University of Maryland Global Campus Anheuser Busch's Profitability Discussion

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Refer to the attached "Anheuser-Busch and the U.S. Brewing Industry" case. Please write detailed two-page case analysis and recommendations report focusing on the following questions:

  1. Anheuser-Busch's profitability qualifies it as a "steady moderate performer" over the 1960-1990 period. What factors contributed to Anheuser-Busch achieving leadership in the U.S. brewing industry?
  2. What has been Miller's strategy since its acquisition by Philip Morris in 1971? Has Miller also been a steady moderate performer?
  3. Do microbreweries and brewpubs promise to change the structure of the U.S. brewing industry? Why was there product proliferation and price discounting around 1990?

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Competition, Strategy, and Business Performance Anita M. McGahan etween 1981 and 1997, the financial-market premium on publicly traded U.S. corporations rose dramatically. At the same time, accounting profitability dropped steadily. Figures 1 and 2 show the trends. In Figure 1, the financial-market premium is the ratio of the value of all financial claims on a firm (including stocks and bonds) to the replacement value of the firm’s assets.1 In Figure 2, accounting profitability is the ratio of after-tax income to the book value of assets. B Figures 1 and 2 are surprising because financial-market premiums and accounting profitability do not move together. If the two performance measures followed similar trends, then the figures would suggest an alignment between investor expectations and actual returns. Although the divergence in the trends is surprising, there are several possible explanations. One is that the average financial-market premium rose even as profitability fell because investors had more money to invest. As the aggregate supply of funds increased, the financialmarket values of firms (relative to their asset bases) increased as well. In this environment, the added supply of financial capital also may have encouraged corporations to expand into markets with lower returns, and thus average accounting profitability declined. A different potential explanation attributes the increased financial-market premium to fundamental improvements in investor expectations, perhaps because of breakthroughs in underlying technology. As Special thanks to Michael E. Porter for discussions and for co-authorship of many of the articles in this research stream. I am grateful to Carliss Baldwin, Barbara Feinberg, Benson P. Shapiro, the editor, two anonymous referees, and seminar participants at the Harvard Business School for comments and suggestions.Thanks to Rebecca Evans for research support.The Division of Research at the Harvard Business School provided generous financial support for this project. 74 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance U.S. Corporations 25 20 15 10 5 0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Ratio of Market Value FIGURE 2. Accounting Probability of U.S. Corporations 14 12 10 8 6 4 2 0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Ironically, many executives feel more pressure to improve operating results even as financialmarket premiums increase. The pressure may occur with increased threat of takeover, more active boards of directors, or increased competitive threats. Can strategies be improved constantly? Management consultants, business academics, investment analysts, and the business press have all offered executives a range of theories on this question. Companies spend hundreds of thousands and sometimes millions of dollars to get current advice from experts on the newest approaches to improving rates of return. They often advise integrating core capabilities, subcontracting unessential activities, divesting unrelated businesses, and consolidating through merger with rivals. FIGURE 1. Financial-Market Premium of Value of Returns companies pursued the new projects, their accounting profitability was temporarily depressed. Yet despite all the advice, Sources: Developed from data in the Compustat Basic File screened for anomalies and for matching with the Compustat Business-Segment Reports. executives with operating responsiThe screening approach is described in Anita M. McGahan,“The bilities have not had much inforPerformance of U.S. Corporations: 1981-1994,” Harvard Business School mation that can help them set goals Working Paper, July 1998. and frame strategic problems. Little data is available for identifying how the performance history of a business compares with trends in the economy. As a consequence, it is difficult to know when a problem requires a radical solution. When is a small operating problem an indication of deeper strategic issues, and when is it temporary? How often should strategy be reformulated? How common are turnarounds? How long should a high performer expect to sustain its profitability? Is it unusual for a company to show low profitability for a long time? Operating executives often must rely on their experience rather than hard data to make judgments about the magnitude and scope of strategic problems. This article seeks to remedy this problem by providing broad information on the characteristics of businesses with different kinds of performance histories. It CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 75 Competition, Strategy, and Business Performance offers benchmarks to help executives form judgments about strategic challenges and opportunities. This study relies on recently collected data on the profitability of publicly traded U.S. firms within specific businesses. The data has been compiled since about 1980 by Compustat, when a new reporting requirement for businessspecific operating profit, sales, and assets went into effect. The dataset has several limitations. First, private companies are missing. Second, international companies are excluded if they are not represented on U.S. exchanges. Third, the industry definitions, given by the U.S. Standard Industry Classification (SIC) System, are broad in some sectors and narrow in others. Fourth, the reported information on a company’s businesses may not conform to its strategic business units. Companies are required to report on businesses that constitute at least 10% of sales. Many firms often group together several similar operating units for reporting. On average, each business reported by Compustat probably represents two or three different operating units.2 For this reason, the reporting entities are called “business segments” instead of “business units.” Although the dataset suffers these problems, it has the substantial advantage of representing the first source of comprehensive information on the profitability by industry of both diversified and single-business public corporations. Over the past few years, Professor Michael E. Porter and I have used the data in several research studies to identify fundamental facts about business performance over time in a broad range of economic sectors. The studies were motivated by a sense that the new data provided unprecedented opportunities to understand the relevance of industry, corporate-parent, and business-specific influences on performance.3 Patterns in Business Performance Strategic goals for performance are expressed in multiple ways: market share, revenue growth, earnings per share, dividend growth, and operating returns are all common measures. Is there a single correct measure of performance? Surely not. Despite the diverse possibilities, this study relies on a single measure, the ratio of operating income to assets (i.e., “accounting profitability”). This measure represents a return on invested capital and has the advantage of capturing the broad operating qualities of a business. Revenue growth and market share are important drivers of operating income. The requirements to compensate equity and debt claimants are reflected in assets. The ratio of operating income to assets is also one of the only available measures of performance at the business level. This study uses the financial-market premium as a supplementary measure of performance.4 It reflects investor expectations about a company’s prospects for generating value in the future. The financial-market premium is greater than one when investors expect the company to generate more value from its booked assets than if the assets were sold off. Whereas accounting 76 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance profitability reflects historic and current management influence, the financialmarket premium reflects investor expectations about future operating returns. However, the financial-market premium has several disadvantages as a measure of operating performance. First, it is only available at the corporate level and not at the business level. Second, it can fluctuate with shifts in investor expectations that are not fundamentally related to the operations of the business. For these reasons, the classification scheme in this study relies on accounting profitability rather than the financial-market premium. The Compustat Business-Segment Reports, the primary source of information, were screened to eliminate records associated with missing or meaningless industry identifiers. Records were eliminated when assets or sales are less than $10 million because they often do not represent operating businesses. Single-year appearances were excluded for the same reason. For the financial-market analyses, companies with less than $50 million in assets were eliminated because their financial paper may not be traded frequently. Both of these screens conform to precedents in the literature.5 Financial institutions were also screened out of the dataset because their operating characteristics are quite different than those of other types of businesses. Because business units are aggregated in the reports submitted by firms, the dataset is not well suited for analysis