by - Chris Zook
How do you know when your core needs to change? And how do you determine what should replace it? From an in-depth study of 25 companies, the author, a strategy consultant, has discovered that it’s possible to measure the vitality of a business’s core. If it needs reinvention, he says, the best course is to mine hidden assets.
Some of the 25 companies were in deep crisis when they began the process of redefining themselves. But, says Zook, management teams can learn to recognize early signs of erosion. He offers five diagnostic questions with which to evaluate the customers, key sources of differentiation, profit pools, capabilities, and organizational culture of your core business.
The next step is strategic regeneration. In four-fifths of the companies Zook examined, a hidden asset was the centerpiece of the new strategy. He provides a map for identifying the hidden assets in your midst, which tend to fall into three categories: undervalued business platforms, untapped insights into customers, and underexploited capabilities. The Swedish company Dometic, for example, was manufacturing small absorption refrigerators for boats and RVs when it discovered a hidden asset: its understanding of, and access to, customers in the RV market. The company took advantage of a boom in that market to refocus on complete systems for live-in vehicles. The Danish company Novozymes, which produced relatively low-tech commodity enzymes such as those used in detergents, realized that its underutilized biochemical capability in genetic and protein engineering was a hidden asset and successfully refocused on creating bioengineered specialty enzymes.
Your next core business is not likely to announce itself with fanfare. Use the author’s tools to conduct an internal audit of possibilities and pinpoint your new focus
It is a wonder how many management teams fail to exploit, or even perceive, the full potential of the basic businesses they are in. Company after company prematurely abandons its core in the pursuit of some hot market or sexy new idea, only to see the error of its ways—often when it’s too late to reverse course. Bausch & Lomb is a classic example. Its eagerness to move beyond contact lenses took it into dental products, skin care, and even hearing aids in the 1990s. Today B&L has divested itself of all those businesses at a loss, and is scrambling in the category it once dominated (where Johnson & Johnson now leads). And yet it’s also true that no core endures forever. Sticking with an eroding core for too long, as Polaroid did, can be just as devastating. Both these companies were once darlings of Wall Street, each with an intelligent management team and a formerly dominant core. And in a sense, they made the same mistake: They misjudged the point their core business had reached in its life cycle and whether it was time to stay focused, expand, or move on.
How do you know when your core needs to change in some fundamental way? And how do you determine what the new core should be? These are the questions that have driven my conversations with senior managers and the efforts of my research team over the past three years. What we’ve discovered is that it is possible to measure the vitality remaining in a business’s core—to see whether that core is truly exhausted or still has legs. We’ve also concluded from an in-depth study of companies that have redefined their cores (including Apple, IBM, De Beers, PerkinElmer, and 21 others) that there is a right way to go about reinvention. The surest route is not to venture far afield but to mine new value close to home; assets already in hand but peripheral to the core offer up the richest new cores.
This article discusses both these findings. It identifies the warning signs that a business is losing its potency and offers a way to diagnose the strength remaining in its core. It recounts the efforts of managers in a variety of settings who saw the writing on the wall and succeeded in transforming their companies. And, based on these and other cases, it maps the likely spots in a business where the makings of a new core might be found.
When It’s Time for Deep Strategic Change
Not every company that falls on hard times needs to rethink its core strategy. On the contrary, declining performance in what was a thriving business can usually be chalked up to an execution shortfall. But when a strategy does turn out to be exhausted, it’s generally for one of three reasons.
The first has to do with profit pools—the places along the total value chain of an industry where attractive profits are earned. If your company is targeting a shrinking or shifting profit pool, improving your ability to execute can accomplish only so much. Consider the position of Apple, whose share of the market for personal computers plummeted from 9% in 1995 to less than 3% in 2005. But more to the point, the entire profit pool in PCs steadily contracted during those years. If Apple had not moved its business toward digital music, its prospects might not look very bright. General Dynamics was in a similar situation in the 1990s, when defense spending declined sharply. To avoid being stranded by the receding profit pool, it sold off many of its units and redefined the company around just three core businesses where it held substantial advantages: submarines, electronics, and information systems.
