Desperately seeking growth: The virtues of tending to your core
June 01, 2001
Harvard Management Update
The full version of this article is available on Harvard Business Online (subscription required).
The Idea in Brief
If you believe that Internet companies distinguish themselves from the rest of the economy by failing to turn a profit, consider this: even in the best of times, nine out of 10 management teams fail to sustain profitable growth. In our 10-year study of 1,854 public companies from the seven largest industrial countries, only 9% achieved their bottom-end growth targets, despite one of the greatest economic booms in business history. In the old economy as in the new, most bursts of growth do not translate into sustained value creation. But when we compared companies that succeeded in growing profitably—specifically, the subset of firms that sustained growth for a decade—with those that didn’t, some intriguing patterns emerged:
1. The long-term winners narrowed their focus instead of widening it. Nearly 80% of these growing companies had one or more core businesses with clear market leadership. They did not allow themselves to be distracted by buying insufficiently related businesses. For example, the advertising firm Saatchi & Saatchi bought the Gartner Group in 1988 in a misguided effort to become a one-stop shop for media and consulting services. Disappointed in Gartner’s 10% margins and slower-than-industry growth, Saatchi resold Gartner in 1990 to private equity investors Information Partners. By focusing on collecting, packaging, and distributing high value, syndicated data, Gartner developed a deep subscriber base. Sales rose from $55 million under Saatchi to $734 million in 1999; margins tripled to 30%.
2. Winning companies showed disciplined thinking. Defining the competitive, customer, and product borders of your core business is vital to choosing the right related opportunities. Amazon.com began as a successful bookseller, but then prematurely stretched its definition to include all consumer retail, taking on industry giants by expanding aggressively into power tools, cosmetics, and consumer electronics. The results have been gloomy: Amazon is now like a young chess player in a high school auditorium—running from table to table, trying to beat a grand master at every game.
3. Profitably growing companies tapped the full potential of their core businesses. Unsuccessful companies routinely set performance targets that were too low. They underinvested. They abandoned their core businesses prematurely, searching for new opportunities that only eroded their core. Data from 185 companies in 33 industries show that market leaders earned a 25.4% return on capital, compared with 14.3% for companies in a weaker market position. Many firms fail to recognize this power that market leadership provides for launching highly related lines. Grainger, the leader in industrial- products distribution, hit a slump in the 1980s and assumed it had reached the limits of expansion. But when it charted the true boundaries of its core, Grainger found it had underestimated its growth potential: a market originally valued at $3 billion was actually worth closer to $30 billion.
4. Companies that underexploited their core failed to appreciate the importance of reinvestment. Companies with long-term growth and profits invested at a rate of 15.3%, nearly twice that of rivals. In 1980, Intel was smaller in total market value than either Advanced Micro Devices or National Semiconductor. But by reinvesting with a narrow focus on digital logic chips for PCs, Intel today dwarfs those two firms, which spread their R&D funds over a range of businesses.
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