Beyond the Core

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■ Learn... how you can meet the top challenge of CEOs today: finding or maintaining a source of profitable growth.

■ Avoid... the cause of three out of every four business disas- ters: the failure to grow beyond a once-successful core business.

■ Understand... how you can use “adjacency moves” — growth initia- tives that push out the boundaries of your core business into new product lines or channels.

■ Enhance... your knowledge by explor- ing a practical, battle-tested framework for identifying and then evaluating the right adjacency moves.

■ Increase... your odds of success by exploiting the three factors that consistently lead to profitable growth in new products and markets.

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Beyond the Core Expand Your Market Without

Abandoning Your Roots by Chris Zook

A summary of the original text.

The drive for growth has been fundamental to

business for centuries. If businesses have a primal urge, it is the need for prof- itable growth. That growth is the source of value cre- ation to shareholders. It is the gravitational pull that attracts and retains the best people. And it is the fuel to outpace competitors.

No business that has failed to grow has been able to maintain excellence over time. Yet, the pressures to find growth are stronger than ever before, and the penalties for failure have reached new levels.

CEOs facing decisions about major investments in new growth initiatives that push out the bound- aries of their core business into new territory are often right to be concerned. In this summary, we’ll refer

to such initiatives as "adjacency moves."

While bold adjacency moves have proven for some to be the new well that liberates a gusher of growth, often that is not the case. When Zook’s team at Bain & Company examined the top 25 business calamities (other than Internet companies) from 1997 through 2002, it found the same root cause or critical factor in 75 percent of these disas- ters: a failed strategy to grow into a new adjacency around a once-successful core business.

A brief contrast between Wal-Mart and Kmart pro- vides a telling example. In 2002, Wal-Mart became the largest company in the Fortune 500, while Kmart drifted into bankruptcy.

Both companies opened

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their first store in 1962. The history of Wal-Mart is one of methodical movement into successful adjacencies such as Sam’s Club.

The history of Kmart, on the other hand, is strewn with adjacencies gone wrong, like Walden Books and The Sports Authority. These failed adjacency moves sapped the strength of Kmart at exactly the time it was under a blister- ing attack at its core from one of the toughest competitors on earth.

This is just one example of what can happen when a growth strategy overreach- es, pushing a company into spreading its resources too thinly, or leaving its core unprotected, or moving into areas it simply doesn’t know how to manage. Yet, how did some smart man- agement teams make these bad decisions, while others hit the jackpot?

Finding or maintaining a source of sustained and profitable growth has become the No. 1 concern of most CEOs. In fact, Jack Welch has commented that when he was looking for profitable growth within GE, expanding into adja- cent businesses was the easiest way to grow.

Yet, a mountain of econom- ic evidence can be amassed to demonstrate that prof- itable growth is becoming increasingly elusive and more fleeting for most com- panies.

This summary focuses on how to achieve growth through adjacency strate- gies despite this challenge. These strategies have three distinctive features:

• First, they can lead to a sequence of related adjacency moves that generate substantial growth.

• Second, they build on a strong core busi- ness. Thus, the adja- cent area draws from the strengths of the core and at the same time may serve to rein- force or defend that core.

• Third, adjacency strategies are a jour- ney into the unknown, a true extension of the core, a pushing out of the boundaries, and a step up in risk from typical forms of organic growth.

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SUCCESSFUL ADJACENCY MOVES

What are the successful adjacency moves, and why are they so important? Let’s take a look at five of the most common and effec- tive adjacency moves. Of course, the total number of possible adjacency moves is limited only by one’s own imagination.

• The first type of adjacency move is a shift from a flagging product business into services, like the cre- ation of IBM Global Services that rescued the company.

• The second type of adjacency move is a foray into a major new customer and prod-

2 A U D I O - T E C H

GROWTH OPPORTUNITIES SHOULD BE EXAMINED RELATIVE

TO A CORE BUSINESS

uct arena building on the strengths of a core business, like the repeatable adjacency formula that Nike developed to enter dif- ferent sports ranging from running to basketball to golf.

• The third type of adjacency move is a migration into new geographic adjacen- cies, like the string of acquisitions by Vodafone, which trans- formed that company from a small, local wireless operator in the United Kingdom to the world leader in cellular phone services.

