De Geus’s Law

Written by

Sergio Caredda

Posted on

September 18, 2024

Edited on

September 18, 2024

De Geus’s Law and Organizational Design

The observation of De Geus can be linked to a number of features of a system or an organisation, that we should consider in terms of organisation design.

1. The Danger of Short-Termism

De Geus’s steps outline a common pattern in many organisations that shift from a holistic, adaptive approach to a rigid, short-term focus on financial returns. This approach often leads to cuts in essential areas, such as research and development, employee development, and innovation. While this might boost short-term profitability, it undermines the long-term adaptability and resilience of the organisation.

Example: Many companies that have shifted to cost-cutting across the board, often under pressure from shareholders, have seen a decline in innovation, employee morale, and long-term viability. This pattern is particularly noticeable in companies that downsize heavily, outsource core functions, or divest key assets to meet short-term financial goals.

2. “Trimming Assets” vs. Investing in People

One of the key insights from De Geus’s work is the idea that organisations are “living” entities, with their primary assets being people. By indiscriminately “trimming assets” to meet financial goals, organisations risk weakening their core human capital—one of the most crucial aspects of long-term success. A short-term focus on profits often leads to layoffs, loss of institutional knowledge, and a breakdown in organisational culture.

Example: Companies that slash employee training and development programs in favor of short-term cost savings often find it difficult to recover their lost talent and experience when the business environment stabilises or demands growth again.

3. Rigid Financial Targets vs. Organizational Flexibility:

De Geus warns against the imposition of rigid financial goals, such as a specific return on capital employed (ROCE), that drive a one-dimensional focus on financial metrics. Such goals can result in actions that weaken the organisation’s long-term ability to adapt to changes in its environment. In complex organisations, flexibility and the ability to adapt to evolving market conditions are critical for survival.

Example: Kodak’s collapse is a well-known case. Even though they were pioneers in digital photography, a rigid focus on their profitable film business (without enough investment in digital) meant that they missed the market shift toward digital cameras. By prioritising short-term profitability, they were unable to successfully transition to new technology and ultimately filed for bankruptcy.

Reinforcing References to De Geus’s Law

The concept behind De Geus’s Law is shared by a number of management writers and practitioners. But is also sustained by a solid scientific literature. Although the 12 months rule expressed in his observation needs to be taken with a pinch of salt, the concept of short termism as a factor of organisational failure, holds off to the scrutiny of most.

Management Literature

Several other theories and observations in organizational design and management literature reinforce De Geus’s warnings about the risks of focusing too narrowly on short-term financial gains.

Already Peter Drucker warned management about Short-Termism in his Practice of Management (Drucker, 1954). He argued that organisations that focus too much on quarterly profits at the expense of long-term goals, innovation, and adaptability are setting themselves up for failure.

Michael T. Jacobs in his book Short-Term America (1991), analysed how American businesses has increasingly shifted toward short-term financial goals, often at the cost of innovation and long-term investment. Jacobs argued that this short-term focus is driven by market pressures, but that sustainable success requires companies to resist these pressures and focus on long-term value creation.

Also Collins and Porras in their Built to Last insist on the value of focusing on long-term vision, core values, and adaptability, rather than purely financial objectives (Collins and Porras, 1994). Collins’ distinction between “clock builders” (leaders who create sustainable organizations) and “time tellers” (leaders focused on short-term success) reinforces De Geus’s argument for building long-term, sustainable companies.

John Kotter’s view of Change and Leadership is also focused on empasizing the importance of long-term strategic vision and the risks of pushing for quick wins or short-term goals without considering the broader implications for organizational health. He highlights the need for balancing short-term financial pressures with the need for long-term adaptability and resilience (Kotter, 1996).

Finally, there’s definitely a link with tje The Law of Constraints which also indirectly reinforces this idea. It points out that focusing on local optimisations—such as cutting costs or trimming assets without understanding the systemic implications—can actually harm the overall health of the organization, leading to bottlenecks and reduced performance in the long run.

Academic Research

There are several references also in the scientific and management literature that discuss the dangers of short-termism and how a focus on immediate financial returns can undermine long-term organisational viability. Arie De Geus’s insights align with many studies and discussions on organisation design, strategy, and leadership.

Witzel and Jonsson compiled a milestone research in 1989 on the concept of Decline in organizations, reviewing literature and suggesting a framework. Among the factors, they also identify strict adherece to financial cost targets as one of the factors contributing to decline, especially if this is coming at the expense of adaptability and innovation.

In an often cited article on the Academy of Management Review, K.J. Laverty (1996) examines the concept of economic short-termism in management practices and its implications for organisational performance. It highlights the tensions between short-term financial goals and long-term sustainability. The study emphasises that an excessive focus on short-term returns often leads to underinvestment in areas like innovation, talent, and long-term strategy, resulting in negative outcomes for organisations in the long run.

Laverty’s work is further expanded by Marginson and McAulay in 2008, who provide further demonstrations of the issue. They explore the phenomenon of managerial myopia, where executives make decisions aimed at boosting short-term earnings, often at the expense of the organisation’s long-term success. The authors argue that this behavior is driven by pressure from shareholders, the financial markets, and internal performance metrics that emphasize immediate results over long-term value creation.

Rappaport in 2005 examines the detrimental effects of short-termism applied to behaviours of investors and advisors, showing that even when financial measuring tools such as Discounted Cash Flow (technical a forward looking indicator) are used, investors tend to have a bias towards short term results (such as quarterly earnings), creating negative loops of reactions in managers which are incentivised on stock-related performances.

This are of course only some of the articles in academic literature, but there is definitely a body that shows the negative impact of “short-termism” in business and organisations, which are often embodied in the concentration on short-term financial targets.

A Long-Term Perspective on Organisation Design

Arie De Geus’s insight resonates deeply in today’s business environment, where many companies are under constant pressure to meet quarterly earnings targets. While this focus on short-term financials can satisfy investors in the near term, it often undermines an organisation’s ability to innovate, learn, and adapt over time. This is particularly dangerous in industries where rapid change is the norm, and long-term success requires continuous learning and adaptability.

Organisations that follow De Geus’s three steps—focusing narrowly on profitability, trimming assets across the board, and rigidly sticking to this plan—risk stripping away the very things that made them successful in the first place: their people, culture, and ability to innovate.

The “Laws of Organisation Design” Collection. This article belongs to a series focused on the different principles and laws that govern organisational behaviours, decision-making and group work, and that should be taken into account in organisation design projects.

The Laws of Organisation Design

Conway’s Law and Intentional Design
Parkinson’s Law
Law of Triviality
Goodhart’s Law
Brooks’s Law
Hackman’s Law
Larman’s Laws of Organizational Behavior
De Geus’s Law 🆕
Metcalfe’s Law 🆕
The Law of Constraints 🆕
The Pareto Principle 🆕

Law of Requisite Variety
Law of Alignment

Conclusion

In organisational design, De Geus’s Law emphasises that prioritising short-term financial gains over long-term sustainability can lead to the rapid decline of even the most resilient companies. This principle is reinforced by a broad body of literature in management and organisational theory, including works by Peter Drucker, Jim Collins, and several academic research, all of whom argue that long-term adaptability, learning, and flexibility are crucial to an organisation’s survival. Organisations that over-focus on trimming costs and meeting financial targets at the expense of their culture, talent, and innovation capabilities risk undermining their ability to thrive in the long run.

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Cover Photo by Jack Anstey on Unsplash

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