by Evan Hirsh and Kasturi Rangan
Not long ago the CEO of a company we
know convened his top executives and asked them to look for new
strategic growth opportunities, because revenue had stalled and
the existing customer base was shrinking. He encouraged them not
to be bound by the company’s history, the markets in which it
already participated, the expertise of its people, or the assets it had
in place. Instead he wanted them to identify new markets. “We’ve
got to find some other way to extend our business,” he said. “I
don’t care if it’s a stretch for us. We’ll find a way to make
it happen.”
It’s amazing how often senior executives conclude that their problems are simply a function of a decline in their core markets—and how often boards accept that conclusion. The underlying belief is that leaders should find the “best” industries and put their companies in a position to compete in them. There’s bound to be greener grass somewhere, isn’t there?
Actually, no. The idea that some industries are superior—a view promulgated by Wall Street analysts, media pundits, and managers’ own human tendency to look for “easier” businesses—is illusory. The data do not support it. Sure, some industries outperform others, but the differences are far smaller than you might think, and most highfliers eventually revert to the mean. Moreover, the difference in returns within an industry—any industry—is several times greater than the difference across industries, no matter which ones. CEOs and boards shouldn’t waste time—and shareholder capital—trying to jump to “better” industries. In almost every case, a bigger opportunity lies in improving your performance in the industry you’re in, by fixing your strategy and strengthening the capabilities that create value for customers and separate you from your competitors.
We reached this conclusion after analyzing shareholder returns for 6,138 companies in 65 industries worldwide from 2001 to 2011. Firms in the top quartile had annual total shareholder returns of 17% or more. Every major industry had at least one company with a TSR that high. Some industries did a little better, some a little worse, but the top performers in all did incredibly well. Their CEOs didn’t have to seek deliverance elsewhere.
Yet it’s hard to find a leader who hasn’t entertained the idea that his or her company was simply in a bad industry or market space and a better opportunity lurked nearby. This notion explains some of the big gaffes firms make. It explains why product or service lines that still have growth potential get exploited as cash cows—made to fund other businesses instead of being allowed to reinvest in their own. It explains the waste and loss of focus that often result when companies place multiple bets in the hope that one will be a big winner. It explains the reckless pursuit of mergers that are billed as “transformational” but often involve overpayment, underperformance, a big write-off, and the loss of the CEO’s job.
One example of the pitfalls of this reasoning is Mattel’s acquisition of the Learning Company, in 1999. Growth at Mattel (the maker of the Barbie doll) was slowing, and the Barbie franchise was losing market share; CEO Jill Barad thought the company could gain advantage by shifting its attention to a faster-growing market. She saw the Learning Company, which made interactive games and educational software, as the answer. But her optimism (reflected in an acquisition price of $3.5 billion—4.5 times the Learning Company’s annual revenue) was ill founded. The Learning Company had problems of its own, including low free cash flow and aging brands such as Reader Rabbit, and Mattel didn’t have the know-how to succeed in the interactive-learning market. Far from boosting Mattel’s success, the Learning Company undermined it, erasing Mattel’s profits and wiping out two-thirds of shareholder value. Little more than a year after the acquisition, Barad was out and Mattel had sold the Learning Company for a pittance.
Faulty Assumptions Mattel’s troubles illustrate one problem with grass-is-greener thinking: the assumption that managerial talent and knowledge are fungible. Shareholders often assume that a company that’s capable in one area can rapidly learn to be capable in another. In fact, the capabilities that matter form over decades and may involve millions or billions of dollars in human and financial capital. Firms that have moved into and dominated new areas, such as Apple in online music and Amazon in computer services, chose industries that took advantage of unique capabilities they already had.
The second problem is the assumption that an industry that seems superior today will remain so. There are always some industries in a “hot” part of the growth cycle because of a breakthrough innovation, favorable regulations, or some other advantage. But hot industries often cool. Half the industries we studied that were in the top quartile from 1991 to 2001 ended up in the bottom quartile during the next decade. This variability, found in every type of economic cycle, shows why it is generally very risky to enter an industry at its peak. Time Warner’s disastrous 2000–2001 merger with AOL provides a cautionary example. At the time of the deal AOL had a five-year TSR of 40%. A year later, as the dot-com bubble deflated, the combined company’s stock fell from $90 to $33.
