One of the most significant tasks for any business is building a growth engine that will propel the company towards profitability and sustain the company through tough periods.
But what happens when the rules of engagement change, and the company needs to build a second growth engine? This is not something a company encounters on a regular basis, as CEOs will adapt existing growth engines to achieve their unique objectives.
But as we have seen, the rules of engagement have changed. I recently read an article on the Harvard Business Review (HBR) website, which provides more insight into this.
A target market with a large profit potential
The HBR article points out that most successful engine-two businesses were in a market where the profit pool—the total profits earned at all points along the value chain—was sizable, rapidly expanding, or shifting. In more than 80% of successes, revenues and profits were clearly expected to rise faster in the engine two’s market than in the engine one’s. Amazon Web Services (AWS) is the most dramatic and well-documented example. By dominating the rapidly growing market for cloud computing, AWS now consistently delivers more profits than all the rest of Amazon does. (AWS has an operating margin of about 30%.)
The most common success factor in building new core businesses was a company’s ability to ride a technology adoption curve in markets where the profit pools were large or shifting quickly toward players with new forms of competitive advantage. More than 60% of the engine twos we studied had business models based on technology substitution (such as the insurer Ping An’s online medical service Ping An Good Doctor) or technology upgrades (such as Reliance’s Jio 4G network). This ability was also critical to the success of next-generation versions of engine ones (such as Philip Morris’s entry into smokeless products). As these examples illustrate, successful second engines are often built on exciting frontiers opened up by novel technologies. Notably, we didn’t find any successful engine twos predicated on consolidating competitors across a declining industry or on acquiring and rejuvenating an underperforming leader in a lagging industry.
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A proprietary source of competitive advantage
the HBR article points out that businesses make money by being sustainably different and better, not just by pursuing growth. This is the cold truth of hot markets. Most of the time, more than two-thirds of the profit pool in a clearly defined competitive arena is captured by the top two players, with the rest barely earning more than their cost of capital. When we recently studied the distribution of economic profits across a wide range of industries, we found that in many the proportion was even more lopsided. The lesson is clear: If you don’t possess or can’t see your way to developing a strong competitive advantage that will be hard for others to replicate, then think twice about pursuing an engine two.
This lesson was well understood by the management team of the Belgian company Umicore, a global leader in the reclamation of speciality metals, whose core business is two centuries old. Seeing an opportunity in the advent of electric vehicles and clean energy, the company started an engine two, Umicore Rechargeable Battery Materials, to focus on the essential products for batteries and catalysts. Because Umicore had years of experience working with lithium, nickel, cobalt, and manganese, which are all used in batteries for electric cars, and refining them into precise, high-quality formulations, its leadership team was confident that it could build a new business with clear technical differentiation and advantage. To fund engine two, in 2017, the company divested some older assets, including its zinc business, which had begun with a mine granted by Napoléon Bonaparte in 1805. In short order, the engine’s two revenues eclipsed those of the reclamation business and became a major source of growth.
Successful second engines are often built on exciting frontiers opened up by novel technologies.
The article adds that in some cases the differentiated asset or capability of a successful engine two was a product or service built to support the engine one. Ant Group, now one of the top financial technology companies in the world, began in 2004 when Jack Ma, the founder of Alibaba, created a service called Alipay that online shoppers could use to pay for purchases on his company’s e-commerce sites. In 2011, seeing that the online payment market was growing rapidly and that many adjacent markets were forming around it, Ma spun off Alipay as a separate company. Today it is the leading payment service provider in China, used by more than 80% of Chinese consumers. Alipay’s differentiation was not only its link to the Alibaba e-commerce businesses, which fed it tens of millions of customers but also its approach to the market. Unlike other online payment methods—and thanks in part to a conducive regulatory environment in China—Alipay invested in service both to consumers and to vendors of all sizes (in the form of data on their businesses and methods for lowering financial risk). As a multisided platform, it has been able to tap into even larger opportunities for growth.
The ability to leverage the scale and assets of engine one
It’s easy to focus on the disadvantages that large, often bureaucratic companies face in launching new businesses, but incumbents have advantages too—primarily, not having to start from scratch.
The HBR article points out that Ecolab built a successful engine two in water purification by drawing on the capabilities, channels, sales force, and customers of its engine one. Founded in 1923 by a salesman who noticed stains on his hotel carpet and created a cleaning solution, Ecolab grew to be the leader in industrial cleaning products and services and more than twice the size of its nearest competitor.
But when the growth of Ecolab’s markets started slowing a decade ago, its leadership looked for new opportunities and determined that its customers’ greatest need would be securing access to clean water. The company predicted that the water purification market would require highly advanced technology and would rapidly expand, presenting clear engine-two potential. Ecolab jumped into the business in 2011 by acquiring Nalco, a leader in industrial water purification.
Acquisitions were crucial to creating a differentiated advantage in more than half of the successful engine twos.
The article adds that, to fund more than a dozen acquisitions and equity investments in water-purification-technology companies, Ecolab then sold off its noncore assets in chemicals and energy. It also leveraged its cleaning sales force and purification and antimicrobial technologies to cross-sell water-treatment products and services to its core customers. Since 2010, Ecolab’s revenue has climbed from $6.8 billion to $11.8 billion, its enterprise value has increased by a factor of five, and its stock market value has jumped 465%, outperforming the overall stock market by more than 50%.
The sharing of capabilities, customer access, or distribution systems between an established engine one and a fledgling engine two doesn’t come naturally or happen on its own. Tensions and trade-offs inevitably arise. The key is to anticipate some of them early in the process, creating agreements that mitigate them in advance. In addition, it’s critical to regularly hold a standing group meeting, attended by leaders of each business and the CEO, to resolve conflicts, remove bottlenecks quickly, and identify further synergies.
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Think differently
In a previous article, I discussed how inertia is one of the biggest killers when it comes to a company.
It is important to note that inertia can take many forms. When looking to establish a second growth engine in a company, business leaders cannot be comfortable with their existing skills and experience; this can be a source of inertia. The HBR article points out that leaders need to embrace a spirit of entrepreneurship when tackling this undertaking.
The HBR article points out that the need to give start-up enterprises within a company freedom is not a new concept. Robert Burgelman wrote about the challenge of using assets from the original core to build new businesses in his book Strategy Is Destiny, comparing the established core to a creosote bush, which discharges sap to kill any new plants that grow around it—an analogy first used by former Intel CEO Craig Barrett.
Clayton Christensen’s book The Innovator’s Dilemma documented the many factors that prevent companies from putting new ventures in separate units. What is new is how many large companies are finally beginning to crack the code by giving internal start-ups the ability to make decisions independently, empowering their leaders with the incentives of owners, and enabling faster, more entrepreneurial ways of innovating.
