In response to today’s rapidly changing business environment, many managers and executives are in the midst of pursuing transformation — a large-scale overhaul of their companies designed to improve performance in the face of internal or external challenges. Given the high stakes of such programs, leaders should rely on the hard evidence of what works and what doesn’t, rather than basing their actions on anecdotes and intuitions.
A Boston Consulting Group study published in MIT Sloan Management Review analyzes more than 300 large (>$10B market cap) US companies over more than a decade to uncover empirical insights about corporate transformation. At any point in time, about one-third of all large firms are experiencing a severe performance decline — defined as a 10 percentage point decrease in Total Shareholder Return (TSR) compared to their peers over a two-year period — thus demonstrating an urgent need for transformation.
Only one-quarter of those firms proceeded to outperform their peers in both the short and long run, indicating that successful transformations are a minority. And they are becoming rarer — the success rate has steadily fallen from roughly 30% at the start of this century.
However, our research also shows that management can improve the odds of success by avoiding several pitfalls of transformation.
Don’t focus on cost-cutting alone
When faced with deteriorating performance, management’s first reaction is often to cut costs immediately in order to preserve the bottom line. Cost reduction is indeed part of many successful transformations — but perhaps surprisingly, our research shows that raising investor expectations, as measured by the firm’s valuation relative to earnings, is an even stronger driver of short-term value creation during transformation. Thus, in addition to pursuing operational improvements, leaders need to communicate a compelling story about how they will fund future growth.
In the long run, the most successful transformations were primarily driven by an increase in revenue growth. This cannot be achieved by operational improvement alone — it requires management to fundamentally rethink its strategy, vision and business model.
Don’t neglect long-term investment
In designing a substantial change program, it may be tempting to focus on efforts that will produce short-term results — unlike research and development spending, which may take a long time to pay off. However, our research shows that R&D investment is a strong predictor of long-term transformation success: over a five-year period, companies with above-average R&D spending increased TSR by 5.1 percentage points compared to those below the average.
Digital technology and data analytics investments are especially critical for unlocking growth today. Companies are increasingly using emerging technology to better understand and meet customer needs, automate and improve internal operations, and roll out new business models. But we see too many digital investments focused on back-office or support functions. Digital investments are most powerful when they also directly improve customer loyalty or generate direct and quantifiable business value.
The companies that benefitted most from R&D investment were the ones that maintained a dedicated long-term focus, rather than targeting incremental improvements for a faster return. This reinforces the need for leaders to invest in innovative ideas with the potential to rejuvenate the firm’s growth model.
Don’t think like an ‘insider’
Roughly one-quarter of the firms we studied that experienced a severe performance deterioration changed their CEO in response. Those firms performed better in the long run, increasing TSR by 4.6 percentage points more than those that kept their incumbent leader — and the effect was magnified when the new CEO was an external hire. The same pattern extends to the management team more broadly: firms who replaced at least 20% of their executives saw a similar increase in performance on average.
This does not mean that company insiders cannot lead a successful transformation. Rather, it shows that outsiders can bring advantageous characteristics— for example, they may be more likely to identify areas where radical change is needed, or they may identify strategic opportunities that insiders can miss. Incumbent leaders can improve their odds of success by adopting some of these characteristics themselves, including by surrounding themselves with a diverse set of perspectives or using a flat hierarchy that increases the flow of new ideas.
Quick, decisive action improves transformation outcomes
In designing and executing transformations, it is important for management to act before it is too late. Of the firms we studied with the most severe performance deteriorations (20+ percentage points over two years), less than 5% returned to their previous level of performance within five years. Ideally, transformation can occur before any crisis is visible, allowing the firm to preemptively improve its future trajectory.
And leaders should undertake transformation programs decisively, rather than hesitating to commit resources or make major moves. While each of the success factors we identified (such as increasing R&D spending, having a long-term strategic orientation, and changing leadership where necessary) was important individually, there is a multiplier effect with increasing returns when several of these actions are taken together.
Given the high likelihood of future performance decline in a dynamic environment — and the low odds of successful recovery — today’s managers must be prepared to transform their companies. Those that act quickly and decisively with an evidence based approach will be best-placed to succeed.
Martin Reeves is a Senior Partner at The Boston Consulting Group and Director of the BCG Henderson Institute. Lars Fæste is a Senior Partner at The Boston Consulting Group and global leader of the BCG Transformation practice and BCG TURN.
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