of entry and exit from the economy. The screened dataset covers about 60% of the non-financial corporate assets reported to the Internal Revenue Service over the 1981-1997 period. It includes 13,547 business segments in 8,018 corporations and in 664 industries. The average profitability across all businesses over the 1981-1997 period is 9.21%.6 About half of the observations are associated with diversified firms. (Here, the term “diversified” is used to describe corporations that participate in more than one business in the screened dataset.) The average business segment posts $883 million in assets. On average, diversified corporations post $2,688 million in assets, and single-business firms post $791 in assets. (Thus, singlebusiness firms have smaller business segments on average than diversified corporations.) The first step in the analysis is the classification of businesses by their performance over the 1981 to 1997 period.7 It would be too cumbersome to represent all possible paths of profitability among businesses over 17 years, especially since the average business is represented in the dataset for 10.5 years. These complications are handled by classifying businesses based on their profitability ranking during the first four and last four years in which they are represented in the dataset. This approach has the virtue of simplicity. A comparison with more complex classification methods suggests that the biases in the simple classification scheme are not severe, and the relationships across categories in profitability, size, relative growth, financial-market premiums, and financialmarket values are consistent.8 Figure 3 shows the categories. The left-hand-side of the matrix represents average accounting profitability among businesses in the first four years that CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 77 Competition, Strategy, and Business Performance High (25%) Ending Performance Medium (50%) Low (25%) High (25%) Sustained High Performers Declining High Performers Fallen High Performers Medium (50%) Rising Moderate Performers Steady Moderate Performers Declining Moderate Performers Turnarounds Rising Underperformers Chronic Underperformers 15.95% 3.89% Low (25%) 14.80% 2.88% they appear in the dataset.9 The top of the figure represents average accounting profitability among businesses in the last four years in which they appear.10 The lines show the cutoff thresholds.11 The thresholds were selected so that the top 25% of businesses by rank in profitability would qualify as “high” performers, the bottom 25% would qualify as “low” performers, with the rest qualifying as “medium” performers. Each label in each box describes the trend in the relevant range. For example, the upper left box, labeled “Sustained High Performers,” represents businesses that both began and ended with high profitability. Figure 4 shows that the number of businesses was not evenly distributed by category. Only 74 (or 0.5%) of the 13,547 businesses are “Turnarounds,” FIGURE 4. Number of Businesses by Category Ending Performance Beginning Performance Beginning Performance FIGURE 3. Performance Categories 78 Sustained High Performers 2,628 (19.4%) Declining High Performers 599 (4.4%) Fallen High Performers 160 (1.2%) Rising Moderate Performers 685 (5.1%) Steady Moderate Performers 5,517 (40.7%) Declining Moderate Performers 572 (4.2%) Turnarounds 74 (0.5%) Rising Underperformers 658 (4.9%) Chronic Underperformers 2,654 (19.6%) CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance TABLE 1. Sustainability Beginning Performance Ending Performance % with same rank % with higher rank % with lower rank High 77.6% N/A 22.4% Moderate 81.4% 10.2% 8.4% Low 78.4% 21.6% N/A beginning with low performance and ending with high performance.12 “Fallen High Performers,” businesses that dropped from high to low profitability, are also relatively rare and account for just 1.2% of the total.13 The “Steady Moderate Performer” category is the most populated with 40.7% of the businesses.14 Implicit in Figure 4 is information about the sustainability of high, medium, and low profitability. Of the 25% of businesses that started with high performance (top row), the figure shows that most of them (19.4%) sustained their high performance over the period. Table 1, which is derived from Figure 4, makes this explicit. It shows that 77.6% of the businesses that began with high performance also ended with high performance. The rest ended with a lower rank in profitability. Moderate performance was sustained at an even higher rate of 81.4%. Indeed, all types of performance—high, medium, and low—were quite persistent. Surprisingly, low profitability was slightly more persistent than high performance. Moderate performance was more persistent than any other type.15 A question arises regarding the rate of entry and exit from the various categories. Were businesses that began with low performance more likely to exit than those that began with high or medium performance? As indicated earlier, the dataset is not well suited for analyzing questions of economic entry and exit.16 Exit from the dataset occurs with bankruptcy, merger, privatization, and a change in industry identifier. Entry into the dataset occurs with an initial public offering, de novo entry by an established firm, and with a change in industry identifier. During the 1980s and 1990s, corporate reorganization frequently led to changes in identifiers. As a result, the average business segment posted 10.5 years of data between 1981 and 1997. How much lower is the profitability of Chronic Underperformers than of those in other categories? Table 2 shows an average ratio of operating income to assets of –7 .2%.17 Of course, Sustained High Performers, with a 25.9% average, CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 79 Competition, Strategy, and Business Performance TABLE 2. Average Profitability by Category Beginning Performance Category Sustained High Performers Aver- Average Ending age Size in Perfor- ProfitaAssets mance bility ($ mil.) Median Average Average Size in Financial- FinancialAssets Market Market ($ mil.) Premium Value High High 25.9 459 92 1.64 974 High Med. 15.2 853 143 1.31 1,303 Fallen High Performers High Low 7.9 223 73 1.27 318 Rising Moderate Performers Med. High 15.1 677 142 1.39 1,028 Steady Moderate Performers Med. Med. 9.2 967 162 1.14 1,223 Declining Moderate Performers Med. Low 2.3 364 75 1.01 427 Turnarounds Low High 10.7 253 77 1.32 474 Rising Underperformers Low Med. 3.6 867 126 1.11 1,046 Chronic Underperformers Low Low -7.2 419 62 1.28 485 Declining High Performers show the highest average profitability. The statistics in Table 2 are developed from means taken over the entire period in which businesses are represented. Thus, Declining High Performers and Rising Moderate Performers also show relatively high average profitability. Declining Moderate Performers are secondlowest in rank. Table 2 also shows the averages sizes in assets of businesses by category. Categories with high average sizes are highlighted. Steady Moderate Performers are over twice as large as both Sustained High Performers and Chronic Underperformers. The next column of Table 2 shows median size in assets. (The median is defined so that half of observations fall below and half fall above the value.) For all categories, the median size is significantly less than the average, although the relationships between categories are similar. This means that the distribution of businesses by size is strongly skewed. In all categories there are a lot of small businesses and relatively few very large businesses. The very large businesses draw up the averages. In the discussion of core examples, this issue is raised again. Overall, the information on size by category suggests that high performers become moderate performers by growing large, perhaps compromising their original operating strategies. It also suggests that low performance occurs if a high or moderate performer does not grow enough to achieve a minimum efficient scale. 80 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance FIGURE 5. Average Growth Rates by Category Beginning Performance Ending Performance Sustained High Performers 15.3% (10.0%) Declining High Performers 13.7% (8.5%) Fallen High Performers 10.4% (4.5%) Rising Moderate Performers 14.7% (11.4%) Steady Moderate Performers 15.1% (8.9%) Declining Moderate Performers 8.5% (2.4%) Turnarounds 15.5% (9.9%) Rising Underperformers 16.3% (19.6%) Chronic Underperformers 16.9% (22.4%) Note: Simple averages with weighted averages in parentheses.The weights are the inverses of the variances of the estimates. The last two columns of Table 2 show the average financial-market premium and financial-market value of businesses in each category.18 The financialmarket value represents the total amount of investors’ claims on a business in absolute terms.19 The financial-market value is lower for Sustained High Performers than for Steady Moderate Performers. This occurs because Steady Moderate Performers are so large on average. Their size overwhelms the influence of the higher financial-market premium on Sustained High Performers. The regularity carries an important implication for strategy: Steady Moderate Performance may be a worthy objective in its own right if it creates more financialmarket value than Sustained High Performance. Although a detailed analysis of the financial-market premium goes beyond the scope of the study, several of the estimates are striking. The average financial-market premium is greatest for Sustained High Performers, with Rising Moderate Performers and Turnarounds distant followers. In general, improving performers had a higher financial-market premium than declining performers, which suggests that investor expectations about the future were related to the trajectory of accounting profitability. Chronic Underperformers had a relatively high financial-market premium despite their low accounting profitability. (Recall that