Analyzing a global trend

The complex nature of long-term global trends and the way they interact make it challenging for executives to analyze their impact on a company's profitability over the long term. But that complexity makes it all the more important for companies to get to grips with their business environment.

Take, for instance, one of our ten trends: increasingly tight constraints on the supply and use of natural resources, or as your morning newspaper might put it for a particular resource, "Oil price hits new all-time high." Not surprisingly, fully 88 percent of the executives at energy companies and 69 percent of those at manufacturing ones expect this trend to be important or very important for the profitability of their businesses. But across industries, only 40 percent of our respondents agree, though 71 percent view this trend as important to global business overall. Fewer still—30 percent—say that their companies are preparing for shortages or steep increases in the price of raw materials.

We believe that many companies have yet to consider the full range of this trend's subtrends: for instance, water is increasingly scarce, global fisheries are reaching a crisis point, and deforestation threatens to cause more than just economic harm. Moreover, as these ripples spread, even companies that don't seem to be affected in the near term must analyze each development's real impact on their industries, geographies, and business units. The analysis should include the effect on products, processes, customers, competitors, and employees.

Executives should consider the opportunities and risks these subtrends pose. Can companies that know all about the demand for and supply of minerals use these insights in the trading markets? Will the large-scale shipping of water become economically viable for the cargo industry? Will biotechnology companies change the game with crops that require less water or trees that grow much faster than today's?

Corporate leaders must understand how trends interact as well. Auto manufacturers, for instance, should view the trend of booming markets in developing economies through the lens of another: constrained energy resources and increasing concern about pollution. What are the likely implications when hundreds of millions of Indian and Chinese consumers buy cars for the first time? Automakers face a series of challenges: designing energy-efficient cars that are cheap to buy and drive and don't put intolerable pressure on the environment.

To ride the coming waves of global forces, a company must prepare by undertaking a comprehensive longer-range analysis of the external environment. The analysis should go well beyond a superficial scan of global issues not only to build a detailed understanding of the trends and how they will affect the company but also to facilitate open dialogue within the top team about what the future will bring. In addition, the company should regularly review and update this aligned view of the future; only then can it identify growth opportunities, plan for economic discontinuities and risks, and make the big bets necessary to capture the most rewarding opportunities.

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Keep shifting portfolios

To determine the financial impact of broad global trends, a company must sift through their second- and third-order effects even as unanticipated new business models and other hybrid species sprout up and change the competitive landscape. Our research on growth in large companies highlights the importance of analyzing changing competitive factors at the most detailed level (industry, subindustry, geography) and in their most elemental form (the specific trends and subtrends that not only create opportunities and risks but also drive competition at each level). Only in this way can companies obtain insights into the way these factors will affect their future growth and profitability. By unearthing the follow-on effects of trends such as consolidation, regulatory change, the rise of attacker business models, and specific shifts in the needs or power of customers, executives can better move the portfolios of their companies toward segments and markets with favorable prospects.

Our research bears out this point. We analyzed the top-line growth of more than 150 large companies from 1999 to 2004 and tested how closely their organic growth correlated with their mix of businesses. The broadest classifications of portfolios, such as "consumer discretionary," weren't at all useful in explaining the different growth rates of companies. Classifying business portfolios more tightly into 140 subsectors (such as beverages and packaged foods) made it possible to explain about 35 percent of the variance in organic growth across companies. Finally, when we went as far as the reported data allowed—analyzing business segments by geography (for example, ice cream and frozen desserts in Asia)—we explained 60 percent of the variance. Similar results hold for differences in profitability.

What can companies do if they aren't lucky enough to hold legacy portfolios aligned with favorable trends? Quite a lot, it turns out. Our research suggests that strong growth and profits often result from intensive changes in the portfolio mix through M&A, the creation of new businesses, or the radical reallocation of budgets. In fact, significant changes to the portfolio occurred in two out of three companies that, over five years, increased their revenues at a pace faster than the growth of GDP and gave their shareholders total returns that outperformed global stock indexes. (We define a significant change as one of at least 15 percent in the distribution of total revenues over a company's business segments and geographies.) In contrast, almost two out of three companies that failed to expand at a pace faster than the growth of GDP hadn't shifted their portfolios in this way.

