PREFACE

After spending most of my adult life working in marketing and studying the practice of marketing, I've written a book on how to focus a corporation.

The book is devoted to the real objective of the marketing process, which is not just selling a product or service. It's finding the future.

The primary job of corporate management is to find the future. Not just the future in general, but specific futures for the corporations under their care. A focus is the future in the sense that it makes a prediction about where the future lies and then takes specific steps to make that future happen.

That's where the subject of marketing comes in.

"Any business enterprise has two, and only two, basic functions," writes Peter Drucker, "marketing and innovation."

"Marketing is the distinguishing, the unique function of the business," continues Mr. Drucker. "A business is set apart from all other human organizations by the fact that it markets a product or a service. Neither Church, nor Army, nor School, nor State does that. Any organization that fulfills itself through marketing a product or a service is a business. Any organization in which marketing is either absent or incidental is not a business and should never be run as if it were one."

It's about time that marketing received the recognition it deserves. Except that Peter Drucker wrote these words in The Practice of Management, a book first published in 1954. It's taken quite a while for Mr. Drucker's concept to reach the boardrooms of Corporate America.

xii PREFACE

But then again, a corporation changes its emphasis very slowly.

After World War I, the emphasis was on manufacturing. The art of management was embodied in the time-and-motion studies of Frederick Taylor. Business success went to those companies that could get their products out the door faster and cheaper than the competition.

After World War II, the emphasis gradually shifted to finance. The art of management was embodied in the "portfolio" concept. Business success went to those corporations that did the best job of buying and selling companies in order to put together a high-yielding portfolio.

Where are we today? Both the manufacturing and the financial aspects of management seem to have run their course. Today the emphasis is on marketing.

What do Bill Gates (Microsoft), Bert Roberts (MCI), Ross Perot (Perot Systems), Sam Walton (Wal-Mart), Mike Harper (ConAgra), Fred Turner (McDonald's), Michael Eisner (Walt Disney), John Smale (Procter & Gamble), Robert Goizueta (Coca-Cola), and Roger Smith (General Motors) have in common?

You might recognize these men as some of the most celebrated chief executives of the past decade. Actually, they are that and also, according to Advertising Age magazine, "Marketers of the Year" from 1985 to 1994. (Michael Eisner repeated in 1995.)

Advertising Age recognizes the reality of business today. The chief executive is also the chief marketing executive. "Marketing," Hewlett-Packard cofounder David Packard once said, "is too important for the marketing department."

Arguably the most successful company of the past decade is Microsoft. Here's what Lou Gerstner of IBM has to say about Bill Gates and his company, "Our biggest competitor in software is not a very good technical company. But it's one of the best marketing companies I've ever seen, and I've spent twenty years in marketing."

What's a marketing person doing writing a management book, you might be thinking? Good question.

An even better question: What's a management person anyway?

Answer: A marketing person who can read a balance sheet and a profit-and-loss statement.

INTRODUCTION

The sun is a powerful source of energy. Every hour the sun washes the earth with billions of kilowatts of energy. Yet with a hat and some sunscreen you can bathe in the light of the sun for hours at a time with few ill effects.

A laser is a weak source of energy. A laser takes a few watts of energy and focuses them in a coherent stream of light. But with a laser you can drill a hole in a diamond or wipe out a cancer.

When you focus a company, you create the same effect. You create a powerful, laserlike ability to dominate a market. That's what focusing is all about.

When a company becomes unfocused, it loses its power. It becomes a sun that dissipates its energy over too many products and too many markets.

Whither Corporate America? Are companies focusing themselves to develop the power of a laser or are they trying to outshine the sun?

The sun seems to be winning.

In the past few decades an explosion of new goods and services has hit the marketplace. The combination of rapid technological development and less costly production techniques has led to a massive increase in the number and variety of products available to consumers everywhere.

Computers, copiers, color television, video cameras and recorders, cellular phones, facsimile equipment, the list is endless.

Existing companies responded by expanding their product lines. General Electric, a manufacturer of electrical equipment, got into tele-

xiv INTRODUCTION

vision sets, jet engines, computers, plastics, financial services, and a host of other products and services unrelated to their core electrical lines. And so did virtually every company in the world from American Express to Zenith.

Today the bloom is off the rose. It should have been obvious that a company cannot keep expanding its product line forever. You reach a point of diminishing returns. You lose your efficiency, your competitiveness, and most ominous of all, your ability to manage a diverse collection of unrelated products and services.

You become a red giant, a burned-out hulk of a star hundreds of times larger than the sun, but with a surface temperature half as hot. Red giants have included companies like General Motors; IBM; and Sears, Roebuck.

Stars can't be focused, but companies can. That is the message of this book. The time has come to develop a company's power by narrowing its focus.

Fortunately some chief executives have already gotten the message. Recently, the media has reported many examples of companies that have focused or refocused their operations.

Even mighty General Electric is no longer expanding; it's contracting. In the past decade, the company has sold hundreds of businesses and cut its workforce almost in half. General Electric has sold off major businesses like computers, television equipment, and small appliances.

Mathematically, of course, annual growth rates of 10, 15, or 20 percent are impossible to sustain over an extended period of time. Last year General Motors had revenues of $155 billion. If the company grew at an annual rate of 20 percent, in twenty-one years GM would be a $7.1 trillion Red Giant, larger than the current gross domestic product.

What you are seeing today is the beginning of a reaction to this overexpansion. Instead of expanding, some companies are going in the opposite direction. They are getting back to basics. They are learning the lesson of the laser. How to focus.

And so should you. The future of your company depends on it.

THE UNFOCUSING OF CORPORATE AMERICA

What's the driving force in Corporate America? In a word, growth.

Management demands substantial increases in annual sales and profits, even when companies are in markets that show no overall growth.

Predictably, in order to meet these targets, companies offer more varieties and flavors. Or they branch out into other markets. Or they acquire other firms or products. Or they set up joint ventures.

Whether you call this expansion process "line extension" or "diversification" or "synergy," it's the process itself, the urge to grow, that causes companies to become unfocused.

That's why a company like IBM can have $63 billion in revenues and still lose $8 billion. And General Motors can have $133 billion in revenues and still lose $23 billion.

While growth might be an admirable result of other initiatives, the pursuit of growth for its own sake is a serious strategic error. It's the major reason why so many American corporations have become unfocused.

Chief executive officers have been paying the price for their strategic mistakes. There's no question that many CEOs have made strategic errors that have unfocused their companies. Never in history have so many chief executives been handed their hat and told to go home by their own boards of directors.

To name a few: James Robinson at American Express, John Sculley at Apple, Anthony D'Amato and Ervin Shames at Borden, Barry

Gibbons at Burger King, Rod Canion at Compaq, Ken Olsen at Digital Equipment, Kay Whitmore at Eastman Kodak, Robert Stempel at General Motors, Tom Barrett at Goodyear, John Akers at IBM, Joseph Antonini at Kmart, William Agee at Morrison Knudsen, and Paul Lego at Westinghouse.

It's not just the pursuit of growth that causes unfocusing problems. Unfocusing itself seems to be a natural phenomenon that occurs without any conscious effort on a company's part.

A successful company usually starts out highly focused on an individual product, service, or market. Over time, the company becomes unfocused. It offers too many products and services for too many markets at too many different price levels. It loses its sense of direction. It doesn't know where it's going or why. Its mission statement loses its meaning.

You've probably worked for a company like that. Most people have. At first, everything seems to be going well. The initial product or service turns out to be a big winner. The company has momentum and great expectations. The stock is taking off like a rocket.

But success creates something else: the opportunity to branch out in many different directions. The halls are filled with anticipation and excitement. Most often heard comment in the corridors: "We're going to rule the world."

Such a scenario could describe General Motors in the sixties. Sears in the seventies. IBM in the eighties. And Microsoft in the nineties.

It never happens. After a while things start to go wrong. What seemed like a world of opportunity turns into a world of problems. Objectives unmet. Sales flattening. Profits declining. The press unflattering.

"I sometimes wonder if the people at the top of most big U.S. corporations are afflicted with attention deficit disorder," says consultant Barry Spiker. "They don't stay focused." This is what happened at General Motors, Sears, and IBM. But the jury is still out on Microsoft. If history repeats itself, as it generally does, Microsoft is the next IBM, the next company to become unfocused.

In the physical world, unfocusing is called entropy, or disorder. And Rudolf Clausius's law of entropy states that over time, the entropy of any closed system increases. Let's say you straighten out your clothes closet. A month later, the closet is a mess. You have wit-

THE UNFOCUSING OF CORPORATE AMERICA 3

nessed the effects of entropy, one of the fundamental laws of nature.

Corporations are no different from clothes closets. Over time, every company tends to become unfocused.

Also garages. Let's say you take a Saturday afternoon in April to straighten out your garage. It's hard work, but at the end of the day you're pleased with yourself because everything looks great. You have a place for everything and everything's in its place. You make yourself a promise: From now on you're going to put everything back where it belongs and keep the garage exactly as it is this particular Saturday in April.

A year later, you're back to square one. Everything is a mess again. Corporations are no different from garages.

Or glove compartments. Empty the glove compartment of your car and see what you find. Probably a lot of things you never knew were there. Maps, pens, sunglasses, gas receipts, portable telephone, chewing gum, change, Kleenex, vehicle registration certificate, insurance cards for the last three years, owner's manual. Everything except a pair of gloves. Corporations are no different from glove compartments.

Open the top drawer of your desk. Is it focused or unfocused? Enough said.

Like human nature itself, the destiny of corporations is to become unfocused. Peter Drucker paints a bleak picture of the typical corporation: "Analysis of the entire business and its basic economics always shows it to be in worse disrepair than anyone expected. The products everyone boasts of turn out to be yesterday's breadwinners or investments in managerial ego. Activities to which no one paid much attention turn out to be major costs centers and so expensive as to endanger the competitive position of the company. What everyone in the business believes to be quality turns out to have little meaning to the customer."

Does that sound like the company you are working for? Peter Drucker recommends focusing "scarce resources on the greatest opportunities." Or you might consider a strong dose of Ritalin for top management.

There are two reasons for this unfocusing. One has been widely discredited; the other is still alive, but showing signs of wear and tear.

The discredited reason is "diversification." Remember how wildly

popular the management strategy of diversification once was? Literally every major corporation in America went out of its way to proclaim its belief in the philosophy of not putting all your eggs in one basket.

The stool was the favorite analogy. The three-legged stool representing the three major businesses a company was engaged in, or the four-legged stool representing four major businesses. (For obvious reasons the two-legged stool was not a favorite analogy of corporate planners.)

Financial services were a special favorite of the diversification crowd. Scores of companies went down the financial services chute, including Sears, American Express, Xerox, Prudential Insurance, and Westinghouse Electric.

The story at Westinghouse is particularly painful. Nearly crippled by its now defunct credit subsidiary (Westinghouse Financial Services), the company barely skirted bankruptcy court a few years ago. In the past five years Westinghouse has had four chairmen. They also had $2.4 billion in losses on $58.6 billion in sales. There are a lot of Westinghouses out there that could do better by turning the company's assets into Treasury bonds.

Then there's the unhappy experience at Xerox. In the early eighties, the Copier King decided to diversify into financial services. Under the name "The Xerox Financial Machine," the component companies included Crum and Forster property/liability insurance, Van Kampen Merritt mutual funds, Furman Selz investment banking, and Xerox Life insurance.

When The Financial Machine broke down in late 1992, the company took an after-tax charge of $778 million and announced its total withdrawal from the field. "The long-awaited decision was a humbling admission of failure from Xerox," said the Wall Street Journal "which bought into the business at its peak only to watch the investment spoil the acclaimed comeback in its core copier operation."

Yet company after company continues to search for the magic acquisition that will drive sales and stock prices skyward. But in the end they usually find only disappointment and disillusionment.

• IBM bought Rolm in 1984. IBM sold Rolm in 1989.

• Coca-Cola bought Columbia Pictures in 1982. Coca-Cola sold Columbia Pictures in 1989.

THE UNFOCUSING OF CORPORATE AMERICA 5

• Metropolitan Life bought Century 21 Real Estate in 1985. Metropolitan Life sold Century 21 in 1995.

• Chrysler bought Gulfstream Aerospace in 1985. Chrysler sold Gulf stream in 1990.

• Eastman Kodak bought Sterling Drug in 1988. Eastman Kodak sold Sterling in 1994.

• Dow Chemical bought Marion Merrell Dow in 1989. Dow sold Marion Merrell Dow in 1995.

• Matsushita bought MCA in 1990. Matsushita sold MCA in 1995.

A study of these and other acquisitions/divestitures confirms the existence of a six-year itch. Six years is long enough for the acquiring company to be convinced it has bought a lemon. Six years is also long enough for the investing public to forget about the marvelous "synergies" promised when the acquisition was first unveiled.

If things go well on the public relations front, the "back to basics" divestiture announcement gets as much favorable publicity as the original acquisition announcement.

In retrospect, some of the diversification moves were almost comical. On November 7, 1985, Lee Iacocca unveiled the new Chrysler Corporation, now a holding company, with automobiles just one of its businesses. The company would become a "four box" corporation: Chrysler Motors, Chrysler Aerospace (Gulfstream), Chrysler Financial, and Chrysler Technologies.

Iacocca dubbed the latter "the empty box" because he hadn't yet purchased anything to fill it. But he would immediately start searching for a high-tech acquisition in the $1 billion range.

Later he would admit that his biggest mistake was to diversify. "We didn't need a holding company. That's what made us top-heavy. If we went astray—you know, people do go astray now and then in many areas—man, we got focused in a hurry."

Ford Motor Company went through the same drill. CEO Donald Petersen decided Ford should become a three-box company. One was cars, of course. The second was finance, and the third was high-tech. Petersen proceeded to beef up the finance box with the acqui-

sition of a California savings and loan and two consumer-lending companies, one in Philadelphia and the other in Dallas. All told, Ford spent $6 billion on acquisitions between 1985 and 1989. With mediocre results, of course.

"Four-box thinking" is not an exclusive prerogative of the giant corporation. A small company often falls prey to the same kind of thoughts. When annual sales get in the neighborhood of $10 million a year (give or take a few million), a small company often hits the wall and becomes unfocused.

Ten million is about the time the founder decides the company is getting too big and delegates operating responsibility to three or four key people. Result: Each person takes his or her box and runs in a different direction.

