A simple and well-known business strategy framework is to determine where to play (which sector or market to serve) and how to win (what is needed to get the best results in that area). However, the "how" is much more important than the "where": the reward for being among the best performers increases in all sectors. Unfortunately, these rewards are neutralized by a rapid regression to the middle ground.
At the beginning of a new decade, all companies - whatever their starting point - will have to reinvent themselves in order to remain successful in the new competitive environment of the 2020s.
Challenging mediocrity is more important than ever
Markets become more homogeneous: new competitors appear, products become standardised and consumers learn to choose between alternatives, forcing prices at marginal cost and returns on capital expenditure down. The strategy has always been to challenge the powerful forces of homogeneity by being exceptional in relation to other operators in some respect, such as scale, differentiation, speed or capabilities.
Certain sectors are more attractive than others in general terms, but the distribution of performance within each sector is an order of magnitude larger than between sectors. In other words, how we play (and be exceptional in relation to our peers) is much more important than where we play, and there are no bad sectors.
At the beginning 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 upper and lower quartiles of each sector has almost doubled in the last three decades. This is partly attributable to the increase in platform-based, winner-take-all business models, which have risen to the top of the ranking of the world's highest value companies.
It is also a bad time for the average. In the long term, 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 crises reveals that, on average, companies recorded an increase in revenue and a reduction in profitability. But 14% improved their performance in both dimensions, gaining a clear advantage over their counterparts in all sectors.
Maintaining excellence requires continuous reinvention
Even if a company takes the initiative to get out of mediocrity at a certain moment, the guarantee of success cannot rely on inertia. Business activity 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, the top companies are falling fastest: only 44% of the sector leaders by operating income remain in these positions five years later, compared to 77% in the middle of the 20th century. Over the same period, the speed at which companies fall from the Fortune 100 has increased by 60%. Over a period of more than one year, there is no longer any correlation between total past and future profits for shareholders.
In other words, what it will take tomorrow to achieve success will be different from what it takes today; the advantage must 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 ready for future success. Whatever their starting position, leaders must manage the vitality of their organisations - the ability to reinvent themselves for the future - while running their business today.
These thoughts about how organisations can compete and what their leaders should do are part of what relevant companies and key factors such as governments will be discussing at Davos.
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Martin Reeves
Managing Director & Senior Partner, Chairman of the BCG Henderson Institute