The second reason is inherently inferior economics. These often come to light when a new competitor enters the field unburdened by structures and costs that an older company cannot readily shake off. General Motors saw this in competition with Toyota, just as Compaq did with Dell. Other well-known examples include Kmart (vis-à-vis Wal-Mart) and Xerox (vis-à-vis Canon). Occasionally a company sees the clouds gathering and is able to respond effectively. The Port of Singapore Authority (now PSA International), for example, fought off threats from Malaysia and other upstart competitors by slashing costs and identifying new ways to add value for customers. But sometimes the economics are driven by laws or entrenched arrangements that a company cannot change.
The third reason to rethink a core strategy is a growth formula that cannot be sustained. A manufacturer of a specialized consumer product—cell phones, say—might find its growth stalling as the market reaches saturation or competitors replicate its once unique source of differentiation. Or a retailer like Home Depot might see its growth slow as competitors like Lowe’s catch up. A company that has prospered by simply reproducing its business model may run out of new territory to conquer: Think of the difficulties Wal-Mart has encountered as the cost-benefit ratio of further expansion shifts unfavorably. The core business of a mining company might expire as its mines become depleted. In all such circumstances, finding a new formula for growth depends on finding a new core.
For most of the companies my team and I studied, recognition that the core business had faltered came very late. The optical instruments maker PerkinElmer, the diamond merchant De Beers, the audio equipment manufacturer Harman International—these were all companies in deep crisis when they began their redefinition. Is it inevitable that companies will be blindsided in this way? Or can a management team learn to see early signs that its core strategy is losing relevance?
With that possibility in mind, it would seem reasonable to periodically assess the fundamental vitality of your business. The exhibit “Evaluate Your Core Business” offers a tool for doing so. Its first question looks at the core in terms of the customers it serves. How profitable are they—and how loyal? Arriving at the answers can be difficult, but no undertaking is more worthwhile; strategy goes nowhere unless it begins with the customer. The second question probes your company’s key sources of differentiation and asks whether they are strengthening or eroding. The third focuses on your industry’s profit pools, a perspective that is often neglected in the quest for revenue and market share growth. Where are the best profits to be found? Who earns them now? How might that change? The fourth examines your company’s capabilities—a topic we shall soon turn to—and the fifth assesses your organization’s culture and readiness to change.
At the least, managers who go through this exercise tend to spot areas of weakness to be shored up. More dramatically, they may save a business from going under. Note, however, that no scoring system is attached to this diagnostic tool—there is no clearly defined point at which a prescription for strategic redefinition is issued. That would lend false precision to what must be a judgment call by a seasoned management team. The value of the exercise is to ensure that the right questions are taken into account and, by being asked consistently over time, highlight changes that may constitute growing threats to a company’s core.
Recognizing the Makings of a New Core
Management teams react in different ways when they reach the conclusion that a core business is under severe threat. Some decide to defend the status quo. Others want to transform their companies all at once through a big merger. Some leap into a hot new market. Such strategies are inordinately risky. (Our analysis suggests that the odds of success are less than one in ten for the first two strategies, and only about one in seven for the third.) The companies we found to be most successful in remaking themselves proceeded in a way that left less to chance. Consider, for example, the transformation of the Swedish company Dometic.
Dometic’s roots go back to 1922, when two engineering students named Carl Munters and Baltzar von Platen applied what was known as absorption technology to refrigeration. Whereas most household refrigerators use compressors driven by electric motors to generate cold, their refrigerator had no moving parts and no need for electricity; only a source of heat, as simple as a propane tank, was required. So the absorption refrigerator is particularly useful in places like boats and recreational vehicles, where electric current is hard to come by. In 1925 AB Electrolux acquired the patent rights. The division responsible for absorption refrigerators later became the independent Dometic Group.
By 1973 Dometic was still a small company, with revenues of just 80 million kronor (about U.S. $16.9 million). Worse, it was losing money. Then Sven Stork, an executive charged with fixing the ailing Electrolux product line, began to breathe new life into the business. Stork, who went on to become president and CEO of the company, moved aggressively into the hotel minibar market, where the absorption refrigerator’s silent operation had a real advantage over conventional technology. Fueled by those sales, Dometic grew and was able to acquire some of its competitors.
