Recharging IT to Make Your Business Unstoppable

By Rudy Puryear  |  Posted 07-13-2007

Recharging IT to Make Your Business Unstoppable

For more than a decade, from the late 1980s until just after 2000, Instinet was on a roll. Its pioneering software and proprietary computer workstations appealed to professional stock traders who needed to move large blocks of shares efficiently. As the stock market boomed, Instinet rode the updraft. At its peak in 2000, the company, a division of Reuters, took in about $5 million in revenue each day the market was open, earning 20 percent margins and processing more than one in every five Nasdaq trades.

Then, nearly as fast as Instinet reached the pinnacle of an industry it helped to create, its growth formula stopped working. New competitors offered more flexible systems loaded with features and powerful graphics that traders clamored for. By late 2001, with the over—the—counter market in steep decline, Instinet's daily trading revenue slumped to $2.3 million—less than half what it had been at its peak—and Reuters' investment of more than $1 billion in the company was losing value fast.

Instinet's predicament when its success formula hit the wall is far from unique. For a majority of businesses today, fundamental threats to the core have moved from rare events to nearly common occurrences. Strategies are becoming obsolete faster than ever before. Since 1994, research by Bain & Co has found, more than 50 percent of the companies in the Fortune 500 have faced serious threats to their core business models. About half of that group have gone bankrupt or been acquired. The rest have made risky and fundamental changes in strategy. What's more, the pace of business turbulence is likely to accelerate along with globalization and rapid technological change. Within 10 years, the data suggest, only one company in three will resemble what it looks like today.

Alternative to the Bold Move
Many management teams find themselves tempted by big—bang solutions: dramatic, transformative mergers or aggressive leaps into sexy new markets. But seemingly bold moves like these rarely pay off. The success rate for major, life—changing mergers is only about one in 10. It is less than one in seven for moves into a hot new market far from a company's core.

As Instinet would ultimately discover, a better answer for most companies usually lies closer to home. The Bain research shows that nine out of 10 companies that successfully renewed themselves found the solution in mining hidden assets—assets they already possessed but that were previously undervalued, underutilized or simply unrecognized. These hidden assets were not central to the strategy of the past, but they held the key to the future. The study suggests that the most valuable hidden assets are camouflaged as hidden business platforms, untapped customer insights, and underused capabilities.

Next page: Hidden Business Platforms

Hidden Business Platforms

Hidden Business Platforms
The first of these, hidden business platforms, often lie neglected within a company's core. IBM, for example, struggled to compete in the fast—moving personal computer industry and encountered new threats in the challenging mainframe environment it once dominated. Services weren't on the radar screen at Big Blue until the early 1990s, when newly named CEO Louis Gerstner spotted the potential of a captive subsidiary, the Integrated Systems Services Corp., which had languished as an obscure unit within IBM's sales force. Gerstner made ISSC a free—standing services business independent of the hardware divisions, ultimately spinning out IBM Global Services. With revenues today exceeding $48 billion, Global Services is more than twice that of IBM's hardware business and accounts for some two—thirds of the company's market value.

Untapped customer insights are a second source for renewing the core. Autodesk, for instance, rode a steep growth curve developing computer—aided design software for architects and engineers. But successful expansion stalled out in the late 1990s, when the company abandoned its strategy of pursuing deep, technical applications and shifted its focus to new forms of services and direct sales channels via the Web, bypassing third—party resellers and retailers. With sales declining, Autodesk knew it would have to renew its core to survive.

Company executives identified an overlooked source of customer insight: Autodesk's original sales network of third—party distributors. Rather than maintain an arm's—length relationship with these sales channel representatives as before, the company began to treat them like the partners they truly were. Autodesk invested in training them and deepened its partnership with the leading resellers. The software firm also redoubled its efforts to understand the technical needs of its end—users for more powerful 3—D applications and revamped its model for selling software upgrades, migrations, and add—ons. The new strategic initiatives fueled a six—fold increase in Autodesk's stock price between 2002 and 2006, as revenues increased at a 16 percent annual pace and return on equity jumped 46 percent.

