winning ideas v10

WINNING IDEAS FOR STRATEGIC

GROWTH AND VENTURING

BY ANDREW GAULE AND ANDY MORRISON

Ready to roll

Winning Ideas forStrategic Growthand Venturing

Ready to roll

Andrew Gaule and Andy Morrison

Published by H-I (Partners) Ltd32 Duke StreetSt JamesLondonSW1Y 6DFUKwww.h-i.com

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© 2005, H-I (Partners) Ltd

First edition August 2005

Printed in the United Kingdom

ISBN: 0-9551117-0-6

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Contents

iv List of figures and tables

v Author profilesvi Authors’ acknowledgements

1 Executive summary1 The growth gamble2 Fundamental insights2 New Business Traffic Lights3 Research methodology3 Report outline

5 Chapter 1: Why is it difficult to find new business opportunities?

6 Intel and McDonald’s: background7 The difficulty of finding businesses that fit8 Inherent risks9 Avoidable causes of failure

13 Chapter 2: Increasing the number of new opportunities14 The natural flow of new ideas16 Improving top-down processes17 Improving bottom-up processes19 How much to invest in new businesses19 Summary of recommendations

21 Chapter 3: How to screen opportunities for new businesses21 Insight 1: Build a strategic business case22 Insight 2: Consider trading as an alternative value capture22 Insight 3: Allow for learning costs24 Insight 4: Identify unusually low or high return markets24 Insight 5: Assess the quality of your people25 Insight 6: Do not distract attention from core businesses25 New Business Traffic Lights

29 Chapter 4: New Business Traffic Lights in practice29 Traffic Light 1: Value advantage33 Traffic Light 2: Profit pool potential37 Traffic Light 3: Leadership/sponsorship quality39 Traffic Light 4: Impact on existing businesses39 Conclusion

41 Chapter 5: Case studies41 Royal Bank of Scotland/Direct Line43 IBM48 Whitbread

51 References

iv © 2005, H-I (Partners) Ltd

List of figures and tables

9 Figure 1: Avoidable causes of failure26 Figure 2: Product/market matrix26 Figure 3: New Business Traffic Lights29 Figure 4: Sources of unique value32 Table 1: Net non-tradable contribution in eye care35 Figure 5: Five forces analysis44 Figure 6: The three horizons47 Figure 7: IBM’s pervasive computing example50 Figure 8: Whitbread’s cinema example

Winning Ideas for Strategic Growth and Venturing: Ready to roll

© 2005, H-I (Partners) Ltd v

Author profiles

Andrew Gaule is the founder of the H-I Network (formerly the Henley-Incubator), which is the leading group for senior executives in globalorganisations wishing to drive strategic innovation and venturing. Andrewpossesses a passion for growth and the challenges faced by leadingorganisations and people.

Andrew has been a thought leader on the major issues of innovation andgrowth. He is the creator of the 5Ps of Innovation and Venturing which helporganisations align their approach to strategic innovation and growth. Thesuccess of specific ventures has also been assisted by the H-I Business Cubemethodology. The traits of successful innovators have also been captured inthe Extrapreneur® terminology, which was created by Andrew to explain theEXTernal perspective and EXTRA skills of an entrepreneur in a corporate. Thisleading thinking has been implemented in organisations such as Unilever, BT,BOC, Shell and many more. The methods have also been embedded in asystem application to provide visibility to senior executives and best practicein innovation and venturing.

Previous reports in the series that Andrew has been involved in includeCorporate Venturing: Rewarding entrepreneurial talent, Innovation PerformanceMeasurement: Striking the right balance and Review of Leading Global CorporateVenture Units.

Andrew has been a senior executive in an IT services company and a businesschange and project manager. He was previously an international SAP projectmanager and commercial manager with Unilever where he managed majordivisional reorganisations and IT projects.

Andrew has an economics degree from St John’s College, Cambridge, is aqualified chartered management accountant and gained his MBA at HenleyManagement College.

Andy Morrison joined BOC Group, a £5bn global industrial gases andservices company, in early 2005 as global director, new business development.In this role he faces exactly the challenge addressed by this report: how tofind and select significant new growth opportunities for development.

Before joining BOC, Andy led the Energy and Industrial Sector practice at H-Iand at the same time was an associate of Ashridge Strategic ManagementCentre, H-I’s research partner in this project. Andy conducted a considerableamount of the primary research in addition to being co-author of this report.

Andy’s early career was spent in a variety of international B2B businessdevelopment roles with Shell and BG Group. These included salesmanagement, strategic marketing, new product development, new marketentry and, more recently, developing new business ventures. Andy was ableto draw on his experiences and observations as a practitioner in researchingand writing this report.

vi © 2005, H-I (Partners) Ltd

Of course, Andy’s current role at BOC is about more than simply selectingopportunities—it is also about guiding as many of them as possible fromconcept to successful business reality. His earlier report in the series, entitledGoing Beyond the Idea: Delivering successful corporate innovation, addresses thispart of the challenge.

There is no escaping the fact that developing new businesses involves takingsome gambles, but by starting with great ideas and avoiding known executionpitfalls, the odds of success can be much improved. This report aims to helppractitioners to load the dice in their favour with the best opportunities sothey are truly ‘ready to roll’.

Authors’ acknowledgements

We gratefully acknowledge the significant contribution of Andrew Campbelland the Ashridge Strategic Management Centre team. Andrew has providedcontent, significant thought leadership and challenge through this report andwe trust our thinking has contributed to the development of future thinking.

We would also like to acknowledge the invaluable contributions ofindividuals and organisations that provided the case examples, and the H-INetwork members who supplied the inspiration and significant input duringthe thought leadership forums and meetings.

Special thanks to Tim Hammond at Whitbread and Mark Wellings at Grist.


© 2005, H-I (Partners) Ltd 1

Executive summary

Growth in profits can come from improving the profitability of the existingrevenue stream, expanding existing businesses by gaining market share orextending into new markets or products, or entering one or more newbusinesses by acquisition, joint venture or greenfield investment.

This quest for new business opportunities is one of the toughest challenges inmanagement, and every company faces it at some point. They need to findnew business opportunities to solve the problem of a slowdown in the growthof their core business, and they want to look for these opportunities outsidetheir current core. Managers want to know what organisation units andprocesses to set up, what activities are involved in preparing the ground andwhat will be needed once a promising new business has been spotted.

When companies gamble and fail, it is generally at a huge cost to bothshareholders and management.

The growth gamble

This report builds on a research project undertaken by Andrew Campbell andRobert Park of Ashridge Strategic Management Centre and published in TheGrowth Gamble: When Leaders Should Bet Big on New Business and How They CanAvoid Expensive Failures.1 It summarises the research conclusions and tests thepracticality of the core tool developed by the Ashridge team—the NewBusiness Traffic Lights—by applying it to some real cases.

The purpose of the research was to determine why managers often find itdifficult to enter significant new businesses and understand why somecompanies succeed. If the research could explain the less obvious successes, itmight give insights that expand on current received wisdom.

First it is necessary to define ‘significant new business’:

• Significant: units that accounted for 20% or more of their parentcompany’s sales and profits or were worth at least $1bn.

• New: the business model of the unit was new compared with the businessmodels of the existing businesses. In other words, the new businesses werenot replications of existing units in new geographic areas or marketsegments. However, transformations of existing business units wereincluded where the new unit was pursuing a different business modelfrom the previous unit.

• Business: a separate organisational unit within a company that has its ownprofit statement and some autonomy from the rest of the organisation.The research focused on new businesses, not extensions to existingbusinesses.

This quest for new business opportunitiesis one of the toughest challenges in

management, and every company faces itat some point

2 © 2005, H-I (Partners) Ltd

Fundamental insights

The research provided some fundamental insights into the circumstances thatlead to value creation and the mistakes that managers make when evaluatingnew businesses:

Insight 1: Build a strategic business caseManagers pay plenty of attention to the financial business case but often toolittle to the strategic business case (the reason the company is likely to dobetter than average in this new game). This balance can be corrected byoffering managers a tool for developing a strategic business case.

Insight 2: Consider trading as an alternative value captureManagers understand that they need an advantage to succeed in a new sector,but they do not normally consider the alternative of trading their advantageinstead of using it to enter the new business. The solution is to deduct thevalue that could be traded in the strategic assessment.

Insight 3: Allow for learning costsManagers allow for contingencies on the assumption that their plans will notalways turn out as expected, but they do not have the tools to assess the likelycosts, at both the operating and the corporate level, of learning a newbusiness. The solution is to deduct a figure for learning costs in the strategicassessment.

Insight 4: Identify unusually low or high return marketsManagers focus too much attention on the potential of the market they arethinking of entering. Strategy analysis indicates that, in normalcircumstances, a company will earn above-average returns only when it has acompetitive advantage. Hence analysis of markets should focus on identifyingthose extreme situations which are either so good that even a competitor witha disadvantage can earn a good return or so bad that even an advantagedplayer may earn less than the cost of capital. The solution is to focus onidentifying markets that offer either unusually low or unusually high returns.

Insight 5: Assess the quality of your peopleManagers recognise that people are important, but they do not pay sufficientattention to the quality of the managers leading the project relative tocompetitors, and they often do not consider the relative capabilities of themanagers the project will report to. The solution is to make the quality ofproject leaders and project sponsors part of the strategic assessment.

Insight 6: Do not distract attention from core businessManagers take into account the benefits to or cannibalisation of existingbusinesses that can result from a new activity. However, they oftenunderestimate the loss of performance in existing businesses that occurswhen attention shifts to new businesses and some of the most energeticmanagers are allocated to new business projects.

New Business Traffic Lights

The result of the research was the creation of a decision tool called the NewBusiness Traffic Lights. The Traffic Lights are a set of questions built roundsound strategic thinking and the six insights described above. They aredesigned to be used early in the life of a project, before enough informationis available to make a full financial business case. They can also be used as a‘sanity check’ for a financial business plan. They can even be used to reviewa project that is failing to meet its targets. The positioning of the Traffic Lightsis important: early on before much information is available to assess the

Managers pay plenty of attention to thefinancial business case but often too little

to the strategic business case


Executive summary


potential; after some exploration and experimentation has been done andmore information is available; or alongside a full business case analysis afterdetailed research has been done on a new project. The Traffic Lights havetaken nearly three years to develop and test.

Research methodology

The research was conducted in three stages:

1. Shadowing managers responsible for finding and entering new businesses.Over a period of four years ten managers were shadowed. Every three orfour months they were questioned about what they working on and whatsuccesses and failures they had had in the previous period.

2. Surveying the successes and failures of corporate venturing units andcorporate incubators. In combination with a project at London BusinessSchool, more than 100 corporate venturing efforts were examinedthrough interviews or questionnaires.

3. Assembling a database of over 50 success stories. The database is biasedtowards ‘improbable’ successes such as Hewlett-Packard’s move intocomputers, Dixons’ move into Freeserve and GE’s move into financialservices.

Report outline

Chapter 1 examines why companies want to find new businessopportunities and the difficulties they encounter, using Intel and McDonald’sas examples. It discusses the difficulty of finding businesses that fit, theinherent risks and avoidable pitfalls.

Chapter 2 looks at what managers should do to increase the chances offinding a new business opportunity. By auditing the natural flow of newideas, managers can assess any opportunities and use the appropriate tools toanalyse the chances of success. It discusses top-down and bottom-upprocesses as aids to the creation of new businesses, and how much should beinvested in new businesses.

Chapter 3 describes some fundamental insights into the circumstances thatlead to value creation and the mistakes that managers make when evaluatingnew businesses, including: building a strategic business case, consideringtrading as an alternative value capture, allowing for learning costs,identifying unusually low or high return markets, assessing the quality ofyour people, and not distracting attention from core business.

Chapter 4 explores the criteria applied to each of the four New BusinessTraffic Light questions, namely value advantage, profit pool potential,leadership/ sponsorship quality and impact on existing businesses. It alsoprovides worked examples.

Chapter 5 contains three case studies which illustrate how organisations arelooking to grow and the use of the New Business Traffic Lights system toassess new business opportunities: Royal Bank of Scotland/Direct Line, IBMand Whitbread.

By auditing the natural flow of newideas, managers can assess any

opportunities and use the appropriatetools to analyse the chances of success


Why is it difficult to find newbusiness opportunities?

This chapter examines why companies want to find new business opportunitiesand the difficulties they encounter, using Intel and McDonald’s as examples. Itdiscusses the difficulty of finding businesses that fit, the inherent risks andavoidable pitfalls.

The quest for new business opportunities is the toughest challenge inmanagement. Every company faces it at some point, even one like Intel,which was founded in a high-growth, high-tech industry. When companiesgamble and fail, it is generally at a huge cost to both shareholders andmanagement. Clayton Christensen, author of The Innovator’s Dilemma2 andThe Innovator’s Solution,3 and one of the world’s leading strategy gurus, usesAT&T to illustrate the problem. During the 1990s AT&T, the leadingtelephone company in the USA, lost more than $50bn trying to get into newbusinesses. It made three attempts: computers with NCR, mobile telephonywith McCaw Cellular and cable broadband with TCI and MediaOne. Theywere all disasters.

Companies like Intel and McDonald’s need to find new businessopportunities to solve the problem of a slowdown in the growth of their corebusiness. And they want to look for these opportunities outside their currentcore.

Imagine you are a senior manager at Intel or McDonald’s in 2002. Bothcompanies have had successful histories. Intel was started in the 1970s as aproducer of integrated circuits for memory products. In the 1980s it focusedon microprocessors, and by 2000 the company was worth nearly $400bn.McDonald’s was founded in the 1950s. Since then it has become the world’sbest known fast-food chain, and in 2000 had a market capitalisation of over$40bn.

Both companies, however, face a tough challenge: the future does not look asgood as the past. You, as a member of the senior management team, are askedto find new avenues for growth. Fortunately, both companies operate ingrowing industries. Demand for both good-value restaurants andsemiconductors is expected to continue to increase. But the segments inwhich Intel and McDonald’s are strongest—microprocessors andhamburgers—are weak and their recent performance has been poor. In 2002,Intel’s net income was one-third of its peak and McDonald’s published its firstquarterly loss for 40 years. Furthermore, both companies have devotedsignificant resources to finding new businesses with little success to date.What should you do? Should you launch a number of small initiatives?Should you take a big gamble on some major acquisition or greenfieldinvestment? Or should you be more cautious?

Chapter 1:

Companies like Intel and McDonald’sneed to find new business opportunities

to solve the problem of a slowdown inthe growth of their core business


Intel and McDonald’s: background

In early 1999 Craig Barrett, Intel’s then chief executive, decided to focus onthe company’s commitment to new businesses. This was in response tosuggestions from executives who had been on an internal managementprogramme called ‘Growing the Business’, which had labelled Intel’smicroprocessor businesses as ‘blue’ and all new businesses as ‘green’.

