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Study of 57 corporations, with 620 diverse businesses, establishes relationship between strategic planning and profit performance
Sidney Schoeffler, Robert D. Buzzell, and Donald F. Heany
One of the most significant research projects undertaen by the !areting Science "nstitute is the ongoing profit impact of maret
strategies #$"!S% study& 'he basic idea behind $"!S is to provide corporate top management, divisional management, mareting
e(ecutives, and corporate planners with insights and information on e(pected profit performance of different inds of businesses
under different competitive conditions& )mong the *7 factors investigated and analy+ed are maret share, total mareting
e(penditures, product ,uality, -./ e(penditures, investment intensity, and so on& 'hese factors account for more than 0o1 of the
variation in profit in the more than 600 business units analy+ed& "n this article, the authors describe the highlights of their research
!r& Schoeffler, director of applications for the $"!S project, is a senior visiting research fellow at 2arvard 3usiness School4 !r&
3u++ell, $"!S research director, is professor of business administration and chairman of mareting at 23S4 !r& 2eany, manager5
reports and liaison for the $"!S program, is a visiting research fellow
What rate of return on investment (RO! is "normal" in
a #iven ty$e of business, under #iven mar%et and
industry conditions& What factors e'$lain differences in
ty$ical levels of RO amon# various %inds of
Ho( (ill RO in a s$ecific business be affected by a
chan#e in the strate#y em$loyed& By a chan#e in
)any cor$orate $residents and $lannin# directors (ish
they had more reliable ans(ers to these %inds of
*uestions, for they are at the heart of strate#ic $lannin#
in the modern cor$oration. +onsider some of the (ays
in (hich these *uestions arise,
Forecasting profits, n a diversified com$any, the usual
$ractice is for business $lans to be $re$ared by each
$roduct division or other o$eratin# unit. -hese $lans are
then revie(ed by cor$orate e'ecutives, often (ith the
assistance of cor$orate staff s$ecialists. .mon# the %ey
elements of each unit/s $lan are, of course, estimates of
investment re*uirements and $rofits for future $eriods.
Often these forecasts are sim$ly $ro0ections of local
e'$erience. But (hen mar%et conditions are e'$ected to
chan#e, or (hen a chan#e in strate#y is contem$lated,
ho( reliable is the $ast as a #uide to the future&
)uthors6 note7 8e wish to acnowledge the contributions to this
article of Our associates on the $"!S $roject 'eam& -alph
Sultan, who is now chief economist, -oyal 3an o 9anada,
served at project director of $hase " of $"!S during :;7s and
was responsible for much of the basic design of the study&
3radley <ale, 'homas 8ilson, 3ernard 9atry, =ames 9onlin,
and -obert !c/owell also participated in various stages of the
research and offered valuable suggestions on this presentation
of the latest results&
Allocating resources: . ma0or $ur$ose of revie(in#
divisional $lans at the cor$orate level is to ma%e
effective allocations of ca$ital, man$o(er, and other
scarce resources amon# divisions. Often the ca$ital
a$$ro$riation re*uests of the divisions add u$ to more
than head*uarters can $rovide.
-he $roblem, then, is one of em$hasis, Which $roducts
and mar%ets $romise the #reatest returns& Here,
es$ecially, the $rofit estimates su$$lied by divisional
mana#ers are li%ely to be of doubtful reliability, since
each division is in the $osition of $leadin# its o(n case.
Measuring management performance, +losely related to
the $roblem of forecastin# $rofits is the need to evaluate
actual $rofit results. Su$$ose Division . earns 123 on
its investment ($reta'!, (hile Division B achieves an
RO of only /43. s ./s mana#ement t(ice as effective
as B/s, and should it be re(arded accordin#ly&
5'ecutives of Division B (ould no doubt ob0ect to this.
-hey (ould attribute differences in RO to differences
in conditions such as mar%et #ro(th rate and stren#th of
com$etition. 6erha$s they are ri#ht. What cor$orate
mana#ement (ould li%e, in this situation, is some (ay
of determinin# (hat level of RO is reasonable or
"normal" for different o$eratin# units under #iven
Appraising new business proposals: Still another
common $roblem in strate#ic $lannin# is that of
estimatin# RO in a $ros$ective ne( business (hich is
bein# considered for either internal develo$ment or
ac*uisition. When the business is ne( to the com$any,
actual e'$erience, by definition, cannot be consulted.
