The first clear warning sign is when next-generation innovations offer smaller and smaller improvements in the user experience. If the people designing the next-generation offer are having trouble conceiving of new ways to differentiate what you do, that’s not good. If your scientists and engineering types are predicting that some new discovery will undermine the existing trajectory, that is also not good. For instance, RIM’s BlackBerry e-mail devices were the natural descendants of the first pagers, with keypads. The trajectory on which they developed didn’t change much, adding mostly incremental touches such as colored screens, cameras, voice recorders, and some applications. Although customers appreciated these innovations, they were no longer excited by them.

A second clear warning sign is when you start to hear customers saying that new alternatives are increasingly acceptable to them. Or worse, that cheaper alternatives are just as good as what you have to offer and that there is little differentiation between them. For example, Google has developed a maps application for Android-equipped mobile phones that provides turn-by-turn spoken navigation. This has prompted a decline in the attractiveness of standalone GPS navigation devices, and even predictions that such devices will no longer be popular in automobile dashboards or as handhelds.

Even worse is when a competitive or substitute offering shows the threat of changing the dimensions of competition customers are looking for, particularly if it comes as a surprise. Just recently, an insider reported on the reaction at RIM with respect to the 2007 introduction of the iPhone:

RIM, as well as Motorola, Nokia, Palm and other early pioneers, lost ground partly because of a self-defeating attitude. RIM in particular assumed from the start that smartphones would be outgrowths of its pagers and that there would never be enough battery life or wireless technology for more functions. It started growing beyond this view before the iPhone shipped, but the OS foundation until recently was based on the early assumption.

The remarks confirm a widely held belief that BlackBerry Storm development started only after the iPhone was made public rather than having been in development at all before. RIM didn’t have its first touchscreen phone until the Storm shipped in late 2008, almost two years after the iPhone’s unveiling, and didn’t have multi-touch support or a fully accurate web browser until the Torch arrived just this past summer.¹

RIM, in a frantic catch-up position on features customers now say they want (and which are offered at very competitive prices on Android phones at least), is fighting to combat market share declines.

Finally, of course, you can consult your numbers. The first thing that usually happens is a small decline in the sales growth rate. Then a flattening out. Then eventually declining sales. Unfortunately, by the time a decline shows up in your performance numbers, it is usually too late to muster a proactive response, and you find yourself clambering back in a weaker position than you had been in.

At Wolters Kluwer, a once-traditional publishing company navigating a transformation to the digital world, managing the portfolio of products is a skill the company has honed very well. With products that still have some life cycle to them, the company manages by “pruning,” as CEO McKinstry notes. Updates might be a little less frequent, and fewer editorial resources might be dedicated. This is considered “harvesting” and has been readily adopted as part of the way in which publishing life cycles are managed. Far more difficult is the challenge of an outright divestiture. In her company, McKinstry has instituted a review that “organizes micro markets by category.” Anything growing organically more than 5 percent is considered to be high growth and will continue to be supported. Growth in the 2 percent to 5 percent range is considered “maintain.” Growth below 2 percent is a candidate for harvest, and failing that, for divestiture. One of McKinstry’s innovations since taking the reins at Wolters Kluwer was to implement a more structured portfolio review process, with the result that today “more than 60 percent of our capital is going into markets that are growing more than 5 percent,” as she told me in an interview. She attributes this discipline regarding managing the portfolio as helpful to “divesting from more things than we would have done” before shifting the analytical emphasis.

