Value Migration

ChaprrrL

The Challenge of Value Migration What is my company worth todaY? What will it be worth five years from now? Is my business design obsolete? What should my next business design be? What five moves will capture the next cycle of value growth in rrry industry?

Fnou 1984 ro 1994,lBMand DEC Iost $55 billion in market value, while Microsoft, Intel, EDS, and Novell were gaining $80 billion.' The reallocation of value within the computing industry was rapid and dramatic. During the same decade, the operating margin of Nucor, a steel minimill operator, was double that of the Iarge integrated steelmakers. The $5 billion market value Nucor created exceeded that of U.S. Steel, a company whose revenue was twice as great as Nucor's' Over two decades, the integrated steel producers saw their value migrate to four very different business designs, one of which was Nucor's rninimill model. '. From 1983 to 1994, while the market value of many traditional tores stagnated or declined, the value of five new retaildesigns grew by more than $100 billion. these examples constitute a pattem of mismanagement on $t scale? Hardly. They do, howevel constitute a pattern that the increasing obsolescence of traditional business designs, a pattern

ing YALIJE MIGzu.TIONSM away from increasingly outmoded

CoNCEPTS

business designs toward others that are better designed to maximize for castomers and profit for the companies.

utility

It is widely acknowledged that products go through cycles, from growth through obsolescence. It is not as dell recognized that business designs also go through cycles andreach economic obsolescence. Customer priorities-the issues that are most important to them, including and going beyond the product or service offered-have a natural tendency to change; business designs tend to stay fixed' When the mechanism that matches the company's business design to the structure of customer priorities breaks down, Value Migration begins to occur.

Value Migration and Business Design Value migrates from outmoded business designs to new ones that are better able to satisfy customers' most important priorities. A business design is the totality of how a company selects its customers, defines and differentiates its offerings, defines the tasks it will perform itself and those it will outsource, configures its resources, goes to market, creates utility for customers, and captures profit. It is the lo customers and earni -4 litY '-"y'ofi'er yProdrias, thtiY in a comprehensive system technology, but that offering is embedded of activities and relationships that represents the company's business design. Consider, for example, Nucor, a company prospering in the other-

wise "unattractive" steel industry. Nucor's primary focus has been on producing non-flat rolled steel for construction applications. Its customers demand a minimum acceptable quality level and otherwise care about only one tbjng-priu. The company built its entire business design around this central reality of its customers'priorities' The conventional explanation of Nucor's success is the use of lowcost technology and raw materials (electric ore furnaces that melt scrap steel). But this is only one element of its business design equation. The other critical components indude low-cost (rural) and flexibte (nonunion) Iabor and low overhead (a headquarters staff of 23 for a business with revenue of $3 billion). Through employing an explicit policy of reliance on external sources of technology, Nucor

in R&D and technical develophas also achieved a low-cost position

to serve a ment. All in aII, it employs a superb business design is dominated by customer group whose decision-making system price.

Themigrationofvaluecanaffectaspecificdivisionofacompany' make de company, or even a whole industry as customers whole a meet their needs' facto choices about the business designs that best

Valuecanmigratetootherbusinessdesignswithinanindustryol better configflow out of one industry andinto another with designs uredtoSatisfycustom.erprioritiesandmakeaprofit'Inthesteel the integrated example, value flowed within the industry from of Nucor and those like steelmakers to alternative business designs At the the next-generation integrated mills in Japan and I(orea' steel industry as same tim;, value was flowing out of the entire companiesinotherindustries_plasticandaluminum_emerged priorities of with business designs that better satisfied the emerging auto manufacturers' specific customer groups such as canners and

Measuring the Value Migration Process Migration, it To understand the direction and magnitude of value of is helpful to establish a s

e-bglrggsr caPitalizati

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tfrs--pgluer-sf es AAi*d as the given time' Like all financial stock price plus long-term debt) at any it is subject to the numbers, market ui-trr. has its flaws: it is volatile, quarterly earnups and downs of the stock ions' But as the ings-per-share changes and of investors and sum total of the analysis and opi

investmentprofessionals,itisthebestmeasureofabusinessdesign's The market value economic-Stower and future eaming potential'

ofalarge,diversecompanywithmultiplebusinessdesignsisthe to perform in the aggregation of each ind'ividual design's ability value of companies' market.2 Throughout this book the market used as a pragmatic groups of companies, and entire industries will be

proxy for value creation and decline' Thesuccessofabusinessdesignincreatingvalueisindependent the most size. Quite often, new' small firms introduce company of innovativeandpowerfulbusinessdesignsandcapturemostoftheir

Coxcnr"rs

industry,svalueglowth.Thepowerofabusinessdesign,therefore, value relative to the size must be measured by the amount of. market of size' the of the cnmpany. Taking revenue as a useful estimation the value ratio of market vatuJ to revenue allows us to compare scales. For example: creation power of business designs of different 1994

