Chris Zook Highlights the Most Important Ideas from Growth from the Core

Chris Zook highlights the most important ideas from Growth from the Core

The Secret to Growth? First, Define Your Core

Chris Zook is a partner at Bain & Company and leads the firm’s Global Strategy Practice. He is the author of Unstoppable: Finding Hidden Assets to Renew the Core and Fuel Profitable Growth.

On a recent trip to Shanghai, I visited Suzhou Industrial Park and saw, out the window of my bus, what appeared to be a long dark band — like a Möbius strip — winding its way around many buildings. I looked closer and I realized that the band was a line of thousands of people, two abreast, inching their way toward the entrance of what I learned was a massive job fair. This seemingly endless ribbon of humanity was supplying labor to a park that was expanding seven miles in each direction each year, adding a new factory every four days. Only 10 years before, the same park had been a rice paddy. Now it was a gold rush town.

Transforming the “core” of its economy at its highest level, China has found that its people, unshackled and unleashed, are its ultimate hidden asset. There is a lesson here for companies. More organizations than ever before are entering a period of globalization where their historic core is not enough. The good news is they may already have what they need to win, to dramatically transform their core business model and renew profitable growth. The first step in figuring out just what those cards, or “hidden assets,” are is to define your core business itself.

How do you define your core? Start by being realistic. What are you best at? What is the economic center of your activity? Your core relates to the root cause, several levels down, of your competitive advantage. What is the state of that advantage? Is it relevant to the consumer right now? And what about your business’s boundaries: Is the market in which you can compete using your core assets? What’s your reason for being?

Ask yourself how long it has been since your company talked at length about the boundaries of the core or the root cause of differentiation several levels down — or, better yet, since you made a full assessment of the state of the core itself. What did your assessment say?

At worst, such an exercise reinforces your known strengths. At best, it could save you and your employees from standing in a long line at a job fair.

Alexander the Great, Google, and the Full Potential of the Core

In career terms, it’s called the Peter Principle. In corporate terms, I call it the Alexander Problem. Either way, it’s moving too fast beyond your strength and core. Alexander the Great fell prey to this management shortcoming even though — or more accurately because — he quickly conquered the largest area of the earth ever ruled by a single individual, stretching from Mount Olympus to Mount Everest.

Though not everyone’s idea of the model CEO, Alexander achieved this goal in less than four years, covering more than 4,000 miles by foot, and winning l00% of his battles. This is a remarkable record. But did he create lasting value? Just a few years after his death, his empire had dissolved.

Alexander’s problem was not poor execution, it was lack of long-term strategy and inability, because of extensive departure from his core of governance in Macedonia, to consolidate his extraordinary short-term gains throughout the Orient to India.

This tension between expanding the boundaries of a business, in the presence of success and seeming invincibility, and maintaining the original core, is at the center of business strategy today, as more and more companies face slowing growth in their traditional lines of business.

Chris Zook highlights the most important ideas from Growth from the Core

Google, for instance, reacting to a decline in its core business of selling ads tied to search terms, has been scouring the landscape for new fields to conquer. It bought YouTube for $1.65 billion in 2006 (and soon found itself facing a $1 billion copyright infringement suit from Viacom). This year it has bought 11 more companies – ranging from a video conferencing provider to a parallel processing company. Capping this quest was its $3.1 billion acquisition of DoubleClick. With outlays of this magnitude, and at these price premiums, Google will find the next wave of profitable growth increasingly difficult to achieve.

Spurred by such need for spectacular success, more and more companies are likely to face the Alexander Problem. Many will find that one of the greatest mistakes in business is to prematurely abandon the core in search of hot new markets, technologies, or opportunities. Our surveys repeatedly show that more than 60 percent of executives say that their core business is not within 50 percent of its full potential for profitable growth. Yet most of them are not sure where that potential lies.

