How Industries Change

86 HARVARD BUSINESS REVIEW

9 Industries follow distinctive change trajectories.Investments in innovation are more likely to |"

pay offifyou take those pathways into account.

HOW INDUSTRIES

ANGEby Anita M. McGahan

Y ou CAN'T MAKE INTELLIGENT INVESTMENTS within your or-ganization unless you understand how your whole industryis changing. If the industry is in the midst of radical change,

you'll eventually have to dismantle old businesses. If the industry isexperiencing incremental change, you'll probably need to reinvestin your core. The need to understand change in your industry mayseem obvious, but such knowledge is not always easy to come by.Companies misread clues and arrive at false conclusions all the time.Sotheby's, for example, invested in online auctions {its own Web siteas well as a venture with Amazon) as if the Internet were just an-other channel; in truth, the new technology represented a funda-mental shock to the industry's structure.

To truly understand where your industry is headed, you have toshut out the noise from the popular business press and the pressureof immediate competitive threats to take a longer-term look at thecontext in which you do business. That is what some of my col-leagues and I did. The research described in this article is based ona high-level look at a variety of businesses from a broad cross sectionof U.S. industries. The research, which began in the early 1990s andcontinues today, originally focused on how industry structure af-fects business profitability and investor returns. This statisticalanalysis yielded several hypotheses about how industries evolve,which were then tested and refined in a series of case studies on in-dustry structure, industry change, and competitive advantage.

OCTOBER 2004 87

How Industries Change

The conclusion, which I'll oversimplify here for thesake of clarity, is that industries evolve along four distincttrajectories-radical, progressive, creative, and intermedi-ating.' Moreover, a firm's strategy-its plan for achievinga return on invested capital-cannot succeed unless it isaligned with the industry's change trajectory. The fourtrajectories set boundaries on what will generate profitsin a business. Many companies have incurred losses be-cause they tried to innovate outside of those boundaries.One ofthe most famous examples is Xerox, which is leg-endary for its innovations and for its struggle to harvestprofits from them. By the mid 1980s, the copier manufac-turing industry had matured around a business modelthat emphasized creative "hit products." Meanwhile, thepersonal computing industry was in its infancy, and eventhough Xerox PARC had pioneered PC inventions such asthe graphical user interface and the mouse, the company

sets - the resources, knowledge, and brand capital thathave historically made the organization unique. These arethreatened if they fail to generate value as they once did.In the pharmaceutical industry, for instance, blockbusterdrugs are constantly under threat as patents expire andnew drugs are developed.

The exhibit "Trajectories of Industry Change" maps therelationships between these two threats and the follow-ing four change trajectories. Radicai change occurs whenan industry's core assets and core activities are boththreatened with obsolescence. This trajectory is closest tothe concept of disruptive change that Harvard's ClaytonM. Christensen discusses. Under this scenario, the knowl-edge and brand capital built up in the industry erode, andso do customer and supplier relationships. During the1980s and 1990s, an estimated 19% of U.S. industries wentthrough some stage of radical change. A good example is

Industries evolve along four distinct trajectories-radical,progressive,creative,and intermediating-that set boundarieson what will generate profits in a business.

was unable to make inroads in this burgeoning industrythat required an entirely new set of business activities.

No innovation strategy works for every company inevery industry. But if you understand the nature ofchange in your industry, you can determine which strate-gies are likely to succeed and which will backfire.

Four Trajectories of ChangeBefore we look at the four trajectories of industry evolu-tion in depth, it is worthwhile to recognize that they aredefined by two types of threats of obsolescence. The firstis a threat to the industry's core activities-the activitiesthat have historically generated profits for the industry.These are threatened when they become less relevant tosuppliers and customers because of some new, outside al-ternative. In the auto industry, for example, many dealer-ships are finding that their traditional sales activities areless valued by consumers, who are going online for dataon the characteristics, performance, and prices ofthe carsthey want. The second is a threat to the industry's core as-