Source:hbr.org
It’s amazing how often senior executives conclude that their problems are simply a function of a decline in their core markets—and how often boards accept that conclusion. The underlying belief is that leaders should find the “best” industries and put their companies in a position to compete in them. There’s bound to be greener grass somewhere, isn’t there?
Actually, no. The idea that some industries are superior—a view promulgated by Wall Street analysts, media pundits, and managers’ own human tendency to look for “easier” businesses—is illusory. The data do not support it. Sure, some industries outperform others, but the differences are far smaller than you might think, and most highfliers eventually revert to the mean. Moreover, the difference in returns within an industry—any industry—is several times greater than the difference across industries, no matter which ones. CEOs and boards shouldn’t waste time—and shareholder capital—trying to jump to “better” industries. In almost every case, a bigger opportunity lies in improving your performance in the industry you’re in, by fixing your strategy and strengthening the capabilities that create value for customers and separate you from your competitors.
We reached this conclusion after analyzing shareholder returns for 6,138 companies in 65 industries worldwide from 2001 to 2011. Firms in the top quartile had annual total shareholder returns of 17% or more. Every major industry had at least one company with a TSR that high. Some industries did a little better, some a little worse, but the top performers in all did incredibly well. Their CEOs didn’t have to seek deliverance elsewhere.
Yet it’s hard to find a leader who hasn’t entertained the idea that his or her company was simply in a bad industry or market space and a better opportunity lurked nearby. This notion explains some of the big gaffes firms make. It explains why product or service lines that still have growth potential get exploited as cash cows—made to fund other businesses instead of being allowed to reinvest in their own. It explains the waste and loss of focus that often result when companies place multiple bets in the hope that one will be a big winner. It explains the reckless pursuit of mergers that are billed as “transformational” but often involve overpayment, underperformance, a big write-off, and the loss of the CEO’s job.
One example of the pitfalls of this reasoning is Mattel’s acquisition of the Learning Company, in 1999. Growth at Mattel (the maker of the Barbie doll) was slowing, and the Barbie franchise was losing market share; CEO Jill Barad thought the company could gain advantage by shifting its attention to a faster-growing market. She saw the Learning Company, which made interactive games and educational software, as the answer. But her optimism (reflected in an acquisition price of $3.5 billion—4.5 times the Learning Company’s annual revenue) was ill founded. The Learning Company had problems of its own, including low free cash flow and aging brands such as Reader Rabbit, and Mattel didn’t have the know-how to succeed in the interactive-learning market. Far from boosting Mattel’s success, the Learning Company undermined it, erasing Mattel’s profits and wiping out two-thirds of shareholder value. Little more than a year after the acquisition, Barad was out and Mattel had sold the Learning Company for a pittance.
Faulty Assumptions Mattel’s troubles illustrate one problem with grass-is-greener thinking: the assumption that managerial talent and knowledge are fungible. Shareholders often assume that a company that’s capable in one area can rapidly learn to be capable in another. In fact, the capabilities that matter form over decades and may involve millions or billions of dollars in human and financial capital. Firms that have moved into and dominated new areas, such as Apple in online music and Amazon in computer services, chose industries that took advantage of unique capabilities they already had.
The second problem is the assumption that an industry that seems superior today will remain so. There are always some industries in a “hot” part of the growth cycle because of a breakthrough innovation, favorable regulations, or some other advantage. But hot industries often cool. Half the industries we studied that were in the top quartile from 1991 to 2001 ended up in the bottom quartile during the next decade. This variability, found in every type of economic cycle, shows why it is generally very risky to enter an industry at its peak. Time Warner’s disastrous 2000–2001 merger with AOL provides a cautionary example. At the time of the deal AOL had a five-year TSR of 40%. A year later, as the dot-com bubble deflated, the combined company’s stock fell from $90 to $33.
Source:hbr.org
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