A study by MIT Sloan revealed that only one in six companies like Apple and Amazon attained Sustainable Competitive Advantage over five years by outperforming their competitors on a continuous basis.
A firm creates value through competitive advantage by lowering the buyer’s cost or increasing the product utility. Preserving or sustaining the competitive advantage is the main objective of all firms. It is, however, not easy to sustain one’s competitive advantage for extended periods of time. Strategy is all about defying averages and managing something exceptional which in turn enables the company to earn exceptional rewards from the marketplace. It would be of interest to find out how long companies sustain their competitive advantage and superior performance. A study undertaken by MIT Management Sloan (2020) analyzed the persistence of superior performance by tracking the long-term performance of companies. The study analyzed the data to determine whether top performers could sustain their position in the industry.
The performance of 22,000 companies was tracked over four decades. Top performers were identified as companies with an average annual Total Shareholder Return (TSR) in the top quintile for their sector in the trailing five years of a ten-year period. All companies had inflation-adjusted revenue of more than $50 million at the start of the 10-year analysis period. The top and bottom 5% of outliers were winsorized to remove impact of outliers.
The research revealed that strong performance encompassing a wide range of metrics has become difficult to sustain over a period of time. Market leaders find it more difficult to retain their leadership. The study attempted to measure the persistence of performance. Take the example of a company with an annual TSR which was 20% higher than the sector average. If that company faces a 50% decay rate, its performance advantage reduces by 10% a year later, then 5% the following year and 2.5% after three years. A high decay rate implies a faster regression to the mean.
Results of Study:
The study revealed that the decay rate of TSR of top performers has gone up substantially over the past four decades. In 80’s , the decay rate was about 15% indicating a gentle downhill slide of TSR in the following years compared to the industry average. In contrast, companies in the top 20%, experienced a decay rate of 100% during 2008-2013. This implies that they are back to the average industry TSR in the following year. In fact, some companies performed below the average just a year later. The rate at which companies fall out of the Fortune 100 has increased by 60% in the last half-century. The analysis of the data shows that this is not a temporary phenomenon but would continue in the near future. This analysis is common to most of the attractive industry segments. The reasons were numerous. There is a new logic to the competition requiring agility, innovation and reinvention to cope with the technological change and disruption. Size or scale do not protect companies from this regression of performance. The rapid exploitation of digital technologies also contributes to the high decay rates observed by the study.
Analysis of the data revealed that among the out-performers, about 17% or one in six, managed to maintain their high performance over the following five years. These companies included Apple, Alphabet and Amazon, who managed to find new sources of competitive advantage on a near continuous basis. They managed to reinvent their businesses and adapted to the changing market conditions. These companies sustained high performance even as their peers regressed to the average levels. The question that arises is: what makes these companies different?
The study identified four unique aspects of these companies which enabled them to sustain their competitive advantage:
New Mental Models: The first factor was mental in terms of avoiding complacency and making pre-emptive changes. The companies believed that current models are unlikely to succeed in the future. Take the example of Amazon. Its culture of not resting on laurels is well known. It is exemplified by what CEO Jeff Bezos told employees at one all-hands meeting, “One day, Amazon will fail.” Amazon thus avoids stasis as shown by its launch of “free one-day shipping” and new offerings through Amazon Web Services.
Adopting Multi-dimensional Strategies: The context and levers of success in the future are likely to be different from those followed today. Companies thus need to plan and manage multiple time-scale dimensions simultaneously. Current business streams may be looked at in the short-term for optimization and looking at reinventions for the longer term by exploring new pockets of growth. These challenges may need new structures and approaches. Take the case of Google. In 2015, it restructured the company by clubbing emerging subsidiaries under a new company Alphabet, enabling the new businesses to be managed separately from the core search engine and internet business. The new company could explore fresh avenues while the core business could look at fine-tuning and optimization.
New Business Metrics: Metrics such as growth percentage, market share and profitability are normally used for planning or evaluating businesses. These metrics, however, relate to the past and may help in planning or attempting to improve performance. However, to beat the market some forward looking metrics are required to assess fitness for the future. These may pertain to currency of the revenue mix (market share of recent innovations) or the vitality of the portfolio mix (capacity to reinvent the business and sustainability).
Re-inventing Capabilities: When business environment changes rapidly or there are disruptions in the age-old method of improving efficiency and quality may need to make way for newer approaches. There is a need to examine new initiatives and scale up those which appear to be promising. Such approaches require newer ways of functioning such as encouraging challenges, collaboration and a focus on greater learning. This requires breaking down of hierarchies and integrating technologies to find fresh ways of doing things.
Outperforming rivals or peers is a difficult proposition. It is, however, even harder to sustain such superior performance. Leaders need to appreciate that superior performance is becoming less persistent due to competition and technological disruptions. There is a need for new mental models, reinvention and adopting forward looking metrics to overcome the gravity of average performance.
To attain sustainable competitive advantage, organizations need to sustain difference in the product in the long-run. Sustaining superior performance is becoming harder and organizations need to develop new mental models, re-invent capabilities and adopt to the changing market conditions.
1. What is competitive advantage and why is it important?
(Hints: Lowering cost to customers or providing higher value, business success dependent on superior offerings than competition)
2. Which are the means of sustaining superior performance in the face of competition?
(Hints: New mental models, adopting multi-dimensional strategies, new business metrics, reinventing capabilities)
Martin Reeves, Kevin Whitaker, and Tom Deegan (2020), Fighting the Gravity of Average Performance, MIT Sloan, Research Highlight,