• The fourth type of adjacency is the addi- tion of major new product lines to a distribution network, like the Lloyds Bank strategy of applying retail techniques to its branch bank network, thereby adding prod- ucts from mortgages to insurance, and chang- ing its position from one of the worst to one of the best performing banks in the world.

• The fifth type of adjacency expansion is the leveraging of a core asset to create a totally new business. One example would be the creation of the Sabre reservation business by American

Airlines. Unfortunately, pushing out the boundaries of a core business is among the most difficult management chal- lenges. The typical odds of success are low.

In looking at adjacency moves, Zook’s research team conducted an inde- pendent analysis in order to understand as completely as possible the odds that major growth initiatives would truly drive a new source of sustained, profitable growth. It turns out that just 25 percent of investments in growth initiatives created value and added to growth.

This summary attempts to increase those odds:

• First, we’ll provide objective data to assess the odds and risks of adjacency moves under different circumstances.

• Second, we’ll provide a practical, battle-tested framework for identify- ing and then evaluating adjacency moves. Much of this background is based on statistical analysis and Zook’s access to top CEOs through his work at Bain & Company.

While there are risks that go along with an adjacency expansion, the rewards of such a move can be extremely attractive. It can create a new wave of profitable growth, can strengthen, reinforce, and even defend a core busi- ness, and can redefine a business facing turbulence in its market.

There are essentially six primary boundaries that a business can cross in the process of exploiting an adjacency that radiates from its core. Let’s look at

B U S I N E S S B O O K S U M M A R I E S 3

MANY TYPES OF ADJACENCIES CAN RADIATE

FROM THE CORE

each in turn. • The first boundary

involves products. Selling a new product or service to core cus- tomers is one of the most commonly pur- sued and highest-poten- tial adjacencies. The creation of IBM Global Services for IBM’s hardware customers illustrates one of the most successful growth strategies triggered by a product adjacency.

• The second type of boundary is geograph- ic. Moving into a new geographic area is a type of adjacency move that companies consis- tently underestimate in complexity, hence the lower-than-average success rate.

• The third type of boundary is a compa- ny’s position on the value chain. Going up or down the value chain into an entirely new set of activities is one of the most difficult forms of adjacency expansion. Merck’s acquisition and recent divestiture of Medco, a mail-order drug distributor, illus- trates a value chain adjacency.

• The fourth type of boundary is the distri- bution channel. If successful, the move into a new channel can produce an enormous

source of new value. If not, it can turn into a Waterloo. For example, Dell’s entry into the mass retail channel with personal comput- ers caused massive dis- ruption and led to the only time in which Dell lost money.

• The fifth type of boundary involves customers. Modifying a proven product or technology to enter a totally new customer segment is a major adjacency move for many companies. One example is the move by Staples from retail into the delivery of office products to small businesses.

• The sixth type of boundary involves new businesses. Building a new business around a strong capability is the rarest from of adja- cency move, and the most difficult to pull off. The classic exam- ple is when American Airlines created the Sabre reservation sys- tem, which grew into a spin-off now worth more than the airline itself. Sabre, in turn, went on to create a new business adjacency of its own in Travelocity.

With this background in place, we are ready to begin our in-depth look at how to make this enormous

challenge work for your company instead of against it.

The most important element of adjacency growth is repeatability. Repeatability is the essence of mastery and control.

A majority of the most suc- cessful, sustained-growth companies that Zook encountered have one or two powerful, repeatable formulas, "adjacency machines" that generate waves of new growth over time.

Zook and his team at Bain studied 25 highly success- ful companies that could attribute at least part of their growth to adjacency expansions. Three critical factors coexisted in at least 18 of the 25 companies:

• First, each company had a strong core that constituted a sta- ble and suitable launch pad for a sequence of growth initiatives beyond the core.

• Second, these companies hit upon a repeatable formula for adjacency expan- sion that generated strong economic and competitive bene- fits in its repeated application.

• Third, these compa- nies’ formulas were, 80 percent of the

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time, built around specific and deep insights about cus- tomer behavior that could be replicated, in different products or segments or circum- stances, with high odds of success and profit.

