Profit from the Core

1. Focus on a strong, well-defined core business for sustainable growth

"Few companies grow profitably and sustainably, though all plan to do so."

Defining the core. A company's core business is the set of products, capabilities, customers, channels, and geographies that define its essence and provide the foundation for profitable growth. It's crucial to accurately define your core, as misunderstanding it can lead to strategic errors and premature diversification.

Power of focus. Companies with a strong, focused core consistently outperform diversified conglomerates. Our analysis shows that:

• 80% of sustained value creators had one core business with a leadership position
• Single-core companies have a higher probability of achieving sustained value creation than multi-core companies
• Spin-offs and divestitures that increase focus often lead to improved performance

Characteristics of strong cores. The most successful core businesses typically exhibit:

• Leadership economics in their primary market
• A loyal and growing customer base
• Ability to reinvest profits into strengthening the core
• A well-defined, repeatable model for expansion

2. Understand and expand your full core potential before diversifying

"The better performing of your business units are likely to be those operating the furthest below their full potential."

Hidden value in strong cores. Paradoxically, the strongest core businesses often have the most untapped potential. Many companies underestimate their core's full economic potential in three key areas:

1. Increasing returns to market leadership
2. Influence over industry reinvestment
3. Ability to shape the extended industry profit pool

Maximizing core potential. Before seeking growth elsewhere, companies should thoroughly assess and exploit opportunities within their core:

• Analyze profit numbers and map the profit pool across competitors and customer segments
• Identify underserved microsegments or customer needs
• Optimize pricing and operational efficiency
• Expand geographically or into adjacent product lines
• Increase share of wallet with existing customers

Case study: W.W. Grainger. The industrial supply distributor discovered its addressable market was ten times larger than initially believed. By focusing on expanding its core through increased store density and broader product offerings, Grainger grew revenues from $1.1 billion in 1985 to $6.9 billion in 2008, outpacing industry growth.

3. Pursue logical adjacencies that leverage and reinforce your core strengths

"Most successful companies achieve most of their growth by expanding into logical adjacencies that have shared economics and reinforce the core business, not from unrelated diversifications or moves into 'hot' markets."

Types of adjacency expansion:

1. Customer and product adjacencies (e.g., ServiceMaster expanding from carpet cleaning to broader cleaning services)
2. Share-of-wallet adjacencies (e.g., American Express adding new financial products)
3. Capability adjacencies (e.g., Amazon leveraging its e-commerce platform for third-party sellers)
4. Network adjacencies (e.g., Microsoft entering the game console market to protect its software dominance)
5. New-to-the-world adjacencies (e.g., Apple's expansion into music with iTunes and iPod)

Evaluating adjacencies. When considering expansion opportunities, assess:

• How much it strengthens or reinforces the core
• Chances of achieving leadership in the new segment
• Potential defensive benefits against competitors
• Strategic positioning for future moves
• Ability to execute successfully

Repeatable formula. The most successful companies develop a repeatable formula for adjacency expansion, allowing them to consistently identify and capture new growth opportunities that leverage their core strengths.

4. Recognize when industry turbulence necessitates core redefinition

"The management teams that have been most successful in building a strong core business and that have benefited from adjacency expansion are also the most vulnerable to industry turbulence."

Signs of industry transformation:

• Erosion of low-end product segments
• Core customer defection
• Emergence of new microsegments
• Blurring of traditional business boundaries
• Rise of new intermediaries or control points

Types of core redefinition:

1. Frontal assault on the core business model (e.g., low-cost airlines disrupting traditional carriers)
2. Shifting to new business boundaries (e.g., newspapers adapting to digital media)
3. Structural redefinition of the core (e.g., Nokia transforming from a paper mill to a telecommunications leader)

Assessing the need for redefinition. Ask yourself:

• Are venture capitalists funding competitors targeting your core?
• Are new entrants gaining market share in marginal segments?
• Are there emerging customer segments you can't serve with your current capabilities?
• Could regulatory changes threaten your competitive position?

5. Balance core investment with strategic adjacency expansion

"The constant tension between mining the core and breaking out into something new exists in every business."

The growth paradox. Companies face a delicate balance:

• Overinvesting in the core can lead to missed growth opportunities and vulnerability to disruptive threats
• Premature or excessive diversification can dilute focus and erode profitability

Optimal growth strategy. Our research shows that companies achieving both high revenue growth (>10%) and high profit growth (>10%) over a ten-year period deliver the highest shareholder returns (17.7% annually).

Strategic considerations:

• Regularly assess your business's position in its growth cycle (optimizing core, adjacency expansion, or redefinition)
• Allocate resources based on potential for market leadership and economic returns
• Develop a clear point of view on industry trends and how they shape your growth strategy
• Balance short-term performance with long-term positioning

6. Implement organizational structures that support core growth and redefinition

"All organizations inhibit growth."

Organizational challenges. Core redefinition and adjacency expansion often require:

• Different pricing strategies
• New talent and skill sets
• Adjusted reward structures
• Modified channel relationships

Structural options:

1. Integrate new initiatives within existing core business
2. Create separate units within the corporate structure
3. Establish independent entities with outside ownership

Factors influencing structure choice:

• Speed of implementation required
• Ability to attract necessary talent
• Need for strategic neutrality (e.g., avoiding channel conflicts)
• Access to capital and valuation considerations

Success factors for transformation:

1. Short timeframe and sense of urgency
2. Clear, motivating vision for the end state
3. Strong, committed CEO leadership
4. Significant economic stakes for management
5. Willingness to change or replace key personnel as needed

7. Continuously evaluate and adapt your growth strategy

"The Jenga Phenomenon: The more opportunities that I seize, the more opportunities that multiply before me."

Strategic vigilance. Regularly assess your growth strategy to avoid common pitfalls:

1. Premature abandonment of the core for far-flung adjacencies
2. Excessive mining of the core without developing new growth vehicles
3. Failure to anticipate the need for core redefinition

Key questions for ongoing evaluation:

1. What is our most tightly defined profitable core, and is it gaining or losing strength?
2. Where are our business boundaries likely to shift in the future?
3. Are there emerging competitors that pose long-term threats to our core?
4. Are we achieving the full strategic and operating potential of our core business?
5. What is our complete set of potential adjacencies, and are we approaching them systematically?
6. How is our view of the industry's future shaping our strategy?
7. Should major new growth initiatives be pursued inside, adjacent to, or outside the core?
8. Is industry turbulence changing the fundamental source of future competitive advantage?
9. Are our organizational enablers and inhibitors to growth properly balanced?
10. What strategic principles should consistently guide our major decisions?

Adapting to change. In today's rapidly evolving business landscape, the ability to recognize and respond to shifts in your competitive environment is crucial. Regularly reassess your core strengths, market position, and growth opportunities to ensure your strategy remains relevant and effective.

Last updated: September 21, 2024