Every game is different, and every game has its own rules.
The very first rule—the most fundamental and the most often abused—is business definition.
How many times have you heard a company say, “We’re not in the X business (where X is something profitable, stable, and dull), we’re in the Y business (where Y is something new, growthy, and exciting).”
“We’re not in the ball bearings business; we’re in the global frictionless mobility solutions business.” Says who?
The limits of a properly defined business are demarcated by the places where economic leverage begins and ends.
Define a business too broadly and you will assume that you have the ability to compete in places where you will, in fact, get crushed; define it too narrowly and you will miss out not only on opportunities for profit, but also opportunities to gain scale and other forms of leverage that are critical to your business.
That’s why we sometimes say that business boundaries are discovered, not defined; you discover where they are when you run into them, the way Wile E. Coyote belatedly discovers the laws of gravity shortly after he runs off a cliff.
Correct business definition comes from understanding both the scope and the limits of cost, capability, and customer sharing between products and market segments.
Here’s our favorite example: outboard motors. You may have seen this before, but there’s no harm in a refresher. In a correctly defined business, there is generally a strong relationship between relative market share and profitability. But take a look at this:
Why is the relationship broken here?
Because an outboard motor is just one kind of small motor. OMC originally stood for Outboard Motor Company—that’s all they did. Yamaha makes many different kinds of small motors, including for motorbikes and lawnmowers. That allowed Yamaha to move down the experience curve of small motor manufacturing much faster than OMC, lowering their manufacturing costs and increasing their margins.
The correct business definition in this case was not outboard motors, but small motors. Once you account for that, the picture makes sense.
Decades later, Netflix pulled off one of the most successful corporate reinventions ever when they successfully pivoted from the physical distribution of DVDs to the production and distribution of digital content, but not before they nearly snatched defeat from the jaws of victory by misunderstanding the basics of business definition.
The costs and capabilities of the two activities were, indeed, different, but the customer sharing turned out to be almost complete.
The right answer was not to split the company, but rather to have one face to the customer and two operationally distinct supply chains—one focused on the logistics of distributing physical DVDs and the other focused on the production and distribution of digital content. After losing 1 million subscribers and about two-thirds of their market cap, they were forced to reverse course.
We should note in passing that business definitions can evolve over time because markets, customers, competitors, regulations, and technology all keep moving.
The critical takeaway here is that getting the business definition right is foundational to good strategy. Without it you cannot meaningfully discuss the concepts that follow.
A hallmark of correctly defined businesses is that the leader in those businesses has superior economics. Our analysis of 320 companies across 45 markets worldwide shows that in most correctly defined markets, one or two players capture 80% of the economic profit.
That’s why it’s good to be the leader. A market leader has the opportunity to reinvest their profits in order to extend their leadership and bolster the sustainability of their earnings into the future. Sometimes they can even use their superior resources to change the rules of the game to their advantage.
But leadership economics don’t accrue by default. This defines the paradox of leadership: The more strongly positioned a business is, the more likely it is to be operating below its full potential. Management teams must actively work to avoid the trap of “satisfactory underperformance.”
In most markets, the top two or three players capture all of the real economic value, leaving the rest with nothing. This means that if you are a follower the most fundamental strategic question you face is: Can we become the leader?
If there is a path to leadership, you have to take it; when you get there, you have to keep pushing. Don’t settle for being better when being the absolute best is within reach.
If there is no viable path to leadership, then you must either exploit the rules of the game (e.g., by finding a form of differentiation that overcomes your disadvantages of scale), or you must change the rules of the game (i.e., become a disrupter). There’s often good money to be made following these strategies, in part because so many leaders are complacent.
Let others work in service of satisfactory underperformance; at Bain, we believe strategy is about unlocking the path to full potential.
When asked why he robbed banks, Willie Sutton replied, “Because that’s where the money is.”
For similar reasons, all good strategy projects take the (often considerable) time and effort to do two things: 1) map the current state of the industry profit pool and 2) model out plausible scenarios showing how those profit pools may evolve over time.
Mapping the profit pool—the total economic profit earned at each step of the value chain—requires first that you get the business definition correct.
Figuring out how the profit pool might evolve requires the use of tools like e-curves and s-curves, which allow you to model many variables with a reasonable degree of confidence over the near-to-medium term and sometimes even longer.
Here’s an example—an oldie, but a goodie.
Kodak was not, as many believe, “blindsided” by the advent of digital photography; in fact, by doing e-curve analysis in the early 1990s, Kodak was able to more or less correctly predict the year in which digital photography would overtake traditional film.
Why they failed to act on this insight is a long story, one that hinges in part on culture and in part on the natural reluctance to cannibalize one’s own cash cow. Here’s a look at how the photography profit pool evolved from 1995 to 2005.
Notice anything surprising? The profit pool actually got bigger after digital photography took over. The problem for Kodak was that the profit pool shifted from film manufacture and processing to memory cards.
In other words, the business definition changed; the relevant unit of experience went from millions of feet of film manufactured to millions of gigabytes of memory produced. That’s why SanDisk, which makes memory cards for a vast array of applications beyond photography, ended up making most of the money in the digital photography business.
What might cause a similar disruption in your industry? Think about the factors beyond your control that might impact your business over the next five years. To name just five: economic uncertainty, global conflict, trade disruptions, climate change, and AI.
In the face of turbulence, you have to model what you can using the tools at your disposal, then use scenarios and sensitivities to capture remaining uncertainty where it matters.
This will allow you to construct a resilient portfolio of choices: a core set of bold, no regrets moves that make sense under any scenario, plus a handful of bets that will pay off more or less depending on how the future unfolds.
In addition, you must recognize that if change is a constant, then adaptability is non-negotiable: Your strategy must provide enough clarity for the organization to execute while preserving the flexibility to anticipate and respond to changing circumstances.