Value Migration, Adrian Slywotzky, 1996 – Power-packed book with lot of case studies in value migration. This is probably one of the earliest books that made people look at businesses and their ecosystems and stakeholders as a whole and treat them as living/breathing things that grow, mature, age and die.
My notes –
• When the mechanism that matches the business design to the Customer priorities breaks down, value migration occurs
• Business design is how a business selects its customers, defines & differentiates product offerings, decides what tasks it will perform vs outsource, managing its resources and going to market – creating utility and capturing profit
• Value migration can occur to other business designs within the industry to migrate out of it altogether
• Value outflow may start slow and accelerate as the model becomes obsolete
• Value migrated from Ford’s single car stable to price-laddered GM in 1920s. From grocery stores to super-markets in 1930s
• In ’94 when IBM had revenue of $64b and Microsoft has $5b, IBM was worth $43b and latter $36b in market cap (company’s value declines fast when market senses value migration)
• Where will I be allowed to make profit? where will the value of the industry be? what new core competencies do I need? What moves do I need to make to capture value in next cycle? (Some of the questions you must ask as manager/owner)
• Institutional memory – powerful norms, values and behavior built into the mind-set and culture of an org. It’s the biggest hurdle to combating recognition and stoppage of value outflow
• Technology alone is no longer a driver in value growth. Innovation is slowing – Eg. In Chemical industry there were 40 innovations between ’30-’49. 20 between ’50-’69 and only 3 between ’70-’89. (Similar for dyestuff, steel, textiles)
• Information and capital flow through globalization has kept any technology from being profitable for long. As followers rapidly imitate, gross margins crash sooner
• Even when companies’ product/service offerings are comparable, differences in business design can produce different value growth (Southwest Air vs United, Intel vs AMD, Nucor vs Bethlehem in Steel). Technology alone without good business design will not generate value growth
• Toyota tried to overcome cyclicality in Auto industry but doubling selling efforts when demand was low and cutting back when it was high. Its selling was as flexible as its manufacturing. In innovation as well, instead of innovating and selling, it sought what its customers wanted and invented that
• McDonald’s Kroc realized that for a franchising business to be successful, he had two customers – the end Customer and the franchisee. There must be loyalty and growth in both (Innovated in both with menu of only 10 items offered at low prices with decent quality, manufactured the cheap McDonald’s way, for franchisee profitability)
• Value can be flowing in, be stable or flowing out – in any business. Important to identify where a business is. Initial period might have losses, then a steep improvement in profits (J-curve) and a period of stability and then profit plummets in value outflow phase. End of business cycle is the worst as obsolete designs tend to be subsidized and kept alive longer thereby destroying value
• Market cap/Sales is a good metric to identify value migration. High mcap/sales indicates high future expected earnings momentum (cart before the horse?)
• Value migration happens out of societal, economic and technological shifts
• Customers vote on business designs every day. Customer behavior is the strongest indicator of a superior business design. Following the customer will show you where the value is
• Value inflow – How long? How to accelerate? Are we maximizing value? Who else is benefitting? What will signal this phase is ending? (changing priorities/new product from competitor)
• Stability phase – Business is in comfort zone for Customers as well as management. If you are in stability phase, you are probably already under attack from a competitor.
• Value outflow – Cut back or continue to invest in sub-par RoCE? It is hard to turn around once outflow starts – but once past denial – evaluate the threat, see what investments can create value and stop outflow or see how fast you can wind up or you will end up with empty, profitless revenues
• Innovation, regulation, trade restrictions, aggressive pricing, hyperinflation, even war can cause value to migrate into or out of a business design. (Video cassette pushed hollywood studios in stable phase back to value inflow. Oil embargo boosted compact car sales)
• It is new competition, rather than incumbents that trigger value migration
• Industry-think – Past patterns of success and norms that defined the competitive field. Tunnel-vision leads to focus on relevant but incomplete set of competition. Typically outsiders do a better job identifying non-traditional players.
• Post-war retail was dominated by Macy’s Marshall Fields, May’s in high-end and Sears, Montgomery Ward and JC Penney in mid-market brands. In 80s, people’s income stagnated or declines in real terms, time was becoming increasingly precious and people became individualistic. Businesses like ‘The Gap’ and ‘The Limited’ focused on the individualism. Super Stores like The Home Depot, Toys R Us and Circuit City offered cost-conscious, price-sensitive customers great value. Wal-mart captured previous under-served rural C and D counties with large 100,000 sft stores.
