Five Industries Hit the Reset Button

As a prerequisite for growth in the post-crisis environment, leading companies in the consumer products, telecommunications, industrial goods, automotive, and financial-services industries are shifting their business models and operating practices.

In many companies, 2010 will likely be remembered as an improvement over 2009, when merely surviving was viewed as a testament to good health. But last year was also an exercise in patience, as the dislocations wrought by the financial and economic crisis worked themselves out, slowly. The long tail of several multiyear trends — frugal consumers, rampant digitization, innovation in mobile communications, and exploding growth in emerging markets, among them — affected every industry and will continue to influence competition this year.

But 2011 will be different from 2010. The need to respond to the residual effects of the crisis (and the other trends) is forcing many companies to hit the reset button. With renewed discipline, senior leaders are examining their product and service portfolios, business and operating models, process fitness, and cost structure — all through a lens focused more closely on what truly creates value for their companies and their customers. They are figuring out where their companies can excel, based on their distinct capabilities: the things they do better than anyone else. They are using those capabilities to go after opportunities in areas where they know they can win, and scaling back the products and services in areas where they can’t. The best of them have invested, even during their leanest times, to bolster those capabilities that can be capitalized for renewal and growth.

The companies that succeed will also work vigilantly to identify and mitigate the risks — to their supply chains, sources of capital or credit, currency strategies, reputations, regulatory compliance, and so on — that could potentially derail their path forward. And they will proceed with a new, hard-earned understanding that their fortunes — and those of their employees, customers, investors, and other stakeholders — are irrevocably linked with those in other industries and around the globe.

In December 2010, as at the close of previous years, Booz & Company industry teams sent letters to their clients summing up the highlights of the past year and considering what may come in the year ahead. They do this each year in hopes of helping industry leaders clarify their strategies with renewed resolve and vigor. Five of these letters in particular, all excerpted here, aptly illustrate the nature of the reset and how it will affect the larger economic system. Every sector will be affected, but these five — consumer products, telecom, industrials, automotive, and financial services — are at the forefront of major change.

1. Consumer Products: Growth Opportunities

Although the consumer sector fared better than many others in 2010, much of this improvement was due to productivity gains. In 2011, leading consumer products companies will need to focus more on generating real revenue growth by pursuing opportunities enabled by four key consumer trends:

• Frugality with a twist. During the Great Recession, many consumers drastically reduced their spending and cut back on services once deemed essential. For some consumers, these habits are enduring. That said, even frugal consumers seem willing to pay more for so-called high-touch experiences. Demand is broad for products and services with emotional appeal, extending far beyond iPads, iPhones, and other cool gadgets. Consumers still want to indulge themselves occasionally, by springing for a Hermès scarf, a Starbucks Frappuccino, or a weekend at the Ritz-Carlton. They are also seeking greater personalization in products and services; for example, Pandora’s Internet radio service promises to “play only music you’ll love.” Those companies that connect with customers, through simultaneous value and personalization plays, will find ample opportunities to grow.
   
• An aging and health-conscious population. As the population ages, consumers are increasingly demanding foods, beverages, and other goods that promote health and well-being. New categories are being created in weight management, performance nutrition, and disease support. Sales of healthier foods and beverages are growing quickly, gaining share over more traditional options. Reflecting the importance of this trend, PepsiCo announced in October the creation of a Global Nutrition Group with the goal of tripling its business in “good-for-you” products by 2020. And Nestlé is also creating a new nutrition subsidiary, along with a research group, aimed at developing products that prevent and treat a variety of conditions. Other companies are following rapidly.
   
• Fragmented media; digital consumers. Leading companies are building marketing functions that can reach consumers no matter where they are located on the path to purchase — at home, on the go, or in the store. The digital marketer’s mission is to simultaneously generate insights aboutconsumers, engage and build lasting relationships with consumers, and drive sales to consumers. This has led to increased spending on nontraditional programs that connect consumers to brands and to other fans of brands; General Mills’s BettyCrocker.com, for instance, has more than 8 million unique visitors per month. Mobile marketing and mobile commerce also are emerging as ways for retailers and brands to engage shoppers on the go. While they are browsing in bricks-and-mortar retail stores, some consumers can already receive competitors’ offers on their smartphones. And Facebook’s new Deals feature delivers targeted promotions to users based on their locations.
   
• Big emerging markets. Consumer products companies seeking new growth cannot ignore emerging markets. For example, according to the World Bank, GDP growth in China in 2011 is expected to slow to 8.7 percent, compared to 2.9 percent in the United States. In India, GDP growth in 2011 is estimated at 8.7 percent, and income levels are rising rapidly. Consumer companies know that these markets hold rich potential, but capturing this value depends on their ability to navigate through some complex challenges. Competition is fierce from established multinational corporations and focused local companies. Furthermore, these markets are not homogeneous; consumers are in different stages of development both within and across countries.

