Letting Go

Letting Go
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When and how to drop a business that isn't working anymore.

By Rita Gunther McGrath

Letting Go

Rita Gunther McGrath is a professor at Columbia Business School and dean of the Fellows of the Strategic Management Society. Adapted from The End of Competitive Advantage: How to Keep Your Strategy Moving as Fast as Your Business (Harvard Business Review Press). ©2013

Texts on strategy and innovation are full of great ideas of new things that leaders should do. But, lamented a senior executive I was with recently, “There aren’t any textbooks on what to stop doing!” In a world of temporary advantage, stopping things—exiting declining advantages—is every bit as critical as starting things. Activities need to stop because they can no longer demonstrate good growth potential, or perhaps competitors have made them a commodity, or perhaps they simply have few growth prospects.

Growth outlier firms—those rare companies that have maintained steady growth despite industry upheaval—use a process of continuous small changes to avoid having to make more substantive exit and disengagement decisions. But not all firms are so fortunate, and there are occasions in which a more radical disengagement is simply necessary. This could be because a declining business drops off faster than expected (as happened to Fuji Photo in the 1990s), because markets change in a radical way (as happened to the smartphone business with the introduction of the iPhone), or simply because a firm lingers a little too long in the “exploit” phase and didn’t reconfigure.

Evidence that a business or business model is going into decline is usually quite clear long before it creates a corporate crisis. If one is interested in looking, there is usually a lot of good information to be found. The trouble is that this information seldom turns up in the routine measurements that companies use to drive their businesses.

By the time a decline shows up in your performance numbers, it is usually too late to muster a proactive response, and you find yourself clambering back in a weaker position than you had been in.

The first clear warning sign is when next-generation innovations offer smaller and smaller improvements in the user experience. If the people designing the next-generation offer are having trouble conceiving of new ways to differentiate what you do, that’s not good. If your scientists and engineering types are predicting that some new discovery will undermine the existing trajectory, that is also not good. For instance, RIM’s BlackBerry email devices were the natural descendants of the first pagers, with keypads. The trajectory on which they developed didn’t change much, adding mostly incremental touches such as colored screens, cameras, voice recorders, and some applications. Although customers appreciated these innovations, they were no longer excited by them.

A second clear warning sign is when you start to hear customers saying that new alternatives are increasingly acceptable to them—or, worse, that cheaper alternatives are just as good as what you have to offer. For example, Google has developed a maps application for Android-equipped mobile phones that provides turn-by-turn spoken navigation. This has prompted a decline in the attractiveness of standalone GPS navigation devices and even predictions that such devices will no longer be popular in automobile dashboards or as handhelds. Even worse is when a competitive or substitute offering shows the threat of changing the dimensions of competition customers are looking for, particularly if it comes as a surprise. RIM, stuck in a pager-based mindset, never saw the iPhone coming.

Finally, of course, you can consult your numbers. Usually, there’s first a small decline in the sales growth rate. Then a flattening out. Then noticeably declining sales. Unfortunately, by the time a decline shows up in your performance numbers, it is usually too late to muster a proactive response, and you find yourself clambering back in a weaker position than you had been in.mcgrath3

At Wolters Kluwer, a once-traditional publishing company navigating a transformation to the digital world, the executive team has honed the process of managing a portfolio of products. With products that still have some life cycle, the company manages by “pruning,” as CEO Nancy McKinstry notes. Updates might be a little less frequent, and fewer editorial resources might be dedicated. This is considered “harvesting” and has been readily adopted as part of the way in which publishing life cycles are managed. Far more difficult is the challenge of an outright divestiture. McKinstry has instituted a review that “organizes micro markets by category”: Anything growing organically more than 5 percent is considered to be high growth and will continue to be supported; growth in the 2 percent to 5 percent range is considered “maintain”; growth below 2 percent is a candidate for harvest and, failing that, for divestiture.

Who Makes the Exit Decision?