Mr Barrett set up the New Businesses Group, headed by Gerry Parker, one oftwo executive vice-presidents, to take charge of the green businesses. Thisgroup was to handle one big initiative, Intel Data Services, Intel’s entry intothe web-hosting business, and a number of smaller ones. “We’re focusing ontwo areas: the internet and appliances,” explained Mr Parker.

However, despite Mr Barrett’s efforts—setting up the New Businesses Groupand freeing up his own time by putting Paul Otellini “in charge to a largeextent of the core business”—the problem was not being solved. In his bookStrategy Is Destiny,4 Robert Burgelman concludes that, in early 2001, whenJohn Miner was taking over responsibility for new businesses from theretiring Mr Parker, “top management seemed to have concluded that it wasdifficult to develop businesses that were not related to the core business”.Moreover, the ‘internet building block’ vision was now being toned down to‘PC Plus’, implying that Intel would in future focus on businesses that werecloser to its PC/microprocessor heart.

McDonald’s recent experience has been similar. Between 1999 and 2002, thecore hamburger business performed even less well than expected, and inJanuary 2003 Jack Greenberg was replaced as chief executive by the late JimCantalupo. In the reshuffle, Mats Lederhausen, already in charge of strategyand new businesses, also became responsible for partner brands and all newinitiatives within the core business.

The message from McDonald’s was that greater management attention wouldbe focused on improving the core business and that the viability of some ofthe partner brands and other new initiatives would be reviewed. Dow Jonesreported that McDonald’s had contacted several leveraged-buyout firms andfinancial sponsors to gauge their interest in buying a 51% stake in the partnerbrands portfolio (Boston Market, Chipotle, Donatos, Pret A Manger andFazoli).

In January 2003, McDonald’s announced its first ever quarterly loss as a resultof plans to close 700 underperforming restaurants and cut costs. MrCantalupo also declared that the historic goal of 10–15% growth was nolonger sustainable. Instead of opening new stores, he would focus on “gettingmore customers in our existing stores”. The back-to-basics medicine worked.By 2004 McDonald’s was announcing double-digit growth in its US businessand plans to revitalise its European business.

By mid-2005 McDonald’s still retained some of its new businesses, but itsambitions had been curbed. Pret A Manger, for example, abandoned itsinternational expansion plans, changed some of its top managers andannounced plans to refocus its energies on the UK market. Pret, along withthe four other new businesses, had been placed in McDonald’s Ventures. MrLederhausen, CEO of McDonald’s Ventures, has to decide whether any ofthese businesses can become significant for McDonald’s without distractingfrom the core. For those that cannot achieve this difficult objective, he willdevelop an exit strategy.

“Top management seemed to haveconcluded that it was difficult to develop

businesses that were not related to thecore business”


Chapter 1: Why is it difficult to find new business opportunities?


For many, the failures of Intel and McDonald’s were surprising. KlausVolkholz, a member of the research team, former head of strategic planningat Philips and a long-time observer of the semiconductor industry, foundIntel’s failure hard to believe. He pointed out that Intel has strengths inmanufacturing and design, which should be a huge advantage in many of theadjacent semiconductor businesses. He speculated that the problem must bethat Intel is looking for businesses that earn returns as good asmicroprocessors, which would be almost impossible.

Similar comments were made about McDonald’s. Surely this powerhouse offast-food retailing must have many opportunities. Its skills in supply chainmanagement, franchising, branding and international expansion must be ofenormous value to any new restaurant concept seeking to expand. Yet it hasconsistently found it difficult to make a success of its portfolio of partnerbrands; and Pret A Manger, one of its most successful partner brands, appearsto be rejecting McDonald’s help and refocusing on its core.

The difficulty of finding businesses that fit

McDonald’s and Intel are not exceptions. Microsoft has had similardifficulties. According to Business Week,5 the company has invested billions inits new businesses—games, MSN, business software and software for mobilesand handhelds—with little success in terms of growth or profit. Kodak hastried for 20 years to get into digital photography and failed. Oil companieshave also tried many other businesses with little success. The experiences ofMcDonald’s and Intel appear to be the norm. Despite their huge resources,management commitment and ability to take big risks, large companies withmaturing core businesses find it hard to develop new growth businesses.

There are two ways in which companies like Intel and McDonald’s will findsignificant new businesses:

• they will discover a business that fits with their existing businesses andresponds well to the habits and rules of thumb that apply to the core; or

• they will experience a crisis that breaks their commitment to the oldhabits and rules of thumb and brings in new leadership and new ideas atthe top and in the middle.

IBM is an example of a company that has made the transition from its coretwice, and both required wrenching changes. The move to computers wasdriven by a unique manager, Thomas Watson Jnr, at war with his father. Inthe move to services, IBM had to go through one of the biggest crises in USindustrial history. This aim of this report is to help managers find those fewbusinesses that will fit with their existing core rather than deal with a crisis.

Businesses that are significant and fit with the existing core are rare, as theexperiences of Intel and McDonald’s indicate. The research revealed that ahigh failure rate is generally a result of a lack of opportunities, or businessesthat fit, rather than a lack of managerial skill in developing new businesses.Initially, this was surprising. Surely there are many new opportunities.However, a closer examination of the problem and the task that MrLederhausen had been given by McDonald’s—to find out if any of the newbusinesses could be significant without distracting from the core business—showed how difficult this is. Moreover, the research supported thisconclusion. In established companies like McDonald’s and Intel, thecombination of strengths and weaknesses and a mature mindset and culturelimits the number of opportunities that fit.

A high failure rate is generally a result ofa lack of opportunities, or businesses

that fit, rather than a lack of managerialskill in developing new businesses


There are two main reasons for the high level of failure. The first, which ishard to avoid, is that managers are trying to do something that is inherentlydifficult. Like prospecting for oil, a high failure rate is to be expected, not onlybecause each project carries many risks that cannot be managed away, butalso because, by definition, their companies are trying to do things that theyare not skilled at. The second is more avoidable. It stems from the way thatmanagers approach the task. Without a firm theoretical framework forscreening new business opportunities, managers find themselves followingguidance and thought patterns that cause them to make mistakes.

Inherent risks

A good illustration of the serendipity of new business initiatives comes fromthe Royal Bank of Scotland Group, the second largest UK-based bank. One ofthe group’s most successful businesses is Direct Line, which sells motorinsurance, motor rescue and general insurance products direct to the publicand through partner relationships with intermediaries. Yet the beginnings ofthis business are typical of the combination of chance events that are part ofthe stories of many successful new businesses.

Not all the examples of success stories were dominated by chance events.Some were businesses waiting to happen, such as IBM’s entry into the PCbusiness: the company had made a number of earlier attempts. Others wereentrepreneurially opportunistic, such as Dixons’ decision to set up PC World:the CEO noted the success of a new start-up, acquired the business and builton its business model.

However, many different things need to come together to make the businessa success. Even if the probability of each element coming good is 80%, theoverall probability is 32% for five elements and 11% for ten elements. Inother words, projects to get into new businesses are inherently risky.

In addition to the underlying risks, which are similar to those involved inlaunching new products or in any kind of innovation, there is the risk thatthe managers leading the project will not be experts in the new business. Inother words, there is a skills gap. At the business model level, managers maynot know what business model is appropriate or how to make the one theyhave chosen run smoothly. And managers at higher levels may not knowwhat performance to expect from the new business or how to contribute toits success.

In these circumstances it is not unusual for managers in the parent companyto seek to intervene by giving advice, turning down plans, changing some ofthe managers or losing patience with the business and selling out. But howwill they know what is the right decision? Without a deep knowledge of themarket, the competitors, the required business model and the capabilities ofthe managers, it will be hard for the parent managers to judge.

Because new businesses involve new business models, some skills gap almostalways exists. When the business model is new to the company and new tothe world, competitors will have the same skills gap and no company willhave a skills disadvantage. But normally the skills gap is worse for the newentrant. Unless the company happens to have managers who are familiarwith the new area in both operating and ‘parenting’ positions, the skills gapwill reduce the chances of success.

Without a firm theoretical framework forscreening new business opportunities,

managers find themselves followingguidance and thought patterns that cause

them to make mistakes




These inherent risks cannot be eliminated completely, but there are ways ofreducing them:

• Encourage managers to look for projects where many of the ‘requiredevents’ have already come together (as, for example, Royal Bank ofScotland did with Direct Line). Rather than focusing on new ideas wherethe required events still need to happen, managers are encouraged to buildon those opportunities where, for whatever reason, progress has alreadybeen made.

• Managers should assess their skills gap. The New Business Traffic Lightssystem described in chapter 3 contains two terms that involve judgementsabout skills: learning costs and leadership/sponsorship capability.

Avoidable causes of failure

As well as the inherent risks of any new business initiative, there are moresystematic and avoidable problems that reduce the chances of success. Theystem from the way managers think about the task of developing the newbusinesses and the processes they use to approach the problem.

Figure 1: Avoidable causes of failure

The Icarus pitfall

Icarus, according to Greek myth, was trying to escape from the island wherehe was held captive. He and his father glued feathers to their arms and usedthem to fly. However, Icarus became overambitious and tried to fly too high.The heat of the sun melted the glue holding his feathers and he fell to theground. The efforts of some of the managers featured in the research seemedrather Icarus-like.

Managers try to fly too high for various reasons. One is the way strategic plansare developed. Managers developing a strategy for a company like Intel orMcDonald’s will start with the plans of the major businesses. These areaggregated into a corporate plan and an assessment is made about whetherthe company has sufficient capital to support the plans of the businesses andwhether the resulting performance will be good enough.

As well as the inherent risks of any newbusiness initiative, there are more

systematic and avoidable problems thatreduce the chances of success

Process(Numbers game pitfall)

Aims(Icarus pitfall)

Capabilities(Hubris pitfall)

Opportunities(Helen of Troy pitfall)


Jim Collins explained the BHAGs (Big Hairy Audacious Goals) idea in his bookBuilt to Last.6 Since developing new businesses is all about new thinking,beyond the existing businesses, managers assume a BHAG is needed.Unfortunately, this is less than useful for new business development. Whenmanagers are doing something they are familiar with, a big goal will help raisetheir heads and encourage them to consider changes to their routine. Butwhen they are doing something they have not done before, they do not needto be jolted out of a routine; rather, they need to be cautious.

The concern for long-term survival is well captured by the saying “the miseryof uncertainty is less than the certainty of misery”. Managers believe that theyhave an obligation to find new businesses for their companies almostregardless of the risks. Without these new businesses, they worry that theircompany will mature and ultimately become obsolescent. This fear canoverride the caution that normally controls management action.

Companies should resist these pressures. They should set targets for newbusinesses only after they have reviewed the opportunities. Using gapanalysis or survival pressures to set targets suggests that managers have a goalthat is independent of their environment, and that a company with manyopportunities can stop investing in them once the goal has been met. It alsosuggests that companies with few opportunities can conjure up new onesuntil the goal is met.

The Helen of Troy pitfall

Helen, according to myth, was the beautiful wife of the king of Macedonia.She fell for the prince of another country and went with him to Troy, hishome city. Her husband assembled an army and besieged Troy for some yearsin an attempt to get her back. He finally succeeded through deception. Heconstructed a hollow wooden horse in which he concealed soldiers and thenpretended to abandon the siege, offering the horse as a sign of his goodintentions. When it was brought inside the gates of Troy, the soldiers sneakedout and opened the gates to the attacking army.

The myth is probably more famous for the Trojan horse than for Helen.However, it was the pursuit of her beauty that caused the damage in the firstplace. In a similar way, managers obsessed by the attractions of a marketopportunity can become blind to its risks or appropriateness.

The Helen of Troy pitfall stems from a combination of two things: theseduction of ‘sexy’ markets and a failure to apply the appropriate tools ofanalysis. When analysing new business opportunities, managers spend a lotof time searching for large, growing and profitable sectors. By definition theseare relatively rare, so that when one is identified it has a magnetic pull that ishard to resist.

An example is British Sugar, one of two suppliers of sugar in the regulated UKmarket. Faced with a mature market and possible changes in the regulatedstructure, the company (a division of ABF) was actively looking for newbusiness ideas. The head of the development unit was looking atopportunities with some connection to the core skills of the business: theprocessing of agricultural raw materials. Unfortunately, there are few large,profitable, growing sectors in primary agricultural products.

However, the team discovered that automotive companies faced legislationrequiring them to produce vehicles with a greater percentage of recyclable orbiodegradable parts. One area where biodegradability was being consideredwas the interiors, using natural fibres such as hemp. Armed with the prospect

Managers believe that they have anobligation to find new businesses for

their companies almost regardless of therisks




of a fast-growing market, the team looked closely at the industry andidentified one of the leading hemp companies as a prospect. This companywas in a poor financial condition and was looking for a partner.

Excited by the growth prospects, the team pitched the idea to seniormanagement on more than one occasion. They abandoned it only when anexternal consultant reported on the poor prospects for the company and thesector. In their enthusiasm the team had overlooked evidence suggesting thathemp was a low-profit industry, that this growing segment would be sellinginto an industry with the toughest buying policies in the world, and thatthere was little technical connection between hemp and sugar.

Managers also fail to use the appropriate tools of analysis. Too much attentionis paid to growth rates and business model economics (whether the servicecosts less than the customer is prepared to pay) and not enough to whatMichael Porter calls the Five Forces.7 Predicting future profit levels in anindustry sector depends on judgements about five forces: the bargainingpower of customers, the bargaining power of suppliers, the threat of newentrants, the threat of substitutes and the intensity of rivalry betweencompetitors. Each of these can be favourable or damaging to highprofitability. Companies will find it harder to make profits in sectors whereone or more of the forces are against profitability.

Despite being widely taught and included in every textbook on strategy, thistool was not formally used by any of the teams that took part in the research.This does not mean that it was completely ignored: issues such as the powerof customers and the likelihood of competitor response were often discussed.But because the tool was not used formally, the seduction of a growth sectorand of businesses-of-the-future frequently crowded out five-forces thinking.Without such a tool it is hard for managers to resist the temptations of theHelen of Troy pitfall.

Hubris

Hubris is the inappropriate self-confidence that can develop in successfulmanagement teams. The Concise Oxford Dictionary defines it as ‘insolent prideor security’ or ‘overweening pride that leads to nemesis’. Nemesis was thegoddess of retribution. She made sure that those whose pride caused them tochallenge the gods suffered.

One manufacturing company had two such experiences, both stemming fromthe development team. The company was involved in a processing activitythat generated excess heat and excess carbon dioxide. As managers looked forways to use this excess, they came into contact with the tomato industry.