The real breakthrough came when Stork’s team focused more closely on the RV market, which was just then beginning to explode. The point wasn’t to sell more refrigerators to the RV segment; the company’s market share within that segment was already nearly 100%. Rather, it was to add other products to the Dometic line, such as air-conditioning, automated awnings, generators, and systems for cooking, lighting, sanitation, and water purification. As Stork explains, “We decided to make the RV into something that you could really live in. The idea was obvious to people who knew the customers, yet it took a while to convince the manufacturers and especially the rest of our own organization.” These moves fundamentally shifted the company’s core. Dometic was no longer about absorption refrigeration: It was about RV interior systems and the formidable channel power gained by selling all its products through the same dealers and installers. That channel power allowed Dometic to pull off a move that enhanced its cost structure dramatically. The company streamlined its go-to-market approach in the United States by skipping a distribution layer that had always existed and approaching RV dealers directly. “We prepared for the risks like a military operation,” Stork recalls, “and it was a fantastic hit. We were the only company large enough to pull this off. It let us kill off competitors faster than they could come out of the bushes.” By 2005 Dometic had grown to KR 7.3 billion, or roughly U.S. $1.2 billion. No longer part of Electrolux (the private equity firm EQT bought it in 2001 and sold it to the investment firm BC Partners a few years later), the company was highly profitable and commanded 75% of the world market share for RV interior systems.
Dometic’s story of growth and redefinition is especially instructive because it features all the elements we’ve seen repeatedly across the successful core-redefining companies we’ve studied. These are: (1) gradualism during transformation, (2) the discovery and use of hidden assets, (3) underlying leadership economics central to the strategy, and (4) a move from one repeatable formula that is unique to the company to another. “Gradualism” refers to the fact that Dometic never made anything like a “bet the company” move—often tempting when a business is on the ropes, but almost always a loser’s game. As in the other cases of strategic renewal we studied, it redefined its core business by shifting its center of gravity along an existing vector of growth. To do this, it relied on hidden assets—resources or capabilities that it had not yet capitalized on. In Dometic’s case, the treasure was its understanding of and access to customers in the RV market.
Leadership economics is a hallmark of almost every great strategy; when we see a situation in which the rich get richer, this is the phenomenon at work. Consider that most industries have more than six competitors, but usually more than 75% of the profit pool is captured by the top two. Of those two, the one with the greatest market power typically captures 70% of total profits and 75% of profits above the cost of capital. When Dometic focused on a defined market where it could stake out a leadership position, enormous financial benefits followed.
Its new growth formula offers the same kind of repeatability the old one did. Recall that Dometic’s first focus was on applications for absorption refrigeration, which it pursued product by product, one of which was for RVs. The new formula angled off into a sequence of interior components for the RV customer base. Recently, as RV sales have slowed, Dometic has moved into interior systems for “live-in” vehicles in general, including boats and long-haul trucks.
Where Assets Hide
The importance of a company’s overlooked, undervalued, or underutilized assets to its strategic regeneration cannot be overstated. In 21 of the 25 companies we examined, a hidden asset was the centerpiece of the new strategy.
The importance of overlooked, undervalued, or underutilized assets cannot be overstated. In 21 of the 25 companies we examined, a hidden asset was the centerpiece of the new strategy.
Some of their stories are well known. A few years ago, a struggling Apple realized that its flair for software, user-friendly product design, and imaginative marketing could be applied to more than just computers—in particular, to a little device for listening to music. Today Apple’s iPod-based music business accounts for nearly 50% of the company’s revenues and 40% of profits—a new core. IBM’s Global Services Group was once a tiny services and network-operations unit, not even a stand-alone business within IBM. By 2001 it was larger than all of IBM’s hardware business and accounted for roughly two-thirds of the company’s market value.
