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Maximizing return on invested capital must have higher priority than maximizing market share
During the past several years, a great deal of research on profitabihty and market share has uncovered a positive correlation between the two. One study shows that "on the average, a difference of ten percentage points in market share is accompanied by a difference of about five points in pretax ROI." ^ Although in general market share and return on investment do go hand in hand, many of the inferences that both managers and consultants have been drawing from this finding are erroneous and misleading. One of the most dangerous inferences drawn from this generality is that a low market share business faces only two strategic options: fight to increase its share or withdraw from the industry. These prescriptions completely overlook the fact that, in many industries, companies having a low market share consistently outperform their larger rivals and show very little inclination to either expand their share or withdraw from the fight. Perhaps the best example of this situation is the steel industry, where producers such as Armco Steel, Inland Steel, and Kaiser Steel have consistently earned a higher return on equity than their much larger competitors. United States Steel and Bethlehem Steel Often, planning systems that are based on this generality also have serious flaws. Most of these systems place a business in one of four categories, according to its market share and the industry's growth rate.^ Depending on the category a business falls in, a strategy is automatically prescribed. Low market
1. Robert D, Uuszell, Uradley T. Gak, iiiid Ralph G. M. Sulian, "Market ShareA Key to Piofltabiihy," HBR faiiiiary-February 197'^, p. 97. 2. See Paispectives an Experience |Bostcin; Boston Consulting Group, Inc., ty6S and 1970) for a description of a typical classiHeatiiui system.
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share businesses in low-growth industries should be divested; high market share busniesses in low-growth industries should be "milked" or "harvested" for cash; high market share businesses in high-grov^th industries should maintain their growth; and low market share businesses in high-growth industries should increase their market share. Although each classification system has its own nuances, all such systems share the same shortcoming: they define strategy at such a high level of abstraction that it becomes meaningless. A suceessful business strategy must be specific, precise, and far-tanging. It should state the markets in whieh a business will eompete, the products that will be sold, their performanee and priee characteristics, the way in which they will be produced and distributed, and the method of financing. By taking the attention of eorporation executives away from these essential details and instead foeusing their attention on abstraetions, many phmning systems do a great disservice. Finally, such sweeping generahties offer Httle consolation to those businesses that, for one reason or another, find themselves in a poor market position. Since only one eompetitor enjoys the highest share of any given market, most businesses must face the disadvantage of not having the highest market share. They must devise a specific strategy that will lead to the best possible pertormance, regardless of their position. During the past several months, we have been studying businesses that have outperformed other much larger companies in their industries. We have identified four important characteristics that most of these suceessful businesses share. In this artiele, we shall diseuss these charaeteristics.
Report 07] Ameiiaiu indiistTy revealed numerous suceessfuJ low share businesses. From a hst of these eompanies, we chose three-Burroughs Corporation, Crown Cork & Seal Co., hie., and Union Camp Corporation-for dose study. These three eompanies have surpassed not oniy their industries' average return on equity but have actually led their industries in several important performance categories. Consider Burroughs. During the mid-i9<'^os, many analysts predieted that the corporatioii, with its narrow line of computers, aging accounting machines, and market share of less than .]'vv., would soon withdraw frooi the mainframe computer mar ket. Today, Burroughs eompetes more effectively with IBM than does any other computer company. Its market share is still dwarfed by that of IBM, but during the past five years, its sales and earnings per share have grown faster than IBM's. And although Burroughs's net profit margin and return on equity trail IBM's, they exceed those ot NCR, Sperry Rand, Honeywell, and Control Data by a substantial margin. It is significant that results by Une of business, whieh are reported in lo-K statements and which distinguish businesses such as Control Data's finance and insurance lines and Honeyweirs controls line, also indicate that on a return-on-sales basis, Burroughs's computer line greatiy outdistances that of all its rivals exeept IBM. (See Exhibit i ior detailed comparisons of the finaneial positions of mainframe eomputer manufacturers.)
