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Four laws of business

Four laws of business

Economic headwinds are approaching, but downturns are not all bad news for companies. Bain & Company research has shown that changes in economic and strategic position are twice as likely in a downturn as during other economic periods.

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Four laws of business

Economic headwinds are approaching, but downturns are not all bad news for companies. Bain & Company research has shown that changes in economic and strategic position are twice as likely in a downturn as during other economic periods. For companies that are prepared, managing a downturn can open more doors than it closes. Where should managers focus their attention? Most companies encounter four critical pressure points in a downturn, and need to diagnose their current situation in light of them. Once they've done this, they can create a clear plan of attack and prioritise the three or four critical initiatives that will allow them to gain ground on competitors.

Consider Morgan Crucible. When Warren Knowlton became CEO of the British company in January 2003, Morgan was in serious trouble. Sales had declined in each of the previous three years. Profits had vanished. And the stock price had dropped 90 per cent between 1997 and 2002.

But Knowlton led a remarkably quick transformation of this venerable industrial enterprise. By mid-2006, Morgan's continuing businesses had registered 5 to 6 per cent annual revenue growth for three years running. The share price, in the meantime, had risen tenfold.

The pressure to perform is familiar to most CEOs these days. Some 40 per cent of new CEOs last less than two years. And while Knowlton is an exceptional CEO, performance breakthroughs of this sort could be a lot more common than one might think. Leaders of fast turnarounds start by systematically determining the business' current condition. That diagnosis, typically guided by four fundamental laws of business, enables them to gain a deep understanding of the point of departure. They next map out a realistic point of arrival, using the same four laws. Finally, they craft a few vital initiatives that will get them where they need to go.

The fundamental business laws are these: first, costs and prices almost always decline; second, your competitive position determines your options; third, customers and profit pools don't stand still; and fourth, simplicity gets results.

Like the night-time constellation Ursa Major—which always points to the North Star—these laws allow businesses to chart the right path. That's especially relevant in today's times of economic turbulence.

These four laws grow from decades of Bain & Company experience and analysis and are detailed in The Breakthrough Imperative (HarperCollins, 2008). Let's discuss each law in turn.

1. Costs are always a critical dimension. Indeed, it is a basic law that inflation-adjusted costs and prices in nearly every industry decline over time. The rate can best be charted on an experience curve, which maps costs and prices as a function of accumulated experience. In most industries, costs and prices (in constant currency units) decline between 15 per cent and 25 per cent every time accumulated experience doubles. As sales slow, cost leaders find that they have even more built-in advantages than usual. Toyota, for instance, has just unveiled the first car produced under its latest cost-cutting program, which should generate $2.8 billion in savings.

2. A company's competitive position is the second, critical dimension. One of Knowlton's questions for his managers was: "How many business segments do you have, and what is their market share relative to competitors?" Market leaders generally outperform followers—leaders' profits and revenues grow faster, their returns on equity are higher, and their customers are more loyal. In a downturn, the competition grows more intense. The merger talks taking place among US airlines reflect the imperative for every carrier to be top dog in the markets it chooses to focus on. If consummated, the deals may reorder a lot of airlines' market positions, creating great opportunities for some and dire threats for others.

3. Customers and profit pools never sit still, of course. But in leaner economic times, both businesses and consumers are likely to shift their buying patterns faster than ever. These changes in behaviour can significantly rearrange the pools of profits that companies compete for. The US "mass luxury" market is already feeling the pain. A CEO seeking a performance breakthrough needs quick, detailed information about the company's entire customer base. Is the company focusing on the biggest, fastest-growing and most profitable customer segments? How well does it meet customers' needs? How loyal are its customers?

4. Simplicity gets results. This fourth critical concept is not realised often enough in good times, as companies add features, variations, and line extensions. These practices will inevitably complicate both production processes and organisations, and interfere with a company's agility. The drawbacks of complexity are particularly noticeable in a turnaround. Morgan Crucible, though only just over a billion dollar company when Knowlton arrived, was operating 200 individual businesses in 80 countries. Knowlton sold off several businesses and consolidated those that remained into just three divisions, leaders in their markets. He reduced corporate headcount by more than 60 per cent. All these moves increased Morgan's capabilities in the markets where it was choosing to compete.

Turnaround efforts like Morgan's will become more prevalent if the global economy worsens. But downturns aren't always all bad news. As noted above, Bain research has shown that changes in economic and strategic position are twice as likely in a downturn when compared to normal business conditions. Companies that pursued initiatives informed by the four laws gained share and generally improved sales and earnings performance more consistently than their competitors.

Mark Gottfredson, based in Dallas, leads Bain & Company's Global Performance Improvement Practice. Steve Schaubert is a Bain partner in Boston. They are co-authors of The Breakthrough Imperative: How the Best Managers Get Outstanding Results (HarperCollins, 2008).

First published in CEOForum Magazine.

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