NEW YORK, NY -- (Marketwired) -- 05/07/13 -- Leaders often try to expand into hot new growth industries, looking for accelerated performance they think isn't available in their core business. But that's a significant mistake, according to research by Booz & Company. In fact, companies perform better and produce better shareholder returns when they strengthen the key capabilities that help them win in their core industry. Companies that try to grow into new industries are likely to fail.
A Booz & Company study of total shareholder return (TSR) for 6,138 companies in 65 industries shows that, except for the best-performing (tobacco) and worst-performing (computers and peripherals) industries, mean 10-year TSR compound annual growth rates (CAGRs) across all industries were within 15 percent of one another. But within each industry, the top company outperformed the worst company by an astonishing 69 percent, on average.
"The analysis indicates that the best performance improvement and growth opportunity for a company is to rise to the top of the industry it's already in," said Evan Hirsh, Booz & Company partner. (Mr. Hirsh is the coauthor of "The Grass Isn't Greener," a recent Harvard Business Review article that references the study.) "Getting better at what you already do is what gives you the biggest upside," Hirsh added.
"Many leaders spend a lot of time and energy on finding a 'better' industry to get into," he continued. "They convince themselves that their company's growth is slowing because their core industry is unattractive, and the way out is to shift into a fast-growing industry. And boards routinely accept that conventional wisdom."
But the study found that in fact, moving into another industry generally isn't the best way to grow. "When we reviewed shareholder returns over the past decade, we found that median performance across most industries was strikingly similar," explained Hirsh. "What this indicates is that if a company expands into a new industry, the odds are not good that it will exceed its current performance. In fact, by focusing its attention on trying to compete in the new industry, the company will probably neglect its core business and fall behind there."
The better move is for companies to improve their performance and try to rise to the top of their own industry. "We've found huge differences in returns within each industry," said Kasturi Rangan, Booz & Company principal and coauthor of the Harvard Business Review article. "In every industry, there are companies that greatly exceed median performance. For example, the airline industry is often thought of as being a laggard, but the top performer there, Latin America's LATAM Airlines Group SA, has a 10-year TSR CAGR of 35 percent -- better than the median performers in any other industry, better even than the median performer in the best-performing industry, tobacco, where the median was 21 percent. The computer and peripherals industry is the worst-performing industry in the study. But the top performer there, Apple Inc., had a 10-year TSR CAGR of 54 percent. As the Spanish like to say, it's better to be the head of a rat than the tail of a lion. That is, it's better to win in a so-called bad industry than be an also-ran in a supposedly good one."
The authors reported on why companies' expansions into new industries failed -- and why companies succeeded when they instead stuck to and strengthened their core capabilities. Among the lessons:
•Leaders overestimate their ability to manage in new industries. Mattel's 1999 acquisition of the Learning Company failed because CEO Jill Barad and other senior managers didn't know how to turn around a company in the interactive industry -- actually, they didn't have the know-how to recognize the Learning Company's weaknesses in the first place.
•Hot industries don't stay hot. Booz & Company's research shows that of the industries that were in the top TSR quartile in 1991-2001, 50 percent fell into the bottom quartile in the following decade. Only 8 percent remained in the top quartile in2001-11. When AOL acquired Time Warner, for example, AOL had a five-year TSR of 40 percent. But after the dot-com bubble burst, the combined company's share price fell from $90 to $33.
•Success comes when companies focus on those few capabilities that are truly key for success while minimizing all other costs. Off-road vehicle maker Polaris Industries resisted the temptation to look for easier growth areas. Instead, the company chose to focus on investing in two core capabilities -- rapid innovation using deep customer insights, and flexible manufacturing. This allowed Polaris to develop new vehicles in both the utility and the performance-enthusiast markets. The company's market share in off-road vehicles surged from 25 percent to 35-plus percent, and is now more than double its nearest competitor's share.
•CEOs should steer the business toward market share gains rather than revenue growth. Many leaders manage by issuing numerical targets -- for revenue growth, profitability, and expenses. "But it's often better to focus solely on market share and develop a plan for increasing it," Hirsh said. IBM CEO Lou Gerstner famously kept his managers focused on market share and customer satisfaction -- a strategy that kept their attention on serving customers and beating the competition. He was betting that the industry wasn't the problem, and he was right.
Companies can succeed by expanding into new industries -- but only if they have, or can build, the capabilities it takes to be successful in that new market. Leaders need to develop a capabilities-driven strategy: They need to be clear about what they're really good at and look for market opportunities that leverage those key strengths. "If success in a new industry requires capabilities that are too much of a stretch from where the company is today, it does not matter that the industry looks profitable -- the company does not have what it needs to win there," said Hirsh. "The company should instead focus on refining the capabilities it needs to win in its core market. Its aim should be to become truly outstanding and move to the top of the industry. The best performers use that capabilities 'lens' to focus everything they do, including where to grow and how to grow."
This perspective can be vital. "There's a story about two hunters being chased by a bear," Hirsh continued. "One says to the other, 'I don't have to outrun the bear. I just have to outrun you.' In other words, the most important imperative is to outperform your competition, not to meet some abstract standard. A focus on core capabilities enables you to do that. It makes for a more effective growth strategy, whether for organic or inorganic growth."
Evan Hirsh is a partner with Booz & Company based in Cleveland. His focus is on the automotive and industrials sectors. He serves clients on major business improvement programs and growth strategy. Hirsh has more than 20 years of global consulting experience.
Kasturi Rangan is a principal with Booz & Company based in Cleveland. He specializes in corporate and business growth strategies and works with his clients to translate them into executional agendas for their businesses. His consulting experience spans the globe, including the U.S., Europe, China, and India. Rangan has more than eight years of business consulting experience.
About Booz & Company
Booz & Company (booz.com) is a leading global management consulting firm focused on serving and shaping the senior agenda of the world's leading institutions. Drawing on the talents and insights of more than 3,000 people in 58 offices around the world, we help our clients achieve essential advantage by working with them to identify and build the differentiating capabilities they need to outperform.
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