Growth Science International, LLC

A MICRO-EXPERIMENT

Framework in Question: Pursuing “adjacent” markets increases the likelihood of new business success.

Framework Background: The bestseller Profit from the Core; Growth Strategy in an Era of Turbulence (Allen & Zook) asserts that, in order to grow, corporations should (1) define their “core business,” and then (2) limit new growth businesses to those that are “adjacent” to that core business.  More specifically, adjacency expansion is defined as a firm’s migration into related businesses that utilize and, usually, reinforce the strength of the profitable core.  The book cautions against attempting to start new businesses that are too far removed from a core business.  Stick close to your knitting.

Entrepreneurs are less likely to succeed in businesses they know nothing about.  This is not in dispute.  It makes sense to start new businesses that have something to do with one’s general expertise.  However it is quite another thing to assert that adjacencies are in any way predictive of greater success.  In other words, can we predict that adjacencies will be more likely to survive than non-adjacencies?  It it a meaningful distinction?

To begin answering this question, adjacencies must first be defined.  Profit from the Core classifies the most common “adjacencies” as:

• Interlocking customer and product adjacencies (find new customers for your existing offerings, and then adapt your offering to those new customers.  Said to be the most common adjacency.)
• Share-of-wallet adjacencies (selling highly related offerings to customers you know intimately.  ex. American Express expanding from credit cards to credit insurance, travel insurance, life insurance.  Said to have the highest success rate of adjacencies.)
• Capability adjacencies (use known expertise or resources to start other related businesses.  Ex. Motorola using its understanding of ‘walkie-talkie’ wireless electronics to expand into pagers, home radios and cell phones.)
• Network adjacencies (where networks are at play, expand your network of offerings and customers.  Ex. Vodafone’s acquisition of AirTouch.)
• New-to-the-world adjacencies[1] (Take advantage of new, uninhabited opportunities that arise as industries change and future markets develop.)

Examples of non-adjacent growth efforts are provided, such as Motorola’s expansion from wireless electronics into eight track tape players and push button gasoline car heaters (both of which failed).

Our Analysis: To test the predictive relevance of adjacencies a sample was created consisting of more than 50 new business efforts (BUs) funded within a single multi-billion dollar parent company (Parent) throughout a 13-year period.  All BUs were organized within the Parent, not as joint-ventures or subsidiaries.  Each BU was classified as “core,” “adjacency” or “non-adjacency” using best efforts to follow the guidelines set forth by Profit from the Core.

Our classification scheme was as follows:

Core = an existing mainstream businesses of the Parent company.  For example, Motorola launching a new cell phone in 2010 would be considered a “core” innovation.

Adjacency = a new offering related to the core business.  For example, when Motorola (initially a maker of wireless ‘walkie-talkies’) first entered the cell phone and pager businesses.

Non-Adjacency = a new offering that was not related to the core businesses.  For example, when Motorola attempted to commercialize eight track tape players and push button gasoline car heaters.

After classifying each BU, the data set was probed for statistical correlation between the given categorization scheme and the ultimate survival or failure of each BU.

Conclusion 1:  Highly subjective. The classification scheme set forth by Profit from the Core was highly subjective.  The distinctions were extremely porous.  Guidelines were vague, ambiguous and highly susceptible to Socratic interpretation.

With enough argument and creativity, a wide range of new businesses can be contradictorily classified as either core, adjacencies or non-adjacencies.  In-depth discussions between multiple individuals seldom achieved consensus regarding what was “core,” “adjacent” or “non-adjacent.”  Confounding the issue, support for each conflicting view could almost always be found within the text itself.

For example, Profit from the Core itself lists Motorola’s attempt to sell eight track tape players as a non-adjacency.  However, around the time of its eight track effort, Motorola’s founder Paul Galvin defined his firm as an “electronics company.”  Don’t eight track players fall under the umbrella of “electronics”?  Why weren’t they “adjacent”?

Meanwhile Motorola’s entrance into orbiting satellites is listed as an adjacency, stating that Motorola’s core was not truly “electronics,” but “wireless electronics.”  In hindsight, this addition of a “wireless” precondition to Motorola’s core would explain the book’s inclusion of satellites as adjacent, precluding eight track players.  However “adjacencies” are of little practical value if hindsight is required to define them.

The examples surrounding Motorola also reach contradictory real-world outcomes.  Motorola’s “adjacent” satellite businesses went bankrupt, while non-adjacent businesses (i.e. ‘non-wireless’) grew steadily for extended periods of time (ex. Motorola’s home set-top-box business).  Even hindsight can provide poor guidance for defining a firm’s core or adjacencies in this model.

Conclusion 2:  Not predictive. There was no statistically significant correlation between the core/adjacency/non-adjacency BUs in our sample and their likelihood of survival or failure.  It was not predictive.

However the experiment exhibited stark contrast between “core” and all other efforts.  While only representing around 15% of the total sample, “core” businesses survived more often than they failed (over 60% survival rate).  However both adjacencies and non-adjacencies failed more than 90% of the time.

Summary:

It makes sense to know something about the business you are in.  No argument there.  However our results suggest that dividing the world into core/adjacency/non-adjacency categories for innovation does not make one more or less likely to succeed.  A far more probative (albeit still incomplete) categorization scheme seems to be simply “core” and “non-core.”  The notion of adjacencies was loosely defined and too readily misleading.

This is not to assert that firms should only fund “core” businesses.  Nor does it imply that businesses should go to another extreme of funding any random new idea they come across.  Rather, reliable decision tools begin with observed data, upon which categorization schemes are built to make sense of what is being observed, followed by empirical processes to test validity.  How we look at the world determines what we see.  In the case of Profit from the Core, the “adjacency” categorization scheme was highly subjective in practice, and failed to prove empirically meaningful.  Another way of explaining the world is needed.  Back to the drawing board.

“Adjacencies” were not significantly predictive of business survival or failure.  While offering several quality, generic business considerations, Zook & Allen’s model failed to produce empirically relevant answers.  Evaluating businesses by virtue of their proximity to a core may seem intuitively logical, however the empirical value amounted to little more than myth.

Sources:

1.  Allen & Zook, Profit from the Core; Growth Strategy in an Era of Turbulence, Harvard Business School Press (2001)