The Business Times

Focus on Your Core for Profitable Growth

Identifying growth opportunities is a tricky business.

By Chris Zook and Charles Ormiston

First published on marzo 21, 2001
min read


Senior executives should be worried. Ninety per cent of public companies worldwide failed to achieve sustained, profitable growth over the past decade. Ninety per cent. This despite the fact that most CEOs list profitable growth as their No. 1 goal. The critical problem is that many corporate chiefs are looking for growth too far beyond the boundaries of their own business. Our global study of growth efforts over the last decade, across more than 1,800 companies, demonstrated that many companies hit trouble straying too far from their core business. The cost of diversification is at least twofold. First, it leaves the core business undefended. Second, diversification saps management time and resources. And in some cases, straying destroys the company's value by confusing investors and hurting share price performance. Conversely, 80 per cent of companies that achieved profitable growth through the ’90s did so by focusing on their core business. That's not to say focus is easy. Shareholder expectations have driven the average price-to-earnings ratio in the US stock market to a record, nearly 30 times earnings. A 30x PE implies that a stock's earnings will grow three or four times faster annually than US gross domestic product, the total value of all goods and services produced within the nation's borders. But according to our analysis of the financial performance of all public companies in the US, Canada, Japan, Germany, France, Italy and the UK (the Group of Seven industrialised nations) this is unlikely. Over the past 10 years, only 240 companies, fewer than 13 per cent, achieved growth in income and earnings even close to thrice the GDP's, while also earning their cost of capital. In Singapore, Bain & Company evaluated 46 of the DBS 50 companies (the other four did not have a five-year track record from 1995 to 1999) against the same core criteria (real revenue and earnings growth of over 5.5 per cent annually, and average annual shareholder return higher than cost of equity). Only eight of 46 companies (17 per cent) made the grade: Avimo Group, Datacraft Asia, DBS Group, Informatics Holdings, Neptune Orient Lines, Robinson & Co Ltd, SembCorp Marine and Venture Manufacturing. By and large, the companies in this group are characterised by a focus on their core business. Our work shows that even the most sophisticated management teams can make mistakes in identifying adjacent growth opportunities. They think they are moving into a highly related business, but in fact differences in the new business' cost structure or customer base actually diversify operations. And correcting a strayed course is painful. For example, Gillette just announced a 2,700-person layoff and divestiture of its pens business and some small appliance lines to pare back to shaving products, their core of 80 years. Similarly, Bausch & Lomb, pioneers in contact lens technology, have survived a painful five years of executive turnover and divested interests in ointments, laboratory rats and hearing aids to refocus on being the "eyes of the world." A classic case of inadvertent diversification is Mattel Inc's acquisition of The Learning Company. Mattel was the world's largest maker of traditional dolls and soft toys. The Learning Company was a premier maker of children's interactive software. Mattel was struggling. In the last quarter of 1998 it suffered a US $500 million (S$875 million) loss. To Mattel Chief Executive Officer Jill Barad, the US$3.6 billion acquisition of The Learning Company enabled Mattel to get into the new marketplace. It fulfilled Mattel's strategic dream; it would give Mattel "an unparalleled portfolio of branded digital content through one family destination site." But it failed. Mattel misunderstood its core business' relationship to the acquisition. The two companies were so different and incompatible that they couldn't work together. In the middle of a plummeting share price and terrible losses, Ms Barad resigned. Mattel divested The Learning Company for a price of zero and a call on hypothetical future earnings. So what's the lesson from this and similar stories? Mattel looked too far outside its core for growth. Our research suggests that companies should look for growth by looking inside first. They should start by defining their core business; then they should assess truly related opportunities, or "adjacencies," for organic growth or acquisitions. (Adjacency growth does not preclude acquisitions but it narrows the field.) Finally, a company should grow into related businesses in a very careful sequence so each move reinforces the previous move and ultimately the core. Indeed, chief executives wanting to focus their efforts and analysis around growth strategy should focus here. It's tough to go back if you move into the wrong business. Mistakes are reversible only at a high, sometimes crippling, cost in company resources and enterprise. Eighty per cent of