5ven (hen entry is $ro$osed via ac*uisition, the current
$erformance of the e'istin# business may be of doubtful
reliability as a #uide to its future.
-he common thread runnin# throu#h the four ty$es of
strate#ic $lannin# situations 0ust described is the need
for some means of estimatin# return on investment in a
#iven business, under #iven industry and mar%et
conditions, follo(in# a #iven strate#y. 5very
e'$erienced business e'ecutive and cor$orate $lanner
%no(s that RO varies enormously from one business to
another and from year to year in an individual division
or $roduct line. Ho( can these variations be e'$lained
Some ans(ers to these *uestions are be#innin# to
emer#e from a uni*ue research $ro0ect called 6)S 7a
study of actual e'$eriences of hundreds of businesses
(hich is aimed at measurin# the $rofit im$act of mar%et
strate#ies. Buildin# on (or% that has been under (ay at
the 8eneral 5lectric +om$any for more than 92 years
(see accom$anyin# ruled insert!, the 6)S $ro0ect is a
sharin# of e'$erience amon# 4: ma0or ;orth .merican
6)S (as or#anized in early 9<:= as a $ro0ect of the
)ar%etin# Science nstitute, a non$rofit research
or#anization associated (ith the Harvard Business
School. -he $ro0ect (as established as a coo$erative
venture, (ith HBS faculty members and research
assistants (or%in# alon#side $lannin# s$ecialists from
industry. (ndustry $ersonnel did not, of course, have
access to any of the data su$$lied by other com$anies.!
-he $ro0ect is no( or#anizin# its third yearlon# $hase.
-his article is a $ro#ress re$ort on 6hases and of the
6)S $ro0ect. n it, (e shall describe ho( the study has
been carried out and summarize some of the ma0or
findin#s of the first t(o years/ (or%.
PIMS profit models
n 6hase of 6)S, 1> cor$orations su$$lied
information on some 142 businesses. -he information
included descri$tions of industry and mar%et
characteristics, as (ell as selected o$eratin# results and
balance sheet fi#ures for the years 9<:2 and 9<:9.
(.ll financial data (ere submitted to 6)S in "scaled"
form7that is, actual dollar amounts (ere multi$lied by a
scalin# factor, such as .4. -his $rocedure served to
ensure both the confidentiality of the ori#inal data and
the relationshi$s amon# the fi#ures.!
GE's search for answers
'he current effort to find better ways to e(plain and predict
operating performance began bac in :;60, as an internal
project at the <eneral >lectric 9ompany&
?red =& 3orch, then <>6s vice president5mareting services,
called in =ac !c@itteric, his director of maret research, and
pointed out what today is generally accepted as an a(iom as
the maret share of a business goes up, so do operating
economies& 3orch ased !c@itteric to survey any relevant
published research and the e(perience of other businessmen
with respect to this relationship& "f the relationship were valid,
e(ecutives might have an important due as to how to improve
>,ually important, 3orch wanted to find a handle for <>6s
growing AmanageabilityA problem& Sales were already at the BC
billion level& 3y :;70, they were liely to be B0 billion to B;
billion& 2ow could corporate officers lie himself stay in touch
with so many diverse businesses, ranging all the way from
turbine generators to toastersD
)fter months of e(ploration, !c@itteric became convinced that
the best way to address the ,uestion was to do some basic
pioneering wor on the apparent causes of <>6s own
successes and failures& 3orch agreed and authori+ed a major
research project to probe for Alaws of the maret place&A $roject
$-O! #profitability optimi+ation model% was organi+ed under
the direction of co5author Sidney Schoeffler&
)fter five years of intensive research and testing, $roject
$-O! produced a computer5based model that captured the
major factors which e(plain a great deal of the variability in
return on investment Since this model reflects data from diverse
marets and industries, it is often referred to as a Across5
sectionalA model5as contrasted to a time5series model based on
data over a series of years for a single business&
8ith the help of this model, <> could estimate the AaverageA
level of profit or investment or cash flow that went with various
combinations of the success determinants& 'he model did not
and could not predict the ApreciseA -O" of any one of <>6s
