In a world of product saturation and market turmoil, can your company achieve double-digit growth? Absolutely! Read more in this excerpt from How to Grow When Markets Don’t.
Book Excerpt
ISBN: 0446692700
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352 pages
WARNER BOOKS
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1 – The Growth Crisis
This is a book about growth-specifically, about how you can grow your business in the difficult environment most companies are facing now and will face in the decades to come.
Many businesspeople think of the postwar decades as a golden era of routine, almost reflexive growth. This picture is exaggerated but fundamentally accurate. It was significantly easier for most firms to rapidly and steadily increase their revenues and profits during those years than it is today. Many great companies were built using a model that appears, in retrospect, exceedingly simple: Invent a great product. Launch it. Sell it like hell. Go international. Acquire and consolidate. Cut costs. Raise prices if you can. Repeat ad infinitum.
But as most businesspeople realize, cracks have long been spreading in that traditional model of business growth.
The first major stress on this traditional growth model came with the rise of the business design innovators beginning in the mid-1980s. Companies such as Southwest Airlines, Nucor, and Wal-Mart focused not on product innovation but on inventing new ways to better serve the customer, capture value, and create strategic control in their industries. They created innovative business designs even as they sold products similar to everyone else’s.
The result was that billions of dollars of shareholder value migrated from the traditional industry leaders such as United Airlines, U.S. Steel, and Sears to these upstarts. We’ve learned a lot by studying the business design innovation methods developed by these companies and other industry leaders, and many of our consulting clients, as well as readers of our previous books, Value Migration, The Profit Zone, and The Art of Profitability, have benefited from applying the same ideas to their own businesses.
Within the past five years, though, we’ve begun to observe a new and troubling pattern. What was once value migration from one business model to another has increasingly changed into value outflow. Profits and shareholder value are leaving industries altogether as markets become increasingly saturated and traditional sources of growth run out of steam.
This value outflow points out a key challenge to business design innovators in today’s marketplace. Most have done little to shape new customer needs beyond those addressed by traditional product offerings. Take Southwest Airlines, for instance. It has built an innovative point-to-point route system with lower overall costs than the major airlines, but it still sells only the standard airline seat. It hasn’t redefined the travel experience or created new demand by helping customers in some special way before or after they occupy that seat. The same is true of Nucor in steel or Wal-Mart in general merchandise retailing or Dell in computers. All have successful but fundamentally product-focused business designs.
Out of Steam
Unfortunately, in the years to come, traditional product-centered strategies alone will be unable to create the kind of growth companies desire.
In the past, companies searching for growth opportunities have relied on classic product-focused growth strategies: Create innovative products, expand the market for them globally, and make acquisitions to gain market share and create efficiencies. These traditional growth moves are as important as ever (and for a few companies, even more important). But for most companies, these moves will merely replace revenues and profits lost to commoditization and increased competition. They won’t represent a platform for driving significant, sustained new growth. This is true for a variety of reasons. Let’s begin with the challenging dynamics facing product-innovation-oriented growth moves: brand extensions, core product enhancements, and new-product introductions.
After years of brand extensions, most spin-off products are serving ever-smaller niche markets and fighting for space on increasingly crowded shelves. (The same applies to such basic services as banking, hospitality, and travel, which can be thought of as “products” in this context.) For example, between 1980 and 1998, the number of annual new food product introductions in the United States grew five-fold, to nearly eleven thousand. Similarly daunting statistics could be cited for cars and CDs, books and cosmetics, toys and televisions. In such an environment of saturation, is the world waiting eagerly for your next product extension? Not likely.
Thus, most companies’ product extensions-think of American Express Optima or Pepsi Blue-are producing increasingly small returns in terms of growth, especially in percentage terms. The bigger your company, the bigger the growth opportunities you need if you hope to achieve double-digit growth. But while many of the billion-dollar companies of fifteen yeas ago had robust product extension pipelines, the same pipelines are producing only a trickle of growth for today’s $10 billion companies. The disproportion is growing increasingly painful.