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EVALUATING ADJACENCY MOVES

We now turn our attention to the critical issue of choosing direction and eval- uating the true economics of any adjacency strategy.

A survey by Bain & Company reveals three key success factors that appear repeatedly in companies that successfully pursue adjacencies. Let’s look at each of these factors.

The first success factor is that the best adjacencies build on and reinforce the strongest cores. Relatedness to a strong core is the most powerful and reliable engine of value creation for pushing out the boundaries of a business. In the Bain study, the slower value creators clear- ly moved away from this basic principle to their peril relative to the faster value creators.

The need to build on and reinforce unique strengths sounds obvious. Yet, it is surprising how many mas- sive adjacency investments

and strategies flounder on false premises.

You only have to go back and read the press clip- pings to feel the adulation for Mattel when it bought The Learning Company for $3 billion as its foray into the digital age. Within two years, the business had col- lapsed and was sold to a financial buyer for a price of zero, demonstrating that it had virtually no relation- ship to Mattel’s core toy business.

Zook’s team has collected more than 100 examples of major investments made on unsubstantiated assump- tions about the true rela- tionship between the new adjacency and the initial core business. So while it may sound obvious, this rule is violated often and at great peril.

It’s also important to assess the adjacency’s distance from the core. In the study at Bain, many of the most successful growth compa- nies were able to maintain strong, highly measurable, and mutually reinforcing economics between the cur- rent business and the new adjacencies.

Similarly, many of the most disappointing case studies, even those that seemed to have all the right initial ingredients for success, floundered because the link to the core was illusory. So how can a management

team objectively assess true relatedness between a number of different oppor- tunities and real core strengths?

One framework that is useful is to think of the economic distance between the core business and the potential adjacency. This distance can be measured by shared economics. A good starting point is the following method.

For each of the following five dimensions, determine whether the growth invest- ment has characteristics that are identical, or only somewhat similar, to the base business.

1. Customers.

2. Competitors.

3. Cost structure.

4. Channels of distribution.

5. A singular capability, such as a brand, an asset, or a type of technology that gives the core business its uniqueness. The issue is whether this is relevant to the new opportunity.

If the characteristics of the factors that we’ve just mentioned are identical, then the distance from the core is zero. If the charac- teristics are only somewhat similar, then estimate the

B U S I N E S S B O O K S U M M A R I E S 5

extent of the difference in terms of steps away from the core, say, one-half or three-quarters of a step away. Then add up the total as one measure of distance.

A useful rule of thumb is to say that the maximum is five and the minimum is zero steps away. If the total is much less than a step away, then the new opportunity is essentially part of the base business, and not a real adjacency as we are defining it here.

In several analyses, the team at Bain found that the odds of success declined dramatically as an adjacen- cy moved two or more steps away from the core business’s greatest strengths.

It’s useful to compare the distance of different adja- cencies when you need to compare investments to

each other, as well as when you’re going to evaluate them on an absolute basis. This certainly does not mean that companies should avoid investments many steps away from their best businesses.

On the contrary, all compa- nies should have an orga- nized process to experiment at the boundaries and to plant new seeds. What it does mean, however, is that executive teams should be aware of their investment portfolio and be wary if more than 10 to 15 percent of resources are being invested many steps away from the strongest cores.

The second success factor is to drive adjacencies toward the most robust profit pools. A profit pool is different from a market. A profit pool evaluation is designed to embody the size of the industry, its current and potential profit dollars,

and the extent to which those earnings could cover the cost of capital for the leading players.

Some industries, like the airline industry, have decades-long histories of not earning their cost of capital, with the exception of companies like Southwest Airlines with highly specific ways to segment the market, lower their costs, and create profitability. The prism of profit pools is the way to view the fundamen- tal attractiveness of a mar- ket, given its size, growth rate, economic structure, and customer alternatives.

Sometimes, a new competi- tive model, such as that of Starbucks, can create new profit pools where none existed before. However, creating a profit pool in a dog-eat-dog industry through a "new model" is the historical exception, not the rule. When it occurs, the reason is usual- ly a dramatic new way to lower costs, thereby pro- ducing profits where none previously existed.

Profit pools in business are obviously not as stable and knowable in the future as a deposit of gold or a reser- voir of crude oil. However, that does not mean that an attempt to map those pools and anticipate their forma- tion in the future is in vain.

