Wednesday, August 13, 2014

Strategic Planning Analogy #534: You’re Older Than You Feel

According to a study reported in the Psychonomic Bulletin and Review in 2006, adults tend to feel younger than their chronological age. Beginning around age 25, people start reporting a sense that they don’t feel as old as they really are.

The gap between their subjective and chronological age continually increases between age 25 and 40. By the time adults are 40, most adults report feeling about 20% younger than they really are. This 20% gap tends to remain for most of the remainder of their years.

So if we are “only as old as we feel,” then I guess we’re not that old.

Perception is a powerful thing. If we feel younger than we actually are, then we will act younger than perhaps we should. This could lead to foolish behavior and get us a trip to the emergency room at the hospital.

I dare say that the same phenomenon can occur in the business world. I think a lot of executives feel that their company (or business model) is not as old as it really is.

There’s this sense that maturity doesn’t apply to their business. They feel like their industry is still young and growing and that their company is still a growing youngster, too.

But let’s face it. Businesses and industries have life cycles, just like humans. They may start out young and growing, but eventually they reach maturity and then decline. You may not always feel like your company is progressing through these life stages, but it is. And it is probably further along on this path than you think.

The problem is when you manage your company based on the way you feel about its age rather than what its age really is. Each stage of a business’ life requires a different type of strategy. If your company has reached maturity and you still feel like you are in your growth phase, you will be using the wrong strategy. And just as adults when not acting their chronological age can do foolish things that get them into the hospital, managers who do not manage to their business’ actual life stage age can get their companies into serious difficulties.

The principle here is that although the growth phase of an industry may appear to be the most fun and most desirable, the truth of the matter is that in most mature economies, most of the industries are mature as well. Therefore, most of us should be focusing on mature industry strategies.

IBIS World Data
This was really brought home to me when I was looking at a report produced by IBIS World. IBIS World produces reports on a wide variety of industries. To give a perspective, each report shows where that industry fits on the industry life cycle. They do this with a comparative scatter plot showing where about 700 industries fit on the life cycle path. I’ve put a sample of one of these charts in this blog.

As you can see in this chart, the largest number of industry dots are in the mature phase. And although the later growth phase gets the next largest number of dots, the decline phase is not all that far behind. Early growth has the fewest number of dots.

This chart shows just how old most industries are. Mature and decline together dominate the landscape.

The Disconnect
Yet when one looks at business literature and strategic discussions, it seems that the topic of growth dominates. There appears to be a disconnect between the reality of maturity and the desire to act as if maturity has not yet occurred.  Just as our society is preoccupied with youth culture, our businesses are preoccupied with younger business stages.

We may feel younger, but the disconnect between that perception and reality can get us in trouble. Talking like we are in the growth phase or acting like we are in the growth phase does not alter the reality that for many of you, you are already in the mature or declining phase. And by not acting your age, you could be doing your business a disservice.

The Downside of Not Acting Your Age
Here is a list of the major negative consequences from managing to growth when you should be managing for maturity.

1.     Overinvesting in the industry: Because you over-estimate the growth and life expectancy of your industry, you tend to value investment opportunities within the industry as higher than they really are.  This leads to paying too much for bad deals. Hence, you destroy value by overinvesting in areas where the returns will never cover the cost of capital.

2.     Working too hard to grow the top line: If you think there’s still a lot of growth in the industry, then you will have high expectations for what your own growth should be within that industry. However, in maturity, those high growth expectations may be quite unrealistic. Therefore, the only way to hit those high sales goals is to start a price war rampage in order to steal sales from the other mature competitors. This destroys the profit margin for you and the entire industry. If competitors follow your downward pricing, you may not end up with any additional business—just lower margins. But even if competition does not follow you in this downward spiral and you get some of their sales, you may still end up as less profitable because of how you destroyed the margins in order to get the business.

3.     Under-investing in future business models:  If you think there is still a lot of growth and vitality in the current business, then you will see little incentive to investigate or invest in the next big thing that will make your status quo obsolete. The problem is that your business model’s obsolescence is probably a lot closer than you think. By ignoring that, you will be unprepared for when that day comes. You will end up like Kodak, who saw their entire world fall apart because they delayed making the transition from analog film to digital imaging until it was too late. For more on Kodak, look here.

So, as you can see, acting as if your business is younger than it really is is not a small issue. At best, it will cause you to destroy value. At worst it will cause you to destroy the company.

A Better Approach
To avoid these negative consequences, consider the following:

1.     Continually monitor your life cycle using objective tools: Don’t rely on your feelings. They can deceive you. Use objective tools to monitor your path through the business life cycles.

2.     Act Your Age: If you are in maturity, then use the appropriate strategies for maturity such as:

a.      Moving the focus from top-line growth to process efficiency and cost control.
b.     Focus on reaping the maximum return from prior industry investments rather than creating new ones.
c.      Consider shifting emphasis to pockets where maturity is further away, such as emerging nations.
d.     Examine the relative merits of consolidating the industry versus selling out to someone else who wants to consolidate the industry.
e.      Invest in the next big thing that will replace the status quo.

I love what I see in the packaged food industry. P&G realized that its corporate culture and business model were optimized for growth industries. P&G also realized that its food products portfolio had moved on to maturity. Therefore, it sold its mature food businesses to other companies, like Pinnacle Foods. It was a win-win. It freed up money so that P&G could invest in growing industries like health and beauty. And, since Pinnacle Foods has a corporate culture designed to excel in mature businesses, the food businesses were under better management.

In fact, it worked so well that P&G is considering a more massive divestiture of brands.

The business world is a dynamic place, where new business models replace the old. As a result, businesses do not stay in the growth phase forever. Maturity and decline occur. Unfortunately, many business leaders think their business model is younger than it really is. This leads them to manage for growth when they should be managing for maturity. By using the wrong strategies (growth strategies instead of mature strategies), these leaders destroy value. The better move is to align your strategy with the reality of where your business model lies in its life cycle.

You can use this disconnect to your advantage. If you know that your business is in maturity or decline and someone else still thinks it is in its growth phase, you can sell your business to them for more than you think it is worth.

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