Anita M. McGahan (omcgahan(§)bu.edu) is the Everett V.Lord Distinguished Faculty Scholar and Professor at BostoriUniversity's School of Management and a senior instituteassociate at the Institute for Strategy and Competitiveness atHarvard University in Cambridge, Massachusetts. This arti-cle is adapted from her forthcoming book, How IndustriesEvolve: Principles for Achieving and Sustaining SuperiorPerformance (Harwrd Business School Press, 2004).

the travel business. Agencies' core activities and core as-sets came under fire as the airlines implemented systemsto enhance direct price competition (such as SABRE andother reservations systems) and as the agencies' clientsturned to Web-enabled systems (such as Expedia, Orbitz,and Travelocity) that offered new value (online monitor-ing of available fiights and fares, for instance).

When neither core assets nor core activities are threat-ened, the industry's change trajectory is progressive. Overthe past 20 years, this has been by far the most commontrajectory; about 43% of U.S. industries were changingprogressively, including long-haul trucking and commer-cial airlines. In those industries, the basic assets, activities,and underlying technologies remained stable. Innovatorslike Yellow Roadway, Southwest, and JetBlue succeedednot because the incumbents' strengths became obsoletebut because the upstart firms had smart insights abouthow to optimize efficiency.

The other two change trajectories-creat;Ve and inter-mediating -have been neglected in the managementliterature, possibly because of their nuances. Creativechange occurs when core assets are under threat but coreactivities are stable. This means that companies must con-tinually find ways to restore their assets while protectingongoing customer and supplier relationships; think ofmovie studios churning out new films or oil companiesmining for new wells. About 6% of all U.S. industries areon a creative change trajectory.

Intermediating change occurs when core activities arethreatened with obsolescence-customer and supplier re-

HARVARD BUSINESS REVIEW


lationships are stretched and fragile - while core assetsretain their capacity to create value. Sotheby's, for in-stance, is as good as it ever was at assessing fine works ofart, but, because ofthe technology that made eBay possi-ble, the auction house's matchmaking activity no longercreates as much value. The challenge under intermediat-ing change is to find ways to preserve knowledge, brandcapital, and other valuable assets while fundamentallychanging relationships with customers and with suppli-ers. During the 1980s and 1990s, approximately 32% ofU.S. industries went through some form of intermediat-ing change.

Radical ChangeRadical transformation occurs when both core activitiesand core assets are threatened with obsolescence. The rel-evance of an industry's established capabilities and re-sources is diminished by some outside alternative; rela-tionships with buyers and suppliers come under attack;and companies are eventually thrown into crisis. Radicalindustry evolution is relatively unusual. It normally oc-curs following the mass introduction of some new tech-nology. It can also happen when there are regulatorychanges (as in the long-haul, trunk-route airline industryofthe 1970S, for example) or simply because of changes intaste (U.S. consumers' retreat from cigarettes over the past20 years, for instance).

An industry on a radical change trajectory is entirelytransformed-but not overnight. It usually takes decadesfor change to become clear and play out. The end resultis a completely reconfigured-usually diminished-indus-try. The overnight letter-delivery business is currently inthe early phases of a radical transformation that beganabout ten years ago. As Internet usage has become moreprevalent, e-mail (especially securely encrypted e-mail)has loomed as a threat to this industry. Yet the volume ofovernight letters is increasing; business is still thriving,because the threat is still in its infancy.

That is part of the good news associated with radicaltransformation: Industries that are on a radical changetrajectory often remain profitable for a long time, espe-cially if the companies in these industries scale back theircommitments accordingly. Businesses also have time todevelop strategic options that can be exercised in thefuture if they recognize the trajectory they are on earlyenough. For example. Federal Express's acquisition ofKinko's will help FedEx create deeper relationships withsmall and midsize businesses that need document stor-age, management, and dissemination services.

The only reasonable approach to radical change is tofocus on the endgame and its implications for your com-pany's current strategy. Exiting isn't the sole option; some-times a few survivors can sustain profitable positions afterothers leave the industry. The computer mainframe busi-

ness, for example, is still quite large despite the threatfrom PC and workstation manufacturers.

