Between 2002 and 2012, the shareholder return of the average airline company rose an uninspiring 5.6% a year. Diversified consumer services were a notch lower, gaining just 4.2% a year. Worst of all were computers and peripherals companies, with a 3% average annual return — barely the rate of inflation in many parts of the world.
It was just lousy timing if you happened to be in one of these industries, which were all in the bottom quartile of total shareholder returns (share price change plus dividends paid) in the 10 years through 2012.
However, one thing you can probably count on, if you are in one of these industries, is that average TSRs in your sector will be better in the next 10 years. Perhaps by a lot.
This isn’t just a hopeful observation. It is, rather, a statistical fact. Of the worst-performing industries between 1992 and 2002, almost 60% percent wound up in the top half in the most recent 10-year period. These industries’ returns improved as the supply-demand dynamics in their markets came into better balance, as the companies themselves became more efficient, as less well-managed companies got acquired or left the market, and as investors came to realize that the industries’ problems had been exaggerated and that they shouldn’t have been left for dead in the first place.
What’s the takeaway? Not, certainly, that you should relax if you’re in an industry that is going through a rough stretch. Nor that you should panic if your industry has been a recent darling of Wall Street, on the assumption that it’s only a matter of time until you’re out of favor. The takeaway is to stop thinking about whether the industry you are in is “good” or “bad” — recognizing that as the wrong question — and to focus instead on what you can do to win where you are.
Indeed, our study shows that the biggest variations in TSR are not between industries but within them. Yes, at 21%, the median annual return of tobacco, the best-performing industry between 2002 and 2012, was seven times higher than computers and peripherals, the worst-performing industry. The difference in the averages between those two industries was 18 percentage points — no small potatoes.
But the TSR variations of companies within these industries were far greater: 44 percentage points in tobacco and 69 percentage points in computers and peripherals.
In fact, among the 65 industries and almost 6,000 companies we studied across the globe, no industry had a TSR variation that was lower than 30 percentage points, and the variation in one industry, chemicals, was a whopping 206 percentage points. Top dogs in poor-performing industries (like LATAM Airlines, the Santiago-based airline company; Sotheby’s in diversified consumer services; and Apple in computers and peripherals) didn’t have to fret about their TSR performance. For them, industry was not destiny.
So how do the winners do it? In our analysis of companies that generate a top-quartile TSR within their industry, two data points stand out. First, these companies have revenue growth that is often two to three times the average of their industries; they are highly successful at increasing their market share. Second, top-quartile companies operate more profitably than other companies. Simply put, they best find ways to consistently beat their rivals.
Companies that grow their market shares while retaining above-average profitability usually offer a product or service that customers love — and which they can’t get elsewhere. Or they offer an identical product, but capitalize on cost-efficiencies and other operational advantages to offer it at a lower price. They are able to create these unique or low-priced products and services because of a system of differentiating capabilities that they’ve spent years developing. If they know what they’re doing, they reinforce and reinvest in these capabilities, protecting them even during times when they are making cuts elsewhere. If they don’t, they don’t remain consistent share gainers and profit leaders for long.
Profitable growth requires discipline: a realistic assessment of where the opportunities are and how they line up with your strengths. Inorganic growth can be a part of this — especially if the acquirer concentrates on assets that take advantage of its existing capabilities. As for organic growth, one method we use that works particularly well revolves around a framework called headroom. This is a systematic approach to identifying the customers in a market who are not wedded to any one supplier, figuring out which attributes would get them to give all of their business to you, and then adding those attributes. The key is to focus on attributes that draw on your differentiating capabilities. When you do that, it creates a disruption in the market that can work to your benefit.
How Not to Grow
To be sure, gaining share in a market that is a natural fit for your capabilities isn’t the only way to try to improve your financial performance. You could always roll the dice. And in periods when their core markets are weak, plenty of companies do just that — making “transformational” acquisitions or moving into less-familiar markets that they justify as adjacencies. A lot of times they are pushed in these directions by investment bankers and others on Wall Street who make a living off of other people’s willingness to take big risks. The moves that result (the stretch-acquisitions and adjacencies) may in fact lead to higher revenue in the short term. But they are rarely done at the urging of, or to benefit, existing customers. And the absence of needed capabilities within the companies making the moves frequently leads to unforeseen problems and financial losses. You may as well take a wrecking ball to everything you’ve built up.
We aren’t anti-risk and do not believe that any company should ever stand pat. But the shareholder return data over the long term make a pretty good case for staying put. Take your chances where the odds favor you: in your own industry, with customers you can get, using capabilities no one else can match.
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