Fighting Incumbency Sclerosis

Thanks to new technologies and innovative new ways of doing business, established incumbents across all industries have never been more vulnerable to attack by agile challengers who can make rapid inroads with relatively little capital or resources. Indeed, the following dynamic triad of forces clearly favours today’s disrupters: virtualization, digitalization, and capital superabundance.

Using low-cost third-party services, companies can virtualize parts of the value chain, farming out functions that traditionally were done within their four walls. Nearly everything can be outsourced, including R&D, manufacturing, and sales. Online platforms even make it possible to engage labour or find office space on demand. Digitalization undermines the incumbent’s advantage of owning the channel to the customer. E-commerce business models give challengers instant, low-cost access to all types of customers. Finally, in an age of superabundant capital, access to capital is less of a hurdle. Bain & Company’s Macro Trends Group estimates that the global supply of financial capital has tripled to 10 times global gross domestic product since the 1980s, making capital plentiful and cheap.

Together, these three factors—virtualization, digitalization, and access to capital—have helped bring to life surprisingly potent competitors, including unicorns (start-ups valued at more than US$1 billion), which are no longer as rare as their name suggests. As a result, the half-life of business models has been shrinking and incumbents have been disappearing at an increasingly rapid rate—swallowed up in mergers, taken over by activist investors, or broken up. According to Bain research, two out of three large companies (worth US$5 billion or more) will stall out, go bankrupt, be acquired, or break into pieces in the next 15 years.

However, as noted in TIME | TALENT | ENERGY: Overcome Organizational Drag and Unleash Your Team’s Productive Power, the rise of disrupters does not fully explain the ever-shorter lifespans of incumbents. In fact, when we asked executives what they believe are the obstacles to growth, 85 per cent of the reasons they cited were internal barriers. Large, long-established companies suffer from the disease we call “incumbency sclerosis,” which leads to strategic rigidity and an inability to adapt. Hobbled by overly complex organizations and inflexible operating models, victims find it difficult to mount a rapid response, even when the threat is completely obvious and perhaps even life-threatening.

Dollar Shave Club is a useful case to illustrate both the power of the dynamic triad and the perils of incumbency sclerosis. In 2012, the start-up had the audacious idea to attack one of the strongest incumbents around—Gillette. At the time, the century-old company, now a subsidiary of Procter & Gamble, held about 60 per cent of the U.S. razor-blade market, and its (increasingly expensive) razors and blades were sold in drugstores and supermarkets everywhere. Dollar Shave Club’s founders created a new business model—delivering a monthly supply of lower-cost blades directly to consumers who ordered online, relieving two pain points: the cost and the trip to the store. The company outsourced production to a South Korean manufacturer, outsourced logistics to a company in Kentucky, and even figured out a cheap way to be heard above Gillette’s massive advertising campaigns. It posted a clever video on YouTube that went viral and was seen by more than 20 million viewers.

The Dollar Shave Club case has a happy(ish) ending for Gillette, which recognized the danger and set about creating its own monthly supply program. The Gillette Shave Club, launched three years after Dollar Shave Club, has captured about 20 per cent of the market (compared with 53 per cent for Dollar Shave Club). Procter & Gamble rival Unilever purchased Dollar Shave Club in 2015 for US$1 billion, officially making the 190-employee company a unicorn.

In doing so, Unilever exercised one of the great remaining advantages that incumbents have—the ability to buy their way into new markets or buy the upstart challenger.

The pathology of incumbency sclerosis is well understood, but the disease is difficult to cure. Strategic mergers and acquisitions (M&A) constitute one of several possible prescriptions, but their effectiveness depends on providing a catalyst for change in the acquirer’s business model, organizational model, and culture—if the acquired company is not destroyed in the process. And M&A is not a super-drug. The cure for incumbency sclerosis is more often a drug cocktail that includes M&A but also includes other efforts to root out complexity, simplify the company, and build flexible operating models that allow incumbents to take advantage of the same triad of virtualization, digitalization, and low-cost capital that their disrupters use so effectively against them.

 

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