To consider the best strategy when your industry is ona radical change trajectory, look at your productivity fig-ures, the pace and timing ofthe transition in the industry,and buyers' switching costs. Early-moving companiesmight employ a staggered strategy - pursuing incremen-tal improvements to established businesses' activities andconducting selective experiments in developing new as-sets. That is how encyclopedia companies responded tothe radical threat that online search engines posed: Theyexperimented with new electronic products and serviceswhile creating new distribution channels, marketing theirexisting products aggressively, and updating their inven-tory management systems.

Historically, many organizations confronted with radi-cai change in their industries have abandoned their es-tablished positions and moved into emerging lines ofbusiness- incurring enormous risk in the process. Severaltypewriter makers, for instance, attempted to enter thePC manufacturing business only to cut short their effortsas the demands ofthe emerging industry became clearer.(IBM succeeded with this strategy, but its success in thePC industry was closely related to its experience in otherareas of computing.) The alternative-reinvesting in theestablished industry - is also risky because it commitsthe firm to an approach that may become unprofitable.Companies dealing with radical transformation must ac-cept the inevitability of the change and chart a coursethat maximizes returns without accelerating commitmentto the troubled business-much easier said than done.

Intermediating ChangeIntermediating change is more common than radical in-dustry evolution. It typically occurs when buyers and sup-pliers have new options because they have gained un-precedented access to information. The core activities ofindustries on an intermediating change trajectory arethreatened. But the core assets of these industries-knowl-edge, brand capital, patents, or even specialized factoryequipment - retain most of their value if they are used innew ways. In effect, industries are on an intermediatingchange trajectory when their business activities for deal-ing in both downstream and upstream markets are si-multaneously threatened. Intermediating change is oc-curring in auto dealerships, for example, for a number ofreasons. First, traditional auto sales activities are becom-ing less relevant because ofthe Internet and because ve-hicles now last so long that consumers buy cars less fre-quently. Second, car manufacturers are seeking closerrelationships with drivers and, as a result, are starting toshare the management of customer relations with theirdealers; in some cases, they're trying to take over cus-tomer relations completely. Finally, individual dealers are

OCTOBER 2004 89


losing control of inventory management as IT and so-phisticated financing create economies of scope that canbe exploited only by larger, integrated companies.

Managing a company in an industry that is experienc-ing intermediating change is extraordinarily difficult. Ofall the change trajectories described in this article, thisone is perhaps the most challenging because companiesmust simultaneously preserve their valuable assets andrestructure their key relationships.

Executives tend to underestimate the threat to theircore activities by assuming that longtime customers arestill satisfied and that old supplier relationships are stillrelevant. In reality, these relationships have probablybecome fragile. The value of core assets often escalates,which compounds managers' confusion. For example,auction houses initially had a flurry of heightened inter-est in their accumulated appraisal experience becauseeBay had created so much excitement about auctioning.

During periods of intermediating change, pressure inthe industry tends to build until it hits a breaking point,and then relationships break down dramatically only tobe temporarily reconstituted until the cycle is repeated.Consider large brokerage firms. They had long confrontedcriticism about conflicts of interest in their analyst orga-nizations. But the straws that broke the camel's back werethe recent market downturn and accounting scandals -both of which were tied to fundamental changes in theinformation available to investors and companies seeking

investment capital. The core assets in investment broker-age - including the systems for evaluating securities andfor processing trades-retained their value, yet old rela-tionships no longer offered the same opportunities togenerate profits.

Companies facing intermediating change must find un-conventional ways to extract value from their core re-sources. They may diversify by entering a new business oreven a new industry. Or they may sell off assets or servicesto former competitors. In the music industry, for instance,recording companies are beginning to sell their servicesh la carte to aspiring musicians rather than make hugeinvestments in the artists up front and incur all the costsof artist development (radio promotions, choreography,and image management, among other expenses). The cus-tomer and the activities have changed, but the core re-source - the recording companies' ability to develop newartists-retains its value. In another example, some tradi-tional auctioneers, threatened by eBay, have capitalizedon their appraisal expertise online; for a fee, they will cer-tify the value ofthe wares heing exchanged on the Inter-net. By reconfiguring old assets in new ways, these com-panies are dealing effectively with intermediation.

