Over the next decade, 25% of the companies that exist today will disappear, either because they will merge with others or go bankrupt. In an interview with Universia-Knowledge at Wharton, Chris Zook, director of global strategy at consulting firm Bain & Co., discusses the key factors that will allow companies to survive the challenges of increasing their presence in the global marketplace. His ideas are presented in a book titled, Unstoppable: Finding Hidden Assets to Renew the Core and Fuel Profitable Growth. The book will be published in Spain this month.
Universia-Knowledge at Wharton: What are the main problems that companies face when they try to grow?
Chris Zook: Most companies aspire to aggressive growth targets, but very few –only one in ten worldwide — achieve more than a modest level of sustained and profitable growth, which we define as: 5.5% real revenue and profit growth…
Bain’s growth research has shown that successful strategies naturally move through a cycle from focusing on the essence of their competitive advantage, their “core,” to expanding into new “adjacent” markets or businesses, and finally, the most difficult stage, to redefining their core. In my most recent book on growth, Unstoppable: Finding Hidden Assets to Renew the Core and Fuel Profitable Growth, [I discuss] the main problem that we see today, which is that industries are becoming more turbulent at a faster and faster pace. This means that the most profitable activities in an industry are shifting more quickly, and that competitive differentiations are becoming harder to maintain. Because the cycle is speeding up, huge risks emerge from misjudging where you are in the cycle.
UKnowledge at Wharton: What have companies done to get to this point?
Zook: Companies are at different stages of their life spans and not every company is undergoing a crisis in the core that requires redefinition. One of the most difficult decisions a company can face is whether to remain focused on extracting full potential from the core business or, instead, to begin the search for hidden sources of new potential. Knowing your company’s coordinates on a Focus-Expand-Redefine (F-E-R) cycle is the first step when it comes to making correct and well-timed decisions that improve the odds of sustaining or renewing profitable growth.
Each stage of the F-E-R cycle requires a different set of strategic principles that companies must follow. Profitable growth starts by rigorously defining the core business — knowing how it differs from your competitors. During the Focus phase, there are three keys to success: core business definition, consistently lowering your cost position and discouraging competitors from investing in your core. Doing these three things right results in what Bain calls “full potential.”
As companies begin to reach full potential in their current core, three new imperatives emerge in the Expand phase: first, developing a repeatable formula that allows you to replicate your competitive differentiation in businesses or markets that are outside your core; second, investing in bringing that formula to new geographies, new customer segments or new channels; and, third, avoiding over-expansion by recognizing that the odds for success decline when you try to expand too far from the core.
Finally, as the pace of turbulence and change continues to accelerate, companies will find their strategies for growth reaching a natural limit much earlier in their history. As companies expand globally, they become more established, but also more complicated. You accumulate customer segments, business platforms and capabilities whose value you do not immediately recognize.
UKnowledge at Wharton: What are the solutions for each one of these main problems?
Zook: Successful redefinitions are based on “hidden assets” — customer assets, growth platforms or underutilized capabilities which suddenly assume a center role in how you look at your business going forward.
The most common kinds of hidden customer assets are undervalued segments, untapped influence over your customers and underexploited customer insight. Changing the lenses you use to view your customers can change your sense of what’s possible. For instance, Harman International went from impending crisis to a nearly 40-fold increase in market value by changing its customer strategy to focus on automotive OEMs and home entertainment consumers. The OEM business was less than 10% of the company at the low point for Harman. Today, it accounts for 75% of revenues and more than 90% of profits. De Beers was able to transform itself from a mining company by tapping its brand power to gain access and influence to customers. Underexploited customer insight often comes from major databases that allow you do data mining, create new algorithms and actually redefine your business model. FedEx, Amazon.com, Wal-Mart and American Express have each found new ways of using customer insight to change their customer model and redefine customer relationships that fuel further growth.
The second type of transformative hidden asset is undervalued growth platforms. In some cases it’s an orphan product line that that has been neglected in support of the core over time, or an internal support function that becomes extremely strong over time. For example, PerkinElmer sold optical technical measurement equipment to industrial and scientific labs around the world, going back to its founding in the 1940s. Scattered throughout the catalog was a series of important, successful life science products, particularly some relating to the burgeoning market for the study of the human genome and gene sequencing. So the company combed through the catalog and separated products out into a business unit that it called applied bio-systems. It ultimately renamed the entire company Diplara, which was about 25% the size of the original core business. Diplara has now grown to be significantly larger than the original PerkinElmer.
Capabilities are the third and most hidden form of underexploited assets. Capabilities are the equivalent of the elements in the periodic table of business. The most fundamental thing to businesses is how they get specific tasks done. That comes down to capabilities. When you look at the root cause of a company’s competitive advantage, you often drill down through a whole series of things — such as lower cost and greater innovation — ultimately hitting an elemental stage where the essence of the competitive differentiation of the past or of the new model of the future is in capabilities. The most publicized instance of that today is Apple. Its once-successful core was gradually shrinking and eroding in a very difficult neighborhood — the worldwide computer market. But it did have the opportunity to launch a foray into music, which utilized capabilities that had always been central to Apple’s core — design and user interface. It combined these capabilities with new elements to create a business based on digital rights management and a massive web site with millions of downloads a day, which you now see in iTunes. All of those capabilities have come together to form a new core, which has become the basis of enormous successes — most recently, the launch of the iPhone.