Revenue*

1994 Ma

Steel

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Thus,whileallthesecompaniesmanufacturesteel'andU'S'Steel' more powerful Bethlehem, and Inland aie much larger' Nucor's sustained value business design has succeeded in creating significant, growth. If revenue is a measure of the mass of a business design' the

marketvalue/revenueratioisanindicatoroftheprofitabilityand momentumofthatdesign.Isitcapturingvalue?Isitlosingvalue? Atwhatrate?Theratioisafeedbackmechanismthatindicates

to investors, how a design is valued relative to its competitors_and options in other industries'l

Theabilitytomeasuretherelativepowerofbusinessdesigns

and velocity provides a diagnostic for understanding the direction ofValueMigration.Thesemetricsarealsoextremelyusefulinunder-

standinghowtheeconomicpowerofabusinessdesignchanges. The Three Phases of Value Migration

eof to Valug describe

on its abilitY to

and thus to customer priorities better than competitors do earn suPerior returns.

;;;it

to customer priorities that established business design responding into or had neglected' Value flows competitors had fi;;;"tee emerging superior economics and the such designs becaostof their Microsoft and EDS recognition of tfreir po*tt 'o.t"tifV llstomers' inllow phase' the value are among .o*pJ"' experiencing is characterized by busiStlsrr.rrY. The second phase' sqbiliry and by *.u *.t.r"d to customer-pT:tit:t ness designs that "* This phase can vary in length' overall competiil equilibrium' piiorities ctrange and new'

ut which customei depending on the phase' '"tt emerge' ouring the stability more effective business designs relatively design' but eroectations of value remains in the busineis to the prevent new value from flowing moderate future growth phase' as DuPont are in this company. comp#es such the third phase' value starts to outflow' In Otlrxr'ow' V,a'r-us

moveawayfromanorganization,straditionalactivitiestowardbusinessdesignsthat*o..-.ff.oi,nelymeetevolvingcustomerpriorities' as a mav start t1"*tt:11t^":l:rates Although the value outflow DEC like increasingly obsolete. companies business designil;*; business their of flow out and-Bethletttm it-J-tt*t "t" ""L" designs.

Value thrgugh the tluee phases of As a business design passes managers stage' changes' At each Migration, ,n.'"'tt-ot 'i*ugement of moves' and those moves must make at"*"tit"Uy difrerent yrrdt in the Value Miglation process' determine *i,"tti' ""d lo"tt

Game of Business Value Migration and the

from Ford's vertinot new. value migrated away value Migration is"s;;t-t"i-to*ted tusiness design toward GM's cally integrated, grocery in the 1920s' It moved lrom price-laddered o'u!int" at'igtt merin the 1930s' from fragmented store chain, .o ,-]p.il;keis to and sales in the^i:::t^J::ars)' chandisers to natiinal catalogue the I920s (Sears again). Business national *.r.t*Iir. .trinJi" and out of prioritiel l""t been moving into designs process' "rra "o;;er destroying fortunes in the phase to, a.t"at-''-crtiti"g and

UONCEI"TS

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the r In the I990s, however' game o in manY industries' The itt. f q6Ot and 1970s' it was like the ;;;t called plavs' If vou exe-cuted

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ThedeclineoflBM,svaluewasthesymboliceventthatsignaled disapgame. Unexpected'by-and bitterly In sense' tors, it didn't seem to make any IBM the best-managed company in the profits as a corporation. By 1992, world.n rn LggT,it earned its peak by more than 70 percent from however, its market value had fa[en lost' I98l-$70 billion of market value had been and investors was the What was most d'isorienting to executives value' growing disproportion between size and 1994 Revenue*

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.IIIE CHALLENGE

OF VALI]B

IVIIGRATION

II

I felt differently about the future' I knew knew precisely what my three most important moves were' I value' what we had to accomplish to grow the company's JuSt a few years ago

ecoRestmcture and fine-tune the sales force' Bring disciplined process' Create a nomic thinking to the marketing investment to genuine dialogue between marketing and RED' and work reduce R&D development time-by a lot'

TodayI'minarlifferentpredicament'Idon'tknowwhat

matter' my top three moves are. There might be five moves that or one. I can sense that the rules have changed. But I can't put my finger on what they are' It feels awful't and speed He was right. The rules have changed. The frequency

into chess' of Value Migiation have turned the task of management adequate is Execution and speed are still importanL but neither game' New anymore. Managers must leam new rules for this new will I be Where questions must be asked: Speed toward what?