• Premium pricing, reinforced ‘The Economist’s highbrow image among business mags.
• External shocks can rapidly widen the competitive field (Demonetization & digital payments?). In Financial markets in the US, in ’79 inflation was rampant at 13% while bank savings was 5.25% (sounds familiar). Public realized how much they were losing and moved to money market funds. ’79 $10b to ’82 total was $250b (25x in 3 yrs) as savers became investors
• When VCR technology became mainstream, value migrated from network television to video rentals. Network execs looked at programming, broadcasting and selling advertising while ignoring Customer’s utility of “video entertainment” (Same thing happened with Blockbuster and Netflix much after the book. Same mistakes keep happening)
• Multi-directional migration – Value migrated from Steel industry to plastics (in auto due to light-weight and rise in fuel-efficient cars and durables) and from steel to aluminum (beer cans) and from fully-integrated mills to foreign mills and mini-mills (Bethlehem vs Nucor)
• There’s no rule that says there must be profit in an industry. An entire industry can turn and remain profitless
• Southwest Air – low fares, no frills on short-flights. Planes were turned around in 20 mins vs 1 hr, they had higher load factor & frequent flights (instead of wider seats and free drinks)
• There’s no economies of scale in airlines business. Instead a small airline can be profitable with a lower cost proposition. Southwest Air would add one city at a time, become profitable in it and then add another (City pairs instead of hub-spoke)
• Chronic overcapacity kept the load factors (% of occupied seats) around 55-65% range in the airlines business in the 80s. Margins fell from 6.1% in ’78 to -2.5% in ’90. Price war meant 93% of tickets were sold at discount fare with avg. discount of 63%. No one could pull of such a low-price strategy profitably
• Pharma was mostly serendipitous science pre ’75 but from ’75-’90 it was more focused towards creation of blockbuster products.
• Expensive products with questionable efficacy in the ’50s (thalidomide) forced FDA to tighten regulation for testing new products with rigorous statistical evidence.
• ’60s and early ”70s, R&D spend of pharma industry grew from 4% to 7% of sales. Avg. length of discovery of product rose from 2 yrs to 7 yrs
• In the ’70s the FDA also reduced the patent-protected economic life of product – so longer, expensive product development ($1m in ’62 to $12m in ’72 to $50m in ’75) coupled with reduced revenue stream – success rate of products diminished
• Merck’s business design overcame headwinds by making FDA and the physician as customers and focusing on narrow portfolio of blockbuster products and managing them aggressively and getting to market 40% faster. Merck also bought Medco to influence prescribing behavior and also to learn about how its products were used. Merck refused to let institutional memory affect its value growth and always pre-empted the market
• Waxman-Hatch regulation changed pharma landscape by allowing approval based on bio-equivalence and removing the cost of clinical testing for safety and efficacy opening the door for generics
• When competitors all employ same business design, Customers are left with no option but to decide solely on price
• Premium products test the upper end of consumer quality spectrum – Haagen Dazs, TCBY in frozen yoghurt and Perrier in bottled water – gourmet foods at Gourmet prices for the growing population of discerning customers. Starbucks took the same model in Coffee by using premium Arabica beans which were aromatic, more flavorful but expensive
• When people bought a latte from Starbucks, they were drinking the same coffee as movie stars. They could not afford an expensive car as them but could reward themselves a bag of great coffee – coffee was an affordable luxury (Affordable luxury is a powerful concept. Jockey might be a premium brand for most Indians but its an affordable one)
• Starbucks leveraged its IPO to generate name awareness without advertising
• Coke vs Pepsi – draw in retail channel but 2:1 in restaurants, 3:1 in vending machines and 4:1 in international sales. It accept lower margins in retail channel in order to build a brand that earns higher in other channels (As of ’22 PepsiCo and Coca-Cola have similar market cap of ~$230b)
• Unlike McDonald’s Starbucks chose not to franchise and that led to imitators capturing a lot of market share at its expense as it was limited in its growth without franchising
• IBM first PC rolled off assembly line in ’81 and by ’84 annual PC sales was $12 billion (IBM had 37% market share)
• IBM developed the PC but it outsourced the processor chip to Intel and its operating system to Microsoft (without exclusivity) and the rest is history. They had put out a quality product on the market quickly but at the loss of strategic control (be careful what you outsource and how)
• Microsoft was to release OS/2 (under contract to IBM) as successor to DOS but Gates launched Windows 3.0 ignoring OS/2. Developers couldn’t get their apps onto Windows quick enough while Gates launched Excel usurping Lotus 1-2-3, Word eroding WordPerfect and acquired Foxpro developing Access decimating Ashton-Tate’s DBase
• Low cost distribution has displaced traditional sales channels in retail, grocery, financial services, personal computing and basic supplies (Look out for decline or advances in purchasing power). It is a powerful engine in value creation when Customers grow more sophisticated and products and services lose differentiation in the marketplace. Price becomes the dominant criterion for choosing.