over 19% of the businesses in the dataset qualify for the category.) This result means that, on average, investors expected better performance from Chronic Underperformers than from Declining Moderate Performers. Perhaps investors viewed Chronic Underperformers as prospective turnarounds. Figure 5 shows average revenue growth rates by category. The figure shows both simple and weighted averages. The weights are the inverses of the variances of the estimates. The simple averages differ from the weighted averages because the businesses with the highest growth rates also have the highest variances in growth over time.20 Although the simple averages are higher than the weighted averages, the relationships across categories are CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 81 Competition, Strategy, and Business Performance FIGURE 6. Sectors by Category 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Health & Bus. Svcs. Lodging/Ent. & Pers. Svcs. Wholesale/Retail Trade Transportation Manufacturing Agriculture & Mining similar. The highest average growth rates arose in categories in which the businesses ended with high performance. The lowest average growth rates arose in categories where businesses ended with low performance. The major exception is Chronic Underperformers. Figure 6 shows how businesses within each category were distributed across broad sectors of the economy (e.g., agriculture and mining, manufacturing, transportation, wholesale/retail trade). There are some differences across the categories: few Turnarounds arose in the wholesale/retail trade sector, and transportation businesses were rarely Fallen High Performers. The agriculture, mining, and manufacturing sectors were disproportionately represented among Sustained and Declining High Performers, and were less common among Steady Moderate Performers. Table 3 shows additional information about the distribution of industries across categories.21 This information shows whether Chronic Underperformers, for example, were concentrated within just a few industries, or whether they arose in many different industries. For example, the first row reports that 89.3% of the 534 industries that contained Sustained High Performers held between 1 and 10 of them. Just 0.6% of the industries contained between 51 and100 of the Sustained High Performers. The results in Table 3 point to some important asymmetries that are not apparent in Figure 6. Across categories, a high portion of represented industries contain just 1-10 members. In particular, Turnarounds were not concentrated, contrary to the hypothesis that they tended to be members of industries like biotechnology/pharmaceuticals or software. Rather they were distributed across a variety of agriculture, manufacturing, transportation, wholesale, retail, entertainment, and service industries. Overall, this pattern was common. Businesses on all of the performance trajectories were widely distributed across industries. 82 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance TABLE 3. Distribution of Industries Across Categories Count of Industries by No. of Members No. Bus. No. Ind. 1-10 11-25 26-50 51-100 100+ Sustained High 2,628 534 89.3% 9.0% 1.1% 0.6% 0.0% Declining High 599 265 98.5% 1.1% 0.4% 0.0% 0.0% Fallen High 160 98 100.0% 0.0% 0.0% 0.0% 0.0% Rising Moderate 685 301 98.0% 1.7% 0.3% 0.0% 0.0% Steady Moderate 5,517 609 78.7% 14.1% 5.1% 1.1% 1.0% 572 232 97.4% 2.2% 0.4% 0.0% 0.0% Declining Moderate Turnarounds Improving Under’s Chronic Under’s 74 57 100.0% 0.0% 0.0% 0.0% 0.0% 658 267 97.0% 2.6% 0.4% 0.0% 0.0% 2,654 465 87.7% 8.0% 3.7% 0.2% 0.4% A few exceptions to this pattern are evident. Steady Moderate Performers were more concentrated by industry than businesses in any other category. One percent of Steady Moderate Performer industries had more than one hundred members from the category. Of course, this regularity arises partly because of the high number of businesses in the category and partly because of concentration of Steady Moderate Performers in just a few industries. Table 4 shows that Steady Moderate Performers tended toward the transportation sector. TABLE 4. Most Populated Industries Among Steady Moderate Performers No. Industry Identifier No. of Steady Moderate Performers Total Member Businesses Sector Description 1311 Agriculture, Mining Crude Petroleum and Natural Gas Extraction 180 488 4911 Transportation Electric Services 155 168 4924 Transportation Natural Gas Production and Distribution 131 145 5812 Wholesale/Retail Trade Eating Places 106 242 4813 Transportation Telephone Communications 104 212 7372 Services Prepackaged Software 102 339 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 83 Competition, Strategy, and Business Performance TABLE 5. Most Populated Industries Among Chronic Underperformers No. Industry Identifier No. of Chronic Underperformers Total Member Businesses Sector Description 1311 Agriculture, Mining Crude Petroleum and Natural Gas Extraction 121 488 7372 Services Prepackaged Software 101 339 2834 Agriculture, Mining* Pharmaceutical Preparations 57 224 * Pharmaceutical Preparations are classified in “Agriculture and Mining” because they have an SIC in the 2000’s.The classification may reflect historical links between pharmaceuticals and agricultural compounds.This study relies on the convention that agriculture and mining businesses have SIC’s less than 3000, and manufacturing businesses have SIC’s in the 3000’s. Some other studies assign all businesses with SIC’s less than 4000 to “agriculture and manufacturing,” or SIC’s between 2000 and 4000 to “manufacturing.” Thus, care is needed in comparing the results with those from other studies. Chronic Underperformers were also relatively concentrated, with 0.4% of industries hosting more than 100 members. One industry contained 57 members. Table 5 shows the three most populated industries. The third most concentrated category was Sustained High Performers. Although none had more than 100 members, 0.6% of industries had more than 50 members. Table 6 shows that they were the same industries as the most populated among Chronic Underperformers. These results indicate important relationships between the categories. In particular, they show that a subset of industries may be structured to support both Sustained High Performers and Chronic Underperformers.22 The analyses of growth rates, sizes, and financial-market premiums also suggests relationships between categories as businesses evolved. TABLE 6. Most Populated Industries Among Sustained High Performers No. Industry Identifier Sector Description 2834 Agriculture, Mining 7372 1311 84 No. of Sustained High Performers Total Member Businesses Pharmaceutical Preparations 85 224 Services Prepackaged Software 70 339 Agriculture, Mining Crude Petroleum and Natural Gas Extraction 58 488 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance Core Examples of Competitive Strategy This section offers additional information on the diversity of businesses by category and examines “core examples” for each of the categories. Because each category contains diverse businesses, no single example can represent the full range of issues that arise in a category. The examples are selected because their characteristics are near the averages for their categories and, in some cases, because they are interesting in their own right. The discussion highlights only some of the strategic challenges that can arise for businesses on each performance trajectory. Sustained High Performers Most of the 2,628 Sustained High Performers were small business segments. Recall that the average Sustained High Performer posted profitability of 25.9% on assets of $459 million over the period. The average financial-market premium for Sustained High Performers was higher than in any other category at 1.64. A supplementary analysis indicates that on average Sustained High Performers belonged to attractive industries, were part of high-performing diversified firms, and had profitability well above the industry averages.23 Table 7 lists several members of the category along with information on their performance, size, growth, and financial-market premiums. Many are well known. Some are household names. Although Microsoft received great attention for its superior performance in microcomputing software over the period, it was not typical of the category in some important respects. Its average profitability, revenue growth, and financialmarket premium were all much greater than the averages for the category. Microsoft also was not part of a diversified firm and was much larger in size than average. The Gannett Corporation in the newspaper-publishing business is more representative of the “core” of the category. Gannett’s profitability, financialmarket premium, and growth rate in newspaper publishing were near the averages for the category. Also, this business belonged to an attractive industry, was part of a high-performing corporate parent, and posted profits above its industry average. However, Gannett’s newspaper publishing business was somewhat larger than the mean or median firm in the Sustained High Performer category. The business is suggestive as a core example despite its large size because so many of its other characteristics reflected the averages for the category. What was Gannett’s business strategy over the period? During the 1980s and early 1990s, Gannett participated in three industries: broadcasting, outdoor advertising, and newspaper publishing. Over the entire period, Gannett performed above the averages for its industries, perhaps because corporate management was particularly effective in managing its divisions.24 In newspaper publishing, Gannett published USA Today and about 80 local papers with daily and weekly circulation. Its principal national competitors pursued very different strategies. For example, the Wall Street Journal concentrated on business news; CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 85 Competition, Strategy, and Business Performance TABLE 7. Examples of Sustained High Performers Average Size in Assets ($ mil.) Average Revenue Growth Average FinancialMarket Premium 31.7% $9,260 16.2% 3.25 36.8 3,691 45.0 6.73 Average Business ProfitDescription ability Company Industry Identifier Merck & Co. 2834 Human & Animal Health Microsoft Corp. 7372 Microcomputer Software PepsiCo Inc. 2096 Snack Foods 27.7 3,258 10.4 1.60 Kellogg Co. 2043 Food Products 26.6 3,155 7.1 2.52 Home Depot 5211 Building Materials 15.9 2,942 49.4 3.77 Gannett Co. 2711 Newspaper Publishing 26.4 2,207 8.4 1.91 Cisco Systems Inc. 3576 Internetworking Systems 40.1 1,452 100.7 7.94 Dell Computer Corp. 3571 Personal Computers 17.2 1,299 56.4 2.55 Tribune Co. 2711 Newspaper Publishing 29.0 814 2.1 1.40 Armstrong World Indust. 