Today's businesses, under tremendous pressure to push revenues and profits ever higher, ought to give a thought to the parable about building upon the rock and not the sand.
Consider that the average Canadian company sets three-year revenue growth targets at more than twice the growth rate in its market. On top of that, it aims to grow profits twice as fast as revenues. Without a stable base, such ambitions will inevitably begin to wobble.
Most successful growth companies—those that have grown revenues and profits 5% above inflation over an extended period of time, while also generating attractive returns for shareholders—derived their growth from a strong core business or, occasionally, more than one strong core. Finland's Nokia, which transformed itself from a pulpwood and tire-making conglomerate to a telecommunications giant, is the exception and not the rule. Rarely does successful growth come from spotting a hot new market unrelated to the existing core and jumping in early.
The lesson, then, is first to focus growth efforts on the core business. But if a company is confident it is tapping the full potential within the core, what is the best source of growth beyond the core? Our research over five years shows that the best way is outward—only by extending into business territory that is closely "adjacent" to, and can support, the core. The key is not to overreach.
When we examined the growth records of several hundred companies, we found six types of these "adjacency moves." The most obvious adjacencies are geographic (such as Vodafone's acquisition of Mannesmann into the German cellular-phone market); channel adjacencies (Carter's creation of a new brand and logistics system for baby sleepers); and product adjacencies (IBM's shift from hardware to services). In addition, there are customer adjacencies (Schwab's pursuit of higher-wealth customers), value-chain moves (Nike opening retail stores), and new businesses based on core competencies (American Airlines' creation, with IBM, of the reservation system Sabre).
Yet our analysis shows that only one in four of these initiatives succeeds in supporting profitable growth. And overreaching can have severe consequences: 18 of the 25 largest business disasters in the past five years were rooted in major adjacency moves gone awry—from Vivendi and Mattel to Marconi and Enron. The keys to success vary by industry and circumstance, but a few themes emerge.
Develop a repeatable formula. In 1988, Nike's earnings and market value were smaller than Reebok's. Both companies made athletic shoes; Reebok had the better-known brand. Yet Reebok's profits and market value have fallen far behind since Nike hit upon a formula for adjacency moves, refined and applied to one sport after another—basketball to tennis to soccer to golf. The formula involved a product sequence from shoes to soft goods to hard goods, and an overlay of celebrity endorsements and brand building.
Repeatability enables a company to build an organization around its growth program. A repeatable formula creates the confidence to invest quickly, provides a method to find the next opportunity, and makes it possible to handle more adjacencies faster and better.
Keep moves closely related to a strong core. Many companies stumble by either misdefining their core businesses or misjudging how an adjacency relates. Anheuser-Busch's foray into snack foods, for example—which ended when the brewer sold its teetering Eagle Snacks division in the mid-1990s—demonstrates the costs of such miscalculations.
Executives can measure the "number of steps from the core" by looking at key areas of overlap, such as target customers and shared technology. Some CEOs will invest only in adjacencies that are one step away from the core, and restrict their moves to a single parameter at a time—geography, for instance, or channels.
Follow or lead your customers into their adjacent markets. During the 1980s, as charge-card penetration slowed, American Express tried to assemble a "financial supermarket." It made several acquisitions, but these moves proved to have little relationship to Amex's core. Under a new team, Amex segmented its customers more finely to offer tailored products, services and rewards programs. Employing this strategy, Amex grew revenue in its travel-related services business by 50%, while earnings almost doubled. Selecting the right customer "lens"—segmentation, in Amex's case—allows companies to recognize the most promising adjacency expansions.
Nike and Amex demonstrate two key principles of growing outside the core. First, adjacency expansion succeeds only when built around strong core businesses that have potential for leadership economics. Second, the best place to look for adjacency opportunities is inside a company's strongest customers.
As CEOs confront the daunting growth demands ahead, they will need rock-solid success stories like these—and the calculus behind them.
Alistair Corbett is a director of Bain & Company based in the Toronto office. Chris Zook, leader of Bain's Global Strategy practice, is the author of Beyond the Core, recently published by the Harvard Business School Press.