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Lingering worries about whether the recession is really over have combined with long-term changes in the structure of the economy to confound business leaders. Economists say the recession is over, but that doesn't mesh with many companies' front-line experience.
Corporate profits have yet to turn around. Unemployment reached 6 percent in April, the highest level in nearly eight years, giving rise to worries that consumer spending may begin to soften. Business leaders don't have the luxury of crafting elaborate strategies right nowthey've got to focus on what's essential. But just what is most important right now: paring expenses and scaling back initiatives or investing in new growth opportunities?
"Focusing to grow, paradoxical as it sounds, is often the right thing to do," says Chris Zook, a Boston-based director at the management consulting firm Bain & Co. Your company's competitive position in the industry is the crucial consideration. "The focus around a strong, dominant core business, even a core in a lower-growth industry, is a much higher probability event for achieving sustained, profitable growth than even a mediocre position in a hot industry."
Although there's fairly broad agreement about the wisdom of focusing on your core, figuring out what constitutes your core isn't always a simple exercise. "When we survey management teams, I'm always surprised by how much people can vary on this," says Zook. Nevertheless, it's the most important task your company faces. It has important implications for how much of your resources you reallocate to core businesses and how far away from your core you conduct experimental initiativesissues around which there is little consensus.
Focusing to grow, paradoxical as it sounds, is often the right thing to do. |
Chris Zook, Bain & Co. |
To carry out this task, you've got to sift through the past several years of business history, separating what's worth preserving from what needs to be jettisoned. And the stakes are extremely high, says Anita McGahan, professor and chair of the strategy and policy group at Boston University's School of Management. "Corporate profitability has declined for the past twenty years. There's not much room left to get strategy wrong" (see sidebar, "The Bar Just Gets Higher").
Against such a backdrop, the following insights should prove useful.
Boundary decisions are increasingly important
What are the exact boundaries of our core business? Do we have only one core? Where do we partner? Where do we buy? Where do we build? Such boundary questions must become "central to your discussions about strategy," says Don Tapscott, coauthor of Digital Capital: Harnessing the Power of Business Webs (Harvard Business School Press, 2000).
Debate rages over such questions, particularly when they have to do with mergers or acquisitions. "The record on acquisitions is extremely poor," says Zook, who is skeptical of most acquisitions because so few succeed and they distract from a focus on the core. "The odds of success are very low because ten things all have to go right." Assessing the likely merger between Hewlett-Packard and Compaq, he voices the worry that "H-P's crown jewelits dominant and highly profitable $22 billion printer businesswill be used to cross-subsidize the integration of two follower businesses in personal computers."
Tapscott is also skeptical, but primarily because of his disdain for vertical integrationthe involvement of a company in more than one stage of production, as when a steel company mines the coal and iron ore, ships the raw materials to its plant where they are converted first to pig iron and then to steel, and distributes the steel to the end customers. "Most acquisitions that destroy shareholder value are designed to support vertical integration," he says. "Acquisitions to build up the core don't necessarily enhance shareholder value, but at least they don't always destroy it."
Most acquisitions that destroy shareholder value are designed to support vertical integration. |
Don Tapscott, author |
McGahan agrees that successful growth often demands disciplined reinvestment in established core capabilities. But she believes that, in addition to your competitive position, you must also take the underlying rules of your industry into account. "What works in some industries does not work in others," she says. "For example, it would be lethal for the airline, overnight package delivery, and discount retailing industries to become less vertically integrated."
Not surprisingly, Debra Dunn, vice president of strategy and corporate operations at Hewlett-Packard, believes that acquisitions can successfully support a well-defined core, citing Johnson & Johnson as an example. In H-P's case, "the company was originally built around testing and measurement equipment and then it moved into the computer business," she says. The Compaq acquisition supports one of the company's two cores and helps that core develop in a rational way. This latter intention raises additional questions around which the experts seem to be more in agreement: How far away from your core can you place a strategic bet? And should your core stay the same?
Focusing on your core doesn't eliminate any possibility of experimentation, says McGahan, but you should "choose experiments that are most relevant to the core." For fifteen years, New York City-based Loral was one of the great growth companies in the satellite payload business. But then it invested about two-thirds of its capital in the Globalstar system to provide cellular servicea business it didn't understand. When the system collapsed, Loral went bankrupt.
Moreover, your core can and should evolve over time, but you need to understand "how far away and how large the bets are relative to your core," says Zook. The growth moves that tend to be most successful are "adjacency moves around a strong core business." And they eventually redefine the core: They add skills, capabilities, and new product segments, but they don't usually do it in one great leap.