3296 Building Products 18.8 469 5.7 1.02 Jostens Inc. 3911 MotivationRecognition Products 21.8 392 9.7 2.06 Bandag Inc. 3011 Tread Rubber & Equipment 28.6 378 6.0 2.33 Houghton Mifflin Co. 2731 Textbooks— Educational Material 27.1 277 10.5 1.41 Tootsie Roll Inds. 2064 Candy 22.4 179 10.9 2.13 Boston Beer Inc. 2082 Craft Brewery— Beers, Ale 16.5 78 18.1 3.36 Black Hills Corp. 1221 Coal Mining 19.8 49 3.9 1.04 Drew Industries Inc. 3442 Manufactured Housing, Recreational Vehicles 35.8 27 17.2 1.29 Mile High Kennel Club 7948 Greyhound Race Track 20.3 11 5.4 0.36 86 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance the Washington Post was known for political reporting; and the New York Times covered national news, New York stories, and popular features. Because of broad differentiation among the leading competitors, industry-average profits exceeded the national average. Gannett distinguished itself from other large newspaper companies by focusing on the publication of local papers. It decentralized editorial control but maintained centralized coverage of national and world news. Distributed printing systems assured cost efficiency and timeliness of physical distribution. Although USA Today was something of a financial disappointment, the company’s core newspaper operations in local markets continued to generate impressive returns.25 This balancing act—sustaining high profitability within the industry without damaging industry structure—required the careful execution of strategy. Gannett’s continued high operating return on assets, the defining characteristic of its category, attracted attention from customers, employees, and competitors —all of which were interested in improving their own value capture. Apparently, however, Gannett’s tight operations network, local distribution, and journalistic expertise gave it an advantage that could not be replicated. The strategic challenge associated with these kinds of specialized capabilities was growth: How could Gannett build on its strength in newspaper publishing without compromising its differentiation and without inciting retaliation from rivals? Steady Moderate Performers Steady Moderate Performers were much larger on average than Sustained High Performers and Chronic Underperformers. With an average size of $967 million, Steady Moderate Performers were larger than businesses in any other category. Steady Moderate Performance was also quite common (partly because of the broad definition of “medium” profitability). Over 40% of the businesses in the dataset qualified for the category. The large size of the average Steady Moderate Performer was associated with a high financial-market value despite the lower financial-market premium than Sustained High Performers. Several transportation businesses lead the list of industries most populated by Steady Moderate Performers. The largest business in the category was Nippon Telegraph & Telephone in Telephone Communications (industry 4813) with average profitability of 6.0% on average assets of $87 billion. The secondlargest business was AT&T in the same industry with average profitability of 12.7% on average assets of $54 million. This business was labeled “Information Movement and Management” by AT&T from 1993 to 1995, and “Communications Services” from 1996 to 1997. Information was reported on the business for only the five years from 1993 to 1997. Table 8 shows examples of other Steady Moderate Performers with their characteristics. Not surprisingly, the average Steady Moderate Builder posted profits very near the norm for its industry. Overall, businesses in the category belonged to CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 87 Competition, Strategy, and Business Performance TABLE 8. Examples of Steady Moderate Performers Company Industry Identifier Average Business ProfitDescription ability Average Size in Assets ($ mil.) Average Revenue Growth Average FinancialMarket Premium Toyota Motors Corp. 3711 Automobiles 8.0 47,017 15.9 0.95 BellSouth Corp. 4813 Telecommunications 11.9 30,105 6.2 0.98 British Petroleum PLC 1311 On-Offshore Exp.& Prodn 12.1 26,325 n/a n/a Federated Department Stores 5311 Department Stores 7.4 12,419 24.6 1.03 HCA (Hospital Co. of America) 8062 Hospital Management 10.1 5,419 9.5 1.06 Federal Express Corp. 4513 Express Delivery 11.5 3,760 21.6 1.07 Southwest Gas Corp. 4924 Natural Gas 7.1 965 3.1 0.86 Starbucks Corp. 2095 Coffee Retailer & Wholesaler 8.4 371 60.5 3.55 Stratus Computer Inc. 3571 Computer Systems 13.9 321 33.3 2.22 Carmike Cinemas Inc. 7832 Motion Picture Theaters 10.3 258 21.1 0.97 Summit Care Corp. 8051 Nursing Care Centers 10.9 127 24.0 1.26 Hamburger Hamlet Rest. 5812 Restaurants 8.3 33 8.0 0.92 Spec’s Music Co. 5735 Retail Music Stores 9.2 27 16.2 1.15 industries that showed profitability slightly above the average for the economy. Consider Federal Express in express delivery and Starbucks in coffee retailing/ wholesaling as examples. These companies adopted well-tested business models and continually renewed capabilities through internal development of critical resources over time. Federal Express built its overnight delivery business by centralizing all of its nightly sorting and redirecting functions at a Memphis facility. Starbucks became renowned by putting new stores in geographic clusters around the country. As Starbucks, Federal Express, and other businesses built interlocking systems of assets, their advantages became difficult to imitate. The Steady Moderate Performers category contains a disproportionate share of businesses in the wholesale trade, retail trade, and transportation 88 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance sectors. As noted earlier, the category contains more businesses concentrated in specific industries than any other category. The most populated industry, Crude Petroleum and Natural Gas Extraction (industry 1311), was also a leading industry among Sustained High Performers and Chronic Underperformers. Of the thirteen industries with more than 50 Steady Moderate Performers, five were in the transportation sector: electric services, natural gas production and distribution, telephone communications, natural gas transmission, and trucking (except local). Two were in wholesale/retail trade: eating places and grocery stores. Three of the industries were in agriculture and mining: operating builders, paper mills, and petroleum refining. Two industries, prepackaged software and motor vehicle parts, were in services and manufacturing, respectively. The sectoral composition may reflect underlying industry structures that tend to support moderate performers. Federal Express and Starbucks did not make large, preemptive commitments to establish their positions. Rather, they invested incrementally to develop resources internally and to expand their geographic presence over time. In these situations, the central strategic challenge lies in finding incremental growth opportunities that do not compromise the underlying formula. Further research is needed to understand whether the challenges facing Federal Express and Starbucks apply to a wide range of businesses in the category. Chronic Underperformers The “Chronic Underperformers” category contains businesses with long and short histories: American Motors in general automotive, Bethlehem Steel in steel-related operations, Lionel in toys and leisure products, McCaw Cellular in cellular telephone service, Nova Pharmaceuticals in drug research and development, and THQ in video game software. On average, businesses in this category posted profits significantly below their industry averages for a long period. This suggests that the average Chronic Underperformer had strategic problems that differed from those of direct rivals. A significant minority engaged in a process of exit. Many exited only after several years of investment in new assets, however. These businesses may have started with an expectation of better performance, but eventually accepted that the business would never recover the costs of ongoing investment. Exit often took the form of consolidating mergers between members of the same industry, or between a firm and one of its customers or suppliers. What kinds of strategic problems confronted Chronic Underperformers? Consider McCaw Cellular and Nova Pharmaceuticals as examples of newer businesses in the category. Both of these businesses constructed major valuegenerating assets over a long period. The assets had to be fully developed before products could be brought to market: McCaw had to build a cellular network and consumer awareness, and Nova had to find a viable new pharmaceutical product. Their strategies involved years of low profit while resources CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 89 Competition, Strategy, and Business Performance accumulated for future return. The firms bore the risk that rewards would not materialize, or materialize later than anticipated. Some older firms in the category, including Bethlehem Steel in steelrelated operations, faced more complicated strategic challenges. Bethlehem Steel and others like it weathered great technical changes in their industries but invested for the future by rationalizing assets. In these