businesses in a given year&
8hen 3orch became <>6s chief e(ecutive officer in :;6C, he
found the $-O! model to be #a% a tool for detecting high5ris
strategic moves, #b% a rich source of ,uestions for the review of
strategies proposed by divisional managers, and #c% a means of
computing the differential between the entire company6s
financial goals and the e(pected aggregate earnings of its
components& #"f the model predicted a shortfall, it could then be
used to display the future implications of Abelt tightening,A
component by component%
"n addition to maing e(tensive use of the model himself, 3orch
also encouraged his group e(ecutives and division managers to
use it 2e supported follow5on research to improve the coverage
and predictive powers of the early models&
'oday, cross5sectional models are standard elements of <>6s
corporate planning system&
-he $rimary $ur$ose of 6hase (as to establish the
feasibility of obtainin# reasonably com$arable data
from a lar#e number of diverse com$anies. .lthou#h
differences in accountin# systems and terminolo#y did
$ose $roblems, the $ro0ect (as successful, $rofit results
(ere e'$lained and $redicted (ith considerable
accuracy. )oreover, the $rinci$al results of 85/s earlier
(or% (ere confirmed. By and lar#e, the same factors
that influenced RO in 85 businesses also sho(ed u$ in
the analysis of $rofitability amon# the 1> diverse
-hus, in late 9<:=, )S a#reed to s$onsor a second,
enlar#ed $hase of the 6)S $ro0ect. -his time, 4:
com$anies enlisted in the study and su$$lied more
e'tensive information, coverin# the years 9<:279<:=,
for >=2 businesses. .nalysis of this data base over the
$ast several months has led to the current set of 6)S
$rofit models. For the com$osition of our sam$le of
businesses, see 5'hibit .
-he models (e and our associates have develo$ed are
desi#ned to ans(er t(o basic *uestions, What factors
influence $rofitability in a business7and ho( much&
Ho( does RO chan#e in res$onse to chan#es in
strate#y and in mar%et conditions&
n buildin# *uantitative models to e'$lain RO and
chan#es in RO, (e have dra(n on economic theory and
on the o$inions and beliefs of e'$erienced e'ecutives.
5conomic theory su##ests, for e'am$le, that different
"mar%et structures" 7 i.e., the number and relative size of
com$etitors7(ill lead to different $rofit levels. Business
e'$erience indicates that $roduct *uality 7 a factor that
has received little attention from economists 7 is also
related to RO. $rofit levels. Business e'$erience
indicates that $roduct *uality 7 a factor that has received
little attention from economists 7 is also related to RO.
6)S sam$le of individual businesses
Number of companies 57
Number of businesses 620*
Type of company:
Consumer product manufacturers 19!"
Capital e#uipment manufacturers 156
$a% materials producers 119
Components manufacturers 2&1
'upplies manufacturers 165
'er(ice and distribution 121
? -he data $resented in 5'hibits 7@ are based on
analyses of 4=9 businesses. Since the time these analyses
(ere made, information has bean received on an
additional << businesses.
RO and %ey $rofit influences
Return on investment (ROI):
T)e ratio of net* preta+ operatin, income to a(era,e
in(estment -peratin, income is %)at is a(ailable after
deduction of allocated corporate o(er)ead e+penses but
before deduction of any financial c)ar,es on assets
employed .in(estment. e#uals e#uity plus lon,/term
debt* or* e#ui(alently* total assets employed minus
current liabilities* attributed to t)e business
T)e ratio of dollar sales by a business* in a ,i(en time
period* to total sales by all competitors in t)e same
mar0et T)e .mar0et. includes all of t)e products or
ser(ices* customer types* and ,eo,rap)ic areas t)at are
directly related to t)e acti(ities of t)e business 1or
e+ample* it includes all products and ser(ices t)at are
competiti(e %it) t)ose sold by t)e business
Prou!t (servi!e) "ua#it$:
T)e #uality of eac) participatin, company2s offerin,s*
appraised in t)e follo%in, terms: 3)at %as t)e
percenta,e of sales of products or ser(ices from eac)
business in eac) year %)ic) %ere superior to t)ose of
competitors4 3)at %as t)e percenta,e of e#ui(alent
products4 5nferior products4 T)e measure used in
6+)ibit 57 and 6+)ibit 7 is t)e percenta,e .superior.
minus t)e percenta,e .inferior.
