This article was originally published on CFO.com.
What does it take to for a company to have staying power? Long-term, “market-like” management of product lines and business mixes.
Did you know that in 1958 ( a 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 down to around 15 years — driven by both M&A activity (which was the principal historic driver), shifting US macroeconomics and the relentless growth of the “new economy” — essentially, the digitization of an increasing amount of both commerce and society.
To keep up with mergers, buyouts and bankruptcies, the index has added (and thus also dropped) an average of 20 companies to the index annually. It’s easy to see the difference between today’s version and the one that made its debut nearly a half-century earlier. Tellingly, only one “bricks and mortar” retailer (JC Penney) in the original list remains in the index today.
Around 10 years ago it took a market cap of at least $3 billion to get into the S&P 500. Today it takes at least $5 billion, so you have to grow your market value consistently at around that rate to just stay in — never mind moving up the list or avoiding displacement by new entrants. If recent trends persist, more than 75% of the current S&P 500 companies will have been dropped by 2028. So, (a) who will replace them (the raw math says we need to find 375 businesses worth at least $5 billion each, adding almost $2 trillion dollars to the economy) and (b) if you’re there today, how do you stay in?
Just as in the natural world, survival requires adaptation (or a dominant position in an unassailable niche — and there aren’t many of those) and it’s interesting to see how this has played out over the past decades. What we can learn from the survivors?
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;
- Creating (or acquiring) new businesses which meet new or evolving customer needs; and
- Shedding business that once might have been core but now no longer meet company standards for growth and return on capital before they become a drag on earnings and valuations (even if they are still good businesses).
Pretty obvious. 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 and then in letting go “emotionally” of past successes while they are still healthy enough to command a good price. It’s not surprising, then, that many large companies slowly fall behind their markets’ pace of change.
Too often such companies end up continuing on their current course rather than managing for the long-term evolution of their product lines and business mixes. 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 is very difficult.
So what would a winning strategy that enables the company to adapt 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). So companies that mimic market strategies and behaviors should out-compete their rivals much of the time. Markets grow through innovation (the creation of new companies that create value for customers) and 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. Companies can’t afford to have this happen. Getting the balance right (in control, 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 as 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. Of course, if an industry is changing more slowly than the overall economy, that industry will almost certainly experience gradual (or even rapid) decline and risks replacement by lower cost global competitors. Think tech manufacturing, steel, autos, furniture and paper as examples.
- “Do all of our control systems work effectively?” “Control” means more than just financial control. It also means operational controls— such as manufacturing quality, cost and sales effectiveness, and profitability, as well as “societal” controls, the ethical and legal standards under which business is done. Companies that lose control of these standards rarely come back.
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 corporation 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.
Otherwise, sayonara to the S&P 500.