Traditionally, the most reliable way for a firm to find its next wave of growth was to apply the capabilities of its core business in an adjacent market. But recently a new pattern has begun to emerge. More firms are learning the art of building large second cores – what Bain’s Zook and Allen call engine twos. Given that in the past five years, 60% of big public companies have seen their growth stall out or stagnate – often because of technological disruption – finding an engine two has become increasingly imperative.
What does it entail? Successful engine twos have four factors in common: They target markets where the profit pool is sizable and growing or shifting, as Amazon’s cloud computing business did. They have a differentiated competitive advantage, which is often built up through acquisitions, as happened at Disney+. They adopt entrepreneurial approaches, like Bradesco’s digital unit, Next, and leverage the scale and assets of the original core, as the industrial cleaning company Ecolab’s new water-purification business did.
In combination these four elements magnify one another’s effects, often creating businesses that have much greater potential than firms’ original cores.
In a series of forums we held recently with chief executives of large companies around the world, we uncovered a preoccupation with obsolescence and renewal. When we surveyed them, 65% of the CEOs predicted that in five to seven years their firms’ main competitors would be different from their main competitors today, and 63% said that new competitors with new business models would pose a major threat to their firms’ core business. The CEOs projected that in the next decade 40% of the value their companies created would come from entering new markets and launching new business models. Clearly, the business landscape feels highly unstable to them – which is understandable, given that new technologies continue to upend industries and wipe out businesses at a remarkable rate.
The good news is that there has never been a better time for companies to try to build new engines of profitable growth. We are in the longest period of low interest rates in modern history. Besides being cheap, money is abundant: One study by Bain & Company estimated that global investment capital had tripled in the past three decades and stood at 10 times global GDP. In addition, high-growth industries today don’t require as much investment as they once did; disruptive businesses can scale up faster in size and power with less capital.
In the past the most reliable way for businesses to find their next wave of growth was to mine their one or two strongest core businesses and apply their most distinctive capabilities in adjacent markets. Classic adjacency strategies included moves into new geographies (IKEA’s launch of stores in China in 1998 and in India in 2018), new products (Apple’s entry into the wearables business in 2015 with the Apple Watch, which now outsells the entire Swiss watch industry), and new customer segments (Porsche’s foray into the suburban family market in 2002 with an SUV line that now outsells its classic sports cars in the United States by two to one). Many successful companies have been propelled for decades by strategies based on adjacencies. We estimate that in the past 30 years nearly 75% of the companies that grew revenues and profits by at least 5.5% annually for 15 years or more did so by regularly adapting a repeatable business model to related segments, applications, or product categories or new geographies.
Yet recently, we have seen the success pattern begin to change. More businesses with strong, growing cores are learning the art of building large new cores – what we call engine twos. The top eight value-creating companies in the world – Amazon, Google, Apple, Microsoft, Tencent, Ping An, Reliance, and Samsung – have aggressively channeled their capabilities and cash flow into developing new cores. From 2008 to 2018 as much as one-third of the growth in the market value of large public companies could be traced to the prospects of their engine twos.
To be sure, the old playbook of expanding from the core into adjacencies will remain durable for many companies. But change and disruption now happen so fast that it’s very difficult to be certain that your company will be one of them. The risk of inaction is high. In the past five years more than 60% of big public companies have stalled out – experiencing a sudden large drop in growth or shareholder returns – or faced threatening levels of stagnation, underperforming their markets with low-single-digit growth. According to our studies of stall-outs and other research, after a large company experiences a downward trend in sales and profits for 10 years, the chances that it will be reversed are less than 20%.
That makes finding a successful second core an imperative. To better understand what that involves, we identified more than 1,000 companies that exhibited features of engine twos. Out of that set we built a database of 100 new initiatives that were deemed to have the potential to contribute a major share of a company’s future growth and were well-documented in company filings and media reports. We also developed case analyses of engine twos and distilled lessons from the 180 forums on growth and business building we’ve held over the past three years, which were attended by some 3,000 CEOs in 35 countries.
