The idea that some industries are superior to others is a view promulgated by the stock market, the media, and managers' own tendency to look for "easier" businesses.
"In reality, the data do not support this belief," said Evan Hirsh, a Partner with Booz & Company. "While some industries certainly outperform others, the differences are far smaller than one might think, and most highfliers eventually revert to the mean. Moreover, the difference in returns within an industry is several times greater than the difference across industries. Thus, CEOs and boards shouldn't waste time and shareholder capital trying to succeed in a new industry."
Booz & Company's ten-year study of shareholder returns reveals that firms in the top quartile had annual total shareholder returns of 17% or more. What is interesting is that every major industry had at least one company with a TSR that high and the top performers in each did incredibly well. Their CEOs didn't have to seek deliverance elsewhere.
"Yet, it is hard to find a leader today who hasn't entertained the idea that his or her company was simply in a bad industry or market space and a better opportunity lurked nearby," explained Kasturi Rangan, a Principal with Booz & Company. "This explains why product or service lines that still have growth potential get exploited to fund other businesses instead of being allowed to reinvest in their own. It also sheds light on the loss of focus that results when companies place multiple bets across various industries in the hope that one will be a big winner. Finally, it highlights the reckless pursuit of mergers that are billed as "transformational" but often involve overpayment, underperformance, a big write-off, and the loss of the CEO's job."
The Problem with Grass-is-Greener ThinkingUnfortunately, shareholders often wrongfully assume that a company that is successful in one area can rapidly learn to be capable in another. In actuality, the capabilities that matter form over decades and may involve millions or billions of dollars in human and financial capital. Almost all the firms that have moved into and dominated new areas chose industries that took advantage of unique strengths that they already had.
The second problem is the perception that an industry that seems superior today will remain so. "Half the industries we studied that were in the top quartile from 1991 to 2001 ended up in the bottom quartile during the next decade," added Hirsh. "This variability, found in every type of economic cycle, shows why it is generally very risky to enter an industry at its peak."
The fact that there is no such thing as a bad industry is even more relevant to CEOs. In effect, history suggests that periods of turmoil within industries seldom last. Most industries and market segments have remarkably consistent returns over the long term.
"Our analysis of TSRs proves the point," said Rangan. "If you omit the number one and number 65 industries in our study, the median returns of the "best" and "worst" industries are within 16% of one another. The gap within industries, however, is far greater: the top companies in each industry have annual TSRs that are 72% higher, on average, than the TSRs of the worst companies. It is simple: your chance of getting superior returns is far better if you stay in your own industry and improve your performance."
Winning in your own industryWhat can be done to improve a company's performance in its own industry? The first element to consider is its definition of growth. Most companies divide growth initiatives into two categories: organic (which usually means "growing with the market") and inorganic ("growing in adjacencies").
This approach can be counterproductive. Instead, a singular focus on market-share gains leads to superior performance. Secondly, it is pivotal to invest resources in the few capabilities that are critical to the company's success, and minimize all other costs. Finally, the focus of the business units and teams must be altered. Many CEOs manage by issuing numerical targets - for revenue growth, profitability, and expenses. Companies would often do better to focus on market share, a more independent variable.
To conclude, shifting into a new industry provides no guarantee for growth. Companies should therefore capitalize on their capabilities to excel in their own industry, and refrain from pursuing growth opportunities far removed from their scope and line of work. After all, the grass isn't necessarily greener.