Playing To Win
Strategy in High-Growth Industries
A CEO client of mine asked me last month about how to think about strategy in very high growth industries — because his company participates in one. I wanted to give it some thought based on my experience in spaces of the sort and am now ready to dedicate my 11th Year II Playing to Win/Practitioner Insights (PTW/PI) piece to Strategy in High-Growth Industries: The Three Rules You Must Follow. You can find all previous PTW/PI here.
Recognize that High Industry Growth is a Transient Phenomenon
There is actually no such thing as a high-growth industry, just industries that are in a high-growth phase. Industries — just like all things in human nature — are not capable of growing quickly in perpetuity. The fastest growing thing in nature is malignant cancer, but it kills its host and by doing so, causes its own demise.
If we define high growth as in excess of 20%/year, there aren’t many industries that can maintain such a growth rate for more than a limited number of years. It is easiest for a new industry to grow quickly in the years after inception because the base is so low. One such industry was the Personal Computer (PC) industry. This dynamic product showed up in 1975 — with the Altair selling 5,000 units — and was so transformative that it grew at a compound annual growth rate (CAGR) of over 100% between 1975 and 1984, the fabled year of the Apple Macintosh launch. When an industry becomes a real and consequential thing, as the PC industry had become by 1984, it becomes harder to continue the high growth. The PC industry couldn’t maintain the stratospheric rates, but it still grew at a CAGR of 21% for the 16 years between 1984–2000, turning it into one of the world’s most important industries. But as with all industries, the growth party ended and between 2000 and 2020, the PC industry grew at a blasé, 3.7% CAGR — just another slow-growth industry. However, that high growth for a quarter of a century is very unusual — symbolic of an innovation that fundamentally changed how we work and live.
Another industry, smartphones, also grew spectacularly and changed the way we work and live, but had a much shorter high-growth phase. Like the PC industry, it grew spectacularly from 2000–2007, making pioneer BlackBerry worth $70 billion by 2007, the year Apple entered the fray with the iPhone. That precipitated growth at an amazing CAGR of 39.4% for the 2008–2015 period. However, it was short-lived indeed with industry growth from 2015 to 2021 slowing to an anemic 1.3% CAGR.
Hence, the first rule is that even utterly transformative industries like PCs and smartphones don’t experience high growth for very long. PCs had a spectacularly long high growth period of 25 years, while smartphones had one of 15 years — and by the time smartphones was recognized as a high-growth industry that was here to stay, its high-growth phase was half over. Hence, any useful strategy for a high-growth industry has to assume that the high growth of the industry will end — and probably sooner than later.
Think Now about Competitive Positioning in the End Game
During the high-growth phase of an industry, everything is more fluid. Entry is much easier because existing customers don’t have long-established provider relationships and new customers are flooding into the market. Existing players often largely ignore entrants because the incumbents are too busy trying to keep up with demand. Market shares can shift dramatically in the high-growth phase.
All of those friendly features change when the high-growth phase ends. Entry becomes hard because it means taking revenue and share from existing established players — players who notice and defend against the insurgency. There is a high bar for earning meaningful market share increases. To do so, one needs to have a meaningfully new and better strategy, not just ability to supply.
Hence any player during the high-growth phase needs to be thinking then about the end-game positioning that it is seeking to achieve. If it doesn’t have a competitively sustainable positioning as of the time the growth slows, it probably never will.
It appears to me that Apple learned this lesson the hard way from the PC business and applied it productively to the smartphone business. While the PC industry grew spectacularly at a 22.4% CAGR from 1984 to 1996, Apple grew at a perfectly commendable 12.9%. And Apple might have felt particularly good about it because its new product, the Macintosh actually grew at 25.8% CAGR, higher than the industry. But during this period, it phased out its successful Apple II business, resulting in the lower overall growth rate.
As a result, Apple’s impressive 22% market share in 1984 had plummeted to 8% by 1996. As the industry slowed by the 2000’s, Apple was stuck with a low-mid single-digit share position. I love the product and am composing this on my brand new, blazingly fast M1 Max as a member of the small but fervent niche of Mac aficionados. But us notwithstanding, Apple didn’t do what it needed to do in the high-growth phase of the PC industry to position it as a truly consequential player in the PC endgame.
