Pareto is alive and well in competitive markets

Competitive markets have a habit of replicating pareto characteristics regardless of market segment or geography. That is, a small number of (Goliath) competitors hold large and commanding market shares while many smaller sized (David) emerging competitors fight out for the remaining market share. This market structure replicates frequently because of the strength of competitive advantage that often accompanies scale – whether it is depth of available resources, brand equity, positive network effects, and/or scale efficiencies in manufacturing, supply chain, sales and marketing. The market structure is further reinforced by Goliath’s incentivising the most promising Davids to join their army through merger and acquisition activity.

Despite relative advantages Goliaths continue to fall to emerging Davids

Scale advantages should and do favour Goliaths and makes life difficult for the emerging Davids to grow and prosper. However, despite the inherent advantages of scale and immense transparency in the tactics and market approaches of the emerging Davids, some Goliaths continue to fall – with some falling easier and landing harder than others. A key focus of this article is addressing how Goliaths can improve their resilience and compete more effectively with emerging companies by adapting their strategy, organisational structures, business processes, and performance metrics for different growth horizons in their portfolios.

Davids bring advantage in speed, nimbleness and risk-taking 

What Davids may lose in scale, they compensate by having speed, nimbleness, and risk-taking. There are good reasons why these attributes are more challenging for larger companies to replicate as increased scale can easily lead to increased organisational complexity. The most obvious is the human aspect of achieving alignment of purpose amongst larger and more diverse leadership teams that are often operating in an underlying culture of consensus decision-making. Other factors include rigid budgeting processes that makes reallocation of resources in response to change more challenging. Risk-taking is also more difficult as Goliath’s juggle the added risk of embracing the new, while potentially cannibalising the current.

Performance metrics can constrain the fighting ability of Goliath’s

However, a less talked about (and maybe less obvious) impact on the fighting ability of Goliaths – particularly in times of change and market disruption – is the role of performance metrics. There are two metrics that have disproportionate side-effects relative to their underlying intent. The first metric is Return on Net Assets (RONA) which is a metric to determine how effective capital already entrusted in the company is being deployed and delivering a return for shareholders. The second metric is Internal Rate of Return (IRR) that provides an indication of how attractive further capital investment could be, should capital markets allocate more capital to the company in the future. Both metrics are ratio’s and, like any ratio, improvement can be achieved by increasing the numerator or decreasing the denominator.

Incentives are driving Goliath managers to choices that leaves them susceptible to disruption

The challenge for Goliath management teams is that by delivering improvement on these ratios they inadvertently reduce their defenses against emerging and disruptive Davids. In meeting the capital return expectation of shareholders, while also delivering on their annual personal performance incentives, managers are regularly faced with hard choices. Do they improve asset efficiency (i.e. improve RONA) by reducing assets through outsourcing activities, and/or allocating incremental capital to short payback projects (i.e. improve IRR) to deliver near term performance improvement in their core business? Or do they allocate capital to new business ventures that have potential to deliver larger, but more uncertain benefits over a longer time horizon? Managers’ incentives are biased strongly towards the former rather than the later choice, thereby leaving the market open to the emerging Davids to invest and deliver innovative and disruptive change for the benefit of consumers.

Thinking about business activity across three horizons can improve Goliath’s defenses

So what can Goliaths do to overcome this shortcoming? Firstly, they can start to think of their business not as one amorphous or homogeneous activity, but a portfolio that has activities working across three discrete horizons. Ideally, management can communicate business activities more discretely, either internally or externally in the context of the different horizons, thereby enabling better alignment of the appropriate strategies, management styles, performance objectives, and key measures of success for each horizon within the portfolio.

The three horizons of business activity include;

  • Performance managing the core existing businesses – the key strategic focus is ensuring the core business is generating sufficient cash to invest in growth, propelled by a healthy economic value proposition (i.e. gross margins), that is supported by a competitive cost structure. Managers in this horizon tend to hold deep functional and industry expertise and are disciplined and focused on improving measurable activity and well-defined financial metrics of performance. Their guide is the annual business operating plan and budget.
  • Scaling emerging businesses – the key strategic focus is ensuring there are emerging businesses with sufficient potential to replace the core business and that these businesses are gaining momentum in the marketplace because of targeted investment in scaling. These businesses attract managers who are comfortable working in an environment of greater ambiguity and whose entrepreneurial spirit underpins their desire to create and build something new. They value autonomy and freedom to act within a growth agenda and have the potential to create personal wealth by larger variable performance incentives or equity type participation. Their guide is a business building plan with a heavier focus on top line growth, customer acquisition and retention, and growth in market share.
  • Creating options for future business activities – the key strategic focus is thinking about industry evolution and building, nurturing, and refreshing a portfolio of ideas for reinventing or growing new business. This horizon is populated by personnel who know what it means to be a champion to a cause and are comfortable influencing with unconventional thinking. They are rewarded with the organisational space to experiment and explore in ways that satisfies their intellectual curiosity. Their guides are project plans with signposted milestones, and building option value by making tangible and measurable steps to transition the maturity of the growth options and ideas.

These activity horizons are naturally linked as ideas seeded in the third horizon are progressively advanced to testing the merits of the business model and product/market fit, that are then open to business scaling by replicating the offering, and ultimately forming part of the core business, and subject to the disciplines of performance management.

Disaggregating across the horizons can position Goliaths better to attack the advances of potentially disruptive competitors

Failure to undertake activity across all three horizons can impact the longer-term sustainability of Goliaths. If all the focus is on current performance, Goliaths risk the business running out of steam as competitors and customers change. Equally a focus on the future without securing performance in the core can lead to growth aspirations being built on weak and shaky foundations. However, by adjusting the strategy, management culture, and disaggregating key performance metrics (such as RONA and IRR) by the three horizons, Goliath’s can position themselves better to not only defend the advances of the Davids, but shift to attack and thereby leverage the full force of their immense relative scale.