economy - American · PDF file · 2003-09-02a given period; SVC reﬂects the value created for all shareholders—an important distinction when companies issue substantial numbers

The winner-takes-all

David Campbell is a principal in McKinsey’s Dallas office, and Ron Hulme is a director in the Houstonoffice. Copyright © 2001 McKinsey & Company. All rights reserved.

striking performance gap is appearing throughout global equity markets. In industry after industry, spanning both the new and the

old economies, a small set of companies is creating almost all of the newshareholder value. Simultaneously, the value of their less successful competi-tors is actually declining, and to an unprecedented degree.

82

David Campbell and Ron Hulme

Across industries and nations, a select few companies are creating almostall of the new shareholder value. Atomization is driving their success.

A

economy

BRAD YEO

26612-PR (082-093)Winner t.a. 1/8/01 2:48 PM Page 82

The polarization of winners and underperformers is intensifying. Once, achief executive officer could claim that the performance of the industry, notthe company, was the prime mover for stock prices. But with the advance ofglobalization and technology, companies whose products or service modelshave the slightest edge over the competition can quickly exploit that advan-tage. Investors are scrutinizing companies one by one, screening out thosewith merely average performance and investing the bulk of their money withthe top one or two players in each arena. This phenomenon has created a“winner-takes-all” dynamic in which 5 to 10 percent of the companies in agiven industry create all of the shareholder value.

In most industries, the new winners are “atomizers,” which focus on narrowindustry segments where they can achieve a dominant position, even thoughthey may hold only a small fraction of the assets or revenues in their indus-tries. Some of the atomizers are first-to-scale newcomers, which capitalize onwholly new markets that are usually created by technological discontinuities.Others are attackers, which extract value at the expense of industry incum-bents. Both types of atomizer launch and expand focused businesses thatcapture returns highly disproportionate to their size.

83


This new model is, of course, in stark contrast to the old scale-driven notionsof successful corporate strategy. But the evidence is compelling: size, scope,cost economies, and vertical integration are much less important than theyused to be. In this brave new world, the evidence suggests, start-ups andattackers are capturing the lion’s share of value. Nevertheless, several largeincumbents, including Enron, IBM, Nokia, and Texas Instruments (TI), havetransformed themselves and emerged as winners.

A bull market or a few good bulls?

Stock market observers have described the past few years as history’s biggestbull market. Yet in reality, just a few very successful companies have poweredit. Between 1985 and 1995, the median S&P 500 company closely trackedthe mean performance of the index: that is, about half of the companies performed above the average and half below it. But in the latter half of the

1990s, the situationchanged dramatically.While the overall S&P500 delivered annualreturns of 26 percent,more than half of thecompanies in the indexaveraged less than 15percent, with medianreturns falling below 0 percent in 1999 and2000. In other words, a few strong bulls liftedthe overall market to a rate of return nearlydouble that of themedian company.

Comparing the results of the top and bottom 10 percent of the 1,000 largestglobal companies traded in the United States further illustrates this divergence(Exhibit 1). Through 1997, the results were fairly stable: the top decile aver-aged a return of roughly 95 percent, the bottom decile a negative 26 percent.That picture began to change dramatically in 1998. By 1999 or 2000, compa-nies had to triple their stock price to make the top 10 percent. The laggardsfell further behind.

Measuring shareholder value creation

Because company size can skew comparisons of percentage returns, we havemeasured performance in terms of absolute dollars, using a metric we call

84 THE McKINSEY QUARTERLY 2001 NUMBER 1

E X H I B I T 1

The widening performance gap

1Weighted average of 1,000 largest global companies traded publicly in the United States, including200 non-US companies that trade in ADRs (American depository receipts).