I first ran across the remarkable story of Norway’s Schibsted in a 2010 BusinessWeek article.⁶ Schibsted is a newspaper publisher, a venerable institution founded in 1839. Like newspaper publishers everywhere, it is coping with a staggering loss of ad revenue. The BusinessWeek article noted that US newspapers’ ad revenues collapsed catastrophically in the years between 2000 and 2010, from $48.6 billion in 2000 to $24.8 billion in 2009, with classified ads suffering the greatest declines. Like their American brethren, Schibsted’s newspapers, dailies such as VG and Aftenposten, have seen their revenue from advertising, particularly classified ads, collapse. Unlike their American cousins, however, Schibsted doesn’t care at all. As it turns out, most of the customer defections are going from Schibsted-owned companies to … well, a Schibsted-owned company. In 1999, the company spun off an online business called FINN.no that provides a platform for online advertising. It competes directly with the papers, and as far as CEO Rolv Erik Ryssdal is concerned, that’s just fine with him. “We weren’t afraid to cannibalize ourselves,” he told a reporter.⁷

The online business model Schibsted pursues isn’t all that different from that of Craigslist, the scourge of the American newspaper executive. Most listings are available for free. The company charges a premium to give listings more visibility, and Schibsted’s site also carries listings from businesses, which Craigslist does not. It has sister sites that operate job-search and automotive sales operations. Operating costs for both are minimal, with the consequence that the online ads are more profitable than the print ads ever were. The Norwegians have taken their show on the road, opening advertising sites in twenty-two countries either through acquisition or through greenfield development. The company is now the world’s number three player in online advertising, behind Craigslist and eBay. Profit margins at some of its sites are reported to be 60 percent.

Kjell Aamot, the CEO who preceded Ryssdal, is widely regarded in Scandinavia as a visionary, and was one of the longest-tenured CEOs of publicly traded companies headquartered in the region. He rather unpopularly predicted the demise of the current print-newspaper model “within 20 years,” prompting one observer to complain that “we are getting pretty tired of all these predictions of the end of the newspaper business.”⁸ Where does he get his inspiration? From, among other places, his grandchildren. An observer of the print media described Aamot’s conclusions about the future: he saw that his grandchildren were watching less television, preferring instead to use the internet and mobile phones. He was also startled at how often they changed their habits—moving from interactive real-time games to something else. He definitely saw that traditional newspapers were a poor fit for their needs.⁹ Amidst a career filled with controversies, Aamot was the main driver behind the move to internet properties for the company, helping it prepare for the erosion of its primary business model. And the future? Perhaps, he points out, journalism will be paid for from subsidies originating from other businesses, such as car sales.

The Schibsted story is illustrative of how one can disengage from a business by gradually migrating customers, revenue streams, and operating models from the old advantage to a new one. It is also an interesting take on reverse customer adoption. Those customers who wanted to go online found a ready vehicle for doing so and converted early. Those who didn’t want to work this way weren’t forced to do so until they were ready. The migration from early adopters through the mass market was managed pretty skillfully by Schibsted.

Not so much for Netflix. By forcing a transition on customers before many of them were ready, the company enraged them. Rather than figuring out which segments should be exited, and doing so sequentially, Netflix attempted the same strategy for everybody all at once. The result was that the mass market went up in arms. What I think it should have done was realize that preparing customers for transitions is just like getting them through the new product adoption process, except in reverse. Not all customers are going to be prepared to move at the same rate. There is a sequence to which customers you should transition away from first, which next, and so on.

If Reed Hastings had, instead of raising prices for everybody, selectively offered price discounts to those who would drop DVD service, he would have moved that segment over to the new model. Then he could have gone to the “light user” DVD consumers and suggested that instead of getting a new DVD any time they wanted it, they would get one once a month, say, for the same price. If they wanted the instant service their prices would go up. That would shift another bunch to at least a point of lower DVD usage. Then when these segments started to realize that all-streaming wasn’t so bad, he could do the big price increase for the mainstream buyer. The point is that in trying to force customers to move faster than many of them were prepared to, Hastings exposed his company to a strategic miscue.

This is a situation you don’t ever want to be in. The core business is under immediate market share and margin threat, there’s no silver bullet in the pipeline, and you have to make a choice—fast—about where you are going to focus. Imagine the situation at Nokia: a deep recession dampening demand for its products across the line, losses in some of its core businesses, failure to adequately penetrate emerging growth markets, leadership instability, and a collapsing share price. Oh, sorry, I’m not talking about the Nokia of 2011. I’m talking about the Nokia of the late 1980s, when the embattled company was so down on its luck that its leaders took the humiliating step of shopping the company to Swedish rival Ericsson, only to be turned down.