Why would well-established companies even have hidden assets? Shouldn’t those assets have been put to work or disposed of long since? Actually, large, complex organizations always acquire more skills, capabilities, and business platforms than they can focus on at any one time. Some are necessarily neglected—and once they have been neglected for a while, a company’s leaders often continue to ignore them or discount their value. But then something happens: Market conditions change, or perhaps the company acquires new capabilities that complement its forgotten ones. Suddenly the ugly ducklings in the backyard begin to look like swans in training.
The real question, then, is how to open management’s eyes to the hidden assets in its midst. One way is to identify the richest hunting grounds. Our research suggests that hidden assets tend to fall into three categories: undervalued business platforms, untapped insights into customers, and underexploited capabilities. The exhibit “Where Does Your Future Lie?” details the types of assets we’ve seen exploited in each category. For a better understanding of how these assets came to light, let’s look at some individual examples.
Where Does Your Future Lie? If the core of your business is nearing depletion, the temptation may be great to venture dramatically away from it—to rely on a major acquisition, for instance, in order to establish a foothold in a new, booming industry. But the history of corporate transformation shows you’re more likely to be successful if you seek change in your own backyard.
Undervalued business platforms.
PerkinElmer was once the market leader in optical electronics for analytical instruments, such as spectrophotometers and gas chromatographs. Its optical capabilities were so strong that the company was chosen to manufacture the Hubble Space Telescope’s mirrors and sighting equipment for NASA. Yet by 1993 PerkinElmer, its core product lines under attack by lower-cost and more innovative competitors, had stalled out. Revenues were stuck at $1.2 billion, exactly where they had been ten years earlier, and the market value of the company had eroded along with its earnings; the bottom line showed a loss of $83 million in 1993. In 1995 the board hired a new CEO, Tony White, to renew the company’s strategy and performance and, if necessary, to completely redefine its core business.
As White examined the range of product lines and the customer segments served, he noticed a hidden asset that could rescue the company. In the early 1990s, PerkinElmer had branched out in another direction—developing products to amplify DNA—through a strategic alliance with Cetus Corporation. In the process, the company obtained rights to cutting-edge procedures known as polymerase chain reaction technology—a key life-sciences platform. In 1993, the company also acquired a small Silicon Valley life-sciences equipment company, Applied Biosystems (AB)—one more line of instruments to be integrated into PerkinElmer’s.
White began to conceive of a redefined core built around analytical instruments for the fast-growing segment of life-sciences labs. The AB instruments in the company’s catalog, if reorganized and given appropriate resources and direction, could have greater potential than even the original core. White says, “I was struck by how misconceived it was to tear AB apart and distribute its parts across the functions in the organization. I thought, ‘Here is a company whose management does not see what they have.’ So one of the first steps I took was to begin to reassemble the parts of AB. I appointed a new president of the division and announced that I was going to re-form the core of the company over a three-year period around this unique platform with leadership in key life-sciences detection technology.”
Over the next three years, White and his team separated PerkinElmer’s original core business and all the life-sciences products and services into two organizations. The employees in the analytical instruments division were given incentives to meet an aggressive cost reduction and cash flow target and told that the division would be spun off as a separate business or sold to a strong partner. Meanwhile, White set up a new data and diagnostics subsidiary, Celera Genomics, which, fueled by the passion of the scientist Craig Venter, famously went on to sequence the complete human genome. Celera and AB were combined into a new core business organization, a holding company christened Applera.
While Celera garnered the headlines, AB became the gold standard in the sequencing instrument business, with the leading market share. Today it has revenues of $1.9 billion and a healthy net income of $275 million. Meanwhile, the original instrument company was sold to the Massachusetts-based EG&G. (Soon after, EG&G changed its corporate name to PerkinElmer—and has since prospered from a combination that redefined its own core.)
The PerkinElmer-to-Applera transformation offers several lessons. The first is that a hidden asset may be a collection of products and customer relationships in different areas of a company that can be collected to form a new core. The second lesson is the power of market leadership: Finding a subcore of leadership buried in the company and building on it in a focused way created something that started smaller than the original combination but became much bigger and stronger. The third lesson lies in the concept of shrinking to grow. Though it sounds paradoxical and is organizationally difficult for companies to come to grips with, this is one of the most underused and underappreciated growth strategies. (See the sidebar “Shrinking to Grow.”)