allowedtomakeaprofit?wherewillthevalueintheindustrybe? to be good What new corecompetencies do I need? What dolneed at? What moves do

ineed to make to capture the next cycle of value

gowth? Chessisagameofmovesandcounteflnoves.Assessingthedifferthe player entidl power of each piece and eactr square on the boar4 that creates a aooaaio., of and then executes a series of moves Then' as the board strategically adv4ntageous position-for a while' It is a complex game' ckranges, advantage Lut to be created again' pieces, the rianager must look at his or her situation-the board, the

thecompetitor'spieces,thecustomer'spieces-andaskWhat'smy and next move? What series of moves must l make to achieve maintain value growth? Ttrenewgameofbusinesshasbeensodisorientingtoexecutives a new and fundaarid investors because it is different, founded on important: mentally different set of assumptions about what is

Migrasuch a shift is the d eparture point f or understanding value what count tion. Different factors, requiring a different mind-set, are the value today. The mind_set mu;t focus on understanding where future. in an industry resides today and where it will move in the from activiAs customers, priorities change, value can shift away ties-be they manufacturing, marketing, sales' or specific types of or RED; from products-say, buggy whips, slide rules' mainframes' profitbasic materials; from customer segments-such as regulated, Iess segments in home health care; and from entire business designs-for example, integrated broad product line manufacturers, traditional department stores, hub-and-spoke airlines, or proprietary that were computer Systems. Activities, skills, and business designs once highly rewarded fade into economic irrelevance' at It's not that the value disappears, but that it moves-rapidly times-toward. new activities and skills and toward new business

designswhosesuperiorityinmeetingcustomerprioritiesmakes profit possible. In some cases, customers are the only beneficiaries designs of vulrr. Migration because the industry's current business that utility offer customers high utility but fail to recapture any of for remediation, in the form of pricing and profits. (Environmental example,providesgreatutilitytocustomers'buttheindustry'sbusilevel ness designs have not succeeded in recapturing any significant process of profitaUility for shareholders') While the Value Migration spaces new large creates huge economic vulnerability, it also opens of opportunitY.

A Strategic Perspectite on the Customer Thefirsttaskoftopmanagementistounderstandthedirectionand understandvelocity of value nigration in its industry. without such is misdirected' ing, diligent effort b-y thousands of excellent workers

of market value Even worse, thousands of jobs and billions of dollars

areplacedatunnecessaryrisk.Enormousresourcesareinvested ..t,'*s, and opportunities for new value without producing "rr.y growth are lost. TomeetthechallengeofValueMigration'managers'mustask' Ibe,aUnued PrPlit? How is that he

about it?

change?

mY organization do

Beneath these questions lies a more fundamental inquiry: What

accurate, and actionable. customers make choices based on their priorities. Those choices develop potential value for the businesses from which they buy. At any given time, the pattern of those choices auocates value to various business designs. As customers'priorities change and new designs present customers with new options. they make new choices. They reallocate value. These changrng priorities, and the way in which they interact with new competitors' offerings, are what tngger, enable, or facilitate the Value Migration process. One of the most powerful examples of Value Migration occurred in the computer industry where value moved away from business designs built around proprietary mainlrames and minicomputer systems to business designs built around workstations and pCs and finally to those built around the elements of computing functionality that customers mest value-processor chips, operating systems, lowcost distribution, communications software (network software, groupware), and systems integration. What matters to customers, what makes them willing to pay a premium, shifted as their previous priorities were met, as they became more sophisticated, and as new priorities emerged or better ways of satisfying old priorities were developed. Customers' choices have redistributed value from outmoded business designs-those of IBM and DEC o others that deliver more utility to customers and profit to shareholders-those of Intel, Microsoft, Novell, EDS, and others (see Figure l-2). Changing customer priorities, then, trigger the Value Migration process, creating opportunities for new business designs. Incumbents frequently ignore or overlook such opportunities, presenting significant openings for newcomers. Understanding customer priorities requires understanding more than just customer needs. Needs refer to the benefits and features of products that customers would Iike to buy. Most market research focuses on needs. But what customers really want is the result of a complex decision-making system. They are influenced by a number of external factors-regulation, commoditization, the offerings of

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Priorities t. 2. 3.

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External forces have an impact on customer needs, economics, aecision making. What-emerges are new custonrer priorities.

