Strategy to beat the odds PART II
The
power of big moves
So what can you do to improve the odds
that your company will move up the power curve? The answer is lurking in our
data. Consider this analogy: To estimate a person’s income, we can start with
the global average, or about $15,000 per year. If we know that the person is
American, our estimate jumps to the average US per capita income, or $56,000.
If we know that the individual is a 55-year-old male, the estimate jumps to
$64,500. If that guy works in the IT industry, it jumps to $86,000. And if we
know the person is Bill Gates, well, it’s a lot more than that.
Adding ever more information similarly
helps to zero in on the probabilities of corporate success. Even if you know
your overall odds, you need to understand which of your attributes and actions
can best help you raise them. We identified ten performance levers and,
importantly, how strongly you have to pull them to make a real difference in
your strategy’s success. We divided these levers into three categories:
endowment, trends, and moves. Your endowment is what you start with, and the
variables that matter most are your revenue (size), debt level (leverage), and
past investment in R&D (innovation). Trends are the winds that are pushing
you along, hitting you in the face, or buffeting you from the side. The key
variables there are your industry trend and your exposure to growth
geographies. In analyzing the odds of moving on the power curve, we found that
endowment determines about 30 percent and trends another 25 percent.
The moves that matter
However, it is your moves—what you do with
your endowment and how you respond to trends—that make the biggest difference.
Our research found that the following five moves, pursued persistently, can get
you to where you want to go:
·
Programmatic M&A. You need a steady stream of deals every year, each
amounting to no more than 30 percent of your market cap but adding over ten
years to at least 30 percent of your market cap. Corning, which over the course
of a decade moved from the bottom to the top quintile of the power curve, shows
the value of disciplined M&A. Corning understands that doing three deals a
year means it must maintain a steady pipeline of potential targets, conduct due
diligence on 20 companies, and submit about five bids.
·
Dynamic reallocation of
resources. Winning companies reallocate capital
expenditures at a healthy clip, feeding the units that could produce a major
move up the power curve while starving those unlikely to surge. The threshold
here is reallocating at least 50 percent of capital expenditure among business
units over a decade. When Frans van Houten became Philips’ CEO in 2011, the
company began divesting itself of legacy assets, including its TV and audio businesses.
After this portfolio restructuring, Philips succeeded at reinvigorating its
growth engine by reallocating resources to more promising businesses (oral care
and healthcare were two priorities) and geographies. Philips started, for
example, managing performance and resource allocations at the level of more
than 340 business-market combinations, such as power toothbrushes in China and
respiratory care in Germany. That led to an acceleration of growth, with the
consumer business moving from the company’s worst-performing segment to its
best-performing one within five years.
·
Strong capital
expenditure. You meet the bar on this lever if you
are among the top 20 percent in your industry in your ratio of capital spending
to sales. That typically means spending 1.7 times the industry median.
Taiwanese semiconductor manufacturer Taiwan Semiconductor Manufacturing Company
(TSMC) pulled this lever when the Internet bubble burst and demand for
semiconductors dropped sharply. The company bought mission-critical equipment
at the trough and was ready to meet the demand as soon as it came back. TSMC
had been in a head-to-head race before the downturn but pulled clear of the
competition after it ended because of its investment strategy. That laid the
foundation for TSMC to become one of the largest and most successful
semiconductor manufacturing pure plays in the world.
·
Strength of productivity
program. This means improving productivity at a
rate sufficient to put you at least in the top 30 percent of your industry.
Global toy and entertainment company Hasbro successfully achieved the top
quintile of the power curve with a big move in productivity. Following a series
of performance shortfalls, Hasbro consolidated business units and locations,
invested in automated processing and customer self-service, reduced head count,
and exited loss-making business units. The company’s selling, general, and
administrative expenses as a proportion of sales fell from an average of 42
percent to 29 percent within ten years. Sales productivity lifted, too—by a
lot. Over the decade, Hasbro shed more than a quarter of its workforce yet
still grew revenue by 33 percent.
·
Improvements in
differentiation. For business-model innovation and
pricing advantages to raise your chances of moving up the power curve, your
gross margin needs to reach the top 30 percent in your industry. German
broadcaster ProSieben moved to the top quintile of the power curve by shifting
its model for a new era of media. For example, it expanded its addressable
client base by using a “media for equity” offering for customers whose business
would significantly benefit from mass media but who couldn’t afford to pay with
cash. Some of ProSieben’s innovations were costly, sometimes even cannibalizing
existing businesses. But, believing the industry would move anyway, the company
decided that experimenting with change was a matter of survival first and
profitability second. ProSieben’s gross margin expanded from 16 percent to 53
percent during our research period.
