Article

Profit from the Core: A Strong Message for Korean Companies

During the Asian economic crisis of 1998, many blamed the chaebols' unchecked expansion during the growth stages of Korea's economy for much of Korea's ills.

Par Kenneth Chang

First published on novembre 09, 2001
min


Which businesses should we compete in? Where should we reinvest our profits? What is our core? These are questions that have plagued CEO's and strategists for the ages. In the Korean context, these questions seem to be more relevant in today's global economy as many companies now look inward to find their place in the competitive landscape. During the economic crisis of 1998, many blamed the chaebols' unchecked expansion during the growth stages of Korea's economy for much of Korea's ills. When funding was easy to come by, and the competition was not all that fierce, growth strategies were easy to formulate; just follow the next "hot thing." Now Korean companies must answer the basic question to thrive: what is our company's core business? This has become a more vital issue for Korean companies as the cost of funding becomes higher, and the sources of growth are not as easy to find. A recent study by Bain & Company showed that only 6% of large Korean companies showed sustainable profitable growth throughout the 1990's. (See chart 1.) These companies were screened from a pool of the largest companies in Korea (greater than 1 Trillion Won in revenue) for which data was available. We defined these Sustainable Value Creators (SVC) as those companies achieving at least a 5.5% average inflation-adjusted growth rate in both earnings and revenue over ten years. In addition, they had to earn their cost of equity, meaning the total return to an investor in the company's stock over the period had to be larger than what the investor could have earned elsewhere. The 6% in Korea is contrasted to 13% that was found globally. This study builds upon the global research conducted for the book Profit from the Core by Chris Zook, head of Bain's Global Strategy practice, in which 2,000 companies were studied worldwide. This study showed that of those companies, only 13% showed sustainable profitable growth over the past 10 years. The definition of sustainable growth was the same as those used for the Korean study. In the book, Zook defines the lessons learned from this group of companies by citing many practical examples. What are some of the relevant lessons for Korean companies? 1. Focus on your core It was clear from the study that focusing on the core was one of the main drivers of sustainable profitable growth. 74% of the SVC companies had one core business. (See chart 2.) Furthermore, it was found that the SVC companies were extremely dominant in their core businesses, meaning that they held the number one marketing position in one particular market. One of the notable exceptions to this rule is GE, which arguably has six core businesses in which they excel. One recent example of a failure to focus on the core is the Internet bookseller Amazon.com. Starting as an online bookseller, they moved to selling other merchandise online like CD's and videos. Amazon then started to expand further, and ultimately in the words of Jeff Bezos, Amazon's CEO, "Our strategy is to make Amazon.com the place where you can find and discover anything and everything you might be looking to buy online." Such unrelated diversification has hurt Amazon's bottom line and its stock price. This has led to recent retractments of earlier strategy statements and some analysts are now wondering whether Amazon will even make it through the year if they stick to their "everything" strategy. What does it mean to focus on your core? It means that in a world of limited resources, you choose to strengthen your core rather than something else. SVC companies were found to out-invest the average follower by a margin of two to one, as a key measure of focusing on the core. Of course, they have more money to invest since their core is strong. But the temptation that these companies have stayed away from is to invest those funds in unrelated new businesses. They chose instead to further strengthen what is already a strong core. 2. Be smart about diversification Focusing on a core does not mean that diversification is forbidden. Adjacent diversifications are a key source of growth for SVC companies. Walt Disney is a classic example of a company who took their core of "the Mouse" and turned it into an entertainment empire. However, the fact is that most diversification strategies fail. Only one in four M&A transactions will end up creating shareholder value. Furthermore, more than half of all acquisitions are eventually shed, meaning that diversification probably didn't add much value to the company. Or to put it another way, perhaps most diversified companies are more valuable as separate companies. Smart diversification strategies look at the proximity of the adjacency of a new business before deciding to enter. The proximity is measured by how many "steps" include different customers, channels, markets, value chain components and products. For example, if everything is the same except one of these components, such as selling the same product in a new country, then it's probably only one "step" away and a related adjacent diversification. If multiple "steps" are involved, then the chances of success for that adjacency diversification decrease. 3. Adjust your core to turbulence One of the great paradoxes of focusing on one core is that it can leave you vulnerable to changing environments and turbulence. Therefore, it is critical that a company be flexible enough to adjust or even change its core to changing conditions. Polaroid is an example of a company that was once hugely successful through its patented technology for instant image processing. However, when digital imaging came along, Polaroid chose not to change its core and continued to invest in its core of chemical instant image processing. The once high-flying company is now bankrupt. There are, however, numerous other examples of companies who adjusted their cores accordingly and have become even more successful through a readjustment of their core. Charles Schwab is one example. This discount brokerage service, when faced with the threat of the Internet as a direct channel, chose to embrace it instead by offering its services online at huge discounts to what its offline brokers were charging. It now is the leading online service broker, and has created tremendous shareholder. This last point has many implications for Korean companies as well. In our study of SVC Korean companies, it was noted that the major difference between companies in the global study and the Korean study was that Korean companies went through one major economic crisis in 1997, the likes of which was not experienced by other countries in the study. One of the key differentiating points between the SVC companies and the follower companies was the ability to cope with the crisis. In 1997, there was a "scissors-like" effect between companies who responded to turbulence, and those who crumbled underneath it. In general, those companies who had diversified and under-invested in their core, left themselves vulnerable when the market dried out. The strong companies, who had focused or adjusted their cores, weathered the storm of the crisis and came out even stronger relative to their competitors. In this era of turbulence and uncertainty, the message of profit from the core becomes even more important for Korea. This message has stuck a chord with global business leaders since the book was published earlier this year. In times of uncertainty, the top executives tend to do more soul-searching. It is time for Korean executives to do the same thing. Mr. Kenneth Chang is a manager in Bain & Company's Seoul office. Having started his Bain career in Chicago, Mr. Chang has worked on case assignments in multiple Bain offices including Chicago, Atlanta, Hong Kong, Brussels and Seoul. Mr. Chang has experience in a number of industry sectors, including automotive, financial services, telecommunications, computers and private equity and is an expert in corporate and business unit strategy and due diligence. He earned an MBA from Harvard Business School, a MS degree in mechanical engineering from MIT and a BS degree with distinction in mechanical engineering from Stanford University. About Bain & Company, Inc. Bain & Company is one of the world's leading global business consulting firms, serving clients across six continents. It was founded in 1973 on the principle that consultants must measure their success in terms of their clients' financial results. Bain's clients have out performed the stock market 3 to1. With headquarters in Boston and offices in all major cities throughout the world, Bain has worked with over 2,000 major multinational and other corporations from every economic sector, in every region of the world. For more information visit www.bain.com. Bain Book Profit from the Core Learn more about how companies can return to growth in turbulent times.