Initial returns under this change trajectory may be rel-atively high and then drop dramatically only to recovertemporarily. The recording companies' profits, for exam-ple, have been volatile as the companies adapt to inter-mediation with varying levels of success. A plateau in per-

Trajectories of Industry ChangeWhen determining which type of change your industry is going through-and, no doubt, it is going through some type

of transformation -you need to consider whether there are threats to your industry's core activities (the recurring actions

your company performs that attract and retain suppliers and buyers) and to your industry's core assets (the durable

resources, inciuding intangibies, that make your company more efficient at performing core activities).

Core activities

Threatened

Radical Change

Everything is up in the air.

Examples: makers of landline telephone

handsets,overnight letter-delivery carriers,

and travel agencies

Intermediating Change

Relationships are fraglie.

Examples:automobile dealerships,

investment brokerages,and

auction houses

Not Threatened

Creative ChangeThe industry is constantiy redeveloping assets

ond resources.

Examples: the motion picture industry, sports team

ownership,and investment banking

Progressive Change

Companies implement incremental testing and

adapt to feedback.

Examples;online auctions,commercial airiines,

and long-haul trucking



formance can create the illusion that reinvestment inthe business as usual is a good idea. But organizationsthat recognize the trajectory their industry is on can tumrelatively calm periods into opportunities for strategictransformation.

Creative ChangeIn industries on a creative change trajectory, relationshipswith customers and suppliers are generally stable, butassets tum over constantly. The film production industryis a good example. Larger production companies enjoyongoing relationships with actors, agents, theater own-ers, and cable television executives. Within this network,they produce and distribute new films all the time. Thiscombination of unstable assets (new films) and stable re-lationships (with buyers and suppliers) makes it possibleto deliver superior performance over the long term. In-deed, the top companies in creative change industriesusually retain their standing for long periods.

Other industries evolving on creative trajectories in-clude Pharmaceuticals, oil and gas exploration, and pre-packaged software. In Pharmaceuticals, companies re-search, develop, and test new drugs and then use theiradministrative and marketing skills to commercializethem. In oil and gas exploration, companies manage theirportfolios of exploration ventures and maintain relation-ships with refineries and distributors. In the prepackaged

A Fair Share?

The four change trajectories are not at all evenly distributed

among industries,SurprisingIy,given the time and attention

much of the management literature devotes to it, radical

change affects less than one-fifth of all industries. More preva-

lent are progressive and intermediating change.The percent-

ages shown are estimates of the distribution of change trajec-

tories among U.S. industries between 1980 and 1999, based on

variability in revenues and assets among iarge firms.

Radical19%

Intermediating32% Creative \

6% ^

Progressive43%

software industry, developers create and test multiple ap-plications in the hopes that one or more will become akiller app. By applying well-honed user-testing and mar-keting skills, the industry leaders perpetuate their success.

The creative change trajectory, like the intermediatingtrajectory, has not been studied extensively. It is easy tomistake it for radical change, despite the stability of rela-tionships within the network. When this mistake is made,companies can overreact and neglect important relation-ships that are critical to their profitability. For example,some pharmaceutical companies became so focused onemerging methods of drug discovery that they investedcapital exclusively in new research relationships and didnot develop appropriate sales forces in new markets.

Innovation under creative change occurs in fits andstarts. Although there are several long-standing formulasfor making hit movies, for example, occasionally a newgenre or technical approach to filmmaking emerges. Sim-ilarly, companies in the pharmaceutical industry havebeen experimenting with new methods of drug discoveryover the last 15 years. Despite these changes, the compa-nies that lead these industries are not new entrants. Theyhave retained their strength by capitalizing on their net-works of relationships.

There are many ways for companies in an industry ona creative change trajectory to generate strong returnson invested capital. For instance, the leading companies inthese industries tend to spread the risk of new-project de-velopment over a portfolio of initiatives. As a result, theirreturns are less volatile than those of smaller competitors.Other tactics include outsourcing project managementand development tasks.

