13

Building scale platforms

“If the shoe fits, you’re not allowing for growth.”

Robert N. Coons

• A scale platform allows a large company to exploit the structural advantage of its size across multiple business units and markets

• Traditional scale platforms such as networks and brands are designed to boost scale advantages and improve operational efficiency and effectiveness

• Two new scale platforms—insight engines and M&A engines—can help large companies gain advantage across all their businesses

IN THE TRADITIONAL view, large companies create a competitive edge through scale advantages, often connected with cost and sometimes with scope. We believe that scale can also produce benefits for granularity. CEOs frequently object that increased granularity would undermine the advantages of scale. But it is possible for large companies to retain the benefits of scale while operating in a more granular fashion. They can do so by developing scale platforms that enable granular units to fire on more cylinders over time.

 

The role of the granular blueprint is to unleash the entrepreneurial energy and accountability of an army of small communities to pursue granular growth opportunities in the marketplace. The role of the scale platform is to ensure that a large company realizes the advantage that derives from its size by building systematic capacity across multiple business units to manage greater granularity.

Rethinking scale

Designing your architecture for granular growth demands that you transcend traditional notions of scale. It’s not simply a matter of lowering costs (though a low cost position can, of course, be a critical driver of growth). Sometimes scale platforms are based on distinctive operating capabilities such as an outstanding supply chain. They can also derive from a company’s formal and informal processes. A scale platform might, for instance, be built on processes that generate market insight, support decisions linked to that insight, drive performance, and shift the portfolio over time. Examples might include CRM (customer relationship management) or business intelligence systems. In a knowledge economy, scale platforms can be based on better ways to build knowledge or talent across a portfolio.

 

Many of the companies that leverage scale platforms do so to improve operational efficiency and quality control and to reduce costs: consider Wal-Mart’s supply chain, UPS’s physical delivery network, and Toyota’s lean management system. Others, such as P&G, PepsiCo, Johnson & Johnson, and Pfizer, have created scale platforms that produce direct top-line benefits in areas such as branding, innovation, and alliance building.

 

Some scale platforms are designed to improve both the top and the bottom line. GE, for example, has focused recently on driving commercial excellence across its portfolio. This will complement the scale platforms traditionally associated with the company, such as talent development, performance management, insight, and M&A. The thrust behind commercial excellence was prompted by GE’s realization that there was $5 billion of discretionary pricing in appliances alone. CEO Jeff Immelt says, “It was the most astounding number I’d ever heard—and that’s just in appliances. Extrapolating across our business, there may be $50 billion that few people are tracking or accountable for. We would never allow something like that on the cost side.”¹

 

It’s important to remember that the sources of scale advantage can change over time. Having set your growth direction across the three horizons, you should question whether your current scale platforms will continue to be sufficient, and for how long. Given the cylinders you have decided to fire on in horizons 2 and 3, might you even need entirely new scale advantages?

 

Rather than examine each type of scale platform in detail, we’ll now focus on the two that are most helpful in improving your cylinder-firing performance over the medium and long term. The rest of this chapter examines how you can build an insight engine (to fire on your portfolio momentum cylinder) and an M&A engine (to fire on inorganic growth). Insight engines enable companies to identify and pursue, in a highly systematic way, a much larger number of growth opportunities at the G4 and G5 level. M&A engines enable companies to identify and execute, again in a highly systematic way, a much larger volume of mergers and acquisitions.

Building an insight engine

Insight into potential sources of growth is essential when companies are constructing and managing a portfolio of granular strategies. Without insight into future growth, companies will follow the growth trend rather than ride it from the start.

 

There are many techniques for garnering insights, and some of the best stories are about accidental or serendipitous discoveries. But the key to building a scale platform is to create an insight engine that can generate insights regularly and systematically from both the people and the processes in the organization. Broadly speaking, either companies can change some of their existing core processes (such as performance reviews) so that they uncover more market insight, or they can create parallel “overlay” processes dedicated to insight generation. Either way, the purpose of an insight engine is to funnel new knowledge, ideas, and perspectives gathered from multiple sources into the strategic management of the company and its portfolio.

 

Let’s examine these two different approaches. Both offer practical ways to gather granular insights from the whole organization.

Redesigning management processes

What happens in a typical performance review? Managers explain their business at an aggregate level and the CEO and executive team try to dig deeper to understand what’s really happening. But the dialogue seldom gets to where it needs to go.

 

An average business unit has a multitude of product lines, markets, R&D projects, and marketing programs. Even if the BU head manages to run through the high-level financial and operating numbers for most of them, there may well be a heap of talent issues for the CEO to tackle next. Amid so many competing claims, the discussion of the outlook and risk never gets beyond “what you should expect from my business unit next quarter, and why we may not meet that expectation.” Hardly any time is devoted to talking about the underlying texture of the market, or the drivers of growth and profitability across the different component businesses, or how these drivers are changing. A rich opportunity to involve the CEO in making portfolio choices and allocating resources at the level where growth and profitability actually take place is wasted.