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Analyzing customers' decision-making systems makes it possible to interpret what customers say they want. It also helps decipher what customers are not saying and to anticipate what they will say .Suplqmers in the future. want. priorities*irn-alyiii d,e-termineq yy;\41 business design creates the for omers greatest )lF-or-example, in the business forms market, customers describe ffiii needs as high-quality products, quick-cycle delivery, and Iow price. Extensive market research reveals how well various suppliers meet these criteria. A priorities analysis, howeveL will reveal something completely different. It will show that the top priority for many large customers is to accomplish the transition from paper to electronic forms. Ttre implications for the business designs of form suppliers are clear and Profound. In business-to-business settings, understanding a customer's decision system means knowing as much (or more) about the customer's business aS its management does. It requires a level of relationship well beyond the traditional sales rep-purchasing agerLt,

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Institutional Memory Whenacompanyisestablished,itcraftsitsbusinessdesignaround focus of everything the its customers. In fact, customers are the

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hrge market value, a company in the stability phase can and acquire ensure the financing required to move in new directions after the But capabilities needed to thrive in a new environment. departs, transition to value outflow, market value shrinks, talent

cash flow diminishes, financing is more difficult to obtain, and competitors are likely to have staked out sfrong positions in the new areas of value growth. At this point, the company is caught in a powerful downward spiral. Large revenue streams have led to a Iarge infrastructure that customers see as "cost-added," not valueadded. When these costs and head count are removed, morale declines and the best performers in the organization leap to competitors with inlovative business designs that offer the promise of significant value growth. Customers move. Talent moves. Value migrates away.

Learning to Play Business Chess There are always winners ald losers in the Value Migration process. At critical junctures, companies must make sharp transitions to a new, more effective busingss design or risk losing the value they've built. The historical record provides examples of companies that have identified key moves and made transitions effectively. In the I950s, value migrated from radio networks to TV networks. NBC, the leader in radio, led the transition to network TV. Also in the 1950s, value migrated from tabulating to computing. IBM, the Ieader in tabulating systems, entered computing in 1953. By the end of the decade, it had actrieved undisputed leadership in the new value space. In the I930s, value flowed from chains of small grocery stores to chains of supermarkets, which were larger in scale, broader in product offering, and lower in cost. A&P made the move belatedly. Although the shift was traumatic and late, the company emerged at the other end of the transition process with its leadership position intact. More recently, as value flowed out of television manufacturing, Motorola switched to semiconductors and communications equipment. As cornmoditization threatened the long-distance telephone industry, AT&T invested in business designs that created significant new areas

of value growth. In each transition, the trauma of change was the trauma of changing how ttre company did business. For AsR for IBI\A for Motorola, it was not just a technology or format. It was how these cornpanies organized themselves, how they con-figured their resources, and how they fashioned their approach to the customer.

The examples of companies that have successfully changed their business design in response to changing customer priorities demonstrate that Value Migration is not a process beyond your control. As a manager, as a fiduciary responsible for shareholder wealth, and as an investor, you have choices. In every industry there is a limited set of key moves that allows you to take advantage of the next cycle of value growth. Every business design has a limited value creation lifecycle. Managers must act to create the next viable business design. IBM may have made such a move with its purchase of Lotus and its innovative Notes product. Nucor may have missed one as minimill saturation has threatened its unique position. The key questions are: Which move should I make? Which future business design element will be most important? Which future competitors do I have to worry about most? It is a complex game. When you Iearn to play chess, you start by becoming acquainted with the pieces. You learn.how to deploy them, how to capture them. Then you acquire some basic moves, simple techniques-openings, traps to Iook for, end-game moves. Next you learn the strategic values of the different squares and the importance of controlling the four central ones. You can finally play chess competently because you know the rules. Leaming to play well enough to win, howeve[, involves Iearning patterns.6 Winning is based on the ability to see and understand patterns quickly. Pattems allow the player to see moves in series, to look at the position of the pieces on the board and see strategic meaning. The player who grasps the most patterns has a tremendous advantage. In fact, chess grand masters can describe and use hundreds of discrete patterns with great facility. One Iearns to play the game of business chess the same way. A set of basic rules must be understood. Part I of this book describes the basic rules of Value Migration and the workings of the new game of business. Equipped with that set of tools, you can play the game. Playing the game well, however, requires that you become familiar with its patterns. You Iearn chess patterns by studying games played by others. Fortunately, as Value Migration has been e>rperienced in industry after industry, many of its basic patterns are becoming clear. While complex, the interaction of customer priorities and business designs can be mapped and understood.

I

20

i il

Corvcnpts

Part tr describes seven basic patterns that every manager and investOr should know. There are, of course, dozens of others. New ones emerge constantly as Value Migfation affects new industries. However, the seven included hdre have proved to have wide applicability and are the beginnings of a basic vocabulary. Part Itr is devoted to learning to play the game well on a dayto-day basis. It is about the specific actions that you can take to avoid value loss and to preempt the next cycle of value growth. The final chapter of the book focuses on the increasingly high-stakes nature of the decisions that determine future value growth. In most cases of Value Migration, five or fewer key strategic moves determined how value was redistributed in the next cycle of value growth in tlre industry. The chapter provides away of thinking about these moves that can help your organization improve its odds of making

the right decisions.