UKnowledge at Wharton: What steps can a company take to avoid reaching the point of stagnation?
Zook: It is something of a paradox that increased turbulence can lead to increased stagnation, but in many ways, this paradox is simply one of the natural laws of business. Most forces of turbulence are macro-level forces that companies cannot avoid or ignore. Bain has identified seven key trends as root causes for much of the turbulence in global business today:
· Faster movement of information — on everything
· Speed of capital formation
· Emergence of China and India, and their disruptive impact
· Reduced capital intensity among the most profitable new industries
· Increasingly rapid movement of executives among companies
· The rise and impact of private equity firms
· Speed of overall technology cycles
If you look at the processes through the lens of “Focus-Expand-Redefine,” you see the value of achieving a deep understanding of your current core customers and competitive advantage. It intensifies your focus as well as opens your lines of sight into the potential of hidden assets. Operational excellence and low-cost economics are another foundation on which you build both your core business and your new businesses.
What does not work is waiting too long to respond to changes in the profit pool or to acknowledge an extended period of stalled growth. Instead, that path leads to situations of intensified confusion and even desperation. The best way to maintain balance is to understand your core and to plan for your next wave of growth no matter where you are in the cycle.
UKnowledge at Wharton: Do you think today’s large multinationals will remain the same 10 years from now?
Zook: To put it simply, no. Bain conducted an extensive analysis of change in the Fortune 500 over the past two decades. We found that 153 of the top 500 companies in 1994 either ended up in bankruptcy or were acquired and integrated into another company. An additional 130 had made fundamental changes in their core strategy. Only one in three survived intact.
Overall, the facts are quite sobering:
· Only 1 in 10 companies achieve sustainable growth over a 10-year period.
· Business life spans have plummeted to an average of 14 years.
· CEOs are leaving their jobs twice as often as in previous decades, with today’s average tenure only four years.
· The average period an investor holds a share of common stock has decreased from about eight years to eight months.
· Market leaders are more quickly losing their lead positions.
· Product lifecycles in many industries have shrunk by 70% or more.
In the next decade, we expect the survival rate to approach only one-in-four, as major global forces accelerate the pace of change.
UKnowledge at Wharton: Could you give two examples of large companies that have their future assured, and another two that, according to your criteria, will have difficulties reaching 2017?
Zook: Three decades ago, only about 20% of industries could be described as turbulent. Today we estimate it to be 62%. Industries where we saw the most extreme turbulence in our research include: Automobiles & Parts, Banks, Technology Hardware & Equipment, Software & Computer Services, Airlines and Media. Overall, I actually see a very level playing field — challenging, but level. I don’t see any guaranteed outcomes for specific companies, but what I do see are some very consistent patterns for success.
Most strong businesses have many options for investing in expansions or new businesses. The real question is which to pursue, and when. But the right choices depend on making a logical adjacent move. We have seen consistently that the best sustained-growth companies develop a repeatable format that works in new markets, new channels or new geographies. More than 80% of the best ideas come from drilling down into the core customer rather than looking outside for ideas.
We found that 85%–90% of companies that successfully redefined themselves were able to increase the odds of success by a factor of 5 to 10 by rescuing hidden, undervalued assets buried in their business. Last gasp attempts to redefine through big moves, through distant adjacent moves, big mergers or movement into hot new markets — all of these paths are fraught with dangers when you look at the odds of success over the last 10 years. You can succumb to the urge to leap to a hot new market from your core, but the odds of success we found statistically are less than 10% — closer to 5%.
So, while, as I have said, there are no guarantees, companies can raise their odds by investing in the appropriate strategies for focusing, expanding and redefining their core.
UKnowledge at Wharton: Where will large firms find more customers? Are low-income consumers an alternative?
Zook: Lower-income consumers can be considered an untapped segment, provided you have the insights to deliver products and services that meet real demand, and provided you can meet that demand in ways that are both profitable and sustainable. There are also many other sources of untapped customer value. Emerging markets, or segments within mature markets, can offer attractive profit pool characteristics that are not immediately apparent. Sometimes, too, companies can be surprised that some of their existing core customer segments offer forgotten potential. And finally, it is often the case that companies have not yet truly segmented their customers in a way that allows them to target customer demand more effectively.
Asking about customers seems like a logical conclusion for this interview. I end Unstoppable with three principles of self-awareness that are critical for companies searching for profitable growth and for the assets that will help them avoid extinction: If you do not know yourself, it is difficult to judge what you should become; if you do not know where you are, it is difficult to decide where to go and how; if you do not know what you are really good at, it is tough to know what to do. In very simple terms, understanding your core means understanding who your customers are and what your business is good at doing.