Natural selection explains how businesses respond to changes in their environment just like it explains how organisms adapt to environmental changes. Natural selection in the business world seems to be as cruel as natural selection among biological species since many organizations cease to exist.

From day to day this concept might seem crazy. From one day to the next, organizations change very little, and most do not get liquidated on any given day. However, over time they dramatically alter the way they function, and those that don’t are often liquidated. Businesses, just like species, are not permanent. In fact, while it is difficult to see adaptive changes in species as they take many decades, the adaptive changes that an organization goes through can be observed on an annual basis.

Business may be more cruel than nature. If you were presented with a list of companies which formed the Dow Jones Industrial Average 100 years ago, you will see mostly unfamiliar names. Most of the companies on the list have either become less prominent, have gone through liquidation, or have been acquired by other firms. Business organizations do not remain on top for very long, especially if they do not adapt with time.

Who are the winners of this natural selection? Organizations that are the most efficient in using resources tend to beat firms that do not. Firms which attempt to charge more than other firms for identical products will have no sales. Firms with lower costs will drop their prices below the prices of other firms to steal their business. This is price competition, and it is how firms that can offer products at lower prices than less efficient firms eventually drive them out of business.

In a market for identical goods, this price competition is very vicious and forces firms to innovate to lower costs (or find new markets where there are no competitors).

It should be noted that organizations which create differentiated products have a chance of avoiding direct competition. This kind of competition between somewhat different products is called monopolistic competition, in which firms use differences in location, product or other attributes to offer a unique product.

Many organizations have strategies to prevent other organizations from producing identical products. A strategy like this is sometimes referred to as an “economic moat” or sustainable competitive advantage. Many forms of intellectual property such as brands, trademarks, copyrighted material and patents are economic moats that make direct competition illegal. Violation by using intellectual property without permission is grounds for litigation.

This is in contrast to companies which produce commodities. Commodities are fungible, meaning that each unit is not meaningfully different than the next. For example, a kilogram of copper is the same as another kilogram of copper as far as a buyer is concerned. Two bars could come from different mines and could have been smelt in different ways, but they are valued only by mass and purity. Commodity producers must accept the market price and have no way to demand more than their peers for fungible products.