In temperate climates, tomatoes are often grown in heated glasshouses.Moreover, they grow better in a carbon dioxide-rich environment. Thecompany, therefore, tried to link up with a tomato grower to sell its spare heatand carbon dioxide. However, growing tomatoes is not very profitable andthe growers had little cash for investing in new capacity. Attempts to persuadea grower to build glasshouses near the company’s factory failed. This spawnedthe idea of using the company’s strong cash position to finance theglasshouses and, at least in part, enter the tomato-growing industry.

The company’s management was, however, highly risk-averse. Knowing thatthe company had little experience in growing tomatoes, the board insisted ona plan that would reduce risk to a minimum. This involved signing a contractwith one of the major growers to sell all the tomatoes at an agreed profitmargin, sufficient to provide a respectable return on the investment inbuilding the glasshouses.

Too much attention is paid to growthrates and business model economics and

not enough to future profitability


Inevitably there were start-up problems, but after a year the project seemed tobe going well. However, unbeknown to the company, there were big changesgoing on in the tomato industry. Supermarkets were changing to a newvariety with a better shelf life. Customers were responding favourably to thesenew tomatoes, which could be grown successfully only in hotter climates. Inthe second year, there was such a glut of the old variety that prices only justcovered transport costs. Moreover, it seemed likely that the market woulddeteriorate further.

In mid-2005 the project was still in operation, but its future is in doubt,especially when the contract with the grower expires. Looking back,management had considered some negative scenarios, but none that involvedprices that left no margin for transport costs.

The primary cause of hubris is the lack of a framework for deciding whetherthe company has the appropriate capabilities, experience and knowledge torun the new business. The problem stems from focusing primarily on areas offit rather than taking a balanced view of a company’s full set of skills.

There are two levels in the organisation where fit issues need to be analysed:the business unit level and the parent company level. The main questionsmanagers should ask are:

• Does our company have a contribution to make to this new business thatis more important to success than the contributions of current or likelyfuture competitors?

• Will the managers we put in charge of this new business, taking accountof the habits, instincts and experience that they already have, understandthe business as well and be as capable of making a success as their currentand likely future competitors?

• Will the managers this business reports to, taking account of their habits,instincts and experience, understand the new business and be as capableof helping it as the parent companies, venture capitalists or otherfinanciers of competitor businesses?

There are many stories of misjudgements and mistakes caused by theinexperience of business-level managers. Mars’ move into ice cream in Europeis an example. Based on some successes in the USA, Mars decided to enter theEuropean ice-cream market using its strong brands and low-costmanufacturing skills. After a successful market test, Mars followed its normalstrategy of building a large, scale-efficient plant to serve the European market.Unfortunately, the test had been carried out during the two hottest summersin Europe for over 100 years. Demand for ice cream had outstripped supply,influencing the test results. Without the long experience of the industry, itwas easy for Mars’ managers to misjudge the results. In the event, the factoryproved to have nearly twice the capacity the company needed.

Purpose and process

When deciding whether an innovation approach is required, organisationsmust consider the business environment and their own strategy to determinetheir purpose in undertaking new business and innovation initiatives. Manyorganisations do not do this and projects start without due consideration.They may then become exercises in generating a lot of ideas and forcing themthrough a gated process, to try to achieve numbers that are not really alignedto the strategic context.

The primary cause of hubris is the lack ofa framework for deciding whether the

company has the appropriate capabilities,experience and knowledge to run the new

business



Increasing the number of newopportunities

This chapter looks at what managers should do to increase the chances offinding a new business opportunity. By auditing the natural flow of new ideas,managers can assess any opportunities and use the appropriate tools to analysethe chances of success. It discusses top-down and bottom-up processes as aidsto the creation of new businesses and how much should be invested in newbusinesses.

All companies face the question of what they should do to increase thechances of successfully creating new businesses. Managers want to know whatorganisation units and processes to set up, what activities are involved inpreparing the ground and what will be needed once a promising new businesshas been spotted. What to do once a promising new business opportunity haspassed the screening tests is addressed in a Henley-Incubator report, GoingBeyond the Idea.8 This chapter addresses the first question: what should acompany do to increase the chances of finding a new business opportunity?

One of the difficulties in thinking clearly about new businesses is that it iseasy to confuse efforts to develop new products for existing businesses, effortsto extend core businesses and efforts to find new business opportunitiesoutside the current core. Investments in a central research function, forexample at Unilever or Intel, are often thought of as an appropriate way ofdeveloping new businesses. However, most of the work of these researchfunctions will and should be devoted to technologies and products for theexisting businesses.

So how much should be invested in more speculative research that might leadto new businesses outside the existing core? A similar question can be askedof the new product development function, the corporate venturing unit (ifone exists) and the efforts of the strategic planning team. The obvious answeris that if growth in the core is slowing, the company should increase itsinvestment in research, new products, new ventures and strategic analysisoutside the core.

But managers should be wary of the seemingly obvious answer. All companieshave a natural flow of new ideas for new products, new markets and newbusinesses driven by the environment they are in and the corporate businessmodel they are operating. It is hard to accelerate this natural flow. It can behelpful to remove any blocks, but these changes are unlikely to make asignificant difference within a three-year planning period.

There are pressures on managers to grow the business and these often demandsome investment in new businesses. By auditing their natural flow of ideas,managers can assess whether there are many or only a few opportunities. Byusing the appropriate analytical tools, they can resist the temptation to rollthe dice when the chances of success are low.

Chapter 2:

By auditing their natural flow of ideasand using the appropriate analytical

tools, managers can avoid rolling thedice when the chances of success are low


The natural flow of new ideas

The environment in which the business is operating has an importantimpact. In the late 1990s, during the internet boom and the entrepreneurialbubble that ensued, many new businesses were developed and manycompanies were inundated with proposals. For example, in research on theimpact of the internet on corporate centres, managers were asked how thecorporate centre handled the flow of potential new businesses, joint venturesand alliances. A senior manager at AstraZeneca, a pharmaceuticals company,responded mischievously, “We have set up machine guns in the lobby!” Inorder to deter the flow, managers were turning away every proposal that didnot come via a privileged route.

BAT, a tobacco company, created two units in response to internal andexternal pressures. Imagine was set up to work with managers or externalagents to refine and develop new ideas. Evolution was set up as an investmentunit to provide funds for new ideas that seemed promising. Although, withhindsight, BAT probably overreacted and AstraZeneca kept its feet morefirmly on the ground, both companies experienced a huge increase in thenatural flow of new business ideas.

At certain times, some industries have a higher rate of flow than others. Forexample, industries faced with disruptive technologies, as most were duringthe internet boom, have a higher flow, as do those experiencing such thingsas changes in legislation (utilities), fragmentation (financial services) or thecollapse of a dominant competitor (computers in the 1990s). By contrast,industries that have been stable for many years and where few of the sourcesof advantage are changing (such as mass-market consumables and mining)have a lower flow of new business ideas.

The second factor affecting the natural flow is the business model of thecorporate parent company (and/or of divisions within the parent company).Some companies, such as Philips or Canon, invest heavily in research andtherefore have more new products and new business ideas than companiesthat do little research. Other companies, such as 3M, build businesses oninnovation as a source of competitive advantage. All 3M’s businesses seek tobe the technology leader in their market and thus to achieve higher margins.This encourages managers to search for technical or innovative solutions.Inevitably, these companies will have a higher flow of new business ideas.

Other companies actively seek new businesses. Virgin is famous for itsopenness to new ideas and entrepreneurial behaviour. As a result, thecompany’s central team receives many new business ideas every day. WhenRichard Branson, Virgin’s founder, takes a long-haul flight, people come up tohim on the plane with ideas for new businesses. “After a transatlantic flight,he will come back with 5–10 business proposals,” commented Virgin’s headof strategy. Virgin is, therefore, more like a venture capital company than anormal corporation. Mr Branson has demonstrated that he is prepared toconsider any interesting new business proposal so he attracts a larger numberof proposals than most companies. Virgin is not in an environment that isparticularly vibrant. The reason it has such a high flow is because the businessmodel of the parent company is more geared to spotting and launching newbusinesses than administering its existing businesses.

Some industries have a higher flow ofopportunities than others, for example

when faced with disruptive technologies,changes in legislation, fragmentation or

the collapse of a dominant competitor


Chapter 2: Increasing the number of new opportunities


Should companies try to increase their natural flow?

Managers often conclude that they are not getting enough new ideas. Theylook at companies like Virgin and 3M and envy their higher flow rate. Sincethey can do little about the environment, they try to solve the problem bychanging the corporate business model to encourage more ideas.

Nevertheless, of the 50 or so examples of success in the research database, lessthan a handful of significant businesses started out as initiatives stimulatedby a desire to ‘get more ideas into the hopper’. The vast majority appeared tooccur through the natural flow of ideas: they emerged from below as a resultof initiatives taken by managers close to the market; they were unexpectedopportunities brought to the company from outside; or they were part of adeliberate top-down strategy. In other words, the successes came from naturalrather than forced processes.

Gary Hamel, Visiting Professor of Strategic and International Management atLondon Business School, argues that companies should focus theirinnovation efforts primarily within their core businesses. Once these areeffectively using innovation to improve performance, there will be a knock-on effect for new businesses: some of the ideas will form part of the naturalflow of new business ideas. This makes sense. Innovation in new businesses isaimed at something managers understand, where their instinct about whatmakes sense is likely to be sound. In these circumstances, managers have afeel for how much to spend and which ideas are foolish.

When managers are advised to ‘relax into the flow’ they are surprised. Surely,they argue, it is possible and sensible to increase the number of new businessideas that are being considered, to ‘fill the hopper with ideas’. It seems suchan obvious thing to do, and it is more managerially attractive than waitingfor something to turn up.

The research finding is clear. Successful new businesses depend on the leadershipof unusual managers (the leader/sponsor Traffic Light, see chapter 3). Thesemanagers normally have an insight into some aspect of the market or businessmodel that enables them to see opportunities where others do not. They alsohave the entrepreneurial initiative to get the new business going. H-I Networkrefers to them as ‘extrapreneurs’, people whose entrepreneurial talent, externalperspective and extra skills enable them to succeed. An H-I Network researchreport, Innovation Leadership: Roles and key imperatives,9 explores the roles ofextrapreneurs and other stakeholders in the innovation process.

When managers with entrepreneurial courage have important insights, theyare only too keen to tell other managers about the opportunity and to startlobbying their organisation. They may try to influence the top-down strategyprocess or create a bottom-up ‘skunk works’, that is, projects without explicitcompany approval. In other words, when the natural flow brings togetherspecial knowledge and entrepreneurial talent, you will not have to look hardto find the new insights. It is not necessary to set up search parties to turnover every stone. It is more likely that the manager with the idea will beatyour door down whether you are looking or not.

Some managers argue that this conflicts with the normal behaviour in abusiness. If you are losing market share, one of the tried and tested ways ofresponding is to boost your new product development process. Why would thisnot work at the portfolio level? The answer is that in an existing business,managers understand the market, the technical risks and their own skills wellenough to be able to select new products with a good chance of success. Whenthey are screening new businesses involving unfamiliar markets, technologiesand business models, they are less able to distinguish good ideas from bad ones.

The vast majority of significantbusinesses came from natural, rather

than forced processes


Improving top-down processes

Although it is not a good idea to try to force the pace of ideas generation,managers should be encouraged to analyse the situation and think abouttheir corporate strategy. It is important for them to know how they are goingto develop their portfolio of businesses and to explain why this is likely tocreate value for all stakeholders.

Top-down, corporate-level strategy involves assessing the industries in whichthe business is currently competing. This should have been done in thebusiness-level plans, but it often needs extending. In particular, managersshould look at changes in the environment and the likely impact on existingbusinesses, as well as the periphery of the industry, where disruptiveinnovations may be evident or where new business opportunities may beemerging.

There are three steps:

1. Record all the competitors that are connected in some way to the currentbusiness. These may be up or down the value chain, in different channels,in adjacent segments, in substitute technologies, and so on. Pay particularattention to new competitors and small but successful competitors.

2. Analyse some of these competitors in more detail, focusing on theeconomics of their business models. It is important to choose those fromwhom you have most to learn.

3. Extract the messages from these analyses. There may be potentialdisruptive technologies or business models, new market segments andnew customer expectations, or innovations in any aspect of the business.It is important that this is not done solely by the senior managers of theexisting businesses whose commitment to the existing business modelmay make them blind to changes that are happening in their industries.The team extracting the messages should be broadly based and includemanagers from the periphery whose understanding of the trends may bebetter than that of managers at the centre.

The object of the analysis is to make sure that managers have thoroughlyexplored developments around their existing businesses.

Whitbread is a good example of effective top-down strategy. The companyhas a diverse portfolio of restaurant and leisure brands, mainly in the UK.Some of these brands—Marriott Hotels, Pizza Hut and TGI Friday’s—aremanaged in collaboration with their US brand owners. Others, such asBeefeater (steak houses), Travel Inn (low cost hotels), David Lloyd Leisure(health and fitness clubs) and Brewer’s Fayre (pub restaurants), are UK-focusedbrands.

Whitbread’s top-down review examined each brand and its market sector.Travel Inn was allocated to the ‘develop’ category and Beefeater to the‘improve’ category. Travel Inn was growing fast in the UK and had clearopportunities to grow overseas. Beefeater was the UK’s leading steakrestaurant but was underperforming. The priority was to ensure the brand wasearning its cost of capital.

The work involved surveying 30 other market sectors. Changes in the wayconsumers used their leisure time, such as linking eating out with a leisureactivity, were creating new opportunities. These sectors were put through abrief screen and quickly reduced to two, which appeared promising.

It is important for managers to know howthey are going to develop their portfolio

of businesses and to explain why this islikely to create value for all stakeholders




Whitbread defined its corporate-level skills as developing leisure brands,driving performance, improving brand positioning and developing a pool ofmanagers good at operating leisure brands. Although these skills did notpoint to any particular sub-sector in the leisure industry, they fitted well withthe two opportunities identified. One of these, an opportunity closely linkedto an existing business, was worked up into a business plan. Within ninemonths of the strategy review, the business proposal had been approved andwork had started on the first site.

Another part of the strategy was to look at the potential for expanding twoexisting brands into new geographic markets. For one brand the first step wasa joint venture in Spain. For the other the way forward was an extension ofits franchising concept to other markets.

Whitbread’s corporate vision continued to be focused on leisure andrestaurant brands. However, in the medium term the plan now included anadditional UK leisure brand and an ambition to develop some brandsinternationally.

In this example, the top-down strategy resulted in a few snappy decisions.This was because it took less than a year, the new business efforts were seenas an integral part of the corporate strategy and managers throughout thegroup were committed to the initiatives. Without such a strategy, companieseasily fall into the trap of investing in a range of new initiatives, none ofwhich has sufficient corporate support to ensure success.