In mapping out a profit

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SUCCESS DECLINES WITH DISTANCE FROM THE CORE

pool, it is first necessary to decide on the definitions and boundaries of the rele- vant markets. These could be defined by geography, stage in the value chain, current owner, product, end user, time phase, chan- nel, or distance from the relevant core business.

In addition, it is important to think about what consti- tutes profit. Is it pure dollars, or is it dollars earning more than the cost of capital? Is it poten- tial profit under a new economic model?

Once the definition has been decided on and information has been assembled, consider the full range of profit pool effects that come into play. Specifically, there are five profit pool effects to consider:

1. The direct profit pool entered by the adjacency move.

2. The impact of the adjacency move back on potential profitability of the core business.

3. The impact of the core business on the adjacency.

4. The option value of the move in creating further opportunities.

5. The profit pools of customers, suppliers, or complementary

products. Finally, the third success factor when it comes to evaluating adjacencies is to insist on the potential for leadership econom- ics. The decision to make a major investment to push out the boundaries of a core business into an adjacent area requires a clear view of the reinvestment and cash requirements in the future.

If you do not have the potential to ever achieve economics equivalent to the leader, then you may be constantly out-invested or put in a position of having to match the leader’s investment to achieve lower returns.

This situation was rein- forced by the Bain study. In two-thirds of the companies, weak performers allowed themselves to be lured into investments in clear follower positions without leadership economics.

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ORCHESTRATING ADJACENCY MOVES

Up until now, we have said relatively little about the condition of the core business itself. Yet, it is the central character in all dramas

B U S I N E S S B O O K S U M M A R I E S 7

BEWARE OF PITFALLS

When it comes to evaluat- ing adjacencies, there are, of course, any number of potential pitfalls that can derail a company. But there are two pitfalls that are especially common.

• The first pitfall is com- petitor mimicry. In cer- tain situations, there is enormous pressure to act, even if the numbers do not add up. For

example, when a com- petitor moves into an adjacency, a company feels pressure to follow, or to fail. Competitive moves are tough not to copy in the heat of bat- tle. Nevertheless, some of the most costly errors have come from following competitor behaviors.

• The second pitfall is untested assumptions about customer buying preferences. Untested assumptions in this area have led many companies into massive and costly adjacency moves that they have subsequently had to unravel. The most com- mon arena in which businesses rely on untested assumptions is financial services, and the most common topic is customer bundling. The belief in the concept of a finan- cial supermarket has led companies like American Express in the mid-1980s into a range of product adja- cencies that turned out to be costly, far from their true cores, and unjustified by customer interest.

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concerning adjacency moves. Even the most attractive growth opportu- nity can turn unattractive, unrealistic, or even destructive when bolted onto the wrong core busi- ness. And even a relatively modest adjacency move by a strong core business with pent-up resources to invest can act as a catalyst to trigger a burst of new growth.

In his studies at Bain, Zook found that more than 80 percent of the most success- ful companies achieved a large portion of their profitable growth by moving into adjacencies surrounding their original core business.

In this portion of the sum- mary, we’ll focus on critical judgments regarding the state of the core. Core businesses differ widely in their abilities to support a major new growth initia- tive. The three critical dimensions along which

they vary are: 1. Competitive position

2. Market dynamics

3. Financial performance

Competitive position can range all the way from a weak follower to a strong market leader with parity.

Market dynamics range from strong growth to sta- ble low growth to total meltdown.

Financial performance can vary from full potential to underperformance.

Ironically, the businesses with the strongest competi- tive positions and the highest economic returns also tend to be the most prone to performance below their full potential. This paradoxical conclusion stems from the ability of a leading business to achieve strong earnings while underperforming, the internal dynamics that

allow the best businesses more latitude in budget and target setting, and the ample opportunities available for the best businesses.

By contrast, businesses with weak competitive positions are preoccupied with survival and typically not surrounded by an abundance of high-quality opportunities.

Zook’s earlier book, Profit from the Core, established the strong link between sustained, profitable growth and leadership in a highly focused core busi- ness. Specifically, 88 percent of the sustained value-creating companies mentioned in that book had strong leadership in one or two core businesses, and 80 percent of these companies aggressively used adjacency expansions to fuel their growth.