Three distinct archetypes of successful engine twos emerged. About a third were next-generation versions of original core businesses, or engine ones. These were separate units that often had been started in response to perceived threats from an insurgent competitor with a new business model, to a major shift in customer purchasing patterns, or to rapid technological advances that allowed companies to quickly create new offerings. Examples of this form of new engine include the digital bank that DBS founded alongside its traditional legacy bank, the digital media business that the traditional German periodical publisher Axel Springer shifted to, and the content-streaming service that Netflix built next to its original DVD-by-mail core.
A second form, accounting for nearly half the successful engine twos, involved moving into a market that historically was just minimally related to the engine one business, drawing on the first core’s assets and on new technologies. Consider the French multinational Schneider Electric: Alongside its core as a provider of heavy equipment for the transmission and distribution of electrical power, it created a thriving software and services business focused on energy management for factories and businesses. Such engine twos almost always have the additional benefit of strengthening the engine one and protecting it from market shifts or competitive threats. As part of its move into services, for instance, Schneider added internet capabilities to its equipment, which enabled the company to monitor it and offer customers invaluable “predictive maintenance” that prevented disruptions. Eventually, connectivity to the cloud could allow Schneider to shift to a new model in which it charges customers for the amount of energy they use instead of selling them equipment outright.
The third engine-two pattern, accounting for less than one-fifth of success cases, involved building a brand-new business almost completely unrelated to the engine one. Nearly all the examples in this category followed a common formula: preemptively making a major investment in a new technology, using current corporate capabilities to leapfrog into a leadership position, following up with additional heavy investments, and making acquisitions to obtain needed capabilities or build scale quickly. This was the path taken by the conglomerate Reliance, which started out as a synthetic-fiber producer, eventually expanded into oil and gas, and now is the most valuable company in India. In 2016, Reliance drew on its capabilities in raising capital for industrial projects, recruiting top management, and working closely with government agencies to launch its engine two – Jio, India’s first 4G mobile network – with an investment of $21 billion. It then spent an additional $15 billion to buy content and data service providers such as the KaiOS phone operating system and the music-streaming service Saavn. Today Jio is the leading telecom company in India, with some 400 million wireless subscribers and a 36% share of the market.
In our research we saw that four foundational elements were instrumental in the success of all three types of engine twos. They should be viewed as essential criteria for any new core a leadership team is contemplating entering at scale.
A Target Market With Large Profit Potential
Most successful engine-two businesses were in a market where the profit pool – the total profits earned at all points along the value chain – was sizable, rapidly expanding, or shifting. In more than 80% of successes, revenues and profits were clearly expected to rise faster in the engine two’s market than in the engine one’s. Amazon Web Services (AWS) is the most dramatic and well-documented example. By dominating the rapidly growing market for cloud computing, AWS now consistently delivers more profits than all the rest of Amazon does. (AWS has an operating margin of about 30%.)
The most common success factor in building new core businesses was a company’s ability to ride a technology adoption curve in markets where the profit pools were large or shifting quickly toward players with new forms of competitive advantage. More than 60% of the engine twos we studied had business models based on technology substitution (such as the insurer Ping An’s online medical service Ping An Good Doctor) or technology upgrades (such as Reliance’s Jio 4G network). This ability was also critical to the success of next-generation versions of engine ones (such as Philip Morris’s entry into smokeless products).
As these examples illustrate, successful second engines are often built on exciting frontiers opened up by novel technologies. Notably, we didn’t find any successful engine twos predicated on consolidating competitors across a declining industry or on acquiring and rejuvenating an underperforming leader in a lagging industry.
A Proprietary Source Of Competitive Advantage
Businesses make money by being sustainably different and better, not just by pursuing growth. This is the cold truth of hot markets. Most of the time, more than two-thirds of the profit pool in a clearly defined competitive arena is captured by the top two players, with the rest barely earning more than their cost of capital. When we recently studied the distribution of economic profits across a wide range of industries, we found that in many the proportion was even more lopsided. The lesson is clear: If you don’t possess or can’t see your way to developing a strong competitive advantage that will be hard for others to replicate, then think twice about pursuing an engine two.
