Theory of the Business

I recently read an old article by Peter Drucker titled "The Theory of the Business."  Even though it was written in 1994, the major concepts are still very valid.  I thought it was interesting so I will share some of the main ideas:

A company's "theory of the business" is essentially the assumptions about what the company gets paid for.  These assumptions change over time to the extent that the realities that each organization actually faces change quite dramatically from those that company assumes it lives with.

A theory of business has three parts:

1. Assumptions about the environment of the organization:  society/structure, market, customer, and technology (these define what an organization is paid for).
2. Assumptions about the specific mission of the organization (these define what an organization considers to be meaningful results).
3. Assumptions about the core competencies need to accomplish the organization's mission (these define where an organization must excel in order to maintain leadership).

In order to be a valid theory, these specifications must meet certain criteria:

1. Assumptions about environment, mission, and core competencies must fit reality.
2. Assumptions in all three areas have to fit one another.
3. Theory of the business must be known and understood throughout the organization.
4. Theory of the business has to be tested constantly.  

Eventually, every theory of the business becomes obsolete and then invalid.  It is important to recognize this.  When a theory starts showing the first signs of becoming obsolete, it is time to start thinking again about which assumptions are no longer valid.  It is also important to build systematic monitoring into the organization, in order to test the theory.

As an investor, I would like to see the businesses I'm investing in or thinking about investing in use a framework that includes some or all of these ideas.