As Zook and his team inter- viewed CEOs running companies with dominant and focused core business- es, it became apparent that these companies had much higher-than-average success rates in moving successfully into adjacen- cies. One of the important elements of their success, of course, is the strength of the core business that they were using as their platform for new growth.

It is critical to understand exactly how your core

8 A U D I O - T E C H

CRITICAL DIMENSIONS OF CORE SITUATIONS

business is positioned. Understanding competitive position means defining the relevant market bound- aries precisely. For exam- ple: Is Xerox in the copier business or the document creation business? Industry leadership stems from market power and influence, low-cost econom- ics, and from control over the industry profit pool.

These are only partly relat- ed to scale, which is often a secondary factor in the equation. So these determinations about true competitive position are not the easiest of judgments and are prone to distortion. Most companies participate in many businesses, though one or two dominant cores usually deliver the true economic profit. These strong cores are often sur- rounded by weaker posi- tions that have their own adjacency opportunities. If you have a portfolio of busi- nesses, it is critical to have a clear point of view about the relative position of each of the different cores.

Companies frequently find themselves in three common situations when they contemplate growth initiatives.

The first situation is the harsh reality of the weak follower. The world is filled with companies that are distant followers in their industry. Some may contain a small core of

strength buried among weaker positions. Others may no longer have a viable core in which com- petitive advantage remains. These companies are dying to leap to a new lily pad, fleeing their core. What are the real odds that adja- cency moves will reposition a company, springing it free from the bonds of followership?

While this is not a question that has been researched extensively, there is some evidence that the odds are low. One study finds that only under two sets of conditions would a dis- tant follower move up significantly. In the first situation, the follower was able to suddenly come up with a unique product advantage in its core relative to the leader. In the second condition, the follower developed a suc- cessful strategy directly targeting an equally weak follower, confiscating its share, but not chipping away at the leader. Again, the feasibility of this strat- egy is low. Movement to a totally new adjacency did not even come up as a viable alternative.

Thus, it seems fair to conclude that weak follow- ers seldom find a miracle cure by jumping into an adjacent area. The three primary strategies that have worked for companies in this situation are not adjacency dependent.

These options consist of combining with other com- petitors, creating powerful product differentiation, or retreating to build around a hidden core, an area of strength buried in a larger business.

The second of the three primary situations that companies face when they are grappling with funding growth initiatives is the melting core. The challenge of managing a business whose entire core product market is eroding is not common. At any point in time, only 2 to 3 percent of markets are in severe decline. There are two main approaches that will sometimes provide a way out of this extremely troublesome dilemma. Both involve adjacency expansion combined with systematic thinking and hard work.

The first method involves taking assets like distribu- tion and brand when the core product is eroding and leveraging them to obtain a new lease on life. Often, when a company fails to use an adjacency expansion to try to leverage its remaining strength, it ends up disappearing.

The other way is to attempt to leverage a strong but declining franchise in a major product into a ser- vices business. The changeover seldom happens sustainably or successfully,

B U S I N E S S B O O K S U M M A R I E S 9

as it begs the question of whether the services busi- ness can be made into something sustainable beyond just servicing the declining products.

Occasionally, however, a strong but declining installed base of products has been leveraged into a successful services business that eventually redefines the core and offsets the market decline. Most of the best examples of this are in computer equipment and software markets, where product life cycles are usually short and fragile.

The situation of the melt- ing core may signal that it’s time to combine with another company or that the core may provide new status in a multicore company, as an asset to manage for cash. However, before any strategy is iden- tified as the preferred alternative, it is worth- while looking closely at one of the two aforementioned strategies for exploiting a strong but melting core.

The odds of making these adjacency strategies suc- cessful are not extremely high, but are definitely worth exploring and even pressure-testing in the field if your are endowed with these infrastructure assets to build upon.

The third of the three primary situations that

companies face when they are grappling with funding growth initiatives is when a core is strong but is underperforming.

When evaluating potential adjacencies, it’s important to know whether your core is performing at its full potential. How can you determine this?

