by Andrew Campbell & Robert Park, Nicholas Brealey International, 2005.
Most firms fail when they try to create new growth businesses. Managers should be more selective - they should assess new opportunities with a tough set of business criteria and only invest in those that pass a strategic business screen. Two tools will help managers make better decisions. The New Business Traffic Lights Toolkit helps to identify the best new business opportunities. The Confidence Check assesses projects as they progress. There may be times when low growth is the best strategy.
(Summarised by Kevin Barham in November 2005)
(These book summaries aim to represent some of the key aspects of what the author has written. They do not necessarily represent the views of the summariser or of Ashridge. Equally the author of the book summarised must not be held responsible for any misperceptions of the summariser. A summary does not have space for all the illustrative cases which provide the richness of a book and there is no substitute for reading the whole book. There is an element of simplification in a summary so that the message may seem more obvious than it necessarily is, though the most powerful ideas are often simple and obvious in their essence.)
This book, though highly controversial in parts, is bound to make managers think very deeply about the future of their business.
Many companies, say Andrew Campbell and Robert Park, have a growth gap. Their existing businesses are not growing fast enough to meet their ambition. The usual solution is to add new legs to their portfolio of businesses. Yet as many as 99% of firms fail when they try to create new growth businesses.
Andrew Campbell is a Director of Ashridge Strategic Management Centre (ASMC), well known for his research and consulting in corporate strategy. Robert Park was formerly Head of Group Strategy with the NatWest Group and is an associate of ASMC. Their book aims to help managers with one of today’s most complex problems – how to find, enter and grow new businesses more successfully without disrupting the profitable core of today.
Based on extensive research, the authors contradict received wisdom in concluding: that corporate venturing units do not generate new growth; most firms have few new opportunities that justify investment; and most companies are spending too much on new businesses and taking too much risk. Most controversially, they also argue there may be times when low growth is the best strategy.
The overall message is that managers should be much more selective in their approach to new businesses. Most companies could reduce the number of new businesses they are investing in by half and have a better chance of succeeding. It is about being smart rather than trying harder. They should assess opportunities with a tough set of business criteria and only invest in those that pass a strategic business screen. Campbell and Park provide the tools to do this. The core tool, the New Business Traffic Lights Toolkit, is a new screening and strategic thinking technique for identifying the best opportunities. Another tool, the Confidence Check, is recommended for assessing projects as they progress.
The authors emphasise they are talking about new businesses, not new products or new markets that extend the franchise for an existing business. The focus of the book is the stage in the corporate life cycle when managers are looking for new growth businesses because the core businesses are maturing.
Campbell and Park give McDonald’s and Intel as examples of businesses that have devoted significant resources to the search for new growth businesses but which have achieved little success to date. These firms show that the strengths of the core business are often weaknesses when applied to other businesses. Those strengths and weaknesses are often so ingrained in managers’ minds that they are not easily changed, even if you take the managers out of the company.
Companies like these can only find significant new businesses under two circumstances – (a) they discover a business that “fits” with their existing businesses and responds to the habits and rules of thumb that apply to the core; or (b) they suffer (or engineer?) a crisis that breaks their commitment to old ways of doing things and brings in new leadership and ideas. This book aims to help firms with (a).
Although nearly every company tries to do it, 99% of companies fail to create successful new growth platforms. Finding new businesses is therefore a “growth gamble” where the bet, moreover, is against the odds.
Companies have established habits and mindsets that are well attuned to the needs of existing businesses but which get in the way when they try to enter new businesses. Success comes when companies select new businesses that respond well to these mindsets; failure is often the result of trying to do things that do not fit.
This shortage of new opportunities explains the low success rate and calls for a different solution than simply becoming more “entrepreneurial” or setting up a corporate venturing unit. Trying to generate additional ideas and experiment with a portfolio of new ventures are likely to be fruitless. A screening tool to identify new opportunities will be more helpful than a series of process steps for developing new businesses. Trying to make dramatic changes to corporate mindsets is also unlikely to succeed.
The authors’ research suggests that it is the shortage of opportunities that fit that is the biggest challenge for new growth.
Campbell and Park propose six rules for developing new businesses:
[In his foreword to the book, strategy guru Gary Hamel suggests another rule: Don’t be afraid to partner – your company may not have all the assets and skills necessary to ensure new business success. Hamel notes that Campbell and Park have not made partnering a central focus of their book but he believes that alliances will become increasingly important in future.]
There are two reasons, say Campbell and Park, why investments in new businesses often destroy more value than they create. First, it is inherently risky - each project contains many risks that cannot be managed away. Many new things need to come together to make a new business a success. The overall probability of every element coming good is low.
Secondly, the way that managers think about new businesses (and the lack of a robust theoretical framework for doing so) leads them to make mistakes. The four avoidable causes of failure which arise from this are:
This is perhaps the most controversial part of the book. The authors suggest there are two arguments for growth: moral and value-driven.
