The Entropy Principle: Why Companies Like Yahoo Turn to Crap

1:05 pm - October 28, 2010

Of all the half assed companies out there, I cannot for the life of me figure out WTF is going on with Yahoo. There are some companies that suck, but they do so in a way you almost understand.

- Barry Ritholtz

TBP has an interesting discussion going: Why Do Companies Like Yahoo Degrade & Implode?

Barry wonders aloud as to why YHOO “seems hell bent on destroying their own value as fast as they can, across all of their properties” — message boards, messenger, etcetera.

While other survivors of the dot com bubble have (for the most part) demonstrated focus and purpose, YHOO has given the strategic appearance of a handful of spaghetti thrown up against a wall.

Venture capitalist Paul Graham, whose startup was acquired by Yahoo in 1998, has a straightforward answer as to what did them in: “easy money, and ambivalence about being a technology company.“ (You can find Graham’s full piece on Yahoo here.)

In pondering what makes companies “degrade and implode,” I offered a slightly more philosophical view:

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This is an interesting question. What happens if you flip it around, though, and consider it from an entropy perspective?

Randomness tends to increase, not decrease. The energy of the universe tends to get dispersed.

Via the second law of thermodynamics, you cannot reduce randomness (decrease entropy) in one place without increasing it somewhere else.

How does this relate to Yahoo, or any other company? Simple: Being a great company is hard. To become great and stay great, you have to fight hard against entropic forces. It is much easier to simply drift into crappiness.

But for focused and sustained leadership, all companies would be crappy. And companies that temporarily became great by accident, or had greatness thrust upon them without understanding it, are far more likely to revert back to crap.

Yahoo, like Microsoft, enjoyed a tremendous outlier of timing and success many years ago, and has coasted on the inertia from that success ever since. But, lacking leadership, it has been unable to build on it. The total entropy in Yahoo has been increasing, not decreasing, because there has been no sustained leadership vision to fight that entropy.

Another way to think of it is to see all great companies like big sand hills in a mostly flat landscape. Normal entropic forces — wind, compaction, erosion etc — tend to grind those hills down. If you get a really huge hill (via outlier combinations of timing and chance), the grind-down process can take a while.

So maybe another way to rephrase the inquiry is, “What STOPS once great companies from degrading and imploding.” The answer being coherent vision, strong leadership, and a dedication to core principles that gave the company a sustainable competitive advantage in the first place.

It ain’t rocket science. But it does provide food for thought. To stop the entropic forces of randomness and mediocrity from taking over, you have to fight them with gusto — consistently and persistently, each and every day.

And for long term investors, this is why lack of leadership, coupled with lack of clear vision and strong execution, so often constitutes a “sell” signal for a once-great investment in a once-great name.

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