There are eight clear indicators:

1. A poorly defined core.

2. A core that is declining, marked by a shrinking share of a customer’s wallet.

3. Flattening unit cost experience curves.

4. Increasing competitor reinvestment rates or market share.

5. Disappointing recent adjacency attempts.

6. Increasing product and process complexity.

7. Varying and unex- plained performance difference across units.

8. A lack of revision of customer segments.

These eight indicators emerge from an examina- tion of case studies in which greater potential was discovered in a core business. If three or more of these apply to your busi-

ness, it is likely that there is substantial additional potential in your core.

Before we move on, consid- er six key lessons about adjacency moves:

1. Major adjacency moves are virtually never the salvation for a very weak core in a distant- follower competitive position.

2. For followers, the most viable paths to the cre- ation of value entail consolidating with a competitor or finding deep with within the business a strong, prof- itable core where the principles of full poten- tial and adjacency expansion can be applied. In a sense this is "shrinking to grow."

3. Adjacency moves are critical to the survival of business with a melting core.

4. Businesses that have a strong core but are severely underperform- ing operationally and financially should almost always work on reaching full potential of the core first.

5. Businesses that have a strong core but are close to full potential are probably entering a phase in which the quality of their adjacency moves will

10 A U D I O - T E C H

shape their future. 6. Companies with a port-

folio of core businesses should ask themselves whether they are defin- ing the boundaries of those cores correctly, and whether they really understand the compet- itive position of each business.

These six lessons all point to the importance of know- ing the state of your core. Acquiring and interpreting key information about the core is critical, because there is no sidestepping this important aspect of adjacency moves.

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EXECUTION

Deciding on an adjacency move is one step in going beyond the core. This next portion of the summary will discuss how to execute this decision once it is made.

When it comes to executing adjacencies, managers face two primary organizational concerns. The first is man- aging linkages between the core and adjacencies. The second is organizing for repeatability to exploit the new math of growth.

Let’s examine each of these scenarios. First, we’ll discuss managing linkages between the core and adjacencies.

There are a host of ways

to successfully execute an adjacency move. For exam- ple, when Dell entered the printer market, it did so by fully integrating printers into its core. Enterprise Rent-A-Car used a similar core-integration approach when it entered the truck rental business.

On the other hand, when Centex Homes started offering services like mort- gages to homeowners, it did so by separating the divi- sion that offered these new services from its core. Other companies such as Staples and UPS have used a hybrid approach.

Three analytical lenses have proven to be particu- larly important in looking at an adjacency and trying to understand how it links to the core.

First, there’s the lens of shared economics. Understanding the extent to which the new growth initiative and the core have overlapping, or shared, customers and the extent to which they have common types of infrastruc- ture, or shared cost, is important in making the right organizational choice.

This sharing can be quanti- fied and is often quite revealing. For example, the ability of GE Capital to purchase and integrate 220 acquisitions successfully over 10 years came about because of its ability to

recognize patterns of shared economics and develop a repeatable formu- la for swift and effective integration.

As a rule of thumb, an adjacency move with less than 25 percent cost shar- ing, but high customer sharing would usually be set up quite separately, though with highly choreo- graphed sales and market- ing activities, and maybe even a combined sales force.

The second lens is the lens of shared decisions. Identifying and mapping out the key decisions that must be made during an adjacency expansion can be a surprisingly valuable first step toward the devel- opment of a repeatable adjacency expansion method.

The next step is to work out who gets to make the decision — the core or the adjacency. Consider the situation of a company’s branching out into another country, such as when Staples moved into Canada and Germany. For Staples, office products differ sub- stantially in Germany, and even in Canada, from those in the United States. Thus, the company had to grapple with many important and difficult questions about how much standardization should be imposed, and how much local discretion should be allowed.

B U S I N E S S B O O K S U M M A R I E S 11

12 A U D I O - T E C H

The third lens is the lens of shared culture and people systems. Zook found that cultural issues and other issues related to people management were highlighted in nearly all of the interviews and case studies as a top concern of CEOs moving into new adjacencies. And cultural issues are cited in public accounts of a significant percentage of acquisitions and expansion programs that encountered problems.

Examples include the dis- astrous acquisition of The Learning Company by Mattel, and the continuing saga of how the AOL Time Warner merger achieved virtually none of the syner- gies that were targeted at the time of the merger.

