The hit show “House of Cards” highlights a remarkable journey for its owner Netflix. The company that once desperately offered itself to the now-bankrupt Blockbuster Video for $50 million—and was rejected—is now a profitable $5 billion company growing at about 20 percent per year. Few would have imagined that a company built around the distribution of CDs by mail could, in just a few years, migrate its business model to streaming content on the Internet and eventually to producing its own content, moving Netflix towards being the next-generation equivalent of a television station. By the same token, who would have imagined that Amazon would enter the storage and IT services business with great success? And who would have expected to see Apple in the phone—and now luxury wearables—business?
Historically, the odds of these kinds of “distant adjacencies”—growth moves outside the core business—are remarkably low. We estimate that only one in four adjacency initiatives are successful. But today, multiple distant moves can be made faster and surer—and with better odds of success—than before. What’s going on? How are the Apples and Amazons beating the odds? What has changed?
In 2005, in a book called Beyond the Core, I identified six types of adjacency growth moves: moving your core business to a new geography, serving a new customer segment, entering a new channel of distribution, selling a new set of products for your core customers, integrating new steps along the value chain, and building a new business based on your capabilities. My Bain colleagues and I estimated the odds of success of investments in major adjacency moves using a sample of nearly 200 companies’ experiences including “close-in moves” like expansion into a neighboring country and “distant” moves like a new business to new customers using new technologies. Across the full sample we found that the odds of success were only about twenty percent. Most growth initiatives failed and the reason turned out to be because companies moved too far beyond their core business too fast into areas where they were not skilled (and where others were skilled). What was an “adjacency” to one company was the “core” to someone else and companies consistently underestimated how hard competitors would fight to defend their core. The highest odds of success were associated with introducing new products to your own core customers; the lowest odds were associated with building new businesses based on a capability.
Back then, what was especially notable was how fast the success odds declined as you began to move away from your core (see the chart). These odds, we found, hinged crucially on the “distance” that the new move would bring you from the core (ranging from one to five steps away) and the market power of your own business to shape its environment.
The implication was that the best growth strategies were usually those that extended your greatest strengths step-by-step, not those that seemed to leap into the unknown too fast. When he saw the work, Andy Grove, Intel’s former CEO and chairman, referred to it as the “game of Go applied to business,” underpinned as it is by “one close move at a time.”
Now it appears that the rules of systematic growth in business have been suspended. But research shows that it isn’t that the rules have changed, it’s that companies can now build, obtain access to, or acquire new capabilities— especially those related to digital technologies— faster and better than ever before. The historically low odds of entering what looks like a distant adjacency have been transformed because of how quickly companies can acquire new capabilities. New capabilities, once acquired, can bring “distant” adjacency moves much closer. Moves that might have been impossible decades ago are now coming into reach of savvy companies faster than before.
One of the most impressive renewals of a company by bringing in new capabilities is eBay under CEO John Donahoe. Since he took over the helm, the stock, after a long slide down to less than one quarter of its highest value, has increased from about $10 per share to nearly $60 per share. One of the key reasons is how they’ve acquired new capabilities. During the past five years, eBay had made more than a dozen acquisitions of founder led companies with specific technologies like Zong in mobile payments. As Donahoe explained, the objective has been to “fill eBay with young entrepreneurs,” who bring their competence at new digital capabilities. Many of them have stayed, taking jobs in the core business itself—the ultimate internalization of new capability.
I am constantly amazed that so few management teams can agree on (or have even discussed) their four or five strongest capabilities, which new capabilities need to be added and at what level. In a world where generic strategies are increasingly similar (the “what” of strategy), competitive differentiation is increasingly moving to the “how.” Yet few things in business differentiate a company more than having a unique portfolio of capabilities, including new ones that rivals have not yet mastered. And those same capabilities usually provide the best new growth opportunities.
Most companies would benefit from being much more explicit about the state of their capabilities and the investments they need to make in new ones. A start would be to set aside time in your next strategy offsite meeting to explore the following questions:
1. If a few capabilities are the crown jewels of business, what are our crown jewels?
2. What is the state of these capabilities relative to competition? How do we know in a measurable way? Do our customers and employees agree with us? What are we going to do about it?
3. What are the new capabilities that we need to add or bring up to world class status? What is the plan to add them and ensure they are world class?
4. What are the growth opportunities that these new capabilities will enable in the short term and the long term? Are we investing enough?
Many management teams will be surprised by the results of this exercise and wonder why they have waited so long to talk about it. Investing in capabilities defines what is possible in the future—and will determine how far outside your core you can venture successfully.
Source: Havard Business Review