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29

Are you too

focused?
Neil W. C. Harper and S. Patrick Viguerie

As successful companies mature, they must diversify to survive—and

they can dramatically improve their shareholder returns as they do.
The only questions are when and how.

O f all the levers that a CEO can pull to achieve superior performance,
managing a corporation’s scope may offer the greatest potential to
generate strong shareholder returns. Economic cycles and other factors that
contribute to a company’s fortunes or misfortunes may be beyond even the
boss’s control, but among the activities that he or she can influence, adjust-
ing the breadth of a corporate business portfolio represents a significant por-
tion of the company-specific drivers of shareholder returns.1

It is therefore odd that so little consensus exists on the topic. True,

long-standing conventional wisdom maintains that “focus is the answer.”
Volumes of finance theory argue, correctly, that investors allocate capital
among diverse businesses more efficiently than corporations do and that
good projects can typically attract funding in public or private capital mar-
kets. Conversely, markets are quicker than ever to discount the valuations of
diversified companies as a result of their perceived shortcomings, including
the cross-subsidization of financially unattractive projects and difficulties
in aligning the management incentives of diverse business units with the
fortunes of the corporation at large.
1
This claim is based on a multivariate regression, including more than 350 S&P 500 companies, to
identify the industry- and the company-specific drivers of total returns to shareholders. The degree of
focus accounted for 31 percent of the company-specific drivers, followed by the type of M&A, at 25
percent, and the level of M&A, at 13 percent.
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30 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 2 S P E C I A L E DI T I O N: R I S K A ND R E S I L I E N C E

And yet . . . every CEO knows that no matter how focused his or her busi-
ness is, at some point diversification is necessary to regenerate growth and
create value over the long term. Companies must branch out into new busi-
nesses to compensate for the declining prospect of creating value in older
ones. What is more, many CEOs of successful businesses assert, in a kind of
street-smart amendment to the findings of academics, that investors implic-
itly fund strategies and management
teams, not individual projects.
Moderate diversification represents
a strategic sweet spot between Our research has uncovered a par-
focus and broader diversification ticularly fertile middle ground
between focus and diversification.
While focused companies generally
do trump more diversified ones, companies we categorize as moderately
diversified perform at least as well as, and often better than, their focused
counterparts. Focus, in short, isn’t always the best answer. Moreover, these
moderately diversified companies share a common approach to managing
scope—an approach that, applied at the right time in the life cycle of a busi-
ness, generates superior returns through higher growth that is both realized
and anticipated by capital markets.

Finding the sweet spot

In our research, moderate diversification emerged as a strategic sweet spot
between pure business focus and broader diversification. This trick isn’t easy
to pull off: the optimal balance can vary widely from company to company
and from point to point in the stages of a business’s life cycle. Furthermore,
managers of scope shouldn’t think of moderate diversification as a steady
state; they must direct a process of continuous balancing between tightening
a company’s focus and branching out through business building, acquisi-
tions, and other forms of related diversification. We believe that the goal
should be a portfolio with an appropriate balance of current performance
and growth potential and that an intense management focus can meet the
markets’ expectations through the dynamic reshaping of assets.

Moderate diversification can be positive indeed. We began our analysis by

using publicly reported revenues to classify 412 S&P 500 companies as
focused (that is, deriving at least 67 percent of revenues from one business
segment), moderately diversified (with at least 67 percent of revenues from
two segments), or diversified (with less than 67 percent of revenues from
two segments).2 Then we validated our results by testing them against two
2
While our cutoff point of 67 percent wasn’t chosen empirically, we are confident that the results
would be the same even if the cutoff varied within 10 percentage points in either direction. We
entirely excluded conglomerates because their general underperformance has already been heavily
researched and we didn’t expect new work to reveal new insights.
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A R E YOU T O O F O C U SE D? 31

other common measures of focus.3 Even a broad analysis based on publicly

reported revenues by a Financial Accounting Standards Board (FASB)–
defined segmentation scheme confirmed the idea that in total returns to
shareholders (TRS), focused companies outperformed diversified ones
(Exhibit 1).