Which businesses should we compete in? Where should we reinvest our profits? What is our core? These are questions that have plagued CEO's and strategists for the ages. In the Korean context, these questions seem to be more relevant in today's global economy as many companies now look inward to find their place in the competitive landscape. During the economic crisis of 1998, many blamed the chaebols' unchecked expansion during the growth stages of Korea's economy for much of Korea's ills. When funding was easy to come by, and the competition was not all that fierce, growth strategies were easy to formulate; just follow the next "hot thing." Now Korean companies must answer the basic question to thrive: what is our company's core business? This has become a more vital issue for Korean companies as the cost of funding becomes higher, and the sources of growth are not as easy to find.

A recent study by Bain & Company showed that only 6% of large Korean companies showed sustainable profitable growth throughout the 1990's. (See chart 1.) These companies were screened from a pool of the largest companies in Korea (greater than 1 Trillion Won in revenue) for which data was available. We defined these Sustainable Value Creators (SVC) as those companies achieving at least a 5.5% average inflation-adjusted growth rate in both earnings and revenue over ten years. In addition, they had to earn their cost of equity, meaning the total return to an investor in the company's stock over the period had to be larger than what the investor could have earned elsewhere.

The 6% in Korea is contrasted to 13% that was found globally. This study builds upon the global research conducted for the book Profit from the Core by Chris Zook, head of Bain's Global Strategy practice, in which 2,000 companies were studied worldwide. This study showed that of those companies, only 13% showed sustainable profitable growth over the past 10 years. The definition of sustainable growth was the same as those used for the Korean study. In the book, Zook defines the lessons learned from this group of companies by citing many practical examples. What are some of the relevant lessons for Korean companies?

1. Focus on your core

It was clear from the study that focusing on the core was one of the main drivers of sustainable profitable growth. 74% of the SVC companies had one core business. (See chart 2.) Furthermore, it was found that the SVC companies were extremely dominant in their core businesses, meaning that they held the number one marketing position in one particular market. One of the notable exceptions to this rule is GE, which arguably has six core businesses in which they excel.