situations, established customers and suppliers often had little incentive to encourage the adoption of new ways of doing business. Older Chronic Underperformers had to invest in the hope of either attracting new trading partners or compelling established partners to change. In an important sense, both the newer and the older Chronic Underperformers were prospective Turnarounds at the end of the period. The persistent refusal to exit indicated an ongoing commitment and the implicit intent for a recovery. Some of the firms made compelling cases that their turnarounds were imminent. McCaw Cellular sold to AT&T in 1993 for an unprecedented $12.6 billion despite low accounting profitability. The analysis raises a hypothesis that some industries were structured to encourage long-term investments with differed reward. The most populated industries among Chronic Underperformers were the same as among Sustained High Performers: crude petroleum and natural gas extraction, prepacked software, and pharmaceutical preparations. Pharmaceuticals, for example, hosted both established leaders and a range of low-performing public biotechnology companies. Declining High Performers Unlike Microsoft in microcomputer software and Gannett in newspaper publishing, some businesses that began as high performers subsequently experienced a decline in profit. About a quarter of the businesses that started with high performance ended with a lower ranking. Most became Declining High Performers with medium profitability. The “Declining High Performers” category includes Whirlpool in major home appliances, Benihana in restaurants, Carnival Corp. in cruise lines, Coca-Cola Bottling in soft drinks, Rite Aid in retail drug stores, and Snap-On in tool manufacturing and distribution. What went wrong for Declining High Performers? On average, they lost distinctive performance within their industries, but their industry effects did not deteriorate.26 The analysis shows that Declining High Performers started with somewhat lower performance than Sustained High Performers in the first place. Although industry effects eroded over time, the greatest decline by far occurred in the business-specific effects. Consider, for example, Benihana in restaurants. Benihana operated a chain of Japanese restaurants, and appeared as an independent entity in the dataset from 1983 to 1992. Restaurant industry profits exceeded the average throughout the entire period. Initially, Benihana performed well above the 90 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance industry average. The restaurants were famous for an entertaining style of food preparation in which chefs cooked food to order on grills that formed part of patrons’ tables. By some accounts, Benihana is credited with originating the “eatertainment” concept, which augmented the dining experience with entertainment.27 By 1992, Benihana’s business-specific effect had declined substantially, and profits dropped below the industry average. Customers apparently lost interest in the novelty associated with Benihana’s approach and simply switched to other dining and entertainment experiences. The main issue was not direct imitation of Benihana’s teppanyaki cooking approach. Rather, customers wanted novelty, and entrepreneurs responded by creating new entertainment restaurants using other approaches.28 For Benihana, the innovations that spawned high performance had two lingering effects. The first was that the business continued to generate value for a core group of customers and suppliers and retained medium profitability.29 The second was that the high profitability of the business attracted competitive attention. Competent rivals discovered ways to overcome customer and supplier switching costs, although not by imitating directly. Instead, they learned from the leader’s approach and extended it sufficiently to lure away the leader’s customers and suppliers.30 The strategic challenge was not in fending off direct imitators, but in competing against rivals that extended and adapted Benihana’s approach. Fallen High Performers Businesses in the Fallen High Performers category include Boeing in military transportation equipment, Fair Grounds Co. in horse racing, L.A. Gear in shoes, and Sierra On-Line in entertainment software. For the average Fallen High Performer, the industry, corporate, and business-specific effects all fell off quickly and dramatically in about the same proportion. Profit typically declined rapidly. On average, the businesses in this category were low performers just a few years after posting high performance. Consider L.A. Gear, a maker of high-end fashion sneakers and shoes. L.A. Gear’s revenue in the shoe business increased from $36 million in 1986 to a phenomenal $902 million in 1990. The company’s products appealed to teenagers and young adults interested in fashion shoewear. L.A. Gear’s customers had very low switching costs, however. In fact, the fashion quality of the product may have generated negative switching costs: customers may have preferred a different brand just for the difference in fashion once they tried L.A. Gear shoes.31 At a minimum, L.A. Gear shoes were unlike Benihana’s dining experience in that there was no compelling reason for repeat purchases. By the 1990s, competition from Converse, Reebok, and Nike greatly eroded L.A. Gear’s sales and profitability. In 1994, L.A. Gear sales in the shoe business were $416 million, less than half of the 1990 peak of $902 million. The company did not unwind its investments at nearly the same rate, however. In every year between 1991 and 1994, operating profitability was negative. CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 91 Competition, Strategy, and Business Performance Several problems plagued L.A. Gear. The first was increasing price competition. Given low switching costs for customers and suppliers, competitors attracted L.A. Gear’s customers with lower prices. The second problem was specialized assets that locked the businesses into position. L.A. Gear held significant inventory and sold products at locations that were tightly packed geographically, for example.32 As competition escalated, the company could not exit the industry without walking away from valuable assets.33 It is difficult to know whether these kinds of strategic challenges were widespread across the category, but they probably did arise for a significant group of Fallen High Performers. Fallen High Performers were small on average with sales of $223 million. For a company like L.A. Gear, larger competitors had greater bargaining power and access to scale economies. Although Fallen High Performers were often small, they did not have a greater tendency to exit than businesses in the other categories. In fact, the disinclination to exit may have contributed to long-run fragmentation in the industries populated by these businesses. Declining Moderate Performers The Declining Moderate Performers category includes businesses that began with medium performance and ended with low performance. Digital Equipment in computers, Pizza Inn in restaurants, Crown Books Corp. in retail book stores, Everest & Jennings in medical equipment, Bowl America Inc. in bowling centers, and Todd Shipyards in shipbuilding belong to this category. The average industry effect on Declining Moderate Performers was initially slightly positive but quickly became slightly negative. As industry structure shifted, the average business-specific effect became significantly and persistently negative. Case studies of some of the companies in the category reveal an interesting dynamic. Like the core examples of Steady Moderate Performers, some Declining Moderate Performers had a history of investing gradually to achieve medium profitability. Unlike the Steady Moderate Performers, however, the Declining Moderate Performers became highly committed to positions that could not be quickly adapted as customer tastes and supplier technologies shifted.34 For example, Everest & Jennings continued to manufacture parts for vinyl-covered, standard wheelchairs through the early 1990s because many hospitals and nursing homes demanded them. Everest & Jennings’ customers—the hospitals and nursing homes—had co-invested by building fleets of the older wheelchairs that sometimes needed new parts. As the Invacare Corporation developed and commercialized newer models of standard wheelchairs using different raw materials and designs, it gradually attracted customers from Everest & Jennings.35 For Everest & Jennings, conflicting incentives arose. To serve established customers and suppliers, the business continued to offer traditional standard wheelchairs. Investment in new products may have appeared too risky or too difficult. As a result of these conflicting incentives, the strategic problems facing Everest & Jennings were particularly challenging. 