The authors respond by arguing that a company that starts many new businesses that fail or under-perform is not benefiting society. Given the odds of creating successful new businesses, a strategy of careful selection rather than ambitious expansion is likely to create more value for society. Moreover, the existing managers of an existing business are not necessarily the best able to exploit a new opportunity. Society will benefit more if it encourages managers to select between those battles they can win and those where they will do better to sell existing resources to a third party. Managers have a responsibility to give such resources back to the market so that others who know what to do with them can use them.
Managers must recognise, say Campbell and Park, that at many points in their history, companies will be able to grow only slowly, if at all. At some point, a company will screen out all ideas for new businesses and will have to depend on its core business for its rate of growth. If the core market is growing slowly, the company will probably be low growth. But low growth is not necessarily a bad thing. In some circumstances it is acceptable to choose low growth or even not to grow at all. Low growth companies and even negative-growth companies can still produce acceptable financial results.
The problem, according to the authors, is that most managers assume low-growth companies are failing companies that cannot generate decent returns for shareholders. The message that low growth is bad is reinforced by the catastrophic declines in market capitalisation of firms who hit a growth stall. This fear of low growth, however, is based on a misunderstanding of the way the market anticipates performance.
Campbell and Park argue (convincingly) that the challenge of producing decent returns for shareholders year on year is no different for low-growth companies than for high-growth companies, as long as this is what the market expects. By way of illustration, the authors provide a worked example which shows how two companies, one slow growth and one fast-growing, produce identical total shareholder returns (TSR is the growth in value of the company over the next year plus the dividends as a percentage of the original market value of the company).
While this may seem counter-intuitive, the explanation lies in the different starting valuations which occur because the market anticipates performance.
“Companies can only produce a superior total return for shareholders if they outperform shareholder expectations. If they perform according to shareholder expectations, they will deliver an average total return. If they perform less well than expected, the return will be below average. In other words, the problem of low growth is less about the annual performance challenge and more about shifts in market perception. If a company suddenly moves from high growth to low growth, perceptions will change and the shares may decline by 50% or more. If, however, a low-growth company remains low-growth but earns returns better than the cost of capital, it will perform better than the average.”
Living with market expectations has different implications for highly rated firms and lowly rated firms. The main problem for managers in highly rated companies is the shift in value that occurs when expected growth rates change. A company with a growth track record is likely to be highly rated, perhaps with a price earnings ratio (PE) well over 20, based on an assumption of continued growth. If management abandons attempts at new business, the market might downgrade its assumptions about growth, leading to a significant fall in the stock price. Rather than suffer today, managers are tempted to launch additional new businesses to maintain growth and hence (if shareholders believe management’s story) maintain the share price.
The authors demonstrate (again by way of an example) that if the new businesses succeed to such an extent that high earnings expectations are met, then the share price will have been justified and the firm will continue to prosper. If the new businesses only earn meet the cost of capital, in due course the market will re-rate the company downward. In terms of cumulative shareholder value, this would be the same as if the firm did not invest in new businesses but instead returned funds to shareholders. If the new businesses fail to earn the cost of capital, the fall will be more precipitous and the long-term result will be worse than under the less risky policy of returning the cash to shareholders.
This “overvaluation trap” presents a real dilemma for managers who know that growth in their core business is likely to slow down soon. Should they signal this to the market today and face a significant (and career-threatening) decline in the stock price? Or, should they invest in new businesses to find new sources of growth and risk a much more disastrous share price fall if the businesses fail?
The rational answer to the trap is to pursue new business projects only if they have a good chance of earning above the cost of capital.
Lowly-rated companies face the “undervaluation” trap whereby managers can feel trapped into low-growth, high-distribution strategies, even though there may be good opportunities to invest in new businesses. It is harder to criticise managers for choosing such a risk-averse strategy but, if the company does have good new business opportunities, the value lost can be significant.
Campbell and Park maintain that low growth is the right choice for companies when there are few opportunities for the core business to grow, or when there are few new businesses that have a good chance of outperforming the average company on the stock market. Under such circumstances, a low-growth strategy minimises the risks of value destruction and increases the chances of value creation.
The following principles should guide the choice of growth policy:
Highly rated companies (with high PE ratios) face an “overvaluation trap”:
Lowly rated companies (low PEs) face an “undervaluation trap”:
For managers who are unconvinced that low growth can be a winning strategy, the authors offer two case studies (Crown Cork & Seal and IBM) that support their case.
This is a screening tool for new business ideas, based on a “distillation of good strategic thinking”, which managers can apply to an idea before a business plan has been developed. The tool is informed by five insights:
There are four Traffic Lights:
Each element is scored red, yellow or green:
Campbell and Park suggest that if this screen is applied to a typical portfolio of new business investments, it will usually result in red lights for many projects. It means most companies are taking too many risks in search of new growth businesses. Reducing the amount they gamble on new businesses will give extra resources for improving their existing businesses, and will produce good rewards until better new projects emerge.