Speaking to me some years later, Matti Alahuhta, one of the executive team members who participated in what eventually became a spectacular turnaround, said, “You know, back then it was almost easy. We had no other choice.” The company decided to pin its hopes to its nascent telecommunications business, depending on assets from previous investments in computerization and communication technologies and the acquisition of the previous state-owned telecom monopolies. It shed everything else. Rubber boots, cable manufacturing, the other industrial businesses, the TV business—gone, gone, and gone. This is the nature of disengagement when the core business is on the brink of becoming irrelevant.

But of course, you could write a similar story about Nokia today, a company that I’ve studied, worked with, and watched for many years. Like many people, I was very admiring when I first started interacting with it in 2000: the company’s success was absolutely amazing, as it had grown with the mobile handset category in a rather spectacular manner for some time. But as I began to spend more time with the company, first in its Choices program for the Nokia Ventures Organization, and later on in a number of its management programs, I began to be concerned. Its venturing process, which I had long held up as a fantastic example (and studied, with results published in several academic articles), seemed to be losing senior executive support.¹⁰ The appointment of a new CEO with more of a numbers orientation and less of a product orientation resulted in the loss of many talented people. And although it was growing like gangbusters in places such as India and China, the company was nowhere in the United States, despite years of strategy statements that said the United States was a core target market for it.

As a veteran Nokia watcher and industry expert said to me, “Their biggest problem is complacency.” Leaning back over his desk, and perfectly mimicking the body language of a fair number of Nokia leaders at the time, he knitted his hands together and said, “In fact, they are actually complacent about their attitude toward complacency.” At the time, I laughed. I laughed again when working with the company in 2001. There I was in a frozen hotel in Oulu, Finland, with a bunch of Nokia engineers. The subject of the newly released iPod came up. The reaction was entirely dismissive. “That?” they said. “It’s just a hard drive built on older technology in a fancy case.” I stopped working actively with the company around 2006, but by this time warning bells were ringing every time I learned afresh about management decisions that were being made.

I was dismayed to receive this e-mail from a colleague, who had worked on a number of research projects involving Nokia, dated January 2007:

Rita,

Today I had a very interesting meeting at Nokia. I didn’t get to meet the head of the New Business Group because he had to go out of town last minute but met his strategy director. Since they had a lot of personnel change (CEO as well as the head of what was NVO) they have reinvented their new business development once again. They went completely away from venturing and now view what was the NVO as a business group of its own that should show revenue AND growth. They have abandoned pretty much all early stage activities (e.g. divesting Innovent last August) and try to gain access to different business areas in the form of what they call projects or business lines … In my view they are setting themselves up for major failure and even worse many in the organization are aware of that (the Strategy Director was talking about how everything is dependent on the people in some key positions).

Well, by this time, dear reader, you know where this is heading. My colleague and I had a phone conversation later, in which we decided for teaching purposes to drop Nokia as an exemplary innovator. That was in 2007. Now it is 2012, and the company is once again staring at the brink.

Stephen Elop, the CEO that Nokia brought over from the Office business at Microsoft, faced almost exactly the same challenge that the company leaders of the late 1980s faced. What should be jettisoned so that the company could move onto its next growth trajectory? I first met Stephen when he was with Microsoft, running its core $19 billion Office franchise. He was interested in sharing points of view on strategy, growth, the right size for the business, how to handle freeing up resources from the core franchise to go after new areas, how they had blundered in a few key places—in short, a lot of the things that I thought would be very helpful for the software giant to think about.