Product enhancement is another largely depleted avenue for new profit growth. In most industries, truly differentiating new-product breakthroughs are becoming increasingly rare. As a result, product competition in one industry after another is reduced to back-and-forth jockeying, as first one competitor and then another introduces a product with slightly better performance. Think of Nintendo and Sony, Intel and AMD, Boeing and Airbus, Avis and Hertz. The advantages gained in this tit-for-tat combat are invariably slender and fleeting.
And because meaningful product breakthroughs have become rare, customers are extending their product replacement cycles. If the newest car, copier, or computer is only marginally better than last year’s model, customers can wait longer to replace it. Sales growth thus shrinks further.
Even new-product innovation is a largely depleted avenue for consistent profit growth. Of course, there will always be new technologies and new products, and some of these will provide genuine growth opportunities. But the intensity of today’s product competition means that most product-driven growth is likely to be increasingly low-margin and short-lived. This is why consumer electronics companies struggle to post profits despite a never-ending cascade of new gadgets.
In high-tech industries, the vast majority of companies and initiatives founded on breakthrough technologies fail to get off the ground. Think of NeXT Computer, Apple’s Newton, or Sprint’s ION communications platform. Even the most successful high-tech companies have been “bottle rockets” that experience three to four years of spectacular growth and stellar financial performance followed by equally spectacular collapse, as newer technologies emerge and customer needs shift. This pattern has been borne out in the histories of such former high-fliers as Wang, Data General, Rolm, and Digital. Recently, with companies such as Lucent and Palm, this cycle has compressed to two years.
Thus, while technological innovation will be a source of growth for some companies and is clearly a major contributor to macroeconomic growth, relying on it for sustained growth is a highly risky proposition. For all these reasons, the vast majority of companies are now finding that product innovation is, at best, a source of profit replacement or profit protection; it isn’t a source of new, long-term growth.
The other legs of the traditional growth strategy, international expansion and acquisitions, are also largely depleted of their potential.
International markets, often viewed as a rich field for growth, have indeed created decades-long growth for companies such as Coke, Boeing, and McDonald’s. Increasingly, however, international markets hold declining opportunities for significant new growth. For one thing, many companies have already exploited the richest international opportunities. A decade ago, international sales might have been 15 to 20 percent of revenues at most Fortune 500 companies. Today, foreign markets drive 40 to 50 percent of revenues. In addition, in most industries, the largest foreign markets-Western Europe and Japan-are now as mature, competitive, and saturated as the United States. And most emerging markets, despite all the billion-consumers-in-China rhetoric, are much smaller, especially when measured by consumer and industrial purchasing power rather than by mere head count. They’re also generally plagued by inefficient distribution channels, economic and political instability, and protectionist laws.
Worse, emerging markets that once looked promising are increasingly producing world-class competitors that challenge U.S. firms not only abroad but also on their home turf (think of Korea’s Samsung in electronics and Hyundai in autos). Or they backslide suddenly into economic chaos (think of Brazil, Argentina, Russia, and Thailand).
Now let’s turn to mergers and acquisitions, a huge component of the 1990s growth story. From 1994 to 2000, M&A activity grew sevenfold to $1.4 trillion per year. But the pace of deal making has dropped precipitously as the high stock valuations that allowed many companies to make cheap acquisitions in recent years have dropped back to more reasonable levels. In many industries, moreover, consolidation has reduced the number of viable acquisition targets to a handful, making antitrust concerns a barrier to future growth through M&A. In any case, numerous studies have shown that acquisitions rarely produce new value and often lead to disaster, which has dampened investor enthusiasm for such moves.
When you strip away the effects of international expansion and merger activity from the seemingly impressive growth rates of the 1990s, what remains is often less than impressive. Many companies with nominal growth rates in the double digits have real growth rates in their base businesses of less than 5 percent. That holds true even without considering the use of aggressive and sometimes dubious accounting practices to boost reported revenues-a big problem and one that’s much harder to disentangle.
