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Creative Destruction in Economics – why standstill means regression

“Creative destruction is the basis for innovation, entrepreneurial growth and prosperity,” according to the economic philosophy of Joseph A. Schumpeter, an Austrian economist in the first half of the 20th century. What sounds contradictory at first glance becomes clear at second glance. But let’s start at the beginning. Much more about innovation and approaches to innovation you will find in our brandnew FREE book “How to Create Innovation”. Register for the download now!

Creative Destruction definition and history

Joseph Alois Schumpeter is an Austrian economist and social scientist. He was a professor since 1909, among others in Graz (1911 to 1919), Bonn (1925 to 1932) and since 1932 at Harvard University. Schumpeter developed a theory of the economic development of the capitalist economic system, which he explained by intra-economic changes. These changes are based primarily on “dynamic entrepreneurs” who push through innovations, achieve pioneering profits and bring about the economic upswing. This process of “creative destruction” enables growth and technical progress. Schumpeter thus made an important contribution to business cycle theory. However, he also feared the end of capitalism, as the innovative process would weaken, primarily due to bureaucratization in companies and an increased role for the state. Schumpeter is considered one of the most influential economists of the 20th century.

What is Creative Destruction?

Creative destruction sounds pretty harsh at first. But what is it all about? The term goes back to the Austrian economist Joseph Schumpeter. He coined it in the first half of the 20th century. The economist believed that creative destruction is the basis of entrepreneurial growth, prosperity and innovation. Hardly anyone doubts that innovations are important for economic growth. But how can an innovation come about in the first place? And what happens when the innovation is there? The old is destroyed, must perish and make way for the new. Although Joseph Schumpeter was referring to national economies, the model of creative destruction can also be applied to many other areas. The development of services, products, technologies and methods can be explained by this model.

Read also our article about the connection between creativity and innovation.

The term “creative destruction” was coined by economist Joseph Schumpeter. Creative destruction is the destruction of old markets and those active in them through innovation. This can be new technologies, methods, business models, services or products. 

In the first half of the 20th century, Joseph Schumpeter came to the conclusion that markets and economies do not develop statically, but that dynamic development takes place. Individual products or services are therefore not improved and refined in small steps, but innovative ideas are the fuel of the market economy. Innovation and risk-taking can be important keys to success for companies. According to Schumpeter, creative destruction is the driving force of capitalism. Creative destruction ensures that there can continue to be growth and progress and that we can generate sustainable wealth. From this, we can conclude the following:

  • If companies are willing to constantly question their business model and adapt it if necessary, they have a better chance of remaining active in the market.
  • Newly founded companies and start-ups should be given special support, as innovative ideas often come from new market participants. These do not have to take into account already established products and existing markets.

Standstill means regression

“The new”, according to Schumpeter in his book “Capitalism, Socialism and Democracy”, allows for erratic, radical and dynamic development. Many companies, however, try to manifest stability and plannability as basic principles. It may be in the nature of man to strive for stability and to avoid change.

From a business perspective, however, this is tantamount to standing still and insisting on the status quo. In an economic system characterized by competition, this leads to other companies that continue to develop moving past and strengthening their competitive position.

If you want to develop, you need more. This “more” is the “creative destruction”. “Creative destruction” in this context means:

  • to question the status quo and to improve permanently
  • to create something “new”: the “old” faces competition and disappears. “New” refers not only to products and inventions, but also to processes, methods, procedures, …
  • the “new”, the innovation, changes everything that was before (for the better) and brings about further and far-reaching changes
  • these changes have an impact on many companies, create new jobs, new business models, technologies and industries or more generally formulated:

Creative destruction = the better is the enemy of the good

Creative Destruction - Innovations Mean Opportunity and Risk

Innovations and changes are not always welcomed joyfully by many people. We like to stick with the tried and true. We like habits and are happy to persist if it feels good so far. However, without development there is no further growth and capitalism is built on this. If a company has a product that is actually doing well in the market and then rests on it, it can quickly be overtaken by competitors. The competitor’s product offers something completely new. Of course, the competitor doesn’t know whether this will be well received. For this reason, innovations are always a risk. They are part of the entrepreneurial risks that you have to take if you want to survive as a company in the long term. If a company manufactures carriages, even if they are the best, most beautiful and even cheapest carriages available, this does not benefit the company at all if the competitor brings cars onto the market. The carriage manufacturer can invest as much as he likes in advertising and marketing, he will simply be overrun by the car manufacturer. It is therefore important for managers to allow innovations and take risks time and again. Entrepreneurial thinking and action do not involve simply accepting every risk, but analyzing them and proceeding in as controlled a manner as possible. In today’s fast-paced world, where change is the order of the day, companies must also adapt. Either they simply react to these changes, or they try to actively shape the market. The concept of creative destruction is therefore more relevant to modern companies than ever before.

Creative Destruction Examples

The following are some creative destruction examples of immense value creation:

  • The printing of books ensured that knowledge could be disseminated and enabled education of the population
  • The record player has been replaced by cassettes, cassettes by CDs, and CDs by digital offerings
  • Automobiles have displaced carriages. The automobile provides mobility (and created gas stations)
  • Analog photography has been almost completely replaced by digital innovations for photography 
  • The railroad ensured the settlement of larger areas and faster communication
  • In the future, cars with gasoline or diesel may be replaced by electric cars and autonomous driving
  • Assembly line work was a process innovation that lowered the cost of cars

These creative destruction examples show that often, not only the old products disappear from the market, but also their manufacturers. However, there are always companies that recognize the current trends and adapt accordingly. Those that manage to adapt in this way often also succeed in continuing to secure market share.

Especially in recent times, under the keyword “disruptive or innovative technology“, many examples can be found:

  • The Internet, of course, which is changing pretty much everything we know – from television to social interaction (and also made publication formats like this blog possible in the first place)
  • Mobile telephony and smartphones changing the telecommunications industry and creating something like “apps”
  • Peer-to-peer data exchange was ultimately the basis for the digitization of the music industry
  • and many, many more that you can find in our article on disruptive innovation examples

Conclusion on Creative Destruction

Creative destruction teaches us that we should generally place more emphasis on competition and market mechanisms in our economy. Overregulation by politicians must be avoided. Companies should be allowed to develop. Innovations are always a risk, but they also offer a great opportunity to help shape future markets. Those who do not develop further, do not take risks and do not dare to innovate will probably not be able to survive in the long term. In this context, there are of course also many examples of innovation flops.

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