In 2001, Chris Zook wrote: “Profit from the Core.” This book was written to really address the topic of focusing on the core business and on diversification from the core business.
Here is a quick synopsis on it:
The key to growth is to focus on the core of a business. This means truly understanding what the core of the business is.
What’s the best approach to defining the core business?
- define the business boundaries, and core business;
- sources of differentiation that will continue to create market power and influence over customers, suppliers, competitors, and industry profit pool;
- comb through the core and assess if the business is operating at it’s full potential
Identifying the boundaries to a business is important. By identifying these boundaries, you can better classify your competitor’s and new opportunities.
How does one identify the core business?
- The most potentially* profitable customers
- The most differentiated and strategic capabilities
- The most critical product offerings
- The most important channels
- The most important strategic assets that contribute to the above (patents, brand, people, relationships, etc.)
What are the paradoxes of growth?
- Better to focus on the best business units rather then fixing the under performing business units
- The stronger your core is, the more opportunities to move into other adjacencies will present itself
- Any management team that is successful in building it’s core will be the most vulnerable to industry turbulence
- All existing organizations inhibit growth
- Opportunity for growth comes from focus
What does the first paradox of growth mean for your business?
By focusing on your core business you can achieve excellence. Focusing your resources on under performing units is not judicious. When there is industry turbulence, the more you should focus on your winning or more competitive units. You should really: (a) identify what your core business is (b) identify key differentiation and (c) assess the full economic potential.
Identifying your core business is not as easy as it seems. It means looking at: who is your best customer (in this case, your most profitable), your most highly differentiated strategic capabilities, and what your most important assets are: channels, relationships, distribution channels, product, etc.
For instance, perhaps you are a luxury online shoe retailer. And your most profitable customers are women who are 35 to 55 years old. Perhaps, they are women who live in rural areas where access to retail stores are limited. And that these women are looking for a shoe retailer that curates the latest styles, and that they are looking for a provider who can educate them on the latest styles. The more critical and narrow you are in identifying your core customer, their specific needs, and which internal capabilities match their needs – will help you.
Identifying your key differentiation can be different depending on each of your customer segments. For one group it might be your price, and for another it can be your brand. Differentiation can range from being easily replicate-able to being virtually impossible to replicate. Once you identify your differentiation, you should focus on it by preserving and exploiting it.
For some retailers, their source of differentiation could be economies of scale. One retailer might have the ability to control select suppliers and their prices. By controlling their prices, the retailer can have a better profit margin or value proposition to their customer. This differentiation should be emphasized, promoted, and exploited.
To assess the full economic potential of your business means to evaluate whether or not your business is extracting the most value it can from its customers. It means asking questions like: how much should my business be earning if it is the leader? How can we generate more profits then our competitors?
What does the second paradox mean?
As a firm’s core grows, the amount of opportunities to explore other adjacencies grow. This a double-edge sword: on one hand, you can expand and on the other you can loose focus from your core.
One should: (a) identify all adjacencies, (b) choose the right adjacency and (c) avoid the most common pitfalls.
Potential adjacencies can vary. They typically fall in the categories:
- New Business
- New Products
- New Channels
- Backward Integration
- Downstream Integration
- New Geographies
- New Customer Segments
- New Capabilities
The key to choosing the right adjacency is to ask the following questions:
- How much would this new idea strengthen our core business?
- What are our changes in becoming a leader in this new segment?
- Could this move preempt a potential initiative by our current or future competitors?
- Would this idea position us advantageously for future opportunities?
- Could we execute with excellence in this new area?
There are a variety of common pitfalls that needs to be avoided when using this strategy. In the book, they list the following:
- Expanding towards an entrenched competitor
- Overestimating the profit pool
- False bundling
- Competition from unexpected parties
- Failure to consider all possible adjacencies
- Missing an entirely new emerging segment
- Pursuing the high-end adjacencies alone