Total costs for sales force* ad(ertisin,* sales promotion*
mar0etin, researc)* and mar0etin, administration T)e
fi,ures do not include costs of p)ysical distribution
Total costs of product de(elopment and process
impro(ement* includin, t)ose costs incurred by
corporate/le(el units %)ic) can be directly attributed to
t)e indi(idual business
$atio of total in(estment to sales
8n inde+ %)ic) reflects 91: t)e number )er of different &/
di,it 'tandard 5ndustrial Classification industries in %)ic)
a corporation operates* 92: t)e percenta,e of total
corporate employment in eac) industry* and 9;: t)e
de,ree of similarity or difference amon, t)e 5ndustries in
%)ic) it participates
Whatever economic theory or businessmen/s o$inions
may su##est, ho(ever, the ultimate test of (hether and
ho( a #iven factor is related to $rofitability is an
em$irical one. -o ma%e such a test, (e have constructed
an e*uation that e'$lains more than A23 of the
variation in $rofitability amon# the >=2 businesses in
the 6)S data base.
-his $rofit level e*uation includes more than >2 terms
com$osed of various combinations of 1: basic factors.
.s mi#ht be e'$ected, $rofitability is related to many
different factors. Some of the most im$ortant ones are
listed and defined in 5'hibit .
-he 6)S $rofit level e*uation and a se$arate e*uation
(hich $redicts chan#es in RO have been used to
construct se$arate re$orts for each business in the data
$ool. -hese re$orts "dia#nose" the factors influencin#
RO in a business, #iven all of its s$ecific characteristics
such as its mar%et, com$etitive $osition, ca$ital
intensity, and so on.
Because every business is, in some res$ects, uni*ue,
these dia#nostic re$orts vary enormously. But by
com$arin# businesses that are similar in terms of one or
more basic $rofit7influencin# factors (ith businesses
that have different characteristics, (e can identify some
#eneral $atterns or relationshi$s.
For e'am$le, (e can determine an avera#e relationshi$
bet(een mar%et share and $rofitability by com$arin#
avera#e levels of RO for #rou$s of businesses (ith
different mar%et shares. -his is the a$$roach (e have
used in subse*uent sections of this article.
.s (e mentioned a moment a#o, our $rofit model
includes 1: distinct factors (hich, in various
combinations, are si#nificantly related to $rofitability.
Ho(ever, (e shall limit our discussion to 0ust 1 ma0or
determinants of return on investment revealed by our
analysis of the 6)S data base7namely, mar%et share,
investment intensity, and com$any factors.
Our analyses #ive stron# su$$ort to the $ro$osition that
mar%et share is indeed a ma0or influence on
$rofitability. .s sho(n in 5'hibit , RO #oes u$
steadily as mar%et share increases. On the avera#e,
businesses (ith mar%et shares above 1>3 earned more
than three times as much, relative to investment, as
businesses (ith less than :3 share of their res$ective
mar%ets. (5ach of the five mar%et share cate#ories
sho(n in this e'hibit re$resents a$$ro'imately one fifth
of the sam$le.!
-he relationshi$ bet(een mar%et share and $rofitability
has been (idely discussed since the ince$tion of 6ro0ect
6RO) at 8eneral 5lectric, (hen the idea (as relatively
novel. But ho( and (hy mar%et share affects
$rofitability is not fully understood as yet.
Our findin#s su##est that businesses (ith relatively
lar#e mar%et shares tend to have above7avera#e rates of
investment turnover, $articularly (or%in# ca$ital. .lso,
the ratio of mar%etin# e'$ense to sales is #enerally
Co(er for hi#h7share businesses than for those (ith
small mar%et shares. -hese differences are indications
of economies of scale that may #o alon# (ith stron#
Ho(ever, much remains to be done, both in e'$lorin#
the connection bet(een mar%et share and RO and in
determinin# ho( the relationshi$ varies for different
ty$es of businesses or for different mar%et conditions.
Whatever the reasons, the data in 5'hibit 999 clearly
sho( that it is very $rofitable to have a hi#h share of
mar%et. Beyond this, the 6)S $rofit model sheds some
li#ht on ho( mar%et share and other factors (or%
to#ether to influence RO.
Relationshi$ of mar%et share to $rofitability
7"/1&" 1&"/22" 22"/;6" -(er ;6"
+onsider, for e'am$le, the im$act of both mar%et share
and $roduct *uality on RO, as sho(n in 5'hibit D. n
this e'hibit, and in several others that follo(, (e have
divided the 6)S sam$le of businesses into three
a$$ro'imately e*ual #rou$s on the basis of each of t(o
factors. -he $ercenta#es for each of the nine sub#rou$s
sho(n include bet(een B2 and :2 businesses.
