MARKETING AND THE CEO’S GROWTH IMPERATIVE

by

George S. Day

Corporate leaders are being squeezed between the pressure by equity markets, for sustained growth in earnings, and shrinking opportunities for growth in their saturated and hotly contested markets. This squeeze is being worsened by the recent stock market plunge which has ruled out growth by stock swap acquisitions and precluded accounting manipulations that artificially grow earnings. This puts organic growth close to the top of the personal agendas of most Chief Executive Officers.

Will CEO’s get much help from marketing in resolving their organic growth dilemma? The growth gurus, including Clay Christensen, Richard Foster, Gary Hamel and C.K. Prahalad, are dismissive. In their view marketing is too close to the immediate demands and requirements of current customers and competitors to be a source of breakthrough sources of growth. At the same time new organizational forms are subordinating marketing’s traditional functional role in the innovation process. My intention is first to challenge this restrictive view, because it is not in the organization’s best interest to have marketing performing below potential, and then show how good marketing practice can enhance fast-paced growth through discontinuous innovation.

WHY IS IT IMPERATIVE TO GROW?

The growth imperative is shaped by the four forces in Figure One. They impinge on top management by imposing constraints and requiring challenging objectives. At the

1 top is the intense focus on shareholder value creation. Bonuses and option awards are increasingly linked to this metric, and the market clearly rewards companies that deliver profitable growth. Figure Two illustrates the rewards from maintaining revenue growth and profit growth above the median for the S&P 500.

The achievement of these superior returns is constrained by demanding customers and intensifying competition. Most managers bemoan the reality that there is too much of everything (except customers) in their markets. Intensifying competition for these scarce customers puts continuing pressure on margins, and limits opportunities for profitable differentiation. Meanwhile the customers are expert at playing rivals against each other in search of price concessions, and have become less loyal. An extreme case is the U.S. mobile phone market where the churn rate went from 20 percent in 1998 to 35 percent in 2001.

How is a high rate of superior growth in total returns to shareholder achieved in the face of slow growth markets? Richard Foster and Sara Kaplan make a compelling case that only substantial or discontinuous innovations deliver superior shareholder value.

They also contend that more than 90 percent of all innovations are “incremental.”; they are necessary for continuous improvement but don’t change the competitive balance.

Technology innovations play a dual role in the quest for superior returns. On one hand discontinuous innovations frequently offer performance that current customers can’t readily use, with lower profits than a business can support. The reluctance of incumbents to pursue these innovations provides an opening for new entrants. Conversely sustaining technologies offer performance improvements for existing customers, and help established firms maintain their lead by delivering superior value. Is marketing equipped

2 to help top management fend off attacks from discontinuous innovations while capturing the value from sustaining technologies?

WHAT ROLE FOR MARKETING?

As the growth trajectory accelerates, from seeking incremental gains within the current market arena to pursuing breakthroughs from discontinuities in the strategy, the marketing function becomes steadily marginalized. This is partly due to the short-run tactical priorities that come with any functional responsibility. A further reason is that the innovative organizational arrangements needed to manage the uncertainties of a discontinuity tend to subordinate all functions. But the main reason is that the skill sets needed to initiate and manage an array of discontinuous growth strategies have been migrating from marketing to other parts of the organization. This is not a healthy development because the strategy dialogue becomes unbalanced. When internal or technology considerations are predominant, the voice of the customers will not be clearly heard and the ability to match customer needs with technological possibilities is compromised. Before we can propose a more assertive role for marketing we need to assess each of these reasons more deeply.

Functional Myopia

The myopia of successful firms in general, and marketing in particular was revealed most clearly by Clay Christensen2. The question he asked was, why are firms

reluctant to participate actively in potentially disruptive technologies that initially attack

low priority peripheral markets? He concluded that the mental models that guide how

3 managers make choices are strongly shaped by their intimate familiarity with existing customer’s needs and may lead them to underappreciate that the “disruptive” technology may offer different benefits that are highly valued by non-customers. They may also be misled because of the initial inadequacies in the performance of the disruptive technology, and underestimate the potential for improvement.

