3 Signs It’s Time to Transform Your Core Business

HANNAH BATES: Welcome to HBR On Strategy, case studies and conversations with the world’s top business and management experts, hand-selected to help you unlock new ways of doing business.

Bain and Company partner Chris Zook says you may need to redefine your core business in order to power new growth. Zook was co-head of Bain’s Global Strategy practice for 20 years. He’s also a best-selling business author.

In this episode he shares three warning signs that indicate your core business needs to be redefined and he explains how to approach that transformation. In particular, he focuses on how to uncover hidden assets within your company and its brands that can offer Nnew sources of growth.

This episode originally aired on HBR IdeaCast in June 2007. Here it is.

ANNOUNCER: Hello, and welcome to the HBR IdeaCast from Harvard Business Online. In this week’s episode, HBS press editor, Melinda Merino, talks with Chris Zook, author of the new book, Unstoppable: Finding Hidden Assets to Renew the Core and Fuel Profitable Growth.

MELINDA MERINO: Hello. I’m here with our guest, Chris Zook, author of the new book, Unstoppable: Finding Hidden Assets to Renew the Core and Fuel Profitable Growth. He is here with us today to talk about arguably the number one challenge facing executives. Where to find new sources of growth? Chris Zook, thank you for joining us.

CHRIS ZOOK: Thank you, Melinda.

MELINDA MERINO: So, let’s start with an alarming statistic. In your book, you tell us that in the next decade, two of every three companies will have to redefine their core business in order to grow. That’s pretty scary. This means that executives not only have to find new sources of growth, but most of them will have to do it by making major changes in their core business. So, first, can you explain exactly what you mean by redefining the core? And second, whether this alarming statistic represents a huge change from before?

CHRIS ZOOK: Sure. By redefining the core, what we mean is dealing with the phenomenon when your business strategy of the past, when your business model of the past, begins to reach a natural or unnatural limit. We looked at the record of the Fortune 500 companies over the last two decades. And we found that two decades ago, only one in two companies had to encounter such a crisis of the core, leading to either redefining their strategy, to failing to do that and being acquired and being absorbed and losing their independence, or to actual bankruptcy and financial collapse.

Whereas in the last decade, we found that had risen from one in two companies to two in three. And all of the trends that we have analyzed suggests that over the next 10 years, the number will be at least three in four. At least three in four companies, we believe, will encounter a situation where they actually discover their growth formula of the past reaches a limit. They have to redefine their strategy.

We think that this is the toughest act in business. It is something that few executives have experience doing. And the book Unstoppable attempts to collect experiences from a large number of companies that have encountered and successfully dealt with such crises in the core, in order to package insights and ideas in the CEO’s words for people who might believe that their growth formula is beginning to reach a limit.

MELINDA MERINO: So, fundamental threats to most core businesses will continue to proliferate. And most companies, you say in the book, will only see the threat when it’s already too late. So, how does a company get a better handle on when is the right time to redefine the core? I guess another way of asking that is, how can executives better predict when their growth formula will stall out, even if their company happens to be performing extremely well at the time?

CHRIS ZOOK: We’ve just completed seven years of extensive research on the topic of how companies grow and how companies evolve, in order to find the next wave of growth over time. And what we’ve discovered is that strategies and companies over time move through a cycle, from focus to expand to redefine.

And each of those phases has quite a different set of priorities, and even a different set of skills, a different set of risks, a different set of cash characteristics. The focus cycle is a period when you’re essentially focusing on driving costs out, fixing or refining your fundamental core model. That’s what the first book of this series, Profit From the Core, was about.

Second phase is when you have basically come close to full potential in your core, but believe that you can begin to expand and take your strongest capabilities and expand those into adjacent areas around your core. That’s what the second book, Beyond the Core, was about. But all good things come to an end.

And Unstoppable is about the situation that you just highlighted, when your growth formula of the past comes to a limit. We found there are three main situations, which can signal that your growth formula of the past is reaching a limit. It’s possible for all of them to coexist in a company, such as happened in the photography situation. For example, with Kodak. Or one at a time.

Let me just quickly indicate what those are. Number one, it could be that the profitability in your industry is shifting somewhere else, from products to services, or possibly collapsing completely. For example, the world of telecommunications companies. Wireless companies grew substantially when people were able to shift over to cell phones. And when one country after another could be built out with cell phone networks. But now when you observe even the leaders in that segment, you discover that their stock prices have collapsed by nearly 70% to 80% from their peak. Because people are asking the question, now they have cell phones, what’s next?

