers move in and make it pay year after year after year. The best metaphor for a healthy third wave company is probably sustainable agriculture. The frontier may be exciting, but it's not where most real money is made.

Continue to Part 3: Managing Commandos »

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