2Annualized for 2000 as of September 30, 2000.Source: Compustat; McKinsey analysis

Total returns to shareholders, percent1

∏100

∏50

0

50

100

150

200

250

300

350

400

1989–94 1995 200021999199819971996

Winners: companiesin top 10%

Losers: companiesin bottom 10%


shareholder value creation, or SVC (see sidebar, “Calculating shareholdervalue creation”). Compared with the more conventional metric—totalreturns to shareholders (TRS)—SVC has three key advantages. First, as wehave noted, it measures economic impact in terms of absolute dollars, thusmaking it possible for us to compare companies of different sizes. Second,TRS reflects only the returns to shareholders who hold a stock throughout

85T H E W I N N E R - TA K E S - A L L E C O N O M Y

To compare the relative performance of compa-

nies, we have developed a metric called share-

holder value creation (SVC). The exhibit, using

AT&T, Corning, and Morgan Stanley Dean Witter

(MSDW) as examples, illustrates the methodology

for calculating SVC.

We start with the overall change in equity market

value and then make several adjustments to

determine SVC. First, we subtract required per-

formance, defined as shareholder returns relative

to the beta-adjusted S&P 500 index. This mea-

sure reflects an opportunity cost against which

investors generally benchmark performance.

(Everyone, after all, has the low-cost investment

option of buying an index fund.) AT&T started as

a very large company, so its shareholders would

reasonably have expected it to expand its market

capitalization by $190 billion just to stay even

with the market on a risk-adjusted basis. That

$190 billion should not be counted as part of

AT&T’s SVC.

The next adjustment involves share issuance,

which accounts for much of AT&T’s increase in

market value, reflecting the impact of large

acquisitions. Finally, we adjust for dividends

and share buybacks. AT&T returned substantial

cash to shareholders over the period. It must be

credited for delivering this value.

Thus, though the three companies enjoyed a

comparable overall increase in their equity values,

their SVCs varied dramatically. AT&T, which

increased its total market capitalization by the

largest amount, destroyed over $200 billion in

value. In contrast, Corning and MSDW both deliv-

ered tremendous value for their shareholders.

Calculating shareholder value creation

E X H I B I T

Calculating shareholder value creation

Shareholder value creation, January 1, 1995, to September 30, 2000, $ billion

1The required return is calculated by compounding each company’s initial equity market value by the beta-adjusted market index return;the same adjustment is made for share issuances, dividends, and spin-offs, starting on the issue date.

Source: Compustat; McKinsey analysis

Required returnon initial

equity marketcapitalization1

Changein market

capitalization

Shareissuances1

Dividends,share buybacks,

spin-offs1∏ + Shareholder

value creation=∏

AT&T

Corning

Morgan StanleyDean Witter

118 190 ∏$202 billion84214

80 16 $60 billion59

98 14 339 $48 billion


a given period; SVC reflects the value created for all shareholders—animportant distinction when companies issue substantial numbers of sharesfor M&A or other purposes. Third, our central thesis—the winner-takes-alldynamic—emphasizes the importance of specialization, but SVC inherently

favors large companies.By creating a biascounter to our thesis,the SVC metric tests itmore rigorously.

The SVC results for the 1,000 global com-panies are staggering(Exhibit 2). Of thecompanies in thesample, we defined the biggest winners as those achieving value gains of morethan $10 billion each.

Only 13 percent of the companies were among these winners, but they cre-ated $4.7 trillion in value for their shareholders. At the other extreme, the 15 percent of the companies categorized as big losers —defined as those thatlost more than $10 billion in SVC—delivered an equally stunning result bydestroying more than $4.2 trillion.

A universal effect

This bifurcation in performance has occurred roughly proportionally acrossmost industries, in both the old and the new economies. Even the most problematic of sectors, such as banking and energy, have had big winners.Citigroup, for example, created $129 billion in SVC over the past five years,while ExxonMobil created $59 billion. Meanwhile, even the best-performingsectors, including telecommunications and computers, include big underper-formers. AT&T and EDS, for instance, lost $202 billion and more than $38 billion, respectively, over the same period. Clearly, not all boats haverisen or fallen with the industry tide.

