A simple and familiar framework of business strategy is to determine where to play (which sector or market to serve) and how to win (what it takes to get the best results in that area). However, the "how" is far more important than the "where": the rewards for being among the best performers increase in all sectors. Unfortunately, these rewards are neutralised by an increasingly rapid regression to the middle ground.
At the start of a new decade, all companies - whatever their starting point - will need to reinvent themselves to remain successful in the new competitive environment of the 2020s.
Challenging mediocrity is more important than ever
Over time, markets become increasingly homogeneous: new competitors emerge, products become standardised and consumers learn to choose between alternatives, forcing down prices at marginal cost and returns on capital expenditure. The strategy has always been to challenge the powerful forces of homogeneity by being exceptional relative to other players in some respect, such as scale, differentiation, speed or capabilities.
Some sectors are more attractive than others in general terms, but the distribution of performance within each sector is an order of magnitude greater than between sectors. In other words, how you play (and being exceptional relative to your peers) is far more important than where you play, and there is no such thing as a bad sector.
At the dawn of the 2020s, challenging mediocrity is more important than ever. On the one hand, the value of being exceptional has increased; for example, the difference in operating margin between companies in the top and bottom quartiles of each sector has almost doubled in the last three decades. This is partly due to the rise of winner-take-all platform-based business models, which have risen to the top of the rankings of the world's most valuable companies.
It is also a bad time to be in the simple middle ground. In the long run, growth generates returns, but growth rates have been on a downward trend. Demographic trends will further slow future growth in most major economies.
Even in very adverse circumstances, some companies compete and achieve excellence. Our study of 5,000 US companies in the last 4 economic downturns reveals that, on average, companies experienced both an increase in revenues and a decrease in profitability. But % improved its performance in both dimensions, gaining a clear advantage over its peers in all sectors.
To maintain excellence it is necessary to continually reinvent oneself
Even if a company builds momentum out of mediocrity at a particular point in time, the guarantee of future success cannot be relied on inertia. Business has become increasingly dynamic, driven by rapid technological and social change. As a result, past performance has become a weak indicator of future success and ability to compete.
According to our analysis, it is the companies at the top that fall the fastest: only 44 % of industry leaders by operating income remain in those positions five years later, compared to 77 % in the mid-20th century. Over the same period, the speed at which companies fall out of the Fortune 100 has increased by 60 %. Over time horizons longer than one year, there is no longer a correlation between past and future total shareholder returns.
In other words, what is needed tomorrow to achieve success will be different from what is needed today; the edge has to be constantly renewed. The metrics traditionally used to manage a business, such as sales, profitability and return on assets, look to the past and are therefore less and less useful in indicating whether a company is poised for future success. Whatever their starting position, leaders need to manage the vitality of their organisations - the ability to reinvent themselves for the future - while running their business today.
These reflections on how organisations can compete and what their leaders will need to do are part of what relevant companies and key players such as governments will be discussing in Davos.
This article has been published in ABC. Access through this link
Martin Reeves
Managing Director & Senior Partner, Chairman of the BCG Henderson Institute