Who's On Your "Red Team?"

According to a McKinsey study, in the corporate world, for every five attempts to enter a new market, four fail and only one succeeds.

And this isn't limited to startups or novice businesses; it includes very sophisticated firms. For example?

Anheuser-Busch tried to diversify into snack foods. Not, you might think, such a stretch. Distribution channels for beer and snacks are similar; advertising venues are nearly identical; the target market is indistinguishable; impulse point-of-purchase displays are mirror images; even shelf lives and production facilities are, in many ways, complementary.

But what they didn't count on was the ferocious counterattack from Frito-Lay, who saw their fundamental franchise being assaulted. The result: "Eagle" snacks (the Anheuser-Busch brand) is no more.  (In a move combining equal measures of rationality and humiliation, Anheuser Busch sold a number of plants that made Eagle snacks to Frito-Lay.)

Corporations launch forays into new markets all the time, be they geographic, brand or line extensions, or "next door" like beer into snacks. And there's a reasonable amount of management literature out there about the odds of success and "best practices." Can we learn something? And hopefully improve upon the 80% failure/20% success rate? Let's see.

To begin with, what's the real problem? Here are the basic dimensions which need to be working in your favor if you want to launch into a new market successfully:

• Timing. Never underestimate this. Human nature is always subject to the temptation to buy at the top when all is palmy and sell at the bottom when all is dire. How many firms went piling into Silicon Valley shortly before the dot-com bust? And how many are piling into Dubai, Abu Dhabi, and Qatar now that "sovereign wealth" is the new mantra? Not all will come to tears, by any means, but it's worth thinking a minute or two about what seems to be terribly out of favor and asking searching questions about why and how long that might be.
  
  
• "Scale relative to the competition," in McKinsey speak: Meaning simply whether you can enter with anything resembling critical mass and, if not, how long it will take you to get there and how much it will cost in the interim. Law firms are famously allergic to long-term investments, because they have to be funded out of current (after-tax) income. But if you're not serious about invading, say, New York, or London, or Abu Dhabi, best not try.
  
  
• Whether the new market complements your existing strengths. This may sound obvious, but it's shocking how often it's honored in the breach. It might make sense, for interest, for Texas-based energy firms to launch in Moscow or Kazakhstan, or for Silicon Valley firms to launch in Austin, Texas or the Research Triangle Park area, but how much sense does it make for everyone and his brother to think, just on general principles, that they need to be dragon slayers in core capital markets practices in New York?

But if these preconditions for success are so obvious, why do we see such a high failure rate?

Attribute it to cognitive biases, which McKinsey describes as "systematic errors in the way executives process information."  For example:

• Believing the potential market is bigger than it is;
• Failing to consider the certitude that rivals will respond; and/or
• Relying heavily or exclusively on "inside" views and opinions rather than trying to develop an untainted, outside perpsective premised on the track record of similar attempted market penetrations.

The last one is the most interesting, so let's dwell on that.

Begin by trying to assemble some examples of similar attempted market penetrations by other firms in the past.  Whether you choose to characterize this as the grandiloquent "reference class" is up to you but that's what MBA's call it—just so you can defend yourself at the conference table. Once you have your precedents assembled—something you should be quite comfortable with—bring in a "Red Team" to play the role of devil's advocate, seeking out flaws in your analysis, anticipating potential competitive responses, coldly gauging the investment required and the time frame, and, in general, seeking to avoid the myopic but all too human tendency to seek out confirming data and ignore or discount contradictory information or analyses.  (The term "Red Team" comes from CIA parlance, standing for the team designed to attack the strategy of the good guys, the "Blue Team.")

Again, rehearse in your planning the key indicators of success or failure in entering a new market:

• The size you will enter with, compared to "minimum efficient scale," or breakeven capability.  If you plan to enter at a scale assuring you will lose money for awhile, just make sure you know what you're getting into.
• How related the market is to your exisiting core competence.  (See above re piling into New York's capital markets.)
• The timing, or order, of your entry.  This can of course cut both ways depending on the savviness of you and your competitors at exploiting the new market.  In some cases, first movers by rights out to have a clear advantage, but a corollary phenomenon is that of the "optimistic martyrs" who fall in the face of more experienced players who diversify later.
• The life cycle of the market.  You might assume that some markets are evergreen, and some may be, but to tear an example out of recent headlines, are you tempted to plant a flag in Abu Dhabi (say) to snag a share of the "sovereign wealth" investment frenzy?  First of all, you will scarcely be alone, as some high-profile firms have already announced this year that they will be opening up there.   But it's not just firms leaping off the starting line more or less in tandem with you; consider that some Magic Circle firms have been there a quarter century. 

It's hard to overemphasize the need for cold-blooded, disinterested analysis of the opportunity and how it matches up against your firm's current competencies.    This comes hard up against some intrinsic human tendencies:

By and large, we're optimists.  We tend to gravitate towards the positive outcome rather than the negative one, to buy stock rather than to short it, to assume that what we paid was fair and the asset we acquired can only appreciate in value. 

Another flaw in our thinking is the power of "anchoring," or of giving undue weight to the first price, the first growth rate, the first level of investment that is mentioned.  Professionals are not immune.  McKinsey reports a study which distributed ten-page booklets on houses to residential real estate brokers, detailing prices and characteristics of comparable houses in the area.  The brokers visited each "comp" as well as the house in question, and were asked to select an appropriate asking price.  Unbeknownst to the brokers, the listing prices for the key house had been randomly assigned over a range of plus or minus 11% from the true listing price.    These bogus listing prices strongly affected the brokers' estimates—and even when they were told about the set-up, they denied that the "anchor" had any impact on them. 

Can you avoid these "cognitive biases?" 

Yes, with analytic rigor and a scrupulous insistence that the "Red Team" be taken seriously.  But never lose your sense of optimism.  Optimists may not always be right, but pessimists never change things for the better.