the 240 publicly quoted companies that achieved sustained, profitable growth over the past decade have expanded through adjacencies. (We define this subset as stock-exchange listed companies in the G7 nations that achieved 5.5 per cent growth in revenue and profits over 10 years, while repaying their cost of capital.) Finding the path to success Venture Manufacturing is one of the strongest performers against the Bain "profitable growth" criteria. From 1995 to 1999, it displayed very strong financial performance, with revenue growth of 40 per cent, net income growth of 40 per cent and ROE consistently above 20 per cent. A key reason behind the success of Venture Manufacturing has been its growth strategy that has focused on expanding its core electronics manufacturing services (EMS) into two adjacent areas: original design and manufacturing (ODM) and e-fulfilment services. Realising that they needed to move out of simple contract manufacturing in order to remain profitable, Venture Manufacturing moved into adjacencies by offering ODM services in 1996, and e-fulfilment services a few years later. By offering adjacent value-added services like product design, order fulfilment and supplier management, and focusing on certain product segments like various types of printers, storage, networking and communications, Venture Manufacturing has kept abreast of global competition to continue to be ranked as one of Asia's best EMS-based companies. The merger of SembCorp's maritime assets with those of Jurong Shipyard to form SembCorp Marine is an example of an acquisition guided by a focus on core capabilities. By combining their core operations, the two companies command the largest share of docking capacity in Singapore and are able to obtain greater operating efficiencies through facilities sharing and procurement savings. Beyond pure considerations of scale, the merger offers additional growth opportunities that leverage the core business. SembCorp's presence in Indonesia and China brings the combined entity a larger regional footprint, with the ability to serve a broader range of customers as well as a diversified cost base. Additionally, the merger expands the range of maritime capabilities that can be offered, as Jurong's shipbuilding expertise complements SembCorp's refurbishment and conversion capabilities. Venture Manufacturing got it right, Mattel got it wrong. What distinguishes viable adjacency growth? First: it's the extent to which a new opportunity draws on relationships, technologies or skills that currently exist in the core business. Second: it's whether seizing the opportunity will generate a competitive advantage. Does it lower cost? Increase loyalty? Genuinely offer more value to customers? Will it, in other words, add to and reinforce the existing business? Mapping adjacencies can sometimes lead to a resurgence of growth in a strong core business. In the mid-1980s, for instance, Grainger, the leading US industrial supplies distributor, saw its growth drop from 10 per cent to 2 per cent. As a result, its stock price declined substantially. The company tried to understand whether it had reached the limits of its US$3 billion target market. It wasn't even close. When it expanded its market map to include related customer segments, geographies and industrial products, it discovered that its market was closer to US$30 billion. The new strategy took advantage of these adjacent opportunities, and relaunched Grainger back to 10 per cent growth for more than the next decade. Likewise, management teams that develop a full inventory of growth opportunities around their core quickly find themselves awash in interesting and potentially attractive options for investment. But before executives embark on data collection, they should step back and apply their strategic judgment and operating knowledge to rate opportunities along five key dimensions: How much does this opportunity strengthen our core business franchise? What are the chances of our becoming a leader in the new segment or business? Could this move have a defensive benefit, preempting or interdicting our present or future competitors? Does this investment position our core business strategically for an even stronger future adjacency? Does it hedge against uncertainty or constitute one step in a well-defined sequence of strategic moves? Can we be certain of superbly executing implementation? Asking and answering these questions should increase your odds of finding the grail of growth. But they are difficult decisions. They are calls that even excellent managers can misjudge in the chaos of battle. Chris Zook directs Bain & Company's Strategy practice and is the author, with James Allen, of Profit from the Core: Growth Strategy in an Era of Turbulence, forthcoming from Harvard Business School Press. Charles Ormiston is the managing director of Bain SE Asia and directs Bain's Global Merger Integration practice. For more information on Profit from the Core, please visit www.profitfromthecore.com. Bain Book Profit from the Core Learn more about how companies can return to growth in turbulent times.