Apple refused to let it happen again in smartphones. While the industry grew tenfold between 2008–2015, iPhone shipments grew almost twenty times (an insance 53.3% CAGR from iPhone’s first full year). During that period, and the slow growth period thereafter, Apple maintained a global share of between 13 and 18% of shipments, not far off the industry leader Samsung, but double Samsung’s revenues due to iPhone’s much higher price point (not to mention additional revenues from the huge and highly profitable service business driven by iPhone users).
Apple created a unique strategy for the smartphone business that required it to be a consequential player — in order to be big enough for its App Store ecosystem to thrive — and did what it took to set itself up for the endgame that came a mere 8 years after its entry into the business.
Such was not the case for Korean powerhouse LG Electronics. It hopped into the high-growth industry two years after Apple in 2009 and grew nicely until 2015 along with the rest of the industry. But as of the start of the endgame, it had an irrelevant position — low share and no differentiation — which deteriorated dramatically causing LG to exit in 2021 after six straight years of operating losses and global share of 2.3% at time of exit.
High-growth markets are forgiving. Low-growth markets aren’t. Don’t be like Apple in PCs or LG in smartphones and be content to ride with the positive wave during the former period. The second rule is that this is the time that you must plot and shape your strategy for competing in the endgame. That means having a Where to Play (WTP) within that burgeoning industry and a clear How to Win (HTW) in your chosen WTP. Playing to play like LG will be deadly to your health as soon as the growth slows — and that time will come and probably sooner than you think.
Be Wary of Overvalued Equity
If companies get fooled into believing that high growth will last forever, capital markets get fooled far worse. Analysts can’t help themselves projecting current growth rates into infinity and discounting them back to the present to create insanely high valuations.
One of the most impactful case studies during my entire time at Harvard Business School was on Avon Products, which in 1967 was the 17th highest market capitalization company in America (at $26B in 2021 $) — if you can believe it ahead of P&G at 19th ($25B) and Coca Cola at 21st ($24B). At the time Avon was flying high as it rolled out its door-to-door direct selling model across America — and the penetration of home after home across America produced awesome growth. But when every home was already covered by an Avon salesperson, sales would inevitably slow to the moral equivalent to same store sales growth. Cracking the HBS case meant figuring out that to justify the 1967 valuation, Avon would soon need to have $10,000 of its products in the bathroom of every woman over age 18 in America. Of course, that was never going to happen.
The challenge for Avon was the pressure created by its massively overvalued equity, about which Michael Jensen wrote persuasively in his 2005 article, The Agency Cost of Overvalued Equity. When a company has overvalued equity, its management feels the pressure from the capital markets to undertake risky actions to try to justify the unjustifiable valuation. This includes making crazy acquisitions — as Avon did with Tiffany, which it sold a mere five years later, as well as numerous other of its failed acquisitions. There was nothing that Avon could have done to justify its $26 billion valuation in 1967. And thanks to all the desperate things it tried to do, it eventually sold itself to Natura in 2019 for $2 billion, less than one tenth of its 1967 valuation. Meanwhile steadily growing P&G and Coke were, at last measurement, worth $397B and $261B respectively.
The third rule is that every company in a high-growth industry needs to be wary of the agency cost of overvalued equity and work against getting into that position. Among other things, that means being clear with the equity markets that your growth is positively going to slow — so don’t project current growth rates to the horizon line.
To survive and prosper in a high growth industry, you must obey three rules — without exception. First, you have to internalize that the high industry growth is a temporary phenomenon. If you are really lucky, it might last ten years from the time you are contemplating your high-growth industry. But even Apple only had eight years in smartphones before growth plummeted; LG had six.
Second, and most important of the three rules, you have to think now about establishing your target positioning in the endgame. Do not play. It is incredibly tempting because all you need to do in a high-growth industry is play and your revenues and profits will probably soar. However, all the leading endgame players establish their winning ways of competing during the high-growth phase. There may be examples of companies that were mediocre in the high-growth phase of their industry and then emerged as leading players in the mature phase. I just can’t think of any. Even more specifically, you need to craft a WTP/HTW that will continue to be competitively robust in the mature phase of the industry.
Third, fight hard to keep your equity from becoming overvalued. You should know more about what your stock is worth than do equity analysts. If their valuation is higher than yours is, your job is to talk it down. And if they don’t listen, sell treasury stock to dilute your earnings per share until they do listen. It is in your shareholders’ long-term interest for you to not have to defend an indefensible valuation.