While the traffic lights may not always provide clear go/no go decisions, they often give a no go answer where managers would have been inclined to give it a try. They thus screen out many new projects that would subsequently fail, saving both time and money.
Campbell and Park put forward three guiding rules to follow when searching for new businesses:
Manage the flow of new business ideas. Start with a thorough analysis of the existing businesses – without this, managers do not have a sound platform from which to screen new business projects. The strategy review should focus not only on the current business model and current product-market segments, but also on adjacent business models and new disruptive competitors. This provides senior managers with “top-down” insights for new businesses. Avoid over-stimulating the idea flow as this may encourage managers to launch too many new ventures and may distract them from the one or two that have real potential. Establish a process for capturing “bottom-up” ideas (for example, a venture board) – it is important that people know such a process exists and that decisions are taken in a timely and rational manner. A generally accepted and clearly communicated strategic framework will help managers deal with the flow of ideas. People look to the CEO to explain the corporate strategy in a way that helps them understand which ideas might be welcome and why some are supported and others are rejected.
Use the Traffic Lights “diligently”. These will help ensure that silly ideas do not get through the screening process. If the Traffic Lights are widely communicated as a tool for assessing the strategic business case, managers at all levels will feel empowered to propose and reject ideas that do not pass them. A strong and objective governance process will also be needed to turn down the pet projects of the CEO and other top managers.
Effectively parent each new business initiative. Once a new business idea passes the Traffic Lights, managers must give a lot of attention to parenting it appropriately. Processes are needed for assigning a good sponsor, putting them in the right place in the organisation, orchestrating the right amount of support and reviewing progress. The Emerging Business Opportunities programme at IBM and the New Projects Programme at Philips are good examples.
Campbell and Park advise that when we are considering how to position and support a new business, we should ask four questions:
The degree of integration or separation can be determined by using the four tests of “fit” (market advantage; parenting advantage; people; feasibility) and the five “good design” tests (specialist cultures; co-ordination solutions for difficult links; accountability; redundant hierarchy; and flexibility). Separate the new venture from the existing businesses unless these nine principles of organisation design suggest otherwise.
The appropriate reporting level (low vs high) depends on four factors. The new business should report into a layer in the organisation for which it is an important part of the strategy at that layer. It should report to a manager with the knowledge, skills and time to be a good parent to the business. There should be a minimum of layers between the manager allocating the money and the manager leading the new business. The reporting relationships should also provide some process of objectivity to avoid the risk of the manager who is allocating the money becoming its champion.
“Parenting Opportunity Analysis” should be used to decide the degree of support necessary from layers above. This examines the opportunities that exist for parent managers to help the new business. Parent managers need to think about each new business individually to decide what support is needed. The analysis identifies, among other things, major tasks facing the management team of the new business and assesses whether it has the capability to carry them out.
Monitoring the progress of new ventures poses problems. They are difficult to monitor against plan or budget. When performance is poor the question arises of whether to “pull the plug”. Received wisdom says new businesses should be monitored and funded against short-term milestones. But how do managers decide what the next milestone should be and when should they decide to stop funding the project? To help with these questions, the authors provide the Confidence Check.
The purpose of this tool is to help managers assess their level of confidence that the new venture will succeed. It has two sections: confidence about the continuing validity of the judgements in the Traffic Lights, and confidence about execution i.e. the ability to do what is necessary to make the project work. It can be applied as each milestone is reached. (There are nine major questions, each of which is broken down into more detailed areas of investigation.)
The four main questions concerning the Traffic Lights are:
Are we confident that:
The main issues about execution concern the degree of confidence we have about sales; technology and operations; partners, suppliers and enablers; support from the core; and funding and governance. The five major questions here include:
Are we confident that:
Projects should be killed when a number of confidence categories have deteriorated or have remained low despite setting “stage gates” to improve them. The Confidence Check can also, on the other hand, reinforce confidence in further investment.
The book ends with two appendices. The first summarises advice that other authors might give to McDonald’s. Campbell and Park chose these two firms as the focus because they faced “particularly interesting” challenges: a very successful core business that had hit some problems, run by an acknowledged management team, but with question marks about the future. The second appendix provides a database of “success stories” (companies who have successfully created a significant new business) identified by the authors during their research.
Reviewers have called this book clear, pragmatic, provocative and persuasive. It certainly is all those. Campbell and Park look forward to an “age of realism” where managers are comfortable managing businesses through long periods of low growth, but nevertheless “delighting” shareholders with excellent and dependable returns. There may be even more growth companies in future than today, they say, because managers who have learned the rules of the game will be better at spotting and developing the opportunities that fit. A lot of society’s wealth will be saved in the process.