How to reignite growth through adjacencies

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Manufacturers across the advanced-industries spectrum, from electronics and automotive products to industrials, continue to reel from the supply-and-demand shocks caused by economic and geopolitical turbulence. As some of these conditions appear to be here to stay, numerous leadership teams are responding by cutting investments and costs. But while defensive moves matter, long-term resilience starts with growth and the courage to make bold moves to pursue that profitable growth.

In earlier downturns, companies that stayed focused on growing through the cycle—by expanding into adjacencies or new geographies during a recession, then stepping on the gas early in the recovery—emerged stronger than their peers and maintained that edge for years afterward. The current period of volatility is a similar opportunity to chart a new course by seeking growth in adjacent markets as part of activating pathways in a company’s holistic growth blueprint. The net-zero transition, in particular, may give advanced-industries companies attractive opportunities in 11 areas of growth.

We define adjacencies as segments beyond a company’s core business where it has a “right to win”—a long-term competitive advantage stemming from better abilities to address customers’ needs, play across the value chain, deploy a unique capability in a new area, or introduce a disruptive business model or technology. A typical large company generates 20 percent of revenue outside its core business. And our research shows that organizations that expand into natural adjacencies generate, on average, 1.5 percentage points of annual shareholder returns above their industry peers.

Adjacency expansion has not been a common strategy in advanced industries, with only 11 percent of major companies moving into adjacent markets over the past 15 years. To see whether that’s a missed opportunity, we analyzed the growth initiatives pursued by the 770 largest companies in the sector between 2004 and 2019 and identified players that had expanded into new industries or segments. We then reviewed annual reports, expert commentaries, and analyst statements to understand whether the new segments were true adjacencies.

We found that, indeed, moves into adjacencies that build on a competitive advantage deliver significantly more value than purely organic growth or “step-outs” that companies may pursue without a clear right to win. (Note that companies stepping out in hopes of developing breakout businesses can find great success—so long as they have a competitive advantage.) Those that ventured into adjacent segments achieved median TSR that was three percentage points above their closest peers’ (Exhibit 1). And these weren’t outliers: two-thirds of adjacency growers outperformed their industries.

Growth through adjacencies delivers higher total shareholder returns than growth in the core or ‘step-outs.’

To help business leaders assess when and how best to expand into adjacent markets, we delved further into the strategies employed by the manufacturers that pursued that growth path. Their approaches can be divided into four categories: those driven by customers, those driven by capability, those based on value chain, and those oriented around a disruptive business model or technology. Each of these adjacency growth strategies delivered between 3 and 4 percent in excess TSR and generated favorable analyst views (Exhibit 2).

All four adjacency approaches drive excess total shareholder returns and positive analyst ratings.

Four approaches to growth in adjacencies

While the four categories have distinct characteristics, customer-propelled, capability-propelled, and value chain–based adjacencies can each require business model shifts to be effective. No matter which value creation logic advanced-industries companies pursued, those that succeeded in adjacencies applied some common practices in how they chose the approach, secured their foothold, and ramped up growth.

Customer-driven adjacency

Adding offerings that meet existing customers’ needs that you don’t already address, such as complementing hardware offerings with software or services, is a tried-and-true path to growth. This strategy was the most common of the four approaches, with six in ten players in our sample pursuing it alone or in conjunction with other adjacency moves. The reason is simple: companies can often find numerous cross-selling opportunities by analyzing what their current customers buy.

When a networking hardware manufacturer, for example, found its customers shifting their spending to enterprise software, it turned the threat into an opportunity by acquiring several software providers. It then used its extensive existing sales channels to deliver this broader portfolio of enterprise technology to both current and new customers. In just over a decade, the company was generating more than half its revenue from software sales, with much stronger margins.

Our experience has shown us, however, the importance of involving sales leaders and customers in identifying the best adjacencies for customer-driven growth. One global mining equipment manufacturer, for example, significantly benefited from bringing its key customers into its growth strategy discussions. Based partly on their feedback, the company started developing mining fleet optimization software in close collaboration with core clients—a move that significantly contributed to its outperforming its closest competitor in TSR by 18 percentage points since 2018.

Capability-driven adjacency

Transferring capabilities that were honed in the core business to an adjacent industry is a growth strategy that was pursued by a quarter of the companies in our sample. In advanced industries, these capabilities tend to fall into three categories: product development, operational, and commercial (see sidebar, “Three capability archetypes”).

A producer of electronics testing equipment that was facing flat growth, for instance, scanned for opportunities in adjacencies and identified robotics as a fast-growing segment wherein it could leverage its operational capabilities. The company acquired a robotics business and applied its expertise in automation to galvanize the target’s growth, then expanded further into industrial automation with additional acquisitions. The move was a triumph, contributing 13 percentage points to the top line within three years of expansion.