Not all companies will be able to leverage these four growth opportunities effectively. The key to success will be coherence. As our own research shows, the most sustainable, superior returns accrue to companies that know what they are best at (their key three to six capabilities) and grow by aligning brands, products, and services that match. In both shareholder returns and profits, companies with well-integrated business models, capabilities systems, and product portfolios — such as Alberto Culver, Tupperware, and Kellogg — outperform larger, more diversified competitors.

What capabilities will be most important for generating consumer value? The answer depends on how a company chooses to meet the challenges of the four main trends. For example, playing in the new health and wellness categories might require companies to develop “scientifically advantaged” products, practice claims-based marketing (stating health benefits for key products), and comply with regulations while influencing government policy and professional communities. In contrast, building a leading position in emerging markets requires a business model tailored to those countries — and often requires big investments, virtually guaranteeing low profitability in the early phases of expansion. The leading companies in this sector will turn these trends to their advantage — pursuing opportunities consistent with what they do well, and developing the capabilities system they need to preserve their right to win in the marketplace.

2. Telecom: A Data Tsunami

The most significant development of the past year for telecom operators all over the world has been the explosion of digital traffic on their networks. Driven by Internet voice and video, by significantly increased use of mobile applications in smartphones, and by accelerating levels of person-to-person communication, this represents a “data tsunami”: a paradigm-shifting increase in usage and volume. The “digital generation” — people younger than 25, who have lived most or all of their lives with the Internet — continues to demand ever more enhanced communications, richer content, and more powerful social networking anytime, anywhere.

Leaders in nearly every industry and government sector now recognize the value of advances in information and communication technology — for reaching customers and constituents, understanding their needs, and devising products and services accordingly. These new industry-specific offerings will also contribute to accelerating traffic. In 2011, the telecom industry will be greatly affected by the ongoing digitization not just of its own and adjacent industries, including technology and media, but of other industries such as healthcare, electric power, telematics, and finance.

This development affords huge new opportunities to telecom operators, but it also presents major challenges. Many operators will struggle to handle the explosion of traffic on their networks while keeping at bay players from outside the industry intent on penetrating the telecom ecosystem. The data tsunami and related phenomena will affect, in one way or another, the primary trends we see for telecom in 2011.

• Increased competition. Telecom operators recognize that their customer relationships are at risk because of new competitors with innovative, value-added services. Apple and Google have already made real inroads into the telecom ecosystem. This year will bring more competition from companies even further afield, as big-box retailers become mobile virtual network operators, PC makers up the ante in smartphones, and online retailers such as Amazon Wireless leapfrog into online services. These players will likely continue to take market share in devices, while creating new markets in digital telecom and media.

The year 2011 will likely also bring an increasing shift toward “over-the-top” services that travel over operators’ networks but provide them no additional revenues. Google, Skype, Yahoo, and even Facebook will take an increasing share of the industry’s revenues. Incumbent telecom companies face a stark choice: accept and perfect their role as smart, scale-efficient pipe providers or reenergize their innovation engines to win out over aggressive new players. Those who choose the latter path have powerful assets and capabilities at their disposal, including long-standing relationships with their customers; a wealth of customer insights, which they can mine to develop tailored offerings to their targeted customer segments; and the ability to securely authenticate customers, identify their presence on the network, and pinpoint their location.

• The quest for growth. Look for telecom operators in developed markets to emphasize organic growth in 2011. They will develop new services like apps, social media, and TV for existing retail customers; they will create innovative services to attract new enterprise customers in financial services, health, energy, and the public sector; and they will seek out digital customers where they increasingly live: online. Broadband will be another crucial growth area. Mobile telephony is now the dominant force in the industry in emerging markets, but adequate mobile broadband infrastructure (such as the land-based phone network needed to reach transmission towers) is lagging. In 2011, operators will continue to build additional mobile broadband infrastructure to cope with rapidly increasing demand.
   
• Innovation-oriented management. The winners in telecom this year will be those operators that successfully manage five ingredients of innovation: a consistent ideation process, the ability to consistently nurture new ideas at every stage in the innovation life cycle, a culture of innovation, fresh talent from outside the telecom industry, and an entrepreneurial leadership style that brings all of these elements together.
   