To be fair, I should also mention megaconglomerate General Electric, which gets more than one-third of its pretax profits from GE Capital. The question is, does the $20 billion financial powerhouse benefit from its GE connection? Or is it successful in spite of its GE connection?

Just because two facts are related doesn't mean there's a cause-and-effect relationship. The longest field goal in National Football League history (sixty-three yards) was kicked by Tom Dempsey, a man with half a foot, on November 8, 1970, in a game between New Orleans and Detroit. If I wanted to kick field goals for an NFL team, would I get my kicking foot amputated? I think not.

Buying a lottery ticket is a losing strategy because most ticket buyers wind up losing money. But even a losing strategy can have its share of winners. GE Capital is a winner, even though the diversification strategy it represents might be a loser.

Furthermore, success in the past is no guarantee that you'll be successful in the future, especially if you're following a losing strategy. Will GE Capital continue to post those extraordinary gains? I think not.

Luck evens out. In the long run, winning companies are ones that are the most focused. Losing companies are ones that are the least focused. The guiding principle, the one that should drive your company's every decision, is the principle of focus.

If focus is so important, how come so few companies seem to be driven by it? How come focus gets so little attention in the management books? How come the principle of focus is generally ignored and even violated by most CEOs?

THE UNFOCUSING OF CORPORATE AMERICA 7

As dramatized by Edgar Allan Poe in "The Purloined Letter," sometimes the hardest thing to see is also the most obvious. And what is obvious to an outside observer about almost any company today is the constant, day-by-day, relentless march into an unfocused state. Call it entropy or whatever you like, unfocusing is a fact of corporate life. What to do about it is what this book is all about.

What makes the situation even worse is that most companies make a conscious effort to become unfocused. That sounds impossible, but it's not. We call this process "line extension," or in the immortal words of management consultants, "extending the equity of the brand."

Line extension is the second reason for the unfocusing of Corporate America. One that's still alive, but showing signs of wear.

Nobody has extended the equity of the brand quite so far as Donald Trump. At first, The Donald was successful. Then he branched out and put his name on anything the banks would lend him money for. Three casinos, two hotels, two condominiums, an airline, a shopping center, a football team, even a bicycle race.

Fortune magazine called Trump "an investor with a keen eye for cash flow and asset values, a smart marketer, a cunning wheeler-dealer." Time and Newsweek magazines put him on their covers. Today Trump is millions of dollars in debt. What made him successful in the short term is exactly what caused him to fail in the long term. Line extension.

What The Donald did in the United States, The Richard is in the process of doing in the United Kingdom. Richard Branson is the owner of Virgin Group, whose Virgin Atlantic Airways has created a lot of excitement in the North Atlantic airline market. Not satisfied with just owning an airline, Branson is now line-extending the Virgin name.

The Richard has licensed the Virgin name for personal computers and has set up joint ventures to market Virgin cola and Virgin vodka. (One of Virgin's Boeing 747s is being painted to look like a cola can.) On the drawing boards are Virgin water, in bubbly and non-bubbly form, and Seven Virgins, a fizzy lime beverage.

Then there's Virgin Lightships, which rents lightweight blimps to advertisers. Branson has also franchised the Virgin name to two European start-up airlines and is bidding to take over the running of all British train services from the state-owned rail network. There's

also Virgin Financial Services, which includes an index fund and a payroll savings plan.

Meanwhile back at Virgin Atlantic, the airline has been losing money. To cover the losses The Richard has lent $50 million to the airline in the past two years. Is there any doubt the Virgin empire is going to come crashing down at some point in the future? It's hard enough to compete with British Airways and American Airlines without taking on Coca-Cola and Smirnoff on the side.

Branson is following in the slipstream of Sir Freddie Laker. Back in 1977, Laker Airways introduced the Skytrain to the North Atlantic market. A walk-on, walk-off discount flight service that charged for food and other frills, the Skytrain became known as the "cheap and cheerful" way to the UK. Two years later Laker began adding frills.

In the end, Sir Freddie was offering five types of fares, including one for an upscale "Regency" service aimed at the business market. "In addition to blurring the public's image of Laker Airways," said Business Week, "the new services added to the carrier's costs and destroyed the simplicity of the original concept."

Meanwhile in a typical "conquer the world" attitude, Sir Freddie ordered ten A300 Airbuses and filed a rash of European route applications, including one blockbuster to fly "among and between" thirty-five European cities. Just before his 1982 bankruptcy he also laid plans for a "Globetrain" that would circle the world and "assure competition on a substantial part of the world air-transport system."

While Sir Freddie Laker was going down in flames over the North Atlantic, Don Burr was starting a "no-frills" airline in North America. Called People Express, the new airline took off in the spring of 1981. Fares were low and the stewardesses charged for soft drinks and brownies. If you wanted your bags checked, the charge was $2 apiece.

Lured by the low fares, people would hop aboard the airline for weekend jaunts at the drop of a hat. Dubbed the "Trailways of the Airways," People Express was an immediate success. The stock went public in 1980 at $8.50 a share and less than three years later was near $50.

Then Don Burr made the predictable line-extension moves, including rapid expansion of routes and schedules. He bought 747s and started service to London. In 1985, he bought Frontier Airlines for $300 million (and sold it to United Airlines the following year).

THE UNFOCUSING OF CORPORATE AMERICA 9

Then he tried to shift from a no-frills low-cost carrier to a full-service airline. Flying in the face of almost certain bankruptcy, People Express was swallowed up by Texas Air in 1987.

What Burr, Laker, and Branson failed to realize is that the brand name is not a hunting license to go out and nail the big game (the more, the merrier), but a diamond that needs to be cut and polished. In other words, focused. Only when you focus a company or a brand over an extended period of time do you develop a powerful company whose future success is almost guaranteed.

Nowhere is this principle so clearly demonstrated than in the success of Playboy magazine and in the lack of success of all the Playboy spin-offs. The world's best-selling men's magazine, Playboy and the company's trademark bunny logotype are known around the world. With a circulation of 3.4 million, Playboy is bigger than People, Time-Warner's most profitable magazine. Playboy is also bigger than Sports Illustrated, Newsweek, or Cosmopolitan.

What an opportunity for Playboy clubs, Playboy books, Playboy videos and Playboy cable channels. Not to mention clothing, cologne, jewelry, eyewear, and condoms. Playboy Enterprises, now run by Hugh Hefner's daughter Christie, has tried all of these things and more, with little success. (The first Playboy Club opened in Chicago in 1960. The last Playboy Club was closed in 1986.)

Over the last six years, for example, the company racked up $1.1 billion in sales and managed to lose $6 million. But they never give up. Recently Playboy Enterprises hired Hollywood's Creative Artists Agency to help find investors to fuel an ambitious expansion into international television, casinos, and new media.

Playboy magazine is now forty-two years old. One wonders what could have been accomplished by keeping Playboy focused as a magazine. And then by introducing new magazines with different names. Which is exactly what Henry Luce did, starting with Time magazine. (See chapter 12, "Building a Multistep Focus.")

Instead of introducing new brands, companies fall in love with themselves and constantly look for ways to take advantage of their presumably all-powerful brand names. Reebok is the latest brand to make the club scene, opening a $55 million complex in 1995 called Reebok Sports Club/NY. Is there any doubt the Reebok clubs will go the way of the Playboy clubs? Not in my book.

Not to be outdone, Nike has announced that they will build a theme park in Irving, Texas, in and around the Dallas Cowboys' Texas Stadium. Will Nike's next move be to buy the team?

Comsat Corp. has bought a professional team. Created by the U.S. government in 1963 as a publicly traded company to link phone companies to the global network of Intelsat satellites, Comsat decided to diversify into sports and entertainment.

Since 1989, the communications company has bought the Denver Nuggets basketball team, a Hollywood film-production company, one-third of a Denver theme park, and a company that beams pay-television programs via satellite to nearly six hundred thousand hotel rooms. Recently Comsat picked up the Quebec Nordiques hockey team for $75 million.

With a partner, the company is building a $132 million Denver arena to house both the Nuggets and the hockey team, which has been moved from Quebec and renamed the Avalanche. Any wonder Comsat's stock price today is about where it was when it started the entertainment push in 1989?

Jostens, a $665 million company with 40 percent of the market for class rings, yearbooks, and other school graduation products, decided to get into the educational software business. It seemed to make sense. Software was booming, and the distribution channels were already there.

So in 1986 the company launched Jostens Learning Corp. and started to make big-time acquisitions. Education Systems Corp. for $65 million. Wicat Systems for $102 million. By 1992, Jostens had 60 percent of the computer learning market.

But what does a ring company know about computers? Apparently not much. Jostens was selling proprietary computer terminals as the market was turning to low-priced IBM-compatible personal computers and commercial software packages.

In 1994, Jostens took a $140 million pretax write-off, mostly for software development costs and cutting its salesforce. In 1995, Jostens went back to basics, selling its educational software division, its sportswear business, and its aviation-training division. Jostens, said the Wall Street Journal, "is shedding its remaining peripheral businesses and focusing on selling achievement and recognition products to schools and businesses."

Line extension doesn't need much encouragement. It's a process

that takes place continuously in a corporation with no conscious effort. Companies seem to flow like a river into new directions or to fill holes in their existing line.

It's like a closet or a garage or a glove compartment or a desk drawer that becomes unfocused with no conscious effort. There are six different areas that seem to generate these line extension efforts.

1: Distribution. In the case of Jostens, it was the existence of well-established distribution channels that caused corporate executives to ask themselves, "What else can we be selling? What is the hot new product moving into our marketplace?" The more products a salesforce handles, the more likely it is to lose focus.

2: Manufacturing. "What else can our factories be making to increase our efficiencies and reduce our overhead burdens?" Dow Jones & Co. owns the Wall Street Journal, the world's most profitable newspaper. But the Journal publishes only five days a week, leaving two days free for other ventures.

So Dow Jones filled the presses with the National Observer, a weekly newspaper. After fifteen straight years of losses, Dow Jones finally folded the Observer.

3: Marketing. A company that successfully markets a consumer package-goods product assumes it can market any consumer package-goods product. Procter & Gamble, the mecca of marketing, took on Minute Maid and Tropicana with an orange juice brand called Citrus Hill.

Launched in 1981, the brand never had a profitable year. Killed in 1992, the Citrus Hill funeral cost Procter & Gamble $200 million. Marketing is marketing, but orange juice is orange juice.

4: Customer life cycles. "What happens when our customers outgrow our products?" That's the question many companies ask themselves. So the Gerber Products Company comes up with Gerber Graduates. McDonald's tries pizza. And Burger King tries main course dinners and table service. None of these introductions turn out to be profitable.

5: Geography. Sometimes geographic expansion can take place without loss of focus. Starbucks, for example, successfully moved out of its Seattle home market into the national arena. Other times,

the geography is the focus. One of the most profitable newspapers in America is Newsday on Long Island. So Newsday decided to move to the city and introduced New York Newsday.

Over a ten-year period the paper won three Pulitzer Prizes and lost $100 million. You can't blame Newsday's owner, the Times Mirror Company, for shutting the paper down. What you can blame them for is starting it up in the first place.

6: Pricing. "Some customers can't afford our prices. What do we do about that?" No problem, just introduce inexpensive versions of our brands. The biggest name in women's designer clothing is Donna Karan. But, let's face it, Donna Karan is expensive. So the company introduced DKNY, their less expensive clothing line. (Would Coca-Cola introduce CCAT, a less expensive cola? Actually, they might. Let's not give them any foolish ideas.)

In one year Donna Karan spawned five new companies: men's wear, DKNY men's and kids, intimate apparel, plus a beauty company that started life with Donna's own personal perfume.

Will Donna go the way of Liz? Back in the eighties, Liz Claiborne was the single most popular label in women's apparel, dominating the department store segment. The core sportswear label spun off myriad divisions designed to outfit a woman for virtually every phase of her life. Claiborne's Collection, Liz & Co., Lizsport, and Liz wear.

Today Liz Claiborne is in trouble. Recently the company hired a new vice president of merchandising "to refocus the clothing lines at the moribund apparel firm," according to Crain f s New York Business.

Brand inflation is another reason for the raft of recent line extensions. Ask yourself, "What does our brand stand for?" Are you sure?

Gerber apparently thinks its brand stands for "babies." How else can you explain the company's losing line extensions into children's apparel, strollers, and high chairs? The company also spent millions trying to get into the day-care business.

Strange. Ask any mother what Gerber stands for and she will undoubtedly say "baby food." Food does not mean clothing or furniture.

Even successful companies with a reputation for successful line extensions arc not all they seem to be. McDonald's is the leading fast-

THE UNFOCUSING OF CORPORATE AMERICA 13

food company with a reputation as an innovator in menu additions. Since 1983, McDonald's has introduced Chicken McNuggets, ready-to-eat salads, McLean Deluxe, and a host of new products. In a decade, average revenue per U.S. restaurant unit has increased 35 percent.

Terrific. But over the same time period the consumer price index for food has increased 41 percent. If the average McDonald's had not added any new menu items in a decade, but just sold the same items but at inflation-adjusted prices, revenues presumably would have increased 41 percent, not 35 percent.

There are some assumptions here. Could the average McDonald's continue to sell the same volume of hamburgers, Big Macs, Cokes, and french fries? Maybe, maybe not. Certainly there was a strong trend toward out-of-home eating over the past decade, which should have helped McDonald's increase their volume.

If you can't maintain your volume when the tide is with you, how will you fare when the tide goes against you?

Mind you, McDonald's has enormous self-confidence and a sterling reputation in the financial community. "If we served beer and wine," CEO Michael Quinlan once said, "we might eventually have 100 percent of the food-service market."

Many companies mimic McDonald's. These are successful companies with reputations for substantial line and product extensions. But when you look under the covers, you find that most of their growth has been in the consumer price index. When you remove the effect of inflation, you also remove most of the growth.

The road to Unfocus can take many paths. Some companies go the McDonald's route by steadily increasing the number of products in their basic line. Others try to assemble a basket of many different products. It's the latter approach that causes most of the highly visible line-extension failures.

One day a company is tightly focused on a single, highly profitable product. The next day the company is spread thin over many products and is breaking even or actually losing money. Brand inflation strikes again.