The tendency to fixate on serving and retaining current customers is reinforced by rewards and incentives that emphasize short-run market share and profitability. Even the strategy development process is culpable here because the emphasis on competitive benchmarking and competitive advantages leads managers to assess what their competitors are doing and resolve to do it better. As a result the sales and marketing groups are quick to match competitive moves and react to demands from important customers. At the extreme all the energy of the development organization can be absorbed by these incremental reactions. One health care and beauty aid maker found that almost 95 percent of all their development projects were package changes, line extensions and other incremental improvements. Because they were deemed to be urgent they crowded out resources for next generation or platform projects with longer term payoff.

This portrait particularly indicts the sales and marketing functions in firms with a dominant sales and/or product orientation. It is surely overdrawn as a characterization of market-driven organizations. Their culture, capabilities and configuration equip them to better anticipate threats and opportunities from outside their served market. But it is a continuing struggle to prevent being customer-compelled, by accepting every customer request, or converging toward the competition.

4 Organizational Subordination

Two examples of innovative organizational designs will give a flavor of how leading companies are coping with a proliferation of new technologies and market opportunities, while getting greater productivity from their innovation processes. Both are designed to take advantage of cross-functional, team coordination enabled by advances in network technologies. Their net effect however is to shift the organizational power balance from the functional groups toward process-based teams. A related consequence is that traditional marketing tasks are being dispersed throughout the enterprise.

Procter & Gamble is leading the move away from the traditional R&D model that is self-sufficient and resource intensive to a more fluid, and open “Connect & Develop” approach. The objective is to better connect the 150 technologies, 8000 researchers, 600 external partners and 5 Global Business Units and improve access to technologies developed outside the company. The elements are recognizable: a global technology council to figure out how to leverage all the technology, an InnovationNet that hosts 600 web-sites for global project teams and captures business building insights, numerous communities of practice, search and information tools for mining the scientific literature and global patent data on the web, and an array of external partnerships. As the schematic in Figure Three shows, consumer insights have many sources and uses, but don’t rely on marketing as the gate keeper. Marketing research does play a crucial role in this complex web by describing consumer problems and latent needs that the Connect &

Develop network can address.

5 Global firms such as IBM, Citicorp, ABB and Coca Cola are evolving toward opportunity-based designs that have two levels. The foundation level is the business units that do the day-to-day work, deliver current results and house the enabling resources in functional, product, industry or geographic units. On top there are focused

“opportunity units”, catalyzed by entrepreneurs from within the firms, who are authorized to mobilize these resources to pursue breakthrough opportunities in global accounts that cut across geographies or require integrated solutions from several business units. These opportunistic teams combine deep customer knowledge with insights into what is feasible with the firm-wide resource base and prospective technologies, and are incented to pursue these non-traditional opportunities without (too much) resistance from their functional or geographic superiors. While the opportunities are likely to be spotted by the sales and marketing groups, the project team and its leader can be located anywhere.

Long gone are the days where the salesforce “owns” the customer or the marketing function is the sole source of market insights.

Strategic Requirements

The Marketing function becomes marginalized when discontinuous growth strategies require a different approach than is appropriate for the incremental growth strategies driven by marketing and sales. Some of these differences can be seen in the contrast of the growth strategies arrayed along the continuum of Figure Four.

6 Penetrate/Expand the Served Market. Most of these approaches are in the spirit of continuous improvement or kaizen marketing. Because the direct rivals in the market are watching each other closely, and looking for the same edges, the gains are incremental and often short-lived.

SoBe has become a leader in the new age soft drink market by positioning itself as a healthy refreshment and employing each of these penetration and expansion strategies. They used “innovative imitation.” to learn from rivals such as Arizona,

Snapple and Mistic. They didn’t do this just to copy them but to find out what to avoid.

They also exploited three converging trends: the emphasis on healthier foods and beverages, the growing acceptance of natural or holistic treatments, and the aging of the baby boomer segment. Their brand attitude was quite irreverent, which further helped them stand out from the rivals. Growth was further accelerated by line extensions such as herbal tonics that took them toward the nutriceuticals market. Their initial market success made it easier to improve the quality of their distribution, enter new geographic markets and gain entree to a number of new, high volume outlet types like club stores and mass merchandisers.