 

One solution is to structure management dialogues so that they do reflect the granular texture of the markets—and, even more important, the decisions that affect the business. At one large semiconductor company, performance dialogues focused on the four business units. However, the CEO realized that these discussions weren’t reaching the underlying drivers of the business. The company had more than 50 underlying portfolio segments, each of which ran four or five major R&D programs. In effect, there were some 300 individual performance cells. Not only that, but the cells generated very different rates of return on R&D investments, yet this was not reflected in the allocation of funds.

 

The focus on the four business units meant that the decisions that drove overall growth, such as the program-by-program allocation of R&D, were lost in the aggregate figures and therefore invisible to the CEO. Similarly, any market insights that were evident at the cell level were buried in the aggregation. Once the CEO understood this, he demanded a far more granular conversation about performance and strategy.

 

The first step was to get a clearer view of the 300 or so separate cells and to open up direct dialogues with the heads of the 50-plus portfolio segments. The second step was to make sure that these dialogues would inform future choices and not just dwell on past performance. In R&D, for example, the company traditionally focused on whether the ratio of investment to sales was similar to that of previous years, and how it compared to competitors’ numbers. While this seemed a reasonable approach, it failed to take account of a crucial fact: that the company’s chances of success varied significantly across the 300 performance cells.

 

Today, dialogues with the CEO go beyond static performance measures and benchmarks and address the most important questions: the probability of winning in the market cell by cell; whether resources need to be reallocated; and whether it is time to exit a market altogether. These discussions require deeper intelligence on the markets and on the nature of competitors’ sources of advantage. After restructuring its performance reviews, the company reallocated 30 percent of its R&D resources to markets where it had a strong winning play. Two years later, it is growing significantly faster than the broader market.

 

Some managers worry about the amount of time that this management approach demands. “How can I possibly look at 300 cells and still add value? If I have to do this job, why do I need a business-unit manager?” In our experience, though, going for greater granularity in reporting actually saves time rather than squandering it.

 

How can this be? It’s because the critical issues affecting growth are brought to light immediately, making the dialogue between the executive board and the business unit much more specific and thus much closer to the reality of both the market and the internal organization. The dialogue can then focus on solving the problems facing the business unit without undermining its accountability for executing the agreed solution. In most cases, the number of issues discussed doesn’t increase, but the specificity and quality of those issues rises dramatically.

Adding overlay processes

Companies that don’t wish to change their processes can instead augment them to achieve greater insights into their markets and performance. Consider the case of Johnson & Johnson.² In the mid-1990s, it faced a new Democratic administration seeking to reform healthcare. Major change seemed imminent, and this increase in political risk was matched by an increase in managed care.

 

In order to be ready for potential reforms, J&J launched its “FrameworkS” process to garner superior insight into what might happen and how it could respond. The process represented a huge commitment for the company: it demanded a significant investment of time from the executive board and other senior managers as well as involving hundreds of other employees. J&J broke down the problem into different dimensions, dedicated separate teams to each one, and interviewed a large number of industry players including insurers, healthcare providers, consumers, equipment providers, and regulators. Extending across several quarters, the process integrated all the information gained from thousands of dialogues to produce an unprecedented level of insight into the US healthcare market.

 

Johnson & Johnson continues to use a similar process today. It requires each participating employee to produce insights into issues that have been identified or to develop responses to them. Though the complexity of sorting through so many insights is considerable, the benefits are compelling: J&J reduces the risk of missing something important and gives people close to the end markets a fairly direct connection with decision making at the top.

 

In addition to creating proprietary insight on a scale that smaller companies and market analysts can’t match, the FrameworkS dialogues focus the leadership team on the company’s sources of advantage and how well it is performing in each of its three cylinders. This focus helps create alignment on the company’s granular blueprint and “where to compete” decisions and identifies major opportunities and threats on J&J’s equivalent of a growth map. In turn, this results in powerful corporate-level initiatives that shape the way the individual businesses develop their own strategies.

Building an M&A engine

The second type of scale platform we want to discuss here is the M&A engine. With 3 percentage points of the average large company’s CAGR coming from M&A (and as much as 6.9 points for the growth giants), it’s clear that large companies need to possess strong M&A capabilities and ensure they are properly rewarded for their buying. M&A can help create structural advantages across a variety of markets. We argued earlier that the value created by M&A is higher than is generally understood; however, it is far from guaranteed. That’s why the systematic ability to do more and better M&A can create a real scale advantage.