5ffect of mar%et share and $roduct *uality n on RO
=ar0et Product #uality
s)are 5nferior 8(era,e 'uperior
<nder 12" &5" 10&" 17&"
12"/26" 110 1!1 1!1
-(er 26" 195 219 2!;
-he best of all $ossible (orlds is to have both hi#h
mar%et share and su$erior *uality, businesses in this
cate#ory avera#ed =A.13 return on investment. But
even (hen *uality (as relatively inferior, avera#e RO
for hi#h7share businesses (as a res$ectable /<.43. On
the other hand, su$erior7*uality $roducers (ith (ea%
mar%et $ositions earned an avera#e 9:.B3 on
investment, (hich su##ests that *uality can $artially
offset lo( share.
t should be noted that $roduct *uality and mar%et share
usually, but by no means al(ays, #o to#ether. -he
$ercent distribution of the three mar%et share #rou$s, in
terms of *uality levels, (as as follo(s,
Ender 9= 3 9=71>3 Over =2 3
nferior *uality B:3 113 =23
.vera#e *uality 12 1> 12
Su$erior *uality =1 19 42
;umber of businesses 9>< 9:> 9:>
m$act of e'$enditures on $roduct *uality and mar%et
Hi#h mar%etin# e'$enditures dama#e $rofitability (hen
*uality is lo(
Ratio of mar%etin# e'$enditures to sales
Co( .vera#e Hi#h
Ender >3 >37993 Over 993
nferior 94.B3 9B.A3 =.:3
.vera#e 9:.A 9>.< 9B.=
Su$erior =4.= =4.4 9<.A
Hi#h RFD s$endin# hurts $rofitability (hen mar%et
$osition is (ea% but increases RO (hen mar%et share
Ratio of RFD costs to sales
Co( .vera#e Hi#h
Ender 9.B3 9.B371.23 Over 1.23
Ender 9=3 99.B3 <.A3 B.<3
9=37=>3 91.A 9>.: 9:.2
Over =>3 ==.1 =1.9 =>.1
While it is not sur$risin# that both mar%et share and
relative *uality influence RO, in the short term there
may be relatively little that mana#ement can do to
chan#e these factors. .re some strate#ies more
$rofitable than others, #iven the basic com$etitive
$osition of a business& .nalysis of the results achieved
by the businesses in the 6)S sam$le su##ests that
some #uidelines can, indeed, be formulated for
businesses in different $ositions.
+onsider, for e'am$le, the data in 6art . of 5'hibit D.
Here, as in 5'hibit D, the sam$le has been divided into
three rou#hly e*ual #rou$s, this time in terms of (a!
relative *uality, and (b! the ratio of mar%etin#
e'$enditures to sales.
When *uality is relatively lo( 7 e'actly e*uivalent to
com$etition or some(hat inferior7there is a stron#
ne#ative relationshi$ bet(een mar%etin# e'$enditures
and RO. n effect, these fi#ures confirm the old ada#e
that "it doesn/t $ay to $romote a $oor $roduct."
RO is some(hat diminished by a hi#h level of
mar%etin# e'$enditure for businesses (ith "avera#e" or
"su$erior" relative $roduct *uality7but not nearly to the
same e'tent as for com$etitors (ith lo(er7*uality
$roducts. -his mi#ht su##est, further, that sellers of
hi#her7*uality $roducts or services could inflict severe
short7term $enalties on (ea%er com$etitors by
escalatin# the level of mar%etin# costs in an industry7
and that lo(er7*uality $roducers should avoid such
confrontations li%e the $la#ue.
.nother due to ho( $rofit influences vary, de$endin#
on com$etitive $osition, is #iven in 6art B of 5'hibit D.
-his sho(s, for businesses in the same mar%et share
cate#ories as in 5'hibit D, the relationshi$ of RO to
RFD s$endin# levels. When mar%et share is hi#h,
avera#e RO is hi#hest (hen RFD s$endin# is also
hi#h7above 13 of sales.