(See chapter 5 for a Whitbread case study and the application of the NewBusiness Traffic Light approach.)

Improving bottom-up processes

Since managers close to the market or close to operations normally have themost important insights about markets and business models, it is notsurprising that every company has a natural flow of ideas from the bottomup. How can this bottom-up process be used effectively?

At one extreme, there is a danger that the company is so focused and socontrolling that it does not tolerate any activity outside its existingbusinesses. In these situations entrepreneurial managers take their ideaselsewhere. At the other extreme, companies can create so much slack andtolerate so many promising new initiatives that every dreamer is funded andmanagers stop driving the core businesses forward.

Robert Burgelman4 has studied the bottom-up process and gives some advice:

1. Promote a ‘rugged, confrontational/collegial culture’. A company needs away for bottom-up thinking to challenge top-down thinking. The bestsolution is a process for debating issues that is vigorous, issue driven andignores rank, and where disagreements do not interfere with execution.Intel, according to Mr Burgelman, fulfils both criteria. ‘Constructiveconfrontation’ is Intel’s name for robust debating, and ‘disagree andcommit’ for the execution follow-through once the confrontation isconcluded.

2. Tolerate sponsored initiatives. Encourage the CEO explicitly to tolerate afew initiatives that do not easily fit in to the current corporate strategy butare sponsored by the divisions reporting to the CEO.

At the extreme a company may nottolerate any activity outside its existing

businesses or managers may stop drivingthe core businesses forward


3. Embrace ambiguity. Suspend, for new ventures, the drive for certainty thatis often part of the budgeting and planning process. This may requiremore frequent reviews and milestone reporting but should not allowinterference.

4. Don’t separate. Those involved in bottom-up venturing should not beisolated from the mainstream. Linkages are important to the success of theventure, the willingness of the parent to keep supporting it and theprocess of developing the corporate strategy.

5. Bolster the will to terminate. Bottom-up initiatives are experiments thatshould be terminated if they are not making progress. Senior managersneed an explicit termination process.

6. Ensure sufficient general managers. New ventures require managerscapable of linking new ideas with the market place and accessing resourcesfrom different parts of the company. Without a sufficient number ofmanagers with generalist skills, ventures have less chance of succeeding.

The bottom-up process is a healthy activity that needs to be kept inproportion. Out of this process entrepreneurial managers with significantinsights emerge and are either supported by the top-down process or rejected.So long as the criteria used in the top-down process are clear, the interactionbetween the two processes is not difficult. Problems emerge when the top-down process creates confusion lower down. This happens when managersare using inappropriate criteria to screen ideas or because their judgementsare not consistent. The research shows that this confusion frequentlyhappens, but it does not need to. Disciplined use of the New Business TrafficLights (see chapter 3) will solve the problem.

The emerging business opportunities (EBO) process at IBM is a good exampleof how a company can improve its bottom-up processes. Faced with lowgrowth and a concern that IBM had missed out on some of the emergingopportunities in the computer and internet industry, Sam Palmisano, theCEO, commissioned a group of managers to suggest a process for boosting thecompany’s success in new businesses.

The team concluded, as most such teams do, that IBM’s core managementprocesses and complex organisation matrix were blocking the development ofnew businesses. The management processes focused on profitability ratherthan value, and the structure required new businesses to win supportseparately from research, sales and a business group. The solution was to setup a programme to support new businesses. When a new business wasselected as an EBO, it was given some protection from the normal resourceallocation process, some additional funding from a corporate resource pool,and a good deal of attention and help from central research and strategy.

Over the first three years the programme was considered a success. Additionalattention and support was given to some new businesses that mightotherwise have made little progress. Some managers, who might underdifferent circumstances have focused their energies only on the existingbusinesses, were encouraged to propose businesses as EBOs. By 2003, the EBObusinesses were generating sales of $10bn. Some of these initiatives wouldhave happened in any case, but the programme was believed to have giventhem a substantial boost.

(See chapter 5 for a case study of the IBM EBO.)

Out of the bottom-up processentrepreneurial managers with significantinsights emerge and are either supported

by the top-down process or rejected




How much to invest in new businesses

Analysis of top-down and bottom-up processes should help managers decidewhat to do when they feel the need to create new businesses. But that stilldoes not answer the question: how much should we invest in new businesses?

There is a simple answer: enough to support all the new business ideas thatpass the New Business Traffic Lights, constrained only by managerial capacity.In other words, if no ideas pass the screening, managers should make noinvestments in new businesses and use any spare cash to buy back shares orpay larger than usual dividends. If a number of ideas pass the screening,managers should invest in as many as the managerial capacity allows. In alarge company this could mean investing in ten or more new businessprojects, assuming two projects are led by each of five divisions and someadditional projects are led by the corporate centre. This is about the numberof projects in IBM’s original EBO programme.

Is there a financial limit on the amount that should be invested in newbusinesses? In principle, no. For a new independent company, 100% of thecapital is invested in ‘new businesses’. For large established companies withgrowing core businesses, such as McDonald’s or Intel, the amount is likely tobe less than 5% of the total capital spend. For a company that is ending onecore business and investing in a new area, the amount invested in the newarea may be close to 100%.

DSM, now a Dutch life sciences company, has made this decision twice. In the1960s, managers at Dutch State Mines decided that coal mining was no longercompetitive in the Netherlands. They closed the mines and invested in bulkchemicals. By 1975, they had left the mining industry and successfullyentered the chemicals industry. In the 1980s, managers concluded that DSMwould be unlikely to be the winner in the consolidation of the bulk chemicalsindustry. They backed a strategy of developing fine chemicals andbiochemicals, which led to some success in the life sciences industry. As soonas this success became apparent, the company began to shed its bulkchemicals businesses.

Summary of recommendations

Once it has been decided that there are spare resources for pursuing newbusinesses, managers need to decide what to do. It is not necessary to makeelaborate efforts to stimulate new ideas through, for example, ideasworkshops or efforts to define core competencies. Good ideas will be close tothe surface: they may come from managers leading a ‘skunk works’ or existingactivities that have previously been discouraged from expanding; they mayalready have been discussed formally or informally; they may be proposals bythird parties that have previously been made or obvious developmentsadjacent to existing businesses. There is no evidence that ‘good ideas’ liehidden in the minds of shy managers waiting to be released by stimulatoryinterventions, or that deep analysis of core competencies reveals hiddentalents that can lead the company to new horizons.

Project teams will be needed to carry out a thorough review of each industrythe company is competing in. These reviews should look for new emergingbusiness models, changes in the boundaries of businesses, disruptivetechnologies and other trends that may point to ‘new opportunities’. Theproject teams should report to the heads of the core businesses and documentthe new business ideas that emerge from the analysis. The corporate effort canbe co-ordinated by the corporate strategy unit or a central project team.

In principle there is no financial limit onthe amount that should be invested in

new businesses


The new business ideas will include greenfield ideas, acquisition ideas andideas to expand current activities. These should be screened for suitabilityusing the New Business Traffic Lights. The screening should be carried out bypeople at the level of the organisation where the idea emerged and is likely tobe implemented. There should also be a top-down process for checking thequality of screening to ensure that good ideas are not being inappropriatelyrejected or bad ideas inappropriately included.

Defining and screening new opportunities should not be done by a smallgroup behind closed doors. Senior management should assemble a diagonalslice of capable managers, including at least one outsider, to orchestrate asustained dialogue about the analysis, the opportunities, the screening resultsand the plans. This dialogue should include line managers at relevant levelsin the organisation. The process may take a year or two to complete, and theresult will be the executives’ commitment to a few new business initiatives orto some alternative.

If the screening produces lots of good opportunities, companies need tochoose two or three ‘development paths’. Nokia’s development paths, chosenafter an elaborate review of opportunities, were ‘humanise technology’,‘virtual presence’ and ‘telecoms’. As of 2000, Intel’s chosen development pathwas to ‘provide building blocks for the internet’. Development paths willemerge as sets of opportunities. Each grouping will be built around and helpto build up a common capability or technology.

It is important that companies are selective: they should not necessarilyinvest in all the good ideas that pass the screen. Some people argue that thefailure rate for new businesses is so high that companies need to launch manynew initiatives in order to gain a few successes. Based on the research,companies that choose a few new business initiatives and are committed tomaking them work are more successful. This ensures that each initiative hassufficient attention and commitment.

If the screening process produces few good ideas, managers have a differentchallenge. Generally there are too few good ideas rather than too many.Companies often conclude that there are currently no good ideas: allproposals fail one or more of the New Business Traffic Lights. It is importantthat managers prepare themselves for this.

A decision to ‘keep the powder dry’ in this planning period is not a decisionto abandon new growth completely. Over the next couple of years managersshould keep an opportunistic watch for new business ideas, using the NewBusiness Traffic Lights to filter opportunities. If no new businesses emergeover the following year or two, the company should launch another majorreview, in three or five years’ time, to see if the prospects have changed.

Creating new business to meet strategic objectives is the main perspective ofthese recommendations. There is a range of methods to create new businessesand corporate venturing can be considered as one of the means to achieve awider strategic initiative.

Companies that choose a few newbusiness initiatives and are committed to

making them work are more successful.This ensures that each initiative has

sufficient attention and commitment



How to screen opportunitiesfor new businesses

This chapter describes some fundamental insights into the circumstances thatlead to value creation and the mistakes that managers make when evaluatingnew businesses, including: building a strategic business case, consideringtrading as an alternative value capture, allowing for learning costs,identifying unusually low or high return markets, assessing the quality of yourpeople, and not distracting attention from core business.

Managers should be highly selective when looking for significant newbusinesses, as indicated by the numerous failures of both new businessinitiatives and acquisitions by many of the major corporations around theworld. Much shareholder value has been needlessly destroyed. This chapterdescribes the New Business Traffic Lights selection process. If managersunderstand the logic behind the Traffic Lights and use the criteria to chooseprojects, they will invest only in those projects that have a reasonableprobability of success. The New Business Traffic Lights will be explained morefully in chapter 4.

Imagine that you are the chief executive of Mars or Cadbury in Europe. Youhave a strong position in the confectionery business and you are looking foradditional growth. You are considering whether to enter the ice-creambusiness using your brands and your experience of manufacturing andmarketing consumer products. Or imagine that you are the head of Boots theChemist or a quality drugstore business in the USA. You are trying to decidewhether to set up a chain of eye-care shops using your brand. How do youdecide?

Insight 1: Build a strategic business case

Managers pay plenty of attention to the financial business case but often toolittle to the strategic business case (the reason the company is likely to dobetter than average in this new game). This balance can be corrected byoffering managers a tool for developing a strategic business case.

Decision making for acquisitions or new business projects often focuses onwhether the project supports the general direction the company wants to goin and on detailed financial analysis and implementation planning. Too littletime is spent considering whether the project has the qualities that are likelyto lead to success. The solution is to use a decision tool that forces managersto evaluate the strategic rationale for the project.

Chapter 3:

Managers pay plenty of attention to thefinancial business case but often too

little to the strategic business case


Insight 2: Consider trading as an alternative value capture

Managers understand that they need an advantage to succeed in a new sector,but they do not normally consider the alternative of trading their advantageinstead of using it to enter the new business. The solution is to deduct thevalue that could be traded in the strategic assessment.

It is common for managers to assess the contribution they can make to a newventure or acquisition. They ask: “Why do we believe we can succeed in thisnew area?” or “What synergies do we bring to justify the acquisition?” Forexample, the contribution Boots can make to the eye-care business might beits brand or its retailing skills. One way for Boots to turn these resources intovalue is to enter the eye-care business. Another is to try to sell or license themeither to existing competitors in the eye-care business or to some new entrant.

For example, if the Boots brand can increase sales by 10%, it should bepossible to license the brand to one of the less successful players in themarket. Although it would not make sense for the company to pay a 10%royalty, it might pay 7.5% or 5%. Thus Boots could get a proportion of thevalue of its resource without any of the risks and costs associated withentering a new business. Disney, for example, routinely licenses its brand andcharacters to other companies.

The same applies to the ice-cream example. Mars or Cadbury would clearlyhave some important contributions to make to this new business:

• confectionery brands• knowledge of snack products and European markets• manufacturing skills• branding skills• sales and distribution.

Some of these are relatively easy to trade for value, but others can be turnedinto value only by entering the ice-cream business. Most of the value that thebrands contribute could be traded through licensing or joint-ventureagreements without taking any risks in the ice-cream industry. The othercontributions, however, would be much harder to trade. Mars or Cadburycould set up a consulting company offering advice on snack products,manufacturing or branding, but this would be unlikely to create much value.The only way to turn these skills into value would be to enter the ice-creambusiness or some other snack food sector. The sales and distributioncapability, however, could be turned into value by offering to sell anddistribute products for other companies.

The decision about whether to enter the eye-care or ice-cream businessesshould therefore depend on not only the size of the contribution that thecompany brings to the new sector but also the proportion of the contributionthat can be turned into value only by entering the new sector. Since enteringthe new sector involves investment, risks and learning costs (see Insight 3),the reason for making the investment and taking the risks is to capture thatpart of the value that cannot be captured by trading the resources throughlicensing, joint ventures or some other lower-risk solution.

Insight 3: Allow for learning costs

Managers allow for contingencies on the assumption that their plans will notalways turn out as expected, but they do not have the tools to assess the likelycosts, at both the operating and the corporate level, of learning a newbusiness. The solution is to deduct a figure for learning costs in the strategicassessment.

The decision about whether to enterbusinesses should depend not only on thesize of the contribution that the company

brings to the new sector, but also theproportion of the contribution that can

be turned into value only by entering thenew sector


Chapter 3: How to screen opportunities for new businesses


As every manager knows, it takes time to learn a new business. During thisperiod, the management team makes mistakes that impose extra costs on thebusiness and cause it to miss opportunities that could bring in extra revenues.The benchmark here is the competition. The new management team is likelyto perform less well than the competition during the learning period. Ofcourse, if the new team is experienced in the industry, either because themanagers have been hired from the industry or because the team is part of anacquisition, the learning costs can be low. If, however, the new team is froma different industry where different rules of thumb guide the major decisions,the learning costs can be high.

Among successful companies in the research, which was biased towardssituations where companies had a lot to learn, there were few examples wherethe company had ‘lots to learn’ compared with its competitors. Mostsuccesses were in situations where the company was ‘new to the world’,meaning that all competitors had an equal amount to learn, or where thecompany, for whatever reason, had sufficient knowledge of the new sector tokeep the learning costs low.

As well as the learning that needs to take place at the operating level, there islearning required at the corporate level. The new business will have areporting relationship with its parent company and will share resources orfunctions with some other businesses.