This lesson was well understood by the management team of the Belgian company Umicore, a global leader in the reclamation of specialty metals, whose core business is two centuries old. Seeing an opportunity in the advent of electric vehicles and clean energy, the company started an engine two, Umicore Rechargeable Battery Materials, to focus on the essential products for batteries and catalysts. Because Umicore had years of experience working with lithium, nickel, cobalt, and manganese, which are all used in batteries for electric cars, and refining them into precise, high-quality formulations, its leadership team was confident that it could build a new business with a clear technical differentiation and advantage. To fund the engine two, in 2017 the company divested some older assets, including its zinc business, which had begun with a mine granted by Napoléon Bonaparte in 1805. In short order the engine two revenues eclipsed those of the reclamation business and became a major source of growth.
Successful second engines are often built on exciting frontiers opened up by novel technologies.
In some cases the differentiated asset or capability of a successful engine two was a product or service built to support the engine one. Ant Group, now one of the top financial technology companies in the world, began in 2004 when Jack Ma, the founder of Alibaba, created a service called Alipay that online shoppers could use to pay for purchases on his company’s e-commerce sites. In 2011, seeing that the online payment market was growing rapidly and that many adjacent markets were forming around it, Ma spun off Alipay as a separate company. Today it is the leading payment service provider in China, used by more than 80% of Chinese consumers. Alipay’s differentiation was not only its link to the Alibaba e-commerce businesses, which fed it tens of millions of customers, but also its approach to the market. Unlike other online payment methods – and thanks in part to a conducive regulatory environment in China – Alipay invested in service both to consumers and to vendors of all sizes (in the form of data on their businesses and methods for lowering financial risk). As a multisided platform, it has been able to tap even larger opportunities for growth.
When An Engine Two Isn’t Right For You
We have argued that it makes sense for more companies to consider building a second engine of growth. This perspective is based on the abundance of opportunities, historically low interest rates, the widespread availability of investment cash, new approaches to creating a culture of entrepreneurship, and the many ways to acquire or access strong new capabilities. However, any investment in an engine two carries risks, including to the momentum of the core business itself. Here are five reasons to consider backing off from an engine two:
Risk Of Losing Focus:If the original core business is not close to reaching its full potential and needs a lot of attention and resources to do so, the premature pursuit of a new core could derail the company.
Lack Of Commitment:Building an engine two requires a willingness to act fast and make major investments. Senior management must be committed to pursuing market leadership for the second core, not just trying to participate in the market.
Leadership Void:Engine twos can’t succeed if they can’t find leaders with the right passion, skills, and commitment.
Hostility From The Original Core:Leveraging the scale and capabilities of the core is central to building a new growth engine within a large corporation. If a firm’s most powerful business is resistant and controls key assets, then the time may not be right for an engine two.
Hot Market But Uncertain Advantage:If you are not confident that you have a truly differentiated offering, then you probably don’t have the basis for success, no matter how explosive the market’s growth could be.
Looking at Ant Group and at Umicore’s rechargeable battery business, one might conclude that an engine two initiative can be pursued only if all the elements necessary to create the new core already exist in the engine one. That is not the case. We found that only about one in four successful engine twos was built organically end to end; the remaining three did a lot of acquisitions to assemble the pieces needed to quickly scale up.
For engine twos that were next-generation versions of a core business, we saw several patterns of acquisitions. One was a “string of pearls.” Take the Danish company Ørsted. Originally founded to extract offshore oil and gas resources in the Danish sector of the North Sea, it decided to leverage its strong government relationships and engineering capabilities to start a renewable energy business. It bolstered this successful move by buying a series of wind farms, quickly gaining scale. Today wind energy accounts for more than two-thirds of the company’s revenues and a much larger share of its value creation.