Expand the Business Scope The more the growth strategy is a discontinuous departure from the current strategy the greater the reward—at the cost of increased risk over a longer time horizon. In the middle of the strategy continuum are strategies that edge the firm outward from the served market but stay within familiar territory. These strategies are often motivated by two related questions: (1) How can we leverage or extend our existing competencies into adjacent markets? and (2) Which of the functions that our customers perform could we perform better? General Electric has used these

7 questions to great effect to guide the evolution of the company into services. The

Aircraft Engine Business Group now sells “power by the hour” with a package of engines, financing including leasing, servicing and certification, with a commitment to deliver the right engine to an aircraft when the airline needs it. A variant of this strategy is to leverage the brand equity into new markets where the brand meaning gives it permission to participate. Sony and Virgin have taken this path with some success.

This strategic trajectory can be accelerated by the convergence of supportive trends. Thus FedEx found opportunities in global components handling that emerged from trends in globalized freight flow, outsourcing demands and Internet availability.

Trends may emerge from fringe markets. Snowboarding, microbreweries, and extreme sports have become popular with wider audiences. Another kind of trend convergence comes from bottlenecks in trade flows and efforts to eliminate them. Thus 3M foresaw the need for hospitals to improve patient record retrieval and developed a Health

Information Systems business in response.

Discontinuous Growth Strategies. The intent of these strategies is to reshape the industry and grab an early lead. The rewards are high, but so are the risks. The risks of failure will be even higher if the organization is unable to accept the uncertainty and long pay-back periods. Because discontinuous innovations may take years to come to fruition the organizational processes and incentives must encourage trial-and-error learning and accept interim failures. This requires a holistic skill base that combines deep insights into markets, industry forces, and technological trajectories.

The requisite skills are more likely to be found in Corporate Development, R&D, top management, consultants or specialized alliance partners. While the marketing

8 function may not play a significant role, market research is an essential ingredient. There is a misguided belief that neither marketing nor most customers are likely to comprehend what is possible because it is outside their experience. But a balanced appraisal of a discontinuity requires an imaginative understanding of customer needs, problems and behaviors.

Discontinuous growth strategies fall into two broad categories. There are those that exploit a technological discontinuity. While nanotechnology, intelligent materials, smart sensors, digital imaging and the myriad of breakthroughs in genomics and proteomics promise revolutionary changes, it is often hard to know in advance if there will be a disruption. In retrospect the internet did not qualify (with the exception of eBay-type auctions, portals and search engines) because it mainly reformed existing processes, without creating entirely new markets.

The second type of discontinuity sees new ways to deliver customer value through creative strategic thinking—but does not depend on a technological breakthrough. This may mean breakthrough business designs such as Starbucks in coffee, IKEA in furniture, and Home Depot in home improvement. A key ingredient to these strategies is a redefinition of the customer’s needs and (or served market). Thus Callaway innovated with the Big Bertha to help golfers hit the ball more easily rather than simply improve on the existing club designs. Bloomberg came to the fore in on-line financial services by redefining the buyer for data terminals as the trader and analyst, rather than the traditional focus on the IT manager. While the former wanted features-rich terminals with tailored analytical screens the latter wanted standardized systems at the best possible price. By seeing differently Bloomberg joined a host of innovators who have disrupted existing

9 industries by challenging conventional practice and thinking. The open question is whether marketing is too bound by tactical pressures and narrow thinking to be an active participant or leader in the process of transformation.

Balancing risks and rewards. The widespread aversion to discontinuous growth strategies is a natural fall-out of the belief that the potential rewards will come too far in the future at too high a risk. This belief has point and weight, especially in light of the recent experience with internet-based “change the game” start-ups. But there is a cost that need to be understood and contained. For example, while the actual rewards may be realized far in the future, the equity markets account for them in their expectations of future earnings. If the firm is viewed as mired in slow-growth markets, vulnerable to emerging technologies and lacking a compelling story about its future growth thrust, the stock price will surely suffer.