The large number of big winners and big underperformers represents a sub-stantial change from the picture only five years ago. Of the global 1,000 com-panies, 28 percent created or lost more than $10 billion in value from 1995to June 2000, up from only 3 percent in the 1990–94 period. Even afterindexing the $10 billion hurdle for the rise in the market’s overall value, thenumber of big winners and underperformers has more than doubled.


E X H I B I T 2

Winners and losers

Percent ofsample2

13

34

15

38

Shareholder value createdor destroyed,1 $ trillion

Biggest winners(>$10 billion in gains)

All otherwinners

Biggest losers(>$10 billion in losses)

All otherlosers

4.7

1.0

∏4.2

∏1.3

1January 1, 1995, to September 30, 2000.2Sample includes 1,000 largest global companies traded publicly in the United States, including 200non-US companies that trade in ADRs (American depository receipts).

Source: Compustat; McKinsey analysis


These results greatly raise the stakes for the affected companies. Activistinvestors and boards are more and more willing to replace chief executiveofficers of underperforming companies, which often become targets fortakeover. Winners gain a place on everyone’s most-admired list, the ability to fund acquisitions, and, in the United States, an average of $1 billion to $2 billion in stock options to reward managers and attract their promisingnew talent.

More than irrational exuberance

It is fair to question whether the increasingly polarized capital marketsreflect the economy’s underlying performance. Are stock market returnsmerely the product of what the USFederal Reserve Board’s chairman,Alan Greenspan, dubbed the “irra-tional exuberance” of investors?

Perhaps not. The winning companiesin our sample delivered superioroperating results along with superiorstock market returns, suggesting that the winner-takes-all phenomenon also characterizes underlying performance. A comparison between the bigwinners and the big underperformers provides compelling evidence. Duringthe first half of the 1990s, annual earnings for both groups rose by 8 per-cent. During the second half, though, the winners’ annual earnings rose by25 percent but the underperformers’ by only 13 percent. During the first half of the decade, the two groups’ return on equity (ROE) differed modestly:19 percent for the winners, 17 percent for the underperformers. But in thelatter half, the big winners achieved incremental ROEs of 32 percent, farabove the 20 percent for the underperformers.

The winner-takes-all concept

Economists have long described winner-takes-all markets in which small differences in performance lead to big differences in rewards. Such marketsinclude those for star entertainers and athletes. Julia Roberts and TigerWoods, for example, make vastly more than average members of the ScreenActors Guild and the Professional Golfers’ Association, respectively, make.By contrast, in business small differences in performance have traditionallygenerated only small differences in rewards. But the situation is currentlychanging. Notable examples over the past decade include the outsized per-formance generated by single product lines such as Microsoft’s Windowsoperating systems, Intel’s microprocessors, and Nokia’s mobile telephones.Now this dynamic is spreading to other sectors.


Are stock market returns actuallythe product of what Fed ChairmanAlan Greenspan called investors’mere ‘irrational exuberance’?


Most likely, the gap between winners and underperformers will continue towiden. In this new economic landscape, companies that are not the very bestat what they do will not create value, even if they have the foresight or goodfortune to pick attractive industry segments.

Atomize to win

The vast majority of the new winners are atomizers. But many CEOs, sup-ported by the teachings of leading business schools and consultants, stillembrace traditional scale-based notions of successful corporate strategy.These traditional ideas are based on several core tenets: seek to be the

biggest player in the industry, withthe largest market share; maintain a strong balance sheet; establish alow-cost position; integrate verticallyto capture incremental value and tocontrol key channels; and pursueindustry consolidation to captureadditional scale and scopeeconomies.

Unfortunately, this “industry leader-ship” model no longer works—atleast if success is measured in termsof shareholder value. Consider thecontrast between scale and SVC for the US companies in the global1,000 (Exhibit 3). The Fortune 100represents the 100 largest of thesecompanies, ranked by revenue. They

generated over half of the revenues in our sample but only 6 percent of theSVC. By comparison, companies too small to make the Fortune 500 gener-ated only 10 percent of revenues but two-thirds of the SVC. In other words,small companies created more than 65 times as much shareholder value relative to their size.