What is the full potential of your core? How do you know? These two questions need to be at the top of the agenda of any system for evaluating growth opportunities in companies. Though it may sound obvious, the road to full potential begins with the first step of self-awareness. More management teams should ask each other more often in their off sites and strategy meetings these four questions: What is our core? What is the root cause of our competitive advantage today? What will each be in the future?

Legend has it that Alexander cried when he discovered he had no more worlds to conquer. He might cry harder today. For maybe even sadder are hard-fought gains lost, or a strong core rendered weak by overexpansion.

The Value of Leadership Economics

Successful companies considering their next act shouldn’t stray too far from their core. Positions of leadership, even in sub-segments of your business, may be more valuable than you realize. Usually a core of leadership economics accounts for most of the value of a company. How much?

Our analysis reveals that the typical industry has more than six competitors. The top two usually capture more than 75 percent of the profit pool, and the company with the greatest market power usually snares about 70 percent of total profits and 75 percent of profits above the cost of capital.

Wanabees act as the shock absorbers of the economic system, enduring a much bumpier ride during downturns. When we analyzed 22 pairs of global leaders and followers (Nike versus Reebok or Bridgestone versus Continental, for example) we found that the average variance in profit margin was three times as great for followers as leaders. When thinking about new directions, clear leaders also have a much greater success rate at driving their core business into areas close to their core: more than 40 percent. Followers, though, even with relatively close-in growth moves, have a success rate of only about 17 percent.

Accounting systems tend to obscure the power of leadership economics. This is true not only in finding the launching pad for transformation but also in appraising the odds of success of an adjacent move, or even in assessing the value of investing in pure market share.

Ask yourself whether you are absolutely sure that you understand the true boundaries and profit economics of any leadership positions you do have. As it turns out, followers can sometimes have pockets of leadership that they don’t realize exist. One such was Enterprise Rent-A-Car’s top position in the niche replacement and body shop business, serving customers whose vehicles were being repaired. Creating a new strategy around this core may have been unanticipated, but the results were no accident: today Enterprise is the world’s largest car rental company.

Chris Zook highlights the most important ideas from Growth from the Core

When it comes to wanting a larger stage for your talents, it pays to determine where you are already the best. Even then it remains a hard slog. In our study of 801 U.S. followers’ movements from 1990 to 2001, only 10 percent actually moved into the leader’s circle. But if you do nothing, the odds are zero.

What is in Your Company’s Investment Wheelhouse?

The average strong core business might have as many as 70 to 100 investment opportunities that radiate around it, everything from new customer segments to geographic expansion. Tempting as many are, though, most are outside the strike zone.

As an analogy, think of Tony Gwynn, the former Padres right fielder, who will be inducted into the Baseball Hall of Fame this month. His potent hitting at .338 over his career spurred pitcher Al Leiter to say, “The only way to pitch to Tony is throw the ball down the middle and hope he hits it at someone.” Yet consider the slim margin between Gwynn and a journeyman player batting somewhere around .240. In other words, the batting difference between a “futility infielder” and a 15-time All Star is a scant 10%.

The point is that it matters hugely in adjacency moves whether the odds are 20% or 50% and whether they can create competitive separation of the kind that characterizes Nike and Dell (as opposed to Reebok and Gateway).

How do you increase your average? Four big factors are at play: 1) Does the idea emanate from the customer, or has it been validated by the core customer? Some 85% of the best adjacency ideas are. 2) Does it follow a repeatable formula, such as the kind Nike has used to enter one new sports market after another? 3) Is it clearly related to the core and within two steps of it? 4) Does it build on leadership economics or a strong core?

With the typical odds for success at only 25% (or about the same as the average Major League hitter), stardom hinges on establishing clear, agreed-upon criteria on what constitutes a great opportunity. Ask yourself whether you know the criteria for investing in adjacencies and how you compare metrics across alternative growth investments.