92 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance There is some evidence that these challenges may have confronted other Declining Moderate Performers as well. Many of the businesses in the category engaged in significant restructuring and downsizing programs during the late 1980s and early 1990s. Perhaps as a result, the average Declining Moderate Performer was small, with assets of $367 million, and grew slowly over the 1981 to 1997 period. Turnarounds36 Some of the most celebrated businesses of the 1980s and 1990s began with low performance and ended with high performance. The Turnaround category includes Turner Broadcasting in news and the Sprint Fon Group in long-distance communications service, each of which contributed to a revolution in its industry during the period. The category also contains companies that received less attention, including the Ackerley Group in broadcasting, Minnetonka in personal care products, and Pittston in home security systems. Turnarounds typically began in slightly unattractive industries with businessspecific effects substantially below average. The poor business-specific effects quickly dissipated, however. Consider Turner Broadcasting in news. Early poor performance occurred as the business invested for future return. After an initial period of low profitability, profits turned marginally positive, with a positive corporate-parent effect associated with the improvement. After some years, the business showed profitability above the industry average. Once Turner Broadcasting’s news business posted above-average profits, the industry average began to improve. The turnaround stimulated widespread customer interest in a new class of television broadcasting services.37 Other broadcasters offered differentiated products and services to meet the new demand. Turner Broadcasting’s performance in the news business suggests a pattern that may arise for other Turnarounds as well. The new business model required heavy initial investment in physical equipment, brand capital, and other capabilities. Only after construction did the assets begin to generate value. As a result, revenue growth accompanied low profitability for a significant period. Because the business developed specialized capabilities before attracting attention from rivals, it secured a position that would have been too costly to imitate. Turner had secured advantages that became impossible to imitate during the late 1980s and 1990s.38 The Turner Broadcasting example suggests that revenue growth tied more closely to the achievement of high performance than to the sustainability of high performance.39 The factors that made Turner in broadcasting a Turnaround— early investment, followed by secure differentiation and high profitability—tied directly to the pattern of revenue growth in the business. Turner Broadcasting’s profitability turned sharply positive during the mid-1980s and remained high through the 1990s. CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 93 Competition, Strategy, and Business Performance What characterized Turner Broadcasting as a core example of a Turnaround? It invested for a long period despite outsiders’ skepticism about how the investments would pay off in the market. By the time rewards materialized, rivals could not imitate effectively. Customers and suppliers found the approach compelling and quickly flocked to the leader. Followers faced the prospect of long asset-development programs before they could even match the leader’s approach, and they often chose differentiation instead. In many cases, the industry benefited as differentiated rivals learned from the innovation while the leader preserved its position. These kinds of bold investments required strong leadership.40 A visionary leader saw the payoff to asset development years before it occurred.41 Rising Underperformers The Rising Underperformers category contains many businesses that pioneered their industries, including International Paper in packaging, Houghton Mifflin in general publishing, and Ford Motor in manufacturing autos and parts. The accomplishments of these firms are especially impressive in light of both their average sizes and average growth rates. Rising Underperformers were larger on average than businesses in any other category except Steady Moderate Performers and grew even more rapidly on average than Steady Moderate Performers. Early in the period, the old advantages of many of these leaders had become disadvantages. These companies dealt with a large cadre of loyal customers and suppliers that were committed to the old business model, which made change particularly difficult. By the mid-1990s, however, profits recovered to moderate levels—the same category achieved by Toyota Motor, Federal Express, and Starbucks. It would be a mistake to understate the accomplishments of the firms first in envisioning new opportunities and second in finding a way to adapt old resources to new business models. For these Rising Underperformers, better profitability depended on working with customers and suppliers to help them make major transitions. The Rising Underperformers category also contains some newer businesses with short histories of investment. For these businesses, prior investment started to generate return by the mid-1990s. In many ways, the challenges faced by the older and newer businesses were similar: Investment in durable resources initially constrained profitability and then started to pay off. In other ways, the challenges differed: many older firms operated on a much larger scale and faced conflicting incentives to adapt, whereas newer firms operated from a clean slate. Was there anything that clearly distinguished a Rising Underperformer from a Turnaround? On average, Rising Underperformers began the period with performance above that of Turnarounds. For Turnarounds, however, corporate effects were associated with an early positive influence on profitability. In contrast, no corporate effect was associated with early investment for the average Rising Underperformer. Industry-average profitability stayed low. By the end 94 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance of the period, however, industry effects turned slightly positive. The size and history of the core examples of Rising Underperformers made steady, incremental improvement the priority. Value creation could not be deferred given the vast asset base of these businesses. Rising Moderate Performers The Rising Moderate Performer category includes businesses that worked up to high performance over time, including Gillette in appliances, Kroger in food stores, Intel in integrated circuit components, and Sherwin-Williams in paint stores. On average, Rising Moderate Performers started in attractive industries and belonged to corporate parents of above-average profitability. Consider Kroger in food stores as an example. During the 1980s and early 1990s, the food-store industry reaped the returns of early rationalization and showed returns slightly above the economic average. Through impressive asset management, Kroger consistently increased its profitability until it became a high performer. Although sales increased steadily, assets in the business remained at about the same level over time. As a result, operating income moved evenly higher over time. Kroger generated high performance through a strategy of careful investment in a system of tightly linked assets. For Kroger, profits improved through enhanced efficiency in the delivery of value to customers. As a result, profits improved incrementally and reflected less basic risk of failure. In one important sense, Kroger was not typical of Rising Moderate Performers: It did not belong to a diversified company. As with Turnarounds, corporate effects were often associated with profit improvement among Rising Moderate Performers. The Enduring Logic of Competition The analysis of both statistical features and of core examples suggests that an enduring logic of competition influenced the achievement and sustainability of performance between 1981 and 1997. In many cases, the dynamics of competition played out over a period that spanned years and even decades for some businesses. Businesses with high profit in the end, including Gannett in newspaper publishing, Turner Broadcasting in news, and Kroger in food stores, engaged in long processes of asset development for future reward. In some cases, the development of necessary resources and capabilities occurred before returns materialized. Turner Broadcasting built formidable, inimitable advantages before rivals perceived the full value created by its business model. Kroger crafted a strategy based on incremental improvements in asset utilization and cost structure to increase profits gradually over time. Despite increasing pressure for better performance, these businesses achieved enduring advantages from persevering commitment to carefully developed business models, often under considerable risk of failure. CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 95 Competition, Strategy, and Business Performance Many low performers showed signs of engagement in programs to develop assets and capabilities. McCaw in cellular telephone and Bethlehem Steel in steel-related operations invested for future return. For some low performers, prospects were dimmer. The assets that once created great value and deterred imitation locked the businesses into poor position. Companies such as Everest & Jennings in medical devices faced powerful incentives to adhere to old approaches because of sunk investments and demands from established customers and suppliers. For L.A. Gear, low customer switching costs meant that revenues declined quickly as fashion-conscious buyers turned to competing products. The cases show that some low performers faced challenges arising from difficulties in adapting to new business models. In many cases, the adaptation was constrained not by a lack of willingness to change, but rather by the conflicting incentives associated with serving an established base of customers and suppliers that adhered to old ways of doing business. Some businesses with medium performance developed resources incrementally rather than through overwhelming investment under uncertainty about return. Federal Express in express delivery earned profits while investing moderately over time. The risks associated with this strategy were not as great in the sense that the business generated returns as growth occurred. The analysis showed that Steady Moderate Performers more often came from the wholesale trade, retail trade, and transportation sectors than businesses in other categories. With assets of nearly a billion dollars, the average Steady Moderate Performer was larger than the typical business in any other category and over twice as large as the average Sustained High Performer. Why Did Accounting Profit Decline During the 1980s and Early 1990s? So where did competition intensify in the economy? What explains the decline in accounting profitability over the 1980s and 1990s? Why did financialmarket premiums increase over the same period, putting