Last year the world's largest manufacturer of brand-name condoms took $220 million in write-offs and reported an operating loss of $37 million. In this day and age of AIDS, how could the world's largest condom manufacturer lose money?

Easy. London International decided to diversify into retail photo

processing, fine china, and beauty aids. Recently new management took over and out went diversification and in went focus. This year the world's largest condom manufacturer reported a net profit of $19 million on sales of $509 million.

Line extension is not a big-company phenomenon. Small companies are more prone to line-extend their brands than their big brothers. In 1988, Main Street Muffins was a $100.000-a-year retail business in Akron. Ohio, when a local restaurateur asked the owners to sell him frozen muffin batter rather than just fresh muffins. And a wholesale business was born.

Main Street bought new equipment, developed systems, and started selling to other restaurants. Things were looking so rosy, they opened a second store. But all was not what it seemed to be. Serving two different businesses was stretching their resources. Employee morale was falling. A year later both the retail stores and the batter business were bound for bankruptcy. It was decision time.

Confucius say: Man who chases two rabbits catches neither.

The owners. Steven Marks and Harvey Nelson, decided to chase one rabbit only. They sold the stores and focused on the frozen batter business, even though it represented only about a third of their total sales.

Within three months the wholesale business became profitable and has remained so ever since. And business has been rising at a rapid rate. Since 1990, Main Street's sales have increased an average of 100 percent a year. Currently the company does $10 million worth of muffin business a year.

"Instead of doing two things subpar." says Steven Marks, "'we needed to do one thing exceptionally well. We reasoned that to be successful we had to be focused. We had to devote our energies to that part of the business that had the best chance for success

Small companies like Main Street Muffins already have two strikes against them. Of the seven hundred thousand new businesses started this year, only thirty-five thousand (or one in twenty) will be around five years from now. And the primary reason for a small company's failure is trying to do too many different things at once.

If you do one thing, and do it well, you can build a reputation that almost guarantees success in the long term. (Unfortunately, you can also starve in the short term, which is why capital is the crucial component of any start-up.)

THE UNFOCUSING OF CORPORATE AMERICA 15

What's true in muffins is also true in computers. Years ago when IBM was focused on mainframe computers, they made a ton of money. Today IBM makes mainframes, midrange computers, workstations, desktop computers, home computers, and software (to mention some of their major product lines) and they are in trouble.

In 1991, for example, IBM's revenues were $65 billion. Yet they wound up losing $2.8 billion. In 1992, they lost $5.6 billion. In 1993, they lost $8.1 billion. (In 1994, IBM managed to make $3 billion, but the future looks anything but bright for Big Blue.)

Along the way, IBM dropped millions on copiers (sold to Kodak), Rolm telephone equipment (sold to Siemens), Satellite Business Systems (sold to MCI), the Prodigy network (limping along), SAA, Top View, Office Vision, and OS/2. What's the justification for all these unfocusing moves?

In an attempt to maintain its industry leadership, IBM thinks it has to ride the "computer" horse. Wherever the computer industry goes, goes the thinking, IBM has to follow. In fact, there has been considerable criticism in the media that IBM didn't move fast enough. Networking, client-server, and desktop software are some of the areas that critics say IBM should have pursued more vigorously. (The critics even applauded the purchase of Lotus.)

When you try to ride an expanding industry, the way IBM has tried to ride the computer horse, you get pulled apart. It's like being on the rack.

Yet that's what most companies do. When they become incredibly successful, they invariably sow the seeds for their future problems. Take Microsoft, one of the most successful companies in the world. If ever a company is on top, it's Microsoft. (Even though it's one-thirtieth the size of General Motors, Microsoft's stock is worth more than GM's.)

Whom does that sound like? Sounds like IBM. Microsoft is setting itself up as the next IBM, with all the negative implications that term suggests.

There are ominous signs of softness in Microsoft's strategy. The Economist magazine reported in early 1992, "Mr. Gates is putting together a range of products, based on a common core of technology, that will compete across virtually the whole of the software industry: from big computers to small ones, and from operating systems in the information engine-room to graphics programs that draw

every picture for executives. Nobody in the software industry has yet managed a venture of that complexity—though IBM has tried and failed/'

When you try to be all things to all people, you inevitably wind up in trouble. "I'd rather be strong somewhere," said one successful manager, "than weak everywhere."

In a narrow sense, line extension is taking the brand name of a successful product (A.l. steak sauce) and putting it on a new product you plan to introduce (A.l. poultry sauce).

It sounds so logical. "We make A.l., a great sauce that gets the dominant share of the steak business. But people are switching from beef to chicken, so let's introduce a poultry product. And what better name to use than A.l. That way people will know the poultry sauce comes from the makers of that great steak sauce, A. 1."

But business is a battle of perceptions, not products. In the mind, A.l. is not the brand name but the steak sauce itself. "Would you pass me the A.l.?" asks the diner. Nobody replies: "A.l. what?"

In spite of an $18 million introductory advertising budget, the A.l. poultry launch was a dismal failure.

There are as many ways to line extend as there are galaxies in the universe. And new ways get invented every day. In the long run and in the presence of serious competition, line extensions almost never work.

Back in 1978. when 7UP was simply the lemon-and-lime Uncola. it had a 5.7 percent share of the soft-drink market. Then Seven-Up added 7UP Gold, Cherry 7UP, and assorted diet versions. Today 7UP's share is down to 4.2 percent.

Wherever you look, you find line extensions, which is one reason stores are choked with brands. (There are 1,300 shampoos, 200 cereals, 250 soft drinks.)

Take Tab versus Diet Pepsi. The common assumption is that Coca-Cola introduced Diet Coke because Tab was losing the diet cola war to Diet Pepsi. Nothing could be further from the truth. The day Diet Coke was introduced Tab was leading Diet Pepsi in market share by about 32 percent. Today Diet Coke's lead over Diet Pepsi is still about that same percentage.

When two line-extended brands compete against each other, one line-extended brand has to win. So there's always plenty of line-extension successes like Diet Coke to brag about.

THE UNFOCUSING OF CORPORATE AMERICA 17

Invariably the leader in any category is the brand that is not line-extended. Take baby food, for example. Gerber has 72 percent of the market, way ahead of Beech-Nut and Heinz, the two line-extended brands.

In spite of evidence that line extensions don't work, companies continue to pump them out. Some examples:

• Listerine mouthwash. Listerine toothpaste?

• Mentadent toothpaste. Mentadent mouthwash?

• Life Savers candy. Life Savers gum?

• Bic lighters. Bic parity hose?

• Hostess Twinkies. Hostess Twinkles Lights?

• Tanqueray gin. Tanqueray vodka?

• Coors beer. Coors water?

• Continental Airlines. Continental Lite?

• Heinz ketchup. Heinz baby food?

• USA Today. USA Today on TV?

• Adidas running shoes. Adidas cologne?

• Levi's blue jeans. Levi's shoes?

According to New Product News, a leading trade publication, 20,076 new consumer goods appeared on the shelves of America's supermarkets and drugstores in 1994. This was an increase of 14 percent over the previous year. Approximately 90 percent of these new products were line extensions.

It may be just a coincidence, but only 10 percent of these new products are successful enough to be on the shelves two years after their introduction, according to Kevin Clancy, a leading marketing consultant.

Supermarkets today make a substantial part of their profits not by selling products to consumers but by selling services to manufacturers. Under a ubiquitous category called "trade promotion," manufacturers are paying for displays, promotions, advertising, discounts, and a variety of creative schemes designed by supermarket and drug chains to extract money from their vendors.

The latest is the slotting fee, which presumably pays for putting a new product on retailer shelves. Even a modest national launch of a new product can call for $2 million in slotting fees. And if the product fails, retailers sometimes demand a "kill fee" to take the product off the shelves.

Line extensions are unfocusing both the manufacturers that produce them and the retailers that sell them. One supermarket chain counted 240 analgesics on its shelves. Customers don't need that many pain relievers. All they create is a headache for the people who have to stock and maintain the shelves.

Most new products are line extensions. Most new products fail. These are the two immutable facts that management should keep in mind the next time someone recommends the umpteenth line extension of the product.

Why does management believe in line extension in spite of the overwhelming evidence to the contrary? One reason is that while line extension is a loser in the long term, it can be a winner in the short term.

But you can't measure success in the short term only. Every Miller line extension was pronounced a success. First there was Miller Lite, followed by Miller Genuine Draft and Miller Genuine Draft Light. And then, of course, Miller Reserve, Miller Reserve Light, and Miller Reserve Amber Ale. Not to mention Miller Clear. Miller High Life Light, and Miller Genuine Red.

Miller Lite also has had its share of extensions. Lite Ultra and Miller Lite Ice.

Did Miller increase its share o\' the beer business? Short-term, yes, but long-term, no. Furthermore, in the wake o( its line-extension successes. Miller has fallen farther behind Anheuser-Busch.

THE UNFOCUSING OF CORPORATE AMERICA 19

Not that Anheuser-Busch hasn't been busy on the line-extension front. After the launch of Miller Lite in 1974, Anheuser-Busch waited eight years to launch Bud Light. By 1994, Bud Light had become the largest-selling light beer in America, but mostly at the expense of their regular beer.

In the six years between 1988 and 1994, for example, Bud Light gained five million barrels and Budweiser lost seven million barrels. And the decline of Budweiser is likely to continue.

Momentum is the most powerful force in business today. The big mo is the hardest force to capture and the easiest force to lose. One sure way to kill a brand's momentum is by line extensions. Coors was brewing a curious malt-beverage product called Zima. By 1994, the brand had 2 percent of the beer market.

Then Coors introduced Zima Gold. Since Zima, with a gin-and-tonic taste, appeals to women, the idea was to broaden the appeal to men with Zima Gold, which has a bourbon-and-soda taste. Lots of luck.

Today Zima Gold is dead and the original Zima has less than 1 percent of the market.

Managers frequently fall for the fallacy that customers are demanding more flavors, more variety, more choices. Hence, more line extensions. Oddly enough, you find more line extensions in categories that are declining in sales than in categories that are increasing in sales.

Beer, coffee, and cigarettes, three categories that have been steadily declining in sales, have had the most line extensions. (There are a dozen or so varieties of Marlboro cigarettes.)

Per-capita beer consumption, for example, has declined eleven out of the last thirteen years. When customers are walking away from your category, why would you need more brands to satisfy those customers? Logic suggests you would need fewer brands.

But that's customer logic. Manufacturer logic is different. Since our volume is declining, the manufacturer concludes, we need more brands to maintain or increase our sales. When a category is increasing in sales, there's opportunities for new brands, but manufacturer logic suggests they're not needed.

As a result, the marketplace is filled with line extensions in areas where they are not needed and is starved for new brands in areas where they are needed. Go figure.

One of the loonier line extensions was put in the nation's drugstores a few years ago by Sterling Winthrop, when it was the pharmaceutical products subsidiary of Eastman Kodak. Sterling's big brand is Bayer aspirin, but aspirin was losing out to acetaminophen (Tylenol) and ibuprofen (Advil).

So Sterling launched a $116 million advertising and marketing program to introduce a selection of five "aspirin-free" products. The Bayer Select line included headache pain relief, regular pain relief, nighttime pain relief, sinus pain relief, and menstrual formulations. All products contained either acetaminophen or ibuprofen as the core ingredient.

Results were painful. The first year Bayer Select sold $26 million worth of pain relievers in a $2.5 billion market, or a little over 1 percent of the market. Even worse, the sales of regular Bayer aspirin have been falling about 10 percent a year. Why should you buy Bayer aspirin if the manufacturer is telling you that their "select" products are "aspirin-free"?

Management can also be blinded by an intense loyalty to the company or brand. Why else would PepsiCo have introduced Pepsi XL, Pepsi Max, and Crystal Pepsi in spite of the failures of Pepsi Light and Pepsi AM?

Another reason you find so many line extensions on the market is the belief that they are less expensive to launch than new brands. Not true, according to one chief executive who ought to know. "It costs as much to introduce a line extension," says John MacDonough, CEO of Miller Brewing, "as it does to introduce a new brand."

The hottest new beer on the market is not a line extension at all. It's Red Dog from Miller Brewing. In its first five months. Red Dog amassed a 1.4 percent share of major supermarket beer sales in the United States, exceeding the combined volume of all the micro-brewers.

Furthermore, look at the "ice" beer category. Every major beer brand has an ice line extension: Miller Lite Ice, Bud Ice, Molson Ice, Labatt Ice, Coors Artie Ice, Schlitz Ice, and Pabst Ice Draft. So what is the leading ice beer? Icehouse, the only major non-line-extended brand in the category.

But the issue at any company is not line extensions versus new brands. The issue is whether a company should emphasize growth above all other factors.

THE UNFOCUSING OF CORPORATE AMERICA 21

The more products, the more markets, the more alliances a company makes, the less money it makes. "Full speed ahead in all directions" seems to be the call from the corporate bridge. When will companies learn the lesson that line extension ultimately leads to disaster?

If you want to be successful today, you have to narrow the focus in order to stand for something in the prospect's mind.

What does IBM stand for? They used to stand for "mainframe computers." Today they stand for everything, which is another way of saying they stand for nothing.

Why is Sears in trouble? Because they tried to be all things to all people. Sears was big in hard goods, so they went into soft goods and then into fashion. They even hired Cheryl Tiegs. (Do fashion models really buy their miniskirts at Sears?)

In the conventional view, a business strategy usually consists of developing an "all-encompassing vision." In other words, what concept or idea is big enough to hold all of a company's products and services on the market today and planned for the future?

In the conventional view, strategy is a tent. You stake out your tent big enough so it can hold everything you might possibly want to get into.

IBM has erected an enormous computer tent. Nothing in the computer field, today or in the future, will fall outside the IBM tent. This is a recipe for disaster. As new companies, new products, new ideas invade the computer arena, IBM is going to get blown away.

You can't defend a rapidly growing market like computers even if you are a financial powerhouse like IBM. From a strategic point of view, you have to be much more selective, picking and choosing the area in which to pitch your tent.

Technological change accelerates the arrival of the specialist. As time goes on, and new technologies arrive on the scene, business becomes more specialized. In place of a shoe-manufacturing plant, we now have factories that specialize. In men's shoes, women's shoes, children's shoes, work shoes, casual shoes, boots.

As time goes on and lifestyles change, opportunities are created for new specialists who know how to take advantage of change. It wasn't Florsheim or U.S. Shoe that benefited from the arrival of the athletic shoe. It was the athletic-shoe specialists Nike and Reebok.