Another pattern was a “big bang” acquisition that formed a major part of the new core and gave it significant market share, which the buyer then worked to enhance. A dramatic example is Dell’s $67 billion purchase of EMC, the leader in computer storage software and equipment. Note that this is far different from the “catch and kill” approach incumbents often use to squash insurgent competitors by buying them only to shutter their operations.
Acquisitions were also often used surgically to add assets and capabilities and quickly magnify the power of an engine two that had begun organically. A recent example of this is the founding of Disney+ in 2019. This high-profile entry into the streaming business was called the “highest priority” of Disney by former CEO Bob Iger, who stepped down from that position and into the executive chairman role to focus on creating this new core for the company. (Iger retired at the end of 2021.) While Disney+ began with a strong brand and a unique entertainment library, the acquisition of the capabilities of BAMTech, a media-streaming company, and the purchase of the content creator 21st Century Fox were central to its strategy. The venture is off to an explosive start and, if successful, will be the quintessential engine two, expanding the audience for Disney’s content while increasing follow-on sales of products based on its characters and shows – the biggest profit generator of the Disney model.
The bottom line is that acquisitions were crucial to creating a differentiated advantage in more than half of the successful engine twos, either by enabling the quick formation of a new growth core or by giving companies world-class technical capabilities.
The first two criteria for a successful engine two – a robust profit pool and the ability to form a differentiated core – are fundamentally market-facing conditions. The second two elements are quite dissimilar but no less important, and they relate to the internal characteristics of the company.
An Entrepreneurial Mindset
Building a second growth engine requires a way of thinking that doesn’t come naturally in large incumbents. In past research (described in our book The Founder’s Mentality), we defined the attributes of this mindset: a strong sense of insurgent mission, an obsession with the front line, and an ownership attitude. We found that companies that had those attributes accounted for 87% of second engines that were home runs, 66% of those that performed reasonably well, and just 12% of the failures. This mindset emerged as the strongest of the four success factors in our research.
How did companies with these traits overcome the bureaucracy that drags down most large organizations? They didn’t have to. Instead, they set up stand-alone engine-two units. For instance, the Brazilian bank Bradesco’s digital venture, Next, was a separate entity with its own target market of tech-forward customers, culture, brand, and ways of working. Ørsted made each of its wind farms an individual unit and gave the manager in charge the latitude to shape the local culture and strategy, creating a “mini-founder” experience. Jio was separated from Reliance and given a capital structure that allowed outside investors to buy shares of it, while still drawing on corporate assets that accelerated its growth.
The need to give start-up enterprises within a company freedom is not a new concept. Robert Burgelman wrote about the challenge of using assets from the original core to build new businesses in his book Strategy Is Destiny, comparing the established core to a creosote bush, which discharges sap to kill any new plants that grow around it – an analogy first used by former Intel CEO Craig Barrett. Clayton Christensen’s book The Innovator’s Dilemma documented the many factors that prevent companies from putting new ventures in separate units. What is new is how many large companies are finally beginning to crack the code by giving internal start-ups the ability to make decisions independently, empowering their leaders with the incentives of owners, and enabling faster, more-entrepreneurial ways of innovating.
The Ability To Leverage The Scale And Assets Of Engine One
It’s easy to focus on the disadvantages that large, often-bureaucratic companies face in launching new businesses, but incumbents have advantages too – primarily, not having to start from scratch.
Ecolab, for instance, built a successful engine two in water purification by drawing on the capabilities, channels, sales force, and customers of its engine one. Founded in 1923 by a salesman who noticed stains on his hotel carpet and created a cleaning solution, Ecolab grew to be the leader in industrial cleaning products and services and more than twice the size of its nearest competitor.
But when the growth of Ecolab’s markets started slowing a decade ago, its leadership looked for new opportunities and determined that its customers’ greatest need would be securing access to clean water. The company predicted that the water purification market would require highly advanced technology and would rapidly expand, presenting clear engine-two potential. Ecolab jumped into the business in 2011 by acquiring Nalco, a leader in industrial water purification.
