The Eye Strategy
The best returns for investors, with only moderate risk attached, are found in the companies that combine operational excellence — consistently outstanding performance for customers that’s brought to the bottom line — with sustained rapid growth. Operational excellence is a necessity today. Investors mercilessly punish companies that fail to meet these expectations. Deal makers and industry visionaries (like Tyco’s Dennis Kozlowski and Vivendi’s Jean-Marie Messier) don’t deliver results to shareholders. It’s the great operators who do.
But operational excellence isn’t enough. From 1992 to 2001, for example, U.S. companies Sara Lee, Masco, Genuine Parts, and Sonoco Products all sustained attractive returns on assets and economic value added and grew with their industry, but they produced below-average returns for investors since they only met the market’s expectations. Above-average performers must also sustain double-digit revenue growth.
Companies that sustain double-digit growth in earnings and revenue are found across the economy: in low-growth industries (General Dynamics, Harley-Davidson, and Lowe’s) and high-growth ones (Intel, Medtronic, and Oracle); in low-margin industries (consider Cardinal Health, Devry, and Gentex) and high-margin ones (think of Citigroup, Microsoft, and Starbucks). Building upon a 30 to 50 percent advantage in the performance that matters most to customers, these companies face only moderate risks because they control their future. They have to “merely” sustain their performance advantage and find sufficient market opportunities to sustain their extraordinary growth.
Most of these high-return, moderate-risk companies are in the eye of Schumpeter’s hurricane, reshaping not only their own industry, but also adjacent industries. For example, the success of Home Depot and Lowe’s has transformed the formerly fragmented $100 billion home improvement retail industry, eliminated the home center retail industry, collapsed the lumberyard channel, and forced every building-products manufacturer to change its marketing strategy. Similarly, Dell continues to drive its superior direct-to-the-customer approach into contiguous product segments such as networked storage systems (together with the EMC Corporation), printers (including private labeling of Lexmark International Inc.), and resale of hardware and software branded by other companies (including Apple Computer Inc.’s iPod). Threatened by Dell’s expansion, Hewlett-Packard Company, Cisco Systems Inc., and the 3Com Corporation all recently terminated their resale arrangements. The next rounds of this competition will reshape the printer and network equipment industries.
Although an eye-of-the-hurricane strategy carries only moderate risk once it’s successful, how many companies are destroyed in their attempt to move inside and create superior operational performance and rapid growth? Because it’s so much easier to identify companies that succeeded than those that failed, it’s impossible to pinpoint the risk of an eye-of-the-hurricane strategy. However, our best judgment is that the risks are much less than they appear. First, our research suggests that few successful “eye strategies” are risky ideas that are new to the world: Most companies prosper by applying successful ideas taken from other industries to their own industry. Power retailing is a great example. Developed by Toys “R” Us Inc. in the 1950s, power retailing has transformed at least 15 other industries. Forty years later, during the 1992-to-2001 decade, three of the companies in the top 5 percent of performance for shareholders were power retailers (Bed Bath & Beyond Inc., Best Buy Co. Inc., and Lowe’s).
Second, even when they err, eye-of-the-hurricane strategies still create superior long-term returns for investors. Despite the failure of its effort to sell through retailers, Dell has been a superior investment in every decade since the company was founded. Oxford Health Plans Inc. was in the top 10 percent of companies in returns to shareholders during the 1992-to-2001 period, despite losing control of its business in the mid-1990s, despite the retirement of its founder, and despite a painful restructuring that eventually reestablished Oxford as a top performer.