One thing that many companies that have suc- cessfully executed adjacen- cy moves have in common is that they possess strong, almost monolithic cultures that shape the way in which the respective man- agement teams think about adjacencies in and around their core business. In each case, the strong cul- ture is infused into each adjacency, becoming a way to reduce complexity and ambiguity.

Sometimes the way the cultural norms are best infused into an adjacency is not by having the adjacency "owned" by the

core, but by having the adjacency run by someone with intimate knowledge of the core culture. That person will value and embed the key values of the core without compro- mising areas in which independence is critical.

It is not always appropriate to extend the core culture or even the core systems around people management, but it is always appropriate to invest time in making this determination in the most careful way possible. Sometimes the right answer is a temporary, if not a permanent separation of the adjacency and the development of a unique set of cultural norms and people management practices.

Bain recently conducted a study of the extent to which cultural issues can be managed in adjacencies made by acquisition. Looking at 124 deals from 1996 to 2000, they conclud- ed that there was a 14 percent difference in stock price performance between companies that identified cultural integration as critical during the due-dili- gence phase and addressed the issue in integration and the companies that did not.

We’ve just explored how the three lenses of shared economics, overlapping decisions, and cultural fit can assist in developing the options about how to orga-

nize the new adjacency. The range of options for actually linking a new adjacency with the core organizationally is vast. Let’s look at six of the most common and powerful options.

The first option is com- plete separation. Integration of decisions occurs primarily at the level of the CEO.

The second option is back- end integration with front-end separation. Three of the six options that we’re currently dis- cussing are, at their core, marketing and sales driven initiatives that often draw upon a common set of back room operations and infra- structure to produce the product. In these cases, the adjacency would draw almost entirely upon the infrastructure of the core business.

For example, when Enterprise Rent-A-Car moved into airports to serve its customers there, expanding from suburban locations, it used the same back-end IT and fleet management infrastructure for each.

The third option is back- end separation with front-end integration. Businesses whose core is centered on serving a focused set of customers and whose growth comes from increasing share of

wallet in that customer, or following those customers’ needs through their lifecy- cle, represent the classic case of back-end separation and front-end integration.

The fourth option is the complex hybrid. For example, some companies employ a highly customized structure in which the adjacency has its own sales force, but also has mecha- nisms to make combined sales calls on major accounts. In companies like these, the adjacency shares some infrastructure with the core, but not all.

The fifth option is the product-management model. This is a simpler structure in which most services, customer-facing activities, and infrastruc- ture are completely shared with the core. In other words, the core business manages the adjacency directly. An example is the truck rental business of Enterprise Rent-A-Car. The truck business had its own fleet, sales specialists, and financial reporting, but all its other functions were integrated into the core.

The sixth and final option is complete integration. Here, a new adjacency moves as rapidly as possi- ble into full integration with the core on every dimension.

No mechanical formula exists to define the right

way to link an adjacency to the core. However, the questions regarding shared economics, shared deci- sions, shared culture, and shared people systems that shape the best solution are relatively clear.

Sometimes the right solution might be to have the adjacency start in an independent structure, reporting directly to the CEO, with the plan to grad- ually shift into the core. Or the plan might be to have the adjacency incubated in the core, and to spin it off when it grows stronger.

Now we’re ready to look at the second primary organizational concerns that managers have when it comes to executing adja- cencies: Organizing for repeatability to exploit the new math of growth.

Understanding and acting on linkages is critical in increasing the odds that an adjacency move will be successful. A further multi- plier factor is the ability to take the lesson of repeata- bility in growth moves and translate that into how often the organization attacks new growth oppor- tunities, captures the learning, and refines the process for the next one.

There can be little doubt that methods to reduce management complexity when a company is moving into new areas of growth

can be extremely important in increasing the odds of success. If half of your growth comes from moving into new adjacencies around the core, and you can cut in half the time of decision and implemen- tation, then, on average, your growth rate should increase by one-third. If repeatability makes you more reliable, there is a further multiplier effect.

Companies that outgrow their main competitors for extended periods often do so because they have more success at moving into new adjacencies around the core. This success may be due to a fundamentally stronger core.

