Why healthy companies don’t see the cliff edge coming.

Doing well can be the kiss of death: focusing on traditional business indicators can drive you off a cliff.

The last decade is littered with companies brought low by an unexpected disruption, but avoiding the same fate doesn’t require a crystal ball. A new perspective on what a healthy company looks like is the key to preventing calamity.

Photo by Jamie Fenn on Unsplash

Some of the most celebrated business car crashes over the last 20 years were the result of a basic lack of foresight. We look back and wonder how Kodak, Nokia, RIM et al didn’t see what was coming. How could they possibly have missed the signs? Why didn’t they recognise the threats sooner and react when they had time to do so?

The reality is that many established companies remain vulnerable to this type of wholesale disruption, and even more are vulnerable to serious commercial downturns. Many of those who are vulnerable are performing well – even very well – by traditional business measures. And its those traditional indicators of business health that may ultimately be their undoing.

It turns out that you don’t need to be able to gaze into the future to see the cliff edge coming: you simply need to look at a few basic characteristics of the business today to spot those at highest risk.

The curse of EBITDA.

For those unfamiliar, Earnings Before Interest, Taxes, Depreciation and Amortisation is a central measure of a company’s profitability. A healthy EBITDA is generally accepted to be a sign of a good business. Or at least it used to be. Today, in many cases, it may also be a key indicator of fragility.

I get worried about any company whose EBITDA has been steadily increasing over the last 5 or more years while doing largely the same thing as they always have, in largely the same way as they have always done it. These companies’ addiction to EBITDA almost always goes hand in hand with a lack of perspective. They’re run by outstanding operators whose laser-like focus on sustaining growth by maximising their market position, has paid off handsomely – all the while making them progressively more vulnerable.

I get doubly worried about businesses that have been sustaining or growing their EBITDA by driving down costs at a faster rate than a decline in revenue. These efficiency gains start by trimming off some fat, but quickly turn into cuts in key operational resources, compromises in customer-facing services, and a freeze on investments in forward-thinking initiatives.

In each case these companies, robust by accounting standards, are anything but: they’re fragile. Their focus on sustaining EBITDA performance has bred inflexibility into their mindsets and operations and, critically, has prevented them from seriously investing in building the market positions they’ll need after this one.

You have to commit to your future market.

Every business today, no matter how well they appear to be performing, should be focused on building new propositions with the potential to become tomorrow’s core business.

We developed futurestate-focused, service-led strategy model many years ago to reflect this; enabling any established company to build new market positions with clear alignment to the company’s purpose and vision, but without the constraints of current operations. Service-level innovation enables companies to explore and exploit new opportunities intelligently, without betting the farm.

Every company should constantly explore what its future market might be, and where possible, it should be actively trying to invent that market – especially if it thinks that it might kill today’s golden goose. If it does, it’s better than letting someone else do it (I hope everyone would recognise this as disruption-avoidance-101 by now).

Deep pockets plus optimism don’t equal security.

“We have plenty of reserves: even if we do start to hit the buffers we’ll have plenty of time and resources to get back on track”.

I’ve heard this more times than I can count, and it’s always wrong.

Being caught napping by a new or existing competitor (or increasingly commonly in B2B business; by customers doing something themselves) doesn’t just set you back a bit. It resets the perception of your company in the hearts and minds of its customers, and that takes a miracle (and very deep pockets) to claim back. People change to something far more quickly than they change back.

“We’re confident we can maintain a healthy position here: we see things levelling off, but we don’t need to change too much to stay on top”.

Another favourite, because again, it’s likely to be proven wrong. Sustainable competitive advantage is a long-dead concept in the digital economy (read Rita Gunther McGrath’s 2013 book ‘The End of Competitive Advantage’ for the basics of why). If you manage to remain the same as you were some time ago, you’re lucky, not smart. You simply can’t hope or believe that things can remain the same based on past performance.

The reality of course is exactly the opposite: failing to explore new market positions and gain a foothold with new or emerging customers – sometimes requiring bold moves – is a recipe for disaster in the modern business world.

In my view, it’s a fear of getting things wrong that drives this behaviour more than a genuine belief that it’s the right strategic decision for the business’s future. It takes a confident leadership team to drive – or listen to – a case for change in a business that feels secure.

Leaders need a (digital) backbone.

Some of the bravest and smartest corporate leaders we’ve worked with have put their hands up while the business was ‘performing well’ and said “we have to change”. It’s probably the easiest indicator of a good leader today, because they’re looking ahead, seeing the possibility of the cliff edge, and saying “let’s do something about it before we get there”. They’re sticking their neck out to protect the future of their business.

Often these people have to convince boards and shareholders who are resistant to any decline in precious EBITDA. They’ll push back with the corporate shit sandwich “ok, but the investment has to come from savings”, or the old staple “de-risk it and we’ll back it”.

Executives who are attuned to the dynamics of the digital economy would never make these statements. They recognise that businesses can become ex-businesses faster than at any time in history and understand that a continuous programme of meaningful market exploration and innovation is essential core business behaviour, even if it means lower near-term EBITDA. It has always been harder to say ‘no’ or ‘not yet’ than ‘yes’, but in this world it matters a whole lot more.

It takes courage to stick your neck out and it takes courage to support change when it isn’t immediately necessary.

Healthy performance is more than a line on a spreadsheet.

A company’s health simply cannot be viewed in the same way that it was 20 years ago. Basic measures like EBITDA can be an indicator of looming future crisis as much as historic health: it’s all a matter of perspective and mindset.

A leadership team with a digital-first mindset will already recognise that there’s more to future success than maintaining a margin. Investing in meaningful innovation initiatives now arms their business with ‘foresight’ and gives it its best chance of future success, albeit at the cost of short-term earnings. By contrast, those peers who milk their businesses for all they’re worth are likely to be peers no more.

Now, anyone that’s read anything I’ve written before will know that I don’t care much for the ‘pretend’ economics of many startups; businesses that set out to grow fast and sell fast but have no care about becoming a profitable self-sustaining business.

I’m adamant that profit should be a basic design criteria for any new business initiative, but profit itself isn’t the problem here; it’s the protection of profit at the expense of innovation that will kill you.

Put simply, in today’s world healthy businesses need to be deliberately less efficient than they could be. I know that this sounds counter-intuitive, but it’s actually very logical: new initiatives must be developed alongside the current service offering, and current customers must be kept happy. That won’t happen if you short-change their experience to fund the exploration of your future. Remember, once their perception shifts, it’s nigh on impossible to shift it back. I’m afraid you simply have to invest as well, not instead of.

If you see the signs, don’t ignore them.

Look at what you’re doing right now. If you see yourself in anything written above, you need to act. Ask those companies I mentioned at the start how sitting back worked out for them.

Every company is different but the changes needed are often similar and can always be achieved – if the leadership commits to it. A combination of fresh perspectives, lateral thinking and modern approaches to strategy and design can work wonders in even the most staid business – and can deliver genuine changes in behaviour quickly.

There’s a generations-old farming expression that I heard many years ago, which is best paraphrased as: “you only milk an old cow to feed new calves”.

I think of this expression often as it speaks directly to how established businesses should think in the digital economy. That old cow won’t last forever, but while she’s still producing good milk, use it to feed a new generation of calves who may grow bigger and stronger than she ever was.