At Mars in the 1980s, one of the normal rules of thumb when entering a newcategory was to build a factory larger than was immediately needed. In thepast this had proved beneficial, for two reasons. First, the large empty factoryprovided the best kind of incentive for the sales team to work hard. As one ofthe Mars brothers is reputed to have said, “Build a factory larger than youneed and it will cause the sales force to work twice as hard to fill it.” Second,there were economies of scale and market share. The greater the volumerelative to competitors, the more competitive the operation will be.

Unfortunately, this corporate influence encouraged the European managersto build a large ice-cream factory. But partly because of the misleading marketdata and partly because the sales forces did not feel responsible for thefactory—because each sales force reported to a separate country and soldconfectionery and ice cream and some other products as well—it turned outto be much too large. In this case the influence of the parent company hadbeen negative.

Mars’ human resources policies were probably also negative. The ice-creamjob was allocated a grade, which made sense within the broader gradingsystem of Mars. However, it made it hard to recruit a manager with thepolitical weight, market knowledge and strategic skills needed to lead the ice-cream business to success. Again the habits of the parent company had anegative influence on the success of the business.

Stories like these are the norm rather than the exception. When Shell enteredthe aluminium business, its corporate habits encouraged the aluminiummanagement team to pursue a vertical integration strategy. This had provedsuccessful in the oil business and hence there was some, often unspoken,pressure to try it in aluminium. The result was bad. Shell discoveredsomething that most managers in the industry already knew: verticalintegration does not create value in aluminium.

Few managers attempt to assess the costs of learning at both the operatingand the corporate level. None, in the research, put these costs into theirfinancial analysis.

Learning is required at the corporatelevel as well as the operating level


Insight 4: Identify unusually low or high return markets

Managers focus too much attention on the potential of the market they arethinking of entering. Strategy analysis indicates that, in normalcircumstances, a company will earn above-average returns only when it has acompetitive advantage. Hence analysis of markets should focus on identifyingthose extreme situations which are either so good that even a competitor witha disadvantage can earn a good return or so bad that even an advantagedplayer may earn less than the cost of capital. The solution is to focus onidentifying markets that offer either unusually low or unusually high returns.

It is sufficient to focus the analysis on whether the market is a ‘rare game’(green) or a ‘dog’ (red). In all other situations, markets that are neither dogsnor rare games are ‘possibles’ (yellow). If a company has some advantage andexecutes it well, it should make good money.

Rare games are businesses where the profit potential is so good that almostany competitor entering the business at the right time is likely to make apositive return on its investment. In rare games, the business model providesroom for high margins, the industry structure will allow high margins to beearned and there is an opportunity for the company to become the leader. Inaddition, the company can enter the market without a big cash exposure andthe risks are mainly ones under its control.

Dogs are businesses where a weak business model, an unattractive industrystructure and a lack of opportunity for leadership combine with high levels ofvulnerability and high risks relative to reward.

Insight 5: Assess the quality of your people

Managers recognise that people are important, but they do not pay sufficientattention to the quality of the managers leading the project relative tocompetitors, and they often do not consider the relative capabilities of themanagers the project will report to. The solution is to make the quality ofproject leaders and project sponsors part of the strategic assessment.

Evidence from the venture capital industry in the research, and common sense,point to the importance of people. In the success cases, the researchers werestruck by the unique people involved, the often serendipitous way in whichthey had come together and the special experiences that influenced theirthinking. In the venture capital and private equity industry, it is commonly saidthat there are only three factors for success: ‘management, management andmanagement’. Using common sense, you would not consider entering a teamin a sporting competition and expect to win unless you had some exceptionalplayers compared with the opposition. People are important.

Yet it is common for new business projects to be launched with the help ofmanagers in a business development function supported by consultants onthe assumption that the management team can be recruited later. If theactivity is familiar and the company has a pool of managers capable ofmeeting the challenge, this approach is reasonable. However, if the activity isless familiar, involving a different business model, it will be hard to find themanagement talent required.

The questions that need to be addressed are:

• Does the leadership of the new business (the unit head and his or herteam) have the passionate commitment, personal insights,entrepreneurial mindset, execution skills and influence with the parentthat will enable them to overcome the inevitable setbacks, scepticism androad blocks and win in the market place?

The quality of project leaders and projectsponsors should be part of the strategic

assessment




• Does the new business have a sponsor who will provide a compatiblehome for it in the portfolio, exercise effective oversight, protect it fromnegative influences and support it through setbacks?

Insight 6: Do not distract attention from core business

Managers take into account the benefits to or cannibalisation of existingbusinesses that can result from a new activity. However, they oftenunderestimate the loss of performance in existing businesses that occurswhen attention shifts to new businesses and some of the most energeticmanagers are allocated to new business projects.

The loss of performance risk depends on two factors:

• the degree to which the challenges in the existing businesses demandscarce management and financial resources, and

• the degree to which the new business will compete for these scarcemanagement or financial resources.

The greater either or both of these factors are, the greater is the scope for lossof performance in existing businesses. The distraction may not result in anactual reduction in performance; the loss may be between actual andpotential performance.

New businesses can also make claims on critical shared resources, such asexperts in industrial design, miniaturisation or embedded software. Whensucceeding in a new business is a high priority, these experts are drawn awayfrom projects in the core business. The core then suffers imperceptibly overtime, because some key resources are working on ‘more important projects’.

At McDonald’s, partner brands such as Chipotle and Pret A Manger might beconsidered to have a low distraction risk. However, it depends on how theyare managed. At Chipotle, 50% of the top team were managers transferredfrom the hamburger business. At Pret A Manger, the percentage was lower butnot insignificant. Moreover, both these brands had been acquired to see if itwas possible to inject McDonald’s skills to help them improve and grow.Hence it was intended that they would take up the time of some managers inthe core. Given the attention needed in the core business and the plans forbrands such as Chipotle, the distraction risk was high.

New Business Traffic Lights

Where managers need to screen a large number of projects, a simple matrix isoften used (see figure 2). Tim Hammond, corporate development and groupmarketing director at Whitbread, used a matrix like this to screen 30 ideas fornew leisure businesses that Whitbread might enter (he came up with theoriginal idea of a traffic lights system). He defined criteria for each axis of thematrix and graded them red, yellow or green. By eliminating all those with ared signal, he reduced the number of options to six. Further investigationidentified only one with multiple green signals.

Managers often underestimate the loss ofperformance in existing businesses that

occurs when attention shifts to newbusinesses


Figure 2: Product/market matrix

The Traffic Lights incorporate a set of questions that go beyond the simplematrix used by managers such as Mr Hammond. The Traffic Lights are builtaround sound strategic thinking and the six insights described above. Theyare designed to be used early in the life of a project, before enoughinformation is available to make a full financial business case. They can alsobe used as a sanity check for a financial business plan. They can even be usedto review a project that is failing to meet its targets. The positioning of theTraffic Lights is important: early on before much information is available toassess the potential; after some exploration and experimentation has beendone and more information is available; or alongside a full business caseanalysis after detailed research has been done on a new project. The TrafficLights have taken nearly three years to develop and test.

Figure 3: New Business Traffic Lights

The Traffic Lights involve making red, yellow or green judgements about fourquestions:

1. Is the profit pool for this new business average (yellow), a ‘rare game’(green) or a ‘dog’ (red)?

2. Do we have a significant value advantage (green), small or uncertain valueadvantage (yellow), or negative value advantage (red) in this newbusiness?


New

Familiar

Products

Familiar New

Markets

Value advantage

Existing businesses Profit pool

Leadership/sponsorship

STOP

GO

GO

GOGOSTOP

STOP

STOP

?

?

?

?



3. Do we have leaders of this new business (and sponsors in the parentcompany) that are clearly superior to (green), similar to (yellow) or lessstrong than (red) competitor businesses?

4. Is the impact of this new business on existing businesses likely to besignificantly positive (green), uncertain (yellow) or significantly negative(red)?

The overriding question is whether the project should go ahead or not.

The research found that any one green signal can be enough to make theproject go, as long as there are no red signals. One red signal is enough to stopthe project. A project with all yellow signals is marginal.

The Traffic Lights do not focus on execution issues. For example, they do notassess whether suitable partners can be found or whether the technology willwork. These are important, but it is hard to make judgements about them atthe idea or even business plan stage. The Traffic Lights assume thatoperational issues can be surmounted.

The Traffic Lights do not provide clear go/no go decisions for every situation.However, they frequently give a ‘no go’ answer in situations where managersare inclined to ‘give it a try’. As a result, they screen out a larger percentage ofnew business projects that would subsequently fail, saving time and money.

The Traffic Lights may seem a little daunting. There are four majorjudgements that need to be made and each depends on a number of sub-judgements. They are, however, relatively easy to use. It can take less than anhour to talk through the four Traffic Lights and arrive at a preliminaryconclusion. Parts of this preliminary conclusion may be easy to challenge, butfrequently the overall judgement—red, yellow or green—is not disputed. If itis, more work is needed and sometimes this can take days or weeks tocomplete. However, this is rarely wasted work. If the judgement is improved,a better quality decision will result.

The Traffic Lights help managers assess the strategic viability of a newbusiness project. They form the ‘strategic business case’, which, if positive,should support the ‘financial business case’. There should be very little in theTraffic Lights with which managers or academics disagree. The intention hasbeen to pull together the fundamentals of good strategic thinking in a waythat will help managers arrive at judgements, not to create some dramaticnew theory.

The Traffic Lights do contain some insights and new ideas. For readers whowish to test these against their current portfolio of new business ideas,chapter 4 provides a worked example and some additional guidance.

The Traffic Lights help managers assessthe strategic viability of a new business

project


New Business Traffic Lights inpractice

This chapter explores the criteria applied to each of the four New Business TrafficLight questions, namely value advantage, profit pool potential,leadership/sponsorship quality and impact on existing businesses. It also providesworked examples.

Traffic Light 1: Value advantage

One of the truths of business is that a superior return on capital is normallythe result of some area of advantage. Success is hard to achieve without anadvantage, as Michael Porter argued compellingly.10 Business strategy, he said,should be about how one company can achieve an advantage over its rivals.Advantage comes either from superior costs or from superior products.

So how does a management team assess whether it is likely to have anadvantage in a new business situation? Clearly this is difficult, and it can beespecially difficult if the advantage is based on competencies that are hard tounderstand. As a result, the Ashridge team developed the ‘Value AdvantageEquation’ to help managers make the right judgement.

Our value advantage = The unique value we bring (from the operating and parent levels)

Less, the proportion of the value we could ‘trade’Less, the unique value our competitors bringLess, the cost of learning the new business relative to competitors

The unique value

The equation starts with an assessment of what the company can contribute tothe new business that has special or unique value. Figure 4 lists some of the areasthat were identified in the success stories. Most of the successes were based onmore than one source of unique value, the average being two.

Figure 4: Sources of unique value

Chapter 4:

Superior return on capital is normally theresult of some area of advantage.

Business strategy should be about howone company can achieve an advantage

over its rivals

IP/technology/p

roducts0

5

10

15

20

25

Functional c

ompetency

Customer

relati

onships/bran

ds

Other rel

ationships

Undervalu

ation

insight/o

utcome

Market

developmen

t

insight/o

utcome

Business

model

insight/o

utcome

None

Lucky brea

ks

Other ass

ets

Num

ber

of s

uces

ses


For example, when Boots considered entering the eye-care business the list ofspecial contributions might have looked like this:

• trusted health and beauty brand• excess retail space in some locations• knowledge of the mass consumer• distribution system to every significant retail location in the UK• retailing skills• employee loyalty.

The key question is ‘how unique?’ How much advantage does eachcontribution deliver? Consider the following:

• The brand could be significant. If the brand could drive extra sales volumeto a given location compared with existing brands in the market, it couldsignificantly increase profitability.

• The excess retail space would be valuable only if it was worth more to theeye-care business than to some other business. The initial judgementmight have been that the space would be helpful but not significant.

• Knowledge of the mass consumer is important, but unlikely to be a uniquecontribution. Other competitors had been in the market for many years.Unless Boots believed it possessed some insight about the mass consumerthat its competitors did not have, this consumer knowledge is unlikely tobe a significant contribution.

• The distribution system could be a significant contribution if it wouldenable the new eye-care business to have fewer lines out of stock or havelower supply costs than competitors. Given the maturity of the existingindustry and the availability of third-party distribution services, this isunlikely to be a source of significant advantage.

• Retailing skills and employee loyalty could be a major contribution. Thiswould depend on whether the application of these skills would be likelyto enable the business to serve more customers, attract more customerloyalty, operate at lower cost, or sell at higher costs than its competitors.Boots might well believe that this would be a significant contribution.

In summary, Boots might have concluded that it had an advantage inbranding and in retailing skills, which might enable it to earn significantlyhigher margins than most competitors, if all other aspects were equal.

The tradable proportion

Assessing the unique contribution and putting some value on it, such as ‘50%higher margins’, is easier when talking about an existing market, such as eyecare. When the business is a new market, for example internet serviceprovision in the early 1990s or outsourcing auto safety testing in 2000, thetask is harder. Managers need to compare their special advantages with thoseof likely future competitors and try to identify those unique resources thatwill be a significant source of advantage in five years’ time. Guesswork comesinto play along with the biases of the person doing the guessing.Nevertheless, determining the value that managers believe is unique andassessing its significance to relative profitability forces managers to make thenecessary strategic judgements.

It is useful to deduct the tradable proportion of the unique value from theoriginal contribution to arrive at a non-tradable contribution (see Insight 2 inchapter 3). For example, if managers at Boots believe that it would be possibleto license the brand to one of its current competitors, the value of a likelylicence fee, say 5%, should be deducted. Boots’ non-tradable contribution is,therefore, the value the brand could bring to the eye-care business less the

Managers need to compare their specialadvantages with those of likely futurecompetitors and try to identify those

unique resources that will be a significantsource of advantage in five years’ time


Chapter 4: New Business Traffic Lights in practice


value that could be created by licensing the brand plus the value of theretailing skills and employee loyalty. If the previous estimate was that Bootscould earn a 50% higher margin, the non-tradable contribution might be a30% higher margin.

Competitors’ unique value

An alternative to assessing the company’s unique value is to consider whatunique value competitors bring to the business. The analysis can focus firston existing competitors, but should include potential competitors.

The list of contributions of existing competitors in the eye-care businessmight be:

• low rents in some locations because of leases signed some years beforeand/or property purchased at lower prices

• established locations and knowledge about location advantage• volume advantages in purchasing costs and other costs not fixed by site• brand strength, customer loyalty and switching costs• knowledge of customer preferences.

As before, these contributions need to be assessed in terms of their worth.How much advantage do they give?

• The low rents will give a calculable cost advantage. However, should thiscost advantage be taken into account? The competitors ought to beassessing their property costs against market values (the rent they couldget if they sublet the property), hence their central property companyought to be charging the sites a market rent. If so, these sites would haveno property cost advantage over Boots’ sites. But overall, the competitor isstill benefiting from these lower costs and can use the money tostrengthen its business. Hence it should be part of the value advantageequation.