So it seems that many profitable growth companies not only know about the trends in their markets but also act on the way those trends play out at the microlevel.

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Planning for change

Few executives would deny that good strategic planning can help companies find new growth opportunities and evaluate what they should add to or subtract from the corporate portfolio of businesses. Yet when we talked with managers at a score of major companies, most of these people ruefully admitted that the formal strategic-planning process was optimized to maintain and develop the core business through activities such as budgeting, driving incremental growth, and aligning management with short-term financial targets. Other strategic objectives received haphazard treatment, if any.

This kind of strategic-planning process usually drives the performance of the core business effectively. Yet it isn't very efficient. Often, a nine-month planning cycle involving a huge amount of work merely generates a budget that more or less reflects the size of each business unit, with incremental growth expectations layered on top.

We believe that companies can shorten and streamline this formal planning process and thereby allow executives to focus on developing strategies. Companies should reach for these goals through tailored ancillary processes removed from the annual planning exercise and its immersion in the financial and operational details of current businesses. To design such processes, a company should determine which strategic objectives are the most important ones for its own purposes, given the composition of its portfolio and the specific attributes of its industry. One important goal should be to develop and review corporate strategies in a regular rhythm—the better to combat the tendency, revealed by our research, to make most decisions involving major mergers, acquisitions, and divestures in an ad hoc or opportunistic way.

Companies can make a good start by studying what some of them already do. One pharmaceutical company, for instance, established a new function for strategic initiatives to pursue growth beyond the core business. Planners generated a portfolio of ideas in a series of off-site meetings and vetted them with the company's top 100 managers. A strategic-initiative team then explored in detail the business viability of each idea in the queue—typically looking at two or three in parallel—and gave the appropriate business units the best ones to commercialize.

A large multibusiness company implemented a biannual corporate-portfolio review process to ascertain which businesses had an upside for growth and which should be divested to free capital for investment in new growth areas. To help liberate corporate managers from the business-as-usual mind-set of financial and operational planning, the company decoupled this portfolio review from the annual planning process.

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Innovating at scale

For a $20 billion company the required scale of any innovation and the impact it must achieve are staggering. Top managers know that unlike the leaders of a start-up, they can't bet the company on a single breakthrough. What's more, a large company's need to produce near-term results in its core business often seems to be in conflict with its need to innovate for tomorrow.

Yet there is also an upside. Many big corporations haven't yet fully used scale to transform promising ideas into innovations whose value can be amplified by their diffusion among a number of customer and product segments. To seize this opportunity, large companies must overcome two prevalent beliefs: that innovation takes resources away from the core business and that it requires an entrepreneurial culture, which flourishes only in smaller and younger companies. In fact, we would argue that far from being in conflict with innovation, a large company's core business and assets can be used as stepping-stones to innovate with an impact that smaller companies can only dream of.

Innovating at this level begins with an understanding of a large organization's scale advantages. Substantial tangible assets such as technology and human and financial capital can serve as powerful complements to the diversity and reach of brands, knowledge, and other intangibles. Large companies can also bear and manage risk as well as place a number of different bets. Companies should evaluate such assets and identify those that can collectively amplify the value of innovation and, at times, both serve the core business and provide new growth opportunities.

Scale assets can, for example, extend the reach of an innovation beyond immediately addressable core segments. Consider Motorola's successful RAZR mobile phone, which set a new standard in ultrathin handsets. This breakthrough parlays corporate engineering and design assets that can be reapplied under the Motorola brand in other market segments (such as smartphones, which handle a number of applications) where design is a key competitive factor.

Large companies can also use their assets to broaden their sources of innovation. P&G, for example, realized that it couldn't meet its growth objectives solely through internal product development. The company therefore decided to draw on resources (such as global brands, patents, and relationships with suppliers, retailers, consumers, and regulators) in order to set up and widely publicize "open-innovation" networks, where scientists share intellectual-property agreements. Along the same lines, it has also encouraged start-ups with ideas for new products to bring them to P&G. It then uses its brand, marketing skills, supplier networks, and other relationships to diffuse these innovations through various market segments and new products. Each participant benefits as the network grows.

Identifying scale advantages and applying them to innovation isn't easy. But for companies that overcome the obstacles, innovation can be worth more than just the sum of its parts.

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