Progressive ChangeProgressive evolution is like creative evolution in thatbuyers, suppliers, and the industry's incumbents have in-centives to preserve the status quo. The difference is thatcore assets are not threatened with obsolescence underprogressive change, so industries on this trajectory aremore stable than those on a creative change trajectory.Today's discount retailing, long-haul trucking, and com-mercial airline industries are evolving in this way.

Progressive evolution is most similar to the kind ofchange that Christensen refers to as"sustaining." Progressoccurs, and technology can have an enormous impact,but it happens within the existing framework of the busi-ness. Core resources tend to appreciate rather than de-preciate over time. Progressive change doesn't mean thatchange is minor or even that it is slow. Over time, incre-mental changes can lead to major improvements andmajor changes. Think of what has happened in discountretailing over the last ten years. Wal-Mart's cumulativeimpact has been extraordinary, and the company has de-veloped unprecedented clout. But the retailer developed

OCTOBER 2004 91


that advantage by deepening existing customer and sup-plier relationships, not by seeking out entirely new ones.

The most profitable corporate strategies in progressivechange industries generally involve carving out distinctpositions based on geographic, technical, or marketingexpertise. The goal is to build resources and capabilitiessteadily and incrementally. Companies rarely get intobrinkmanship or eyeball-to-eyeball competition, and theydon't have to put large amounts of capital at risk beforelearning whether an innovation creates value. Instead,their performance depends on their quick responses tofeedback. Southwest Airlines, for instance, tests new flightroutes but isn't afraid to pull out if a route ultimatelydoesn't work under the company's approach to air travel.

Successful companies in progressive change industriestend to be viewed by the financial community as mini-mally risky with the potential for only moderate returns.Over the long run, though, these companies can actuallycreate very large total returns for investors. Money hasreported that the two companies that had generated thegreatest total return to shareholders during the maga-zine's 25-year history were none other than Wal-Mart andSouthwest.

Which Trajectory Are You On?Identifying your industry's evolutionary trajectory on thefly is difficult. It is easy to become distracted or confusedby conventional wisdom, customer demands, and com-petitors' moves. To ensure accuracy, your analysis must befocused and systematic.

Tbe first step is to define your industry. You can beginby identifying the companies in your industry that sharecommon buyers and suppliers. Many economists use a 5%rule to assess whether the commonality is sufficient toqualify the firms as direct competitors: If a 5% price fluc-tuation by one company causes customers or suppliers toswitch to another company, the businesses qualify as di-rect competitors. When a group of companies intend toappeal to the same buyers and rely on the same suppliers,you have additional evidence that they are direct competi-tors. And when companies use similar technologies to cre-ate value, it is likely that they qualify as direct competitors.

The second step is to define the industry's core assetsand activities. Here is an easy way to test whether some-thing is core: If it were eradicated today, would profitsbe lower a year from now, despite efforts to work aroundwhat's missing? If tbe answer is yes, then it definitely qual-ifies. In the auctioneering industry, for example, the ca-pacity to evaluate works of art is a core activity. In the soft-drink industry, Coca-Cola's brand is a core asset. Thedisappearance of either of these capabilities would seri-ously damage profitability in their respective industries.

The third step is to determine whether the core assetsand activities are threatened with obsolescence. To qual-

ify, tbe threat must make core assets and activities poten-tially irrelevant to profitability. It must be significantenough to jeopardize the survival of at least one industryleader and widespread enough to influence every com-pany in the industry. Once you know whether core activi-ties and assets are threatened, you can identify which of thefour trajectories applies to the industry you are studying.

The final step in the diagnosis is to evaluate the phaseof the evolutionary trajectory. This step is important: In-dustry change generally takes place over a long period,and the options for dealing with change typically drop offsharply through each phase. (See the sidebar'The Indus-try Life Cycle Revisited.")

It is also essential to note that an industry generallyevolves along just one trajectory at a time. It almost al-ways starts out on either a progressive or creative trajec-tory because, collectively, companies in the industry can'tcapture value without a clear model for organizing theircore activities. Over time, the industry may feel pressureto change these activities - driven by, for example, cus-tomer demands and new technologies. The threat of ob-solescence can catapult the industry on to either a radicalor an intermediating trajectory. As the industry restruc-tures its core activities and assets, the threat of obso-lescence may fade, marking tbe industry's transition backto a progressive or creative trajectory. A company that hassurvived these transitions can sometimes retain prof-itability, although it almost always must operate at asmaller scale and with a very different approach.