Acquisitions were crucial to creating a differentiated advantage in more than half of the successful engine twos.
To fund more than a dozen acquisitions and equity investments in water-purification-technology companies, Ecolab then sold off its noncore assets in chemicals and energy. It also leveraged its cleaning sales force and purification and antimicrobial technologies to cross-sell water-treatment products and services to its core customers. Since 2010, Ecolab’s revenue has climbed from $6.8 billion to $11.8 billion, its enterprise value has increased by a factor of five, and its stock market value has jumped 465%, outperforming the overall stock market by more than 50%.
The sharing of capabilities, customer access, or distribution systems between an established engine one and a fledgling engine two doesn’t come naturally or happen on its own. Tensions and trade-offs inevitably arise. The key is to anticipate some of them early in the process, creating agreements that mitigate them in advance. In addition, it’s critical to regularly hold a standing group meeting, attended by leaders of each business and the CEO, to resolve conflicts, remove bottlenecks quickly, and identify further synergies.
The Power Of Combining All Four Elements
Each of the success factors magnifies and reinforces the effects of the others. The more potential the market and its profit pool (element one) have, the more important it is to harness the assets of the original core (element four) to capture share ahead of competitors. The stronger the differentiation of your entry strategy (element two), the more important it is to have an entrepreneurial mindset (element three) in order to test that differentiation and continually find ways to improve it, so you can remain a step ahead of the competition.
The combined power of all four elements can be seen in the hypergrowth of the Covid-19 PCR testing division launched by Thermo Fisher Scientific, which provides diagnostic, life sciences, and laboratory products and pharmaceutical services. During the pandemic the company built a new lab-based testing business that went from producing zero tests to 10 million weekly in six months. After only 10 months the new venture was on track to account for 25% of company revenues. Thermo Fisher then moved into rapid testing by acquiring Mesa Biotech, a small maker of PCR testing devices for hospitals, physicians’ offices, and urgent care clinics, and immediately scaled up its manufacturing and commercial capabilities, increasing sales volume for those products by 10 times in less than a year.
The company leveraged its engine one capabilities by shifting nearly 1,000 employees to the new business – notably, more than 100 R&D scientists who were given new six-month contracts. It promoted an entrepreneurial culture by temporarily walling that workforce off with a companywide message: “The Covid teams are doing something important for us and for the world. Please leave them alone to do it.” The company also formed executive teams devoted to slicing through bureaucracy, tossing out typical finance-enforced spending limits and speeding the hiring of more than 1,300 new employees, which doubled the division’s workforce. Thermo Fisher’s long-term ambition? The leadership position in testing in the world beyond the pandemic. Today the business boasts more than 20 SKUs developed from its first Covid test.
Conclusion
Engine two businesses are certainly not for every company or every situation. However, the environment today is more conducive to their success than it has ever been before. The financial conditions are uniquely ideal. Market turbulence is generating a burst of opportunities – as Thermo Fisher’s story dramatically demonstrates. As digital technologies continue to come of age, they’re unleashing new business models, redrawing market boundaries, and shifting profit pools. And perhaps most important of all, evolving management practices are making it easier to foster entrepreneurship within incumbent corporations and create the kind of flexible, innovative culture that will keep them strong for years to come.
originally posted on hbr.org by James Allen and Chris Zook
About Authors:
James Allen is a partner in Bain & Company’s London office and a member of the firm’s global strategy practice. He is a co-author of a number of bestselling books including Profit from the Core and The Founder’s Mentality: How to Overcome the Predictable Crises of Growth (Harvard Business Review Press, June 2016).
Chris Zook is a partner in Bain & Company’s Boston office and has been a co-head of the firm’s global strategy practice for twenty years. He is a co-author of a number of bestselling books including Profit from the Core and The Founder’s Mentality: How to Overcome the Predictable Crises of Growth (Harvard Business Review Press, June 2016).