Power lies with the specialist, not the generalist. As new tech-

nologies change the nature of the marketplace, existing companies try to encompass the new technologies within the framework of their organizations. As a result they become unfocused and are easy targets for the specialists.

Technological change in the computer industry heralded the arrival of the specialists who focused on one type of computer and in the process carved out significant pieces of business that Big Blue considered to be its private domain.

Digital Equipment in minicomputers. Sun Microsystems in UNIX workstations. Silicon Graphics in 3-D computing. Compaq in office personal computers. Packard Bell in home personal computers. Dell and Gateway 2000 in mail-order personal computers.

"It's one of the great mysteries of the computer industry," said the Wall Street Journal in 1995. "Why has the world's biggest computer maker—the company that practically created the personal computer market—floundered in PC software?"

Is it really a great mystery? None of the other personal computer manufacturers are a big factor in PC software. Not Compaq. Not Dell. Not Gateway. Not Packard Bell. Not Digital Equipment. Not Hewlett-Packard. Why should IBM be big in PC software?

Who is big in personal computer software? The specialists, of course. Microsoft, Novell, Adobe, Intuit, Borland, Broderbund, and dozens of other software companies, none of which make personal computers.

(Every computer company, of course, has a software business to the extent that they can "tie" software sales to hardware. This bundling practice creates a barrier that competitors find hard to penetrate. Even IBM has an $11 billion software business, two-thirds of which is mainframe related.)

Strategically, General Motors is in the same boat as IBM. GM is into anything and everything on wheels. Sedans, sports cars, cheap cars, expensive cars, trucks, minivans, even electric cars. So what is GM's business strategy? If it runs on the road, or off the road, we'll chase it.

If there were nothing but general surgeons and you were the only brain surgeon, you would have an incredible business and you could charge outrageous prices. Companies that find themselves in similar situations think the opposite.

Imagine a medical practice saying to itself: "We are known as ter-

THE UNFOCUSING OF CORPORATE AMERICA 23

rific brain surgeons, so let's get into the heart, liver, lung, and limb business." In other words, they turn themselves into general surgeons. It never happens in medicine. It does happen in management.

What's the primary purpose of a brand? The number one objective of a brand, according to a recent survey of senior executives, is "to provide an umbrella for products and services." Whether you call it an umbrella or a tent, putting everything under one roof is a dangerous practice. It's the management theory that leads directly to the line-extension trap.

For many companies line extension is the easy way out. It's perceived as the inexpensive, logical way to grow. Only when it's too late does a company turn around and notice that they have become unfocused, perhaps precariously so.

THE DRIVING FORCE OF GLOBALIZATION

The biggest story in the business world today is the rise of global trade. To take advantage of dramatically lower trade barriers brought about by treaties like GATT, NAFTA, APEC, and Mercosur, every country in the world is trying to increase its export business.

How will globalization affect your business?

It will tend to unfocus your business . . . even though you make no changes in your line of products or services.

Why this is so is best explained by an analogy. Let's say you're living in a small town in Wyoming with a population of fifty people. What kinds of retail stores are you likely to find?

Exactly. One "general" store that sells everything: food, clothing, gasoline.

Now move to New York City with a population of eight million. What kinds of retail stores are you likely to find?

Exactly. Many highly specialized retail establishments. Not just shoe stores, for example, but men's shoe stores, women's shoe stores, children's shoe stores, athletic shoe stores.

The larger the market, the more specialization that takes place. The smaller the market, the less specialization that takes place and the more generalized the companies. As the world moves to a global economy, companies are going to have to become more specialized.

Some industries are going global faster than others. The cola industry, the computer industry, and the commercial airplane industry are virtually global now. Others will take decades or longer to achieve the

THE DRIVING FORCE OF GLOBALIZATION 25

same degree of globalization. Retail might never get there, although the television shopping channels and the catalog houses are hastening the process.

The boom in global trade has been astonishing. Take a trip to any major city in the world and read the billboards from the airport into town. "Sharp, Canon, Samsung, Xerox, Philips, Marlboro, Shell, IBM, Coke." What country are you in?

If you just read the billboards, you wouldn't know what continent you were on, let alone which country or city you were in.

You often can't tell by the clothing worn by the natives either. Especially the younger natives. Jeans, T-shirts (with appropriate advertising slogans), and sneakers are the uniforms of the teenage crowd in Europe, Asia, Latin America, and the United States.

Foreign trade is healthy for a country's economy. The Far East is the most spectacular example of what can be accomplished by a global focus. Japan, Taiwan, Hong Kong, Singapore, and Korea have all gotten relatively rich through the medium of trade. Trade is driving virtually every business of any significant size into world markets. A company either competes against imports only at home, or competes around the world in markets of increasing sophistication.

While many companies have benefited, the globalization of business is also rapidly unfocusing many companies that have yet to understand the long-term implications of a world based on free trade. Again, it's back to the basic principle of specialization: The larger the market, the more specialized a company must become if it is going to prosper. When we have truly free trade on a worldwide basis, every company in the world will have to specialize in order to survive.

Except that many companies don't see it that way. They see the rise of a global economy as an opportunity to broaden their lines, not narrow them.

Take the example of a German food company late in 1992. At the beginning of 1993, with the abolishment of border controls and other barriers to free trade, Germany, with a population of 81 million, was going to become an integral part of a "single market" European Union with a population of 347 million people.

In other words, the German company found that its "home" market more than quadrupled overnight. How did most companies respond to that kind of overnight population explosion? The temptation to broaden the line must have been overwhelming.

"Let's see, we'll need a sweet-tasting version for the English, a tart-tasting version for the Italians, an herbal version for the Dutch," etc. While this might be logical thinking, it's also diametrically opposed to the principle that the larger the market, the more specialized a company must become. As your market expands, your product line must contract.

As a result, many corporations all over the world are in trouble. But globalization affects companies in some areas more than it does companies in other areas. Compare Europe with America. Of the two, which area is the scene of more corporate disasters?

Europe, of course, but the reasons are not readily apparent. Most observers tend to blame Europe's high cost of employee benefits, the rigidity of labor laws, the high taxes needed to support the welfare states, and especially the inability to hire and fire at will. While these factors undoubtedly contribute to the economic malaise that has swept the Continent, there's another factor that's often overlooked.

Compared with U.S. companies, most European concerns have a much broader product line. Siemens makes many of the same electrical products that General Electric makes. Plus Siemens also makes a wide range of computers, telecommunication switches, and electronic equipment, products that General Electric doesn't make.

As a matter of fact, intense competition in mainframe computers drove General Electric out of the computer business in the United States. Much tamer competition in Germany helps keep Siemens in the computer business.

Take Philips Electronics of the Netherlands. Here is a $39 billion company trying to compete in the chip business (against Intel), in the video game business (against Sega and Nintendo), in the lighting business (against General Electric), in the VCR and camcorder business (against Sony and a host of others).

Along the way, Philips has dipped its toes into the computer business, the cable television business, and the video rental business. Not to mention the $175 million investment in Whittle Communications, which was almost a total loss.

In 1990, Philips lost $2.3 billion and nearly went under. Needless to say, the stock has gone nowhere the past decade. The current boom in semiconductors is keeping the company healthy in the short term, but Philips desperately needs a locus for the long term.

Take Daimler-Benz, the largest industrial company in the most

THE DRIVING FORCE OF GLOBALIZATION 27

economically successful country in Europe, the Federal Republic of Germany. Along with those natural advantages, Daimler-Benz owns the world's best automotive brand name, Mercedes-Benz. You would think that Daimler would be rolling in deutsche marks, but they're not. In 1995, the company lost substantially more than $1 billion.

The problem is not cars. The Mercedes-Benz division has been consistently profitable. The problem is diversification. During the eighties, Daimler-Benz got into everything from jets to helicopters to trains to satellites. (The latest is a minivan project in China estimated to cost $1 billion.) If you had bought Daimler stock a decade ago and sold it today, you would have had a substantial loss.

As business goes global, Daimler-Benz should have been driving in the opposite direction. It should have been narrowing its focus to luxury cars only and using its car profits to build assembly plants around the world instead of using them to prop up its money-losing subsidiaries.

Or take Fiat, Italy's largest company. The $40 billion Fiat car group makes a full line of automobiles much like $155 billion General Motors. But the Agnelli family, which controls Fiat, also has interests in everything from motor scooters to farm equipment to trucks. Also chemicals, insurance, food, publishing, sports, railroads, and defense. (Listed companies in the Agnelli aggregation represent more than 25 percent of the value of the Milan Stock Exchange.)

The Fiat/Agnelli combination has a much wider product line than General Motors, with much smaller sales. As globalization drives companies into becoming specialists, this combination is going to be under intense pressure to break up.

In 1993, Fiat alone lost $1.1 billion. In 1994, thanks to a 25 percent devaluation of the lira (which helped Fiat abroad while making imported cars more expensive at home), Fiat posted $612 million in profits. More and more, however, it looks like Fiat is organized for the past with its feudal network of so-called salotto buono, or business insiders, linked to state banks and political parties. Fiat's future is far from bright.

There's more to come. Recently, a new $28 billion conglomerate was announced that would combine the chemical interests of Fiat with the Ferruzzi Finanziaria group and its chemical subsidiary,

Montedison. The conglomerate would be under the control of Mediobanca, the powerful Milan investment bank, and the Agnelli family. Ferruzzi itself is a sick company that nearly collapsed two years ago under $20 billion of debt. It was saved only because the banks swapped debt for equity.

The Ferruzzi deal "makes no sense," said one financial expert. It created a huge conglomerate "at a moment when the formula is growing obsolete almost everywhere in the world." (Thanks in part to scathing reports in the media, the ill-conceived merger was recently called off.)

Olivetti is going down the same path. Europe's second largest computer manufacturer (after Siemens Nixdorf), Olivetti has not had a profitable year since 1990. In the past four years the company lost $1.5 billion. Managing director Corrado Passera agrees that Olivetti "used to do too many things." At home, it was a typewriter-to-mainframe company, while overseas it was trying to run a worldwide personal computer business.

Instead of narrowing its focus, Olivetti looked around for other businesses it could enter. It found three: services, telecommunications, and multimedia. As business becomes more global, Olivetti should have looked for ways to reduce, not expand, its product offerings.

In addition, Olivetti suffers from the same organizational problems that Fiat does. The company is controlled by Carlo De Benedetti, a younger version of Gianni Agnelli. De Benedetti's holding company, Compagnie Industriali Riunite, has interests in electronics, retailing, and other fields. It's hard to compete with IBM, Apple, and Compaq when you have a portfolio of other products to worry about.

Currently, Olivetti has 4 percent of the European personal computer market versus 14 percent for Compaq Computer.

Highly profitable Compaq is more than twice the size of its Italian rival, but unlike Olivetti, Compaq has not diversified into telecommunications, multimedia, or services. Not necessarily by choice, however.

It's the larger size of the U.S. market and therefore the driving force of specialization that has made American companies like Compaq more focused. As the globalization of business continues, the pressure will increase on European companies to narrow their

THE DRIVING FORCE OF GLOBALIZATION 29

focuses or they will increasingly be at a relative disadvantage. You can expect to see a lot of turmoil taking place in the European business community.

Of course, the European Union is technically a larger market than the United States. But it's not a single market in the true sense of the word. It will take time for the EU market to become "homogenized" to the same degree that the U.S. market is. Maybe decades.

The same is true of the globalization of business. It will take many decades for the world to approach a truly single global market, even if all governments cooperate in the establishment of such a market. Even then there will probably be many countries that stay on the sidelines in order to protect their home businesses. ("No nation," said Benjamin Franklin, "was ever ruined by trade.")

The same principles apply on the other side of the globe. Japan has been in an economic slump for several years. One reason is that Japanese companies, to a large extent, have product lines that are much too broad.

This is so not only because the Japanese market is smaller than that of the United States, a factor that accounts for part of the broadening of the lines, but also because the control-minded Japanese government has encouraged the trend. It's easier to keep track of a few companies making a broad range of products than it would be here in the wild and woolly United States, where many narrowly focused companies compete for a slice of the market.

Of the top ten corporations in the United States, only one (General Electric) is a classic conglomerate. Of the top ten corporations in Japan, eight are conglomerates. Only two are not (Toyota Motor and Nippon Telegraph & Telephone, a recently privatized government monopoly).

Six of the top ten corporations in Japan are sogo shosha, or trading companies. In total they account for revenues of almost a trillion dollars, or one-fourth of Japan's gross domestic product. Yet they operate on paper-thin margins. Net income is less than one-tenth of 1 percent of sales. Prediction: The sun will soon be setting on some of these Japanese-style conglomerates.

The Japanese Big Six are as unfocused as one could possibly imagine. They are commission agents, dealers, financiers, venture capitalists, and investors in the stock of their keiretsu members. In addition the sogo shosha have been pouring money into oil and gas

production facilities, power plants, satellite communication ventures, and cable television systems.

Many of their keiretsu members are already falling behind the curve. Mitsubishi Electric, for example, is a $29 billion company that makes everything from semiconductors to consumer electronics, from space equipment to transport systems. Sales and profits have been declining since the early nineties.

As brand names become more important, companies like Mitsubishi Electric are going to suffer even more. Annual revenues of some of the companies that share the name include Mitsubishi Motors ($34 billion), Mitsubishi Bank ($30 billion), Mitsubishi Heavy Industries ($29 billion), Mitsubishi Chemical ($13 billion) and Mitsubishi Materials ($10 billion). A name that tries to stand for everything winds up standing for nothing.

The Japanese practice of fielding a wide variety of products under the same name has drawn favorable comments from many business writers who don't always look under the financial covers to find the real story. One particular favorite has been Yamaha. "How a motorcycle manufacturer manages to successfully sell pianos" is the general nature of their stories.

In the first place, Yamaha Motors is a separate company, only one-third owned by the piano company, Yamaha Corporation. In the second place, Yamaha Corporation has been far from financially successful. A typical Japanese-style conglomerate, Yamaha Corp. makes archery equipment, golf clubs, audio equipment, kitchens, skis, electric bicycles, and, of course, musical instruments.

