It’s harder to stay on top than to get there. For every Apple, there is an Atari, for every Fuji a Polaroid, and for every Zara an American Apparel. How can you avoid the seemingly inevitable and remain a profitably growing “evergreen corporation” that stays on top?
In today’s dynamic business environment, leaders of large established companies need more than ever to run and reinvent the business at the same time. This requires applying different approaches to strategy and execution in different parts of their business, as well as constantly re-balancing exploitation (generating cash to support growth) and exploration (finding winning products and models). We (and many others) call this elusive capacity “ambidexterity.” Only few firms manage to be ambidextrous—most struggle to maintain a healthy balance between exploration and exploitation. This can be deadly: corporate mortality has never been higher than today.
Our research shows that U.S. firms
more than ever to maintain this balance and in particular to maintain exploration as they grow and mature. This can be quantified by analyzing the extent to which the share prices of S&P 500 firms are driven by a firm’s present value of future growth options (PVGO) rather than cash flow from current operations. In the last 10 years, firms’ degree of exploration has decreased by 7% points—larger firms are even more affected with a 10%-point reduction. Among these large firms, it’s especially true of the older ones. In other words: Not Amazon and Google, but IBM and recently even Apple. This overall decline represents an enormous loss in future option value. Investors now value the future growth options of these firms relatively less—by a staggering $1 trillion.
To be clear, this tendency to focus on exploitation and not exploration may even be welcomed by some investors who value predictable short-term returns from reduced costs and investments, increasing dividends and share buybacks. And managers focused on immediate total shareholder returns may be delighted with high performance. The path towards over-exploitation and its implications are illustrated in the chart below.
Companies in the success trap over-exploit their current business models and fail to renew or grow future growth options. This has long term consequences: these “exploiters” significantly underperform their exploratory peers. The difference is substantial: “Explorers” grow faster, with 5.7%-points higher sales growth (including M&A) and also deliver higher long term total shareholder returns of up to 2.4%-points p.a., over a 10 year horizon.
Not all firms fall into this trap. Young companies necessarily have to balance exploration and a healthy amount of exploitation in order to survive and thrive. Some firms manage to maintain this dual discipline as they grow. Amazon and Google are examples of companies known for their sustained exploratory drive, while also focusing relentlessly on operational efficiency and commercial excellence.
Unfortunately, these firms are rare—most follow a path towards lower exploration and risk falling into the success trap. Why does this happen to large companies with a legacy of success? Paradoxically, doing so often seems like the right choice. Fine-tuning the established, successful model provides higher immediate rewards at low risk. Over a five-year period, one in three companies makes that mistake. This comes at the cost of lower growth, which jeopardizes the company’s future. Fast forward a few years, and lower growth means fewer interactions with new, demanding customer groups and less inspiration to innovate. Eventually the company is likely to be out of touch with changing market requirements. At that point, it is often too late to course-correct. Once in the trap, it is difficult to escape: seven out of ten fail to leave it in the next five years and get back onto the path of higher exploration.
What can companies do to avoid the tendency to over-exploit today’s success and under-explore new avenues for growth? Five steps can help:
1. Adopt the right approach to strategy and execution in each part of the business. Your strategy needs a strategy. Companies need to apply the right approach to strategy and execution in each part of their business. For many companies, this means extending their repertoire beyond the classical approach to strategy that relies on securing durable advantaged market positions through cost leadership or differentiation. This is easier said than done. In order to execute effective strategies for unpredictable and malleable environments, companies need to build new adaptive and shaping capabilities.
2. Cultivate adaptive capability. Unpredictable environments require adaptation. Big firms need to reduce their excessive reliance on planning, prediction, and precision and instead learn the art of disciplined experimentation through cycles of “vary, select, and amplify.” Tata Consulting Services, an IT service provider, is an excellent example of a large company which runs such an adaptive approach to strategy.
3. Cultivate shaping capability. Scale should help build influence in highly malleable environments. Apple succeeded in forging the initial ground-breaking deals with the five major record labels in 2002 which underpinned its disruptive business model, thanks to its large user base and its technological credibility. Leaders of large firms need to recognize this potential influence advantage and use it to reshape their industries and collaborative ecosystems.
4. Cultivate ambidexterity. Executing the right approaches to strategy is not enough. Big companies need to constantly calibrate the balance of different strategic approaches across their various businesses. In particular they need to maintain exploratory activity. This can start by creating exploratory metrics and incentives. (3M owes part of its innovative success to the “new product vitality index.”) It is also helpful to stop averaging performance contracts across businesses (Pfizer steers its two largest businesses separately, with different strategic approaches, mandates and corporate cultures).
This variety can be hard to contain under the same roof. Google’s recent reorganization into Alphabet now clearly separates the mature search business from exploratory units such as GoogleX. PayPal/eBay went even further by splitting the entire company.
In more complex and dynamic businesses, self-organizing approaches may be needed. Alibaba employs self-steering teams to continuously rematch its business to market conditions via co-creation sessions with customers. This continuous re-matching of business models to market requirements coupled with local autonomy has helped Alibaba build its leading position in Chinese e-commerce.
5. Animate the resulting collage of strategy approaches. The journey towards an ambidextrous organization starts with its leaders. To overcome an organization’s natural tendency to lock in successful strategies, leaders must maintain a state of artful disequilibrium. This can be achieved by building a leadership team that is collectively committed to the health of the overall portfolio, rather than a set of champions for individual businesses. It also requires communicating the contradictory requirements of exploration and exploitation. Peter Hancock, CEO of AIG, told us: “I always hear, ‘You’re giving me mixed messages.’ I say, ‘You’re a leader—you’re paid to deliver mixed messages!’”
The search for the “evergreen corporation” is ever-elusive—we do not claim to have found the answer. Still, companies that take these five imperatives to heart are more likely to avoid over-dependence on past success and survive to actively shape their future.