How can your growth strategy evolve faster than the market?

Many companies are setting their strategy against a flawed view of the markets in which they compete.

How sure are CEOs that their current growth strategy will achieve a competitive advantage and sustainable value over the next two to three years?  

In this article, we look at how to understand a company’s true competitive position, how technology is rapidly making current market assumptions outdated and how companies can use market context to drive sustainable growth.

Understanding market context — competitive position is the strongest indicator of potential performance

A market context analysis (such as EY-Parthenon’s Full Potential Paradigm framework) provides a view of the company’s unique position in scale and profitability compared with its competitors, any adjacent segments and new market entrants. Given today’s competitive dynamics, correctly determining market context is difficult. Properly done, though, it largely answers the following critical questions:

• What are the drivers of growth and profitability for the business and industry?
• Is the industry concentrated or fragmented? Is it consolidating or stable?
• Who are the top competitors? Has there been any turnover at the top, and why?
• Which industry boundaries are under attack?
• What is your market position vs. the leader and runner-up? What are the main sources of relative market share change for your business? How are these factors changing?

By answering these questions, you can determine from where growth will likely emanate, and which M&A targets should be pursued to deliver long-term value.

Using market context to illuminate profitable M&A growth opportunities

Once the market context is set and you have defined your own business and competitive positioning, the next step in the FPP construct is to calculate the relative market share (RMS), one of the best predictors of long-term growth and profit potential. RMS growth drives actual profitability. It is certainly more complex in calculation than standard market share (SMS) because it indexes the end market sales of a company’s competitive set through a geometric mean calculation.¹

RMS provides additional insight into the competitive market that SMS lacks. Why is this so important? A growth strategy that is solely focused on increasing revenue is not sustainable. For a properly defined business (based on the market context analysis), profitability is driven by RMS. Companies with high RMS should, with all else being equal, earn more than those with lower RMS. This, in fact, debunks the notion that companies may be “too big to grow.” A high RMS does not limit revenue growth.

To visualize the power of RMS in setting a growth strategy, a diagnostic from our FPP construct is shown below. Here, we set the RMS against the adjusted return on sales (AROS) to help clients establish growth goals around defined margin targets. In addition, we evaluate specific M&A opportunities to reach these goals.

The Normative Band Diagnostic shows the relationship between which company has the strongest competitive position in the market on the x-axis (the RMS calculation) vs. how they are performing from a profitability perspective on the y-axis (adjusted return on sales - AROS). For each industry, there is a unique normative band sloping up across the chart with a lower band of 20th percentile performance and an upper band of 80th percentile performance.

Using this normative band, companies can determine if profitability is on track (at the 80th percentile, e.g., Company A), outperforming (above the 80th percentile, e.g., Company B), underperforming (below the 80th percentile but above the 20th percentile, e.g., Company C) or a potential candidate to exit the industry (below the 20th percentile, e.g., Company D).

The above chart illustrates the multiple options a company can perceive to improve its market position. Company A can move up and gain more profitability or it can move to the right to achieve a greater relative market share, which should allow a later conversion to higher profitability. Using this type of analysis, a company can evaluate which levers it can pull to affect profitability, including M&A. If M&A is the chosen route, it can then better evaluate to what extent specific M&A opportunities meet the deal rationale needed to drive a company’s competitive advantage and deliver profitable growth and long-term value.

The above chart looks at a sample industry and the companies within it. Each company has a unique perspective and, therefore, a unique set of options it can pursue to achieve profitable growth.

• Company A: If it is content with its current market position, leadership can adjust internally to target 80% performance at the current RMS to achieve optimal profitability (moving the center of the bubble up so that it aligns with the 80th percentile).
•  Company B: It has the highest RMS, and perhaps achieved this by dropping prices. This can be risky as profitability will drop in the short term to gain this additional market share. The company must make sure it takes full advantage of its RMS to help regain profitability.
• Company C: It could gain RMS by acquiring a near or direct competitor, such as Company D, in hopes of both increasing RMS and taking advantage of Company D’s high profitability.
• Company D: If the above happens, diligence is important as Company D could be highly profitable at the fault of letting its R&D program wither, thus halting innovation. Or, it could have great leadership that manages profitability well. In turn, this could introduce a mindset and culture of efficiency that, if integrated properly, could boost the profitability of Company C. Each of these scenarios in Figure 3 addresses the need to gain more relative market share or improve AROS. In this example, Company C and Company D could use the analysis to identify specific M&A targets to accelerate the path to increased RMS and profitability.

It is essential for executives to determine where their own company fits on the normative band in relation to its competitors in order to make thoughtful strategic growth decisions.

Aligning M&A with strategy can help deliver long-term value

With disruption front and center across most industries, it is difficult to pinpoint growth goals with confidence. Organic growth, while an important factor, is often not enough to make a timely and significant business impact. M&A is required to help make up the difference. Understanding market context is critical in evaluating where market power lies in your industry, and how that impacts your business and acquisition opportunities to deliver long-term, profitable growth.