So what was Elop’s big disengagement decision at Nokia? To drop development of Nokia’s operating system, MeeGo, and instead adopt Microsoft’s Windows 7 software. The decision was not arrived at lightly: MeeGo had been widely talked about as the company’s answer to Android and Apple smartphones and was to play a part in saving the company. A review of the product conducted by Elop and chief development officer Kai Oistämö, in which they interviewed twenty people deeply involved with the MeeGo project, resulted in a sad, stunning conclusion. At the best rate of progress, the company would introduce only three MeeGo-powered handsets before 2014, far too late to address the crisis besetting Nokia’s core business.¹¹ Elop made the decision to stop the development effort and instead repurpose the talent who had been working on the doomed operating system to more future-oriented projects. Using Apple’s operating system was out of the question. Working with Google’s Android operating system would fail to position Nokia for leadership (and provide competition for Nokia’s Navteq unit). That left Microsoft. Although the software company’s share in the smartphone market in the United States was extremely small, reviews of its operating system were favorable. More important, Microsoft has strong alliances with corporations and distribution partners that could help Nokia gain traction in its long-lusted-after American markets.

The strategy now comes in three parts: First, get back in the game in smartphones using the Microsoft software to move more quickly than Nokia could have with its own software. Next, make sure the company has an emerging market presence. And, in the medium term, as a BusinessWeek article describes,

Elop’s third priority has been dubbed New Disruptions. It’s a fully sanctioned skunkworks, with teams in Helsinki and Silicon Valley, staffed by top technical talent from the discontinued Symbian and MeeGo efforts, especially MeeGo. That initiative began when Nokia hired a crew of inventive open source evangelists in 2009 with orders to dream up entirely new devices. A few months later they were reassigned to develop a replacement for Symbian. The goal, as Elop told a group of engineers in Berlin on Feb. 29, is once again to “find that next big thing that blows away Apple, Android, and everything we’re doing with Microsoft right now and makes it irrelevant—all of it. So go for it, without having to worry about saving Nokia’s rear end in the next 12 months. I’ve taken off the handcuffs.”¹²

Will it work? I don’t know. By the time a company is wrestling with this form of disengagement, there are many things that can go wrong, and Nokia has lost a lot of time. On the other hand, just as the company realized in an earlier era, there was very little choice. By October of 2011, the first smartphones resulting from the alliance were on the market to critical acclaim, with headlines blaring “Nokia Gets Back in the Game.” We shall see what the next chapter brings.

Some businesses without a particular advantage still have good growth or cash-flow potential, but not with the overhead cost structure or margins that the parent company is used to. The way pharmaceutical companies treat off-patent drugs reflects this dilemma—whereas a generics drug business may look unattractive to an organization such as Merck or Novartis, it looks brilliantly attractive to low-cost global competitor Teva. Similarly, the phone directory business looked like a route to commodity hell to Verizon, but was eagerly snapped up by two private equity firms, attracted by the consistent cash flows the business threw off.

Under Ivan Seidenberg, Verizon’s long-time CEO, the company pursued an aggressive strategy of moving out of slow-growth former core businesses such as landlines and into more competitive and risky, but faster-growth, areas including wireless and data services. Prodded to some extent by my Columbia Business School colleague Bruce Greenwald, as early as 2001, Seidenberg was anticipating the fading of existing advantages, expecting annual revenues over $100 billion, with 35 percent coming from wireless and 20 percent from data.¹³ He also anticipated that traditional voice revenues would represent only about 35 percent of the total book of business, down from 60 percent. Since then, the company has shed slow-growth units (even those with solid cash flows), such as phone directories.¹⁴ In their place—and using the cash these spun-off businesses yielded—Verizon has made massive investments in such new areas as fiber optic service technology to enable it to compete with cable companies in offering television and internet services. Seidenberg did what many companies fail to do: make aggressive investments in the company’s future while the core business was still generating substantial cash.

One of the stiffest challenges of exiting the core business and repositioning the company in growth spaces is convincing the investment community that this is the right thing to do. Verizon’s stock was battered for years as it poured money into broadband offerings. Beginning in 2007, however, articles with titles such as “Verizon’s Big TV Bet Pays Off” started to appear. And in early 2009, an article in Barron’s about Verizon began like this: “In times that are anything but normal, it pays to invest in a company that delivers reliable, business-as-usual results, keeps its focus on avenues of growth and holds the promise of market-beating returns. Verizon Communications, the New York-based telecommunications giant, fits the bill nicely.”¹⁵

The vindication must have been gratifying for Verizon, given the boldness of the company’s moves out of its former core business.