Has the winner-takes-all economy erased the advantages of being thebiggest? So it would seem.1 Plummeting interaction costs, driven down bynew computing and communications technologies, make it possible for com-panies to specialize more than ever before. New entrants thus find it mucheasier to cherry-pick the most attractive products, channels, and customers.


1For a further discussion of the forces driving the new economy, see Lowell Bryan, Jane Fraser, JeremyOppenheim, and Wilhelm Rall, Race for the World: Strategies to Build a Great Global Firm, Boston,Massachusetts: Harvard Business School Press, 1999.

E X H I B I T 3

Big value in small packages

Percent1

1Sample includes 1,000 largest global companies traded publicly in the UnitedStates; non-US companies excluded from both revenue and shareholder-value-creation calculations.

2January 1, 1995, to September 30, 2000.Source: Compustat; McKinsey analysis

10

33

57

69

6

25

Fortune 100

Fortune 101–500

Smaller thanFortune 500

$6.0trillion

$1.5trillion100% =

Revenues2 Shareholdervalue creation2


This sea change, complemented by the emergence of global standards andprotocols, has helped specialized players achieve dramatic growth and globalscale rapidly, even in narrow market “slivers.”

Meanwhile, the increased availability and mobility of capital have dimin-ished the corporation’s role as a financial-portfolio manager. For companieswith a winning idea, access to capital is almost never a problem, so they canscale up quickly. At the same time, investors can more easily diversify risksand generally prefer pure-play companies to broad-scope ones. In addition,barriers that once protected large incumbents have crumbled under waves of deregulation, privatization, and new intermediary markets.

Two breeds of atomizer

Most successful atomizers deploy one of two strategies. First-to-scale new-comers typically take the lead in new markets. In more established indus-tries, by contrast, attackers win by extracting value from their stodgiercounterparts.

First-to-scale newcomers. The predominant atomizers in most high-techarenas are first-to-scale newcomers, which capitalize on technological dis-continuities by launching focused start-ups in new market spaces. Those thatscale up rapidly can achieve an insurmountable lead over competitors—oftenincumbents that saw the same opportunities and had a better position toexploit them but didn’t mobilize fast enough.

The US telecommunications and data communications industry providesmany good examples. Only five years ago, it was dominated by a handful oflarge players such as AT&T, the regional Bell operating companies (RBOCs),GTE, and MCI. These established players saw the discontinuities that wouldbe created by the Internet and mobile communications, and they launched a slew of initiatives to extend their reach beyond voice-based telephony. With few exceptions, however, they ceded the industry’s SVC to newcomers.Eighteen US telecom companies have achieved SVC above $10 billion overthe past five years, but they include only two of what in 1995 were the tenlargest players: BellSouth and Sprint.

Not surprisingly, the other 16 winners were first-to-scale newcomers that staked out attractive slivers. Juniper Networks, for example, created$51 billion of SVC by focusing on high-end routers for long-haul data trans-port. Qualcomm (next-generation wireless technology) created $25 billion. JDS Uniphase (fiber-optic equipment) captured $71 billion. Other winnersincluded Level 3 in backbone wholesaling ($17 billion SVC), Exodus in Webhosting ($15 billion), and Sycamore in optical networking ($25 billion).



Collectively, the 16 atomizers created more than $600 billion of SVC whileAT&T and the RBOCs were losing more than $200 billion.

Similarly, newcomers dominated the computer hardware and services indus-try: EMC (data storage) created $182 billion of SVC; Texas Instruments(mostly digital signal processors), $40 billion; and Applied Materials (wafer-manufacturing equipment), $23 billion. In the software and Internet servicesindustries, almost all of the big winners have been focused, first-to-scale

atomizers, such as Ariba ($28 bil-lion SVC), eBay ($17 billion), i2Technologies ($27 billion), SiebelSystems ($39 billion), and Yahoo!($22 billion).