-hese fi#ures do not, of course, sho( (hich is cause
and (hich is effectG $ossibly businesses that are hi#hly
$rofitable7for (hatever reason7are inclined to invest
more of their earnin#s in research. )ost li%ely, the
$ositive relationshi$ bet(een RO and RFD s$endin#
reflects both this %ind of "reverse causation" and a
$ositive im$act, in the other direction, of RFD on
When mar%et share is lo(, the relationshi$ bet(een
RFD and $rofitability is e'actly the reverse of that
e'$erienced by those (ith stron# $ositions. -he hi#her
the level of RFD s$endin#, the lo(er $rofits (ere, on
the avera#e. Here, there a$$ears to be little doubt about
cause and effect, lo( $rofits (ould be very unli%ely to
lead to hi#h RFD s$endin#.
We should em$hasize, ho(ever, that these data
re$resent short7term effects. Since the 6)S
$artici$ants su$$lied information only for a three7year
$eriod, it may (ell be that 6art B of 5'hibit D reflects a
"transitional" cost of innovation. Some su$$ort can be
#iven for this inter$retation, amon# businesses (ith lo(
mar%et shares, RO (as hi#her (99.>3! (hen ne(
$roducts com$rised a relatively hi#h $ro$ortion of total
sales than (hen ne( $roducts re$resented only a small
fraction of sales (avera#e RO, 4.13!.
-hus, (hen and if RFD s$endin# is successfully
converted into ne( $roducts, it can $ay off. But the
most $rofitable course of all, for businesses (ith (ea%
mar%et $ositions, may be to see% ne( $roducts (ithout
investin# in research and develo$ment 7via imitation,
.$art from mar%et share and $roduct *uality, the most
im$ortant determinant of return on investment that (as
revealed by our analysis of the 6)S data $ool is
investment intensity, (hich is sim$ly the ratio of total
investment to sales.
5'hibit D sho(s the overall relationshi$ bet(een RO
and investment intensity, the hi#her the ratio of
investment to sales, the lo(er RO tends to be.
.$$arently businesses (ith hi#h investment intensities
are not able to achieve $rofit mar#ins sufficient to offset
the #reater amounts of investment they re*uire to
sustain a #iven volume of sales. We sus$ect that a $rime
reason for this may be the heavy em$hasis $laced on
achievin# hi#h volume, and thus hi#h ca$acity
utilization, in investment7intensive industries.
Since both mar%et share and investment intensity are
ma0or determinants of $rofitability, it is not sur$risin#
that the combination of the t(o factors accounts for a
substantial $ortion of total variation in RO. .s sho(n
in 5'hibit D, avera#e RO for businesses that en0oyed
both a hi#h mar%et share and a lo( de#ree of investment
intensity (as 1B.>3 7 more than 9: times the avera#e
return earned by the unfortunate businesses (ith hi#h
investment intensity and small mar%et share.
n most cases, the basic level of investment intensity
re*uired for a #iven business is $robably not sub0ect to
much control by mana#ement. -he amount of ca$ital
re*uired to su$$ort a s$ecified amount of sales is
determined $rimarily by the technolo#y of the business
and by traditional terms of trade.
For further thou#hts on this to$ic, see -heodore Cevitt,
"nnovative mitation," HBR Se$tember7October 9<>>,
Ho(ever, very often mana#ement does have some
choices that affect investment intensity7such as the
de#ree of mechanization or com$uter utilization. Our
data indicate that these ty$es of investments should be
carefully controlled if mar%et $osition is (ea%. Beyond
this, (hat can mana#ers do about investment intensity&
s a business that re*uires a hi#h investmentHsales ratio
sim$ly doomed to e'ist (ith lo( rates of return&
+om$arison of various #rou$s of businesses (ithin the
investment7intensive cate#ory sho(s that some
strate#ies are li%ely to be more $rofitable than others.
+onsider, for e'am$le, the data in 5'hibit D. .mon#
businesses in the hi#hest investmentHsales #rou$, RO
(as stron#ly7and ne#atively7related to the level of
mar%etin# e'$enditures. For businesses (ith lo(
investment intensity, the relationshi$ of RO to
mar%etin# e'$enditures (as *uite different, avera#e
$rofitability (as actually hi#her (hen mar%etin#
e'$enditures (ere "moderate" in relation to sales than
(hen they (ere lo(.
Relationshi$ of investment intensity to $rofitability
&0"/55" 55"/65" 65"/90" -(er 90"
Co( mar%et share $lus hi#h investment intensity
Ender 9=3 9=37=>3 Over =>3
Ender B43 =9.=3 =>.<3 1B.>3
B437:93 A.> 91.9 =>.=
Over :9 3 =.2 >.: 94.:
Hi#h mar%etin# e'$enditures dama#e RO in
Ratio of mar%etin# e'$enditures to sales.