It is unrealistic to expect managers whose careers and future prospects depend on “their” business continuing to put up their hands and suggest that the company kill that business. Indeed, all the skills of increasing efficiency and deepening customer loyalty that are so valuable during the period of exploitation can make a business that really should be a candidate for disengagement look attractive long after its time. Further, many companies fail to effectively aggregate or present information that might lead to questions about a business or division. There seem to be three ways of overcoming this challenge. The first is to set up an ongoing, dedicated team to regularly go through the firm’s portfolio and identify candidates for disengagement or divestiture, as Wolters Kluwer has done. The second is to aggressively and frequently change the management team. The third is for the CEO to drive regular evaluations of what should be in and out of the business’s portfolio, a challenge that Procter & Gamble’s A.G. Lafley defines as “linking the outside to the inside” of a business. As he argues in an HBR article, “only the CEO has the enterprisewide perspective to make the tough choices involved.”

At Wolters Kluwer, a once-traditional publishing company navigating a transformation to the digital world, the executive team has honed the process of managing a portfolio of products. With products that still have some life cycle, the company manages by “pruning,” as CEO Nancy McKinstry notes.

At Yahoo! Japan (a growth outlier company), Makiko Hamabe, head of investor relations, echoes this thought: “Our CEO says that he is his own heaviest user, and as a user he doesn’t want Yahoo! Japan to do something that annoys him. That’s the basic idea.” This connection to the business allows the CEO to drive a relatively dispassionate numbers-based evaluation of what offerings Yahoo! Japan should pursue and which it should abandon. In that company, key reasons for disengagement are when usage and profitability are low, or if a service creates conflicts with other businesses. “For example,” Hamabe says, “several years ago we stopped offering videocast. It was like YouTube in that people can upload videos. But as you know, on YouTube you have a lot of non-licensed unofficial videos. So we have instead a service like Hulu; we call it Yell. It’s also a video service, but the content is authorized.” The videocast business, deemed incompatible with good relations with content producers, was ended.

It’s important to remember that over time, statistically, most businesses lose value. Indeed, in researching their 2001 book Creative Destruction, then-McKinsey researchers Richard Foster and Sarah Kaplan found that as a business ages, its total return to shareholders, relative to its industry, declines systematically. A 2002 HBR article makes a similar point: If you think you have a candidate for divestiture or otherwise ramping down, you should move quickly because the passage of time will rapidly destroy any remaining value.

Here, however, we are contemplating the problem that is sometimes unavoidable: when a business that once created competitive advantage ought to be removed from the corporate portfolio. This can be for any of three reasons. First, you may have concluded, as Netflix has, that your current core offering is becoming obsolete for some reason and you need to transition customers, suppliers, and the organization to some new platform. Second, a business might actually have strong cash flow and be attractive as a going concern, but it no longer fits your strategy. Or, finally, a business or capability may simply be heading into obsolescence.

Strategies for Disengagement

The first dimension concerns the judgment of management about the future of an asset or capability. The second concerns the extent to which there is substantial time pressure to enact the disengagement.

Orderly Migration: Customers’ Needs Are Going to Be Met in a New Way, but You Have Time

Not all customers are going to be prepared to move at the same rate. There is a sequence to which customers you should transition away from first, which next, and so on.

I first ran across the remarkable story of Norway’s Schibsted Media Group in a 2010 BusinessWeek article. Schibsted is a newspaper publisher, a venerable institution founded in 1839. Like newspaper publishers everywhere, it is coping with a staggering loss of ad revenue. The 2010 article noted that U.S. newspapers’ ad revenues had collapsed, from $48.6 billion in 2000 to $24.8 billion in 2009, with classified ads suffering the greatest declines. Like their American brethren, Schibsted’s newspapers, dailies such as VG and Aftenposten, have seen their ad revenue fall dramatically. The difference is that Schibsted doesn’t care. As it turns out, most of the customer defections are going from Schibsted-owned companies to . . . well, a Schibsted-owned company. In 1999, the company spun off an online business called FINN.no that provides a platform for online advertising. It competes directly with the papers, and as far as CEO Rolv Erik Ryssdal is concerned, that’s just fine with him. “We weren’t afraid to cannibalize ourselves,” he told a reporter in 2005. The company is now the world’s number-three player in online advertising, behind Craigslist and eBay. Profit margins at some of its sites are reported to be 60 percent.

