Strategy, Life, Etc.

Today I read a fantastic interview covering strategy (in the McKinsey Quarterly) that actually not only applies to business but also to life. An excerpt:

The Quarterly: Shifting gears a bit, Richard, can you tell us about your research on diversification and focus?

Richard Rumelt: Well, my first research on corporate strategy showed that somewhat diversified but relatively focused companies tend to outperform highly diversified companies. And that finding has held up fairly consistently over the decades. Financial theory would say that companies diversify to reduce risk, but in the business world diversification is done not to hedge risk but to sustain top-line growth. The riskiest companies—the start-ups and early-stage companies—are intensely focused. Companies begin thinking about diversification only when their growth has plateaued and opportunities for expansion in the original business have been depleted. Suddenly, they have more cash flow than they know what to do with.

The Quarterly: Why are the highly diversified companies less profitable?

Richard Rumelt: It seems that the more complex an organization gets, the more likely it is that inefficient and unproductive businesses accumulate in the nooks and crannies and back alleys—and sometimes right up there in center aisle. These businesses are subsidized by their cousin, brother, and sister businesses that are doing well, and they stick around for too long because there’s a bias against shutting things down. Often we’ll find that these are pet projects of senior management and cutting them would cause a huge ego blow. It’s extremely unrewarding to a person’s career to weed the garden inside a company. It is much easier and more popular politically to grow the company than it is to go around and disrupt everybody’s neighborhood.

One of the things we see happening in private equity is highly incentivized people assuming this very unpleasant task of taking a company private, weeding its garden, and then taking it public again. It hasn’t happened with highly diversified companies yet, but we see that, essentially, something like that is happening as relatively complex organizations are cycling through private equity.