• Ongoing efficiency gains. In 2011, the most successful telecom operators will focus on operational efficiency to help pay for the coming restructuring and the massive levels of capital investment it will require. This will mean finding new ways to cooperate with suppliers and other partners, both to shift the financial burden of building next-generation fiber infrastructure from a capital to an operating expense and to devise collaborative new business models to enable the partners to compete successfully. Hence many telecom companies will structurally separate their network business from their services business. All of these imperatives will lead operators to pursue not just cost reduction but cost “reshaping”: new operating models, lean management, resource sharing, and outsourcing.

Further digitization, increased competition, new infrastructure requirements — all of these trends will come to a head in 2011. The leading telecom operators are already making the tough decisions necessary to secure a share of future growth, expand into new areas, protect value, and transform their organizations. This year will test every telecom operator, and those that build the right new capabilities will remain relevant in the more open and competitive telecom environment of the future.

3. Industrials: Change at Last

After a couple of decidedly down years for industrial companies (especially those in the United States), many key statistics are turning positive again. Median sales for American industrial machinery makers grew by 2.9 percent in the first quarter of 2010, and that growth accelerated to 10.7 percent in the second quarter, when median net income jumped a whopping 46.2 percent compared to the same period in 2009. Furthermore, at the end of October 2010, U.S. industrials’ shares were up 12.9 percent year to date compared to just 6.1 percent for the S&P 500.

However, with this still-fledgling industrial revival come some pressing issues involving the makeup of supply chains, manufacturing footprints, currency strategies, R&D spending, and labor costs. Even in good times, these issues are never far from the forefront for industrial companies, but in the unstable footing of this post-recession environment, being right about them is more essential than ever. Many industrial companies are being forced to make changes that they have long deferred:

• Reassessing supply chains. China’s on-again, off-again embargo of rare earth exports in 2010, in which it withheld materials that are critical for sophisticated electronics and electrical equipment, demonstrated the risk of overreliance for supplies on any single developing country. In an environment where nationalistic and political considerations may swamp purely economic ones, industrial companies can be hard hit. The best of them are balancing their supply chain dependencies, creating more flexible footprints that can be altered as market and competitive conditions change, and diversifying their sourcing.
   
• Broadening their geographic reach. Given the continually changing global environment, companies are also rethinking the mix of countries in which they operate. For example, China is losing its position as the preeminent low-cost nation. Escalating wages now place compensation rates in China well above those in Bangladesh, Pakistan, and Vietnam. Moreover, as wages go up and China’s currency inevitably appreciates, the absolute cost of doing business in China will continue to rise to the point that low-cost regions of the West — perhaps eastern Europe or Mexico — could become more desirable for products destined for Europe and the Americas.
   
• Preparing for currency instability. Inextricably linked to a reassessment of the supply chain is the role that global currencies play in determining relative costs of exports, imports, wages, and supplies. China has been warned numerous times by other countries and global bodies that it must let the renminbi appreciate to levels more in line with the nation’s stunning growth rate. If that happens, wage and commodity price escalation will become even more of a concern than it already is.

Meanwhile, the U.S. dollar remains historically low relative to the yen, euro, and Canadian dollar. This potentially helps American manufacturers by making exports cheaper and imports more expensive. But companies in countries that do business with the U.S. and that rely on the American market for a large portion of their sales are putting pressure on their governments to fight back against the soft dollar. That drumbeat got louder in October after the U.S. Federal Reserve announced its new US$600 billion quantitative easing program.

It’s not at all clear how the dust will settle in the global currency flap, but the inability of G20 countries to reach consensus on the issue at their November meeting in South Korea raises the specter of a full-fledged currency war. Leading industrial firms will manage this volatility by adding exchange rate fluctuations to cost considerations when reevaluating supply chains and manufacturing footprints. Currency hedging, commodities derivatives, and minimizing foreign exchange exposure will all be employed to protect against wide swings.

• Spending more wisely on R&D. Booz & Company’s annual Global Innovation 1000 survey last year revealed that in 2009 the industrials sector trimmed its research and development budget by about $1.3 billion, or nearly 2.5 percent; however, when calculated as a percentage of sales, which were down across the board in 2009, industrial firms’ R&D spending actually rose.

With revenue under pressure throughout 2011, and R&D budgets at least equally constrained, industrial firms will work more diligently to maximize the effectiveness of their R&D investments. This could take many forms; one valuable approach will involve placing engineering facilities in multiple sites around the world to enhance their proximity to customers, lower costs, and improve access to emerging pools of technical talent.

Some industrial companies will increase the return on their R&D budgets by taking advantage of so-called frugal engineering — avoiding needless expenses by incorporating only the features and functions needed for particular markets (such as low-cost consumers). General Electric has had success with this approach in marketing its low-cost Mac 400 electrocardiogram, as has Texas Instruments with its LoCosto chip for relatively feature-free cell phone handsets.

