You are a witness to strategy playing out all around you. When the local newspaper runs its yearly story about which restaurants have closed, it is really reporting on failed strategies. Every one of those restaurants felt they could draw a sufficient number of customers to sustain a business…and they were all wrong. Our publisher, Portfolio, in deciding to publish this book, made a strategic decision, one based on the belief that this book could compete with others on the retail shelves. Strategy is not some arcane methodology limited to discussions around a boardroom table. Strategy is about competition and determining a course of action based on the realities of the market.

There are a nearly infinite number of choices when it comes to determining strategy for a company, department or even PTA. The bad news is that once a leader decides on a course of action, there is only a one-in-four chance that action will be successful. That is a sobering statistic and explains just why so many restaurants close within the first year of business. So, what if you could get a hint about which action might be more apt to succeed? What if there was some trustworthy information that could improve your odds?

Chris Zook, head of Bain’s Global Strategy practice, has been looking at where growth comes from for over seven years and he has written three books that detail his work. The first, Profit from the Core, summarizes ten year’s worth of research and proves that successful growth comes from focusing, not diversifying. Beyond the Core takes the next step, and in it, Zook argues for companies to make adjacent strategic moves leveraging their core for growth. The third book, Unstoppable, explains how the need to redefine a company’s core strategy may be the only option and how to make the transition successfully.

These three books can be read together or individually. A specific problem may lead you to read a specific title. The key insights appear in all of the books, but receive varying degrees of emphasis. Let’s start by getting you excited about what Zook has to say.

The Reality of Growth (Say No to the Status Quo)

Companies have to grow: Competitors are in a constant battle to steal customers and their precious dollars; Inflation eats away at steady profits; Investors expect better-than-bond returns. Growth metrics indicate the health of a business and its strategy.

In Profit from the Core, Zook and his team defined reasonable growth levels (at least 5.5 percent growth rate in both sales and earnings) and analyzed market data to determine how many companies meet the criteria. Only one in eight companies met the growth criteria over a ten-year period. It gets worse: a study of strategic planning processes showed 90% of companies believed they would.

To explain the disconnection between strategic hopes and market realities, Zook examined over 160 reports on the topic of growth and found these sober statistics:

• The success rate for new products is about 30%.
• The success rate for startups is below 10%.
• The success rate for joint ventures is about 20%.
• The success rate for related acquisitions is about 30%.

These numbers could be a strong argument to embrace the status quo, but taking no action at all can be just as dangerous. One-third of the top 500 companies did not survive the 1990’s, disappearing through acquisition or bankruptcy. Of the 350 companies which did survive, nearly one-half changed their primary business strategy. Taken together, six out of ten companies faced significant challenges to their core business and only half of them survived the ordeal.

King of the Hill

Let’s revisit those companies who did manage to grow significantly over that ten-year period. They showed an interesting commonality: almost 80% had a single-focused core business. Zook believes defining and distilling a company’s core is the key to long-term growth.

There was something else interesting in the growth group: these companies were all market leaders in their industries. Market leadership brings with it enviable benefits:

• In a typical multi-firm industry, the top player captures 70 percent of the profits.
• Market leaders earned a return on capital twice that of parity players and three times that of followers.
• Market leaders’ market-to-book values are double that of followers.

Zook calls this phenomenon “leadership economics.” This incredible leverage means that market leaders can reinvest at a rate significantly higher than their competitors. (Zook found a nearly 2X difference.) This strengthens the market leader’s position by lowering costs and further improving margins.

Big Fish in a Big Pond

There is no benefit in market leadership if there is no money to be gained. Industry market size is unimportant, says Zook. Locating and properly estimating the size of profit pools within the industry is the key. These funds are what competitors are really fighting for. These profit pools can shift among competitors, flow amid steps in an industry’s value chain, or even disappear completely with step-function changes in technology.

Profit pools bring clarity to strategic discussions. Does our core exist in a market position that has a sufficient profit pool? Do other potential strategic moves have larger profit pools? Can we use our market leadership to draw profits from other pools along the value chain?

To summarize what we have learned thus far: you want to be a big fish growing in a big pond.

Who Am I? (Who Are We?)

Finding the core of your business is relatively easy—identify the customers and products that generate the most economic profit. From there it gets much more difficult. What about all the product lines that are not making any money? What about the planned distribution center in Omaha? The budding partnership with your material vendor to bring a whole new quality level to the industry?

Defining the boundaries of your core is not made much easier by reading Zook’s work. This is no fault of the author. It is simply the reality of strategic thought. The ever-changing realities of suppliers, competitors, customers, and technologies make this the most difficult part of the process. These boundaries need to be questioned and challenged regularly.