enormous pressure on managers? The evidence suggests that business conditions changed during the 1980s and early 1990s in several ways. First, standards of performance increased in many industries. A statistical analysis shows that conventional industry structures remained an important influence on accounting profitability.42 The analysis of financial-market premiums indicated that, overall, investors expected that conventional industry boundaries would remain important to profitability in the future.43 However, a finer look at each of the categories of performance suggests increases in the requirements for operational effectiveness within many industries.44 Deregulation of the airline industry, for example, had a profound impact on the kinds of large commitments necessary for superior profitability. Some airlines continued to redeploy assets twenty years after deregulation took hold. In the postal-service industry, the standards for speed of delivery increased dramatically after Federal Express implemented state-of-the-art technology. In supermarket retailing, Kroger relentlessly achieved great improvements in asset utilization over 96 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance time by integrating detailed knowledge of customer preferences with its operational expertise. Second, the evidence suggests a complicated set of tradeoffs between size and growth. The statistical analysis shows that growth was associated with higher profitability and higher financial-market premiums. Of course, growth generates increased size. Although larger businesses had higher accounting profitability than smaller businesses on average, smaller companies had higher financial-market premiums. The detailed analysis of performance by category points to a two-part tradeoff between size and profitability. At the high end of profitability, Sustained High Performers were less than half the size of the Steady Moderate Performers. At the low end of profitability, the tradeoff went the other way, with Steady Moderate Performers over twice as large as Chronic Underperformers. Businesses that improved from low performance—Turnarounds and Rising Underperformers—had high growth rates. Growth was associated with the achievement of better performance, but sustained high performers were relatively small. These patterns suggest that, during the 1980s and early 1990s, successful businesses had to navigate a varied set of strategic challenges over time. Organizations had to adapt through phases of major investment and growth; leadership and profitability; and competitive challenge and incremental investment. In some cases, businesses were penalized for too much growth with a loss of strategic focus that subsequently led to lower profitability. Third, the evidence suggests that important competitive challenges came from businesses that adapted and extended the successful approaches of their rivals. Although direct replications clearly hurt L.A. Gear, a Fallen High Performer, it was adaptation by imitators that hurt Benihana, a Declining Moderate Performer. The analysis showed that Declining Moderate Performance was more common than Fallen High Performance, which suggests the need for further study of adaptation among rivals. The case examples also showed that Chronic Underperformers engaged not in price wars but rather in major investment projects that reflected new business approaches. In particular, the core examples of Chronic Underperformers engaged in long-term investment programs with the intention of becoming Turnarounds. For older firms that fell into low performance, the case examples indicated conflicting incentives for updating their approaches. When a company held assets tailored to an old way of doing business, the cost of updating its business approach was effectively greater than for newcomers to the industry. For this reason, the accomplishments of many Rising Underperformers are truly impressive. For example, several of the businesses in this category engaged in comprehensive programs for updating their own positions as well as those of critical suppliers. In sum, the nature of the challenges facing low performers did not always have to do with the short-run competitive interaction that characterized direct imitation. Finally, corporate-parent effects were less important than industry and business-specific effects on profitability, although corporate parents may have been somewhat more important for businesses that improved profitability over CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 97 Competition, Strategy, and Business Performance time.45 The statistical and case research shows that corporate effects may have been quite important in specific types of situations, however. For Turner Broadcasting in news, a positive corporate effect brought profitability above the economic average several years before business-specific profits became positive. Corporate effects were especially influential in the achievement of high performance. These observations show an enduring logic of competition that shaped interaction between firms during the 1980s and early 1990s. Industry structure and corporate diversification remained important sources of ongoing advantage. Many businesses earned high returns within their industries by commercializing new products after years of investment. Low performers often innovated aggressively. The standards for moderate performance rose substantially. For managers charged with improving their operating strategies, the critical challenge is understanding the enduring logic of competition in an increasingly competitive environment. Notes 1. The ratio, also called Tobin’s q, is greater than one when financial investors expect the firm to generate more value from its assets than if the assets were sold off at their replacement values. This measure incorporates the values of stocks, bonds, and other invested capital, and it controls for accounting anomalies by calibrating the premium on the replacement value of assets rather than on earnings. 2. See Anita M. McGahan and Michael Porter, “How Much Does Industry Matter, Really?” Strategic Management Journal (July 1997), pp. 15-30. 3. The studies are McGahan and Porter, op. cit.; Anita M. McGahan and Michael Porter, “The Persistence of Shocks to Profitability,” Review of Economics and Statistics (Spring 1999); Anita M. McGahan and Michael Porter, “The Emergence and Sustainability of Abnormal Profits,” Harvard Business School Working Paper, May 1997, rev. April 1998; Anita M. McGahan and Michael Porter, “What Do We Know About Variance in Accounting Profitability?” Harvard Business School Working Paper, December 1997; Anita M. McGahan, “Profitability Data on U.S. Industries and Companies,” Harvard Business School Note 9-792-066, 1992, rev. 1988; Anita M. McGahan, “The Performance of U.S. Corporations: 1981-1994,” Harvard Business School Working Paper, July 1998, rev. December 1998; Anita M. McGahan, “Do Competitors Perform Better When they Pursue Different Strategies?” Harvard Business School manuscript, March 1998. The analysis also provides the foundation for a new advanced course in strategy at the Harvard Business School called “Strategy and Business Performance.” 4. For additional information on this measure, see Anita M. McGahan (July 1998), op. cit. 5. Richard Schmalensee, “Do Markets Differ Much?” American Economic Review, 75/3 (June 1985): 341-351; Larry H.P. Lang, and Rene M. Stulz, “Tobin’s q, Corporate Diversification, and Firm Performance,” Journal of Political Economy, 102/6 (1994): 1248-1280. 6. Because this figure is the average ratio of operating income to assets, it is higher than the average return on assets in Figure 2. 7. The classification scheme used here was developed in an effort to achieve simplicity without obscuring important regularities identified through statistical analysis 98 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. in the previous research. For example, McGahan and Porter [(May 1997), op. cit.] use a Markov analysis to show that the likelihood that a business would post high, moderate, or low profitability depended statistically on the entire available profit history of the business. For example, the ranking by category of the average sizes of businesses is the same when only long-lived businesses are included in the analysis (although all average sizes are larger). Accounting profitability is measured by the ratio of operating income to assets. For the “beginning” categorization, each business was classified as a high, medium, or low performer based on its average profitability ranking among all businesses during their first four years in the dataset. For the “ending” categorization, each business was classified into a category based on its relative average profitability ranking among all businesses during their last four years. The categorization roughly conforms to natural breaks in the economic characteristics of the businesses. See McGahan and Porter (May 1997), op. cit. Businesses in the second and third quartiles are grouped together in the “medium” category because their economic characteristics are similar and because of high degrees of movement between the second and third quartiles. When a business appeared for less than four years, then its position was based on the average profitability for the years in which it appeared. Recall that single-year appearances are screened from the dataset. The thresholds map loosely to the range of cost-of-capital figures obtained in case research on companies in the U.S. economy. It also suggests that a significant number of businesses may not be returning their costs of capital over long periods. If there were no systematic relationship between beginning and ending categories, then 6.25% of businesses would be classified as Turnarounds (i.e., 25% of the 25% that started with low performance would randomly end with high performance). If falls from high to low performance occurred randomly, then 6.25% of the businesses would