Organizational design has new strategic significance
"Lots of thoughtful people have concluded that the Internet was not so important, that we just need to turn back the clock," says Tapscott. A return to fundamentals is not only necessary, they say, it provides a sufficient set of concepts and tools for understanding how to succeed in the new business environment.
"This constitutes throwing the Internet baby out with the dot-com bath water," Tapscott continues. "The Net is a medium of communication that's fundamentally changing the architecture of corporations. Throughout the twentieth century we had vertically integrated models. That's because, as the economist Ronald Coase explained sixty years ago, the costs of transaction, search, coordination, contractingbroadly, the costs of partneringtended to be greater than the cost of doing things within the boundaries of the corporation. But the Net has enabled the creation of an infrastructure in which such costs are dramatically lower."
In a big company the reality is your strategy is the way you spend your dollars every day. |
Debra Dunn, Hewlett-Packard |
Focus on what you do best, and partner for the rest. Moving forward, that's what makes sense for most companies, says Tapscott. The Zeeland, Michigan-based furniture company Herman Miller "has figured out that the very best furniture designers in the world are not furniture designers. They're industrial designers who also build motorcycles and space shuttles; some of them are artists." So the company has built a business web model in which it partners with these designers wherever they're located. And not only the design, but also the manufacturing is outsourced; as strategically significant as these functions are, they are not what Herman Miller does best.
"It used to be that competitive strategy was all about the internal challenge of either creating differentiated products and services or having lower costs," Tapscott continues. "The key to strategy now is architecting capability: How do you orchestrate capability to have lower costs or continually create better products and services? If you stick with the old model, you're going to fail."
Adopt a shorter planning horizon. The windows of opportunity close more quickly these days. "In a big company the reality is your strategy is the way you spend your dollars every day," says Dunn. "If you're locked into a long planning horizon and a long budget cycle, it's very difficult to have the adaptability you need."
The fundamentals still apply. "The foundations of strategy have not changed in the past five years," says McGahan. "The principles that an organization uses to articulate how it's going to translate its work with employees, partners, and suppliers into valuable offerings ... that will bring a profit in the market are still valid."
The mistake that most dot-coms made, says Tapscott, is that "they tried to create indirect value. They weren't focused on real value propositions for end customers. Instead they were simply advertising to capital markets and analysts." And they also succumbed to the "flawed thinking of profitless prosperity," says Zook. You simply can't shy away from the search for profitabilitysooner or later, the bill comes due. Take a cue from Dell Computer, Zook suggests: this company requires its new initiatives to achieve genuine profitability within eighteen to twenty-four months.
Consciously manage trust and transparency. In a business web, the partners typically know one another's costs of labor, materials, and overhead, as well as their profit margins. "Everybody's naked," says Tapscott. "There's a high degree of transparency." Customers and investors are also calling for greater transparency; companies are being held to a higher set of values, and "trust has become a much more valued commodity," says Dunn. Integrity must become an element of strategy that you actively manage.
"In an open world, a company's behavior and the real value that it has to offer will matter more and more," Tapscott continues. "You have to manage your transparency so that people can see who you really are, as opposed to trying to convince people that you're something you're not.
"But at the same time, how open should you be? Clearly, you've got to be way more open than in the past. But at a certain point, there are diminishing returns: You start giving away your intellectual property and enabling opportunism. For this reason, a transparency management program needs to be part of your business strategy."
The Bar Just Gets Higher
How hard is it to be successful these days? Consider the following:
"This is the worst recession the U.S. has seen since World War II in terms of profit declines and bankruptcies," says Darrell Rigby, a Boston-based director at the management consulting firm Bain & Co. And although the current downturn has been mild in terms of its effect on GDP and unemployment, "in terms of layoffs, it's the worst in U.S. history."
"Long-term fundamental trends in the world business environment are making profitable growth harder to find," says Bain director Chris Zook. "Even in the midst of a synchronized recession across seven economiesthe first one of that nature we've had in thirty-five yearsexpectations for profitable growth are as high as we've ever seen in any recession. Right now, an average of all the analysts' forecasts for earnings over the next three years for the S&P 500 is still slightly over 14% annually, which is quite remarkable given that only 13% of companies worldwide achieved 5.5% real growth in earnings over the past ten-year period."
The penalties for underperformance are greater than ever. Miss your earnings targets, and investors are much more likely to dump your company's stockand boards are much more likely to dump your CEO. Indeed, the average CEO lasts only four or five years, says Zook.