When we honed our research further to compensate for a lack of consis-

tency in some standard measures,4 however, we made a more subtle discov-
ery. Across all three measures of scope during the decade from 1990 to
2000, focused companies boasted a median annual TRS that was 8 percent
in excess of the average of their
industry peers—more impressive EXHIBIT 1

than the 4 percent for the diversified Three measures, one result
group. But the moderately diversified Average total returns to shareholders by segment,1 1990–2000,
group notched up 13 percent a year percent

in annual excess returns. The results

Publicly Herfindahl-
were similar over a 20-year period.5 reported Hirschman SIC4
revenues2 index3 codes
Indeed, moderately diversified com-
panies outperformed focused and Focused 21 22 22

more fully diversified ones in 81 per- Moderately diversified 17 18 19

Diversified 16 17 16
cent of the three-year–rolling-average
time periods and generated higher
1
Includes 412 companies from 2001 S&P 500 that existed in 1990.
TRS in every year but one since 1985 2According to segmentation defined by company in compliance with require-
ments of US Financial Accounting Standards Board (FASB).
(Exhibit 2, on the next page). 3
Sum of squares of percentage of revenues generated by each segment as
defined by company and reported to FASB.
4
Standard Industrial Classification.
Source: Compustat; McKinsey analysis
Moderately diversified business
models, we have therefore con-
cluded, are quite capable of generating shareholder returns that are at least
as strong as, and frequently even stronger than, those achieved by the more
focused models. Indeed, the popular view that “focus is better” simply isn’t
right at all times and certainly isn’t applicable at each and every stage of a
corporation’s life cycle.
3
We assessed our own measure against a modified version of the Herfindahl-Hirschman index, calcu-
lated as the sum of the squares of the percentage of revenues generated by each segment as defined
by the company and reported according to the requirements of the Financial Accounting Standards
Board, and against each company’s reported Standard Industrial Classification codes. The results
were similar across all three approaches.
4
We compensated for a lack of consistency in the application of the FASB segmentation and Standard
Industrial Classification codes. AT&T, for example, reported revenues from only the consumer and
business segments and initially fell into the moderately diversified category. In addition to significant
consumer and business telephony operations, however, AT&T has cable and broadband businesses
and, until recently, a wireless business—all suggesting that “diversified” would be a more appropriate
classification. We refined our research by using a smaller sample (broadly tracking the performance
of the S&P 500) of 267 companies in the chemical, computer hardware, oil and gas, pharmaceutical,
pulp and paper, and telecom services industries. Each company’s level of focus was recategorized
with the help of the more detailed information we found by reading analysts’ reports and talking with
experts.
5
The aggregate performance results of 37 moderately diversified companies were consistent over
both 10 and 20 years.
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32 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 2 S P E C I A L E DI T I O N: R I S K A ND R E S I L I E N C E

Diversifying for superior growth

What about moderate diversification contributes to the success of this
approach? One answer is that it can help a corporation navigate key transi-
tions in business life cycles more effectively than a focused route does and
thereby helps generate more sustainable longer-term growth.

Consider, for example, a company that has historically operated as a single

business entity but competes in a rapidly maturing industry whose growth
rates are trailing off. As the company matures, it must put the value of its
legacy business to best use by making trade-offs between strategies to maxi-
mize its short-term cash flow and efforts to retain customers and extend its
profitable growth. At the same time, the company must somehow reinvigo-
rate its growth expec-
EXHIBIT 2
tations and build a
A moderate advantage sustainable, dynamic
Total returns to shareholders relative to sample,1 3-year moving average, percent
organization that
Focused
Moderately
Diversified
can attract and retain
diversified
10 talent and create
8 broader interest
6
Leading
among investors
4 and analysts.
2
0
–2
Corporations that
–4 have pulled off this
Lagging
–6 feat have used their
–8 existing strengths to
–10 diversify moderately
–12
1980 1985 1990 1995 2000
so that they have a
1
Includes 267 companies equally weighted by industry, category of diversification. strong position to
Source: Compustat; McKinsey analysis
exploit emerging
opportunities. Such
diversification usually takes companies into related industries, but it can also
involve new business arenas that present clear opportunities to build on
developed capabilities.

Take Broadwing, which began life as the Cincinnati Bell local-telephone

company. In the 1980s, Broadwing recognized that as a stand-alone, regu-
lated entity its growth prospects were likely to be limited. Management
explored the company’s existing capabilities and saw strengths in certain
telephony-related systems and services, including billing, customer care, and
telemarketing. Rising market demand made the third-party provision of
such services an opportunity worth exploiting. Broadwing thus built a sig-
nificant new business to provide call-center and back-office services to other
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A R E YOU T O O F O C U SE D? 33

companies, and by the late 1990s the company’s call-center services boasted
higher revenues than its traditional fixed-line telephony operations. In 1998,
Broadwing spun off the call-center services business as Convergys (which
had approximately $1 billion in revenue), thereby creating more than $3 bil-
lion in value for Broadwing and Convergys shareholders from the day the
spin-off was announced to early 2002.

