Minding My Own Business

The Loft Principle

June 28, 2007

Merger and acquisition activity is at record levels across not only the American business landscape, but throughout the global economy. Conversations about the frenetic pace of transactions usually focus on the M or the A. That is, the analyses and discussions of the deal typically center around the glamour of the transaction, which is the acquiring entity and its newly enlarged organization. The market is eager to speculate about the buyer's motivations and post-deal strategy, and observers are quick to predict the effects of new ownership on the property and the effect of the property on the new owners. The motivations of the sellers, beyond the cash received, are all too frequently bypassed. Astute analysts, though, take great care in assessing the strategies behind divestitures, as they tell us as much about the sellers and their prospects for the future as does a similar analysis of the acquirers, if not more.

For this reason, I was excited to come across a 2006 survey conducted on behalf of Accenture by the Economist Intelligence Unit, a consulting arm of The Economist magazine. The survey revealed that 27 percent of senior executives believed their companies' divestments would increase over the next three years compared with 11 percent who thought they would decrease. The study in which this survey was analyzed, "Using Divestitures as a Lever for Change" by Accenture consultants Arthur Bert and Caroline Firstbrook, discusses how businesses can use divestitures to transform companies. The methods described include revitalizing overall business strategy, revisiting interactions with customers, fundamentally altering corporate culture, and restructuring back office functions. But what the paper does not address is the crux of successful decision making when weighing both investments and divestitures. It is here where the Loft Principle enters the equation.

I am a firm believer in the Loft Principle, which is in fact the inverse of the principle of core competency. The Loft Principle insists that you have no business competing if you don't have the innate abilities and capabilities to succeed. Or, in the parlance of Dirty Harry, "A man's got to know his limitations." Whether conducting a strategic brainstorming session with clients or speaking at an industry conference, I often find myself explaining the derivation of the Loft Principle and its essential relevance to strategic thinking companies and managers.

The Loft Principle can best be illustrated through the following story: Three weekend golfers arrive at the first tee to discover that the starter has filled out their foursome with the club professional. The three friends are excited by the prospect of playing with a player and instructor of such a caliber, anticipating some useful analysis and tips on technique to improve their respective games. The pro tees off first, and propels his drive 300 yards right down the middle of the fairway. Then the three friends take their hacks. The first fellow hooks his drive into the woods on the left of the fairway. He turns to the pro and asks "What did I do wrong?" The pro responds succinctly: "Loft." The second of the three steps up and dribbles his drive fifty yards off the tee. He too turns to the pro, who nods at him and says "Loft." The third friend slices his drive into the lake on the right, looks at the pro expectantly, and receives the same deadpan "Loft." As the foursome heads down the fairway, the three friends exchange confused glances and gesticulate to each other, until the first one draws up the courage and addresses the pro. "Excuse me, but you've got us really confused. I pulled the ball way left, my buddy grounded his shot, and my other friend sliced his way right - and when we asked you what we did wrong, you told each of us the same thing: 'Loft.' What exactly does 'Loft' mean?" The pro didn't turn around or even break stride as he answered. "Loft: Lack Of Freakin' Talent."

Every business that competes in an open marketplace offers a particular product or service to a defined clientele. Somewhere within the design, manufacture, selling, or servicing of this offering must be a competitive advantage. And this advantage must in some way affect the pricing, quality, service, or delivery of the product to the end user. In other words, it is only a competitive advantage if the customer perceives its added value. The company that understands and develops its competitive advantage is infinitely better positioned for long term growth and success.

The Loft Principle underscores the importance of knowing what it is that you are good at, and at what you are not. Every business model, at its most fundamental level, must be able to lay out the differentiated value the company provides to its marketplace, and ideally, barriers to its competitors matching or beating that offered value. This value can reflect itself in many ways, including quality, customized product or services, pricing, turnaround time, or even personal relationships. For the vast majority of manufacturers in conventional industries, having outstanding capabilities is simply not good enough, because their competitors have those capabilities too. Developing a value proposition that provides unquestionable value to customers is where the truly successful company distances itself from the also-rans.

For several decades, the professional management community has espoused the importance of developing core competencies and building a business around them. Bolstered by the success of Warren Buffett, core competencies has attained as lofty a status among business fundamentals as buy low, sell high. Perhaps the most well known company structured and managed on the basis of this philosophy was Jack Welch's General Electric of the 1980s and '90s. Welch, of course, engineered 20 years of record breaking growth and profitability by demanding that every GE business either possess or be poised to capture the number one or number two market share position in its industry. Those businesses unable to achieve this level of market leadership were jettisoned in order to focus corporate capital and resources on the industry dominating units.

For companies struggling to grow or remain profitable in the face of rising costs, dropping selling prices, and extreme competition, the Loft Principle demands a soul-baring gut check. Are you capable of competing with your product or service (or both) on a world class level? Can you meet the best performance levels of your competitors without pricing yourself out of the ballpark? If the answer is no, you really have only two choices: Either find a way to improve your positioning by ratcheting up the value of your proposition, or consider exiting the business before your situation worsens.

For larger organizations, however, there is an inherent danger lurking within a broad divestment strategy, and that is the possibility of taking things too far. It is easy for managers to fall in love with the improved profit margins and cash positions that such a strategy can yield. But there is a forest-for-the-trees reality for even the most aggressive divestment strategies. I recently came across a fascinating analysis of Unilever's five year "Path to Growth" in Booz-Allen's Strategy + Business magazine in an article titled "How to Slim Down a Brand Portfolio". In this article, the authors discuss how Unilever developed a plan in 2000 to reduce its portfolio of brands and close numerous production facilities. However, within three years, the company saw not only its revenue growth shrink, but was unable to capitalize on up-and-coming product trends and fads, such as low carb foods. The study concluded that Unilever had proceeded with the divestment strategy without properly identifying its competitive advantages or the regional differences in consumers' tastes. As a result, the company was unable to produce the much higher sales from the remaining brands in its portfolio to compensate for the loss of the divested brands' revenue.

As with most management strategies, keeping things simple is usually best. The Loft Principle advises you build your business around what you do best, and to avoid competing against those who are superior and will always be superior. This is timeless advice, as are the words of the great 19th Century American poet Henry Wadsworth Longfellow, who pointed out that "The talent of success is nothing more than doing what you can do well and doing well whatever you do."

Elisha Tropper is president and CEO of T3 Associates, a New York based strategic consulting firm, and the former president of Prestige Label, a North Carolina converter. He can be reached by e-mail et@t3associates.net.