Value chain–based adjacency

Potential upstream and downstream moves within your own or your customers’ value chains are among the easiest growth opportunities to identify and evaluate given their proximity to your existing business. Gaining greater control of the industry value chain can also increase a company’s resilience to supply shocks, a particularly important benefit amid today’s widespread supply chain disruptions. In addition, value chain moves can give companies a stronger ability to customize offerings to client needs—for example, tailoring raw material specifications to refinement processes—and secure a higher share of industry revenue and profit pools.

A mining equipment manufacturer, for example, used a merger to move into metal-refining machinery, which enabled it to integrate crushing and grinding with refining and thus help its customers to reduce waste. The move is expected to yield €150 million in annual revenue synergies and €100 million in yearly cost savings.

Disruptive business model–based adjacency

Companies with strong innovation capabilities can create adjacencies by launching entirely new businesses and revenue streams. In advanced industries, such innovation often takes the form of a disruptive business model or technology. A case in point is an air compression equipment manufacturer’s introduction of a pay-by-use service, a disruptive move made possible by technology the company developed that significantly lowered maintenance costs. Customers embraced the service because the equipment cost no longer required a major up-front outlay; rather, it was tied to their revenue streams.

Let’s be clear: growth through disruptive innovation is rare. Fewer than a tenth of our adjacency expansion sample used this value creation logic. However, when pursued successfully, it can generate strong top-line gains.

Making the most of the right opportunity

As with all growth strategies, companies seeking to expand into adjacent industries or markets should first establish an aspirational culture and mindset. Then they should identify the right pathways and follow through with strong execution. The following outlines how to put adjacency strategy into action.

Apply a broad lens to identify opportunities

Successful adjacency growers first look at how they can better serve their existing customers—60 percent of adjacency growth comes from that client base. What add-on services or complementary products could you offer to increase your share of your customers’ spending?

Recognize, however, that adjacent opportunities can emerge in unexpected segments. To find them, first assess the impact of macroeconomic and sector trends on your industry profit pools and identify entry prospects based on the above four paths to adjacency growth. Complementing that analysis with AI-assisted searches can reveal options you might not otherwise consider—by, for example, uncovering overlaps with other industries and markets within your product development, operational, or commercial capabilities.

Next, map out opportunities along the value chain. Could you improve your offering by gaining more control upstream or serve your customers better by adding more downstream capabilities, such as a dealer network? Finally, consider ways to innovate your business model. How could you improve your connection with customers and become a true partner in boosting their productivity?

Prioritize the opportunities systematically

Having generated a list of potential adjacencies, you can prioritize them based not only on the best customer, value chain, and capability fit but also on the market’s attractiveness according to its size, growth, margins, and the overall profit pool trajectory. While the importance of inherent segment attractiveness may seem obvious, executives often make the mistake of putting a company’s suitability for operating in a market ahead of that market’s prospects. Yet expanding into adjacencies that are above average in profitability and growth can deliver about 15 percentage points more in excess TSR than can venturing into markets in the bottom quartile of growth and profits (Exhibit 3).

Segment attractiveness is a key factor in adjacency growth success.

Next, ensure that the adjacency is aligned with your overall strategy from the perspective of balance sheet requirements, the level of customization needed, or technology complexity. You might choose, for instance, to enter only asset-light segments regardless of your financial restrictions. Finally, use feasibility metrics to assess market entry options, whether through M&A or partnerships (what size of target or type of joint venture could you pursue, for example?) or through the investment needed for organic entry.

Execute with focus and conviction

While companies outperforming in growth pursue all directions of growth over a ten-year period, these bold moves, including those into adjacencies, should be thoughtfully sequenced and undertaken with a focused approach. Our research shows companies that pursued one adjacency move over a five-year period outperformed those that pursued two or more by three percentage points (Exhibit 4).

Outperformers favor a focused approach to adjacency expansion.

Leaders should be clear about the capabilities their companies will need to succeed in the new segment and the implications the adjacency strategy may have for the existing organization—for example, when shifting from hardware to software or services. To fill those capability gaps, the best performers use M&A, acquiring established businesses to gain footholds in their chosen markets. They then grow from those bases through programmatic, “bolt-on” acquisitions to strengthen their positions.

Finally, stay true to your strategy over time, understanding that adjacency growth is a long journey. It can also require tough choices—including divestments and significant up-front investments to gain initial traction.

A time of uncertainty rewards ambidextrous companies: those careful about managing the downside while aggressively pursuing the upside. As supply shocks and changing value pools open new opportunities in adjacent markets, advanced-industries companies can significantly boost both their growth prospects and shareholder returns by moving beyond their core businesses, provided their expansion is based on a clear value creation logic.

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