ADJACENT BUSINESSES — 6 FACTORS IMPACTING STRETCH STRATEGY

By: New Markets Advisors
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The allure is undeniable. For companies with stagnating core businesses, it is tempting to stretch into new markets to invigorate growth. Stretch strategy has worked for high-tech titans such as Google, Apple, and Cisco, and also for firms in more prosaic industries such as BMW, Whirlpool, and UnitedHealth.

Yet there are also countless examples of moves into adjacent businesses going awry. How can companies assess their strengths and odds of success?

From a strategic perspective, six factors — in rough order of attractiveness — impact whether firms should consider moves into adjacent businesses:

• Value migration — New markets can offer avenues for profitable growth that are simply unattainable in the core. Apple recognized that mobile phone manufacturers had too narrowly construed their market space, and that the money would flow not to the superior hardware maker but to the company that could offer the most seamless and intuitive experience of software and services. While some mobile networks tried staking out this territory first (witness the mountains of cash Vodafone pushed into services such as Live!), Apple was the first company to cross the threshold of “good enough” performance to change consumer behavior en masse. Nokia — for all its excellence in hardware design, production, and distribution — has still not caught up, and its traditional strengths matter less and less in the fast-growing smartphone business. Today Apple commands only about 4% of unit volume in worldwide cellphone shipments, but a massive 50% of the profits. Had Nokia, Vodafone, or other incumbents moved more effectively into this new world, they would be vastly more valuable companies today.
• Ecosystem — Some businesses benefit from a corporate parent that can plug the new venture into an ecosystem of supporting offerings. Cisco is aggressively targeting corporate PBX systems with an Internet Protocol-based solution that meshes with its data-centric networking equipment. The company’s “Unified Communications” offers IT managers a safe and cost-effective option that turbo-charges disruption of the decades-old PBX industry. For Cisco, this was a growth opportunity waiting to be reaped. It also further entrenches its core networking business into corporate IT departments.
• Distribution — Where distribution networks are valuable assets (e.g. in emerging markets, or in fast-turn industries such as dairy or snack foods), an incumbent’s distribution can make all the difference to a new venture. If distribution is the primary advantage an incumbent has, it might consider whether an “open innovation” strategy of leveraging outsiders’ bright ideas might build impact fastest.
• Fixed costs — A poorer reason to move into adjacencies is to leverage fixed costs, such as a factory that is producing under its capacity. The danger of this strategy is that it can be so company-centric and inflexible, whereas successful ventures in new markets are customer-centric and eminently flexible.
• Brand — Valuable brands with lackluster growth provide tempting targets for stretch. Be wary. Starbucks’ recent push into the grocery aisle is an intriguing growth opportunity, but also poses dangers of diluting a brand that has been built around an experience, not a flavor. As Clayton Christensen has profiled, some of the most valuable brands are “purpose brands,” not “endorser brands.” If a brand is associated with getting a job done, like Clorox is for disinfecting, then it makes good sense to stretch the brand into new activities associated with that job. If a brand is associated with a product, like Starbucks is with coffee, then it will face stiff competition from more entrenched product-linked brands.
• Expertise — Companies can over-rate the uniqueness of their expertise, and therefore the advantage they have in using that knowledge in new businesses. Moreover, their expertise may be less transferable than they think. Disney thought it had mastered “magic” and media, so it acquired an Internet portal named “Go” in 1998. Go had been one of the largest web-based chat networks, which could have made it a strong contender in the soon-to-emerge world of social media. Instead, Disney used its expertise to reposition Go as a media outlet and search engine. That did not go well.

Adjacent businesses offering new markets are a powerful way to grow, but they must be handled with care. When considering a stretch strategy, ask questions such as:

• What makes us uniquely positioned to win?
• How would the adjacent businesses impact the core?
• How will the profit formula in the new market look different from our core business?
• How big an impact would failure make? In an industry like insurance, the losses in a new market might vastly exceed the money invested in the venture. In an industry where products are licensed, failure will cost much less.
• How loosely can we govern this new venture while managing the biggest risks? Start out by thinking about the opportunity as an entrepreneur, and then layer on only as many restrictions as are absolutely necessary.

Don’t be half-pregnant. While the adjacent businesses must be funded cautiously, much as a venture capitalist would, give them the latitude they need to compete vs. the start-ups who will inevitably be rivals.

Above all, stay mindful of why your company makes the best corporate parent for the new venture. Adjacencies are excellent avenues for new growth, but drive with open eyes.

Story by Steve Wunker.