 

To find out what drives good M&A performance, we looked at some of the largest and most acquisitive US companies of the past ten years.³ We interviewed twenty of their executives and compared the activities of acquirers with above-market TRS (the “rewarded” companies in Figure 13.1) to the ones with weaker shareholder returns (the “unrewarded”).⁴

Fig 13.1 Lessons from successful acquirers

Top 33 US inorganic growers, 1999-2004

	Rewarded (outperformed peers on a TRS basis)	Unrewarded (underperformed peers on a TRS basis)
Organization	Often led by CEOs with longer tenure Recruit deal experts from within	Use business development for execution rather than to shape corporate strategy
		Hire external deal experts
Deal strategy	Use internal and external sources to derive deal ideas	Are prone to herd mentality (following industry trends)
	Focus on long-term development	Use short-term metrics for preliminary evaluation
Due diligence	Use structured processes and procedures	More likely to replace acquired management
	Involve business units in evaluation and process
Integration	Expected key factor: integration	Expected key factor: growth
	Clear focus on customer retention	Overestimate synergies and ability to capture them

At least one of the things we learned challenges conventional wisdom. When large, busy acquirers struggle to create value, it’s not because they have weak or inexperienced M&A teams. Nearly all busy acquirers, whether strong or weak in TRS terms, have a solid mix of world-class lawyers, former investment bankers, and operational or strategy experts.⁵ Similarly, senior team members had a strong background in making deals whether they belonged to rewarded or unrewarded acquirers: about half had between five and ten years of experience and the rest had more.

The advantage of volume

We also studied another category of busy acquirers, the private-equity firms. Now that so many buy-outs go to these players, they are the real M&A machines, and they gain many advantages from the high volume of their deal pipelines.

 

Figure 13.2 illustrates the pipeline of a typical private-equity firm. Having started out with as many as 200 acquisition candidates and carried out due diligence on 40 or so, it produces just four deals. Its overall throughput is a sobering 2 percent.

Fig 13.2 M&A volume pipeline

Per year for a mid-sized private-equity company

How does the volume of this pipeline create advantage? We believe it does so in three ways. First, if you have 200 candidates to choose from, there is a greater likelihood that one of them will be right for purchase, so you can to some extent avoid the prize bias of the corporate shortlist. Second, you also limit your vulnerability to sample bias because the task of selecting so many potential candidates forces you to look beyond the obvious targets. Third, high volume encourages better pattern recognition: exposure to more potential targets gives the M&A and strategy teams much deeper experience.

 

High volume is one of the hallmarks of an M&A engine, but there are three other elements that are vital to its success: making sure that deals are a good fit; knowing when and how to integrate acquisitions; and finding the best way to involve business units.

Getting the right fit

Deals need to fit with a company’s granular blueprint and originate from its growth direction. If your M&A engine is designed to complement your other scale platforms, you are half way to having the criteria you need to evaluate a deal and identify the non-standard synergies that give rise to sources of advantage. The ability to identify the nature of these synergies is important: without them your company is unlikely to be the natural owner of the company you’ve targeted.

 

It’s easy to see why some M&A teams fall back on purely financial criteria, such as the target’s margins and past growth and whether the deal is accretive (expected to increase earnings per share). In fact, when we asked unrewarded acquirers to rank the key factors that prompted them to proceed with an acquisition, their top answer was “short-term accretion.” Rewarded acquirers, on the other hand, nominated “revenue growth potential” or “cost synergy potential.” They looked beyond pure financial metrics to identify and evaluate deals with exceptional synergies.

 

As one executive put it, “Strategic vision plus hidden value, not financial footwork, is the secret of creating long-term value. You need deep appreciation of your core skills and vision if your skills are to be transformed into a sustainable competitive advantage.” And you have to be selective.

Making smart integration decisions

Nearly all rewarded acquirers agreed that integration is where many if not most acquisitions fall apart. The better acquirers know what to integrate and what to leave alone. When FedEx bought Roadway Package Systems in 1997 to expand its ground business, it knew it was buying many customers with profitable volumes. Clearly that was an asset worth preserving. It was also getting a low-cost contractor and driver network that did all package pick-up and delivery, as well as line haul (inter-city freight transport).

 

Some observers expected FedEx to integrate RPS’s ground network into its own network to increase scale economies and reduce average costs. In the event, though, it decided to keep the RPS network separate and preserve the existing business model, partly because the companies had different unions and labor contracts that would have cancelled out the synergies. It upgraded the quality of the RPS service and rebranded it as FedEx Ground. It also merged RPS’s sales forces with its own. These actions reflected the company’s view that its brand, sales force, and network operations were the platforms for its growth.

 

It took two years to complete the integration, but once it was done FedEx Ground took off. Between 1999 and 2004, it achieved average organic growth of 10 percent a year, nearly twice the rate of the small-package market in general.