The popularity of such practices is, at one level, a symptom of the spreading growth crisis.
Creating sustained growth is hard under the best of circumstances. From 1990 to 2000, just 7 percent of publicly traded companies in the U.S. enjoyed eight or more years of double-digit growth in revenues and operating profits. As the growth crisis worsens in the coming decade, you can expect this percentage to shrink significantly-unless companies rethink their approach to growth.
The Human Costs of the Growth Crisis
This is not an abstract problem but rather a painful day-to-day reality. No matter what role you play in the world of business, the chances are good that you’ve already begun to personally feel some of the effects of the breakdown of the traditional growth model.
If you’re a middle manager, for example, you’ve probably found yourself having thoughts like this:
Over the past few years, things have been getting tougher and tougher for me at work. I used to be able to glide from one success to the next. But lately, the raises have been getting smaller and the promotions less frequent. It keeps getting harder to win approval for new investments, new hiring, or new equipment.
When I first joined the company, it felt like an upbeat, innovative, forward-looking place. Now I’m not so sure. The top brass keep saying, at least in public, that this is just a cyclical downturn… that all we have to do is batten down the hatches and ride out the storm. But I don’t think I believe that anymore.
I still have a job-knock on wood!-but who knows how long that’ll last. When my company stock holdings soared back in the 1990s, I toyed with the idea of early retirement. But for the past three years, they’ve been sliding sideways at best, and now I wonder if I’ll ever be able to stop working.
Worst of all, work just isn’t much fun anymore. Walking down the hall, I used to hear laughter and lively debates. Now I hear people whispering nervously behind half-closed office doors. I used to look forward to Monday morning. Now I just try not to think about it.
If you’re a senior executive, you silently share many of the grimmer feelings of the middle manager …along with a few special torments of your own:
It’s always been tough to be a company leader. There’s a lot on my shoulders-that’s the nature of the job. But the weight sure feels heavier today than it did five years ago.
The problem is that earnings growth has gotten so hard to come by. Everyone I pass in the hallways is looking to me for answers. They’re counting on me, and I know it. At staff meetings, I look determined and promise that the initiatives we’re undertaking will turn all the trend lines up. But how am I going to deliver?
We have a strategic planning team that dutifully prepares reports recommending new-growth initiatives. Trouble is, the last ten proposals I’ve read look like the same ideas our company tried three years ago and five years ago. They didn’t work then, and they won’t work now. I visit the folks in R&D. They’re just as smart and diligent as ever. But the new-product concepts they’re working on look small, tired, and unappealing. How are they supposed to usher in a new era of growth?
My job has always been tough, but it used to be fun, too. Now it seems I spend my days scrambling to meet earnings forecasts to keep the wolves of Wall Street at bay. We cut costs a little more here, accelerate revenues a little more there, push a little more inventory out to the retail level somewhere else. I feel as if I’m endlessly pulling rabbits out of hats. Worst of all, deep inside, I’m pretty sure that one day soon the miracles will come to an end, and there won’t be any more rabbits to produce.
Even the professional investor or money manager, who makes a living by picking winners among the thousands of publicly traded companies, is suffering because of the growth crisis:
Not so long ago, it was easy to deliver double-digit returns to my clients. The challenge wasn’t where to invest; it was where to get enough money to chase all the good ideas.
The world seemed to be full of opportunities. New markets were opening up around the world. New technologies were revolutionizing one industry after another. And for years, the markets behaved as if the old rules about P/E ratios and earnings yield had been repealed. The multiples soared, kids straight out of MIT or Stanford became millionaires, and every quarter my portfolio went up another 8 or 10 or 12 percent. Those were the days.
