How well do established companies adapt to digital market disruption? What strategies can they use? Two recent studies give useful pointers ....

A common feeling in the world today, I think, is that change is forever getting faster and more disruptive. In particular, it seems that the relentless growth of the big tech companies and the increasing number of tech start-ups threaten the fortunes, or even survival, of many companies across many sectors. But is this actually true? Aren't there ways for incumbent companies to 'fight back' and prosper? Two recent research studies I noted offer some valuable insight and guidance.

The first study (published in Harvard Business Review, Jan/Feb 2022) entitled 'How incumbents survive and thrive' was by Prof John Birkinshaw of London Business School. It involved comparing the make-up of the Fortune 500 and Global 500 lists of big companies of 1995 with their equivalent lists twenty-five years later in 2020.

The very clear (but I thought surprising) finding was that only seventeen of the companies in the Fortune 500 list did not exist in 1995 (amongst them, of course, Facebook, Google, Tesla, Netflix and Uber). The finding was similar on the international front: only twelve companies in the Global list in 2020 did not exist twenty-five years previously. Plenty of firms were new names on the 2020 lists (324 on the global list, for example), but these had evolved from companies that were already around in 1995. Disruption had only been significant in a small number of sectors - notably technology, media, telecoms and retail.

The clear message from this study is that, despite what many people might have thought, over the last few decades there has really been very little disruption amongst big companies (at least in the US and the top global companies): incumbent, long-established companies have continued to hold their own and not been cast aside by the 'tech wave' of the last two decades. The study has faced a degree of criticism, apparently, for only considering large, public companies and covering only a 25-year period, but these points do not seem to have discredited the basic finding.

Birkinshaw's study went on to look at the strategies pursued by the companies that had successfully adapted during the past twenty-five years of digital change. His research revealed four general approaches:

Fight back: This involves trying to take on a disruptor competitor at its own game and is often the default course of action tried. Examples include the major car makers' moves into electric vehicles to compete with new specialists like Tesla, and the major airlines' launch of 'no-frills' services to compete with new low-cost specialists. Fighting back is appropriate if the new technology represents an existential threat, but this rarely the case. Moreover, the author advises, this approach is normally very hard to do well and established firms generally have a poor track record at beating upstarts at their own game (for example, Microsoft has struggled to compete with Google in search). If attempted, it's usually best to move very quickly, so you keep the new entrants at bay.

Double-down: This approach involves a company focusing on its existing strengths, seeking to leverage its existing/long-term assets as much as possible. This was Disney's strategy in the 2000s, when it chose not to compete in the nascent streaming market and instead built on its proven strengths in movie-making. The danger with this approach, of course, is that the market may not value your strong assets in the future.

Retrench: This is a defensive approach whereby a company seeks to reduce threats from new entrants in order to ensure survival. Very often this involves pursuing increased scale through merger or acquisition. Another tactic can be to lobby government or regulators to introduce constraints on new entrants (established taxi firms did this when Uber first entered their markets). The approach is really a recipe for managed decline, not strategic growth.

Move away: With this (also defensive) approach, the established firm seeks out and seizes opportunities in new markets. A notable example from the last two decades is Fujifilm, once a major competitor to Kodak, that moved - successfully - into healthcare and imaging. But diversification is invariably risky and difficult to pull off.

These four approaches are not mutually exclusive and a combination may be appropriate. But, as the author advises, eventually a company has to focus: strategy is, by definition, a commitment to a particular course of action that precludes others. The author also urges that, whatever approach a company chooses, it should anyway at the same time embrace digital technology to improve its existing operational processes and activities.

Building a new 'growth engine'

The second study I noted ('When your business needs a second growth engine', HBR May/June 2022) by two partners at consultants Bain & Co, James Allen and Chris Zook, offers useful, related advice for those companies looking to enter new markets to try and build a new wave of profitable growth, perhaps because their industry has been upended by new technology.

Over the last few decades, as the authors say, the most reliable way for businesses to find their new wave of growth has generally been considered to mine their one or two strongest, existing 'core' businesses and apply their most distinctive capabilities in adjacent markets (incuding moves into new geographies, new products, or other customer segments). However, in more recent years, particularly as many high-growth industries today don't need as much investment as they once did and disruptive businesses can (thanks often to digital technologies) scale up faster, a new pattern is emerging: more businesses with already strong, growing cores are not simply turning to adjacent markets and instead are choosing to develop and build large, new cores (or 'engine two' businesses).

In their study, the authors investigated what is involved in ensuring a successful, second growth engine. Their research included identifying more than 1,000 companies that had revealed such success and then built up a database of 100 various initiatives they noted from reading the companies' market filings and media reports that looked to have contributed to the companies' success.

From the research three distinct categories of successful 'second engines' emerged. Half of the companies identified had moved into a market that was just minimally related to their engine one's industry but drew in some way on the company's current assets. About a third of the successful second engines were 'next generation' versions of the core business (like Netflix's move from DVD rentals into streaming). And just a fifth involved building or buying a brand-new business almost completely unrelated to the engine one.

Critically, though, the authors also identified four particular 'foundational' elements for underpinning the success of any new engine two. These were:

i) A target market with large profit potential: Most successful engine-two businesses were found to be in a market where total profits available were both sizeable and rapidly growing: indeed, often, revenues and profits were actually expected to rise faster than in engine-one markets. The most common success contributor was a company's ability to ride the curve of a new technology's adoption: the authors found no successful engine-twos based on consolidating competitors in a declining industry or on acquiring and rejuvenating an underperforming leader in a lagging industry.

ii) A strong competitive advantage: It is critical that an engine-two can offer a very strong, differentiated product or service in its market. It may be that the advantage also supports the parent's organisation's core business but - as the authors found in this study - quite probably it may be necessary for the engine-two to carry out some focused acquisitions in order to assemble all the pieces needed to scale up and compete successfully.

iii) An 'entrepreneurial' mindset: This was found to be the most important of the four success elements identified in the study. The authors use the term to refer, firstly, to separating the engine-two business on a stand-alone basis away from the parent organisation, with the ability to make its own decisions independently from the start. And, secondly, the people running the new entity should think like 'insurgent' pioneers on a mission to change their market, they should lead from the 'front line', and they should drive the business like they were its actual owners.

iv) Ability to share assets or capabilities of the parent organisation: The new engine business should, ideally, be able to leverage the scale and some of the assets of the engine-one business. Assets could be, for example, useful technolgoies or systems, access to relevant customers or access to useful distribution channels. Appropriate service agreements should be put in place between the two companies to help manage the ongoing relationship, as quite probably there will sometimes be tensions.

Overall, I took two key messages from these two interesting studies:

Firstly, incumbent firms should always take a calm and considered approach in deciding how to adapt to threats from technological disruption and remember that the effects of new technology usually take decades, not just years, to come into play and, often, new rivals end up co-existing with established rivals. Incumbents have potentially many advantages over upstarts to help their position (e.g. costs of market entry for new players and incumbents' established reputation and trusted relationships with customers and suppliers).

Secondly, for incumbent firms that decide they do want to adopt an offensive adaptation strategy in the face of new disruption, the path of settting up a whole new 'core' engine business is an interesting strategic scenario to consider. But I don't think it's an easy option for most companies: the four key foundational success factors suggested in the Bain study are quite challenging. Perhaps rather, as management practices evolve and embrace more agile and flexible patterns on the back of new digital technologies, incumbent core organisations themselves will adapt and stay strong and the need to rely on wholly-separate new business set-ups will be less critical.

/ Written by Mike P. Owen, Senior Partner at Owen Morris Partnership

July 2022