Settling on a definition for the core is followed by a round of action. Executives surveyed said they only exploit 50 percent of the business opportunities within their cores. Every action should be taken to establish and/or maintain market leadership, influence the industry’s reinvestment rate (re: make others not want to enter), and possibly shape and capture a larger portion of the profit from the extended industry (e.g., what Intel and Microsoft do in the PC market).

Right Next Door

Market leadership feels good. The company grows. Shareholders, employees, and shareholders are all happy. It is time to find the next source of growth. This is where most mistakes occur. Look back at those failure rates.

For this reason, Zook spends an entire book, Beyond the Core, discussing business expansion. Zook calls these “adjacencies” and is one of the themes that appears in all three books. His thinking and the data he shares evolves with each book, but the definition never changed. Busine
ss adjacencies are growth opportunities that allow a company to extend the boundaries of its core business through drawing on skills that already exist.

Zook’s research again helps us make better decisions about our strategic future. His research identified five dimensions (customers, competitors, cost structure, distribution and brand) to consider when planning an adjacent move. When a company uses the strengths it already possesses, the odds of success improve and the insight here is to make small moves. Changing only one of the dimensions in an adjacent move showed a 37% of success, better than most failure rates quoted earlier. Changing two dimensions shows a familiar 28% chance of success. With three dimensions changes, the success rate drops to below 10%.

Every adjacent move should be one made toward robust profit pools, and, in those profit pools, companies want to leverage leadership economics. Expansion requires reinvestment and market leadership is the only way to ensure profits needed.

Core Meltdown

Six in ten companies are going to have to redefine their core business in the next ten years because their profit pool is going to shift, be redistributed, or collapse completely. Our company faced a profit pool collapse in 1996 when Amazon entered the book business. Our robust catalog business evaporated and 1/3 of our total business disappeared in six months.

Unstoppable captures Zook’s thoughts on core renewal. The book is the broadest and most ambitious of the three. Starting over isn’t something companies do well, but Zook believes there are hidden assets in all companies that can be the basis for redefining their cores. New customer insights can reveal previously unseen habits and behaviors. New markets can appear when the company’s capabilities are identified and applied differently. Small peripheral businesses can act as a new center for a struggling core. While not all companies have these starting points, Zook stresses the importance of looking for hidden assets before abandoning everything for a new industry.

Some Help and a Head Start

No matter what stage your business is at (defining a core, growing from that core, or needing to find a new core), Zook’s research offers clear direction¬: search for profit pools, market leadership delivers the needed profits, and small, repeatable moves improve odds of success. If you can clearly identify where your organization appears in Zook’s trilogy, certainly pick up the appropriate book for your needs. However, if you are looking for broad-spectrum knowledge, at the end of Unstoppable, Zook provides a road map for how to read the trilogy together, directing the reader to the strongest material in each of the books. I am certain that reading Zook will also improve your odds of success.

The big news this week was a report from Strategy Analytics on the worldwide smartphone market. In the report, analyst Alexander Spektor estimates that Apple generated $1.6 billion dollars in operating profit from iPhone sales in the third quarter. over the same time period, Nokia made $1.1 billion. There are two comparisons that make those numbers incredible.

Image:neilvaneck

While neither company started off making cellphones, Nokia has a 24 year head start on Apple in the market. Both companies certainly have a command for technology which puts them on equal foot, but we have to be amazed by the speed at which Apple has managed to create all the other parts needed to be successful in the market. Just consider the variety of ways they were able to leverage distribution through the Apple Stores, Apple.com and all of outreach of the AT&T partnership to sell 30 million units since the 2007 introduction.

The second piece is even more amazing. Nokia is the market leader with 35% global share. Apple is able to generate $500 million more in operating profit with 2.5% market share. Two point five percent.

Bain & Company have been huge proponents of looking for profit pools rather than chasing market share. In The Breakthrough Imperative, partners Mark Gottfredson and Steve Schaubert list four drivers that have implication for profit pools:

1. Everyday changes in customer preference and behavior (move from soft drinks to water)
2. Innovations, both from within your industry and outside it, that drive longer-term customer shifts (shift from indie bookstore’s 20K titles to big box bookstore 200K titles to Amazon’s 3M titles offer more choice for customers)
3. Changes in the bargaining power of customers and suppliers (Microsoft and Intel in capture most profits in PC value chain)
4. Changes in the business environment (move by competitors to offshore manufacturing)

Apple clearly innovated to produce a device that was a quantum leap better than the competition creating a new profit pool for them. This also ties back to Nicholas Carr’s idea of top-down disruptive innovation, but here we have some numbers to show how powerful that can be.