In 1996, Harvard’s Michael Porter penned a classic essay in Harvard Business Review titled “What Is Strategy?”. It was an exceptionally clear-headed explanation of a complex topic.
The framing example in the piece was the beautiful simplicity of Southwest Airlines’ business model — serving only secondary airports, with no travel agents, no assigned seating, and one type of plane. This strategic alignment enabled Southwest to be both the largest and by far the most profitable US airline.
So it might come as a bit of a shock to see Southwest’s announcement yesterday that it is buying low-cost rival Airtran, a firm with several strategic differences to Southwest — it is oriented around hubs, serves international destinations, and has a business class. The shock might be compounded by the fact that on the same day another former champion of business model simplicity, Wal-Mart, announced its take-over of South Africa’s third-largest retailer, Massmart. That company is also a low-cost retailer, but as the saying goes “retail is detail” and the firms diverge substantially in many ways. Wal-Mart had already gone a considerable distance toward diversification, and this move pushes the company further away from its Bentonville roots.
In reality, the story of Southwest and Wal-Mart is typical of successful firms — there is a business model lifecycle. Companies gain traction in a market niche. If the market is new, entrepreneurial firms have a chance of beating older competitors and becoming giants in their own right. After a while the market becomes more penetrated and it is harder to sustain growth, so firms reach for new sources of growth. Eventually the Ford Motor Company tapped out the Model-T’s potential and diversified its product line. IBM dominated mainframes and had to look elsewhere. Southwest and Wal-Mart are following in big footsteps as their lifecycle continues to mature.
As business models become more complex there is ample opportunity to destroy the simple core and hinder the growth of the new. Companies often ignore how mindsets, management practices, external partners and much else needs to change between old and new markets. Oftentimes consultants will recommend separating the business units as much as possible to maximize the simplicity of business models.
The recommendation is alluring but often impractical. The whole reason why Southwest and Wal-Mart are good owners for their targets lies in the potential of integrating several key functions, such as purchasing and IT. Moreover, the only person able to make the decision for radical separation is usually the CEO, and in the case of small, nascent markets she may be unwilling to take a step that will increase her workload, ruffle many feathers, and bypass well-proven mechanisms of corporate governance. Therefore the more common path for firms is a complex mix of separation and integration, with appropriate control systems, processes, metrics, incentives, and so forth. This is challenging to execute well, but nonetheless it is often the most practical option.
The complexity of the firm’s business model facing the outside world is then mirrored by the company’s complicated internal operations. Some companies never pull off this feat, so the business model lifecycle ends in takeover or worse. But for those who triumph — IBM, HSBC, and many others — the complexity creates big advantages over more narrowly-focused rivals.
Story by Steve Wunker.