Which aspects of your business offer the greatest growth potential? A systematic approach to making this judgement can help leaders feel less like gamblers.
The lyrics to The Gambler focus on choices: “Know when to hold ‘em, know when to fold ‘em”. For most businesses, identifying the best choice is among the most critical contributions of their planning process. Which business units or market segments or innovation concepts offer the greatest potential for profitable growth, and therefore represent the best use of scarce investment resources?
It’s always a challenge to assess accurately the growth potential that exists across a firm’s various business units and market segments. Peter Drucker once observed “Whenever you see a successful business, someone once made a courageous decision.”Placing bets as to where growth can be realized will always require a bit of courage, but a systematic approach to assessing growth potential can yield insights that clarify choices and lessen the extent to which business leaders feel like gamblers.
A process for gaining these insights involves looking at the market environment and other factors that characterize the position held by the business unit vis-à-vis its competitors.
Three factors that reflect market considerations – headroom, market growth, and margin improvement opportunities – can be assessed across a firm’s business units or market segments.
The headroom metric emphasizes the extent to which the market offers sufficient room for growth. The favourable end of the spectrum involves instances in which the existing business offers sufficient room for growth, while the less favourable end involves situations in which significant diversification or new business models are required.
When a business owns a commanding market share, a first pass look will always say there is sufficient room for growth, but that look can be misleading. The more appropriate approach is suggested by an analogy drawn from the recent US Presidential elections. We frequently heard about states that were “solid red” or “solid blue”, ones that were virtually certain to be in the camp of one candidate or the other. The same is true of markets and customers. An accurate assessment of headroom must look for the equivalent of “swing states”, those which could realistically be won by the business unit in question.
Market growth is the second key factor to assess. It is always a major plus to be selling into growth, rather than having to take share from existing suppliers. The most favourable indicator of solid growth potential is when market growth is at or above the growth rate goals of the business unit. Slightly less favourable, but still attractive, are those situations in which a unit’s growth goals can be realized by capturing a larger-than-normal share of the growth increment in the markets in which it participates. The most challenging situation involves a requirement that business be taken from competitors in order to realize growth goals.
Part of the assessment of market growth involves looking at not only currently-served markets, but also those that are viewed as nearby or adjacent. Most western firms can identify market growth if they include emerging markets like China and India. Less extreme, but equally frequent, are assessments that identify adjacent vertical markets or product line extensions that offer meaningful growth increments. Including such additional markets in the assessment of growth potential can be quite misleading, and should only be done if there is truly a base upon which to build and if movement into such nearby or adjacent markets can be done without a significant shift in the business models operating within the firm.
The third factor in this cluster focuses on margin improvement opportunities, which are closely linked to the intensity of pricing pressures. Capacity balance, barriers to entry, healthy markets, and strong customer relationships are the factors that yield positive scores in this dimension. Excess capacity, ease of entry for competitors with look-alike products, troubled markets, and distant arms-length relationships with customers are characteristics of the unfavourable end of the spectrum.
Also relevant is the importance of pricing to the success of the business unit being evaluated. There are several factors that define how important pricing is to a business. One is the degree to which profit swings are dictated by pricing, instead of being driven by volume, productivity, cost management, etc. Another factor is the extent to which customers’ purchase decisions swing quickly in respond to price changes. Situations in which customers use dual source supply relationships often result in such swings. Vulnerability to commodity price swings is a third factor defining the importance of pricing.
The best circumstance is one where there is low intensity of pricing pressures and pricing is only of limited importance to the firm’s profitability. In this instance the firm has many options available and can select those that are most likely to foster long-term profitable growth. The worst situation is one in which intense pricing pressures are combined with a high importance of price as the main determinant of success.
A second set of factors focuses on positioning vis-à-vis the competition. Here, once again, there are three factors that can be assessed: purchase decision factors, short-term fit, and business drivers. There are market factors that affect all three of these metrics, but the most important aspect of the assessment is the comparison of a business unit’s position to that of its competitors.
The quality of positioning involves the match (or lack of it) between a business unit’s competitive strengths and the top factors that affect customers’ purchase decisions. If customers are focused on price, then a cost advantage is critical to a firm’s growth prospects. If customers are focused on technology and leading-edge products, then advantages along those dimensions will be more important.
Most markets are made up of multiple niches, with some customers focusing on price, others on product leadership, and others perhaps on service offerings. In assessing a business unit’s position in terms of purchase decision factors, therefore, a firm that is well positioned in product leadership cannot claim strength in this factor if product leadership in this segment is only a small niche factor.
The short-term fit assessment involves first-mover advantages, sales model and channel advantages, major customer relationships, and the relevance of the installed base. While choices as to growth priorities shouldn’t focus on the potential for quick successes alone, gaining a head start on the competition can be a factor contributing to long-term success.
The other elements of this assessment involve different short-term considerations. The focus on sales model and channel advantages reflects the challenges that always exist when a firm has to make changes to its existing business model. Avoiding these challenges is an important factor in getting to market quickly.
There is an important future dimension to the assessment of business drivers as well. Often, short-lived successes are associated with mismatches between the offer brought to the market and changes that take place in the business environment. The best growth choices are those that remain relevant and deliver value to customers under all of the likely scenarios that define the future business environment.
Assessing growth potential
We have defined six metrics, three involving market considerations and three involving positioning considerations, which can be used to evaluate the relative growth potential of business units or the segments in which they operate. Accurate assessment along each of these dimensions is complex and involves many considerations.
One of the lessons that has emerged from this process is that ‘red flags’ along any of these dimensions have to be viewed with great concern. Pluses and minuses don’t neatly average out. One executive commented that “The greatest value that came from this exercise was identifying the red flags for each of my business units. That will define my action plan priorities for 2013.”
The lyrics to The Gambler also include advice as to the importance of “knowin’ what to throw away and knowin’ what to keep”.At least over the medium term, it’s possible to change some of the factors relating to growth potential, much as a gambler can change some of the cards in his or her hand.
Being able to identify the business units or market segments where investments will yield rewards is a critical element of business planning. A systematic process of examining the relative strengths of each business unit or market segment in terms of both market considerations and positioning can allow for scarce resources to be targeted at the best opportunities.
See George F. Brown, Jr., How Real Are Those Price Pressures?, Business Excellence, March/April 2011.