As a matter of fact, Yamaha is the world's largest maker of musical instruments. In the past decade Yamaha sold about $46 billion worth of products at current rates of exchange. Yet net income has been less than 1 percent of sales. Profitless prosperity seems to be the Japanese style of business, consistent with their philosophy of massive line extensions and a marketing emphasis on low price.

Japan is a land of a thousand Yamahas. Companies that make everything under a common brand name and sell on price. Hitachi ($76 billion), Toshiba ($48 billion), Sony ($40 billion), NEC ($38 billion), Canon ($19 billion), Sanyo ($16 billion), Sharp ($14 billion), and Ricoh ($10 billion). Collectively these eight Japanese conglomerates did $261 billion in sales in a recent year and managed to almost break even.

THE DRIVING FORCE OF GLOBALIZATION 31

A big contributing factor was a $2.9 billion loss at Sony, but none of the eight conglomerates were particularly profitable. The best performance was at Sharp, with net income of $295 million, or a little more than 2 percent of sales. (With a similar sales volume, Caterpillar had net profits of almost 7 percent of sales.)

In the long run, Japanese conglomerates are going to be no match for narrowly focused companies with strong brand names and even stronger bottom lines. The stock market reflects the poor prospects of Japanese companies. Since 1990, the Japanese market has fallen by 50 percent while the U.S. market was rising by 75 percent.

The situation is even worse in countries like Korea with stronger government control of the economy. Four giant chaebols dominate the Korean economy: Samsung ($63 billion), Hyundai ($63 billion), LG ($48 billion), and Daewoo ($40 billion).

"From chips to ships" said a recent Hyundai advertisement. Here is a company that literally makes everything except the kitchen sink. According to Hyundai, the company is in the following industries: "automobiles, electronics, shipbuilding, engineering and construction, machinery and equipment, petrochemicals, trading, and transportation."

Or look at the Samsung line: consumer electronics, shipbuilding, computer chips and screens, aerospace, petrochemicals, engineering and construction, life insurance. Recently Samsung paid $378 million for a 40 percent stake in AST Research, a money-losing U.S. manufacturer of personal computers.

Even more astonishing is Samsung's 1994 decision to start producing automobiles in a joint venture with Nissan. In autocratic Korea, of course, that decision required government permission, obtained only after a hard-fought campaign by Chairman Lee Kun-Hee, son of the founder.

What if General Electric decided to build automobiles? The stock market would have a fit, and rightly so. The role of the market is not just to supply capital and liquidity to corporations and investors but also to control managements' flights of egomania.

The LG Group is in double trouble. Not only has it given up its name (Lucky Goldstar) for a set of meaningless initials, but the group is also expanding in all directions at once.

In Southeast Asia and India, LG is getting into oil refineries, petrochemicals, communications, and real estate development along with

its core electric and electronics businesses, which include television sets, audio/video products, home appliances, computers and office automation equipment, semiconductors, and liquid crystal displays.

Recently the company spent $351 million to buy 58 percent of television set manufacturer Zenith Electronics. Zenith is no bargain. The company hasn't posted a full-year profit from continuing operations since 1984.

While its protected home market (where LG is number one in television sets, refrigerators, and washing machines) will keep the company relatively healthy, its broad product line is a serious disadvantage in the worldwide market.

In search of synergy, the company has invested $10 million in 3DO to work on the next generation of game hardware, and it's working with Oracle to develop video-on-demand set-top boxes. It's also producing and marketing household appliances with General Electric and developing new operating software with IBM.

Daewoo is following in the footsteps of the other three chaebols. Debt-laden Daewoo recently spent $1.1 billion for a 60 percent stake in a state-owned Polish automobile factory. That's in addition to the $340 million Daewoo invested in another Polish car manufacturer.

The company also put up $156 million to establish a joint venture to build its Cielo family car in Romania. Daewoo already builds the Cielo in New Delhi and plans to invest $5 billion in India's auto industry in the next five years. Daewoo also earmarked $2 billion for a joint-venture auto-parts plant in China. Two years ago, the company broke ground on a $500 million car plant in Uzbekistan.

Mind you, Daewoo isn't just an automobile company. Daewoo is a trading/consumer electronics/construction/shipbuilding/computer/ telephone/financial services/automobile company.

Nor is Daewoo a profitable automobile company. In spite of a protected domestic market, Daewoo has lost more than $450 million in the past four years. Meanwhile the company is preparing a 1997 entry into the highly competitive U.S. automotive market. Good luck.

The chaebol system in Korea and the keiretsu system in Japan help dampen competition in home markets but don't do anything to make the home teams globally competitive, aside from furnishing the funds domestically to lose abroad. (Using domestic profits to subsidize export sales is "dumping," and is illegal under international trade rules.)

THE DRIVING FORCE OF GLOBALIZATION 33

If anything, by encouraging a broadening of the product line, the chaebol and keiretsu systems destroy a company's power outside of its home country.

China seems to be following the same pattern. Zheng Dunxun, president of Sinochem, China's largest company, thinks the $15 billion giant is too small. "We must diversify in all areas and very rapidly to compete." So he's turning Sinochem into a Japanese-style multinational trading, industrial, and financial giant, known in the Chinese media as an "aircraft carrier."

Other Chinese chief executives are rushing to park their aircraft on the deck of a carrier. "Big is beautiful" seems to be the buzzword in management circles.

Big is beautiful, but only if a company is narrowly focused. As a developing country, China offers many opportunities for intra-industry mergers, much like the one that created General Motors in 1908.

The Chinese automotive industry is highly fragmented. Few people can name even one of China's 130 makers of cars and trucks. As it happens, the United States had approximately the same number of car manufacturers the year GM was formed.

Big is beautiful, but not when it's a collection of unrelated businesses. As a matter of fact, General Motors was a financial mess until Alfred Sloan found a way to focus the company in the twenties (chapter 12).

Further complicating the long-term problems of countries like Japan, Korea, and China is the globalization of money. In the future, companies cannot count on low-cost money anymore. It's too easy for investors to shift their capital to companies in other countries where the returns on their investments are higher.

In the past, Japanese companies have benefited from favorable interest rates. Currently the Bank of Japan's discount rate is 0.5 percent. The prime rate is around 1.5 percent. But these low rates are unlikely to continue.

Like products and services, money in the future will flow into those countries that offer the highest returns. Unless the keiretsus and chaebols find a way to increase their profits, they are going to be starved for capital. Without profits, there is no way for a conglomerate to meet its future capital requirements.

Many companies in the U.S. market are creating their own keiretsus with alliances or "soft mergers," which have become extremely

popular. According to management-consulting firm Booz, Allen & Hamilton, the number of formal alliances jumped from 750 during the seventies to 20,000 in the five-year period from 1987 to 1992.

Quick, name one alliance that has been a spectacular success. The truth is, most alliances have been disappointments to their principals. They drain money, resources, and management time into unproductive areas. Alliances unfocus a corporation.

Take Apple's alliance with IBM. This "computer keiretsu" has produced two joint ventures in the software area, Taligent and Kaleida, which have yet to produce a profitable product. (Nor are they likely to do so in the future.) Out of this alliance has emerged the PowerPC chip, a product produced by IBM and the third partner in the deal, Motorola, Inc.

The PowerPC chip has been a mixed blessing. It has helped Motorola sell a few more chips, but it has done nothing positive for Apple Computer. For IBM the new chip is a definite negative because Big Blue must now support two chip standards, the Intel and the PowerPC.

The numbers reinforce this conclusion. The day the pact was announced on October 2, 1991, at an elaborate San Francisco event beamed around the world via satellite, Apple and IBM were number one and number two with 35 percent of the U.S. personal computer market. Four years later the two protagonists were number two and number four with 21 percent of the market.

The hype that accompanied the announcement was awesome. "IBM-Apple could be fearsome," boasted Business Week. "Their final agreement is a sweeping array of joint efforts in hardware, software, and networking that could profoundly alter the $93 billion personal computer industry's balance of power." It never happened.

Furthermore, the two executives who negotiated the deal (John Sculley of Apple and James Cannavino of IBM) are both gone.

One wonders whether the same hype accompanied the creation of the dinosaur some hundreds of millions of years ago. "The ten-ton Tyrannosaurus rex will rule the world." Which is exactly the hype that accompanied the planned merger of Walt Disney and Capital Cities/ABC. (The ABCDisneysaurus rex.)

Also the Time Warner and Turner Broadcasting System merger. (The Timeturnersaurus rex.)

Where have all the dinosaur reptiles gone? Will the same question

THE DRIVING FORCE OF GLOBALIZATION 35

be asked about the dinosaur corporations? I think so. Corporate size is not a measure of corporate power. Size is a weakness if the company is not focused.

IBM was a $35 billion powerhouse when Compaq was just a sketch on a paper place mat. Yet today, thirteen years later, Compaq leads IBM in personal computers by a wide margin. Compaq is focused. IBM is not.

The dinosaur is a good image to keep in mind for companies in smaller countries trying to break into the global market. These companies often complain of the difficulties of exporting to the larger, developed countries. They fear the challenge of competing with larger, more established companies.

But the real problem is not the size of the country but the focus of the company. In a small country, the typical company is far more diversified than the typical company in a large country. The small country is paying the price in export markets for its companies' lack of specialization or focus in its home markets.

To effectively compete in export markets a company has to narrow its product line and concentrate on establishing both a reputation and a market presence. Be it tomatoes or baseball bats, radios or leather coats, the most globally successful companies based in small countries are those with a razor-sharp focus and a dedication to selling in the global marketplace.

With global specialization and focus comes change in the composition of economies and industries. Companies cannot compete effectively in every sector of the market and neither can countries. Change is the order of the day.

When you see industries such as the U.S. television set industry shift offshore, it does not mean that America is any worse off. In fact, it means that the country is better off. Specialization requires sacrifice. In America, capital and workers are better employed in such industries as aircraft, motion pictures, and computers, where the focus of American firms allows them to dominate world markets.

The globalization of business is driving both companies and countries into greater specialization, a trend that is good for everybody. A country that devotes 100 percent of its resources, human as well as material, to a handful of industries is a country that has become a specialist.

And a country that is probably exceptionally wealthy, too.

THE DRIVING FORCE OF DIVISION

Like amoebas dividing in a petri dish, business can be viewed as an ever-dividing sea of categories.

A category starts off as a single entity usually dominated by one company. IBM dominated the computer category, for example, with the mainframe.

But over time, the category divides into two or more categories. Mainframes, minicomputers, supercomputers, fault-tolerant computers, personal computers, workstations, laptops, notebooks, palmtops, file servers. And more to come.

Beer used to be beer. Then the category divided. Today we have domestic beer and imported beer. Regular beer and light beer. Draft beer and dry beer. Expensive beer and inexpensive beer. Red beer and ice beer. Even nonalcoholic beer. And more to come. ' Ford once dominated the automobile category with the Model T, a car that represented basic transportation. Then the category divided. Today we have luxury cars, moderately priced cars, and inexpensive cars. Full-size, intermediates, and compacts. Imported cars, domestic cars. Sports cars, sport-utility vehicles, RVs, and minivans. And more to come.

Bayer once dominated the pain reliever category with aspirin. Then the category divided. Today we have acetaminophen, ibuprofen, and naproxen sodium. And more to come.

Each segment is a separate, distinct entity. Each segment has its own reason for existence. And each segment has its own leader, which

THE DRIVING FORCE OF DIVISION 37

is rarely the same as the leader of the original category. Bayer leads in aspirin. Tylenol leads in acetaminophen. Advil leads in ibuprofen. And Aleve leads in naproxen sodium.

Division is a fact of life, a driving force of business. Division is happening in every product category from computers to communications to consumer electronics to cable television.

Why then do so many corporate executives believe just the opposite? Why do they believe that categories are coming together and not dividing? And why are these beliefs causing them to rapidly unfocus their companies?

What concept has such a powerful lock on their imaginations it's causing them to see things that are not happening?

It's the concept of convergence, the latest and greatest in a long line of management fads.

Every recent decade has had its own management fad that history proves to have been misguided at best. In the sixties, it was conglomeration, the notion that a professional manager could manage anything. Textron, AM International, ITT, LTV, Litton, and a long list of other conglomerates had their moment in the sun and then faded away.

"The conglomerate theory," according to the Wall Street Journal, "held that companies operating in many different businesses would be less vulnerable to downturns in individual sectors and could benefit from centralized management. But the fad was discredited when conglomerate stocks collapsed, along with the rest of the market, in the 1970s. Indeed, much of the takeover activity of the 1980s involved breaking up multi-industry companies and selling off the pieces."

According to UCLA professor David Lewin, the share of the economy controlled by the big conglomerates has declined dramatically from roughly 45 percent in the sixties to about 15 percent today.

In the seventies, it was diversification, the notion that every company needed a countercyclic business to balance out its business cycle. Xerox, Westinghouse, and a host of other companies got into the financial services business to balance out their basic hard-goods products. The losses are still being tallied up.

The latest example is Seagram, with a beverage business and an entertainment business. Sometimes you can get lucky. But as a corporate strategy, diversification has almost nothing going for it.

After studying the performance of thirty-three big American firms between 1950 and 1986, Michael Porter concluded that diversification had done more to destroy shareholder value than to create it. Most of the companies had divested many more acquisitions than they had kept.

Diversification, of course, was based on the idea of combining two different entities so they would "balance" each other out. When one was down, the other might be up. And vice versa. That's why an electrical company like General Electric bought a mining company like Utah International. (Since sold.) The next decade's fad was based on the opposite idea. Buy a company that's similar to yours.

In the eighties, it was synergy, the notion that a company could exploit the similarities between such products as magazines and motion pictures (Time Warner), cola and wine (Coca-Cola's acquisition and divestiture of Taylor Wine Co.), or consumer electronic and motion pictures (Sony's acquisition of Columbia). The results are still coming in, but the first returns have been dismal.

Synergy and its kissing cousin, the corporate alliance, are still popular buzzwords in the boardrooms of Corporate America. AT&T bought NCR but failed to find any synergy between communications and computers. (Recently AT&T has given up on synergy and split up into three parts, an example of the driving force of division.)

The fad of the nineties is convergence, the notion that digital technologies are coming together. So naturally companies have to merge or set up alliances in order to take advantage of this powerful trend. The media hype behind the convergence fad is enormous. Every major management publication has jumped on the convergence bandwagon.