Attackers. In more traditional indus-tries, such as banking, energy, and

retailing, the predominant atomizers are attackers that prey on incumbentplayers. Typically, these industries have not experienced the technological discontinuities necessary for start-ups to succeed as first-to-scale newcomers.Instead, industry attackers thrive by building a better business model andchallenging the status quo.

Consider Enron, which created $38 billion of SVC in an energy industrythat as a whole destroyed value. Enron has built a reputation as one of theworld’s most innovative companies by attacking and atomizing traditionalindustry structures—first in natural gas and later in such diverse businessesas electric power, Internet bandwidth, and pulp and paper. In each case,Enron focused on the business sliver of intermediation while avoiding theincumbency problems created by a large asset base and vertical integration.Enron no longer produces oil and gas in the United States, no longer ownsan electric utility, and has never held a large investment in telecom networks.Yet it is a leading value creator in each of these industries.

Or take Dell Computer, which created $73 billion of SVC by successfullyattacking in the personal-computer market. Competitors such as Hewlett-Packard and IBM were at first reluctant to match Dell’s direct-sales model,for fear of antagonizing their traditional channels: dealers and sales forces.They were also slow to match Dell’s low prices, which ultimately turned PCs into commodities. Dell capitalized on its early lead to build an insur-mountable supply chain advantage and an extremely strong and loyal cus-tomer franchise.

Charles Schwab first attacked in the brokerage industry with deeply dis-counted commissions. It then upped the ante and cannibalized its own


Collectively, the 16 atomizerscreated more than $600 billion ofSVC while AT&T and the RBOCswere losing more than $200 billion


business model to become the leading on-line brokerage. Schwab enjoys amarket-to-book ratio that is five times the industry average. The companycreated $34 billion of SVC, despite competing in a banking industry thathad a negative SVC.

Many dot-com companies also are attackers, hoping to create new Internet-enabled business models that will allow them to extract value from incum-bents. Despite the NASDAQ correction in 2000, several dot-com attackers,including Amazon.com, Inktomi, and RealNetworks, were able to create significant SVC.

Implications for incumbents

What does this winner-takes-all dynamic mean for the large, integrated cor-porations that still generate most of the revenue, employ most of the people,and deploy most of the capital in the economy? How can these corporationsovercome an increasingly competitive global economy and skeptical capitalmarkets to secure a place in the winner’s bracket?

Pick your race

In an atomized world where attackers enjoy large advantages, focus is critical.Jack Welch aside, this arena has very few successful decathletes, for broad-based companies are very vulnerable to attackers. Furthermore, in most com-panies, a scarcity of managerial and technical talent limits the number ofwinnable races to, at best, two or three. Large incumbents need to pick theirraces carefully by focusing on the market slivers in which they have, or canbuild, a leading global position. They will have to divest everything else.

Some leading players have already demonstrated the merits of this approach.By the early 1990s, IBM had fallen from its status as the leading light of US capital markets and become a laggard facing stiff competition. IBMresponded by shedding several large businesses, ultimately reducing its bookvalue by half—a move that many analysts viewed as a retrenchment border-ing on liquidation. But in the mid-1990s, IBM began to build businesses. It acquired two software companies, Lotus and Tivoli, and dramaticallyincreased the revenues of its Global Services business, which became theengine of its turnaround. By 2000, IBM had created $80 billion in SVC.

Texas Instruments, through the early 1990s, was a moderately performingconglomerate comprising semiconductors, defense systems, and other businesses. In the middle of the decade, TI’s leadership decided to bet the company on a single product line: digital signal processors. TI sold its defense business to Raytheon, sold off or closed down several lines of



semiconductors, and invested billions in its chosen segment. These movesproved extraordinarily successful: TI positioned itself at the center of thewireless digital revolution and created $40 billion in SVC.

