Growth Choices: Which Business Units Offer the Greatest Potential?
The lyrics to The Gambler focus on choices: “Know when to hold ’em, know when to fold ’em.” For most businesses, identifying the best choices 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 our scarce investment resources? Correctly answering that question can ensure that goals are realized and shareholders are rewarded.
It is always a challenge to accurately assess the growth potential that exists across a firm’s various business units and market segments. But it is a challenge that must be addressed, given the reality of scarce resources for investment and the need to spotlight the initiatives that on which management should focus its attention. 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 the leaders of the business feel that they are in fact gamblers.
A process for gaining such insights involves looking at factors that characterize the market environment in which a business unit operates and at other factors that characterize the strength of the position held by that business unit vis-à-vis its competitors. In the sections below, this process is outlined, including a high-level approach to assessment that can help to identify those business units or market segments that have the strongest potential to yield success.
Three factors that reflect Market Considerations – Headroom, Market Growth, and Margin Improvement Opportunities – can be assessed across a firm’s business units or across the market segments in which it participates. In working with a variety of firms, there have been sharp differences across their business units and market segments along all of these dimensions.
The Headroom metric emphasizes the extent to which the market in which the firm participates offers sufficient room for growth. With respect to Headroom, the favorable end of the spectrum involves instances in which the existing business, defined in terms of both customers (and nearby prospects) and products, offers sufficient room for growth, while the less favorable end involves situations in which significant diversification or new business models are required.
Assessing the available headroom for growth must be done carefully. In all but a few exceptional circumstances in which 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 U.S. Presidential elections. Over and over, we 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. In one application in the medical equipment market, while the business unit for which the assessment was done only had a modest market share, between situations involving long-term contracts and others involving “committed customers,” the available headroom in the coming year was only about a tenth of the overall market.
Market Growth is the second key factor to assess. It is always a major plus to be selling into growth, rather than having to battle to take share from existing suppliers. The most favorable indicator of solid growth potential is when market growth is at or above the growth rates goals of the business unit. Slightly less favorable, 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 existing 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 quickly say there is sufficient market growth if they include growth from 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 time frame of the assessment is also relevant in this regard; success in even truly adjacent markets rarely comes overnight.
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 along this dimension. Excess capacity, ease of entry of competitors with look-alike products, troubled markets, and distant arms-length relationships with customers are characteristics of the other, unfavorable, end of the spectrum.
But it is not only the intensity of pricing pressures that enters into this calculation. 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, and other factors. Another factor is the extent to which customers’ purchase decisions swing quickly in respond to price changes. Situations in which customers involve dual source supply relationships often result in such swings. Vulnerability to purchased commodity price swings is a third factor defining the importance of pricing to a firm.
The best circumstance is one in which there is low intensity of pricing pressures and pricing is only of limited importance to the firm’s profitability. In such instances, the firm has many options available to it (including raising prices), and can select from among them those that are most likely to foster long-term profitable growth. The worst situation in 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 with respect to Purchase Decision Factors involves the match (or lack of it) between a business unit’s competitive strengths and the factors that are top on the list in terms of customers’ purchase decisions. If the customers in a business unit’s market are focused on price, then a cost advantage is a critical determinant of a firm’s growth prospects. If the customers are focused on technology and looking for leading-edge products, then advantages along those dimensions will be critical to success.
Most markets are made up of multiple niches, with, for example, some customers focusing on price, others on product leadership, and others perhaps on service offerings. In the assessment of a business unit’s positioning in terms of Purchase Decision Factors, the sizes of each of those segments comes into consideration. A firm that is well positioned in terms of product leadership cannot claim strength in terms of this factor if the segment in which product leadership matters is only a small niche.
The Short-Term Fit assessment involves such factors as 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 first mover advantages of firms that are ahead in technology and product development are seen over and over in market after market.
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 which a firm has to make changes to its existing business model. Avoiding such challenges is an important factor in quickly getting to market. Strong major customer relationships are a similarly important factor enabling early success, with firms that can draw upon strong and trusting relationships to gain sales and “reference successes” likely to be the ones that succeed in other markets as well. And the quality of the match between a new product and customers’ installed base is always a factor determining acceptance.
Evaluation of Business Drivers not only focuses on whether a business unit’s offer addresses the key forces motivating customer interest and solving the problems that are keeping them awake at night, but also whether prospective changes on the horizon work for or against your position. Over and over, disappointments in terms of product development are linked to a mismatch in this regard. Knowing the unmet or poorly met needs of customers is critical to success, and growth potential is highest when initiatives match well to the needs highest on such lists.
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. A solid assessment of plausible future scenarios and scoring of the degree to which such changes are positive or negative is an important element of the process. 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
The previous sections of this paper have defined six metrics, three involving Market Considerations and three involving Positioning Considerations, which can be used to evaluate the relative growth potential of a firm’s business units or of the segments in which it operates. Accurate assessment along each of these dimensions is complex and involves many considerations, as described above. Without reflecting all of that dimensionality, the table below provides a quick summary of the assessment themes and a short statement defining the characteristics of assessments that suggest Low, Average, or Strong Potential for growth:
The earlier sections went into considerable depth about the many dimensions relevant to the assessment of each of the six factors included in this table, and the short summary statements in the table are, at best, quick tests as to whether the evaluation of a business unit’s potential along each dimension is a reasonable one or not. But unless the leadership team doing the assessment can say that the statement in the table is a fair and accurate summary, it should go back to the drawing board and look carefully at the detailed considerations that have been defined in the earlier sections of this article.
One the lessons that has emerged from applications of 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. If there are dimensions along which the assessment for a business unit or market segment identifies negative elements, these must be taken very seriously, as they are more likely than not to thwart growth aspirations. 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 that enter into the assessment of growth potential, much as a gambler can change some of the cards in his or her hand. A focus on shortcomings that identifies action plans to remedy them can transform a business’ potential favorably.
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 and for attention to the factors that are inhibiting the growth potential of other units or segments.
Author: George F. Brown, Jr.
1. See George F. Brown, Jr., How Real Are Those Price Pressures?, Business Excellence, March/April 2011.
2. See George F. Brown, Jr., You Know It Ain’t Easy, Business Excellence, September 2011.
3. See George F. Brown, Jr. and Atlee Valentine Pope, Best-in-Class Behaviors in Business-to-Business Relationships, Blue Canyon Partners, Inc., © 2007.
4. See George F. Brown, Jr., They Only Had One Pig, iP FrontLine, September 2012.