Crown Cork & Seal is another sueccssful low share eompany. In fact, as Exhibit ll shows, its fmaneial performance over the past deeade has consistently been the highest of the major metal can manufaeturers. Yet Crown Cork & Seal has not aiways enjoyed such sueeess. In early 1957, the company w-is near bankruptcy, and with sales of S n s million in ii.)^(\ it had to compete witb American Can {\9S<-^ saies of S772 miiiion! and Continental Can (19^6 sales of $1 billion). Today,, Crown Cork & Seal is still mueh smaller than its two giant rivals, but with profits of $4^^ million (15.89; return on equityl, the prospeet of bankruptcy has long since passed. Although Crown Cork & Seal's competitors have all diversified, an analysis of lO-K statements for 1976 shows that the pretax returns on sales ot their metal paeiaigmg
raontl CiHcy "Kt-y Op!km> iu M.irkci Sfic^-linri .usJ Piojuct Pliinnin;,',." iUSR
Indications of performance
Although there are numerous ways to define sueeessful performance and low market share, we have chosen two straightforward definitions. Low market share is less than half the industry leader's share, and successful companies are those whose five-year average return on equity surpasses the industry median. Applying these criteria to the over 900 husinesses in 30 major industries Usted in Forbes Anmial
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Earnings per share growth (five-year average) 14,1? 17.1 12.9 46.0 5.1 -0.1
8.5 12.4
Source; Annual reports of the above companies and Forbes, January 9,1978
$ 910 3.458
917
5.1% 3.8
2.5 3.3
14.5% 14.3
5.9
3,143
16,9
Source; Annual reports of Ihe above companres and Forbes, Januarys, 1978,
Exhibit III Comparative performance of major forest products companies through 1976
Company Sates in millions of dollars) $1,003 2.868 1.599 3.540 1,932 Net profit margtn 11.1%
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Annual sales growth (five-year average) 13.6% 15.4 7.5 11.0 1,2
Earnings per share growth {five-year average) 24.9% 18.1 31.7 21,5 Not applicable
5.6
6.0
5,2
Source: Annual reports of the above companies and Forbes, January 9.1978.
businesses were all below 6%; Crown Cork pretax return on sales was nearly io%-^
Seal's
Our third company, Union Camp, competes in the extremely competitive, highly fragmented forest products industry. Over 3,000 companies have major product lines in this industry, and it has been highly volatile and plagued with overcapacity, depressed prices, pollution control problems, and high construction costs. Despite these problems. Union Camp's earnings per share have increased by almost 27% annually over
the past five years, and average return on equity has been over 20%. As the ninth largest company in its industry, Union Camp competes with such giants as International Paper and Weyerhaeuser, which are three and a half and two and a half times larger than Union Camp. As shown in Exhibit IU, Union Camp's weak market position has not prevented the company from outperforming its larger competitors. Comparisons of the pretax return on 1976 sales of the paper and paperboard portions of these companies shows that Union Camp leads the paek with a 287^^ return. The next highest rate was posted by Boise Cascade's paper operations.
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May-Iune J97S
Elements of strategy
Except tor their low market share positions and exceptional pcrfonnances, Burroughs, Crown Cork & Seal, and Union Camp seem to have little in common. Certainly their competitive environments are extremely different. Computer mainframes constitute a highly technological, rapidly growing industry that is dominated hy one company. The metai container industry is extremely mature and, with only four major competitors, is a classic oligopoly. The forest products industry is also mature, hut it is very fragmented. Given these rather substantial differences in industry settings, arc there any common strategies that these three successful low share companies have implemented to yield profits? Our research suggests four characteristics that these companies sh^re: they carefully segment their markets, they use research and development funds efficiently, they think small, and their chief executives' influence is pervasive.
Although the metal container industry sells to numerous industries and faces competition from glass, aluminum, fiberfoil, and plastic containers. Crown Cork & Seal has elected to concentrate on two product segments: (1} metal cans for hard-to-bold products such as beer and soft drinks and (2) aerosol cans. In an industry where transportation costs represent a large proportion of total costs. Crown Cork & Seal has built small single-product plants close to its customers instead of large and possibly more efficient multiproduct plants located at some distance from its customers. The two market segments Crown Cork & Sea! serves have both grown more rapidly tban the total industry, but tbey also require expert skills in container design and manufacturing. The company has a particular advantage over competitors in the soft drink and brewing industries because it is the largest supplier of filling equipment to these companies. Thus Crown Cork & Seal has segmented its market by products, customers, customer service, and plant location. It is significant tbat the company sells to growtb segments in which it bas special expertise.
Four large paper mills
In the forest products industry, Union Camp has had to overcome the disadvantages of having a relatively small timberland holdingonly i.6 million acresin contrast to International Paper's 23.7 million acres and Wcyerhaeuser's 167 million acres. Although this difference makes Union Camp's raw material prices higher, the company has achieved consistently lower operating costs Lhan its large rivals. Since the location of plants is important. Union Camp, like Crown Cork & Seal, operates only four very large mills, strategically situated in deep water ports close to both Union Camp's southern timberlands and its eastern customers. For example, at its Franklin, Virgini:? plant. Union Camp operates the largest fine-paper machiiie in the world. As a low-cost producer of paper products, this corporation produces large volumes of only a limited number of paper products, and in bleached paper. Union Camp is not fully integrated. Instead, it sells most of its output lo end-product converting companies. Ry selling to a rather small number of paper converters, tbe corporation has establisbeti a superior service record. Thus UnioEi Camp has segmented its market by stage of production, manufacturing policies, prices, products, custoiners, and services.