Fortune: "Convergence will be the buzzword for the rest of the decade. This isn't just about cable and telephone hopping into bed together. It's about the cultures and corporations of major industries—telecommunications (including the long-distance companies), cable, computer, entertainment, consumer electronics, publishing, and even retailing—combining into one mega-industry that will provide information, entertainment, goods, and services to your home and office."

Wall Street Journal: "Shock is a common feeling these days among leaders of five of the world's biggest industries: computing, communications, consumer electronics, entertainment, and publish-

ing. Under a common technological lash—the increasing ability to cheaply convey huge chunks of video, sound, graphics, and text in digital form—they are transforming and converging."

New York Times: "It's no mystery why telephone and cable are pursuing each other. The technological differences that separate telephone, television, and computer transmissions are rapidly disappearing, so one company can now provide all three."

Who will be hurt by the digital revolution?

Michael Crichton, author of Jurassic Park and other best-sellers: "To my mind, it is likely that what we now understand as the mass media will be gone within ten years. Vanished without a trace." And Mr. Crichton has some specific candidates in mind. "The next great American institution to find itself obsolete and outdated will be the New York Times and the commercial networks."

Reminds one of a 1913 prediction by Thomas Edison. "Books will soon be obsolete in the schools," to be displaced by the far more efficient medium of "motion pictures," which instruct "through the eye." (Books have never been more popular, with annual growth rates of 2 percent and more.)

One highly touted combination that has yet to come together is computers and communications. This concept was first publicly articulated in 1977 by Japan's NEC Corporation. A pet project of former CEO Koji Kobayashi, computers and communications, or C&C as it is widely called at NEC, has become well-nigh a religion inside the corporation.

C&C didn't seem to help NEC. The world's fifth largest maker of telecommunications equipment, the world's fourth largest maker of computers, and the world's second largest maker of semiconductors, NEC makes everything but money. In the last decade, NEC shares have lagged behind the Japanese stock market by 28 percent.

AT&T pursued a C&C strategy for more than a decade before throwing in the towel. Back in 1983, chairman Charles Brown said: "The driving force of this revolution, of course, is the convergence of communications and computer technology, which is literally redefining the telecommunications industry."

The 1982 consent decree spinning off local telephone service to seven newly formed Baby Bells included one "benefit" for AT&T. The Justice Department allowed the company to go into the computer business.

Big deal. So far that benefit has cost AT&T billions of dollars. The first iteration of the C&C strategy was the formation of AT&T Information Systems and the less-than-successful marketing of a line of personal computers and workstations. In eight years, the unit rang up $2 billion in losses.

The second iteration of the C&C strategy began in 1991 with the $7.4 billion purchase of NCR Corporation. With NCR, AT&T would "link people, organizations, and their information in a seamless, global computer network," vowed chairman Robert Allen.

NCR (since renamed "Global Information Solutions") has been a financial disaster for AT&T, bleeding losses ever since its acquisition. In five years Global Information Solutions has had four CEOs.

Another sign of trouble was the full product line, from desktop to midrange to mainframe. Global Information Solutions also tried to market a line of "massively parallel" computers, thanks to the $520 million purchase of Teradata Corp.

Personals? Midrange? Conventional mainframes? Massively parallel mainframes? Where's the focus? No wonder AT&T decided to spin off the entire mess. "AT&T abandoned yesterday its once-grand vision of combining communications and computers into a single corporate empire," reported the New York Times. "In the end, that vision proved to be a costly illusion."

Some people call convergence "the broadband-cyberspace-interactive-multimedia-full-service-network-500-channel-digital-information-superhighway revolution." Whatever you call it, the reality is quite different. The driving force in business today is not convergence, it's division.

Convergence is against the laws of nature. In physics, the law of entropy says that the degree of disorder in a closed system always increases. By contrast, a pattern of convergence would make things more orderly.

In biology, the law of evolution holds that new species are created by the division of a single species. Convergence, on the other hand, would have you believe that species are constantly combining, yielding such curiosities as the catdog.

Actually, it's the opposite. Instead of combinations like the cat-dog, new breeds of dogs are coming into existence. Currently the American Kennel Club recognizes 141 breeds of dogs, with a new breed added to the list about once a year.

THE DRIVING FORCE OF DIVISION 41

Take the computer again. According to the convergenists, the computer is going to combine with the telephone, cable, and television industries, producing what is likely to be called "telecableput-ervision." Note that these revolutionary developments are always going to happen sometime in the future.

What about the past? Good question. After all, the computer industry is now pushing forty-five years old, starting with Remington Rand's launch of Univac in the early fifties. In more than four decades has the computer converged with any other product?

Not that I can recall. On the other hand, the computer has certainly done a lot of dividing.

"Those who cannot remember the past," wrote George Santayana, "are condemned to repeat it." The first computer, if you remember, was known as a computer. It was never called a mainframe until Digital Equipment Corp. launched the minicomputer. With that development the computer industry had divided into mainframe computers and minis.

Over the years the computer industry divided again and again. Today we have personal computers, portables, laptops, notebooks, palmtops, pen computers, workstations, supercomputers, super minicomputers, fault-tolerant computers, fault-tolerant minicomputers, parallel processing computers.

If we are to believe the convergenists, all of this division is going to suddenly come to a halt and computers are going to converge! With what? Is someone forgetting the past? It would certainly seem so.

Is the computer going to merge with television? Bill Gates thinks so. "The device we're talking about here has all the benefits of a TV. It is fairly inexpensive; you can stick it in your living room and use a little remote control to control it. But inside are chips that are even more powerful than today's PCs. And if you add a keyboard or a printer you can do PC-like things. So it's a device that needs a new name. We call it the TV/PC."

The TV/PC? Great idea, but doomed to failure. Technologies don't converge, they divide. But companies seem willing to spend millions of dollars exploring these technological dead ends. A few years ago Hewlett-Packard and Time Warner announced plans to jointly develop technologies that would allow a television set to print out sales coupons, advertisements, magazine articles, and color stills of TV shows. Expect nothing of the sort to occur.

Pretty soon they might be introducing a combination TV/VCR. Why not? It's a natural. As a matter of fact there are combination television and videocassette recorders on the market, but very few are bought. The problem is people don't usually buy a new TV or a new VCR until their old one breaks down. Unfortunately for the manufacturers of these combination products, your television set and your videocassette recorder seldom give up the ghost at the same time.

And how about the microwave oven? Did it combine with the electric or gas oven? No, because of the same problem. Why do I have to throw out a perfectly good oven to buy a combination microwave/gas or microwave/electric oven?

Take another example. If any two products should merge, it's the washer and the dryer. Sure, you can buy a combination washer/dryer, but almost nobody does. There are too many advantages with separate units, starting with the revolutionary feature of being able to wash the second load while you are drying the first.

Another favorite convergence concept is "one-stop shopping." Many companies have dropped a bundle trying to make this one work. Saatchi & Saatchi, one of the world's largest advertising agencies, became enamored of the idea. So they bought a basket of design and consulting firms in an effort to handle all of their corporate clients' needs.

Soon after, with losses mounting, Saatchi was forced to sell its nonadvertising businesses. (The stock fell from $80 a share eight years ago to around $2 today.)

Gates has another convergence idea that he calls the Wallet PC. This one combines keys, charge cards, personal identification, cash, writing implements, passport, and pictures of the kids! Not to mention a global positioning system so you can always tell where you are and how to get where you want to go.

Silly? Of course, but the media makes enough of a fuss about the concept that many ordinarily unflappable people get all worked up about the electronic wallet. The truth is that the driving force in business is not convergence. It's division.

When convergence products are introduced, they usually attract only a small market. Witness Apple's Newton, a combination pen computer, electronic calendar, fax machine, and wireless communicator. Few new products received so much media attention as

the Newton. And, unfortunately for Apple, few Newtons are being bought.

One of the most persistent predictions is that cable television and local phone service will converge. After all, both industries wire up houses in similar ways. Why not combine the two operations, reduce overhead, and make the system interactive? Both the Baby Bells and the cable companies have explored mergers and set up joint ventures to explore the possibility.

Bell Atlantic's $32 billion planned takeover of Tele-Communications Inc. was the most visible example of this kind of convergence thinking. The deal collapsed but convergence lives on. Cable companies are talking about offering phone service. Phone companies are talking about offering "movies on demand."

"Every cable company today has a business plan," says a Bell Atlantic vice chairman, "that calls for it to get 10 percent of the market from the local telephone company." Time Warner's chairman predicts that by the year 2000 his company's telephone revenues will surpass $1 billion, about one-third of the company's current cable income.

What's technically feasible isn't always acceptable in the marketplace. Aside from low price, what's the number one customer requirement for telephone service?

Reliability, of course. If your house is burning down, you want to be able to reach the fire department in a hurry. Ditto the police department or the 911 emergency line.

Ask someone the last time their telephone service was out. "Seldom, if ever" is the typical reply. Ask someone the last time their cable service was out. "Last Tuesday" is the typical reply.

Why would anyone switch from a reliable Bell company to an unreliable cable company for telephone service? Highly unlikely. You can live without ER. You might die without EMS.

While cable companies are broadening their services to include telephone and two-way communications, the cable industry itself is dividing. More than a million customers are now getting HBO, CNN, NFL games, Showtime, MTV, and other cable channels via digital satellite systems, or DSS.

DSS was pioneered not by the cable industry but by Hughes Electronics, a subsidiary of General Motors. (Primestar Partners, a consortium of six cable operators and General Electric, is struggling

to catch up.) DirecTV, the Hughes service, is currently outselling Primestar by two to one.

It's typical. The cable companies are so busy trying to get into somebody else's business they don't have the time to see the division taking place in their own business. Leaders are almost never overthrown from the outside. Leaders are almost always toppled from within as the category divides beneath them.

Also on the horizon is wireless cable, which provides a high-quality signal where conditions are favorable. Cable used to be cable. Now we have three kinds: regular cable, wireless cable, and DSS. And more to come.

Why has convergence gained such acceptance in the absence of tangible evidence that it is happening? Again, it's the enormous emphasis that chief executives place on growth. They want to believe in convergence because it promises to double their size. "If my business is converging with somebody else's business, then I can put the two together and be twice as big."

Traditionally, convergence can be thought of as a horizontal combination, the coming together of two equal partners. Lately another kind of convergence has captured the imagination of business leaders everywhere. It could be called vertical integration or vertical convergence.

Vertical convergence is best illustrated by the Walt Disney deal to buy Capital Cities/ABC for $19 billion in stock and cash. It's a merger of content and distribution. "One plus one equals four," said Michael Eisner, Disney CEO.

His thinking is as faulty as his math. Competition is the driving force in improving the breed, not sweetheart distribution deals. From ABC's point of view, the network should be searching for the best content. They should not be forced to take the Disney output.

From Disney's point of view, they should sell their content to the highest bidder. They should not be forced to take the ABC distribution deal. One plus one equals maybe one and a half.

Ask Matsushita. They thought they needed content to fill their Panasonic hardware, so they bought MCA, a major motion-picture studio. While MCA did well under Matsushita's hands-off management, they found precious few synergies with hardware. So they sold the movie business to Seagram.

Ask Sony. They also thought they needed content to fill their

hardware, so they bought Columbia Pictures. Five years and a string of box-office flops later, Sony was forced to take a whopping $2.7 billion write-down.

Sony surrender? Never. The new president of Sony Corporation, Nobuyuki Idei, is going one step further. He plans to move into the distribution of movies, television shows, music, computer software, and other forms of programming to fill in the missing link between Sony's two existing main businesses: creating the programming and building the electronic boxes to play, or consume, the programs.

"My dream," said Mr. Idei, "is to fill the gap between content creation and content consumption."

Whether you call it filling the gap or line extension or vertical convergence, it's just another route toward unfocusing a corporation. Companies that broaden their line, for whatever reason, are vulnerable to narrowly focused competition that takes advantage of division, not convergence.

Since no one can predict the future, how can one be so sure that convergence won't take place?

A study of history is the best place to start. If the computer was the defining product of the second half of the twentieth century, then the automobile was the defining product of the first half. If convergence is a natural effect of technological progress, then what similarities can we find between cars and computers?

In other words, if the computer is going to converge with another product, then perhaps the automobile has already done so.

Most historians credit the invention of the automobile to Karl Benz in 1885. In more than one hundred years, has the automobile converged with any other vehicle?

No, of course not, although many people have tried. In 1945, Ted Hall developed the Hall Flying Car, which was introduced to a wildly enthusiastic public with grandiose predictions.

Roads would become obsolete, traffic jams a thing of the past. You could go anywhere, anytime, with complete freedom of movement. Every major airplane manufacturer in America hoped to cash in on Hall's invention. The lucky buyer was Convair.

In July 1946, Convair introduced Hall's flight of fancy as the Convair Model 118 ConvAirCar. Company management confidently predicted minimum sales of 160,000 units a year. The price was

$1,500, plus an extra charge for the wings, which would also be available for rental at any airport.

In spite of the hype, only two ConvAirCars were ever built. Both now rest in a warehouse in El Cajon, California.

Three years later, Moulton Taylor introduced the Aerocar, a sporty runabout with detachable wings and tail. The Aerocar received a great deal of fanfare at the time. The Ford Motor Company even considered mass-producing it. But the Aerocar met with the same predictable fate as the Flying Car.

A bad idea never dies. Recently Paul Moller, president of Moller International, introduced the M400 Volantor, a "sky car" that Moller has spent twenty-five years and $25 million developing. A former professor of aeronautical engineering at the University of California at Davis, Mr. Moller has taken seventy-two orders for the craft, with a $5,000 deposit each, at a projected price of $800,000 each. (Not exactly a mass-market vehicle.)

Designed to hover motionless in midair and to take off and land vertically from a standing start without a runway, the Volantor is more of a cross between a helicopter and an automobile. Will the product take off? Very unlikely.

If it wouldn't work in the air, maybe it would work on the water.

In 1961, the Quandt Group of West Germany introduced the Amphicar, which was sold around the world until 1965. This was not a flight of fancy; there was a serious marketing effort put behind the product. But the Amphicar foundered for the same reason that almost all combination products go under. It combined the worst of both worlds. Owners said it drove like a boat and floated like a car.

They keep trying. Recently a group of California entrepreneurs demonstrated the Aquastrada Delta, a $25,000 surf-and-turfmobile with a fiberglass hull, a 245-horsepower Ford truck engine, and wheels that retract into watertight compartments. Will it sink or swim? History has a habit of repeating itself.