• Incorporating intelligence. As virtually every industrial sector — transportation, power grids, robotics, and construction, among others — demands smart products to drive more sophisticated applications, the intelligence of embedded software will differentiate products from their competitors. In this environment, industrial manufacturers must learn how to think and act like software companies, relying on agile R&D processes for enhanced innovation, speed, and continuous improvement, and putting in place research and development cycles, tools, and testing to maintain high quality standards in products.
   
• Rebalancing cost structures. Leading industrial firms have already taken a close look at whether their overall cost structure is in line with their size, scope, and direction, which may have changed radically or subtly during the recession. They are now reassessing their product portfolios to identify the most profitable segments, and ensuring that their capabilities — processes, systems, tools, and skills — are appropriate to sustain and enhance those segments. There will probably be further pressure to reduce labor costs (salaries and benefits), which have continued to rise haphazardly in many companies even in difficult times, creating an imbalance that poses risks for both workers and employers. With proper execution, a reassessment of compensation throughout a company can generate net labor savings of 15 to 20 percent.

For industrial firms, the changes described here have been on the agenda for years, but given the fast pace of growth in emerging nations and the slow recovery in the West, they can no longer be sidestepped. This year offers a crucial opportunity to finally address the fundamental obstacles that separate merely good industrial companies from great ones.

4. Automotive: Accelerating Momentum

Among industrial companies, the automotive sector merits special mention, given its historical significance and its position at the epicenter of the globalization battleground. After an unprecedented downturn, the American automotive industry is beginning to recover. The dislocations of bankruptcy and restructuring are mostly finished, credit is becoming more readily available, and many observers expect demand to grow as the cars already on the road age. Long-term industry fundamentals are improving now that the Detroit Three have greatly reduced legacy costs and are introducing more competitive passenger vehicles. Further, Toyota appears to be recovering from its recall crisis, and South Korean automaker Hyundai is gaining market share with an impressive line of new products.

By and large, suppliers are enjoying a similar turnaround. Several large Tier One suppliers have emerged from Chapter 11 bankruptcy, and some suppliers are benefiting from the revival in industry volumes and improved product portfolios, which are generating solid profitability and cash flow.

Yet automakers in North America and elsewhere still face significant obstacles to achieving sustainable profitability over the long term. Competition is fierce across most segments. Hyundai has launched a compelling lineup at attractive prices. Honda is fighting back with aggressive lease deals on its aging Accord, and Toyota is working to reestablish its reputation for industry-leading quality while using incentives to maintain share and volume.

The Detroit Three face a separate set of obstacles. GM, Ford, and Chrysler still confront the difficult task of closing the cost gap with advantaged global competitors. Despite union concessions, wages and benefits for current hourly workers are still well above benchmarks established by new North American plants. In addition, the unions are working hard to reverse recent concessions, which could erase hard-won gains.

The Detroit Three also have a quality perception gap to overcome. Although the quality, reliability, and durability (QRD) statistics for U.S. automakers are closer than ever to those of their Japanese counterparts, Booz & Company research shows that car buyers can take as long as 10 years to catch up to the quality data. Despite smart investments by GM and Ford in new automobile interiors and other feature and performance improvements, including a raft of technology enhancements, some entries still lag behind other global brands. Finally, GM and Chrysler need to rebuild their financing capabilities and dealer relationships, which were both badly damaged during the bankruptcy process.

To navigate the course ahead, automakers and suppliers must build on their recent progress. They will watch expenses closely, guarding against excess cost creeping back in as volumes recover, and they will work particularly hard to further reduce labor cost and boost productivity. The pressure for superior QRD will also remain high; gaining share in the U.S. market requires consistently convincing consumers that a car will stay out of the shop, last years on the road, and maintain its resale value.

Sustained product excellence will also continue to be a requirement for long-term success. Toyota, Nissan, and Honda have a rich legacy to draw on but cannot rest on their laurels. For the Detroit Three, significant gains can be realized by reconnecting customers to iconic brands and, in the process, earning the sale by offering real improvements in overall and relative value. The winning combination will involve great-looking vehicles, innovative technology, good fuel economy, and high QRD — all rolled up into one difficult-to-achieve combination.

One major change will be new requirements that every vehicle “pay its share of the rent.” Historically, many automakers have not demanded that each vehicle model earn its true cost of capital or have a clear strategic justification in the portfolio. Now, they will be more disciplined, with a predetermined return on investment for all products. They will also be forced to better align supply with market demand. Too many cars are still chasing too few consumers. That will change as automakers become more sophisticated in setting capacity levels and in manufacturing flexibility.