The Schibsted story illustrates how one can disengage from a business by gradually migrating customers, revenue streams, and operating models from the old advantage to a new one. It is also an interesting take on reverse customer adoption. Those customers who wanted to go online found a ready vehicle for doing so and converted early. Those who didn’t want to work this way weren’t forced to do so until they were ready. Shibsted skillfully managed the migration from early adopters through the mass market.

In its 2011 price-hike debacle, Netflix had more trouble. By forcing a transition on customers before many of them were ready, the company enraged them. Rather than figuring out which segments should be exited, and doing so sequentially, Netflix attempted the same strategy for everybody all at once—and made no one happy. Management should have realized that preparing customers for transitions is just like getting them through the new-product adoption process, except in reverse. Not all customers are going to be prepared to move at the same rate. There is a sequence to which customers you should transition away from first, which next, and so on.mcgrath4

If CEO Reed Hastings had, instead of raising prices for everybody and moving to orphan the company’s DVD service, selectively offered price discounts to those who would drop DVD service, he would have moved that segment over to the new model. Then he could have gone to the “light user” DVD consumers and suggested that instead of getting a new disk any time they wanted it, they would get one a month, say, for the same price. If they wanted the instant service, their rates would go up. That would shift another bunch to at least a point of lower DVD usage. Then, when these segments started to realize that all-streaming wasn’t so bad, he could do the big price increase for the mainstream buyer.

Hail Mary: The Core Business Is Under Immediate Threat, and It Sure Feels Like a Crisis

This is a situation you don’t ever want to be in. The core business is under immediate market-share and margin threat, there’s no silver bullet in the pipeline, and you have to make a choice—fast—about where you are going to focus. Imagine the situation at Nokia: a deep recession dampening demand for its products across the board, losses in some of its core businesses, failure to adequately penetrate emerging growth markets, leadership instability, and a collapsing share price. Oh, sorry, I’m not talking about the Nokia of 2011. I’m talking about the Nokia of the late 1980s, when the embattled company was so down on its luck that its leaders took the humiliating step of shopping the company to Swedish rival Ericsson, only to be turned down.

Speaking to me some years later, Matti Alahuhta, one of the executive team members who participated in what eventually became a spectacular turnaround, said, “You know, back then it was almost easy. We had no other choice.” The company decided to pin its hopes on its nascent telecommunications business, depending on assets from previous investments in computerization and communication technologies and the acquisition of the previous state-owned telecom monopolies. It shed everything else. Rubber boots, cable manufacturing, the other industrial businesses, the TV business—gone, gone, and gone. This is the nature of disengagement when the core business is on the brink of becoming irrelevant.

But of course, you could write a similar story about Nokia today, a company that I’ve studied, worked with, and watched for many years. Like many people, I was very admiring when I first started interacting with it in 2000: The company’s success was absolutely amazing, as it had grown with the mobile-handset category in a spectacular manner for some time. But as I began to spend more time with the company, first in its Choices program for the Nokia Ventures Organization, and later on in a number of its management programs, I began to be concerned. Its venturing process, which I had long held up as a fantastic example (and studied, with results published in several academic articles), seemed to be losing senior executive support. Many talented people left upon the appointment of a new CEO oriented more toward numbers than products. And although Nokia was growing like gangbusters in India and China, it was nowhere in the United States.

As a veteran Nokia watcher and industry expert said to me, “Their biggest problem is complacency.” Leaning back over his desk, and perfectly mimicking the body language of a fair number of Nokia leaders at the time, he knitted his hands together and said, “In fact, they are actually complacent about their attitude toward complacency.” At the time, I laughed. I laughed again when working with the company in 2001. There I was in a frozen hotel in Oulu, Finland, with a bunch of Nokia engineers. The subject of the newly released iPod came up. The reaction was entirely dismissive. “That?” they said. “It’s just a hard drive built on older technology in a fancy case.” I stopped working actively with the company around 2006, but by this time warning bells rang every time I learned afresh about its management decisions.

Stephen Elop’s big disengagement decision at Nokia was to drop development of Nokia’s operating system, MeeGo, and instead adopt Microsoft’s Windows 7 software. . . . Elop made the decision to stop the development effort and repurpose the talent to more future-oriented projects.