Then there's the fax/phone that Canon introduced with a big advertising and publicity campaign. These combination ideas sound terrific in the boardroom, but they usually have a fatal flaw that keeps them from gaining wide acceptance. Do you own a fax/phone? Most people don't. Why? It's a mediocre fax combined with a mediocre phone.

If the fax won't work with the phone, maybe it will work with the

copier and computer printer. Currently the media is getting all worked up about the combination copier, facsimile, and computer printer (with a scanner sometimes added as an extra feature). The hype is enormous, but sales remain modest.

So what do you think? Do categories divide or do they converge?

Many otherwise intelligent people have a personal philosophy that they call "the law of the middle." If half the people say "black" and half the people say "white," then the correct answer must be "gray."

Therefore, we're likely to get some convergence, which is going to take longer than many people believe. That's the gray answer to the convergence question and the one that's most likely to be wrong.

"Yet while convergence has diverged from the high road of early expectations," reported the Wall Street Journal recently, "it remains the way of the future. It's only that the journey, executives in multimedia businesses say, will take longer, cost more money, and be far more complicated than first imagined."

It's the Vietnam syndrome. Once we have decided to take action, we cannot be wrong. Therefore, we have to redouble our efforts, convinced of the Tightness of our cause and our confidence in the ultimate outcome.

Do categories divide or do they converge?

Does the Earth revolve around the Sun, as Ptolemy thought? Or does the Sun revolve around the Earth, as Copernicus thought? The gray answer is that half the time the Sun revolves around the Earth and half the time the Earth revolves around the Sun.

Is capitalism the better economic system for a country? Or is communism? The Middle Way has been an economic disaster for countries that have tried it.

Do categories divide or do they converge?

Gray is usually the worst of both possible worlds. Focusing a corporation requires courage. You have to look the Wall Street Journal in the eye and say, "You're wrong."

There is no middle way.

ENCOURAGING SIGNS FROM THE CORPORATE FRONT

The Fortune 500 list of the largest industrial corporations is a fairly accurate barometer of the health of American business.

• 42 out of the Fortune 500 companies lost money in 1988.

• 54 companies lost money in 1989.

• 67 companies lost money in 1990.

• 102 companies lost money in 1991.

• 149 companies lost money in 1992.

At the rate the barometer was falling, every Fortune 500 company in the year 1997 would have been losing money.

In 1993, things started to change. Only 114 of the 500 companies lost money. (That's still 23 percent losers, however.)

And in 1994, forty companies lost money, although the list is not comparable with previous years because service companies were added for the first time.

One reason for the improvement might be a change in corporate philosophy. With diversification dead in the water and synergy looking more and more like a lame strategy, there seems to be a movement in the opposite direction. Yes, the business world is getting focused.

Underneath the hype of convergence, alliances, and mergers, another story is unfolding. Thoughtful business leaders are quietly beginning

to bring their companies into focus. Some recent stories that illustrate this trend:

Wall Street Journal, May 4, 1994. "Eastman Kodak Co., in a surprisingly sweeping reorganization, said it will put up for sale its big Sterling Winthrop drug unit and two other businesses to focus on its core film operations."

Wall Street Journal, May 27, 1994. "While much of corporate America is racing to produce electronic data products and services, Mead Corp. is chasing more mundane markets such as paper and notebooks. Last week, Mead decided to put its Lexis/Nexis electronic data services division on the block and beef up its old-line paper, packaging, and pulp businesses. Rather than searching for the next hot technology to pursue, Mead believes there's lots of money to be made in paper products if done right."

New York Times, June 21, 1994. "Citicorp, continuing to shed nonstrategic assets in an effort to build capital and focus on its core financial businesses, said yesterday that it had sold I/B/E/S Inc."

Wall Street Journal, September 29, 1994. "Just when its office-paper business is finally on the upturn, James River Corp. has decided to shed that operation and possibly its profitable packaging business. Instead, the Richmond, Va., company plans to concentrate on its core consumer-paper business, which includes Dixie paperware and Brawny paper towels. Not a bad idea, analysts say."

International Herald Tribune, November 5-6, 1994. "Bowater PLC said Friday it was selling its tissue and timber business in Australia as part of its drive to focus on its core printing and packaging sectors."

Wall Street Journal, November 11, 1994. "Sears, Roebuck & Co., completing a return to its retailing roots, plans to spin off its $9 billion controlling stake in its huge Allstate Corp. insurance unit. The Allstate spin-off will return Sears to its retailing roots dating to 1886, when it opened its mail-order business. Since September 1992, the company has shed its Dean Witter, Discover Corp. holdings and its Coldwell Banker real-estate unit."

Advertising Age, November 14, 1994. "R.L. Polk & Co. is getting out of the full-service direct marketing business as part of a plan to bolster its core operations, gathering and interpreting data."

Wall Street Journal, March 2, 1995. "St. Joe Paper Co. saw its stock jump 14% as investors cheered the expected sale of more than

$800 million in assets and the company's new focus on transportation and real estate."

New York Times, April 27, 1995. "Pitney Bowes Inc., in the midst of a restructuring program to cut costs and focus on core businesses, said it agreed to sell its Dictaphone Corp. unit for $450 million to a New York investment group."

International Herald Tribune, June 22, 1995. "After wild buying sprees in the 1970s and 1980s, Guinness PLC has decided that Guinness is good for it. It has divested itself of virtually everything but beer and liquor, because 'I have a strongly held point of view that you can only be good at a limited number of things,' the chairman, Anthony A. Greener, said in a recent interview."

New York Times, August 23, 1995. "Domtar Inc. is planning to shed its gypsum and decorative-panel divisions as part of a new strategy focusing on lumber, papers, and packaging."

Wall Street Journal, August 30, 1995. "Fisons PLC neared completion of a six-month drive to divest itself of noncore operations by agreeing to sell most of its Laboratory Supplies division to Fisher Scientific International Inc. of the U.S. for $311.9 million."

Finally, business is getting around to doing what Peter Drucker recommended years ago: "Concentration is the key to economic results. Economic results require that managers concentrate their efforts on the smallest number of activities that will produce the largest amount of revenue. ... No other principle is violated as constantly today as the basic principle of concentration. . . . Our motto seems to be: let's do a little bit of everything."

"We've had some real problems," said a Colgate-Palmolive executive recently. "We may have tried to do too much in the past year with new products, manufacturing changes, and organizational changes. There may have been too much activity with not enough focus on the base businesses. We have to refocus now."

Does that sound like a company you might know? My experience tells me this complaint could be heard at almost any company in the United States.

Too many corporations today are a mile wide and an inch deep. Maybe this formula could work in an era when there were fewer companies and less competition. But not today. Today a company needs a narrow focus to compete in a marketplace that is rapidly going global.

ENCOURAGING SIGNS FROM THE CORPORATE FRONT 51

TRW is a good example. Once a conglomerate with eighty different businesses, TRW has shed nearly half its units. Says TRW executive vice president William Lawrence: "The key words for the nineties are focus and flexibility."

Union Carbide is another. Before the Bhopal disaster a decade ago, Union Carbide had 110,000 employees and sold $10 billion worth of Eveready batteries, Glad bags, and countless industrial chemicals. It was an unwieldy, barely profitable mishmash. After Bhopal and a failed takeover attempt by raider Samuel Hayman, things got worse.

"We had too many diverse businesses competing for capital and management attention," says Robert Kennedy, Carbide's CEO since 1986. So Kennedy sold noncore assets such as the battery and consumer products units, reduced debt to less than $1 billion, and shed 90 percent of the workforce. Sales are now approaching $5 billion and profits nearly $500 million. Less is more. Half a focused loaf is better than the whole loaf with slices that are spread too far apart.

Merck bought Medco, a drug benefit-management company, because it promises to help the company reduce the cost of its drug distribution systems. But Merck has been dropping its noncore businesses like Calgon Vestal Laboratories (sold to Bristol-Myers Squibb for $261 million) and Calgon Water Management (sold to English China Clays for $308 million). It also sold Kelco, its chemical company, to Monsanto for $1.1 billion.

Merck's only nondrug unit left in its portfolio is Hubbard Farms, a turkey breeding company. Want to bet that turkey will soon hit the chopping block?

Fingerhut, a $1.8 billion Minnesota company, has sold its computer service bureau and its deep-discount cataloger and is about to sell its food catalog in order to concentrate on its direct-marketing business.

Quaker State sold its insurance company to GE Capital for $85 million and then turned around and bought a specialty oil company for $90 million. According to Herbert Baum, the company's CEO, the moves fit into Quaker State's strategy to refocus on lubricants and lubricant services.

After a review by McKinsey & Co., Shoney's said it was selling four of its seven food divisions. CEO Taylor Henry said that the company's resources were "spread too thin." As a result, he said,

"We need to reduce the complexity of our business and focus on the Shoney's flagship."

Looking to become a pure restaurant company and also to reduce its debt, Flagstar sold most of Canteen Corp., its contract-feeding business, to Compass for $450 million. "It really was a strategic decision to focus on the restaurant business as opposed to being a more broad-based food-service company," said vice president Coleman Sullivan.

Philip Morris sold its Kraft Foodservice unit to Clayton, Dubilier & Rice for $700 million. "Food service is a business of relatively low margins and nonbranded items, whereas Kraft sells branded items through supermarkets," said Barry Ziegler, a securities analyst. "The sale is a good move since the food service is so different from the Kraft core business."

In 1991, Boole & Babbage, one of the oldest companies in the software field, lost $11 million on sales of $101 million. Over the years Boole had accumulated a hodgepodge of businesses, including a time-sharing company. Newly appointed president Paul Newton decided it was time to focus.

"We decided we were only going to sell two kinds of products to one kind of customer," says Newton. "Anything else had to be sold off or written off." In their latest fiscal year Boole reported sales of $132 million and an $8 million profit. The stock has quadrupled.

There are encouraging signs from the banking industry. Today's bankers speak eloquently of their own bank's "focus" and sense of direction. The days of everything for everybody seem to be disappearing from the typical banker's agenda. Which is surprising because most bankers have been fighting the Glass-Steagall Act (which restricted activities of commercial banks) ever since Congress passed the law in 1933. On their own, most commercial banks today are voluntarily restricting their target markets.

There are encouraging signs in the political arena. No recent president of the United States has been as focused on a single issue as Bill Clinton . . . before he was elected. "It's the economy, stupid," was James Carville's famous rallying cry.

But after the election it was a different story. No issue was too small for Mr. Clinton to be involved with. When asked what three things Bill Clinton had to do to get back the public's confidence, one practical politician said: "Focus, focus, focus."

There are encouraging signs from Europe, a continent noted for the notion that companies should be as diversified as they possibly can. Volvo, Sweden's largest company, has been paring down to its original role as a manufacturer of cars and trucks by getting rid of a 26 percent interest in Hertz and a 44 percent interest in Cardo, a Swedish investment company.

Companies like Volvo are not helped by a raft of magazine articles suggesting that it cannot survive without increasing its 1 percent share of the worldwide market. For years, automotive editors have encouraged Volvo to explore mergers, including one with Renault, which would have been disastrous.

By itself a 1 percent share of market doesn't make a company vulnerable. It all depends on how focused the company is. Volvo is focused on "safety," an enormously powerful and profitable position for any automobile company. Share of market isn't the driver here; share of mind is. For a company its size, Volvo has an outsized share of mind.

Tata Iron & Steel, India's largest company, is a good example of the problems facing third-world companies. Although it has $5 billion in annual revenues, Tata is not one company. It's a collection of forty-six companies that make everything from tea to trucks, from cosmetics to computer software.

But Tata's dream is to become a major player in passenger cars. Is this possible? Sure, as long as you can get a little help from your government to keep the competition out. But this is exactly what a developing country like India doesn't need. More tariffs and government regulations.

Ratan Tata, the new chairman at Tata, seems to understand the nature of the problem. "Our critical task is to refocus," he says. "We must restructure and divest noncore businesses." He wants to make his group a leader in a few key industries: trucks, autos, computer services, steel, and construction engineering as well as a domestic pioneer in multimedia and telecommunications. Sounds like a company biting off more than it can chew.

The same problems can be found in virtually all of the developing countries. The small size of these countries (economically speaking) and their high tariff barriers have combined to produce companies that are far too unfocused to compete in global markets. Only by making wrenching changes will many of these companies survive.

There are encouraging signs from the many corporate mergers that have occurred recently. Actually, there are two kinds of mergers: the good and the bad.

The bad mergers are the ones that emphasize market coverage or "fit." They are the ones that combine two dissimilar operations in order to increase the range of a company's operations.

Let's say you combine a company that specializes in the high end of the market with a company that specializes in the low end. Or perhaps a cable company with a phone company. Or in the entertainment industry, you might combine a content company with a hardware or a distribution company. None of these mergers, in the long run, are going to be very successful.

The good mergers are the ones that emphasize market dominance. In theory, the ideal merger, sure to be frowned on by the Justice Department, would combine two competitors, each with 50 percent of the market, into one company with 100 percent of the market.

In practice, companies can achieve a degree of market dominance by merging with competitors that match their own product or service offerings. Some recent mergers that illustrate this trend include:

• Lockheed merged with Martin Marietta to form Lockheed Martin, the world's largest defense company.

• Cineplex Odeon merged with Cinemark USA to create the world's biggest movie theater chain.

• First Data acquired First Financial Management in a $6.6 billion deal to create America's largest independent processor of credit card transactions.

• Interstate Bakeries bought Continental Baking to become America's largest baker.

• Rite Aid is buying Revco for $1.8 billion to cement its position as the nation's largest drugstore chain.

• Crown Cork & Seal acquired CarnaudMetalbox for nearly $4 billion to become the world's largest packaging company.

• International Paper bought Federal Paper Board for $2.7 billion to become the U.S. leader in bleached board used for packaging.

• Glaxo bought Wellcome for more than $14 billion to become the world's largest prescription-drug company.

• United HealthCare bought MetraHealth for $1.65 billion in cash and stock to become the largest U.S. health care management company.

• Abbey Healthcare merged with Homedco to create the largest U.S. home health care provider.

• Medpartners acquired Mullikin Medical Enterprises for $360 million in stock to create the nation's largest physician-management company.