One recent example of a failure to focus on the core is the Internet bookseller Amazon.com. Starting as an online bookseller, they moved to selling other merchandise online like CD's and videos. Amazon then started to expand further, and ultimately in the words of Jeff Bezos, Amazon's CEO, "Our strategy is to make Amazon.com the place where you can find and discover anything and everything you might be looking to buy online." Such unrelated diversification has hurt Amazon's bottom line and its stock price. This has led to recent retractments of earlier strategy statements and some analysts are now wondering whether Amazon will even make it through the year if they stick to their "everything" strategy.

What does it mean to focus on your core? It means that in a world of limited resources, you choose to strengthen your core rather than something else. SVC companies were found to out-invest the average follower by a margin of two to one, as a key measure of focusing on the core. Of course, they have more money to invest since their core is strong. But the temptation that these companies have stayed away from is to invest those funds in unrelated new businesses. They chose instead to further strengthen what is already a strong core.

2. Be smart about diversification

Focusing on a core does not mean that diversification is forbidden. Adjacent diversifications are a key source of growth for SVC companies. Walt Disney is a classic example of a company who took their core of "the Mouse" and turned it into an entertainment empire. However, the fact is that most diversification strategies fail. Only one in four M&A transactions will end up creating shareholder value. Furthermore, more than half of all acquisitions are eventually shed, meaning that diversification probably didn't add much value to the company. Or to put it another way, perhaps most diversified companies are more valuable as separate companies.

Smart diversification strategies look at the proximity of the adjacency of a new business before deciding to enter. The proximity is measured by how many "steps" include different customers, channels, markets, value chain components and products. For example, if everything is the same except one of these components, such as selling the same product in a new country, then it's probably only one "step" away and a related adjacent diversification. If multiple "steps" are involved, then the chances of success for that adjacency diversification decrease.

3. Adjust your core to turbulence

One of the great paradoxes of focusing on one core is that it can leave you vulnerable to changing environments and turbulence. Therefore, it is critical that a company be flexible enough to adjust or even change its core to changing conditions. Polaroid is an example of a company that was once hugely successful through its patented technology for instant image processing. However, when digital imaging came along, Polaroid chose not to change its core and continued to invest in its core of chemical instant image processing. The once high-flying company is now bankrupt.

There are, however, numerous other examples of companies who adjusted their cores accordingly and have become even more successful through a readjustment of their core. Charles Schwab is one example. This discount brokerage service, when faced with the threat of the Internet as a direct channel, chose to embrace it instead by offering its services online at huge discounts to what its offline brokers were charging. It now is the leading online service broker, and has created tremendous shareholder.

This last point has many implications for Korean companies as well. In our study of SVC Korean companies, it was noted that the major difference between companies in the global study and the Korean study was that Korean companies went through one major economic crisis in 1997, the likes of which was not experienced by other countries in the study. One of the key differentiating points between the SVC companies and the follower companies was the ability to cope with the crisis. In 1997, there was a "scissors-like" effect between companies who responded to turbulence, and those who crumbled underneath it. In general, those companies who had diversified and under-invested in their core, left themselves vulnerable when the market dried out. The strong companies, who had focused or adjusted their cores, weathered the storm of the crisis and came out even stronger relative to their competitors.

In this era of turbulence and uncertainty, the message of profit from the core becomes even more important for Korea. This message has stuck a chord with global business leaders since the book was published earlier this year. In times of uncertainty, the top executives tend to do more soul-searching. It is time for Korean executives to do the same thing.

Mr. Kenneth Chang is a manager in Bain & Company's Seoul office. Having started his Bain career in Chicago, Mr. Chang has worked on case assignments in multiple Bain offices including Chicago, Atlanta, Hong Kong, Brussels and Seoul. Mr. Chang has experience in a number of industry sectors, including automotive, financial services, telecommunications, computers and private equity and is an expert in corporate and business unit strategy and due diligence. He earned an MBA from Harvard Business School, a MS degree in mechanical engineering from MIT and a BS degree with distinction in mechanical engineering from Stanford University.

About Bain & Company, Inc.
Bain & Company is one of the world's leading global business consulting firms, serving clients across six continents. It was founded in 1973 on the principle that consultants must measure their success in terms of their clients' financial results. Bain's clients have out performed the stock market 3 to1. With headquarters in Boston and offices in all major cities throughout the world, Bain has worked with over 2,000 major multinational and other corporations from every economic sector, in every region of the world. For more information visit www.bain.com.