The second phenomenon that signals that perhaps the need to redefine your core is when your business is under attack from a new and superior model. For example, the newspaper business, maybe The New York Times, went through a phenomenal period of growth, where they took the company to be a national newspaper from regional newspaper over the last 10 years. Yet, in the last few years, we’ve seen the stock price collapse, because people are asking, what is going to happen to newspapers now that bundled information in a paper form is in some cases replaced by free unbundled information over the internet?

The third phenomenon where growth formula begins to reach a limit occurs when a company’s differentiation basically evaporates. Either it is no longer relevant, or competitors have caught up to it. And the company has not advanced. Possibly the situation Home Depot finds itself in now against Lowe’s, where the company’s stock price has declined relatively steadily over the last seven years, is a situation like that. How will Home Depot redifferentiate itself in its core?

MELINDA MERINO: Those are three really big warning signals that you’ve given us. And the overall dilemma is, how do you know whether your core is at full potential or not? These are very difficult questions for executives to have to grapple with. Could you give us an example of how a company you’ve studied saw the need to redefine their core? And then how they did it?

CHRIS ZOOK: Sure. “Diamonds are forever” is a phrase that characterized De Beers. De Beers, for nearly 100 years, sold and mined 90% of all the diamonds on the planet. But in the mid-90s, De Beers was in trouble. New mines had opened up. Its market share had plummeted to 40%. Its market value, which was $6.2 billion, had plummeted to $800 million.

And the company was wondering what to do? There were people who had various points of view. One point of view was, hopefully this will blow over. Let’s just wait. One point of view was, let’s try to regain our market share by buying more mines or consolidating the industry. One point of view was, maybe it’s time to move into other businesses.

So the company studied this extensively for about six to nine months. And during a severe African thunderstorm that they all remember, memorialize today, they decided to redefine their core and shift from essentially a supply based strategy to a demand based strategy. De Beers is remarkable, because during their 100 years of strategy, what they were able to do was essentially control price by virtue of controlling supply. And when they only have 40% market share, they realized they could no longer do that and had to compete like normal companies for customers.

What De Beers did in a short period of time was really quite remarkable. They shifted to this demand based strategy. They increased their advertising for diamonds from 1% of their revenues to 10% of their revenues. The $60 billion diamond business is now growing, where it was actually in decline. They also began exploring retail stores. They invested in technology and methods to brand diamonds, thinking if you can brand water, surely you can brand diamonds. And those and many other similar initiatives that are continually being rolled out are proven to be quite successful.

Right now, De Beers’ market value has gone from $800 million in the last six years to an estimated $12 billion to $15 billion right now. And analysts are projecting that by the year 2010, it will be $20 billion, given the success and hopes for their branding strategy. What they discovered, and one of the things that both gave them the ideas and the assets to build around, was what we call, hidden assets. They found that their brand, their access to customers, and their knowledge of diamonds was superior to anybody. And those are capabilities they really had not exploited fully in the marketplace.

MELINDA MERINO: So, you talk about hidden assets as the vehicle for finding new sources of growth in big companies and any kind of company. Could you explain to us a little bit more what you mean by hidden assets? What are these things? Where do you find them? And how to use them?

CHRIS ZOOK: Sure. The primary discovery of the book Unstoppable was that 90% of the successful cases of redefining your core utilized, in some form, what we called, hidden assets. Hidden assets are not actually assets that are completely hidden. They really are assets that have the properties that allow you to see your business in new lights you had not seen before, or whose full potential, such as the case of the De Beers brand, had not been exploited or even recognized.

We found there were basically three main types of hidden assets that were central in 90% of the successful cases of redefining your core. One are we called, customer assets. This could be a brand as in the case we just talked about. It could be a segment of extremely great strength, buried in your customer base that you can reform around.

For example, the remarkable rejuvenation of Harman International, culminating in a sale for $8 billion to KKR and Goldman Sachs, is a company that in the early ’90s remarkably was only worth $132 million. That’s an improvement of about 68 times for an iconic name, Harman Kardon. And essentially, they built their strategy around the discovery that in a very small percentage of their business, they were actually the most respected and desired for stereo systems in cars.

Second type of hidden asset are what we called platform hidden assets. These are small businesses that are spawned in war around the core. Or they are, in some cases, capabilities that were required to fully develop and protect the core, but then suddenly like a secondary actor that suddenly can assume center stage, have the opportunity to be prominent in changing the strategy.