Senior executives should be worried. Ninety per cent of public companies worldwide failed to achieve sustained, profitable growth over the past decade. Ninety per cent. This despite the fact that most CEOs list profitable growth as their No. 1 goal.

The critical problem is that many corporate chiefs are looking for growth too far beyond the boundaries of their own business. Our global study of growth efforts over the last decade, across more than 1,800 companies, demonstrated that many companies hit trouble straying too far from their core business.

The cost of diversification is at least twofold. First, it leaves the core business undefended. Second, diversification saps management time and resources. And in some cases, straying destroys the company's value by confusing investors and hurting share price performance. Conversely, 80 per cent of companies that achieved profitable growth through the ’90s did so by focusing on their core business.

That's not to say focus is easy. Shareholder expectations have driven the average price-to-earnings ratio in the US stock market to a record, nearly 30 times earnings. A 30x PE implies that a stock's earnings will grow three or four times faster annually than US gross domestic product, the total value of all goods and services produced within the nation's borders. But according to our analysis of the financial performance of all public companies in the US, Canada, Japan, Germany, France, Italy and the UK (the Group of Seven industrialised nations) this is unlikely.

Over the past 10 years, only 240 companies, fewer than 13 per cent, achieved growth in income and earnings even close to thrice the GDP's, while also earning their cost of capital.

In Singapore, Bain & Company evaluated 46 of the DBS 50 companies (the other four did not have a five-year track record from 1995 to 1999) against the same core criteria (real revenue and earnings growth of over 5.5 per cent annually, and average annual shareholder return higher than cost of equity). Only eight of 46 companies (17 per cent) made the grade: Avimo Group, Datacraft Asia, DBS Group, Informatics Holdings, Neptune Orient Lines, Robinson & Co Ltd, SembCorp Marine and Venture Manufacturing. By and large, the companies in this group are characterised by a focus on their core business.

Our work shows that even the most sophisticated management teams can make mistakes in identifying adjacent growth opportunities. They think they are moving into a highly related business, but in fact differences in the new business' cost structure or customer base actually diversify operations. And correcting a strayed course is painful. For example, Gillette just announced a 2,700-person layoff and divestiture of its pens business and some small appliance lines to pare back to shaving products, their core of 80 years.

Similarly, Bausch & Lomb, pioneers in contact lens technology, have survived a painful five years of executive turnover and divested interests in ointments, laboratory rats and hearing aids to refocus on being the "eyes of the world."

A classic case of inadvertent diversification is Mattel Inc's acquisition of The Learning Company. Mattel was the world's largest maker of traditional dolls and soft toys. The Learning Company was a premier maker of children's interactive software. Mattel was struggling. In the last quarter of 1998 it suffered a US $500 million (S$875 million) loss.

To Mattel Chief Executive Officer Jill Barad, the US$3.6 billion acquisition of The Learning Company enabled Mattel to get into the new marketplace. It fulfilled Mattel's strategic dream; it would give Mattel "an unparalleled portfolio of branded digital content through one family destination site."

But it failed. Mattel misunderstood its core business' relationship to the acquisition. The two companies were so different and incompatible that they couldn't work together. In the middle of a plummeting share price and terrible losses, Ms Barad resigned. Mattel divested The Learning Company for a price of zero and a call on hypothetical future earnings.

So what's the lesson from this and similar stories? Mattel looked too far outside its core for growth. Our research suggests that companies should look for growth by looking inside first. They should start by defining their core business; then they should assess truly related opportunities, or "adjacencies," for organic growth or acquisitions. (Adjacency growth does not preclude acquisitions but it narrows the field.)

Finally, a company should grow into related businesses in a very careful sequence so each move reinforces the previous move and ultimately the core.

Indeed, chief executives wanting to focus their efforts and analysis around growth strategy should focus here. It's tough to go back if you move into the wrong business. Mistakes are reversible only at a high, sometimes crippling, cost in company resources and enterprise.