One of the most frustrating things about the temporary-advantage phenomenon for a management educator is that no sooner do you find a great example of a company that is doing something really interesting, strategically, than that company falls victim to the stings of eroding advantage. The later poor performance then completely discredits the interesting idea they began with. That’s a bit the way I feel about Mexican cement producer CEMEX. Not that I’m alone—many management researchers have written admiringly of the plucky regional firm that through innovation, clever use of digital technologies, and aggressive M&A activity rose to become a global player and is today the world’s third-largest cement company.

Unfortunately, some poorly timed acquisitions and the global construction slowdown have created a real black eye for CEMEX, with a near bankruptcy in 2009 and losses in the third quarter of 2011 alone totaling $821.7 million.¹⁶ With the core business under threat, CEMEX proceeded with a substantial disengagement of so-called noncore assets, to the tune of $1 billion’s worth by the end of 2012, to reduce debt and meet financing covenants. Lorenzo Zambrano, CEMEX’s CEO, has thrown down the gauntlet for businesses wishing to remain within the corporate parent’s purview: earn 10 percent return on capital, or you are on the block. On the list are quarries, assets held in joint ventures, real estate, and other idle assets that don’t produce earnings before interest, taxes, depreciation, and amortization by the end of the year.¹⁷

Unlike the more modulated asset disposals of the previous category, such fire sales are often made under significant duress as investors and analysts, armed with metaphorical pitchforks, put pressure on management to stem the losses, focus, and create a compelling story for why the firm is going to get out of its rut. As my friend and colleague Harry Korine has often pointed out, activist investors can sometimes provide a pivotal push to a management team that is reluctant to make some tough choices in this regard.

Even when something is in an end-of-life stage, there are often important constituents who are still depending on it. A firm at that point has to figure out some way of shrinking the business to the right size while providing appropriate support to the customers and other stakeholders who may be left behind. Often, these are niche customers who are relatively price insensitive and have a deep need.

Privately held GDCA (formerly GD California) provides a fascinating example of a company that benefits from product obsolescence by allowing client firms to sunset older technologies without abandoning commitments to key customers. When mainstream manufacturers of computer equipment (such as boards) respond to technological improvements and end-of-product-life decisions by getting rid of older equipment and filling their factories with shiny new machines, they create enormous problems for manufacturers of precision medical, military, and industrial equipment who have embedded the boards in their own products. When the components are changed, this can necessitate a product redesign on their part, which in turn can trigger the need for a renewed round of qualifications and a certification that the equipment will work properly. With end-of-life situations occurring with greater frequency, the previous solution of simply buying up enough of the old boards to meet expected demand was proving expensive and unwieldy.

Into this breach stepped GDCA, which counterintuitively went into the business of manufacturing obsolete board designs to guarantee the downstream customers that they could continue to buy the exact boards embedded in their designs. Its Availability Assurance Program is essentially an insurance policy against component obsolescence and the resulting problem for customers. Subscribers turn to GDCA when the original manufacturer decides to discontinue making a board. The company then transfers the technology from the original manufacturer to its own engineering group, stores spares, produces more units if necessary, provides repairs, and, when the customer eventually decides it is ready to move on, closes the program. As of 2003, subscriptions were $10,500 per event, plus $3,000 annual maintenance per board.¹⁸ It is worth noting that GDCA has also benefited from the declining category by developing an innovative business model—insurance, rather than simply relying on manufacturing.

A consideration for many technology companies in this “shrink to the right size” strategy is that they often risk losing valuable technology capabilities when the business in which they were developed is discontinued. To address that issue, companies often develop a special business unit just to focus on keeping those capabilities alive. Telecommunications manufacturer Avaya, for example, maintains what is called a “custom engineering” unit, which basically keeps capabilities on the shelf but which can reinvigorate them when they seem relevant once more to a customer’s problem or retire them when the customer no longer needs support. Mohamad Ali, Avaya’s former head of strategy, explained the mechanism the company uses for “keeping certain capabilities alive.” After early adopters have agreed to purchase a given solution, he said, “You can’t just kill it and leave your customers in the lurch.”

