Few words are more overused and less understood by corporate America. From functional changes to the next strategic acquisition, all are characterized as "transformation" in hopes of garnering attention in an increasingly complicated business world.
In fact, today's world can be downright scary for corporate leaders. The growth of activist investors and a competitive business media environment is increasingly propelling executives from behind the desk to under the spotlight. Business performance has become a blood sport as the spectators not only set expectations but lay out the solutions they expect management to adopt. According to the Argus Research Company, activist investors have a 69% success rate in convincing management to accept their proposals. Parents don't enjoy that degree of success with their children.
Unfortunately, capitulating to outside pressure isn't producing lasting results for businesses. Using the Fortune 500 as a proxy, the storyline is bleak. The largest companies in the US delivered organic revenue growth of exactly "zero" in the past year, while recording roughly $44 billion in restructuring charges. Almost 30% missed their consensus estimates in the past fiscal year. Something is missing: How can the energy expended generate such a negative return?
The Underlying Problem
An analysis of almost 900 transformations during the past five years illuminates the underlying problem. The concept of a transformation program has morphed into an endless series of "slicing the cheese," with management teams compelled to chase next quarter's numbers. Companies with any history have already gone through multiple waves of functional improvements. At a certain point, the scar tissue has built up to the point that more corporate surgery becomes less effective. How many more accountants can a finance function trim? Does cutting receptionist coverage in half really increase profitability? The incremental benefit doesn't outweigh the effort to get there in most cases.
Fortunately, our analysis revealed some shining stars, chiefly among companies that focus on fewer, bigger programs. Companies with these "big bang" programs generated market cap growth of 78% between 2010 and 2015, while the S&P 500 index rose 55% and companies with a pattern of serial transformations gained only 26%, over the same period. Unwrapping the "big bang" experience highlights lessons for business leaders:
Key Lessons for Business Leaders
Be bold. Of course, process improvements and budget discipline will remain important parts of performance gains. They should not be considered transformative. The most common mistake is attaching big energy and big labels to small projects. Accretive transformation is based on understanding the performance needed to meet expectations and challenging the organization to find solutions that surpass those expectations. Part of this is foreshadowing and taking a realistic look at the next three to five years in an attempt to get ahead of it. It is a lot easier to ride the wave when you are on top, rather than below. With this in mind, transformative performance improvement should target a 2x-3x increase in EBITDA as a starting point. By applying that lens, organizations can unlock traditional constraints.
Be integrated. Today's business organizations are complex and divided, rather than being integrated. The challenge of multiple, functionally-isolated programs is they allow large cost centers to "opt out" of transformation efforts. Take sales for example. Imagine a sales efficiency effort where the sales operations team declares they are more aligned to operations and therefore excluded from the efficiency discussion. Then when it comes time for an operations improvement program, that same group is now seen as a crucial part of the sales team and is too "client facing" to be considered part of the new program. As you can see, pockets of costs are excluded from potentially transformative, efficiency-driven efforts. The other advantage of integration is it allows leadership to make decisions across multiple functions that would be difficult to achieve in isolation.
Attack complexity. Our experience suggests that 30% of an organization's costs are embedded between functions. Most of this is tied up in the concept of "internal customers" and the need to meet service levels that are rarely challenged or judged within the cost portfolio. Organizations develop collections of work-arounds and short cuts used to "get things done." By attacking complexity, successful transformations have the license to use a clean sheet of paper and design what the function should look like based on that future need. Don't mistake this approach as an academic exercise divorced from the reality of the current state. Rather, starting fresh removes the anchor of the current organization as the limiting factor. Compromises can be made after the complexity is understood and challenged.
Manage thoughtfully. Rolling out a program charged with doubling or tripling EBITDA is an ambitious and disruptive task. In many cases, success will generate more profit than any other aspect of the business. As such, planning and execution needs to remain at the executive level. A common fail point for transformations occurs when they are rushed to execution as management teams move on to the next challenge. Analysis suggests that large programs are a series of decisions that should remain a key focus of leadership. This would include holding the organization accountable for implementation, providing resources to support success, and communicating success both internally and externally.
Focus to the Finish. Business pages are full of examples of leadership failure. Oftentimes, shortcomings can be traced back to a lack of urgency to think in transformative ways and the struggle to create the necessary trigger event to breakthrough business as usual. Today's media environment suggests M&A as a high-probability trigger, as long as leadership avoids the temptation to simply tuck away the acquisition. Leadership teams that consistently find success are those that find the right target (whether it is acquisition or internally driven), develop a clean plan rooted in "confidence" (rather than "hope") and drive results to the bottom line. Executed successfully, the benefits should have lasting value to shareholders.
There are no shortages of challenges facing today's business leaders, and how leaders react and set the course is crucial for a successful future--if management doesn't take control and guide the business to that future, someone will force its hand. When it comes to transformative actions, the path to that future is clear. The theme of do it big, do it right should be top of mind.
Originally Published in JEGI's Client Briefing.