Naturally, companies with widely diversified portfolios and companies that

have all but exhausted the synergies across their business units can add value
and build confidence in the capital markets by imposing a greater degree of
focus. In the mid-1990s, for example, poor performance in the capital mar-
kets and negative comments from analysts forced the pharmaceutical com-
pany Ivax to recognize that it was hampered by an imbalance between focus

EXHIBIT 3

Alltel’s odyssey

1990 1996 2001

Growth

Wireline Wireline
Time Wireline
($1.30 billion) ($1.80 billion)
($2.30 billion)

Information services Information services

($0.95 billion) ($1.30 billion)

Wireless Wireless
($0.48 billion) ($3.20 billion)
Wireless
($0.05 billion) Emerging businesses
($0.35 billion)

1983 –90 1991–96 1997–2001

Compound
annual growth 8% 14% 24%
rate of EBITDA1
Excess TRS 2 0 1% 9%
Moderately diversify into
Build capabilities information services while
in core wireline placing bet on wireless Expand wireless as new core
• Alltel formed through merger • Made series of acquisitions • Acquired 360 Communications, Aliant
of Allied Telephone with in data processing, billing, Communications, Liberty Cellular to
Mid-Continent Telephone; information systems/soft- expand wireless operations Change
became 5th-largest US ware to diversify moderately (1998–2000) business mix
incumbent local-exchange into information services • Made hostile takeover bid for
carrier (ILEC) (1983) (1990–93) CenturyTel (2001)

• Sold cellular rights in • Swapped wireless properties

Northeastern United States in 13 states with Bell Atlantic Position for
to focus on faster-growing and GTE (2000) growth
Southeastern and Mid-
western regions (1987)
• Launched wireless service • Began offering long- • Obtained Personal Communications
(1987) distance services to local Service licenses in 12 states (1997)
markets (1995) • Acquired fiber-optic assets (1998) Streamline
• Began offering Internet • Acquired stake in joint venture
access (1996) with IBM to offer Internet banking
systems (2001)
1
Earnings before interest, taxes, depreciation, and amortization.
2
Compound annual growth rate of excess total returns to shareholders (TRS): that is, of the difference between the company’s cumulative
average return and the mean of its industry peers.
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34 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 2 S P E C I A L E DI T I O N: R I S K A ND R E S I L I E N C E

and diversity, since the long-term growth prospects of its diverse portfolio
were seen to be weak. In 1997 and 1998 the company divested its cosmetics,
intravenous-products, and specialty-chemicals businesses. In 2000 it made a
series of international acquisitions to build a moderately diversified position
as a producer of branded and generic pharmaceuticals. Recalibrating the
company’s scope worked: the share price of Ivax has more than tripled since
1998, and better long-term growth
expectations are thought to be
Corporations in maturing industries responsible for more than half of
have reached the juncture where the increase.
most of the benefits of moderate
diversification are to be found Companies with overly focused
portfolios also can benefit from
moderate diversification. Consider
Alltel, which like many telecom companies launched a wireless business
in the mid-1980s. Recognizing that changes in technology and consumer
demand represented opportunities, Alltel bolstered its moderately diversified
position with a series of acquisitions, including 360 Communications, Aliant
Communications, and Liberty Cellular (Exhibit 3, on the previous page).
By 2001, Alltel’s wireless business, with $3.2 billion in revenue, had sub-
stantially surpassed even the company’s traditional wireline telephony busi-
ness. Alltel’s share price, which has roughly doubled over the past five years,
reflects investor recognition of these improved long-term growth prospects.

Scoping out scope

To get started in active scope management, a company must consider the
timing. Companies in an emerging or growth industry should devote the
majority of their management time and attention to meeting the challenging
expectations likely to be factored into their stock prices, so a strong degree
of focus is warranted.

By contrast, corporations in maturing industries have reached the juncture

where most of the benefits of moderate diversification are to be found. Such
a company must begin with a candid assessment of its capabilities—the
crucial first step in shaping, and reshaping, a corporate portfolio. Managers
must also establish a clear understanding of its current degree of focus—an
understanding based on the share of the company’s total revenues generated
by its different, discrete business units. They must also calculate the com-
pany’s relative expected long-term growth rate6 as reflected in the capital
markets. Once this exercise is completed, a company can develop an initial
hypothesis about the opportunities available to reshape its portfolio.
6
The part of the stock price, relative to the mean of the company’s industry peers, that is explained by
long-term (greater than five years) market expectations.
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A R E YOU T O O F O C U SE D? 35

Logically, companies with little diversification and low expected long-term

growth would do well to diversify by introducing growth businesses into
their stagnating portfolios. Conversely, highly diversified companies in which
the market lacks confidence would benefit from focusing their portfolios.
Diversified companies, even those with high growth expectations, need to
anticipate the point when business units will probably become so mature
that their prospects of creating value will start falling—and to divest them
proactively rather than wait until they begin to lose value.