Now it seems to be almost impossible to find solid companies with meaningful growth plans. Most are pinning their hopes on tired old tactics that even they don’t really seem to believe in. And after the dot-com collapse, the telecom fiasco, and the accounting scandals, I’m almost afraid to look at my Bloomberg screen. It seems like every other day, some company I believed in and supported with my investors’ money comes out with a new round of bad news-an earnings restatement or massive layoffs or a CEO firing.
As for those fancy new economic models that no one can explain in one-syllable words, I don’t even want to hear about them anymore.
The question I keep asking myself: Where can I find companies to invest in that have real prospects for long-term growth?
If you’ve had such thoughts or conversations, you may have assumed they were symptoms of some personal malaise or a problem affecting one company or one industry. In fact, they are symptoms of something much more profound. Companies looking for significant, sustained growth in the future will need to find new platforms for growth. Otherwise, their stock prices will be going nowhere, while their talent goes elsewhere.
The Great Divide
Maybe these kinds of complaints don’t resonate with you. Maybe you and your company have avoided the growth crisis so far. If so, congratulations. You are in the distinct minority.
During the past decade, most companies have crossed a great divide, moving from a past of strong growth for their base businesses into a future of low or no growth. Many did so without fully recognizing the change. The crucial shift occurred at different times in different businesses.
For Polaroid, the moment might have been in 1992.
For McDonald’s, in 1994.
For Gillette, in 1997.
For Hewlett-Packard, in 1999.
For Merck, it is just beginning.
What about your company? What are the prospects for product-based growth in your industry? Have you already passed over into the no-growth zone, or is the shift coming in the next year, or two, or five?
The timing is important, because a delay in recognizing the problem exacerbates it, sometimes fatally. It takes two to four years for an organization to learn how to create truly new growth. The sooner you acknowledge the problem and move to address it, the better your chances of beating it.
Demand Innovation
The good news is that we’ve recently begun to observe a new form of business design innovation-a new response to the challenge of growth that is being pioneered by a handful of farsighted companies. These companies are focused on creating new growth and new value by addressing the hassles and issues that surround the product rather than by improving the product itself. They have shifted their approach from product innovation to demand innovation.
Rather than being about value migration, demand innovation is about creating new growth by expanding the market’s boundaries. It focuses on using one’s product position as a starting point from which to do new things for customers that solve their biggest problems and improve their overall performance. Thus, companies skilled in demand innovation do more than simply take value and market share away from traditional businesses. They also create new value and new growth in revenues and profits, even in mature industries that appear to have reached a plateau.
We’ve written this book to explore the new art of demand innovation, as illustrated by the stories of several of today’s most innovative growth companies, including Cardinal Health, Johnson Controls, Air Liquide, GM OnStar, John Deere Landscapes, and Clarke American. The names of these companies may not be as familiar to you as those of Southwest Airlines, Wal-Mart, Intel, Dell Computer, and the other practitioners of value migration. They compete in widely divergent industries, and the specific business strategies they practice vary greatly. But all have one thing in common: They have managed to create impressive new revenue and profit growth in industries or industry niches that most observers and business leaders consider inhospitable to growth.
The more we studied the approach to business practiced by Cardinal, Johnson, and the rest, the more convinced we became that it represented a genuinely new phenomenon. Like Dell, Wal-Mart, and the other masters of value migration, the new-growth innovators are great business model innovators as well as imaginative and insightful analysts of the business environment, skilled at recognizing opportunities where others do not and developing profitable ways to respond. But where value migration businesses focus on reallocating value by responding to preexisting demand, new-growth businesses focus on growing new value by discovering new forms of demand.
Because demand innovation involves a new and emerging set of skills, many businesspeople will find it challenging to understand and master. But it can be done. We see traditional product-centered companies across a wide range of industries beginning to discover and create new business spaces with growth opportunities that will last not months or quarters but years or decades. In the chapters that follow, you’ll learn about these firms and see what you can do to bring the same kind of new growth to your company, no matter what business you’re in.
Copyright © 2003 by Mercer Management Consulting, Inc.
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