It may also be due to better selection and implementa- tion of those adjacencies that permits higher success rates, a faster ramp-up to success, a greater ability to achieve the full potential of an adjacency move, and the ability to handle moves of a given type. All these performance levers can be improved by better managing "good" and "bad" complexity.

Zook’s research reveals that moderate improve- ments in the success rate or the speed of execution translate into substantial changes in growth. Speed of execution, reliability of execution, and reduction of the cost of failure are each critical to the way

B U S I N E S S B O O K S U M M A R I E S 13

that adjacency expansions create value. These are the reasons that a relentlessly repeatable adjacency formula can have such powerful economic and competitive implications.

Three themes emerge over and over in Zook’s detailed analysis of organizations trying to execute on an adjacency expansion. One theme is the value of map- ping out the detailed link- ages between the adjacency and the core and using this information to decide on organizational structure, reporting relationships, and the decision processes.

The power of repeatability and the high economic value that accrues to an organization that can execute faster and more reliably on adjacencies was a second consistent theme. This allows the value to be captured faster, enables companies to handle more adjacencies over any peri- od, and increases the odds of success.

The final theme concerns the need to exit disappoint- ing adjacencies soon enough. Exiting adjacen- cies reduces the complexity of management and frees up resources for more productive activities. The active management of exits can also reinforce a culture of performance in an organization.

Attention to detail, the

implantation of clear performance standards for growth, the insistence of rigorous analysis of economics, and high metab- olism of organizational reaction time are common attributes of companies that handle these critical issues of execution well. Of course, it is not enough just to believe you are fast-acting, rigorous, and detail-oriented. You must compare yourself to world- class companies on these critical dimensions.

■ ■

Let’s conclude by briefly reviewing the four key

components of an adjacency expansion that can turbo- charge, and in some cases even transform, a company.

• First, a strong core on which to bolt adjacency moves.

• Second, adjacency moves that satisfy the three key success factors of relatedness to a strong core, robust profit pools, and the potential for leadership economics.

• Third, a repeatable adjacency formula.

• Fourth, adaptable and replicable organization- al processes to manage adjacencies.

A dominant core — or, at a minimum, a strong position

in a channel, a customer segment, or a product line in a weaker core — is the first requirement for successful adjacency expansion.

The availability of moves that satisfy the three key criteria of relatedness to a strong core, robust profit pools, and the potential for leadership economics is the second condition.

When your options fail to link tightly to the core, fail to target a robust profit pool, or never have the potential for leadership economics, you have the ingredients for future value destruction. Though these criteria look obvious, many companies struggle with establishing criteria and even more companies find it difficult to assess growth initiatives factually and objectively.

The best companies seem to be the most rigorous in deciding when to fund a growth initiative. Given a core to build on and a menu of potential moves, the third level of the game occurs when successful moves begin to suggest a series of similar future moves.

The final level of the game occurs when the organiza- tion can literally mobilize internally to have repeat- able processes in which the organization need only make small changes to

14 A U D I O - T E C H

successfully implement movement into a new adjacency.

Adjacency expansion is what CEOs today identify as the primary way they hope to achieve their next major wave of new growth. As we have seen, the potential is great to create value from well-executed moves that push out the boundaries of a strong core business.

In this summary, we’ve cited examples of immense value creation through thousands of individual adjacency moves along the way.

By contrast, 75 percent of the greatest business disasters from 1997 to 2002 were either triggered, or worsened, by major adjacency moves that went horribly wrong.

To be among the companies that succeed at growing profitably, you need to move beyond the core, but you must stay close enough to the core that you can take advantage of your strengths and create new value.

■ ■

NOTES

B U S I N E S S B O O K S U M M A R I E S 15

ABOUT THE AUTHOR

Chris Zook is a director at Bain & Company, a Global management consulting firm focused on making companies more valuable. He heads the company’s Global Strategy Practice and is a member of Bain’s Management Committee and Investment Committee.

During his 20 years at Bain, Zook’s work has focused on companies searching for new sources of profitable growth, in a wide range of industries. This work led to the writing of his best-selling business book Profit from the Core(Harvard Business School Press, 2002) which provides a blueprint to finding new sources of growth from a core busi- ness, based on a three-year study of thousands of companies worldwide.

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