Seven Steps to a New Core Business
The first step is simply to shine a light on the dark corners of your business and identify assets that are candidates for a new core. Once identified, these assets must be assessed. Do they offer the potential of clear, measurable differentiation from your competition? Can they provide tangible added value for your customers? Is there a robust profit pool that they can help you target? Can you acquire the additional capabilities you may need to implement the redefinition? Like the four essentials of a good golf swing, each of these requirements sounds easily met; the difficulty comes in meeting all four at once. Apple’s iPod-based redefinition succeeded precisely because the company could answer every question in the affirmative. A negative answer to any one of them would have torpedoed the entire effort.
A Growing Imperative for Management
Learning to perform such assessments and to take gradual, confident steps toward a new core business is increasingly central to the conduct of corporate management. Look, for example, at the fate of the Fortune 500 companies in 1994. A research team at Bain found that a decade later 153 of those companies had either gone bankrupt or been acquired, and another 130 had engineered a fundamental shift in their core business strategy. In other words, nearly six out of ten faced serious threats to their survival or independence during the decade, and only about half of this group were able to meet the threat successfully by redefining their core business.
Why do so many companies face the need to transform themselves? Think of the cycle that long-lived companies commonly go through: They prosper first by focusing relentlessly on what they do well, next by expanding on that core to grow, and then, when the core has lost its relevance, by redefining themselves and focusing anew on a different core strength. It seems clear that this focus-expand-redefine cycle has accelerated over the decades. Companies move from one phase to another faster than they once did. The forces behind the acceleration are for the most part well known. New technologies lower costs and shorten product life cycles. New competitors—currently in China and India—shake up whole industries. Capital, innovation, and management talent flow more freely and more quickly around the globe. The churn caused by all this is wide-ranging. The average holding period for a share of common stock has declined from three years in the 1980s to nine months today. The average life span of companies has dropped from 14 years to just over ten, and the average tenure of CEOs has declined from eight years a decade ago to less than five today.
In 2004 my colleagues and I surveyed 259 senior executives around the world. More than 80% of them indicated that the productive lives of their strategies were getting shorter.
Business leaders are acutely aware of these waves of change and their ramifications. In 2004 my colleagues and I surveyed 259 senior executives around the world about the challenges they faced. More than 80% of them indicated that the productive lives of their strategies were getting shorter. Seventy-two percent believed that their leading competitor would be a different company in five years. Sixty-five percent believed that they would need to restructure the business model that served their primary customers. As the focus-expand-redefine cycle continues to pick up speed, each year will find more companies in that fateful third phase, where redefinition is essential. For most, the right way forward will lie in assets that are hidden from view—in neglected businesses, unused customer insights, and latent capabilities that, once harnessed, can propel new growth.
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Core Business is the main economic activity carried out by a company and that provides it with the largest source of income. Due to its economies of scale, it can provide a competitive advantage over other companies in the sector.
The meaning of Core Business, which is also known as distinctive competence, refers to that productive activity that a company develops and allows it to generate value to be able to stay in the market.
Likewise, the main activity of a company should be the one that brings it the highest income. Along with this, it must place you in the best possible position against your competitors. Establishing the Core Business of an organization is not an easy task, due to the level of competition that exists.
Thus, for a company to maintain its activity, it is necessary to establish a distinctive competition that contains the different elements differentiated from the competition. In this way, in order to attract a greater number of clients, a differentiation and specialization exercise must be carried out in a certain area.
The Core Business will allow, if good management is carried out, to establish a competitive advantage over other companies in the sector. Therefore, it is vitally important to acquire that weight as it will allow the company to consolidate an interesting market share.
Establish the Core Business
In order to establish the Core Business, it is necessary to do a thorough analysis of the company. In this sense, it is important to answer the following questions to obtain the necessary information.
- How is my product compared to the competition? It is necessary to study the characteristics of our product and that of the rest of the competitors.
- How is my product different? Once the products on the market have been studied, it is time to analyze the differences of our product with the rest.