• Knowledge about locations will enable the competitors to choose bettersites than Boots, at least for a few years. It is possible to assess the likelyimpact of this based on a typical comparison between better sites andaverage sites in Boots’ current portfolio. This might be given a value of anaverage of 5% extra sales per site.

• The volume advantages could also be estimated. They might amount to alower cost base; for example, by 2% of sales.

• Brand strength and loyalty is hard to put a number on. However, it ispossible to estimate the discounts Boots would need to give (and for howmany years) and the extra marketing involved in order to build up marketshare. This could lead to an extra 3% on the cost base for five years.

• The knowledge of customer preferences will enable competitors to fulfilcustomer needs more often than Boots. This would reduce their cost persale. It may also enable the competitors to successfully sell customers moreexpensive items more often. The impact of this temporary advantagecould be a further 3% sales volume per year over five years.

Putting this all together, is the unique contribution that the competitors areable to make significantly greater than, roughly equal to or significantly lessthan the non-tradable contribution Boots can make? The judgement iswhether Boots has a net non-tradable contribution (table 1).


Table 1: Net non-tradable contribution in eye care

% of margin

Unique contribution 50

Less tradable portion 25

Less competitor advantages

– site selection 20

– scale benefits 2

– marketing costs 3 (for 5 years)

– cost per sale 3 (for 5 years)

Net non-tradable contribution –3

At this point the judgement involves trying to weigh both the quantitativeand the qualitative parts of the different contributions. This is not easy norcan it be done on a calculator. However, managers who understand thebusiness and who have worked through the details normally reach the sameanswer. In this case the net non-tradable contribution is probably about zero.At least, based on the analysis above, it is possible to be confident that the netnon-tradable contribution is not significantly positive. In other words, thereis no strong value advantage logic for Boots to enter this business.

If a project has a neutral or negative net non-tradable contribution, it is notnecessary to look at the other terms in the value advantage equation and itcan be rejected without further analysis. If it has a positive net non-tradablecontribution, however, it may still not be supportable. The remaining term inthe equation, the cost of learning the new business, may be sufficientlynegative to outweigh the positive.

Learning costs

The difficulty with learning costs is to judge how big they are. If the businessmodel or the relationships, or the required beliefs, behaviours andorganisational structures and processes are different for the new business, thelearning costs will be high. If the business model, relationships and culturalrequirements are familiar, the learning costs will be low.

In the Boots example, it is tempting to think that the learning costs would below. Boots managers are already experienced retailers. However, eye care is anew category and experience suggests that each dimension of newness islikely to involve learning costs that reduce profitability for five years by 10%.If Boots is entering eye care and retailing with a different business model,such as franchising, it would make sense to assume 20% learning costs. If it isentering eye care with a new business model in a new market, such as theluxury segment or France, the learning costs should be assumed to be 30%.And if it is entering the eye-care business with an acquisition, the learningcosts could be assumed to be zero. Instead, however, there would be anacquisition premium which would be likely to be 30% or more.

As well as the learning costs at the project level, there is also learning at theparent level. How far will the parent managers, functional heads and sharedresource leaders need to modify their normal behaviour and policies to givethe new business good guidance and influence? If the new business can bemanaged in the same way as the other businesses in the portfolio, thelearning costs will be low. If it requires the parent to learn some newbehaviour that is compatible with its existing habits and instincts, thelearning costs will be significant but manageable. If it needs to be managed ina different way from the existing businesses, requiring different behavioursand organisational approaches, the learning costs are likely to be high.

How far will the parent managers,functional heads and shared resourceleaders need to modify their normal

behaviour and policies to give the newbusiness good guidance and influence?




Moreover, because the parent is less directly involved in the new business andhas other influences, the learning can often take much longer. If the learningcosts are estimated to be high, the value advantage equation should includea value deduction of 20–30% of profits for ten years.

It could be assumed that the Boots parent would have little to learn aboutretailing eye care. However, given that it is a new category, some learningcosts should be considered. As before, the learning costs are greater the moredimensions of difference there are between the new business and the existingbusinesses (or at least those businesses the manager in the parent is familiarwith). For each dimension, a cost of 10% lower profits for ten years is areasonable assumption. In the Boots case, therefore, the learning costs couldbe assumed to be 20% for the first five years and 10% for the next five years—something like 15% of value overall.

Learning costs are common. When Xerox tried to translate its remarkableR&D efforts into a new office automation business, comprising the Starworkstation and the Ethernet, a word processor and a laser printer, theinclination of corporate managers was to require the same product review andinvolvement in decision making that they were used to in the copier business.They had difficulty understanding a business model that required rapidinnovation cycles, indirect sales, lower margins and third-party software.They hired an outside team and gave them free rein, but the team alienatedthe rest of the company and racked up huge losses over two and a half years.Xerox eventually abandoned the new business and concentrated on thechallenges to its copier business from Japanese competitors.

Traffic Light 2: Profit pool potential

Based on Insight 3 (see previous chapter), the analysis of profit pool potentialshould focus on whether the profit pool is a dog (a market where even goodcompetitors are likely to earn less than the cost of capital), a possible (amarket that is likely to be fairly normal), or a rare game (a market that is likelyto provide good returns even for weak competitors). To help with thisanalysis, five criteria need to be assessed:

• business model potential for high margins (value relative to cost, break-even as a percentage of market)

• industry structure potential for high margins (five forces taking account oflikely growth rates)

• opportunity to be a leader in this market• cost of trying relative to size of the profit pool (taking account of time to

commercialisation)• business model vulnerability (number of enablers, sensitivity to key

variables).

These variables have not been calibrated or worked into an equation becausethe judgement required—dog (red), possible (yellow), rare game (green)—doesnot demand accurate calibration.

A dog market is one where:

• the economics of the business model are poor, meaning that the value tothe customer is only slightly greater than the cost of production or thebreak-even volume demands at least a 50% market share, or

• the industry structure, even with the benefits of growth, is such that fewif any competitors will cover their cost of capital, or

• the cost of proving the idea is more than one-tenth of the market size, or• the business model is dependent on partners, stakeholders or variables

that are uncertain and could be disastrously negative.

Analysis should focus on whether themarket is one where even good

competitors are likely to earn less thanthe cost of capital, it is likely to be fairly

normal, or it is likely to provide goodreturns even for weak competitors


These markets should be avoided, regardless of the outcome of the other partsof the Traffic Lights.

A rare game market is one where all the criteria are favourable:

• the value to the customer is more than twice the variable costs ofproduction and the break-even point requires a market share of less than 5%

• the five forces are all favourable and growth is greater than 10%• there is an opportunity to become the market leader• the market size is more than 50 times the investment needed to test the

opportunity• the business model is not vulnerable to any major uncertainties.

In these markets, companies can contemplate investing even if they do nothave a clear advantage and the impact on the existing businesses is negative.

Managers find this tool relatively easy to use. Around 90% of markets turn outto be yellow, so the analysis is normally focused on making judgements at theboundaries. A few markets will be borderline rare games and a few will beborderline dogs. Instead of worrying about which side of the border themarket should be, it is often better to acknowledge that it is a borderline caseand move on to the next part of the Traffic Lights.

Potential for high margins

The business model has the potential for high margins when the valueprovided to the customer is high relative to the variable (or per unit) cost ofproduction and when the break-even volume is low.

A pill sold by a pharmaceuticals company is a good example of customervalue added. The manufacturing cost of the pill may be a few cents, but thevalue to the customer of better health may be thousands of dollars. Similarly,a microprocessor chip is relatively inexpensive to manufacture comparedwith the valuable function it performs in a PC. In both cases, the value is highrelative to the cost. Boots’ eye-care business is also one where the value to thecustomer is high relative to the cost of providing the care. Mars’ ice-creambusiness is more balanced. The value is greater than the cost but not hugelyso. This makes high margins harder to earn.

In investment-intensive businesses, such as pharmaceuticals with high R&Dcosts or chip manufacture, where the cost of capacity can amount to billionsof dollars, gross sales have to far exceed the capital investment. Otherbusinesses, such as retailing, are less capital intensive but have high levels offixed operational costs once the service level and geographic coverage havebeen set. These businesses often also require a big share of the market to breakeven.

A pharmaceuticals business requires sales of hundreds of millions of dollarsand a chip manufacturer requires an even higher volume to achieve payback.An eye-care retailer needs to attract a significant share of local trade in orderto break even. In ice cream, however, capital intensity is modest and thebreak-even point is low. A small factory may need to operate at above 70%capacity to make good returns, but it will serve only a small proportion of themarket. Generally, the larger the upfront fixed costs in plant or serviceinfrastructure and in developing the products, the bigger is the percentage ofthe market needed to break even.




Industry structure

The economics of the business model shows the potential for profit, but it isthe structure of the industry that determines what profit is actually earned.Mr Porter’s five forces model is the ideal tool for assessing the structure (figure5). The five forces—customer bargaining power, supplier bargaining power,threat of new entrants, threat from substitutes and competitive rivalry—arethe determinants of profitability. Any of them can be the cause of lowprofitability. Companies earn the full profit potential of their business modelsonly when customers and suppliers do not bargain on price, entrants are nothreat, there are no price-based substitutes and competition is muted.

Figure 5: Five forces analysis

Source: Porter, M. (1980) Competitive Strategy, Free Press.

Favourable conditions exist in eye care and pharmaceuticals, but not in icecream or auto manufacturing. In ice cream there are few problems withcustomers, suppliers, new entrants or substitutes. But the competitors,Unilever and Nestlé, are unlikely to welcome a new entrant. Rivalry, whichwas not intense before Mars’ entry, would be likely to increase. This wouldreduce margins for all competitors.

Market growth rate

When considering a new business, the growth rate of the market is normallyan important criterion. From the perspective of profit pool potential,however, growth is good only in so far as it helps raise profitability. It is notvaluable in its own right. Growth often affects profitability because it lessensthe negative forces in the five forces model. Hence high growth—above 10%volume growth—is normally associated with high profitability.

However, when an industry becomes over-hyped, growth can be negative.High-growth markets can attract too many competitors. Since mostcompanies are looking for growth, every growth market will be a potentialnew business opportunity for many of them. These markets then becomeoversupplied with competitors as each tries to establish a foothold in whatthey expect to be a promising future. An example is the cellular telephoneindustry in the 1990s.

High-growth markets can attract toomany competitors

Competitive

rivalry

Threatof

Entrants

SuppliersPower of

BuyersPower of

Threatof

Substitutes


Both eye care and ice cream are growing markets, but neither is growing sofast that it is undersupplied; nor has it become attractive to a large number ofnew entrants. For these two examples the growth factor is neutral.

Leadership potential

The potential to become a leader is important to long-term profitability.Leaders earn greater margins than followers. They can influence the rules ofthe game, set standards of performance and reap scale economies. Smallplayers are normally more vulnerable to changes in the business that areimposed or readily embraced by large players. They also have less opportunityto exploit economies of scale. Unfortunately, the path to leadership issometimes blocked. The market may have an established leader or a numberof large competitors which are unlikely to be up for sale. This is the positionin the ice-cream business. In Europe it is dominated by Unilever, with Nestléa distant number two. However successful Mars might be, it could never hopeto wrest leadership from Unilever without making some major acquisitions.In eye care there were dominant competitors, but Boots might have believedsome of these could at some point be sold, giving Boots the opportunity tobecome the leader.

Investment/profit pool ratio

Entering a new business requires investment. Until the business is establishedthis investment is at risk. The suggested assessment, therefore, is a ratio of thesize of the investment at risk (the cost of trying) to the size of the profit poolin the new market.

Managers have to assess whether the market is large relative to the cost ofproving that the business can be profitable. If the total investment neededbefore profitability is proven is $10m, the market would need to be worth atleast $100m to be attractive. This ten-to-one rule of thumb is based on somesimple calculations. Assuming the company gets 20% of the final market andearns a 10% margin, there will be a margin of $2m a year available to pay forthe start-up costs. It will, therefore, take five years to pay back the $10m start-up costs. Hence the rule of thumb that the market needs to be at least tentimes the size of the risk investment. Any market that is smaller than this isa potential dog. A really attractive market is 50 times the size of the riskinvestment (that is, the start-up costs can be recovered from one year’s profitassuming a 20% share). If the share ambitions are much lower than 20%, thesize to investment ratio needs to be correspondingly larger. For Mars ice creamand Boots eye care, the markets were more than 50 times the size of the riskinvestment needed to prove the opportunity.

Some business models depend on the co-operation of partners or otherstakeholders for their success. For example, when Apple launches a newcomputer platform, its success is dependent on gaining the support ofsoftware companies to produce applications that will run on this platform.

Business model vulnerability

Managers need to assess the business model vulnerability taking into accounta number of factors. Having business models that involve multiplenegotiations and agreements with others, especially regulators and evencompetitors, increases both vulnerability and time to commercialisation, andso the ‘cost of trying’. The Boots eye-care business and the Mars ice-creambusiness appear to have low vulnerability. They do not depend on partners,

If the total investment needed beforeprofitability is proven is $10m, the

market would need to be worth at least$100m to be attractive




suppliers or regulation, and they are not overly exposed to movements in rawmaterial prices or exchange rates. In ice cream, however, the business modelwas vulnerable. Unilever and Nestlé reacted by trying to prevent Mars fromplacing its products in freezer compartments that these companies hadhelped finance. If they had been successful, this would have denied Marsaccess to many outlets.

To summarise the analysis for eye care, the conclusion is yellow: ‘a possible’.Eye care is not a dog. It has some features of a rare game, but not enough tobe classified as a rare game.

Traffic Light 3: Leadership/sponsorship quality

Leadership

When assessing leadership, it is necessary to make judgements about someimportant qualities. Do the leaders of the new business feel passionate aboutit? Will they struggle hard when the going gets tough? Will they remainpositive when faced with setbacks? Do they have personal insights about thisbusiness based on experiences they have had in other jobs or in the earlypursuit of this project?

This combination of commitment and personal insight is necessary whenmanagers are faced with setbacks, scepticism and road blocks. The personalbelief ‘I know there is a successful business in here somewhere’ will providethe motivation needed. Experience is not the only requirement. Indeed, longyears of experience in a sector can create a locked-in mindset. A managementteam that has not been programmed by history may be much better atreading the signs about impending changes than the incumbents.

Another quality is entrepreneurial flexibility. One thing is certain: the originalbusiness plan will need to change and the market and competitor landscapewill develop in unexpected ways. Does the team have the entrepreneurial andexecution skills to adjust their plans so that they will come out on top whencircumstances change?

