How does a company create value? I want us to take a minute and think about this fundamental business question. Let's imagine that you have some money on the side, and you would like to invest it. You think hard, and you come up with a product idea that you believe will serve an unmet need in your city. You convince a friend to lend you some more funds, and you create your own company to build and sell this ingenious product. Let's assume that, at the start, your business is worth one million dollar. By this I mean, if you want to sell your company, an investor would be happy to pay that amount of money to own it. Fast forward five years, your business has grown to be worth 10 million dollars. Here's my question, "Where do you think this additional value is coming from?" Well, there is a variety of sources. Maybe your business has some real estates that appreciated over time, maybe it quickly became profitable at some point in time and that profit was kept in the company. Maybe you grew from your city, to covering the country, to maybe a global player. If you are like the largest 125 S&P 500 companies in 2004, those growth prospects would be fueling 78 percent of your market capitalization. However, this source of growth has an inherent limitation. You will reach a plateau in the adoption curve, that Mike has described in Module Two. Once you have gone from the city, to the country, to the globe, where else do you want to go? This is the point where you will need to look for new sources of growth, and in fact, this has become harder and harder over time. If you look at the period between 2004 and 2014, growth options' contribution to market capitalization has dropped to 68 percent, 10 percentage points lower than 2004. One of the reasons is that technology has deconstructed established industries and lowered significantly the barriers for entry, especially for new digital attackers. New startups, in fact, became very good at capturing value from market leaders, especially those that felt a bit too comfortable in their stable, slow-growing plateau. So, if we go back to your business, as a business leader instead of trying to cope with disruption when it happens, you might want to anticipate it by proactively looking for self-disruption. That is, finding new digital growth, sometimes at the expense of your legacy business. This is actually not trivial when we talk about incumbent, established industry players. They should be efficient at managing the legacy business, which is still the predominant source of value, and at the same time, build new ventures that might make the legacy business obsolete. In other terms, run exploitation of their core and exploration of adjacencies at the same time. This ability is an example of what we have called ambidexterity, and large organizations are not good at it. In fact, only 11 percent of firms manage to achieve ambidexterity. What typically happens is, once a company pursues innovation, it loses efficiency. Once it is exploring, it neglects exploitation, like 3M, for example. In the early 2000's, they have deployed Six Sigma teams throughout the organization to increase operational excellence. Surely enough, operating profits as a percentage of sales went up, but they neglected innovation during that time. The New Product Vitality Index, that is, the percentage of sales from products that are less than five years in the market, went down. In 2005, Sir George W. Buckley was appointed CEO, and he shifted gears towards innovation. The New Product Vitality Index went up, but operating income went down. If you want to intuitively feel why it is hard to do both, let's do an experiment. I want you to start by crossing your arms. Feel comfortable? Now I want you to shift your lower arm to the top. How does that feel? Awkward, right? Organizations also are like that. When they find a way of doing something, they are uncomfortable changing it. So they fall into one of two common traps, the success trap or the perpetual search trap. Nokia has been victim to the former. They underestimated the migration to touch screens, and continued a bit too long with the feature phone. BCG research shows that, over a 10 year period, explorers grew six percentage points faster than exploiters, and delivered two point four percentage points higher total shareholder returns. The other extreme, pure exploration, or what we have called the perpetual search trap, is not risk-free neither. Xerox is a good example here. They invested heavily in innovation, especially at the end of the last century. Engineers in Xerox PARC were the first ones to create an early prototype of the modern PC, with a graphical user interface, a mouse, even before Apple's Macintosh in 1984. They have invented laser printers, invented Ethernet, but they have failed to monetize them.