Overcome the incumbent’s curse

Picking the right race is only part of the battle. It is crucial to address theproblems that generally make traditional companies lag behind start-ups inbuilding businesses. After all, incumbents start out with industry expertise,established brand names, up-to-date technology, and, in many cases, the verysame people who later leave them to direct the management teams of success-ful start-ups. Why then have incumbents fared so poorly? In general, fourchallenges combine to create what we call the incumbent’s curse. To becomea winner, established companies must address these challenges head on:

1. Start-ups, with their “get rich or go broke” mentality, attract entrepre-neurial talent by providing incentives that few incumbents are willing or able to match. Incumbents must raise the ante in the war for talent.

2. Incumbents naturally face pressure to keep the best people in today’s most important jobs, where they manage billions in revenue and thou-sands of employees, rather than transferring them to new growth ventureswith few if any employees, revenues, or profits. In most large companies,smaller and newer business ventures tend to be run by mid-level man-agers. But an attacker directed by an entrepreneurial CEO and a highlymotivated leadership team will almost always win the fight against themiddle management of a large corporation.

3. Attackers have everything to gain and nothing to lose. Incumbents mustadopt a comparable ruthlessness and be willing to cannibalize core busi-ness models, customer relationships, and brands.

4. Attackers benefit from initial-public-offering mania, while mature compa-nies with no track record in building new businesses are often “guilty untilproved innocent.” This phenomenon impedes the incumbents’ ability tofinance dilutive ventures, to attract talent, and to form key partnerships.

Is it possible to adopt a new-business-building mind-set and overcome theincumbent’s curse? Once again, Enron provides an example of success. Overthe past ten years, the company has built at least five major wholly ownedgreenfield businesses, which collectively provide more than 90 percent of its market capitalization. In achieving this track record, the company hasdirectly attacked all four dimensions of the incumbent’s curse. It has regu-larly deployed its top talent in new start-ups and provided these managers



with entrepreneurlike incentives: when Enron launched its broadband busi-ness in 1999, for example, it reassigned the top two executives of its largestbusiness unit, and its corporate president devoted 80 percent of his time torunning the new company. Enron also proved its willingness to cannibalizeits core business by launching an on-line gas and power site that discloses, inreal time, the prices at which it is prepared to buy and sell.

Just as important, Enron has convinced Wall Street of the favorable long-term prospects of its new businesses;about half of its current market cap is attributable to businesses that have yet to generate annual earnings. As a result of this persuasiveness, Enron trades at a price-to-earnings ratio of 60, in contrast to an industry aver-age of 14. A few other companies—for instance, IBM,Nokia, and TI—have also succeeded with a go-it-alone model for buildingnew businesses. However, the short list of successful examples shows justhow hard it is to succeed at building businesses organically.

Another way of addressing the incumbent’s curse is to spin off new growthinitiatives as independent ventures. For most companies, this is the bestchoice, and the almost daily announcements of spin-off plans demonstrateits popularity. Notable examples include NTT’s DoCoMo, Telefónica’s TerraNetworks, and Wal-Mart’s joint venture with Accel Partners.

No matter which option fits best, success at building businesses will con-tinue to be the primary driver of breakout shareholder returns. Incumbentcompanies that hope to win against focused new entrants dedicated exclu-sively to business building must expend disproportionate energy on over-coming the incumbent’s curse.

Today’s winner-takes-all capital markets signal a new era. Determined com-panies that build focused businesses in atomized market slivers will capturemost shareholder value; those that fail to do so will fall far behind. Thisenvironment poses tremendous challenges and tremendous opportunities. To be the world’s best in a broad set of markets is almost impossible. By contrast, successful niche strategies, scalable as never before, will generatetens or even hundreds of billions of dollars of value for shareholders. Therisks and rewards of corporate strategy have never been greater.



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economy - American · PDF file · 2003-09-02a given period; SVC reﬂects the value created for all shareholders—an important distinction when companies issue substantial numbers