F-E-R whom the bells toll

Something has fundamentally changed in the world of business. Although just a handful of people seem to have internalised this shift, the effect is astounding and profound. Ten years from now, one in three companies will no longer be independent because of bankruptcy or a takeover, while another one in three will be completely different at its core—maybe even having a different core. Just one in three will resemble what it looks like today.

What this means for countries with dynamic markets, such as India's, is that around two-third of companies will discover in the coming years they need to make fundamental changes in their business models. Surveys reveal the No. 1 innovation priority for CEOs is to find ways to innovate around the fundamentals of their strategy and its underlying economic engine. That's what De Beers did in the end-1990s and early 2000s in response to a slump in the diamond market that resulted in its profit margins hovering near zero. The world's largest diamond producer successfully shifted its decades-old strategic focus of reigning over global diamond supply to developing the power of the De Beers brand by zeroing in on its hidden assets: the company's unique relationship with customers.

RELATED INSIGHTS

Beyond the Core selected as one of "The 100 Best Business Books of All Time"

INDUSTRY EXPERTISE

Aerospace, Defense & Government ServicesConsumer ProductsFinancial ServicesAirlines & Transportation

HOW WE CAN HELP

Fundamentals of GrowthBain BothBrain® Innovation

As the world's economy speeds up—all the more tangible in economically booming India—company evolution will be faster, just as evolution of organisms in a changing environment is hundreds of times faster than at the bottom of the sea. Firms that don't redefine face a higher risk of going out of business.

While the pace is accelerating, the cyclical process of regeneration is predictable and universal. Many human and natural phenomena follow foreseeable cycles, such as our biorhythms, or the phases of the moon, which allow us to chart and understand them better.

A similar process of regeneration exists in business, which we call the Focus-Expand-Redefine (F-E-R) cycle.

It sounds simple, but companies—more now than ever—need to be acutely aware of which phase of the F-E-R cycle they are in to safely negotiate the increasingly turbulent crosscurrents of the global economy.

In the Focus phase, a company concentrates on building its core business to its full potential. In the Expand phase, it takes advantage of its capabilities and market position to move into—and conquer—adjacent markets. But inevitably, many companies experience dwindling growth and profitability, or a direct threat to the core, from a new competitive model with inherently superior economics. This is the time to Redefine the core.

Core And Beyond
Some businesses, however, have successfully remained in the Focus stage and extracted tremendous value by sticking to their core. India's Hero group, the country's top seller of motorcycles, is one such case.

In the early 1990s, Hero was quick to seize on the customer shift from scooters to the fast-growing motorcycle segment through its company, Hero Honda. By turning the spotlight onto motorcycles—which witnessed 26 per cent compounded growth from 1993 to 2000—it assumed leadership in the two-wheeler industry from Bajaj and surged ahead of rival TVS.

Its efforts to strengthen its two-wheeler core paid off in other ways: the share of Hero Honda in overall group sales rose to around 80 per cent in 2006 from slightly over 40 per cent a decade earlier.

On the other hand, the Bajaj Group did not zero in on its two-wheeler business—Bajaj Auto—with such gusto and lost its way: the share of two-wheelers in overall group sales in 2006 was around 60 per cent, basically unchanged from 1996. Unlike Hero, a large percentage of Bajaj's sales continued to come from its other businesses in steel, electrical equipment and sugar.

The fallout? By March 2003, Bajaj was significantly behind Hero in the two-wheeler market; a dramatic shift in fortune from March 2000 when it had close to double Hero Honda's share.

For other companies, each stage of the F-E-R cycle helps fire and drive the next. Success at the Focus phase provides the fuel to move to adjacency expansion: in other words, into a business relatively close to the core. Success at adjacency moves often provides the growth—and breathing room—to redefine your business model over time, or add a new core.

As India's economy grows strongly, many of its companies are in the Expand phase. Take Bharat Forge, for instance. In recent years, the auto parts maker and the world's second-largest forgings company has moved into geographies such as the US and Germany through strategic acquisitions with the aim of boosting sales.

In 2003, it bought Carl Dan Peddinghaus, one of Germany's largest forging companies, gaining access to car makers BMW, Audi and Volkswagen. Two years later, it acquired Michigan-based Federal Forge, which gave it a foothold in General Motors and tyre maker Goodyear.

Bharat Forge's adjacency strategy has hit pay dirt: its worldwide revenues soared from $137 million in 2001 to $741 million by March 2007. It is reported to be eyeing acquisitions and greenfield projects in China and, once again, in the US.

Other Indian companies, too, have made a habit of moving into related adjacencies. ICICI Bank, India's biggest private bank, is a high-profile example.

From its core banking sector in the early 1990s, it has leapt into multiple adjacencies, including non-life insurance and travel portals. The company has also expanded into new countries, including Russia, the US, Britain and South Africa, and plans to set up more branches overseas.

However, it's not always smooth sailing. Companies face risks as they look at the Expand phase of the cycle, such as premature abandonment of the core into distant adjacencies—stemming from failure to see the full potential of a core business—as well as hasty leaps into adjacencies that were further and more difficult to develop than recognised at first.

Another timing error that companies face is the failure to start redefining quickly enough when profitability declines or a new competitive model becomes a threat.

A third and final timing error in the cycle is plain old inattention, or taking the core for granted. This could be fraught with risk, as a once clear, low-cost leader can be mimicked, allowing competitors to catch up.

Redefinition: Pay Attention
But cycles often play out over decades, lulling managements into complacency and making it imperative for CEOs to perceive the need to redefine early. One company that paid attention soon enough was General Dynamics, which perceived a major profit pool collapse ahead of it competitors.

In 1984, General Dynamics reigned as America's largest defence company, with comfortable revenues of $7.8 billion. But with US defence expenditures dwindling in the late 1980s and early 1990s, it underwent one of the most thorough transformations in business history.

By 1992, it had reduced itself to three core businesses and $3.5 billion in revenues, a 70 per cent downsizing in three years. Its transformation included selling businesses ranging from aerospace to land systems. It then followed this up with selective acquisitions to bolster its profitable submarine core and build a new, related core in electronics and information systems for defence programs.

Its redefinition has held the fourth largest US defence contractor in good stead over the years. The company's net profit in 2007 rose 22 per cent to $2.1 billion year-on-year. Total sales in 2007 increased 13 per cent to $27.2 billion over 2006, a nearly eight-fold rise from 1992.

The key to General Dynamics' resurgence was a major study it commissioned in the early 1990s of its demand and asset values for every sector in which it participated. This was an unusual step as Bain studies show that managers typically spend less than 3 per cent of their time developing a long-term view of their industry. It helped the defence contractor see the writing on the wall before other defence companies, and perfectly time its redefinition.

In your own planning, ask yourself if you are probing into each phase of the F-E-R cycle in a balanced way. Are you sure where you are? What are the warning signals to look for? Answering these questions could help you change your strategy or redefine—before it is too late.

Chris Zook is a Bain & Company partner who leads the firm's Global Strategy Practice and is based in Amsterdam. Ashish Singh is the managing director of Bain & Company, India and is based in New Delhi.