But the most spectacular series of mergers is the one started by Rick Scott with the purchase of two large hospitals in El Paso, Texas. Eight years later, his company was the largest private health care provider in the country with 326 hospitals and more than 100 outpatient surgery centers.

Called Columbia/HCA, the company has annual revenues in excess of $15 billion and is three times the size of its closest for-profit competitor. This is focus and this is dominance.

Mergers are either good or bad depending on whether or not they increase a company's focus. Every merger with a similar company increases the focus of the resultant combination. Every merger with a dissimilar company decreases the focus.

There used to be a perception that a company was better off if it was in two lousy businesses rather than one good one, but that perception is changing.

Andrew Grove, CEO of $10 billion Intel, sums up the thinking of many chief executives today: "I'd rather have all my eggs in one basket and spend my time worrying about whether that's the right basket, than try to put one egg in every basket."

How to put all your eggs in one basket is what this book is all about.

ENCOURAGING SIGNS FROM THE RETAIL FRONT

If you want to be an expert prognosticator of trends, go to the movies, listen to popular music, and keep your eyes on retailing. Especially retailing.

No other segment of the market is as sensitive to trends as retailers. As retailing goes, so goes the nation. So how is retailing going?

In a word, specialization. The era of the generalist seems to be over.

Let's go back a few decades when the generalists, the department stores, ruled the retailing roost. Macy's in New York; Marshall Field's in Chicago; Garfinckel's in Washington, D.C.; Rich's in Atlanta; I. Magnin in San Francisco.

As a matter of fact, every major city in America had a glittering array of department stores. In New York City, you could find Abraham & Straus, Alexander's, B. Altman, Arnold Constable, Bergdorf Goodman, Best & Co., Bloomingdale's, Bonwit Teller, EJ Korvette, Galeries Lafayette, Gimbel's, Henri Bendel, JC Penney, Lord & Taylor, Macy's, Ohrbach's, Saks-Fifth Avenue, and Stern's, to name a few.

Today, Abraham & Straus, Alexander's, B. Altman, Arnold Constable, Best & Co., Bonwit Teller, EJ Korvette, Galeries Lafayette, Gimbel's, and Ohrbach's are gone. Macy's and Bloomingdale's have been in and out of bankruptcy. And Saks-Fifth Avenue has required a substantial capital infusion.

What caused the decline of the department store?

Critics are often quick to criticize the stores themselves. They neglected

ENCOURAGING SIGNS FROM THE RETAIL FRONT 57

customer service. They didn't keep up with fashions. Their prices got out of line. They were mismanaged. And so on. To a certain extent all of these factors may have been true. But have department store customers given up buying?

Of course not. Today more and more people are shopping at specialty stores. It wasn't the department store that caused the decline of the department store. It was the specialty store. Focus strikes again.

The department store versus the specialty store. It's a fundamental principle of business that the more focused competitor usually wins. You can apply that same principle to your business. Compared with your major competitor, which company is the more focused? The advantage always lies with the more focused operation.

Nor did Wal-Mart cause the decline of the New York City department store. (There are no Wal-Mart stores in New York City.) Although Wal-Mart has wiped out many inefficient stores in smaller cities and towns, they are just starting to move into the larger cities, where they will face the same specialist competition that has decimated the department stores.

Nationwide, the department store has been suffering for a decade or longer. Many have clogged the courts seeking financial relief. In 1989, L. J. Hooker, owner of the Bonwit Teller and B. Altman department stores, filed for bankruptcy. (B. Altman & Company, whose 124-year-old flagship establishment was on Fifth Avenue, was one of the first stores to cater to Manhattan's carriage trade.)

Rights to the Altman name went for $1.75 million, prompting Alan Milstein, a retail newsletter editor, to comment, "In my opinion Altman's died fifteen years ago. Why would anyone want to resurrect it? It's stuck in the 1960s."

In 1990, Campeau Corporation collapsed, bringing such department store jewels as Bloomingdale's, Abraham & Straus, Stern's, Jordan Marsh, Burdines, Rich's, and Lazarus into bankruptcy court. In April that same year, Ames Department Stores Inc., with 680 stores east of the Mississippi, filed for Chapter 11 bankruptcy. That summer, Garfinckel's, the pride of Washington, D.C., found its way into bankruptcy court.

In 1991, Hills Department Stores Inc., with more than two hundred stores mostly in the Midwest, filed for Chapter 11 bankruptcy. Also that same year Carter Hawley Hale Stores Inc., the largest

department store operator on the West Coast, filed for Chapter 11 bankruptcy.

Later the same year P.A. Bergner & Co.. one of the Midwest's largest department store operators, including sixty-eight Carson Pirie Scott units, sought bankruptcy-court protection.

In 1992. tony retailer Saks-Fifth Avenue was forced to seek an additional S300 million in funding from its owner, Bahrain-based Investcorp. According to news stories. Saks had lost $398 million in the preceding two years.

In 1994. Woodward & Lathrop Holdings Inc. filed for Chapter 11 bankruptcy. Joining the filing was John Wanamaker Inc., a Philadelphia retailer and Woodward subsidiary. Woodward & Lothrop. with sixteen stores in the Washington-Baltimore area, and Wanamaker, with fifteen stores in the Philadelphia area, are venerable retailers with strong reputations.

A good reputation is not enough when the tide is against you. We have entered the era of the specialist. A store that sells everything is living in the past.

Sears also has a good reputation. In a way. Sears is also living in the past because it has gone against the trend toward specialization. For exactly one hundred years. Sears steadily expanded the scope of its operations. In 1886, Sears mailed out its first catalog. It wasn't until 1925 that Sears opened its first retail store. Six years later it established Allstate Insurance, at first to sell auto insurance and then property, casualty, life, and even mortgage insurance.

In 1959 Sears formed Homart Development Co. to develop shopping centers. In 1981 Sears bought Dean Witter Reynolds, a stock brokerage firm, and Coldwell Banker, a real estate firm. In the eighties Sears opened Financial Network Centers in many o\ its retail stores, the infamous "socks and stocks" strategy. Also in the eighties the company opened Sears Business Systems Centers to sell computers and software.

In 1986 came the nationwide launch o\' the Discover credit card. This was the high-water mark: from now on everything would be downhill. On Wall Street analysts were calling on Sears. Roebuck to break up into separate companies that would be worth more individually than as parts o( the retailing giant.

In 1988 Sears sold Coldwell Banker's commercial real estate business. In 1992 Sears spun off Dean Witter, including the Discover

ENCOURAGING SIGNS FROM THE RETAIL FRONT 59

credit card. In 1993 Sears shut down its Business Systems Centers and its general catalog business. It also sold its mortgage operations to PNC Bank Corp. and Coldwell Banker Residential business to The Fremont Group.

Size is not the determining factor in creating a profitable business. Focus is. The general catalog operation was a $3 billion business. That's right, three billion dollars, but it managed to lose $450 million in the three years before the ax fell.

In 1994 Sears announced plans to spin off the rest of Allstate and to seek a buyer for Homart. What's left at Sears? A retailing company with eight hundred department stores, a credit company, and twelve hundred specialty stores, including Western Auto Supply Company and Homelife furniture stores.

Even the real estate venture, Sears Tower in Chicago, turned out to be a disaster. Sitting with an $850 million mortgage on real estate worth only about $400 million, Sears literally walked away from the property.

What has replaced the department store?

A host of specialty stores, each with a narrow focus. The Limited focuses on upscale clothing for working women. The Gap focuses on basic clothing for the younger crowd. Victoria's Secret focuses on expensive women's undergarments. Circuit City and Best Buy focus on consumer electronics and major appliances. The Home Depot on household products. Office Depot on office supplies.

Then there are the catalog houses, each with a narrow focus. L.L. Bean, Sharper Image, J. Crew, and others.

Most fair-minded observers of the retail scene have concluded that the golden age of the department store has passed. Those that remain will be under constant pressure to cut costs to stay alive. Prognosis: more department store bankruptcies to come.

This is not to say that some department stores won't succeed. Many will. In a declining industry the few survivors that remain can be fabulously profitable.

There's always a market, even though small, for almost any product or service. And the advantage of serving a declining industry is the fact that you can develop a semimonopoly. A declining industry attracts almost no fresh, new competitors.

The horse, for example, has been almost totally replaced by the automobile. But the cost of saddles, bridles, and reins has gone up,

not down. Reason: little competition for a small market. In the New York area you can buy four car shoes (tires) for the installed price of four horseshoes ($250). And the car shoes will last a lot longer than the four to five weeks the horseshoes are good for.

One department store weathering the storm is Nordstrom. The ninety-four-year-old Seattle-based retailer has burned its way into the mind of the department store customer by emphasizing "service." But isn't service the essence of the department store concept? Why couldn't all department stores do what Nordstrom has done?

Because there are only so many people who want to shop at a place that sells everything. A big-name consultant once suggested that American department stores had a customer base of perhaps 30 percent of the market. "Yet their failure to pay attention to the 70 percent who were not customers largely explains why they are today in a severe crisis."

Maybe it's just the opposite. Maybe by trying to appeal to the 70 percent of the market that doesn't shop at department stores with sales and special promotions, they lost sight of their core customer, the market that Nordstrom is targeting.

The numbers prove the point. Nordstrom figures that 90 percent of its retail business comes from 10 percent of its hard-core, repeat customers.

Many department stores have gotten the message and are beginning to focus on not just their customers but their high-volume customers. (The Nordstrom 10 percent, for example.) Known in retailing circles as "clienteling," the strategy involves plying these hardcore customers with personal attention and special services, an approach traditionally used by boutiques.

For some shoppers, Bloomingdale's sends reminders to husbands to buy birthday or anniversary presents. Other shoppers get free alterations and gift-wrapping service. Helping in this effort are new computer programs that allow stores to tap their vast databases to identify their most profitable customers.

Bloomingdale's, for example, has 1.8 million credit card users. Yet the store estimates that 20 percent of credit customers account for 75 percent of sales.

While department stores have been declining in importance, specialty stores have been booming. One chain in particular has served as a pattern for all the rest: Toys "R" Us. Today the company has 618

ENCOURAGING SIGNS FROM THE RETAIL FRONT 61

stores in the United States and sells 22 percent of all the toys in the country.

In addition, Toys "R" Us is moving its concept overseas with 293 units outside the United States. Already the company is the largest toy retailer in Germany.

Ironically, Toys "R" Us started as a children's furniture store to which founder Charles Lazarus added toys. The original name: Children's Supermart.

Now here comes the interesting dilemma. How does a children's supermart grow? The obvious answer is to add children's clothing, bicycles, diapers, baby food, etc. In other words, broaden the base of the merchandise.

But that's not what Charles Lazarus did. He threw out the furniture and opened another, larger store with discount toys only. In other words, he narrowed the focus to toys. How unusual and how effective. No wonder Forbes magazine calls Mr. Lazarus "without question one of his generation's most brilliant retailers."

Toys "R" Us pioneered a pattern since adopted by every retailer trying to create a category killer.

There are five key steps in the Toys "R" formula: (1) Narrow the focus. (2) Stock in depth. (3) Buy cheap. (4) Sell cheap. (5) Dominate the category.

Let's discuss each of these five steps in more detail.

NARROW THE FOCUS

This is the most difficult step of all, because it is counterintuitive. Most managers and entrepreneurs look for ways to expand their product offerings. If you want faster growth, you should offer fewer product lines? How can this be? It seems obvious that if you want faster growth, you should offer more products and services.

What's obvious and logical is also not true. In business, more is less and less is more. If you want faster growth, you must first narrow the range of products and services you offer. Or if you are planning a start-up company, you must offer a narrower range of products than existing stores.

Take housewares, just one of the many products for the home traditionally bought in department stores. By focusing on housewares only, Gordon Segal and his wife Carole built a robust business. Because they couldn't afford store fixtures, the Segals opened their

first store selling European-designed tableware displayed on packing crates and barrels. Hence the name, Crate & Barrel.

Today, the chain has fifty-five stores with revenues of about $275 million and, according to Mr. Segal, is "at the upper end" of retail operating margins.

What Crate & Barrel did in housewares, Lechters is doing in kitchen ware, but at the lower end and with smaller stores. With more than six hundred stores (80 percent of them located in malls), Lechters does $400 million in annual volume. Recently Lechters abandoned its sharp focus on the kitchen and started to stock a hodgepodge of stuff for other rooms in the house.

Earnings per share promptly declined 28 percent and the stock dropped 40 percent. New management is now refocusing the Lechters chain on, what else, kitchenware.

Take athletic shoes. Traditional shoe stores sell all kinds of shoes, but the most successful shoe store chain in America is Foot Locker, which sells just athletic shoes. The fifteen-hundred-store chain sells more than $1.6 billion a year in athletic shoes and plans to open another thousand stores by the end of the decade.

Take coffee. Years ago every town in America had one or more coffee shops that served everything from hamburgers to apple pie a la mode. So what did Starbucks do? They opened a coffee shop that specialized in, of all things, coffee. Amazing.

Today Starbucks has turned into megabucks for its principal owner, Howard Schultz. In a recent year Starbucks took in $285 million from its 425 company-owned stores. Currently it has 680 stores and plans to have "2,000 by 2000," when Starbucks will be a billion-dollar company.

Taking another bite out of the traditional coffee shop market is Cinnabon. The chain sells huge nine-ounce cinnamon rolls fresh from the oven, rich and sticky and dripping with frosting. So what if a bun costs $ 1.89 and has 810 calories. The chain now has 276 shops (about half franchised) and does about $100 million in sales with a 500-store goal by the year 2000.

Take manicures. Every community has a handful of "beauty salons," many of which are convinced that the road to success lies in adding products like wigs, clothing, handbags, jewelry, health and beauty aids, and services like facials, body massages, body waxing, and other personal services.

ENCOURAGING SIGNS FROM THE RETAIL FRONT 63

At the same time, the industry is seeing a growing trend based on narrowing the focus. This is the "nails only" salon. While the traditional beauty salon manager was figuring out how to increase sales by broadening his or her business, the business itself was dividing into two categories, hair and nails. (In the New York area, the nail salons are dominated by Korean immigrants.)

Take cigarettes. Virtually every retail establishment sells them, from drug and grocery stores to restaurants and convenience stores. Yet one of the fastest growing retail categories in America is the cigarettes-only superstore carrying more than three hundred brands. Today there are about two hundred such stores, and they have doubled their share of the market in the past year.