Companies like Nike consistently find ways to connect. When it entered the soccer market years ago, the company didn’t immediately go head to head with market leader adidas. Rather, it refined segmentation of soccer balls into balls for various surfaces and conditions (such as dirt, hard surfaces, grass, even night play), and soccer shoes tailored by position and style of play. Today, Nike is challenging adidas in its core market. It’s making strides in baseball, as well, among other ways by becoming the sole Major League provider of performance, dry-fit wear. In 2005, the company estimated that more than 55% of Major League players wore Nike footwear, and vowed the number would go higher still.

All growth moves are risky, so the key is choosing where to focus and how to increase the probability of success. Our analysis shows that companies that can improve their odds of growing sustainably by even 20% relative to their competitors can ignite a process that leaves their competitors behind. Yet too few companies understand and manage well the four factors that can better their odds, whereas every management team aiming to grow their core business should.

What are you doing to increase your average?

Chris Zook highlights the most important ideas from Growth from the Core

Recognize the Power of Repeatability in the Core

How do some companies sustain profitable growth year after year? Our recent five-year study of 1,850 companies yielded two major insights into the behavior of companies that find profit, time and again expanding their boundaries. One: such performance usually stems from a company expanding its core business into an adjacent space. Two: outstanding companies consistently outgrow their rivals by developing a formula for expanding those boundaries in predictable, repeatable ways. Their numbers tell the story: The average company succeeds only 25% of the time in launching new initiatives. Yet companies that have hit upon a repeatable formula have success rates of at least twice that.

Companies that master repeatability work within any number of adjacencies. Some make repeated geographic moves, as Vodafone has done in expanding from one geographic market to another over the past 13 years. Others apply a superior business model to new segments. During its long growth spell, for instance, Dell repeatedly adapted its direct-to-customer model to new customer segments and product categories. In other cases, companies develop hybrid approaches. Nike expanded into adjacent customer segments, introduced new products, developed new distribution channels, and then moved into adjacent geographic markets. The first time Nike did this, it undoubtedly struggled with the inherent complexity, but as it repeated the process again and again, managers learned to execute consistently.

Successful repeaters in our study had two common characteristics. First, they were disciplined, applying rigorous screens before making an adjacency move. This discipline paid off in the form of learning-curve benefits, such as sharper strategic clarity, increased speed, lower complexity and better decision-making. And second, in almost all cases, they developed their repeatable formulas by studying their customers carefully.

American Express, for example, based its successful expansion into adjacencies by studying how its customers used it cards. With such customer information, AmEx managers have created a family of cards with varied interest rates, terms, services, and reward programs. They found new customer segments; created new, more precisely targeted credit-card products, including rewards programs; expanded the types of merchants where cardholders can use their cards; and sold additional services to card customers.

Executives should ask themselves whether they value repeatability highly enough, and begin discussing it in management meetings and strategy sessions. Then it’s time to start practicing, preferably on a small scale at the outset.

As a role model, consider Danaher Corporation, once a tiny industrial tools maker that is now a diversified manufacturing and technology company. From 1987 to 1995, the company made about 1.5 acquisitions a year, averaging $80 million. Since 1995, it stepped up the rate to about six acquisitions a year, averaging $100 million each. Focusing on just five criteria, the company has grown at 16 percent a year — from $617 million in revenues in 1987 to $7.9 billion in 2005 — and has seen its stock price rise more than 5,000 percent. Now that’s repeatability.

When Lost, Return to the Core Customer

People frequently remember that, prior to 1992, Nokia was a supplier of timber and rubber boots. Yet even its spectacular transformation into a mobile technology giant wasn’t enough to keep it out in front forever. After losing share to competitors’ clamshell handsets, the Finnish company only regained its lead through deeper understanding of the one true north in business: customer desires. Today, Nokia has branched out into a host of adjacency markets, selling more than 100 phone types, everything from $45 models in China and India (where it enjoys 42% and 60% market shares) to $750 sets with global positioning capabilities in affluent nations. Nokia’s resurgence underscores a primary finding in

Chris Zook highlights the most important ideas from Growth from the Core our research: More than 80% of the best adjacency ideas in successful companies came from (or are related to) the core customer.