Pricing discipline will also take on more importance. Automakers have too often pursued unit sales and market share at the expense of life-cycle profitability, although the Detroit Three, historically the worst offenders, have shown much more discipline recently. Making the right pricing and promotion decisions requires advanced modeling to understand price–volume trade-offs and to estimate residual value effects, as well as a willingness to prioritize medium- and long-term profitability over immediate market share.

In the U.S., GM and Chrysler will also have to rebuild their finance capabilities; the recent acquisition of AmeriCredit by GM is a good example. They must also heal the wounds in their dealer networks caused by bankruptcy-driven closures. Finally, incumbent automakers everywhere will need to get ready for new international competitors with inherently lower cost structures. Most of these will come from countries with exploding markets, notably Korea, China, and India. Competing successfully in this industry will require continuous improvement in products, technologies, costs, investment economics, and business models.

5. Financial Services: A New Long-Term Agenda

The worst of the financial crisis may be behind us, but financial firms still confront a raft of challenges, including negative public sentiment, vocal investors unhappy with their returns, and stricter regulation in four key areas: capital requirements, liquidity management, consumer protection, and trading. For large, diversified financial-services firms, these regulations will permanently boost the cost of doing business and reduce profitability. Additionally, as investors demand that financial firms diversify their funding sources, competition is becoming fierce for liquidity-rich clients who can provide stable sources of funding. Finally, risk is being repriced across the board, by providers and buyers of financial services, investors, and even employees, who now prefer cash to stock and other forms of deferred compensation.

In response, many financial-services executive teams are now charting new long-term strategic agendas in four key areas: risk and capital, growth, capabilities, and operating model. The risk and capital agenda is mainly aboutsurviving in a new regulatory environment and better management of risks. The remaining three are about thriving in this new environment and will vary widely by markets, businesses, and individual companies.

• Risk and capital agenda. Financial-services firms will seek to stabilize long-term funding by raising more common equity, defending their base of client deposits, and rebalancing their portfolios of asset- and liability-rich businesses. They will also upgrade their risk and capital management systems. The crisis revealed that many firms did not adequately understand, quantify, and prepare to manage certain sources of credit and market risk. Regulators are demanding that firms do better. To accomplish this, they will need to develop more rigorous processes throughout the organization. Accountability for risk and capital management processes has been siloed too often in the past; now those processes will be aligned with each other (with capital as the “currency of risk”), integrated into strategic management, and shared more broadly across the firm.
   
• Growth agenda. Moving forward, most firms will find profitable growth harder to attain. The industry leaders will need to set realistic but ambitious growth targets, create more organizational and investment focus on specific product and client markets, and enhance their capabilities for growth, through organic means as well as mergers and acquisitions. This growth agenda will be informed by a clear view of how profit pools have shifted and where they will be located in the coming years.
   
• Capabilities agenda. Leading companies will identify and develop a carefully selected system of mutually reinforcing and differentiating capabilities that support the firm’s growth agenda. A capability may take the form of superior knowledge of a particular client segment (such as premium clients) or client needs (such as payments), the management of a particular asset (for example, a payments network), or an organizational ability (such as innovation or talent management).
   
• Operating model agenda. Financial-services companies will need to align their cost structures more effectively with growth and value creation. For instance, a better focus on new markets and revenue sources will often require them to deploy their capabilities systems more consistently, while also reducing costs. Most financial firms are likely to invest in multiyear transformation programs designed to implement leading-edge technology solutions. Many of these programs will use lean methodologies to drive down structural costs and improve customer service throughout the organization.

By recognizing the profound and enduring changes the industry faces and crafting a new strategic direction, the most farsighted financial-services companies will position themselves for renewal and growth.

Resetting for Revival

Fresh on the heels of the Great Recession, senior leaders are changing their perspective. They have managed their companies through a period of sustained and painful adversity. They have a heightened awareness of what makes sense — and what doesn’t — for their businesses. And they are keenly aware that success in the new era will require new skills and capabilities.

The reset for business is real, and its consequences are still somewhat unclear. But this year, for the first time since 2008, one can see the shape that revival will take. Some companies will embrace its nitty-gritty, frugal, customer-oriented ethic. A handful of them will learn to focus their strategic choices (with enough discipline to divest the businesses that don’t fit). These relatively coherent companies, with a relatively clear view of their potential growth path, will be leaders of the new industries and masters of the new practices that emerge.

by the Booz & Company industry teams; introduced and edited by s+b Senior Editor Karen Henrie