He gave an example of a product the company had developed for Citibank in Japan, developing what it terms a “thin call” solution in which customers can interact with a teller remotely, using a phone and a video feed to allow the teller to interact with a customer who could be hundreds of miles away. As he put it, “Let’s say we decide to kill thin call. Citibank isn’t going to like it if we abandon them. So we put it in the custom engineering group. As long as Citibank is a customer, we’ll continue to support it.” The custom engineering group is also a place in which Avaya keeps people and know-how accessible, even if it doesn’t draw on them for an immediate product. This illustrates two principles for effective disengagement: (1) that you don’t lose key capabilities because a business ends, and (2) that stakeholders who are adversely affected by your decision to stop doing something are made whole.

One strategy for disengagement is to effectively lead the market down by prompting consolidation of a declining industry and remaining as one of its leading suppliers. The strategic logic here is that a business in decline requires relatively low investments, costs are sunk, and, to the extent that you aren’t facing competitors in survival mode, cash flows can actually be quite good even if volumes are going down. Of course, for this strategy to work, not all players in the business can pursue it successfully: some will have to be prompted to exit. The process can be helped along by one competitor that can operate with extreme efficiency, cutting costs to the point at which others drop out. Another way of reducing excess capacity is to reduce it yourself by buying other companies’ assets, taking over their production capacity, forming joint ventures that take out capacity, or acting as an outsourced partner. There is also, for the strong of constitution, the option of aggressively investing in the declining category, making it far less attractive for competitors to remain. This was the strategy quite successfully pursued by Jon Huntsman, Sr. of Huntsman Chemicals in consolidating various industries, such as that for textile dyes and the chemicals used to create “clamshell” containers for fast-food chains.

Such a strategy is not without its risks, of course, because the behavior of competitors and likely future pricing in an industry are hard to anticipate. An interesting sector that illustrates this beautifully is the global steel business. No one would accuse Lakshmi Mittal, the CEO of ArcelorMittal, as lacking in confidence or vision. Following the mantra “Boldness changes everything,” Mittal has engineered dozens of sometimes controversial mergers. The one that brought him attention on the world stage for the first time was when his Indian firm, which had grown to a substantial size, made a play for the French steelmaker Arcelor in 2006. The French were dismissive (the stocks proposed to fund the deal were referred to as “monkey money”), and Europeans in general were alarmed that a firm from an emerging economy could muster the strength to take over a European icon.¹⁹

Mittal prevailed, the acquisition of Arcelor being just one more milestone in the realization of a twenty-year vision to prompt consolidation of the global steel business with the goal of attaining a leadership position in this industry where there are few remaining competitive advantages other than cost. Unfortunately for Mittal, years of effort have not yielded the desired cost efficiencies or consolidation benefits, and in the summer of 2010 ArcelorMittal announced that it intended to spin off its stainless-steel business. The situation reflects the classic difficulty of trying to lead in a declining arena. As one observer (a Nordic-based analyst who declined to be named) remarked, “It would benefit the sector if capacity were cut, but no one wants to volunteer. I tend to think nothing will happen.”

So, there we have the principles of healthy disengagement. First, identify the warning signs. Often, these are qualitative leading indicators rather than quantitative lagging ones. Next, create a way for the import of the numbers to be recognized. Then, once the decision has been made, determine the situation you are in and design the disengagement strategy that makes the most sense.

As you will have seen by now, conventional budgeting and planning processes are unlikely to be of much help in a transient-advantage context. The decision to exit a business and to implement that exit effectively requires the ability to break through budget logjams and effectively move resources to other places. In the next chapter, we’ll look in more depth at how what I call “deft” organizations use their resources to increase responsiveness and flexibility as they move from advantage to advantage.

Note: For a discussion of how to conduct a value-capturing disengagement review, see chapter 8 of Discovery-Driven Growth.