Industries do not shift their trajectories very often; noindustry that I have studied has shifted between evolu-tionary paths more than once in ten years. So it is a goodbet that a given industry has been on a single evolution-ary trajectory for at least a few years. And while it is some-times possible for individual companies to infiuence the tra-jectory of an entire industry, the effort required is almostalways too great to be worthwhile, and failure can be dev-astating to the company's profitability or even its survival.

Capitalizing on IndustryEvolutionUnderstanding industry change can do more than helpyou avoid mistakes. The rules under each trajectory canhelp you forecast early on how change will occur in yourindustry-and help you determine how to exploit changeas it occurs. It would be impossible to list here all the pos-sible contingencies for change on each trajectory and ateach stage. But here are a few general insights:

Analyzing Radical and Intermediating Cliange. Asnoted earlier, companies operating in an industry that ison a radical or intermediating change trajectory must per-form a balancing act-aggressive!y pursuing profits in thenear term while avoiding investments that could laterprevent them from ramping down their commitments. To



The Industry Life Cycle RevisitedOnce you've determined which change trajectory your in-

dustry is on, you'll need to figure out which phase of change

the industry is experiencing. The classic industry life cycle

model is relevantfor understanding the phases of progressive

and creative change. But this model does not apply to indus-

tries that are experiencing radical or intermediating change,

tn the traditional life cycle model, industries begin in a

period of/ragmeniof/on as companies experiment with dif-

ferent approaches to a market. The companies offer a vari-

ety of products and operate at low volumes. They tend to

be entrepreneurial, private, and focused on serving nar-

row geographic areas. Over time, the industry experiences

a shakeout, usually because a specific business model

achieves greater legitimacy than any other. Competitors

become more efficient, the volume of sales increases, and

the industry generates unprecedented value for suppliers

and buyers. When industries reach maturity, sales growth

slows.and leaders often lock their positions. As the volume

of sales drops, industries move into decline. In this phase,

companies often search for incremental improvements in

efficiency to recover profitability. (See "The Traditional

Model" below.)

But if you apply this model in industries that are expe-

riencing radical or intermediating change, you may end

up trying to renew your position in an industry that will

no longer generate significant returns. Or you may end up

missing opportunities in both the established and emerg-

ing industries.

A more accurate model for those on radical or interme-

diating trajectories is the one below, which reflects

changes in the ways buyers and suppliers respond to the

level of the threat of obsolescence. {See "An Alternate

Model.") During an initial period o^emergence, upstart

firms warrant attention but may not be significant enough

to prompt established companies to restructure. As the

new approach coni/erges in volume, established companies

may react by reconfiguring some of their activities. During

a period of coexister^ce, buyers and suppliers become in-

creasingly sophisticated at evaluating the new approach,

and as a result, new opportunities for value creation may

emerge even in the old industry. During a final phase of

dominance, the industry's products and services are evalu-

ated on new criteria that reflect the popularity of the new

approach.

The Traditional Model An Alternate Model

get the right balance, put yourself in the suppliers' shoesas well as in those of the buyers. What new options areemerging?

Take the example of auto dealerships, which are on anintermediating change trajectory. They are locked intomultiyear pacts with the manufacturers, their suppliers.Yet the intermediation of the dealers presents new oppor-tunities for the automakers to relate to consumers: Whatare the trade-offs for the manufacturers if they advertisecollaboratively with the dealerships rather than directlyto consumers? How can the carmakers pull off somethinglike this without violating their contracts with the deal-ers? Only with unconventional thinking-beyond stan-

dard market research and advertising plans-can the man-ufacturers find answers to these questions.

Radical and intermediating change also call for newways of dealing with competitive threats. Instead of view-ing rivals in conventional terms, consider whether youcan use alliances to protect common interests and defendagainst new competition from outsiders-or to facilitateconsolidation. When some regions of the U.S. becameovercrowded with auto dealerships, affiliated car lots(Honda dealers in adjacent towns, for instance) merged.

