The Potato Principle And The Differentiation Dividend

"All mammals have a strong exploratory urge, but for some it is more crucial than others. It depends largely on how specialised they have become during the course of evolution. So long as the ant-eater has its ants and koala bear its gum leaves, then they are well satisfied and the living is easy. The non-specialists, on the other hand can never afford to relax. Looked at in this way, it might seem rather inefficient not to specialise. Why should there be any opportunist mammals at all? The answer is that there is a serious snag in the specialist way of life. Everything is fine as long as the special survival device works, but if the environment undergoes a major change the specialist is left stranded. If it has gone to sufficient extremes to outstrip its competitors, the animal will have been forced to make major changes in its genetical make-up, and it will not be able to reverse these quickly enough when the crunch comes. If the gum-tree forests were swept away the koala would perish. For the opportunist the going may always be tough, but the creature will be able to adapt rapidly to any quick-change act that the environment decides to put on. Take away a mongoose's rats and mice and it will switch to eggs and snails. Take away a monkey's fruit and nuts and it will switch to roots and shoots." - Desmond Morris, The Naked Ape

Diversity of species, genetics, age, thinking and specialism (skillsets) is fundamental to the?health?of an ecosystem. Homogeneity puts ecosystems at risk. Despite mother nature's wisdom, we often think we know better. A drive for profits and short-termism frequently trump what is best for the long term.

For example, over the past century, the number of varieties of artichokes grown in Italy has diminished from around 200 to just a dozen. Pressure to produce the most profitable varieties means a specific disease could wipe out an entire crop or species. This happened to my Irish brethren between 1845 and 1849 when the Great (Potato) Famine wiped out one million Irish, and a further million emigrated in treacherous conditions.

Irish farmers struggled to grow cereal crops in the nutrient-poor land, particularly in the rural west. They chose the potato as a hardy crop that grew abundantly even in such poor conditions. By the early 1840s, half of Ireland depended on the potato to survive.

In 1845, a strain of blight arrived from North America and thrived in the cold, moist Irish weather. It was a perfect storm of weather conditions, blight and an overreliance on the lumper potato, a perfect host for the blight. Diversification of the crop could have diverted the tragedy.

South Americans first domesticated the potato, where natives cultivated wide varieties, while the Irish relied on just one. South American growers knew that diverse varieties meant that a specific blight wouldn't mean the population would perish.

The point here is that species with diverse capacities can weather the storm when conditions change. In contrast, species of animals, humans, businesses and business models with a narrow focus are vulnerable to extinction.

Business Diversification

In our latest episode of The Innovation Show , Sven Smit tells us that differentiation is typically treated as part of an operational performance review, even though it is a strategic differentiator. He shares the excellent example of the memory card manufacturer Sandisk. The company made a big move by investing in innovation and improving its gross margins, leading to a 13% CAGR in total shareholder return over a decade. Appreciating that it was a strong player in a good market, Sandisk invested ahead of the industry in capital expenditure, reducing circuitry size, lowering manufacturing costs, and increasing output. Sandisk kept its prices at a premium to the market and invested heavily in trade promotion and its Sandisk Extreme team, a public network of expert photographers, as a centrepiece of a lively and permanent social media presence. Over the ten years, Sandisk expanded its gross margins from 40% to 48%, while the broader industry experienced modest gross margin contraction. In the context of a promising industry trend, Sandisk achieved an average economic profit of $945 million at the end of the period.

The British luxury fashion house Burberry is another company that Sven and the McKinsey research team share. At the beginning of their research period, Burberry was experiencing a quasi-identity crisis, with its luxury status under threat. By the early 2000s, the company’s distinctive camel-coloured check had become the uniform of the “chav,” the stereotypical white working-class delinquent looking for trouble. Bouncers and taxi drivers learned to turn away young men sporting Burberry baseball caps and jackets. . . . The brand’s elite reputation seemed to be lost.

Burberry's defence against this drift included vertical integration into the retail channel. Burberry grew its retail store footprint aggressively through Burberry-branded stores, concessions in department stores, and outlets. From having only 145 stores contributing 38% to group revenue in 2004, the company saw the retail channel grow to 497 stores plus digital commerce, contributing 70% of revenue a decade later.

This diversification of channels gave Burberry more control over how customers interacted with its brand: Burberry now controls everything from how sales staff greet customers and the training they receive, to the store ambience and visual merchandising, to the consistency between stores and digital platforms and direct marketing. The more potent mix of retail gave gross margins a boost, saving on the retailer’s middleman margin and increasing bargaining power with its wholesale customers by reducing the brand’s dependency on that channel. Furthermore, Burberry leveraged the brand into adjacent product lines. In 2004, accessories and children’s contributed only 30% of group revenue. By 2014, these categories grew to 40% of group sales revenue. Burberry also successfully launched a high-margin beauty products range, which grew to 7% of group revenue.

With greater diversification and new higher-margin product lines, and investment in the supply chain to meet digital needs and keep supply costs low, Burberry’s gross margin expanded from 59% at the beginning of Sven's research to 76% at the end. Economic profit rose from $92 million to $435 million, and the total shareholder return grew at a CAGR of 17% over the decade.

Business Model Diversification

In my book, "Undisruptable", I share a chapter on capability diversification. Specifically, I highlight that while it is wise to diversify business interests, it is even better when you correspondingly diversify business models. This is an important distinction: a business model is not a product. A product can have multiple business models. For example, @Nestlé is the parent company of both Nespresso and Nescafé. Nespresso sells products coffee pods direct to consumers via a B2C subscription model and branded boutique stores.

Meanwhile, Nescafé sells via the traditional method of B2B to suppliers and partners. This means Nestlé enjoys a portfolio of business models, not just a portfolio of brands. In a world of disruption, the difference is crucial because if a business model is disrupted, it does not drag the entire organisation down, just like an overreliance on a specific crop.

Now relate that same principle to employment diversification. When we only have one string to our professional bow, we are at risk of career disruption. When our roles are made of repeatable tasks, we are susceptible to automation. This means a portfolio of capabilities provides some comfort in turbulent times. Don’t wait for the storm to hit. Get ahead of it because it is always on the horizon.

Thanks for Reading

I highly recommend "Strategy Beyond the Hockey Stick" by Sven Smit to dive deeper into differentiation and understand the levers you can pull. The winner of that book is Debbie B. Debbie. I will be in touch. Meanwhile, you can win a copy of "The Imperfectionists" by Charles Conn and Robert McLean . Paid subscribers of our Substack have 3x chances to win (plus extra content and more).

On another note, our previous guest on the show,? Jane M. ?has a newsletter?Gig Mindsetters – a Bold New Breed - from NetJmc?Jane is offering a copy of her book to those who complete her survey below. Please help her out if you can…

https://netjmc.substack.com/p/imagine-ourselves-in-2043