Richard Foster is a senior faculty fellow at Yale University and a director of athenahealth. He is the author of Creative Destruction (2000) and Innovation: The Attacker's Advantage (1986). He was a senior partner and director of McKinsey & Company for more than 20 years.

Austrian economist Joseph Schumpeter's "gales of creative destruction" are certainly blowing this year and many companies will be taken under by this storm. Perhaps more importantly, the great companies of the next decade or two will be born during this same period, filling the void left by those departing with more effective and efficient products and services.

This has always been the way. This will continue to be the way. Emerging from the crisis of 1974 in the US were The Limited, The Gap, Home Depot and Wal-Mart, all discount chain stores, which were far more cost effective than dying department stores.

The benefits for consumers and investors from these companies which were innovating more in the way they put their "business system" together than in their products were substantial. The Limited for example, earned returns of 52 per cent per year for the 15 years between 1974 and 1989. A $10,000 investment in The Limited in 1974 would have returned $4.6 million in 1989.

Innovators win because they do not have to dispose of the legacy costs of the current market leaders. Disposition of these legacy costs is both time consuming and difficult for incumbents. As the incumbent wrestles with these problems, innovators grab market share and eventually dominate the industry. Of course, not all innovators win, but the winners are always innovators.

Winners and losers

Looked at over very long periods of time, what one sees is not a pattern of "excellent companies" all knowing, all seeing, all wise corporations with the advantages of scale and scope winning in one competitive battle after another, but new companies replacing existing ones as the factor costs of production continually shift.

Rather than a pattern of "operational excellence" as the distinguishing feature of winning competitors, one sees patterns of great waves of creation, operation and trading within the markets. Of course the trick for individual companies is mimicking this market success at the pace and scale of the market without losing control of their operations. Few companies are up to this challenge. Those who are, win.

This will be the case in IT in the decade ahead as cloud computing and software-as-a-service (SaaS) companies increasingly displace existing competitors. It is not that SaaS companies are smarter (although they will tell you they are), but that they do not have to slough off the legacy costs of their larger and more richly-financed competitors. Sloughing off old costs is very hard (that is, expensive and slow), often because it means "sloughing off" old skills e.g. the engineers who built the existing giants. 

Consider Polaroid, one of the Nifty 50 during the 1970s. It was not able to make the transition to digital photography even though they clearly saw it coming. The issue was what to do with hundreds of very skilled, very loyal chemical engineers who built the place.

Moreover, new products often require new manufacturing systems and new sales distribution channels. Bringing together new talent, new tools and new distribution channels is hard enough by itself. Having to do this while simultaneously getting rid of formerly-productive employees and well functioning but obsolete manufacturing equipment, as well as shutting down old channels of distribution, is often overwhelmingly difficult. So difficult in fact, that the defence strategy rarely works in the long run.

Investing in innovation

The difficulty in innovating is not so much in coming up with the "killer app", although that is tough enough. The difficulty is in justifying using the available incremental resources to develop, build and distribute a new product line that will, perhaps, replace existing product lines and suppliers and distributors. This decision to "destroy" (or trade) is often as a practical matter far more difficult than the task of envisioning what the future might look like.

It is far simpler to start a new company with new capital from investors who do not have legacy costs to protect, than it is to go into competition with an existing product line which will eventually have to be written off. Or so it seems, until the day when the suits show up to inform you that they own the majority of your stock. It all happens so quickly at the end.

It will be that way this time, too. The financial industry is likely to be completely restructured. Bear Stearns, Lehman and WaMu are well known examples but on the other side, Goldman Sachs is now a commercial bank. What could be more surprising? Many will certainly want to have Goldman Sachs cheques and credit cards, but who could have imagined even six months ago that could ever possibly happen?

The insurance industry will also be restricted as AIG has demonstrated; it is possible that new companies dedicated to trading collateralised debt obligations over newly established exchanges will become quite powerful. The hedge fund industry will have to learn how to operate in a more transparent way, and that will change their trading strategies dramatically.

Agriculture will also likely change as the price of commodities continues to remain volatile. Companies which are not backward integrated into commodities trading may well have a very difficult time competing against those companies whose trading abilities give them a cushion from the increasing volatility of commodities prices.

Obama's big changes

And so "creative destruction" in its own way will affect agriculture, food distribution and undoubtedly our diets. Healthcare will also change, as the Obama administration changes the very structure of the industry.

Small biotechnology firms will come under increasing pressure to be integrated into large pharmaceutical companies. Hospitals will have to learn to survive, and pay their doctors well (40 per cent of all primary care physicians would like to leave medicine one survey reports) with even more Medicare and Medicaid patients than they have now, and even more restrictive payment regulations (e.g. hospitals will have to pay for the cost of their own errors).

The Obama administration has also said that it wants to see an improved healthcare IT infrastructure in place within the next five to 10 years. The game is certainly worth the prize. Some say that the gap between the cost of the US healthcare system and that of other countries is due, largely, to the much bigger costs of administration. If this is true, then healthcare IT may be the highest leverage tool the US has for bringing its healthcare costs into line with the rest of the world.

Who will provide the new systems will it be the dominant players in IT? Or recent start-ups, who are growing rapidly as they're meeting the real needs of doctors, hospitals and patients in a more cost effective way? Perhaps history has an answer for us. History suggests that despite the scale and market power of the incumbents the advantage is with the attackers. On and on the changes will come. The age of creative destruction is still before us.

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