Business transformations: Why pre-emption is better than cure

'Fortune is of sluggish growth but ruin is rapid.' There's truth in the great Seneca's words - as Kodak and many others found out.

by Martin Reeves and Lars Fæste
Last Updated: 03 Oct 2018

By traditional measures of performance, large businesses today may appear to be in a more comfortable position than ever. The S&P 500 recently set a record for the longest ‘bull market’ in history, having lasted nearly a decade without a significant downturn. Corporate profits are rapidly rising from already-elevated levels. Geopolitical tensions are certainly rising, but on aggregate, they have not yet damaged most companies’ bottom lines.

However, these sunny performance metrics are inherently backward-looking, which can be deceiving. It is well-known that new challengers are growing faster than ever, thanks to the agility and low asset intensity of digital business models. However, the flip side of the same trends is that incumbents are also falling more rapidly. Using data from S&P Global, we studied the historical leaders of 69 different industries by operating income and measured how long they maintained the top position. We found that only 44% of today’s industry leaders have been on top for at least five years, down from a peak of 77% in the 1950s.

Furthermore, the dynamics that lead to failure are often entrenched well in advance — so by the time warning signs appear in financial performance, it is too late to avoid collapse. In other words, as Intel cofounder Andy Grove once said, ‘Business success contains the seeds of its own destruction.’

The fall is often faster than the rise

Why are companies susceptible to sudden failure? Businesses are complex adaptive systems, in which individual agents’ actions can combine to create unpredictable outcomes at the aggregate level. The modeling of similar complex systems, including biological ecosystems or human societies, indicates that such systems often grow slowly but collapse rapidly. This has been called the ‘Seneca Cliff’, after the Roman philosopher who wrote, ‘Fortune is of sluggish growth, but ruin is rapid.’

For an example of the Seneca Cliff in business, take Kodak. A longtime giant of the American economy, Kodak’s turnover grew consistently for more than a century. As late as 2005, the company had more than $14bn in annual sales, nearly matching its all-time peak. But by that point, it was already too late to avoid a rapid and brutal fall: only six years later, it filed for bankruptcy.

Because collapse can happen so quickly, business leaders cannot afford to wait for their financial dashboards to turn red before deciding to make critical changes to their business — often through risky large-scale ‘transformations’. In the past, transformation was often seen as a tool of last resort, involving cost-cutting moves aimed at restoring viability for firms that had no other choice. But applied preemptively, transformation can be a way for companies who are still performing strongly to find new sources of growth and develop the capabilities necessary to succeed in the future.

In fact, our research shows that ‘preemptive transformation’ — programmes undertaken while companies are still experiencing above-average performance — generates three percentage points higher annualised Total Shareholder Return (TSR) than transformations launched in reaction to poor performance. Furthermore, the estimated ROI of preemptive change programs is 50% higher, and leaders who launch such programs are more likely to keep their jobs.

For example, Alibaba rapidly grew into a corporate giant in part due to the success of Taobao, a consumer-facing e-commerce business with more than 80% market share in China. But in 2011, instead of relying on business momentum, the company reorganized its Taobao unit into three independent businesses with different business models. Two of those businesses became mass-market leaders (Tmall in B2C and Taobao in C2C), propelling Alibaba to further growth and a market capitalisation that surpassed $500bn.

How to foster preemptive change

Though the value of preemptive action may be clear, it is often difficult to achieve in practice. Companies may feel little motivation to implement major initiatives when performance is still strong, preferring to follow the old maxim, ‘If it ain’t broke, don’t fix it.’

To protect against the risk of sudden collapse, forward-thinking leaders must create a sense of urgency in their organisations in order to spur preemptive change. Here are a few ways they can do so:

Conduct a maverick scan. Disruption often comes from the periphery of an industry, where there are many start-up companies who are making bets against prevailing business models. By studying these mavericks closely and understanding what it would take for them to succeed, incumbents can understand emerging threats and learn where to invest and innovate.

Survey disaffected customers and non-customers. Traditional customer surveys are often directed at current buyers, which may generate results that are biased toward the positive. Asking why other consumers stopped buying the company’s products — or who never started in the first place — can yield invaluable signals from the outside to foster urgency.

Use a balanced set of metrics. Traditional benchmarks like sales, profits and growth are important for measuring business performance. But they should be complemented with forward-looking metrics that aim to assess ‘vitality’, the capacity for growth and reinvention. Otherwise, leaders end up driving their companies while looking in the proverbial rearview mirror — and missing the cliff that lies ahead.

Martin Reeves is a senior partner at the Boston Consulting Group. Lars Fæste is global leader of BCG's transfomation practice.

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