When Rising Revenue Spells Trouble
Written by Scott Anthony
Readers in industries where the pace of change has slowed and ambiguity has decreased, please stop reading. This post isn’t for you.
Everyone still here? Thought so. An interconnected world where technology advances at a dizzying pace and new companies emerge, scale, and decline in the blink of an eye means never a dull moment for corporate leaders.
Despite conceptually understanding that this change mandates fresh strategic approaches, Roger Martin (among others) has highlighted the mistakes companies continue to make by relying on processes and tools honed in a differently paced era.
One of the most frequent challenges we observe in the field is that companies tend to radically underestimate the threat that disruptive change poses to their business.
For example, back in early 2005, I and my colleague Clark Gilbert (now the CEO of Deseret News and Deseret Digital) ran a workshop for 100 top executives in the U.S. newspaper industry. The sentiment in the room was clearly triumphant. Pundits had proclaimed that the newspaper industry was a shuffling dinosaur as the commercial Internet took off in the late 1990s, yet most companies still had healthy financial statements and stable balance sheets.
We saw it differently, describing to industry leaders the need to radically change in response to disruptive content models (later that year, Huffington Post and YouTube were founded) and emerging advertising models like Google’s search-based advertising.
Industry leaders were buoyant because advertising revenues continued to grow over the next couple of years. But the warning signs were in plain sight. Readership had been dipping for four successive generations, as most youth turned to social networks and other online media for news. Advertising spending was shifting, albeit more slowly than readers were changing their behavior. For example, a prescient report by McKinsey in 2005 showed that classified advertisement (the true driver of profitability for many newspaper companies) had decoupled from newspapers’ economic growth. Executives dismissed the argument, with Tony Ridder, the gruff chairman and chief executive of Knight-Ridder (which was sold to McClatchy in 2006 for what now appears an incredible $4.5 billion), proclaiming McKinsey’s analysis “shallow and superficial.”
When the industry tipped, it did so with a fury. A beautiful (yet scary) graph from University of Michigan economics professor Mark Perry shows how 60 years of growth was wiped out in three. There is still money to be made in what remains of the newspaper industry, but the past few years have seen dramatic retrenchment and downsizing.
Amara’s law teaches us that we tend to overestimate the amount of change in the short term but under-estimate it in the long term. Leaders at Kodak, Blockbuster, Research in Motion, Digital Equipment, and, perhaps now, Best Buy can explain that one of the toughest challenges about responding to disruptive change is that the full financial impact only appears when it’s too late to respond in any material way. As Kodak president Philip Faraci told a group of newspaper executives in 2008 (oh, the irony), one of Kodak’s biggest problems was the apparent stability of its core film business. The company wasn’t blind to the disruptive changes in its industry (after all, it was a Kodak engineer who had invented digital photography way back in 1975), but its impact on the company’s financials lagged far behind changes in both technology and customer behavior.
In 1999, Kodak’s photography business peaked at $10.3 billion. The business stayed basically flat in 2000. The next year featured a modest decline of 8%, which could be explained away by a global recession. But then the pace accelerated dramatically, and by the end of the decade, revenues had dropped to less than $1 billion. Kodak’s leaders legitimately struggled to square the story they kept hearing (“the future is digital!”) with their own data (“the future is still in the future”).
Sometimes rising (or even flat) revenue and profits are good things, of course. So how can you spot circumstances where an apparently healthy business masks an existential threat?
One way is to pay very careful attention to any development that fits the pattern of disruptive innovation – something that makes it simpler, easier, or more affordable for people to do what used to be complex or costly – emerging in the edges of your industry. You may see the signs in a fringe group of customers. Pay attention when college students pick up what appears to be an inferior product as a workaround substitute for one of your products. Or when they start behaving in new ways (as when they started providing status updates on social networks). Or you may see suppliers or distributors start to encroach on what you considered to be your business. Perhaps new competitors are starting to emerge from industries that historically had only a tangential connection to yours. Pay particularly close attention any time someone comes toward your market with a business model that looks highly unprofitable to your company or is based on a technology that no one in your company understands very well.
Spotting disruptive business models early is very powerful but arguably difficult. It can be hard to infer a potential rival’s business model, and most start-ups change their models a few times before finding one that sticks. That’s not an argument not to scan for disruption but rather to make sure you do it diligently.
Another, arguably simpler, technique is to change the way you measure market share. Rather than looking at your revenue growth relative to that of your competitors or the share of units you sell in traditional market segments, estimate the share you have of the job that you historically do for customers. For Kodak, looking at its share of the “memory sharing” market as it declined over the first decade of the 2000s would have shown how it had gone from dominance to a bit player with the rise of on-line sharing mechanisms — even as its revenues appeared stable. Newspaper companies would have seen that jobs such as finding movie times, renting an apartment, searching for a job, and even getting general information were rapidly migrating away from them to new technological platforms, even while many consumers hadn’t yet taken the step to stop their newspaper subscription.
Disruptive innovation rarely sneaks up on a company, yet it is easy to discount since its impact is often nonlinear—slow for a long time before the crunch comes. Carefully monitoring shifts in the periphery and the market share that really matter will give you a more grounded view of the risk to your business brewing in today’s market.