The most successful scope managers we studied share a number of traits.

Such companies continually and proactively monitor and match their cur-
rent and emerging internal capabilities with external discontinuities—
changes in technology, regulation, and consumer behavior
that may create opportunities in related industries or require
management skills they already have. They rapidly divest
businesses that show early signs of potential failure.
Further, they separate successful new businesses earlier
than their peers do and actively and continually trade
their business portfolios.

In particular, a process of active and balanced trad-

ing of assets to achieve an appropriate level of focus
is critical. Companies that actively manage their corpo-
rate portfolios (in the top third of total M&A activity) create
30 percent more value over the long term than do relatively
passive companies. Furthermore, for mature companies,
strategies that involve both acquisitions and divestitures
outperform strategies focusing on one or the other.7

Another characteristic of the moderately diversified compa-

nies we studied is a willingness to part early with strongly
performing businesses. This approach may seem counter-
intuitive if not downright foolhardy, but we see it as one of the
hallmarks of successful scope managers. Given what we know about the suc-
cess of companies that actively manage their portfolios, executives should
probably be divesting businesses far more proactively than they typically do;
during the 1990s, nearly 60 percent of the largest US companies completed
no more than two divestitures exceeding $100 million.8 Moreover, three out
of four divestitures are completed during a fire sale or a shutdown or under
the pressure of persistent long-term underperformance by a business unit

7
Jay P. Brandimarte, William C. Fallon, and Robert S. McNish, “Trading the corporate portfolio,”
McKinsey on Finance, Number 2: autumn 2001.
8
This point is based on an analysis of the 200 largest companies (by market capitalization) in 1990
that still existed in 2000.
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and irresistible investor pressure to divest it when that underperformance

becomes totally obvious to the market.9

Holding on too long can cost a company dearly not only because a founder-
ing business fetches less on the market when sold but also because propping
up a unit in decline drags down the whole organization and exacts an oppor-
tunity cost in the form of scarce management time. Typically, it is less suc-
cessful companies that hold on to underperforming businesses too long in
the often vain hope that they will eventually turn
around and so vindicate management’s judgment
about them. By contrast, successful scope
managers sell or separate high-performance
businesses as soon as the majority of syner-
gies have been captured. In this way, the
benefits of separation—such as improved
management focus, targeted management-
incentive programs, and enhanced strategic
freedom—can be banked earlier.

Kimberly-Clark is one example of a moderately

diversified company that dynamically reshuffled its
portfolio to take advantage of internal capabilities.
From origins in consumer products and newsprint,
Kimberly-Clark eventually diversified even to the extent of
building and managing a small airline business by leveraging the
capabilities it developed while managing its own corporate jet fleet.

Over the course of the 1990s, Kimberly-Clark actively traded its

portfolio, continually buying and selling as well as looking for spin-off
opportunities. Its management closed a number of relatively small under-
performing businesses that had limited opportunities to improve and spun
off its airline business as Midwest Express. The company also added to its
business mix, acquiring Tecnol Medical Products in 1997 and the disposable-
latex-glove manufacturer Safeskin in 1998, thereby using its existing skills to
diversify into a small but growing health care business. Kimberly-Clark’s
active approach to trading has clearly generated superior returns for share-
holders: the company has maintained long-term growth expectations, on a
rolling basis, of up to 30 percent of its share price.

The appropriate breadth of the corporate portfolio is a critical component of

the CEO’s agenda. Yet a consistent view of how best to manage a company’s
9
This observation is based on analysts’ reports, articles in the press, and a financial analysis of all
divestitures mentioned in the Wall Street Journal in September 1998, 1999, and 2000 as well as
August 2001.
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A R E YOU T O O F O C U SE D? 37

scope is elusive. While it is clear that a tendency toward focus generally

leads to superior performance, we have found that the ongoing processes of
moderate diversification—ensuring an appropriate balance among growth
potential, current performance, and the intensity of management focus—
can help a company deliver significant additional growth and superior share-
holder returns.

The authors wish to thank Albert Caesar, Jean-Christophe De Swaan, Onur Erzan, Anya Schiess, and
Rohit Singh for their contributions to the research that led to this article.
Neil Harper is an associate principal in McKinsey’s New York office, and Patrick Viguerie is a
principal in the Atlanta office. Copyright © 2002 McKinsey & Company. All rights reserved.