Next page: Tapping underexploited capabilities

Tapping underexploited capabilities

Tapping underexploited capabilities
Capabilities—the ability to perform specific tasks over and over again—are the third set of hidden assets. A typical business unit operates with 80 to 200 significant capabilities, but just a small number of these are truly core, allowing the organization to create economic value for customers and providing a source of differentiation from competitors. Therein lay the problem for Instinet: its core IT capabilities that had powered the company's rise were based on proprietary applications, but were no longer what Instinet needed to ensure its success in the new open—standards Internet environment.

In our experience, sometimes the best way to obtain a set of missing capabilities is to acquire them, especially if the industry is evolving rapidly. The new capabilities that would power Instinet's renewal were assets hidden in plain sight at its Island division, a nimble electronic trading competitor, which Instinet acquired in 2002. One stark measure of the capability gap that separated Instinet from Island was headcount. Instinet, which added new functions and people with each link to a new trading exchange, had swollen its IT payroll to 1,000 at its peak. Island, by contrast, was able to serve nearly the same volume of trades with fewer than 100 IT staffers.

Instinet managers recognized that inertia had set in: years of profitable growth had blunted the drive to rebuild the technology which was the company's core capability. Instinet simply added on more IT to fuel its growth, no matter how awkward the fit. Using Island as its roadmap, Instinet's managers committed to fundamentally rethink its systems. By leapfrogging from the old IT platform designed for an obsolete minicomputer environment all the way to industry standard Linux systems, the company would be able to improve cost, reliability, scale, and speed to market in a single stroke. For customers, the move meant that Instinet could now roll out more functionality faster and at lower cost.

Educating the Inexperienced
Instinet had also built its IT architecture so that less experienced IT people could understand and maintain the systems. Now, Instinet adopted the same approach used at Island: Hire top—flight financial IT specialists who had grown up in the IT industry and understood how IT and the trading business are related. That allowed the company to invest in financial technologists capable of working alongside their business counterparts, truly aligning IT and business goals for the first time.

Adapting Island's capabilities also led Instinet to rethink how best to deploy its IT—support functions. Under Instinet's old model, the company bought large amounts of expensive hardware and supported installations in lots of locations. The costs had to be amortized over each trade Instinet handled. But as the footprints for its data centers grew smaller and more efficient, those fixed costs melted away. Exploiting capabilities adapted from Island, the company's systems were able to conduct more transactions with a footprint just one—tenth the size of its predecessor, relying on customers' technical staffers to service their own desk—top PCs.

At the same time, Instinet adjusted its outsourcing strategy. Following conventional wisdom, Instinet had formerly tried to hold down costs simply by outsourcing to low—cost vendors. But as the company began building high—performing systems, it discovered that outsourcing was less cost—effective and far riskier than keeping support in—house and paying a small, highly skilled team to continuously simplify its systems.

Next page: Adapting to Customer Needs

Adapting to Customer Needs

Adapting to Customer Needs
As the new IT capabilities began to gel, Instinet executives also gained eye—opening insights into its customers' needs and expectations. Instead of looking at customers' businesses as their customers see them, Instinet had been forcing customers to adapt to its internal IT organization. Some broker/dealers wanted nothing more than a fast, efficient, reliable network. Others, mainly institutional investors wanted added functionality tailored to their unique circumstances. With very different customers willing to pay for different levels of service, the company came to a stark recognition that it was really in two businesses, not one. If Instinet and Island were to thrive, they had to be separated.

To extract the highest value from the revived divisions, Reuters decided to sell Island to Nasdaq, where Island was folded into the over—the—counter market's SuperMontage electronic commercial network. Island, which had been acquired for $508 million in Instinet shares in 2002, ended up fetching a cash price of $2 billion. At the same time, the reinvigorated Instinet division, now focused on institutional clients, was sold to Silver Lake Partners, a private equity firm, for $208 million. In all, the sale of Instinet ended up netting Reuters' shareholders $1 billion, value that was created by renewing the division's core businesses with rediscovered capabilities.

Capabilities are different from other kinds of hidden assets a company possesses because, at least in theory, they are usually also available to rivals. The special chemistry that's created by the unique mix of capabilities gives them their value. By unlocking that chemistry to discover a hidden asset in Island's core IT capabilities and systematically putting them to work, Instinet was able to breathe new life into a business that had lost its way.

Chris Zook is co-head of the Global Strategy Practice and Rudy Puryear is a partner and head of the Americas' IT practice at Bain & Co. Senior Advisor David Shpilberg contributed to this article.