In 2007, a colleague and I decided for teaching purposes to drop Nokia as an exemplary innovator. Now it is 2013, and the company is once again staring at the brink. Stephen Elop, the CEO who Nokia brought over from Microsoft’s Office business, faces almost exactly the same challenge that the company leaders of the late 1980s faced: What should be jettisoned so that the company can move onto its next growth trajectory?

Elop’s big disengagement decision at Nokia was to drop development of Nokia’s operating system, MeeGo, and instead adopt Microsoft’s Windows 7 software. The decision was not arrived at lightly—the Linux-based MeeGo had been touted as the company’s answer to Android and Apple smartphones and was to play a part in saving the company. A review of the product conducted by Elop and chief development officer Kai Oistämö, in which they interviewed twenty people deeply involved with the MeeGo project, resulted in a sad, stunning conclusion: At the best rate of progress, the company would introduce only three MeeGo-powered handsets before 2014, far too late to address the crisis besetting Nokia’s core business. Elop made the decision to stop the development effort and repurpose the talent to more future-oriented projects. Using Apple’s operating system was out of the question; working with Google’s Android operating system would fail to position Nokia for leadership (and provide competition for Nokia’s Navteq unit). That left Microsoft. Although the software company’s share of the U.S. smartphone market was extremely small, reviews of its operating system were favorable. More important, Microsoft had strong alliances with corporations and distribution partners that could help Nokia gain traction in its long-lusted-after American markets.

Will the plan work? I don’t know. By the time a company is wrestling with this form of disengagement, there are many things that can go wrong, and Nokia has lost a lot of time. On the other hand, just as the company realized in an earlier era, there was very little choice. By October 2011, the first smartphones resulting from the alliance were on the market to critical acclaim, with headlines blaring “Nokia Gets Back in the Game.”

Garage Sale: The Business Has Value, but It Isn’t for Us Anymore

Some businesses without a particular advantage still have good growth or cash-flow potential, but not with the overhead cost structure or margins to which the parent company is accustomed. The way pharmaceutical companies treat off-patent drugs reflects this dilemma—whereas a generics drug business may look unattractive to an organization such as Merck or Novartis, low-cost global competitor Teva finds it brilliantly appealing. Similarly, Verizon saw the phone-directory business as a route to commodity hell, but two private-equity firms eagerly snapped it up, attracted by the business’s consistent cash flows.mcgrath5

Under CEO Ivan Seidenberg, Verizon pursued an aggressive strategy of moving out of slow-growth core businesses such as landlines and into more competitive and risky areas including wireless and data services. Prodded to some extent by my Columbia Business School colleague Bruce Greenwald, as early as 2001, Seidenberg was anticipating the fading of existing advantages, expecting annual revenues over $100 billion, with 35 percent coming from wireless and 20 percentfrom data. He also anticipated that traditional voice revenues would represent only about 35 percent of the total book of business, down from 60 percent. Since then, the company has shed slow-growth units (even those with solid cash flows) such as phone directories. In their place—and using the cash these spun-off businesses yielded—Verizon has made massive investments in such new areas as fiber-optic technology to enable it to compete with cable companies in offering television and Internet services. Seidenberg did what many companies fail to do: make aggressive investments in the company’s future while the core business was still generating substantial cash. And Verizon weathered years of investment-community abuse before its bold moves paid off.

Fire Sale: A Garage Sale in a Hurry

For a management educator, one of the most frustrating things about the temporary-advantage phenomenon is that no sooner do you find a great example of a company that is doing something really interesting, strategically, than that company falls victim to the stings of eroding advantage. The later poor performance then completely discredits the interesting idea they began with. That’s a bit the way I feel about Mexican cement producer CEMEX. Not that I’m alone—many management researchers have written admiringly of the plucky regional firm that through innovation, clever use of digital technologies, and aggressive M&A activity rose to become a global player and is today the world’s third-largest cement company.

Lorenzo Zambrano, CEMEX’s CEO, has thrown down the gauntlet for businesses wishing to remain within the corporate parent’s purview: Earn 10 percent return on capital, or you are on the block.

