Mental Models

Core Competence

Many a times we come across businesses which seemed to have grown large doing seemingly unrelated activities but has been equally successful amongst them.

Take for example the case of Titan Company Ltd. It has a meaningful presence in watches, jewellery and eye gear categories. When they started back in 1984 focus was on watches alone and did so for next 12 years gaining market share from the then dominant maker of mechanical watches HMT. Then in 1996 they came up with Tanishq brand under which they decided to sell jewellery.

Now, it might look as if an unnecessary distraction when your core business i.e. watches is generating cash flows and your brand ‘Titan’ is becoming dominant in the market. ‘Why get into something like jewellery when your core business is that of watches?’ reluctant investors would think. No one would ask that question today when operating profits derived from jewellery segment is almost 5x that of watches!

So what explains this massive wealth creation which company created for its shareholders over last two decades? It not only broadened its opportunity set – it multiplied it by several times!

It seems that they had a clear picture in their minds that they are not into selling watches like HMT or other dominant players at the time were. They were into the business of creating brands. This subtle distinction enabled them to avoid being complacent and get going crafting one success after another. Today company owns more than 12 brands under its hood spread across multiple categories.

Titan was an exception rather than a norm. Companies in general stick with what they do and are comfortable with what they are doing. This is a classic example of ‘narrow framing’ as Daniel Kahneman would say.

Think about Berkshire (and fortunes of Mr Buffett) had it stuck with the legacy textile business and not moved out of it! You and me would have never heard about this oracle of Omaha! Due to his approach of looking at a company as a conduit for wealth creation and not merely relating them with the activities they indulge for doing so, he had the required mental flexibility to reallocate capital from textile to owning insurance companies, local bank and using the resulting float to invest in listed securities.

He committed himself to wealth creation instead of textile business back in 1970s and is even ready to reduce focus on insurance segment as things stand today. Muddled thinking could only lead to mediocre results, if not a disaster.

CK Prahalad & Gary Hamal in their book Competing for the Future beautifully explained this concept with the help of an example –

For example, while SKF, the world’s leading manufacturer of roller bearings, might be tempted to define its core competence as bearings, such a definition would be unnecessarily limiting in terms of providing access to new markets. The company’s growth need not be totally dependent on finding new uses of roller bearings because, when SKF moves away from a product based view of its competencies to a skill-based view, new opportunities quickly emerge. SKF has competencies in anti-friction (understanding how different materials work together to generate or reduce friction), in precision engineering (it is one of a very few European companies that can machine hard metals to incredibly tight tolerances), and in making perfectly spherical devices.

 

In case of Titan the skill lies in creating successful brands while for Berkshire it is about compounding wealth without risking capital for permanent diminution, thereby creating an enduring enterprise.

Had once dominant companies like Kodak or Nokia tweaked their thinking to view themselves as someone who enables archiving memories or connecting people and serving their on-the-go computing needs, they might have been still around us doing things differently.

While above is certainly an error of commission, there are countless others who are ‘guilty’ of an act of omission – they couldn’t help detaching themselves from the activities they are into. Sometimes it is due to narrow framing and at other times, due to complacency. Either ways, they fail to achieve what they otherwise could have been within their potential.

At worse, they could end up losing what they have created over decades of labour.

Joseph Schumpeter said it best, for such companies, when he observed that successful businesses stand on the ground that is ‘crumbling beneath their feet’.

Adopting the right mindset and figuring out the core competence and focusing on it not only helps in expanding your opportunity set, it also helps in navigating over potential disasters.


Niraj

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions.

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