Did you know that in 1958 (just one year after the creation of the index in its current form), the expected tenure in the index for an S&P 500 company was 61 years and that by 1980, this had dropped by more than half - to 25 years? It’s been declining steadily ever since – now (2016) down to around 15 years - driven by both M&A activity (which was the principal historic driver of “exits”), shifting US macroeconomics and the relentless growth of the “new economy” – essentially the digitization of an increasing amount of both commerce and consumer society.
To keep up with mergers, buyouts and bankruptcies, the index has added (and thus also dropped) an average of 20 companies annually. It's easy to see the difference between today's version and the one that made its debut nearly a half-century earlier. Around 10 years ago it took a market cap of at least $3bn to get into the S&P 500. Today it takes at least $5bn – so you have to grow your market value consistently at around a 5.25 compound annual growth rate to just stay in – never mind moving up the list or avoiding getting displaced by new entrants. That might not seem that hard, but it’s beyond what many companies can consistently deliver. Hence the “churn”: If recent trends persist, over 75% of the current S&P 500 companies will have been dropped and replaced by 2028. So, (a) who will replace them (the raw math says we need to find 375 businesses worth at least $5bn each – potentially adding almost $2 trillion dollars to the economy if they are all actually new businesses that don’t yet exist) and (b) if you’re in the index today, how do you stay in for the next 20 years?
Just as in the natural world, long term survival requires adaptation (or a dominant position in an unassailable niche – and there aren’t that many, if any, of those) and it’s interesting to see how this has played out over the past decades – and what we can learn from the survivors as the evolutionary pressures shift to provide new challenges.
In general, three common themes seem to be involved:
- Running all aspects of business operations effectively, so that the business has (steadily growing) earnings (and thus highly valued equity) to use to invest in…
- Creating (or acquiring) new businesses which meet new or evolving customer needs, while…
- Shedding business that once might have been core but now no longer meet company metrics for growth and return on capital, before they become a drag on earnings and valuations (even if they are still “good” businesses).
Pretty obvious, huh? But the second requirement is often at odds (organizationally and culturally) with the first, and the evidence indicates that the third is just plain hard – both in getting the timing right (so you don’t miss value by exiting too early) and then in letting go “emotionally” of past successes while they are still healthy enough to command a good price (so you don’t get left with worthless dregs).
It’s not surprising, then, that many large and seemingly successful companies slowly fall behind the pace of change of their markets – even companies that were previously the drivers of change. All too often such companies end up continuing on their current course (the course that created their success) rather than managing for the long term evolution of their product lines and business mixes in order to keep pace with the overall changes in the economy. That’s the problem with “decline by erosion” – nothing much changes day by day, but a few years down the road things look very different and catching up with those who started early and got things right is very difficult.
So what would a winning digital strategy have to look like?
One way to build a strategy would be to “think like the market”. Markets as a whole tend to outperform most individual companies (with only a few obvious exceptions that are the major contributors to growth). So companies that mimic market strategies and behaviors should out compete most of their rivals much of the time. Markets grow through aggregate innovation (the creation of new companies that create new value for both existing and customers) and the trading of assets from lower performing managers to higher performing. Companies need to do the same. Just as financial investors are advised not to “fall in love” with assets, so companies should take a hard look at their portfolio of products and brands and ask “could someone else do better with this?” If the answer is “no” keep them and continue to invest for growth. Otherwise sell while there is still value and reinvest the proceeds in something new.
Unfortunately, markets from time to time get out of control for a while (lots of reasons for this, many poorly understood). Companies can’t afford to have this happen. Getting the balance right (visibly in control and able to predict future performance with confidence, but not over controlling, which stifles innovation and creativity) requires a skillful blend of leadership, strategy and operations. To assess how well you are doing in achieving this balance, ask yourself:
- “Are our business operations as good as they could be, even if they are already the best in class?” If not, the first order of business is to bring current operations up to optimum levels. Undertaking the more challenging tasks of creating new value and trading assets before achieving operational excellence is well established is risky and unlikely to work.
- “How fast do we have to change to maintain our position within our changing markets?” The pace of change required varies by industry, business line and geography, but you need to be moving at least as fast as the market – a pace increasingly determined by your customers rather than your competitors.
- “Do all of our control systems work effectively?” “Control” means more than just financial control. It also means operational controls— such as: manufacturing quality and cost; sales effectiveness: and profitability as well as “societal” control, the ethical and legal standards under which business is done. Companies that lose control of these standards rarely come back from the brink of trouble.
As we head towards what’s likely to be a protracted period of global turmoil and intensifying competition, coupled with continuing technological change, the message for senior executives is clear: to maintain control of your business and deliver value to shareholders and customers, you must embrace the continuing creation of new value and actively trade assets without losing control of day to day operations. That’s what winning digital will look like.
Otherwise, sayonara S&P.