Ender >3 >37993 Over 993
Ender B43 =<.13 19.:3 ==.23
B437:93 9:.> 91.= 9A.1
Over :93 92.< 92.9 1.<
Similar com$arisons of sub#rou$s (ithin the 6)S
sam$le sho( that (hen investment intensity is hi#h (a!
hi#h levels of RFD s$endin# de$ress earnin#s shar$ly,
at least in the short run, and (b! hi#h labor $roductivity
is vital to $rofitability. (-he avera#e return for
businesses (ith hi#h investment intensity and lo(
$roductivity7measured by sales $er em$loyee7(as a
ne#ative 93 of investment.!
. third cate#ory of $rofit determinants revealed by the
6)S $ro0ect consists of characteristics of the com$any
that o(ns a business. 5ven (hen all of the
characteristics of t(o businesses are identical, our
analysis su##ests that their $rofit results may vary if
they belon# to cor$orations that differ in terms of size,
diversity, and other factors.
RO varies (ith size and diversity of $arent com$any
-otal com$any sales (n millions!
Co( .vera#e Hi#h
Ender I:42 I:427I9,422 Over I9,422
.vera#e RO 94.A3 9=.43 =9.:3
De#ree of diversity
Co( .vera#e Hi#h
.vera#e RO 9>.93 9=.<3 ==.93
Car#e com$anies benefit most from stron# mar%et
Ender 9=3 9=37=A3 Over =A3
Ender I:42 9B.43 91.:3 9<.>3
I:427I9,422 >.A 94.2 =4.2
Over I9.422 9=.2 9:.A =<.B
5'hibit @ sho(s avera#e RO levels for businesses
belon#in# to com$anies that are in "lo(", "avera#e,"
and "hi#h" sales cate#ories, and that have different
de#rees of cor$orate diversity. -he ran#e of cor$orate
size re$resented in the 6)S sam$le is, of course,
limited, "small" com$anies are those (ith annual sales
volume under I:42 million. Within this ran#e, RO at
the business level (as hi#hest for the lar#est com$anies
and lo(est for those in the "avera#e" #rou$.
-he e'$lanation for this, (e believe, is that the lar#e
cor$orations benefit from economies of scale, (hile the
smaller com$anies #ain some advanta#es from #reater
fle'ibility. -hose in the middle are neither fish nor fo(l,
and conse*uently they earn the lo(est rates of return.
-he relationshi$ bet(een business7level RO and
cor$orate diversity is similar to that based on com$any
size. On the avera#e, RO (as $ractically identical for
businesses belon#in# to hi#hly diversified cor$orations
and for those o$erated by nondiversified com$anies.
6resumably, the diversified cor$orations achieve #ood
results throu#h effectivenessness as "#eneralists."
.t the other e'treme, $rofitability reflects the
advanta#es of cor$orate s$ecialization. -he lo(est
levels of RO are for the middle #rou$, (hich benefits
from neither. (-hese and other observed relationshi$s
bet(een RO and com$any characteristics are tentative
findin#s, of course, because of the limited number of
com$anies included in our sam$le.!
Our final e'am$le of a relationshi$ bet(een RO and a
combination of factors serves to illustrate further ho(
com$any characteristics affect $rofitability. n 5'hibit
@, (e sho( avera#e levels of RO for businesses that
have different mar%et shares and that belon# to different
com$any size #rou$s.
.s in earlier e'hibits, the $ositive im$act of a hi#h
mar%et share is a$$arent. But, in addition, the data
indicate that lar#er com$anies derive #reater advanta#es
from stron# mar%et $ositions than smaller com$anies
do. -his $robably reflects the ability of lar#er
com$anies to $rovide ade*uate su$$ort for stron#
$ositions, in terms of mana#ement $ersonnel and funds
for mar%etin# or RFD.
On the other hand, smaller com$anies do sli#htly better
than lar#e ones in businesses (ith lo( mar%et shares.
-his lends su$$ort to the belief that the relatively small
com$anies derive some advanta#es from fle'ibility.