The overall assessment of the management team of the unit, therefore, willinclude some specifics, such as insights and influence, but it will also takeinto account the overall quality of the team compared with others. If thedifferent management teams in the industry were put up for auction, would‘our team’ sell for a significantly higher or lower price than that of the leadingcompetitor?

If the team is led by top-quality managers, with a track record of takingadvantage of new developments and reacting swiftly to new events, someexperience or insight relevant to this business and a passion for success, ‘unitleadership’ can be graded green. Sir Peter Davis, when CEO of Prudential, oneof the UK’s lead insurance companies, hired Mike Harris to run Egg, aninternet banking venture. Mr Harris had previously started up First Direct, theUK’s first telephone banking operation. He had been involved in convertingFirst Direct to an internet bank as the technology changed and had othersuccessful new business experiences. He and the team he set up were headand shoulders above the management teams of the other internet banks thatwere starting at that time.

Normally, however, the team involved in leading a new business cannot claimto be the most capable and entrepreneurial team, unless the business is newto all competitors. When Dixons launched Freeserve, a UK internet service

A management team that has not beenprogrammed by history may be much

better at reading the signs aboutimpending changes than the incumbents


provider, the business was new to all competitors. Dixons had no reason tobelieve that its managers were the best in the industry, but it also had noreason to believe they were inferior. In such a case the starting presumptionshould be one of neutrality and a yellow score awarded, unless there is clearevidence either way.

In the sample of successes, over two-thirds involved management teamswhich, with hindsight, were unusually strong. They had developedsignificant reputations in their industries.

Sponsorship

Sponsors are important because they can make up for qualities that arelacking in the new business’s management team. They have authority overthe new business and can help it gain from the positive and avoid thenegative aspects of the parent company. Without a strong sponsor or thelikelihood of one, it is often unwise to embark on a new business.

As well as controlling some resources and having power and influence in thestructure, sponsors should:

• provide effective oversight and an ‘understanding home’ for the newbusiness

• have some personal knowledge of the new business, or the time andinclination to learn fast

• have enough time to challenge and coach the business and share in someof the critical decisions that need to be taken along the way

• be influential in the development of the new business.

The more the sponsor has the ability, motivation and real understanding toexert that positive influence, the greater are the chances of success.

A CEO or line manager is a good sponsor when the new business is animportant part of his or her strategy. As a compromise, the new business teamcould report to a line manager within the power structure and extra supportcould come from a business development function. An arrangement such asthis would score yellow. It is possible to get a green light for sponsorship onlyif the sponsor is a line manager with the necessary power in the organisationand the appropriate skills.

In the sample of successes, 90% (where the information was available)reported to the CEO or a main division head. In just under a quarter of these,the CEO was the initiator of the original plan.

The leadership/sponsorship Traffic Light often overlaps with the valueadvantage Traffic Light. The insights of the leaders or the sponsors may bepart of the ‘unique contribution’. The knowledge that leaders and sponsorshave of the new business will also affect the ‘learning costs’. Experiencesuggests that where double counting occurs it is more likely to be a benefitthan a disadvantage. Because the tendency is to give more weight to tangiblefactors such as patents or brands when assessing value advantage, there is abenefit in giving extra emphasis to people issues under the leadership/sponsorship Traffic Light.

Without a strong sponsor it is oftenunwise to embark on a new business




Traffic Light 4: Impact on existing businesses

The fourth Traffic Light concerns the impact the new business will have onexisting businesses. This might be significantly positive as a result of customeror cost synergies (green), significantly negative as a result of conflicts ofinterest and/or distraction of key managers (red), or somewhere in between(yellow). It is necessary to consider both synergies and distraction risks.

Synergies

Synergies can be positive or negative. When commercial banks entered theinsurance business, the benefit for the core business came from greater use ofthe existing branch networks. By selling additional products and servicesthrough these branches, the fixed cost was spread across a larger volume ofbusiness. However, when Grand Metropolitan owned a gaming businessalongside its food brands, such as Green Giant, there were negative synergies.The bad reputation of the gaming industry undermined Grand Metropolitan’soverall reputation in the USA. The solution was to sell the gaming business.

Sometimes synergies can be so important to the existing businesses that theybecome the dominant logic for the new activity. Irish Life, Ireland’s largest lifeinsurance and pensions company, merged with the country’s largest buildingsociety (savings and loans) for the benefits it brought to the insurancebusiness. It provided the insurance business with an additional channel ofdistribution: the branch network of the building society. When Centrica, agas and electricity utility, set up the Goldfish credit card, the main logic wasthe loyalty benefits for the core business. Competitors were introducingloyalty programmes that could threaten the core utility activities. Goldfishwas Centrica’s response. It turned out to be so successful that it quicklydeveloped into a broader financial services business.

Based on the database of successes, 75% of the new businesses had nosignificant synergy benefits for existing businesses. In other words, this doesnot normally have a significant positive influence on the decision. It is alsocomparatively rare for the synergies to be significantly negative. However, inthe few cases where synergies are important they need to be taken intoaccount. In over half the cases where synergies were important, a primereason for the new development was to strengthen the core business.

In summary, distraction risks are real and often underestimated. Assessingthem involves understanding the issues facing the core businesses andjudging how much each new business will compete for scarce resources.

Conclusion

The Traffic Lights should help organisations identify better opportunities andunderstand the business and management issues that need to be addressed toimprove the chances of growth opportunities being successful. The systemhas been used by H-I Network to assess strategic domains. This is a valid useof the thinking as it utilises the fundamental insights that were highlightedin the research.

The case studies in the next chapter provide insights into the business contextand strategic purpose of some leading organisations. The Traffic Light tool hasbeen applied to illustrate how it could be used. The cases are based on genericand secondary source examples as there would be confidentiality issues iforganisations that are currently assessing their strategic growth and ventureareas were used.

The Traffic Lights should helporganisations identify better

opportunities and improve the chances ofgrowth opportunities being successful


Case studies

This chapter contains three case studies which illustrate the use of the TrafficLights system to assess new business opportunities: Royal Bank ofScotland/Direct Line, IBM and Whitbread.

Royal Bank of Scotland/Direct Line

Key lessons

• The business and technology environments are important in providing context for new business ventures.

• New business opportunities can be serendipitous.• People are a crucial element in the success of a business venture.

Direct Line is well known within the UK and is becoming familiar elsewhere.Apart from being a shining success, it is included because it is easy to relateits success factors to the New Business Traffic Lights system.

In 1980, Mike Flaherty and Roy Haveland were managers in the ITdepartment at Alexander Howden, an insurance broker. Mr Flaherty reportedto Mr Haveland, the head of IT, and Mr Haveland reported to Peter Wood,head of group services.

“At the time some important changes where happening in technology:relational databases, a major shift in mainframe technology (which meantthat mainframes that had previously cost £2m were now available second-hand for £20,000), changes in drive technology, the arrival of laser printersand the development of software for composing documents,” explained MrFlaherty. “This was making it possible to have multiple indexes. If there wasa train strike and you wanted to identify all your employees in the affectedpostal districts, it would previously have taken days if not weeks. It could nowbe done in a day.”

In an attempt to justify a large computer, exploit these new technologies,fulfil the entrepreneurial instincts of the managers involved and prove thevalue of the IT department to a sceptical management, the department startedto sell its services, such as manipulating databases and printing low-volumedocuments, to outside customers. It produced internal catalogues for the BBCand the electoral register for the London Borough of Croydon.

“It was probably one of these rare situations where you have a combinationof people with technical and commercial skills. We had all been detailedsystems programmers. We were all more fluent in Assembler language thanwe were in English. We could write the machine code that made ourcomputers sing. But we were also commercial.”

Chapter 5:


In 1982, the team was approached by two people who had worked for aninsurance broker selling motor insurance. “They originally asked us if wecould print rate books for them a couple of times per year.” As therelationship developed, the motor insurance brokers, who had also been in IT,recognised the capabilities of Mr Flaherty and Mr Haveland. At that time therate books allowed only £5 step changes in motor insurance rates. Because ofthe competitiveness in the industry, the brokers felt that it would be a bigadvantage to be able to quote rates between these numbers. The idea was toproduce more fine-tuned rates and download them for a fee on to ‘midi’computers, which they would sell to insurance brokers. “At the time, thebrokers’ systems asked 16 questions and gave rates with step changes of £5.Their idea was to ask 21 questions and give step changes of 50 pence. We werecapable of doing this number crunching because we had this huge,underutilised computer.”

The business proposition was to sell midi computers and software to thebrokers at cost and then make money by selling them the ratings. But the costof midi computers meant that they were not able to produce a package thatwas attractive enough for the brokers and the idea fell apart.

The big payoff from this experience was that Mr Flaherty and Mr Havelandlearnt about producing rate cards. They considered producing rate cards forAlexander Howden’s motor insurance department, but the company had justbeen acquired by Alexander and Alexander. The acquisition had unearthedsome dodgy accounting and the whole company was in turmoil. Costs werebeing cut and people were worried about their jobs. Mr Wood suggested thatthe three of them should try to set up an independent motor insuranceservice using this new technology.

Mr Wood and Mr Haveland knew some ex-Howden employees who had setup as independent brokers. Working with them, a business plan wasdeveloped. The plan was to set up as a direct insurer to avoid the 20–30%commissions paid to brokers. “We had seen that people were beginning tobook theatres and things over the telephone with credit cards. We justthought of it as a processing task. We could have been just a panel on the AAplatform. But we decided to set up a whole business, with the underwriters assuppliers.”

The team spent 18 months looking for a backer while they were still workingat Howdens. Then they got a break. One of the jobs they had done earlier wasdata entry of invoices for Time Life. The person they had been dealing withat Time Life became finance director at the Royal Bank of Scotland (RBS). MrWood was talking to him about doing printing work for RBS, and one day hetold him about his idea for a new business.

RBS decided to back the idea and, 20 years later, the business is worth around£2bn. Mr Flaherty reflected, “If you had 40,000 people in the UK who knewabout relational databases and motor insurance, the chances of one of themcoming up with what turned out to be Direct Line is about as close to zero asyou can get. The number of chance events that had to come together to getthis to happen was mind-numbing.”

In particular, chance had a big impact on the combination of people andexperience necessary for this business to work:

• the excess computer capacity in the hands of entrepreneurially minded ITexperts who were under pressure to demonstrate their value

• the chance encounter with insurance brokers who could see theopportunity to produce fine-tuned rate cards

“The number of chance events that hadto come together to get this to happen

was mind-numbing”


Chapter 5: Case studies


• Mr Wood’s commitment to this unpromising project because of internalcost cutting.

Mr Flaherty commented on the importance of the balance of skills and poweramong the three founders. “We were a unique combination of people withthe right balance of skills. Roy and I had agreed that we would share whateverwe got out of it. As a result, we were the ideal counterbalance to Peter.”

Without the deep IT knowledge, the motor insurance knowledge, the‘seniority’ that Wood brought to the team and the balance between the teammembers, the business would never have succeeded. In fact, even after theRoyal Bank’s investment, the business had a difficult first three years, onlyavoiding closure because of Mr Wood’s negotiation and persuasion skills.

IBM

Key lessons

• Gaining scale in large corporations is difficult.• Determining the market opportunity in a new business area is difficult

without early and constant monitoring.• Initiatives must be thought to be truly strategic by the CEO and the

organisation to gain the appropriate sponsorship.• The organisation structure can hinder the development of emerging

businesses.

International Business Machines (IBM) is a global IT business which in 2004had revenues of $96.3bn and net income of $7.6bn. Beginning life in 1911 asa manufacturer of clocks, scales, electromechanical tabulators and otherindustrial equipment, it now has over 320,000 employees. The business formost of its existence has not been defined by its products. In the late 1980sand early 1990s, IBM recognised that it did not innovate to meet thechanging market, and in 1992 it suffered a loss of over $5bn on $64bn ofrevenue. This ‘near death’ experience caused the company to transform againand bring in a new CEO, Lou Gerstner, from outside the organisation.

Business and technology environment

IBM is in probably the most rapidly changing business sector, withtechnological innovations occurring constantly. This creates conditions thatother organisations can observe and learn from. However, care must be takenas the issues IBM faces and the solutions it has put in place may not directlyapply to other sectors or organisations where the changes and industrydynamics are not the same.

‘Moore’s Law’, which states that computer power doubles every couple ofyears, was established by Gordon Moore in 1965. This exponential growth intechnology power continues and the technical barriers are still beingremoved. Increasing power at lower costs is driving the development ofinternet technologies, mobile communications and embedded computingpower in the home, car and other products.

IBM is in probably the most rapidlychanging business sector, with conditionsthat other organisations can observe and

learn from


IBM believes the significant technology and business influences are:

• network ubiquity, with over 800m people online globally • open standards for technical and transaction specifications, freeing up

resources and providing a critical base to build the added-value servicesthat customers demand in computers, internet, mobile phones, creditcards, and so on

• new business designs and business processes using IT to deliver just-in-time logistics and manufacture, buyer behaviour, one-to-one marketing,and so on.

Like many large organisations, IBM faces the challenge of meeting thesebusiness and technology changes. Sam Palmisano, the company’s chairman,president and CEO, stated in the 2004 results: “Our company is alignedaround a single, focused business model—innovation.”

The technology cycle from innovation to commodity product is becomingshorter. Organisations will need to be at the forefront of innovation and havethe ability to capture the value to gain a return on investment, or focus on alow-cost model to fit the commodity product position. In the technologysector there is unlikely to be space in the middle ground.

During this time of rapid change IBM has been an enthusiastic implementerof the ‘Three Horizons’11 (see figure 6).

Figure 6: The three horizons

Source: Baghai, et al. (1999) The Alchemy of Growth, Perseus Books.

The challenge for organisations is to achieve an appropriate balance betweenthe horizons, to ensure the correct focus of scarce investment and even morescarce talented manager resource. IBM found that it was focusing on short-term business objectives which were killing the opportunities to develop newand available market places. In September 1999 Gerstner ‘blew his stack’when he discovered that promising new opportunities in the life sciencessector were not progressing as their return was expected in the medium term.

There were a number of reasons for this:

• Management reward was for short-term execution.• The focus was the current market and product. • The objective was sustained profit and earnings per share rather than

achieving high price/earnings ratios, which are heavily influenced bygrowth opportunities.

• Market insight-gathering was inadequate for embryonic markets.

The challenge for organisations is toensure the correct focus of scarce

investment and even more scarce talentedmanager resource


Profit

Time (years)

Horizon 1Defend core businessesRationalise costs eg HO moveFocus on current servicesBetter sellingBusiness as Usual

Horizon 2Build emerging businessesICT solutions, RFIDeg Transformation solutions

Horizon 3Create viable optionsBusiness solutionseg Ventures



• There was a lack of discipline in selecting, experimenting, funding andterminating new growth businesses. IBM’s approach was ‘180° to venturecapital’; in other words, it started big and whittled back.