Risk aversion may have more crippling consequences. Certainly the probability of success goes down sharply when the business ventures beyond incremental initiatives in familiar markets. But this should not be an excuse for passivity. It is healthier to properly calibrate the risks and then seek creative ways to reduce the risk exposure.

Guidance on these issues can be found in the matrix in Figure 5 that contrasts the probability of success of different growth paths.

APPRAISING THE RISK MATRIX

This matrix has many sources, including long-buried consulting reports by firms such as A.T. Kearney, the extensive literature on the economic performance of acquisitions and alliances, and numerous post-audits of new product initiatives. The wide ranges in probabilities absorb some of the variability in the definitions of “newness”, and “success”, as well as the simplifying consequences of clumping into four cells growth strategies that belong on a continuum. We have tried to consistently define “success” as the achievement of the objectives that were used to justify the investment in the growth

10 initiative. These estimates have been extensively validated in interviews with consultants and senior managers. In deference to the saying that “all generalizations including this one are false” there are several qualifications to keep in mind. The probabilities do not apply to fast- moving consumer goods (where incremental innovations have high long-run failure rates) and ethical pharmaceuticals, and do not distinguish whether “new to the company” is also “new to the world”. Also new markets means new customers and not necessarily new geographies.

The most obvious messages from this risk matrix are that (1) the farther a firm ventures from its currently served markets and present products/technologies the greater the risks, and (2) that unfamiliar markets hold much greater risks than new technologies.

Within this matrix there are also some less obvious insights into how to contain

risks. Starting with the diversification cell where the prospects are most dismal, and even

acquisitions have a poor track record, the imaginative strategist can find opportunities to learn. These could be exploratory acquisitions intended to learn about the market, internal venture groups that build capabilities with emerging markets and technologies via

licenses or minority equity stakes in start-ups. The objective is to shift the discontinuous

innovation into a market or product development initiative where the risks are more

palatable. The amount at stake can be managed with joint ventures, fast-to-market/fast-to

fail prototypes, intensive competitive monitoring and ambidextrous organizational

arrangements that have more tolerance for ambiguity. Here is where marketing research

should play a crucial role by orchestrating market probes, delving into the latent needs of

consumers, working with lead users and watching competitive moves. The pay-off from

this expanded role comes from interpreting and communicating what has been learned about the emerging market and the plausible scenarios that might unfold. What are the prospects that marketing is ready for this challenge?

11 ENHANCING THE CONTRIBUTION OF MARKETING

Discontinuous growth strategies that expand the business scope or reshape an industry are a different game with unfamiliar rules for most firms. Those that excel have superior strategic imaginations, staying power and ambidextrous organizations that can understand and contain the sizeable risks.

It is not inevitable that marketing be marginalized in the identification and development of these discontinuous innovations. Indeed the eventual success of a breakthrough requires an informed marketing input to the strategy dialogue. Before marketing can make this contribution, there must be broader acceptance that marketing is simultaneously an organizational orientation that ensures the primacy of a market perspective, a strategic management responsibility for defining and articulating the eventual value proposition and a functional specialty with expertise in market sensing and demand stimulation. Marketing must be the expert on the customer, interpreting and incorporating information about customers into all of the processes involved in defining, developing and delivering value to these customers.

However, this expertise has been honed in the more predictable setting of incremental innovation and is not sufficient to cope with the uncertainties of emerging technologies and breakthrough business models that create tomorrows markets.

Insightful market assessments in these conditions should be guided by four considerations:

‰ Paint the big picture. During the early exploration the issue is whether the potential market is “big enough” to be worthwhile. It is premature to expect precisely calibrated results.

‰ Focus on needs, not products. It is a truism that prospective customers can’t envision dramatically different products or business models.

12 However they can be eloquent about their needs, problems, usage situations and changing requirements—but only if the right users are asked.

‰ Use multiple methods. All methods of market analysis are flawed or limited. A combination of methods may yield conclusions that deserve greater confidence.

‰ Probe and learn. Most successful discontinuous growth strategies follow a halting development path, marked by stop-and-go metamorphoses, before emerging from a series of market experiments with a feasible application. This requires a process of successive approximations and accumulating learning. The path to market of fiber optics, cellular phones was guided by probes with immature versions of these products, learning from these probes and trying again in different market segments.