Eighty per cent of the 240 publicly quoted companies that achieved sustained, profitable growth over the past decade have expanded through adjacencies. (We define this subset as stock-exchange listed companies in the G7 nations that achieved 5.5 per cent growth in revenue and profits over 10 years, while repaying their cost of capital.)

Finding the path to success

Venture Manufacturing is one of the strongest performers against the Bain "profitable growth" criteria. From 1995 to 1999, it displayed very strong financial performance, with revenue growth of 40 per cent, net income growth of 40 per cent and ROE consistently above 20 per cent. A key reason behind the success of Venture Manufacturing has been its growth strategy that has focused on expanding its core electronics manufacturing services (EMS) into two adjacent areas: original design and manufacturing (ODM) and e-fulfilment services.

Realising that they needed to move out of simple contract manufacturing in order to remain profitable, Venture Manufacturing moved into adjacencies by offering ODM services in 1996, and e-fulfilment services a few years later.

By offering adjacent value-added services like product design, order fulfilment and supplier management, and focusing on certain product segments like various types of printers, storage, networking and communications, Venture Manufacturing has kept abreast of global competition to continue to be ranked as one of Asia's best EMS-based companies.

The merger of SembCorp's maritime assets with those of Jurong Shipyard to form SembCorp Marine is an example of an acquisition guided by a focus on core capabilities. By combining their core operations, the two companies command the largest share of docking capacity in Singapore and are able to obtain greater operating efficiencies through facilities sharing and procurement savings.

Beyond pure considerations of scale, the merger offers additional growth opportunities that leverage the core business. SembCorp's presence in Indonesia and China brings the combined entity a larger regional footprint, with the ability to serve a broader range of customers as well as a diversified cost base. Additionally, the merger expands the range of maritime capabilities that can be offered, as Jurong's shipbuilding expertise complements SembCorp's refurbishment and conversion capabilities.

Venture Manufacturing got it right, Mattel got it wrong. What distinguishes viable adjacency growth? First: it's the extent to which a new opportunity draws on relationships, technologies or skills that currently exist in the core business.

Second: it's whether seizing the opportunity will generate a competitive advantage. Does it lower cost? Increase loyalty? Genuinely offer more value to customers? Will it, in other words, add to and reinforce the existing business?

Mapping adjacencies can sometimes lead to a resurgence of growth in a strong core business. In the mid-1980s, for instance, Grainger, the leading US industrial supplies distributor, saw its growth drop from 10 per cent to 2 per cent. As a result, its stock price declined substantially. The company tried to understand whether it had reached the limits of its US$3 billion target market.

It wasn't even close. When it expanded its market map to include related customer segments, geographies and industrial products, it discovered that its market was closer to US$30 billion. The new strategy took advantage of these adjacent opportunities, and relaunched Grainger back to 10 per cent growth for more than the next decade.

Likewise, management teams that develop a full inventory of growth opportunities around their core quickly find themselves awash in interesting and potentially attractive options for investment.

But before executives embark on data collection, they should step back and apply their strategic judgment and operating knowledge to rate opportunities along five key dimensions:

How much does this opportunity strengthen our core business franchise?
What are the chances of our becoming a leader in the new segment or business?
Could this move have a defensive benefit, preempting or interdicting our present or future competitors?
Does this investment position our core business strategically for an even stronger future adjacency? Does it hedge against uncertainty or constitute one step in a well-defined sequence of strategic moves?
Can we be certain of superbly executing implementation?

Asking and answering these questions should increase your odds of finding the grail of growth. But they are difficult decisions. They are calls that even excellent managers can misjudge in the chaos of battle.

Chris Zook directs Bain & Company's Strategy practice and is the author, with James Allen, of Profit from the Core: Growth Strategy in an Era of Turbulence, forthcoming from Harvard Business School Press. Charles Ormiston is the managing director of Bain SE Asia and directs Bain's Global Merger Integration practice.

For more information on Profit from the Core, please visit www.profitfromthecore.com.