How do you determine customer needs? There are five main lenses: the customer life cycle of purchases, customer system economics, customer share of wallet and purchasing patterns, your own customer adjacencies, and customer segmentation. Nokia used the last superbly. For instance, it offers more features on its emerging market products than rivals’ cheaper $35 versions, and can anticipate great rewards as these consumers eventually trade up for more sophisticated phones. Emerging market insights come in other flavors, as well. Consider Olam, launched in 1989 as an intermediary between Nigerian producers of cashews and sheanuts, an ingredient in chocolate, and big food processors like Mars and Planters.

The young company quickly became a reliable source, establishing a strong presence in its core market. With customer wants leading the way, the company began handling cashews in other countries, then expanded into coffee, cocoa and sesame. Not all of Olam’s moves worked out. The company had to exit the unfamiliar black pepper and rubber markets. Yet today, Olam is the leading global supplier of cashews and sheanuts, the original core business, and ranks among the top six suppliers worldwide in its other key products. By staying closed to its core customers, the company grew revenues at 28% and earnings at 31%, from 1997 to 2003, and launched a successful IPO in early 2005. As it pursues yet another adjacency in Australian cotton, it recently reported continued strong growth of 24% in profit and 22% in earnings.

The clear lesson of Nokia and Olam is that the odds of success for customer-led adjacencies are higher than for others. When in doubt, drill down to the core customer. The best ideas come studying their behavior, not from outside big ideas. With shrinking differentiations, the ability to find microsegment opportunities and gain insight faster may be the ultimate competitive advantage. Certainly Nokia, which has taken an early lead in the African market with a deft combination of price and features, thinks so. What do you think?

Remember the Focus-Expand-Redefine Cycle of Growth

With the average life span of companies dropping to just over 10 years from 14 a decade ago, and a dramatic decrease in the useful life of a company’s strategy, more and more companies must redefine themselves to survive. Nearly 80% of businesses will soon encounter the issue of redefinition, according to our analysis, compared with only 50% two decades ago.

Although the pace is accelerating, the cyclical process of regeneration is predictable and universal. Many human and natural phenomena follow predictable cycles. In business, we’ve dubbed it the focus-expand- redefine (F-E-R) cycle.

In the focus phase, companies concentrate on building their core business to its full potential. In the expand phase, they take advantage of these capabilities and market positions to move into adjacent markets. Inevitably, though, many companies experience dwindling growth and profitability. This is the time to redefine the core.

Like a reciprocating engine for growth, each stage helps fire and drive the next: Success at the focus phase provides the fuel to move to adjacency expansion. Success there then often provides the growth — and breathing room — either to redefine your business model, or add a new core.

There are three classic timing errors that we found in looking at hundreds of companies’ strategies over the cycle, and each shows how important self-awareness of FER really is.

Chris Zook highlights the most important ideas from Growth from the Core

The first is premature abandonment of the core into distant adjacencies. This stems from boredom with the core, failure to see its full potential, or leaps into distant adjacencies that were farther and more difficult than recognized. This was the case of Bausch & Lomb years ago.

The second mistake can be traced to a failure to start redefining soon enough, teamed with an inability to figure out the plan and difficulty mobilizing.

Last on the list is plain old inattention, or taking the core for granted.

Cycles often quietly play out over decades. One company that paid attention soon enough was General Dynamics. In 1984, it reigned as America’s largest defense company. But with defense expenditures dwindling, it underwent one of the most thoroughgoing transformations in business history. By 1992, it had reduced itself to three core businesses and $3.5 billion in revenues, a 70% downsizing in just three years. General Dynamics then began making selective acquisitions to bolster its profitable submarine core and build a related core in electronics and information systems for defense programs. Recently, the company reported revenues of $6.6 billion, up 11%, in the second quarter, alone.