These diverse sources of market information flowing from the periphery create

white noise that may obscure the weak signals. To fully appreciate the implications there must be an openness to a diversity of viewpoints, a willingness to challenge entrenched

mental models, and an organizational climate that encourages continuous experimentation and accepts “well intentioned failure.” Marketing can and should play a

central role in building this learning capacity.

Expanding the Role of Marketing

When marketing is in top form it will contribute to a discontinuous growth

strategy in three ways.

Navigation through effective market sensing and sharing of market information

and anticipation of opportunities. Discontinuous opportunities signal their arrival long

before they bloom into full-fledged commercial success. However the signal-to-noise

ratio is initially low so one has to work hard to appreciate the early indicators These

weak signals usually come from the periphery, where new competitors are making

inroads and unfamiliar business models or technologies are used. Here marketing can

13 play a role by widening its peripheral vision outside the currently served market. These insights should be followed up with investments in small market probes of the best opportunities.

Articulation by refining and renewing the core value proposition in light of emerging opportunities. The main issue here is to link technological possibilities with valid market concepts, and then specifying the mechanisms for taking the new product or service offering to the market. This requires a willingness to challenge the prevailing mind-set in the industry, and overcome the constraints of tradition that make incremental innovations the comfortable way to grow.

Orchestration by providing the essential “glue” for a coherent market-driven whole. This last role for marketing ensures that the new business model or product offering continues to be aligned with the emerging market and adapted to shifting requirements and competitive moves.

When the marketing mindset and function pursues an expansion of its role with discontinuous growth strategies while continuing to play a lead role with incremental growth, it will help the CEO satisfy the corporate growth imperative.

14 REFERENCES

1 Richard Foster and Sara Kaplan, Creative Destruction, New York: Currency, 2001.

2 Clayton M. Christensen, The Innovators Dilemma, Harvard Business School Press, 1997.

15 Figure One Why is it Imperative to Grow?

Focus on Shareholder Value

Demanding Accelerating Customers Growth Technological •less loyalty and Imperative Change more churn • shorter life cycles •changing • discontinuities and requirements disruptions

Intensifying Competition • eroding advantages •saturated markets • too much of everything

16 Figure Two Growth and Shareholder Value You can’t save your way to prosperity. Wayne Calloway ex.-CEO, PepsiCo

Total Return to Shareholders* Growth (CAGR)

Revenue 15% Growth Profitable 7% Growth 10% Above Unprofitable Median Growth Cost Below 0% Cutting Median Profit Below Above Growth Median Median * Five year rolling average – S&P 500 – from 1996 to 2001

17 FigureFigure Three Four From R & D to Connect & Develop Consumer R&D Insights Customer Labs teams Trade partners Employees

Joint Development Suppliers

Research Virtual Institutions networks Contract VC’s labs Source: Larry Huston, VP Innovation, Procter & Gamble Alliances

18 FigureFigure FiveFour Sources of Growth

Increasing rewards Incremental Discontinuous Growth Initiatives Greater Risks Growth Strategies Longer time frames • Extend the line • Reconfigure the • Find a new value •Reduce defections value chain profile •Innovative imitation •Seek adjacent •Anticipate value markets migration • Exploit shifts in needs / demographics • Look for trend •Redefine the served convergence • Expand geography market • Leverage brand •Exploit • New channels equity technological discontinuities

Penetrate / Expand Expand the Business Reshape the Industry Served Market Scope

19 FigureFigure Five Six Balancing Risk and Reward Along the Growth Path

P(S) = Probabilities of success

Diversification New Product a) Internal Innovations Development P(S) = . 05 - .15 New to Company P(S) = . 40 -.55 b) Acquisition P(S) = . 35 - .45 Line extensions Product Market Development Incremental a) Internal innovations P(S) = . 60 -.75 P(S) = . 25 -.30 Present b)b) JointJoint ventureventure P(S)P(S) == . . 45 45 -.50

Market Expansion Present New to Company End-Use Market

20