- Why do customers choose us? It is a matter of identifying the advantages of our product and what consumers will buy from us.
- Where is the company headed? The answer to this question will make us aware of whether it is necessary to apply any modification to the product we sell.
- What difficulties do I find in carrying out the production? Problems make production difficult and even slow it down. It is important to identify the errors in order to act on them and fix them.
Core Business Examples
We can find an example of Core Business in each of the companies that exist and work in every part of the planet. We can highlight the following:
- Coca-Cola: The distinctive competition of this company is the sale of soft drinks.
- Amazon: This example will surprise you, the activity that generates the most benefits for Amazon is the AWS division. They have a competitive advantage in the field of servers, which make you earn more money than e-commerce itself.
- Apple: Although this company has a multitude of services and products, the iPhone is its main source of revenue. The Core Business of this company are mobile phones.
In conclusion, the Core Business of a company is that productive activity that is its main source of income. Added to this, it allows you to stand out from the rest of the companies in the sector thanks to your good practice.
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How you can approach your business in a way that makes it easier for you to understand your business?
Inventory, product, clients, business structure, etc. Those pieces, what do you pay attention to and how do you make them work together in a way that makes them work for you. Personally, I’ll be using these pieces for the next year to better understand my business and identify what changes I may need to change.
1. Product
2. Customer Service
3. Systems
4. Time Management
5. Team Management
6. Marketing
7. Finances
8. Leadership
9. Forecasting
10. Visions
LEVEL 1
Product Do you have a product? Most people think of product of a thing you sell, a dog leash, a widget, keys, etc. Products are what you sell, which may be your services. As a small business manager my service is my product. When I first started my product wasn’t very well understood by me and therefore I couldn’t clearly communicate to people who asked, what I did. Now I am able to say the stages, concerns, and specific elements I work with my clients with and people have a better understanding of what I do and in turn whether I can help them. Confused minds don’t purchase. Products are the physical products or the specific purpose you sell or offer to your clients.
Customer Service It begins from the moment they hear about your business and continues through their use of your product over the years.
Systemic Systems Systemic Systems is the operation of your business, how does your business work? Do people call in, do you meet them in person, is there a brick and mortar store or is your product delivered? The systems in place that allow your service or product to get to your clients are your systemic system. A plumber has a system for what happens when someone calls them. There are things in place that take the call from a finished and delivered product and service.
LEVEL 2
The following three are what most small business focus on most.
Team Management Someone on your team that is responsible for a part of your business. There is a person who manages your website, your phone, your client interaction, your office furniture, etc. How you manage your team will make a difference to your business.
Time Management How you spend your time and your team are a large part of your business. All the time you spend on your to-do list, your finances, are part of being mindful how you spend your time.
Marketing If you don’t market, people don’t know about you. Some people think of marketing as selling and they don’t want to be salespeople, but your business may not grow if you don’t do the work to make sure you are putting who you are, what you do, and what value you offer, to the world. If you don’t tell people you exist you don’t have the permission to serve them or to make a difference in the world. From sales to branding, to social media and networking, they all fall under the umbrella of marketing.
Finances Working capital and cash reserve help you to be able to run your business.
LEVEL 3
Leadership Leadership is within your business and your industry. There’s something that happens in your business where it starts to have a natural sense of growth. You accepted your business vision and therefore you’ve been called to be a leader in relationship to your employees and your customers. You should also be a leader in your industry, someone who contributes, stays up with what’s happening in the industry, and someone who is seen as an expert.
Trends and Forecasting The trends in your industry and the things to come are what business owners have to stay aware of. Are the times and ways business is conducted in your industry changing? Are the times and technology dictating how your clients now interact with your product or how you offer your service?
Vision and Strategic Plan You had a vision, the forethought of what you wanted to create and you started a business. I challenge you to take a look at the original vision and plan and update it.
For the upcoming year I encourage you to get involved with me, this blog, my radio show, and these core business elements. Call our hotline at 626-844-8842 if you want to be interviewed, if you have a question, want to be a guest speaker or you have something you want to contribute to the conversation. I look forward to hearing from you.
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