The key to General Dynamics’ resurgence was a major study it commissioned in the early 1990s of its demand and asset values. This was an unusual step, as studies show that managers typically spend less than 3% of their time developing a long-term view of their industry.

In your own planning, ask yourself if you are probing in a balanced way into each phase. Are you still sure where you are? What are the warning signals you look for?

Exploit the Power of Hidden Assets

If one had to name Apple’s primary capability, it would be tempting to call it an ability to create “cool” user interfaces, going way back to the original Mac. That asset certainly came in handy as its core PC business started to wane, and its “digital hub” strategy led it into consumer electronics.

Indeed, Steve Jobs’ 2001 announcement of the iPod, an intuitive little device that “puts 1,000 tunes in your pocket,” has created a whole new core, one that today accounts for nearly 50% of the company’s revenues and 40% of its profits. And it’s the basis of an exciting adjacency in its just-introduced iPhone, which the company says it will sell a million of by September.

Apple’s response to a dwindling core is remarkable, but its predicament wasn’t. According to our research, in the next decade as many as four of five companies may need to redefine their core strategy fundamentally, or find a new core in order to continue to grow or even survive.

Under such pressure, CEOs will face many temptations to do something bold and daring. These moves include leaping to new hot markets, doing a big-bang transforming acquisition, or creating a massive corporate innovation program in the hopes that this will increase the cycle speed of an engine that is fundamentally slowing down and needing an overhaul.

Yet, our research shows the success rates of these moves are much less than one in 10 for the simple reason that they do not address the fundamentals.

Rather, in our seven-year study of sustained profitable growth, we found that companies that did have the ability to redefine their core and find the next wave almost always did it using capabilities and assets that it already had — hidden assets, like Apple’s knack for creating intuitive and almost-playful technology. 6

Chris Zook highlights the most important ideas from Growth from the Core

Most hidden assets tend to fall into three categories: undervalued business platforms, untapped customer insights, and underexploited capabilities. All, it turns out, can provide a new core for a company.

Not so long ago, De Beer’s was sitting atop a $5 billion stockpile of rough diamonds, yet profits were sinking. The real gems turned out to be consumer insights that set the company on a profitable new direction. Liquidating 80 percent of its inventory, the firm created a new business model, shifting it focus from supply control to a demand and customer-centered strategy.

Suddenly couples were buying three-stone rings to celebrate the past, present, and future of relationships. Men were buying rings designed with a male flair. Women were buying “right hand” rings as symbols of independence. Shrinking to grow, De Beer’s market value initially plummeted to $1 billion in 1999. Now it’s hovering around $12 billion.

Not every company has such diamonds in the rough waiting to be polished. Indeed, this is not a miracle cure for companies that are weak, distant followers. Rather, it is the way that once-strong businesses used the strengths of the past as a platform for a renewed future.

Managing the strategic balance sheet — including hidden assets, hidden liabilities, and strategic equity — is the first job of a CEO and management team. They need to recognize that many of the most important liabilities in the present, and assets for the future, are hidden from view and need to be sought out and uncovered.

Thinking of Capabilities as Building Blocks

Capabilities are the fundamental elements of business. If there were the equivalent in business of Mendeleev’s Periodic Table of the Elements, it would be populated by capabilities. The typical business is made up of 80 to 200 significant capabilities, of which only a few, maybe 5 to 10, are truly core. Combining capabilities in new ways can create new sources of profitable growth or even lead to redefinition of the core strategy itself. Some companies have developed a capability around reshuffling these building blocks in to new combinations, often adding in new capabilities, in order to deepen and extend their competitive advantage.

Google, for instance, understands that its essential software capabilities are at the core of its success. It continually scours the landscape for new venues and media for extending and mixing these capabilities. It thus bought YouTube for $1.65 billion in 2006. And this year it has already bought 11 more companies, ranging from a video conferencing provider to a parallel processing company. Most of these acquisitions, such as DoubleClick, the leader in online advertising software, bring with them not just a core business, but some uniquely strong and deep capabilities that can be used by Google in its own core.