The movement of old General Electric, frankly from GE to the GE Capital as a primary source of value creation in the ’90s, arguably you could say that was a hidden asset. The small leasing business that was discovered, or rediscovered, by Jack Welch and his team improved the basis for 220 acquisitions.

The third type of hidden asset are capabilities. Capability assets. Arguably, you could even say that the rejuvenation of Apple was based upon identifying capabilities that could be repurposed for a new market, music, and that were hidden assets in terms of software knowledge and design, and knowledge of small disk drives, whose potential had been hidden but then discovered and realized.

MELINDA MERINO: So, you say that using one of these forms of hidden assets is much more successful in transforming the core than other methods of redefining the core. Could you describe a little bit what those odds of success are for each method of transformation?

CHRIS ZOOK: Sure. As in the case of De Beers, when the pressure is on, and it becomes apparent that the business model of the past might be reaching a limit in a large and complex company, there are naturally many points of view that emerge on what to do. Sometimes the belief is to jump completely into a new business.

We found the odds of success, if you’re moving four to five steps away from the core, even if it’s a very hot fast growth market, turn out to be less than one in ten. The key in improving the odds in business is building upon your strengths, building upon your core. An example of that would be Vivendi, jumping from the water business, which is actually not such a bad business, into entertainment and ultimately collapsing.

Second method would be to look for a big bang transformation move or possibly an acquisition. It’s interesting to look back on how heralded the combination of AOL and Time Warner was at the time, but that has obviously turned out to be a disappointment for shareholders and ultimately a value destroying act. And that is often the case. We find the odds of success of big bang transformations are about one in ten. It’s difficult to unwrap or untie or cut through the Gordian Knot in one single move. Very complex strategic problems need a lot more than one move often to solve them.

Sometimes people decide to just try and hold tight and try to be the last one standing. So, maybe Blockbuster Video is trying to do that. But when we looked at turbulent industries, we’ve found the odds of success of companies that were in situations where the rules of the game are truly changing, and they stuck with the old model, was about 7% or less.

The case of improving the odds, we found, ultimately came from seeing your core in a new light, and discovering that you perhaps had access to hidden assets or capabilities that either allowed you to see the core in a new light, or in some cases, allowed you to build upon those assets and increase the odds of success of a move like that. This does not, of course, mean that every company has such hidden assets or can transform or succeed like that.

The book Unstoppable is by no means meant to be a recipe for the terminally ill to give hope to companies that are hopelessly behind. What it is, is a prescription based on examples from other companies that had, at one time a strong core, and could go back and ask themselves what De Beers called, the 50 Carat Question, which is what were all our assets and capabilities when we were at our greatest? And how have they changed? And what are the lessons we can learn from that?

MELINDA MERINO: So, what is the first thing a CEO should do, if she believes her company’s growth strategy has reached its limit?

CHRIS ZOOK: If I’m allowed to have a three-part answer to that, I think there are three things that have to happen simultaneously. One, apply a rigorous diagnostic to the core and really understand the state of the core differentiation. Ask the tough questions. Test the underlying assumptions of the past business model with data and with rigor and with people in your company and with your customers. And really make sure you understand, is it time to redefine?

Second, develop the broadest list of possible options. Often this involves going outside, talking to customers, looking a parallel industries for how those businesses have evolved. Even the case of De Beers drew upon insights from what other consumer products businesses have done in terms of our branding products. There are often many insights on the outside. And companies and management teams that have been running their business with one model often have difficulty seeing their assets in their company with a new light.

And third, is to take inventory of the hidden assets. The book Unstoppable contains a method for uncovering your hidden assets. And sometimes that can trigger new growth options. Or sometimes it can make growth options that were on the table, but looked difficult to attain, appear to be more realistic.

MELINDA MERINO: Well, thank you. A lot of wonderful things for executives to think about here. Chris Zook, thank you for joining us today.

CHRIS ZOOK: My pleasure. Thank you for hosting me.

HANNAH BATES: That was author and Bain and Company partner Chris Zook in conversation with Melinda Merino on the HBR IdeaCast.

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This episode was produced by Anne Saini and me, Hannah Bates. Ian Fox is our editor. Special thanks to Maureen Hoch, Erica Truxler, Ramsey Khabbaz, Nicole Smith, Anne Bartholomew, and you – our listener. See you next week.