Greater than the sum of the parts
Big moves are most effective when done in
combination—and the worse your endowment or trends, the more moves you need to
make. For companies in the middle quintiles, pulling one or two of the five
levers more than doubles their odds of rising into the top quintile, from 8
percent to 17 percent. Three big moves boost these odds to 47 percent.
To understand the cumulative power of big
moves, consider the experience of Precision Castparts Corp. (PCC). In 2004, the
manufacturer of complex metal components and products for the aerospace, power,
and industrial markets was lumbering along. Its endowment was unimpressive,
with revenues and debt levels in the middle of the pack, and the company had
not invested heavily in R&D. PCC’s geographic exposure was also limited,
though the aerospace industry experienced enormous tailwinds over the following
ten years, which helped a lot.
Most important, however, PCC made big
moves that collectively shifted its odds of reaching the top quintile
significantly. The company did so by surpassing the high-performance thresholds
on four of the five levers. For mergers, acquisitions, and divestments, it
combined a high value and large volume of deals between 2004 and 2014 through a
deliberate and regular program of transactions in the aerospace and power
markets.
PCC also reallocated 61 percent of its
capital spending among its three major divisions, while managing the rare double
feat of both productivity and margin improvements—the only aerospace and
defense company in our sample to do so. While nearly doubling its labor
productivity, PCC managed to reduce its overhead ratio by three percentage
points. It lifted its gross profit-to-sales ratio from 27 to 35 percent.
The combination of a positive industry
trend and successful execution of multiple moves makes PCC a showcase of a
“high odds” strategy and perhaps explains why Berkshire Hathaway agreed in 2015
to buy PCC for $37.2 billion. Could our model have predicted this outcome?
Based on the moves PCC made, its odds of rising to the top were 76 percent.
Patterns of movement
You should be mindful of several dynamics
when undertaking major strategic moves. First, our research shows that really
big moves can “cancel out” the impact of a poor inheritance. Making strong
moves with a poor inheritance is about as valuable as making poor moves with a
strong inheritance. And even small improvements in odds have a dramatic impact
on the expected payoff, owing to the extremely steep rise of the power curve.
For example, the probability-weighted expected value of a middle-tier company
increasing its odds to 27 percent from the average of 8 percent is $123
million—nearly three times the total average economic profit for midtier
companies.
Big moves are also nonlinear, meaning that
just pulling a lever does not help; you need to pull it hard enough to make a
difference. For instance, productivity improvements that are roughly in line
with the improvement rates of your industry won’t provide an upward boost. Even
if you are improving on all five measures, what matters is how you stack up
against your competitors.
And four of the five big moves are
asymmetric. In other words, the upside opportunity far outweighs the downside
risk. While M&A is often touted as high risk, for example, in reality
programmatic M&A not only increases your odds of moving up the curve but
simultaneously decreases your odds of sliding down. Capital expenditures is the
one exception. By increasing capital expenditures, your chances of going up on
the power curve increase, but so do the chances of dropping.
In general, making no bold moves is
probably the most dangerous strategy of all. You not only risk stagnation on
the power curve but also miss out on the additional reward of growth capital,
which mostly flows to the winners.
So how do you set up a strategy process
that embraces a data-based outside view in order to tame the social side of
strategy and generate winning, big moves? As we show in our book, there are
several practical shifts you can make to transform what happens in your
strategy room, such as changing the annual strategy-planning exercise into a
continual strategy journey, replacing base-case scenarios with momentum cases
that extend the past trajectory into the future, and making strong bets on a
few breakout opportunities rather than spreading resources across your
divisions.
Adjustments such as these, combined with
an empirical, objective benchmark for the quality of a strategy that is
independent from subjective judgments in the strategy room, will change the
conversation at the top of your company. When you know, ahead of time, the
chances of your strategy succeeding, and you can see the levers that matter
most to your own business, you can make better choices and mitigate the impact
of fear, ambition, rivalry, and bias. A good strategy is still hard to shape,
but you can at least navigate toward one based on an accurate map.
By Chris Bradley, Martin Hirt, and Sven Smit
MKinsey
Quarterly February 2018
https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/strategy-to-beat-the-odds?cid=strategybook-eml-alt-mkq-mck-oth-1802&hlkid=8cc6c11a37654259b784146337f13ea7&hctky=1627601&hdpid=f341a41b-a466-47b8-9aa9-eecf8be4c89d
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