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Three distinct computer lines Unlike Union Camp and Crown Cork & Seal, which do not offer complete lines in their industries, Burroughs offers a full line of computers. But in developing its full product line, the corporation has taken advantage of historical ties to the financial community, where it has been a major supplier of accounting machines for decades. Today, Burroughs possesses an i8% share of the banking segment, almost three times its overall market share. In designing its large computers, the B5000 series, Burroughs has emphasized ease and flexibility of programming at the expense of efficient use of main memory. This form of segmentation has been justified by the ten-fold decrease in memory costs since 1964, while talented programmers have become both scarce and expensive. In medium-size computers. Burroughs has chosen to imitate IBM's design and to compete on price. The company has reportedly underbid IBM by considerable amounts on some large government contracts. In the small computer market. Burroughs has continued to upgrade its electronic accounting machines and has given them the capability to serve as either terminals to a larger computer or as free-standing accounting machines. Thus, although Burroughs offers a full line of mainframe computers, within each line it has segmented the market to capitalize on its particular skills and resources.
staff have been of little help. About a year ago, we decided to do a detailed study of our industry. We found that, although we had the highest market share, in all of the important and more profitahle market segments, we were taking a beating. We were leading the pack, however, in the unappealing segments of the markets."
That Crown Cork & Seal, Union Camp, and Burroughs have had to compete in unique market segments in order to attain their success should not he surprising. But what these three companies reveal is that the opportunties to segment an industry are enormous and extend to every facet of a business. When a business segments its markets in unique and creative ways, it can far surpass the performance of its larger competitors. The marketing vice president of one high market share business once commented: "For years, we have been unable to understand why our profits have been mediocre despite our strong market position. The expert planners at corporate
4. "Crown Cork ^ Su.il and the Metal Container Industry," Harviird Business Schoul case siudy, ICCH No, (.-Myajy (Boston: IiueEtolIegijite Case CkaringluitiiL', 1971I, p. ^o. 5. "Uiiion Camp Corporation," Harvard Business School case study, ICCH No. .i-!7i-TQy (Boston: initTColkgiatf Case Cleariiighouse, 1971], p. 6,
Alexander Calder, Jr., Union Camp's chairman, has adopted a similar R&D strategy: "We arc known to be very strong in process and in the manufacturing of industrial products We do little basic research like Du Pont. But we are good at improving processes, developing improved and some new products, and helping to build new manufacturing capabilities."'' Another R&D strategy Union Camp and Crown Cork & Seal have developed is to work closely or jointly with their largest customers on major developments. For example. Crown Cork worked closely with large breweries in the development of the drawn-and-ironed cans for the beverage industry. As a result, the company beat all three of its major competitors in equipment conversion for the introduction of this new product.
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Concentrate on innovations For Burroughs, tbe problem of developing an R&D strategy is much more difficult and crucial than for the other two companies because of the rapid changes and higli technology in the computer industry. Although Burroughs spends 6% of its sales on R&D compared with IBM's 7.s%, ^n dollar terms the dilference is staggering-$ii2 miUion versus Si.2 billion. To compensate. Burroughs runs an extremely efficient R&D operation and concentrates on truly innovative products. And because of its low share position, these products are able to attract enough new customers to more than offset the trading up by Burroughs's existing custonicrsIBM, on the other band, has paced its innovations because, whenever it introduces a new system, a Significant amount of its leased equipment is exchanged for the new system. As a result, Burrouglis IS recognized as one of the technological leaders in the computer industry. Burroughs also runs an extremely efficient R&D operation. Its chairman, Ray Macdonald, spends a great deal of time at his R&D center and exerts tremendous pressure on his engineers.