Whether or not Google’s talents will create economic value across all of these new platforms remains to be seen. But managers everywhere seem to be increasingly aware of the inherent economic power packed within capabilities. In our recent survey, 98% of global executives said it was important to create a new core capability in order to reach their growth targets. (Some 57% said it was highly important.) Indeed, in our recent work on how successful companies periodically redefine their strategy, we found that the acquisition of a new capability was central in about two thirds of our case studues.

Yet, few management teams hold focused discussions on their company’s most differentiating capabilities, much less on the critical ones they will need to develop or acquire in the next five years. Why not?

Perhaps it’s tougher to see, feel and touch capabilities than a customer database, a business unit or a product line. Or perhaps in complex organizations no one is responsible for a capability that cuts across product lines. 7

Chris Zook highlights the most important ideas from Growth from the Core

Yet, the addition of key new capabilities has helped any number of companies magnify the power of their core, rejuvenate a flagging growth model, and push into previously unattainable areas. GE Capital is just one example of the detection of an internal building block that helped generate a new future. In this case, GE’s financing arm was picked up by Jack Welch and his team because, though small, it was highly profitable. Other capabilities, of course, have to be acquired externally. That’s what happened when Roche initially bought a 60% of Genentech and key assets of Cetus Corporation to position itself astride the crossroads of pharmaceutical science and biotechnology.

What’s the state of your capabilities? In some businesses it is almost as if the organization, and its ability to add capabilities, is the strategy itself, or the ultimate source of lasting competitive advantage. Are you spending enough time taking inventory of your existing capabilities? Do you know which are the most critical to differentiation, how they currently stack up, and which need to be added?

When all else fails, retreat to simplicity and see whether you have agreement to this question: “What are we best at, what have we been the best at in the past, and why?” Then see where that leads.

Don’t Underestimate the Power of Focus

If I had to reduce the essence of my years of research down to one word, it would be focus. Successful companies maintain it to sustain profitable growth, while others get lost in a diffusion of possibilities. At first blush, narrowing the focus to grow sounds almost counterintuitive. But just as plants often must be cut back to concentrate their energy on fewer, stronger branches, so too, businesses must be pruned to counter their tendency to branch out more than they should. I’m constantly amazed by how often the correct first step to growth and expansion is to tighten the perspective and sometimes even to shrink. This boring in on the essential has been the dominant theme of my books.

Profit from the Core is about strategic focus of a core business. It is based on hundreds of examples we found of businesses that lost their opportunities by becoming unfocused and losing track of what those few things at the center of their core really were.

Beyond the Core is also about focus, but in a different way. It shows that following a repeatable formula is the best way to reduce risk as well as a powerful organizing principle behind profitable growth. The pursuit of repeatability based on a strong core is a formula for focusing and concentrating resources.

Unstoppable is about transformation and renewal, but it conveys a central message that is about focus in yet another sense: focus to understand and build on the hidden assets you already have. If you can do that, you have a better chance of success and differentiation than if you leap into something completely new. For companies struggling to reignite growth, one of the most underused and most reliable ways to create economic value is to consider narrowing focus and even shrinking in order to grow.

The world serves up a never-ending series of temptations, distractions, doubts, and uncertainties. It is possible for management teams to bounce like ping-pong balls from one topic or issue to another, never digging in and understanding their core and what it means.

The real focus of businesses should be external—on competitors, shifts in technology, and customer dynamics. Yet my overwhelming feeling from seven years of studying success and failure among companies searching for profitable growth is that, ironically, many of the most challenging demons are internal, and our most difficult foes are ourselves. And so, the following rings true:

Chris Zook highlights the most important ideas from Growth from the Core

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.

The starting place in each of the three phases of the focus-expand-redefine (FER) cycle of business growth is to make sure that you understand and are profiting from your core.

Do you? Are you?