• Low Cost Distribution – Aldi (German grocery retail) – limited selection, passable quality but rock-bottom prices. Even wealthy customers shop at Aldi because “Poor people must save and rich people like to save”. Avg. store size 8000 sft. 600 SKUs, mostly non-perishable, high-turn staples – sell product even before payment is due to suppliers. Minimal customer service – 3.5% of sales vs 6% for supermarkets
• Low Cost Distribution – In ’80s discount brokers handled tiny fraction of retail trades, by mid 90s their share rose to 14% (today almost 85% in US and 55% in India)
• Low Cost Distribution – Grainger did to industrial purchasing of MRO (Maintenance, Repair and Operation) supplies what Wal-Mart did to retailing. It grouped 1100 suppliers and 73k products in a single catalog and became one-stop shop for MRO supplies – cutting purchasing and paperwork (consolidated billing)
• Low Cost Distribution – Dell cut down ASP and invented mail order distribution for computers coupled with telemarketing – IBM’s sales force was $150k/person producing sales of $2m vs Dell’s $40k telemarketer selling $4m
• When needs are emerging, the customer looks for performance, when needs are mature, the customer looks for lower cost. Investment in improved performance for mature needs provide no returns. A dollar invested gets little in return (Will be interesting to study what Apple spent on iPhone R&D last 5 yrs)
• In ’70 market cap of world’s companies was $929b and 66% in US. By ’93, it was $12.6 trillion with only 36% in the US. (In ’20 its $90 trillion with 44% in US)
• Andy Grove’s Intel moved from DRAM chips that stored data to processor chips that did the thinking made them shed their institutional memory to embark on something new
• 3M has systems for defeating institutional memory that made it transition from abrasives to adhesives to chemicals to video tape to computer disks and other product areas. 3M makes it employees believe they work in smaller, more flexible orgs (startups within mature org) with 15% of time dedicated to individual projects. Each year they try to achieve 25% of revenue from new products that did not exist 5 yrs ago. 3M has 60k products (They still have same 60k products and available at 15x earnings and 5.4% Div yield!)
• Much of future is actually knowable to a high degree of certainty, given a rigorous examination of facts (in the context of businesses).
• A poorly examined fact is more dangerous than wrong reasoning (French proverb)
• Consumer packaged goods have extremely long lifecycles measured in decades (Coke is 130 yrs old, Tide is 70+) Only sustained neglect can erode and undermine them.
• Increasing price without increasing utility also kills brands. In the inflationary 80s, brands kept increasing price – where brands where 20% more expensive than generic alternatives in early ’80s to being 2x more than generics by early ’90s. This drove customers towards alternatives
• Global mercantilism – hostile trading blocs and economic instability. Much harder to implement policies for greater good due to prisoner’s dilemma Eg. Environmental issues are ignored and no agreements on emission reductions (All currently underway as ESG has been swallowed by Energy crisis)
If you enjoy thinking about business models or business designs as this book calls it, you will find lot of insights here. Only issue is the outdated nature of the book in terms of some of the numbers and what transpired later (some heroes here suffered later and must be kept in mind) – but that’s to be expected – as IBM which was the hero in 50s and 60s made a come back in the 80s after suffering in the 70s, only to lose it all post ’90s in the computing business even in this book. There can be no permanent winners and the lessons here are timeless. 11/10
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