Even 50 years if you had a great business model you could sit back and make money for five or ten years. But nowadays, it only buys you 6-12 months of advantages and you almost have to start thinking the next 5 steps. No one can afford to relax and be happy for long. Most executives I talked to are well aware of the acceleration in the pace of change, and they all want to know what to do about it. I discuss these issues with their executive teams and bring out several business-model myths that are often not fully understood. One big question is whether corporations should diversify(or attack adjacent markets) or not? And if they do, should they move into another industry with an established market or use innovation to create a new marketplace that currently doesn’t even exist? An example, the photo above is the rumored Apple VW iCar. Should Apple diversify into automobile?
I was on a long conference call with my client this morning, we were talking about how do we convince the mgmt board that this innovation project is an important undertaking that not only hedges the company’s future, but also have the potential of allowing them to becoming a leader in a new marketspace. This is often the single most difficult challenge as companies often have a very limited and biased view of diversification.
There are obviously both benefits and costs associated with any corporate diversification. There are many different strategies for this. The efficient internal capital market logic suggests that any diversified firms have more access to internally generated resources and can exploit superior information to allocate resources among different divisions. The assumption big organizations allocate their resources more effectively. We all know the answer.
The other logic is diversified firms can also employ a number of mechanisms to create and exploit market power advantages, tools that are largely unavailable to their more focused counterparts. These include predatory pricing (generally defined as sustained price-cutting with the design of driving existing rivals from future entry), cross-subsidization (whereby the firm taps excess revenues from one product line to support another, in fact they are doing too much of this today), entry deterrence (achieved by constructing a reputation for predatory behavior or by signaling that such a response is likely in the event of a new entry, this has always been effectively), and reciprocal buying and selling (whereby the focal company gives preference in purchasing decisions or contracting requirements to suppliers, this is bullying your suppliers). From a resource-based perspective (let me academic for a minute), further benefits of diversification include the ability to exploit excess firm specific assets and share resources such as brand names, managerial skills, consumer goodwill and technological innovations. The question is how effective the organization can transfer and mobilize.
Companies who are desperately seeking to diversity particularly when their core businesses are reaching the limits of the S curve. The S-curve is often not technological and more organizational. Often they delay the need for innovation until a point the core business is at significant risks.
As it reaches this point of Inflection on its industry S-curve, such a company faces a set of choices to maximize value from the “legacy” business as it matures, to reinvigorate growth expectations and to create a more sustainable entity in the longer term. This typically involves trade-offs among strategies to maximize short-term cash flow, to retain customers and ensure the value of a business well into its maturity, and to leverage customer relationships to build new businesses.
And when evaluating their innovations, which are to create markets of the future, they use financial tools such as DCF (discounting cash flow), which is not really designed for this use. It’s often tempting but wrong (without knowing it) to assess the value of a proposed investment by measuring whether it will make the organization better off than they are today. It’s wrong because, if things are deteriorating on their own, they might be worse off than they are now. If you use DCF 15 years ago to help Kodak to decide whether they should invest in marketing digital cameras, the answer would be stick with film and develop new micro-formats. The same thing as with TDK developing a DCF for development of other media such as CDs versus the revenue from selling VHS 20 years back.
We simply cannot assume that tomorrow we will be in the same shape as we are now especially if low cost high vale competitors are attacking us on all fronts and technologies allow market power are shifting rapidly to customers. Those who attempt to distill the value of an innovation into one simple formula that they can compare with other simple numbers are missing the idea. Let’s start with the S-curve and build dynamic scenarios linking the decline of the old and growth of the new. Spreadsheets are great, but it is garbage in and garbage out.