• There were execution failures because of inadequate entrepreneurialleadership, a lack of business-building skills and the absence of sustainedfunding. As the start-ups were only part of an individual’s role, there wasnone of the passion that comes from being dedicated.

Emerging business opportunities

To address these issues, in 1999 IBM began formulating the implementationof its emerging business opportunity (EBO) programme. The group, led byJohn Thompson, then senior vice-president and group executive for software,made the following recommendations.

At the corporate level:

• adopt the three horizon model and devote senior executive time on H2and H3 businesses

• define H3 emerging business opportunities that cross business domainsand provide corporate level leadership

• build an EBO management system driven by the central unit whileensuring clear ownership of all EBOs by line management.

At the group level:

• decide on the appropriate investment balance by horizon• take the lead in specific corporate EBOs• build group EBO management systems.

When Mr Gerstner appointed the well-respected Mr Thompson as vice-chairman in July 2000 to take responsibility for the EBO, everyone knew thecompany was serious about change because the CEO had given theprogramme huge credibility.

Mr Thompson was initially the only dedicated resource and the focus was onthe seven corporate EBOs, with monthly reviews and support. The process upto mid-2002 was predominantly informal and depended on Mr Thompson’spersonal intervention. When he retired in September 2002, Bruce Herrald,senior vice-president, corporate strategy, took responsibility for EBOs.

Purpose

The purpose of the EBO was clearly defined. The EBO initiatives were targetedto add 2% revenue growth annually to the group, that is, around $2bn. A keyobjective of the EBO group was to achieve ‘strategic clarity’: a deepunderstanding of the market place, the customer and the capabilitiesrequired. Engaging early customers was crucial for these emerging businesses,and providing dedicated resources with adequate, but not excessive, fundingwas a crucial task for the EBO group.

Process

The EBO management system that Mr Herrald instigated included theelements of:

• monthly and quarterly reporting and meetings, which were intended tosupport emerging businesses without clearly defined customers orofferings

The initiatives were targeted to add 2%revenue growth annually to the group,

that is, around $2bn


• identifying leaders with the company knowledge and experience to getthings done with corporate support.

During 2003, in an interview with an investment analyst,12 Mr Herrald saidthat in one quarter IBM’s EBO had looked at over 150 ideas, and then chosenabout 20 to examine more closely. From those, 11 were added to the seventhey had already established.

The EBO had identified a challenge: when should a business make a transitionfrom H3 to H2? Significant issues are the timing of a transition, the resourcesthat are dedicated and the focus the business will have in a much largerdivision. Sales revenue or segment market share are studied to help decide ifa business or solution should make a transition.

Rod Adkin, who led the Pervasive Computing EBO group, believed that wherepossible emerging businesses should be measured as H1 businesses, and whenthey have predicable sales they should be integrated into normal business.13

The dilemma of measuring innovation and business is tackled in InnovationPerformance Measurement: Striking the right balance, by David Birchall, GeorgeTovstiga, Andy Morrison and Andrew Gaule.14

New Business Traffic Light analysis

How would an EBO such as pervasive computing be positioned in thestrategic Traffic Light analysis?

‘Pervasive computing’ is the term IBM uses to describe its efforts to bring theinternet with its anytime, anywhere access to non-PC devices such as mobilephones, PDAs, wired homes, vehicles, and so on. This is a broad range ofdevices and applications and IBM took a portfolio/domain approach toaddress as many of the areas as possible as it was unclear which segments werelikely to be successful. The results were as follows:

• The mobile devices market developed rapidly, especially in Europe.• Smart cards were less successful and IBM realised it could not be a

significant player.• The residential gateway market initially appeared promising but has not

yet taken off.• Telematics had enthusiastic uptake, especially from the automotive sector.

The Traffic Lights tool can be used to examine IBM’s decision to commit topervasive computing. It shows that there are likely to be many product areasin pervasive computing that score one or more red lights, but there may be afew that score multiple green lights. IBM should, therefore, be highly selectivein its investments in this domain.




Figure 7: IBM’s pervasive computing example

• Value advantage: green to yellowIBM’s unique contribution (at operating and parenting levels)IBM has a significant technology capability and resource of patents whichprovides a strong contribution compared with many other organisations.It also has management capabilities, market positions and a brand.

Less percentage of IBM’s contribution that is tradableIBM already ‘trades’ its technology capabilities by licensing its technologyand patents to companies. Thus a significant percentage of its technologycapability could be traded and this is unlikely to be the prime reason forentering this sector. IBM’s other advantages are harder to trade and willneed to be assessed against individual opportunities within the computingsector.

Less unique contribution of competitorsCompetitors include the major technology players as well as telecomscompanies entering IT supply areas, consultants and a host of specialists.Each competitor type has special qualities, suggesting that IBM will needto pick its products areas carefully.

Less cost of learning the new business relative to competitors (at operating andparenting levels)As the new technology is likely to be new for any business, IBM should notbe at a disadvantage. However, it may have a learning cost disadvantagein terms of understanding customers or unfamiliar business models. Thevalue advantage will therefore differ by product area. Some, especiallythose where IBM’s brand, distribution strength and managementexperience are relevant, will be green. Others will be red. Most willprobably be yellow.

• Profit pool potential: yellowThere is no reason to suppose pervasive computing will be a rare game andsome concern that it will be a dog because it will attract so manycompetitors. Having a significant defendable advantage is, therefore,likely to be critical.

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Value advantage




• Leadership/sponsorship quality: mainly yellow In some product areas, IBM may have unique people to drive forward theproduct. Combined with the support and enthusiasm built round the EBOprogramme, the light will be green for these products. However, for mostproduct categories IBM is likely to have managers who are no better orhave significantly less experience than those of its competitors.

• Impact on existing businesses: yellow and redSome product areas may have strong technology and market links withexisting businesses. For these, the synergies are likely to balance or evenexceed the distraction costs. These will score a yellow or a green. However,many of the product opportunities in pervasive computing are likely tohave distraction opportunities greater than synergies, leading to a redscore.

The IBM case illustrates the need and purpose for innovation in the company.The EBO process has been put in place, with its resulting challenges. TheTraffic Light system can be seen as a method of thinking through the areasthat need to be considered and acted on by an organisation that isundertaking innovative changes.

Whitbread

Key lessons

• New business development needs to be considered in the wider corporatedevelopment context.

• Management and financial resources are limited and screening can help focus on the best opportunities.

• Using an appropriate business model, such as partnering/franchising, can gain additional value from existing assets in new markets.

This case study is based on the experience of Tim Hammond, who developedthe earlier concept of the New Business Traffic Lights screening system (seechapter 3).

Whitbread has a long history dating back to 1742, when it started a brewingbusiness which continued until 2000. It is now the number one UKhospitality company in the business of eating out, lodging and health andfitness. The group comprises Brewer’s Fayre, Beefeater (bought in 1970s), TGIFriday’s and Pizza Hut (UK franchisees), Costa Coffee (bought in 1995), DavidLloyd Leisure (bought in 1995) and Premier Travel Inn, which wassupplemented with the acquisition of Premier Lodge in 2004.

Purpose

Prior to 2002 Whitbread experienced a few tough years. It became good atselling businesses rather than concentrating on how it would grow in thefuture as a more focused hospitality company. It became clear that a corporatedevelopment role was required to cover new and core business strategicplanning, increase brand focus and evaluate new opportunities.

It became clear that a corporatedevelopment role was required to cover

new and core business strategic planning,increase brand focus and evaluate new

opportunities




Process

In the new corporate development role, Mr Hammond set about defining thefocus areas:

• Growing the core. This was and still is the top priority. There was astrategic planning round to give a sharper portfolio focus, for examplegrow Travel Inn versus review Beefeater. All Whitbread’s brands werereviewed and a major exercise involving all managers was instigated toenhance brand skills. Highly selective merger and acquisitionopportunities in current sectors were also considered.

• Expanding internationally. For the businesses Whitbread controlledthis was worth serious consideration. The franchise of the WhitbreadCosta brand to new markets is a good example because it needed good on-site management with a simple system across all sites, it managed thedownside risks rather than gaining full value potential of the upside, andgrowth potentially exceeded the available capital or skills base. The DavidLloyd Leisure business, being more complex, did not suit the franchisemodel, so international expansion required more investment andmanagement and was therefore more focused.

• Moving into new sectors in the UK. The first task was generating thelong list of leisure/hospitality sectors where Whitbread might add value.These fell into the loose categories of emerging (the market taking off withno major mergers or acquisitions) and established (the market is provenand entering it is likely to require major mergers or acquisitions). Theembryonic category (the market size is unclear) was avoided because of thescale and risks for the time period being considered.

Whitbread then undertook a strategic review for these focus areas consideringleisure sector trends, to gain understanding of consumer drivers andcompetitors, and to determine Whitbread’s skills and assets.

To review the opportunities that were identified, Mr Hammond developed theTraffic Lights system, which initially considered:

• market attractiveness (size and growth, profitability)• Whitbread’s ability to succeed (competitive advantage, time to establish a

leading position)• fit with Whitbread’s core (fit with the company’s future vision, benefit to

current core business).

These criteria were further developed and refined in the research withAshridge Strategic Management Centre.

New Business Traffic Lights application

Mr Hammond applied the Traffic Lights system to the cinema sector, one ofthe many leisure sectors considered for entry (see figure 8).

Whitbread undertook a strategic reviewto gain understanding of consumer

drivers and competitors, and todetermine the company’s skills and assets


Figure 8: Whitbread’s cinema example

With knowledge of the sectors and an understanding of the organisation’sstrategy and capabilities, a rough screening can be done relatively quickly.

• Value advantage: yellow to redWhitbread was considered to have leisure sector skills, but in the analysisthey were not considered to be unique. Given the learning costdisadvantage that Whitbread would have in dealing with film distributorsand operations, the light is a reddish yellow.

• Profit pool: yellowCurrent players in the cinema business are not making super profits.However, the best players do earn a reasonable return.

• Leaders/sponsors: yellow to redAcquiring the right target would provide adequate leadership at thebusiness level, but there would be nobody with cinema experience at thecorporate level. Moreover, an acquisition would involve paying apremium.

• Existing businesses: yellowAssuming the initiative involved an acquisition, there would be littledistraction cost other than at the parent company level. Managers wouldnot have to be taken out of existing businesses to staff the cinemabusiness. However, capacity at the parent company level was limited, so amove into cinemas would make it hard to invest in any other new sectors.It was also unlikely to benefit the current core business.

• Conclusion: rejectThe screening showed there were no greens and one or more red lights.This was sufficient to reject the opportunity.

Performance

In the period 2002–05 Whitbread achieved double-digit earnings growth,acquired Premier Lodge for £505m and integrated it with Travel Inn. Thecompany’s share price increased by 64%, from 574p in April 2001 to 944p inApril 2005, while the FTSE100 index dropped by 10%.


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References

1 Campbell, A. and Park, R. (2005) The Growth Gamble: When LeadersShould Bet Big on New Business, and How They Can Avoid ExpensiveFailures, Nicholas Brealey Publications.

2 Christensen, C.M. (1997) The Innovator’s Dilemma, Harvard BusinessSchool Press.

3 Christensen, C.M. and Raynor, M.E. (2003) The Innovator’s Solution,Harvard Business School Press.

4 Burgelman, R. (2001) Strategy Is Destiny, Free Press.

5 Greene, J. (2004) ‘Microsoft’s Midlife Crisis’, Business Week, 19 April.

6 Collins, J. and Parras, J.I. (2000) Built to Last, Random House BusinessBooks.

7 Porter, M. (1980) Competitive Strategy, Free Press.

8 Morrison, A. (2003) Going Beyond the Idea: Delivering successful corporateinnovation, Grist.

9 Hender, J. (2003) Innovation Leadership: Roles and key imperatives, Grist.

10 Porter, M. (1985) Competitive Advantage, Free Press.

11 Baghai, M., Coley, S. and White, D. (1999) The Alchemy of Growth,Perseus Books.

12 www.ibm.com

13 Garvin, D.A. and Levesque, L.C. (2004) Emerging Business Opportunities atIBM, Harvard Business School, Case No N9-304-075.

14 Birchall, D., Tovstiga, G., Morrison, A. and Gaule, A. (2004) InnovationPerformance Measurement: Striking the right balance, Grist.

InnovationPerformanceMeasurement:Striking theright balance

Recent studies suggest that thereremains a serious disconnect betweenwhat firms are hoping for and whatthey are reaping from theirinvestments in innovation.Conventional approaches toperformance measurement, whileserving performance-driven firmswell in a variety of traditional areasfocusing on cost, efficiency andspeed, have as yet had little impact inthe area of innovation management.

Innovation performancemeasurement must go beyond mereafter-the-fact measures based onmacro-level input/output indicators;it must address the right balance ofsoft and hard innovation parametersfor effective short-term and long-term innovation decision making.

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CorporateVenturing:Rewardingentrepreneurialtalent

In today’s knowledge-basedcompetitive environment,companies must mobilise andmotivate their employees’ latententrepreneurial talent. At the sametime, firms must avoid distracting ordemotivating the core business. Akey element of this is themanagement of personal risk andreward systems.

How can reward systems encourageentrepreneurial behaviour? What arethe problems that venture managersface in designing these systems? Howdoes personal risk affect innovation?How are the needs of the corporateentrepreneur reconciled with theneeds of the existing organisation?What solutions are companiesadopting?

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Going Beyondthe Idea:Deliveringsuccessfulcorporateinnovation

Most innovative companies are ableto generate plenty of ideas and toprioritise those with the greatestpotential, but that is often the pointwhen the greatest problems begin—driving validated business ideasthrough to operational reality.

Although there is no single recipe forsuccess, this report identifies five keysuccess factors that transcend sectordifferences: relentless focus onsolving a customer problem; a leaderand team with a passion to achieve; acommon language forcommunicating and chartingprogress; relevant and quantifiableassets and skills to contribute; andinternal and external networking.

InnovationLeadership:Roles and keyimperatives

Different skills are requiredthroughout the life cycle of aninnovation project and it isnecessary to have the right peoplewith the right skills at the right time.The process begins with thinkers orinventors generating ideas and endswith operators managing businessadoption and benefits realisation.

Yet it is the innovation leaders—those people who bridge the gapbetween thinkers and operators,turning ideas into reality—who arethe most vital to innovation success.

This report helps executives todetermine the necessary leadershiproles and imperatives.

Quantity Price Total

Innovation Performance Measurement: Striking the right balance £345

Innovation Leadership: Roles and key imperatives £295

Going Beyond the Idea: Delivering successful corporate innovation £295

Corporate Venturing: Rewarding entrepreneurial talent £245

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winning ideas v10

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