Applying the findings
-he cor$orate a$$lications of the 6)S findin#s are
many and varied. -hese include aid in $rofit forecastin#
for individual business units, measurin# mana#ement
$erformance, and a$$raisin# ne( business
.s $art of the 6)S $ro0ect, re$orts are $re$ared for
each business, sho(in# ho( its e'$ected level of RO is
influenced by each of the 1: distinct factors included in
the $rofit model. -he result of this %ind of analysis is
(hat (e call a "6.R" return on investment for a
business, #iven its mar%et and industry environment, its
com$etitive $osition, its ca$ital structure, and so on.
Some of the $artici$atin# com$anies are be#innin# to
$ut the findin#s to (or% by usin# the 6.R re$orts as a
standard of $erformance for individual divisions. For
e'am$le, if actual RO is substantially above the 6.R
level, this in an indication that divisional mana#ement is
$erformin# (ell. -he e'cess of actual over 6.R reflects
#ains made by current tactical su$eriority, since the
factors considered in calculatin# 6.R are lar#ely
as$ects of the strate#ic $osition of the business.
.$art from mana#ement $erformance, s$ecial
circumstances may cause actual RO to fall above or
belo( 6.R. For instance, the effects of $atents and
trade secrets are not reflected in the $rofit model.
Sub0ect to this *ualification, (e believe that 6.R or
e'$ected $rofit levels derived from the 6)S model Jr
from a similar analysis of actual e'$eriences under
different conditions7can serve as a meanin#ful standard
for evaluatin# actual results. +ertainly, this %ind of
standard is $referable to the sim$le interdivisional
com$arisons used to 0ud#e divisional $rofits in many
lar#e com$anies today.
6otentially, the most valuable a$$lication of the 6)S
findin#s (ill come from usin# them to estimate the
effects of strate#ic chan#es. 5ach $artici$atin#
cor$oration has recently received a second set of re$orts
(hich sho( ho( RO in a #iven business could be
e'$ected to chan#e, both in the short and lon# term, if
modifications (ere made in its strate#ic $osition.
t is too soon to tell ho( accurate those estimates (ill
be. But it is clear already that many of the mana#ers and
$lanners have obtained valuable insi#hts into the
reasons for $ast $erformance and the most fruitful
directions for chan#e.
)ar%et and industry situations, and results achieved can
be or#anized into a multi$ur$ose data base, and analysis
of this data base has yielded useful #eneral findin#s.
5'ecutives of the $artici$atin# com$anies are be#innin#
to utilize these results in the develo$ment and a$$raisal
of strate#ic $lans for individual business units.
Beyond the current benefits, (e can also s$eculate on
the broader im$act that the a$$roach re$resented by
6)S may have on the functionin# of the $rivate
+om$etition is at the heart of our economic system.
Will the $rocess of com$etition become more effective
or less effective if 6)S7ty$e information becomes
increasin#ly available& s the ans(er the same if (e
0ud#e effectiveness by some inde' of "social benefit,"
rather than by the health and $rofitability of individual
t seems entirely $robable that the ans(ers are, more
effective and yes.
While com$etition has been one of the mains$rin#s for
the dynamic #ro(th of the E.S. economy, the #reat
(asta#e of com$etition is increasin#ly retardin# our
national $roductivity. +an (e maintain the benefits
(hile reducin# the dra# of the (asta#e&
Research on multicom$any data may enable us to
accom$lish 0ust that, by hel$in# individual com$etitors
to lessen the fre*uency and scale of their com$etitive
mista%es. -he $ooled record of business successes and
failures, analyzed in 6)S7ty$e fashion, can identify the
courses of action that sim$ly have no $lausible $romise
at all, (hether for the com$any or the customer or
anyone else. t can also identify the other courses of
action that have a #ood $robability of yieldin# viable
results. +om$etitors can therefore concentrate their
ener#ies on the hi#her7yield actions, and not dissi$ate
their resources on *ui'otic ventures and forlorn causes.
-he 6)S $ro0ect has demonstrated the feasibility and
the benefits to be realized (hen com$anies $ool their
e'$eriences. nformation on strate#ic actions,
Business is not a zero7sum #ame, (here one man/s #ain
is inevitably another man/s loss. Sometimes most
everyone (ins, and sometimes most everyone loses.
-he systematic com$arative study of on#oin#
e'$erience can hel$ ma'imize the fre*uency of the first
outcome and minimize the second.
Source , Harvard Business Review, )arch7.$ril 9<:B,
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