How would you define the main premise of your first book Profit from the Core?
The main idea was that large number of companies that seem to have all the pieces in place for sustained profitable growth, somewhere along the way lose sight of their core, misdefine it, or prematurely abandon it in search of new growth.
Profit from the Core had several main strands. First, we wanted to compile some basic data on the odds of managing sustained profitable growth. We were writing at time when companies had extremely aggressive growth targets, both in terms of revenue and earnings. However, we defined our threshold growth at the relatively modest level of 5.5 percent in real terms for both revenues and profits, and earning back the cost of capital on average over five years. Most businesses aspire to do that. They certainly did at that time. Still, we found that only 13 percent of companies worldwide achieved this average level of performance over 10 years.
Then we looked at the companies which had achieved this (performance level) and asked what was unique or distinguishing about them? We looked at the companies from many different dimensions and discovered several interesting things that proved to be jumping off points for our later work.
There wasn’t, for instance, disproportionate number of technology companies, despite the fact the book was written at the end of 2000. Eighty percent of the companies were in basic industries. The distinguishing factor was that they had leadership position or very strong core. The companies tended to be market leaders or have strong niche position in one core business or two at the most. They were companies like Tesco or UPS. Conglomerates or multi-industry companies were significantly under-represented.
More than 80 percent of companies that achieved good growth levels over 10 years grew in pattern that resembled the emanating rings of tree. They grew in their core business, possibly gaining small amount of market share, but they also pushed out the boundaries of their core businesses to new areas.
The third thing that came out of the book was framework that we now use throughout Bain & Co. When we go into company to work with the client on growth we usually begin by focusing on four questions. These are prescriptive and very diagnostic. The four questions may sound trivial, but they form the building blocks of growth strategy. They are:
* What exactly is your core?
* How close are you to full potential for profitable growth within your core?
* What are the most attractive adjacent moves that surround your core business – that both reinforce it and draw upon your strengths – and which ones should you pursue, in what order, and can the core support that kind of growth?
* Is the core in the process of being redefined or fundamentally changed in terms of the rules of the game?
How does company define its ‘core’?
Defining your core involves combination of judgement and analytics. Start by asking where you are, should be or will be vis-a-vis your competitors, and are you earning returns equal, or superior to, your competitors? In which customer segments do you have uniquely loyal customers that value you more highly than they value your competitors?
Start with the answer to those two questions. Then drill down layer and ask what exactly is it that allows you to earn differential returns and have more loyal customers. It might be unique product, unique insight about customer behaviour, or even an entire business system as in the case of Dell Computers. It could be business that combines two or three competencies in unique way.
Could you give an example? For instance, Intel. What would its core be?
Intel’s core would begin with its IA-32 processor architecture and the embellishments of that. Add to that low-cost manufacturing capabilities with very low error and failure rates, something that is extremely hard for competitors to mimic. Then add into the core the Intel brand and what it stands for. At the centre of the business and the reason they dominate market share is the microprocessor architecture, low-cost, low-error, high quality manufacturing and the brand.
What do you believe constitutes good growth?
Our strict definition of good growth is market share growth or adjacency growth around strong core, which earns more than its cost of capital and therefore creates value. We are sceptical of growth that is pure diversification unless the company has unique skill that allows it to buy business and uniquely add value to it. Equally, we are sceptical of revenue growth without profit growth, and also of the sustainability of profit growth without any accompanying revenue growth. Companies frequently make precipitous moves because of the pressure imposed by the equity markets and market analysts to do something in the name of growth.
Which growth path is most often advocated by executives from companies with solid growth? And this term ‘adjacency’ – what exactly does that mean?
Companies with sustained good growth built on taking the strongest core business and moving into new areas around the core and leveraging the core. We define that form of growth as ‘adjacencies’. Our research identified six types. These all have three things in common: they are fundamentally strategic in nature as opposed to tactical; they entail higher level of risk than the average growth move because they are pushing out into the unknown; and they are typically decision that the executives at the most senior level, CEO or president, get involved in.
Think of the six most simple types as atoms that can be assembled into molecules. For example, Nike’s growth strategy isn’t any one of these but rather combination of several.
The six types are: geographic adjacencies – Vodafone purchasing Mannesmann to go into Germany for example; product or service adjacency – totally new product, or service but leveraging your current customer service base or leveraging other assets; going into new channel; new customer segments; more rarely done, and more rarely successful, are significant moves up or down the value chain, so forward integration, manufacturer going into retail, or backward integrating into supply; and finally company that feels it has core capability, so to speak, that can be transferred to totally different arena and the fields of business around it – this is also rare.
These are what we call adjacencies. We analysed the data on moves closer and further from the core. Eventually we developed measure for the number of steps away from the core, so adjacent moves could be up to five steps away depending on how far they departed from what was considered the core. We discovered that for growth moves more than one and half to two steps away from the core the odds of success declined dramatically. Amazingly, the average adjacent move had failure rate of 75 percent.
What is good example of company that moved too far from its core?
In 1998, (toy maker) Mattel purchased the Learning Company Inc based on the premise that both companies sold to children and, that the plastic toys Mattel sold were vulnerable to being replaced by digital products and software. Mattel figured it needed to make this move to survive. But it paid US$3 billion, enormous in proportion to the size of the Learning Company.
The Learning Company was based on the East Coast of the US while Mattel was on the West Coast. And if you read the press clippings about Mattel at that time it sounded as if the two businesses were more related than it ultimately turned out. It was, in fact, case of different customers, different channels, different products, different infrastructure, different competitors, and different brands. It didn’t leverage anything of Mattel’s. It was fundamentally four or five steps away from the core. Mattel sold the Learning Company in 2000.
If you had message for practising managers, not necessarily senior managers, what wou
