The insidious threat that could torpedo more big-name firms
October’s collapse of Monarch Airlines was one of the most visible examples of business disruption in action we’ve seen in recent years – it was a drama that affected well over 150,000 passengers and threatened some 2,000 jobs. And though many British CEOS may feel their companies are immune from this kind of seemingly sudden and precipitous fall from grace, that’s not the case.
In fact, Monarch’s failure was an example of a lethal form of slow decline that may already be affecting many more businesses – a kind of disruption that can easily escape the attention of business leaders.
We are all familiar with the abrupt disappearance of popular brands. Comet, the electronics store, seemed a bright star, with a valuation of £2bn in 2008. Three years later, it was bought for just £2 and then shut down.
Blockbuster disappeared almost overnight. HMV, MFI and JJB Sports left vacant high street shops and forgotten acronyms in the wake of their closings. And the UK’S dependence on its service sector may make it particularly vulnerable to sudden business failures, as upstarts use digital technologies to break traditional business models.
Monarch’s failure was different. Its demise was under way long before the inevitable happened. Like Monarch, much of the UK’S high-value jobs, R&D and exports depend on asset-heavy industries.
At first glance, these solid fortresses of stability seem protected from digital disruption. In truth, though, they face an insidious threat that is all the more perilous for its slow pace. We call this kind of danger “compressive disruption” and our analysis of companies in sectors from telecoms and utilities to automotive and industrials reveals its full nature.
First, revenues grow substantially over a period of years, but profits are less attractive for much of that time. We have seen this trend in the automotive industry in the past decade. This “empty growth” can only last so long.
A decline in both margins and revenues is likely to follow. The beer and soft drinks industry is one good example here, as is telecoms. To appreciate the intensity of compression, consider the accelerating decline of “voice” as a means of communicating via mobile telephones, and the effect of that decline on revenues. From 2013 to 2015, average mobile voice revenue per user declined globally by 19pc. A further 26pc decline is expected through to 2020.
Then comes a period of false hope. An effort to cut costs and discount prices offers a respite as demand rises for a while. Monarch Airlines experienced this respite as it turned from a package holiday model into a low-cost airline. But the practice of offering cost cuts and share buy-backs can become a vicious cycle. When companies are unable to resist the pressure to deliver short-term results, they can (and often do) end up sacrificing long-term potential.
Finally, there’s a sudden collapse in revenues and profits, and administrators may have to be called
‘UK CEOS need to recognise that an apparently stable industry is no longer an effective bulwark’
in. As the effects of compressive disruption become visible, an incumbent’s ability to arrest decline in its operating profits weakens.
Expensive, non-liquid assets become more of a burden, restricting cash flow and limiting the organisation’s ability to invest outside the core business. As the pattern continues, compression accelerates. And the longer a company hesitates to address the issue head on (resorting instead to short-term “fixes”), the more compression eats away at the existing business model, eventually eroding all the economic headroom a company would need to rotate a core business to new growth markets.
Which sectors are most vulnerable? The telecommunications, utilities and energy sectors are among those most exposed. Consider the future value of the current businesses in these fields – future value being a calculation of the growth that investors embed into the share price based on expectations for products and services that have yet to be developed. For these sectors, future value is less than 1pc of overall enterprise value. In other words, their total value is tied almost entirely to their core business, leaving them dangerously exposed if that core comes under attack.
UK CEOS need to recognise that an apparently stable industry is no longer an effective bulwark. Their companies’ ownership of expensive assets is no longer a barrier to market entry for new players that can create effective and sustainable business models built on cloud infrastructure, artificial intelligence and digital platforms. And long-standing advanced technologies are not necessarily a defence either, as we have seen recently with North Sea wind power beginning to compete on a more equal footing with natural gas and nuclear energy.
To anticipate and handle compressive disruption, business leaders must take a long look at the sustainability of their core business. They must seek to unlock trapped value in the top line, and balance their efforts to protect the bottom line.
They must strive to reinvent their core business using digital innovations that not only deliver cost competitiveness, but also release the investment capacity needed to create new revenue streams and unique customer experiences.
We often hear of companies appointing CEOS to confront threats that are close at hand, or to perform a turnaround once damage has been done. But compressive disruption – from its stealthy origins to its drawnout (and then sudden) conclusion – will likely outlast any single CEO’S tenure. That makes it harder for the company to identify the true cause of the slow squeeze on revenues and margins, let alone respond effectively.
For all of today’s short-term distractions and incentives, and for all the near-term fears surrounding Brexit, the long-term threats to some businesses may be far greater. Britain’s most successful CEOS will be those with a long-term view and the courage to act before compressive disruption delivers its knockout punch.