Unfortunately, some poorly timed acquisitions and the global construction slowdown have created a real black eye for CEMEX, with a near bankruptcy in 2009 and losses in the third quarter of 2011 alone totaling $821.7 million. With the core business under threat, CEMEX proceeded with a substantial disengagement of so-called noncore assets, to the tune of $1 billion’s worth by the end of 2012, to reduce debt and meet financing covenants. Lorenzo Zambrano, CEMEX’s CEO, has thrown down the gauntlet for businesses wishing to remain within the corporate parent’s purview: Earn 10 percent return on capital, or you are on the block. On the list are quarries, assets held in joint ventures, real estate, and other idle assets that don’t produce earnings before interest, taxes, depreciation, and amortization.

Unlike the more modulated asset disposals of the previous category, such fire sales are often made under significant duress as investors and analysts, armed with metaphorical pitchforks, put pressure on management to stem the losses, focus, and create a compelling story for why the firm is going to get out of its rut. As my friend and colleague Harry Korine has often pointed out, activist investors can sometimes provide a pivotal push to a management team that is reluctant to make some tough choices in this regard.

Run-off: A Declining Technology or Capability, but Someone Still Wants It

Even when something is in an end-of-life stage, there are often important constituents who are still depending on it. A company at that point must figure out some way of shrinking the business to the right size while providing appropriate support to the customers and other stakeholders who may be left behind. Often, these are niche customers who are relatively price-insensitive and have a deep need.

Companies often develop a special business unit just to focus on keeping those capabilities alive. Telecommunications manufacturer Avaya, for example, maintains what is called a “custom engineering” unit, which basically keeps capabilities on the shelf but which can reinvigorate them when they seem relevant once more to a customer’s problem or retire them when the customer no longer needs support. Senior VP Mohamad Ali explains the mechanism the company uses for “keeping certain capabilities alive.” After early adopters have agreed to purchase a given solution, he says, “You can’t just kill it and leave your customers in the lurch.”

He gives an example of a product the company had developed for Citibank in Japan, developing what it terms a “thin call” solution in which customers can interact with a teller remotely, using a phone and a video feed. As he puts it: “Let’s say we decide to kill thin call. Citibank isn’t going to like it if we abandon them. So we put it in the custom engineering group. As long as Citibank is a customer, we’ll continue to support it.” The custom engineering group is also a place in which Avaya keeps people and know-how accessible, even if it doesn’t draw on them for an immediate product. This illustrates two principles for effective disengagement: (1) that you don’t lose key capabilities because a business ends, and (2) that stakeholders who are adversely affected by your decision to stop doing something are made whole.

Privately held GDCA provides a fascinating example of a company that benefits from product obsolescence by allowing client firms to sunset older technologies without abandoning commitments to key customers. When mainstream manufacturers of computer equipment (such as boards) respond to technological improvements and end-of-product-life decisions by getting rid of older equipment and filling their factories with shiny new machines, they create enormous problems for manufacturers of precision medical, military, and industrial equipment who have embedded the boards in their own products. When the components are changed, this can necessitate product redesigns, which in turn can trigger the need for a renewed round of qualifications and a certification that the equipment will work properly. With end-of-life situations occurring with greater frequency, the previous solution of simply buying up enough of the old boards to meet expected demand was proving expensive and unwieldy.

Into this breach stepped GDCA, which counterintuitively went into the business of manufacturing obsolete board designs to guarantee downstream customers that they could continue to buy the exact boards embedded in their designs. Subscribers turn to GDCA when an original manufacturer discontinues making a board. The company then transfers the technology from the original manufacturer to its own engineering group, stores spares, produces more units if necessary, provides repairs, and, when the customer eventually decides it is ready to move on, closes the program.

So there we have the principles of healthy disengagement. First, identify the warning signs. Often, these are qualitative leading indicators rather than quantitative lagging ones. Next, create a way for the import of the numbers to be recognized. Then, once the decision has been made, determine the situation you are in and design the disengagement strategy that makes the most sense.

Conventional budgeting and planning processes are unlikely to be of much help in a transient-advantage context. The decision to exit a business and to implement that exit effectively requires the ability to break through budget logjams and effectively move resources to other places.