qualify for the category. If the retention of moderate performance occurred randomly, then 25% of businesses (i.e., 50% of 50%) would qualify for the category. The 40.7% figure is much higher than the number that would occur randomly. These results are verified statistically in McGahan and Porter (Spring 1999), op. cit.; McGahan and Porter (May 1997), op. cit. One type of analysis does shed light on issues of exit, however. A separate study, McGahan and Porter [(May 1997), op. cit.], using a similar Compustat dataset, established that the rate of business “exit” from 1981 to 1994 was about 15% per year for businesses that ranked in the bottom 10% by profitability. Among businesses that ranked in the top 90% by profitability, the annual rate of exit was nearly uniform at about 10%. Even high performers exited at this rate, which suggested that their owners might have been inclined to sell at a performance peak. Thus, the rates of business exit for high, medium, and low performers do not follow a simple pattern, partly because “exit” from the dataset occurs for a variety of reasons. The average is obtained from the mean rate of profitability for each business over its reporting history. Theoretically, this average is slightly biased because it gives equal weight to the profitability of businesses with long and short reporting histories. In practice, the average is not substantially different from the unbiased estimator, which weights each observation by the inverse of the variance of the estimate. The simple averages are reported here to make them clear to the general reader. CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 99 Competition, Strategy, and Business Performance 18. The financial-market premiums in Table 2 are the means across businesses. The value for each business is the mean for its corporate parent over the entire period in which it appears in the dataset. 19. The financial-market value for a business is equal to the financial-market value for a corporation multiplied by the portion of the corporation’s assets in the business. 20. The growth rates here should not be used for forecasting and should be interpreted to apply only to the 1981-1997 period. Even in the weighted averages, a bias arises from the end points of the series on each business. See McGahan and Porter (Spring 1999), op. cit., for discussion of the problem and of unbiased estimators. 21. Industries are defined by 4-digit Standard Industry Classification codes. 22. McGahan and Porter (July 1997), op. cit., report that the influence of industry, corporate-parent, and business-specific effects varied by economic sectors. Over all sectors, the fixed effects of industry, corporate parents, and specific businesses accounted for 19%, 4%, and 32%, respectively, of variance in accounting profitability. 23. See McGahan, “Facts on the Logic of Competition,” Harvard Business School Working Paper, November 1998; McGahan and Porter (December 1997), op. cit. The term “attractive industry” indicates that average profitability among industry members was above the overall average. 24. The tendency of a corporation to perform differently than the averages for its industries defines a “corporate effect” for the firm. 25. See Pankaj Ghemawat and Scott B. Garrell, “USA Today: Making Headlines Across the Nation,” Harvard Business School Publishing Case Study 792-030; John Deighton and Anthony St. George, “USA Today Online,” Harvard Business School Publishing Case Study 598-133. 26. The figures were constructed by examining the average of coefficients in a nested ordinary-least-squares regression of industry, corporate-parent, and businessspecific influences on profitability. See McGahan and Porter (December 1997), op. cit. 27. “Benihana Inc. Opens 62nd Restaurant, Introducing New Sushi Theme Concept,” Business Wire, July 20, 1998; Richard Gibson, “Restaurants,” Wall Street Journal, June 30, 1998. 28. See Rona Gindin, “Market Segment Report: Casual Theme,” Restaurant Business, 91/17, November 20, 1992, p. 169; Jeffrey A. Trachtenberg, “Planet Hollywood Founder Sees a World of Theme Cafes,” Wall Street Journal, December 13, 1995, p. 4; The Associated Press, “Theme Restaurants Abound,” The Columbian, December 12, 1995; and Deborah Adamson, “’Entertainment’ a Hot Dish Theme Dining Serves Up Some Popular Recipes,” Los Angeles Daily News, February 9, 1998, p. B1. 29. Following Michael E. Porter [Competitive Strategy (New York, NY: Free Press, 1980)] and Adam Brandenburger and Barry Nalebuff [Co-opetition (New York, NY: Doubleday, 1996)], this approach emphasizes the importance of both the suppliers to the firm and the customers of the firm. Suppliers account for the firm’s cost structure, while customers account for the firm’s revenue structure. 30. The business press contains many reports that themed restaurants like Benihana compete to attract customers interested in the “eatertainment” experience, for example. See “Benihana Profits up 35.6% as Same-Store Sales Grow,” Nation’s Restaurant News, 31/45, November 10, 1997, p. 12; Tracy Kolody, “That’s Entertainment Restaurants Are Catering to Diners Who Have a Taste for Fun and Excitement for the Whole Family,” Sun Sentinel, September 22, 1996, p. 1G; David Farkas, “Theme Dreams,” Restaurant Hospitality, 82/1 (January 1998): 36-44. 100 CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 Competition, Strategy, and Business Performance 31. L.A. Gear targeted products at teenagers and young adults, demographic groups famous for shifts in their fashion interests. See “Teen Spending Keeps Climbing,” American Demographics (January 1998). 32. In 1993, Forbes reported that “By 1991, L.A. Gear counted 12 million pairs of shoes in warehouses and only 1.5 million in cash. [New investors brought $100 million to the company in late 1991, and installed a turnaround specialist as president.] . . . Goldston’s first move upon becoming president was to stop inventory from piling up by shutting down production at contract factories overseas for 70 days. . . . Goldston then began a fire sale of excess inventory, a move that further hurt the already soiled brand image, but it gave the company close to $100 million of much needed cash.” Damon Darlin, “Getting Beyond a Market Niche,” Forbes, November 22, 1993, p. 106. 33. L.A. Gear’s Annual Report for 1991 indicates a new strategic direction emphasizing “price and value,” a sign that the company had to lower prices. It introduced a new marketing program intended to “differentiate L.A. Gear from its competition.” 34. For information on lock-in and sunk costs in the U.S. Airline industry, see “The U.S. Airline Industry in 1995” Harvard Business School case 795-113 and “The U.S. Airline Industry in 1995, Teaching Note” Harvard Business School case 799-023. 35. The source for this paragraph is Anita M. McGahan, “Sunrise Medical, Inc.’s Wheelchair Products,” Harvard Business School 9-794-069. 36. Here, “Turnaround” indicates only that the accounting profitability in a business improved significantly over the 1981-1997 period. This definition of “Turnaround” does not imply that good management replaced bad management; indeed, the definition encompasses the possibility that a business is confronted with a dramatic new investment opportunity. 37. CNN’s success in cable news preceded broad investments in other kinds of specialized cable formats, including nature-oriented, weather, sports, and children’s’ channels. 38. Hank Whittemore’s book CNN: The Inside Story (Boston, MA: Little Brown and Company, 1990) describes the long period of investment by Turner in broadcasting, and the kinds of tangible and intangible resources that emerged as a result. The book also describes initial, widespread skepticism about the viability of CNN’s format and the subsequent attempts to imitate the approach after it proved successful. 39. McGahan and Porter (May 1997), op. cit. 40. See Gene N. Landrum, Profiles of Genius (Buffalo, NY: Prometheus Books, 1993), chapter 18, for an account of the skepticism that preceded Turner’s success in broadcasting, as well as Turner’s personal leadership and the accolades that followed the turnaround of CNN. 41. For a detailed framework for analyzing these kinds of asset-development opportunities, see Pankaj Ghemawat, Commitment (NY: Free Press, 1991). 42. McGahan and Porter (July 1997), op. cit. 43. McGahan (July 1998), op. cit. 44. In “What is Strategy?” [Harvard Business Review, 74/6 (November/December 1996): 61-78], Michael Porter made a distinction between operational effectiveness and competitive strategy. His definition of operational effectiveness is used here. 45. Nitin Nohria documents the trend toward networked organizations in “From the M-form to the N-form: Taking Stock of Changes in the Large Industrial Corporation,” Harvard Business School Working Paper 96-054 (June 1996). CALIFORNIA MANAGEMENT REVIEW VOL. 41, NO. 3 SPRING 1999 101
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Running head: ANHEUSER-BUSCH’S PROFITABILITY

Anheuser-Busch's Profitability

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Institutional Affiliation

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ANHEUSER-BUSCH’S PROFITABILITY

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Anheuser-Busch's Profitability

Factors that Contributed To Anheuser-Busch Achieving Leadership in the U.S.
Brewing Industry

Anheuser-Busch leadership in the industry between 1960s and 1990s could be attributed
to the growth of its market since the Prohibition period. In the 1970s, for instance, the per capital
consumption of alcohol was 21 gallons, a record high in the industry. Following the Second
World War, there was a tremendous fall in the number of players in the industry that prompted a
growing phase in large national breweries like Anheuser-Busch. Moreover, the American Can
Company successful canning of beer for the first time contributed to tremendous growth.
Moreover, in the 19...


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