Under radical and intermediating change, it is also im-portant to interpret confiict within your organization ina new way."Civil wars"can emerge within an organization

OCTOBER 2004 93


as divisions with exposure to different segments of thebusiness develop opposing views about the nature andpace of change. It is uncanny how frequently this hap-pens. Strong, central leadership is required to deal withthe problem effectively.

Surviving Radical and Creative Change. Under theseconditions, it is smart to evaluate how quickly your coreassets are depreciating. The easiest way to do this is toidentify how much you are spending to renew them. In-vesting in a full-blown cost-accounting effort is worth-while since the value of your assets may vary acrossdifferent segments of the business in surprising ways. *The goal of this analysis should be to distinguish the Tsegments in which you can protect your competitiveposition from those in which your position will erodequickly. Often, this assessment yields important in-formation about the value of intellectual property andhow it can be guarded more intensively. For example, afilm studio might discover that, in some geographies,losses from video piracy outweigh the potential profitsfrom distributing content, at retail, on videotape or DVD.

To navigate radical and creative change trajectories suc-cessfully, companies must have the mettle to disappointsome buyers and suppliers, regardless of their trackrecords, if the risks are too high. Despite Marlon Brando'sbox-office successes during the 1950s, film studios were re-luctant to work witb him because of his personal idiosyn-crasies. The stakes in developing new films are simply toogreat for producers to take many risks. Because of the vol-atility of new-asset development, it is also crucial to culti-vate relationships with investors to ensure quick access tocapital when a worthwhile project comes around.

Managing Progressive Change. Progressive change isnot simple to manage, despite the fact that neither coreassets nor core activities are threatened. The accumulatedimpact of incremental changes can raise the standards fordoing business to tbe point where only a handful of com-panies are competitive. For example, the standard-bearersin discount retailing (Wal-Mart and Target among them)have relentlessly managed incremental changes in activ-ities for decades. As a result, only a few national retailershave competitive cost structures on a large scale. Ultimately,one of the most successful strategies for companies inindustries on a progressive change trajectory is to developa system of interrelated activities that are defensiblebecause of their compounding effects on profits, not be-cause they are hard to understand or replicate. Considerthat very little about Wal-Mart's approach is secret. Thecompany's efficiencies have accumulated ever since SamWalton built his first distribution centers decades ago.

Adapting to the Stages of Change. As we've noted, allfour trajectories typically unfold over decades, whichmeans organizations have time to outline strategic op-tions for the future. As change happens, fighting it is al-most always too costly to be worthwhile. In the late

stages, companies invite trouble by sticking with outdatedbudget systems and cost-accounting processes. Organiza-tions must reconfigure themselves for lower revenuegrowth and develop the ability to move activities and re-sources out of the business.

Diversifying Your Business. Some of the most excitingopportunities associated with industry evolution relate todiversification across industries. By participating in morethan one industry on a progressive trajectory, Wal-Marthas enhanced the effects of its powerful distribution sys-tems. And with its acquisition of Kinko's, FedEx has diver-sified in response to radical change. Some of the majorchallenges of diversification have to do with sharing coreactivities and core assets across divisions on different tra-jectories, and developing clear lines of authority for resolv-ing disputes between divisions as their industries createdifferent investment requirements. It is virtually impossi-ble to diversify profitably without understanding the dif-ferences in the trajectories and phases of industry change.

The trajectories outlined above can help you anticipatehow change will unfold in your industry-and how to takeadvantage of opportunities as they emerge. To get outfrom under industry threats, your company must culti-vate a deep understanding of how changes to the indus-try will unfold over time. How will buyer and seller rela-tionships be affected? And are intangible assets like brandcapital and knowledge capital truly adaptable across in-dustries? The work of systematically analyzing the busi-ness environment is not easy, but the payoff is great: bet-ter strategic decision-making for your company. ^

1. This article builds on the author's"How Industries Evolve,"Business StrategyReview, Autumn 2000.

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How Industries Change

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