Involving the business units

According to our interviews with executives, business units generally bear the responsibility for integration. However, that doesn’t mean it’s their fault when integration goes wrong. As the vice-president of corporate business development at one conglomerate told us, “Our biggest challenge is ensuring that the corporate M&A team and business-unit executives work in concert on an acquisition.”

 

When and how you involve individual business units depends on the type of transaction. Acquisitions designed to transform the company, deals in unfamiliar markets, and deals that don’t fall neatly into any one business unit are typically led by the M&A team from start to finish. But if we look at deals destined to be integrated into an existing business unit, the rewarded acquirers we interviewed were twice as likely as the unrewarded to have involved their business units in the acquisitions from the outset, through origination and due diligence to negotiation and integration. As the senior vice-president of corporate strategy at a global media company told us:

“The individual business units handle joint ventures, partnerships, or acquisitions that are in line with their business and which Corporate considers tactical issues in their growth. For these tactical issues, the business unit drives the acquisition and the M&A team oversees the work and provides support where necessary.”

Indeed, while the involvement of the M&A team is essential to ensure that all transactions are consistent in quality and degree of rigor, many rewarded acquirers believe that having the business unit lead the process can yield dramatic improvements in the results of the integration. Rewarded companies involved business units in the due diligence phase, and some set up ad hoc teams comprising high-level business-unit executives, members of the M&A and legal teams, and experts such as tax accountants and environmental specialists. These teams drove the process through to integration and played an active part in identifying and quantifying opportunities and risks, especially during due diligence.

Other scale platforms

We’ve established that building an insight engine will help you fire on the portfolio momentum cylinder, while building an M&A engine will boost your performance on the inorganic cylinder. We believe there are two other scale platforms that can be just as valuable: a scaling engine and a talent engine. They don’t relate to a single cylinder, but can help improve your firing performance across the board.

• A scaling engine. The Alchemy of Growth argued that the transition from horizon 3 to horizon 2 is the most difficult stage in a company’s pipeline of developing businesses.⁶ In a recent article, Geoffrey Moore explored the challenges large companies face in making precisely this transition.⁷ Drawing on Cisco’s experience, he offered six rules of the road that represent compelling advice for any CEO trying to accelerate the growth of major new businesses. We believe that Cisco and a few other companies have managed to create a core competence in moving businesses systematically through the horizons; we call this a scaling engine.

• A talent engine. Talent is the fuel that powers most growth strategies. It’s common for companies to claim that they see their people as their greatest asset, or to include talent management as one of the four or five planks of their growth strategy. Yet few companies approach this issue in a truly systematic fashion. Those that do manage to build a talent engine that attracts, develops, and retains a pipeline of distinctive people at all levels of the company, thus creating another type of scale advantage.

Thinking about your scale platforms in this way can help bring about a change in your definition of what business you are in and thus shape your future growth direction. One client we served described this well: “We ask ourselves provocative questions. Are we really just a payment platform? Are we a processing company? If so, what markets should we think of entering next?” Scale platforms don’t only help achieve advantage; they can also bring about renewal.

 

We’ve now covered the four key elements of an architecture for growth, but we haven’t yet shown how they all come together using the fifth element, management processes. In the next chapter, we describe a model for creating a fully resonating architecture for growth. We call it “cluster-based growth.”

NOTES

1 T.A. Stewart, “Growth as a process,” Harvard Business Review, June 2006, p. 64.

2 For a comprehensive account, see R. Foster and S. Kaplan, Creative Destruction: Why companies that are built to last underperform the market—and how to successfully transform them (Currency, New York, 2001), pp. 260-87.

3 This effort was led by our colleagues Rob Palter and Dev Srinivasan. See their article “Habits of the busiest acquirers,” The McKinsey Quarterly, 2006, number 4, pp. 19-27.

4 The sample here is the same as that used in Figure 10.1. We started with a population that combined the top 75 US companies by market cap with the top 75 by revenues as of June 2005. After accounting for those that appeared in both lists, we were left with 102 companies. From this sample, we identified 33 companies that had accumulated at least 30 percent of their market value through acquisition. The executives most responsible for M&A activity at 20 of these companies agreed to take part in a rigorous 60-minute conversation covering over 100 questions about organization, process, tools, and the metrics used in acquisitions and integration.

5 The only difference we could observe in M&A team composition was that rewarded acquirers were more likely to recruit internal people into the M&A group, while unrewarded acquirers relied more heavily on outside hires. This may help explain why M&A groups are able to work more closely with the business units at rewarded acquirers. That said, we can’t necessarily fault the unrewarded for relying on outside hires; we didn’t probe deeply enough to know if they had the right talent inside the company.

6 The Alchemy of Growth, chapter 5.

7 G. A. Moore, “To succeed in the long term, focus on the middle term,” Harvard Business Review, July-August 2007, pp. 84-90.