Union Camp and Crown Cork & Seal have also emphasized profits rather than size. At Crown Cork & Seal, management decided not to continue to compete m the oil can market even though the company had a $O'A share of this segment. Despite the loss of sales, management decided that i other more profitable opportunities and that n niatenals such as fiberfoi] provided (:oo great a thieat ill the motor oil can business. During the J 973- 197s recession. Union C:ariip's management resisted customer pressure to produce a broad line of white papers. To Union Camp, the extra sales could not be justified by the added produetion costs. Diversify cautiously Unlike many of their larger competitors, most successiul low market share companies are not diversified. For example, both Continental Can and American Can have diversified widely, while Crown Cork & Seal has continued to concentrate on making metal cans. When successful low market share companies do diversify, they tend to enter closely related areas. For example. Union Camp has diversified into wood-based chemicals and retail distribution of building materials. Union Camp's vice chairman, Samuel Kinney, Jr., explained another element of Union Camp's diversification strategy: "You must have someone in the parent organization who really understands the [new] business before its gets heavy. Other paper companies have had troubles along these lines. They had these MBAs who, T am sure, were intelligent. But once they failed, there wasn't a damn thing anyone could do back at headquarters. They didn't know the business, and they were completely out on a limb," '^
Think small
Another characteristic of successful low market share companies is that they are content to remain small." Most of them emphasize profits rather than sales growth or market share, and specialization rather than diversification. Limit growth Macdonald limits Burroughs's growtb m the rapidly growing computer industry to is'/< per year because he maintains that fast growth does not allow (or the proper training of people and the development of a management structure. And in an industry where giants such as General Electric and RCA have faltered because they have found the pursuit of market share to be too costly, Burroughs has been consistently profitable despite only slow and modest gains in market share. Macdonald notes: "There arc two theories of growth m this industry. One is ours, where you plan to grow at a sustainable and artordable rate and put market share low on the list of objectives. Tben there arc others who thought that tbis rate was inadequate and took risky measures to increase their growth and market share. They were moths around a candle on tbat (snc," ''
HKR Sepwnihci' Ocrtihfr !v7?, p. iO'.J. C'l'iHtii IBM's ioij,i;]i(.' tK)n," liinniVJ ];i!!ti:iiy i i r y , p 'I*-
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ProliS
1967
1977
1967
"This disguised example was also reporled on in Richard Hamermesn's article "Responding lo Divrsional Profit Crises," HBH Mafcti-April 1977, p-124,
1977
To a large extent, it is understandable that leaders of low market share companies are dynamic, tough people who see ohstacles as challenges and enjoy competing in unorthodox ways. It may simply take a strong-willed leader to eonvince and inspire an organization to "beat the odds." This is not to imply that the chief executives of large share companies are not also strong-willed, dynamic, and tough. But most often these executives work with teams of other senior managers and limit
their responsibilities to a few key areas. In successful low share companies, the influence of the chief executive often extends beyond formulating and communicating an ingenious strategy to actually having a deep involvement in the daily activities of the husiness. At Union Camp, for example, Calder still retains responsibility for sales and marketing. Macdonald of Burroughs is deeply involved in both the development and the marketing of new products.
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May-Iune 1978
Of course, the pervasive influence of the chief executive in low market share business makes the problem of management succession an extremely difficult one. Connelly, now i%, has yet to retire or to pick a successor. While Macdonald retired in December [977, he has retained the position of executive committee chairman, and analysts are already questioning Burroughs's prospects without him. Though reports differ about what the actual situations are, only Union Camp's Calder seems to have been able to delegate significant responsibilities and to practice a more participatory style of leadership than tbe others have.
gories. Categorization schemes can provide a useful conceptual handle for top executives, hut the best planning systems are those which encourage and cnahie a division to seek the best fit between the opportunities in the competitive environment and tbe particular skills, strengths, and resources each division possesses. ill sum, our findings indicate that, in a division or in an independent company, management's first objective should be to earn the maximum return on invested capital rather than to achieve the highest possible market sbarc.
Alternative to growth
Although this article has an optimistic tone, we must acknowledge that there are some serious obstacles a low market share husiness must overcome. These usually include small research budgets, tew economies of scale in manufaeturing, little opporrunity to distribute products directly, little publie and customer recognition, and difficulties in attraeting eapital and amhitious employees. Moreover, pievious research indicates that, on die average, the return on investment of low share businesses is significantly less than that of businesses with high market sh;ires. We have made no attempt to refute these research findings or to deny the ohstacles tacing low share husinesses. But we have sought to tleinonstraie th-it many of the infercnees being drawn from these findings are sinjplislic and misleading. Simply put, not all low share businesses are "dogs." Rather, we have found that .i small market share is not necessarily a handicap, it can he a significant advantage that enables A asmpany to compete in ways that are unavailahle to its larger rivals. We helieve that these findings are significant. For the independent low share ings represent an alternative lo high costs and risks associated crease market share. , these fiiidcy and the th eflorts to in-
To the large diversified company, the findings suggest th.it formal planning systems must go beyond simply placing eaeli division in one of several eate-
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