Edge Strategy: A New Mindset For Profitable Growth

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L.E.K. Consulting is a leading global strategyconsulting firmLondonWroclawBeijingChicagoSan FranciscoLos AngelesBostonMunichParisMilanNew YorkSeoulNew DelhiTokyoMumbaiShanghaiChennaiSingaporeSӓo PauloSydneyMelbourneEstablished in 198321 Offices 100 Partners 1000 Staff2Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

L.E.K. is a thought leader in growth strategy Edge Strategy: A New Mindset for Profitable Growth is a new businessbook by Alan Lewis & Dan McKone, published by Harvard BusinessPress in 2016John Tague, President and CEO, Hertz Corporation“Alan Lewis and Dan McKone offer an alternate path to growth and show how implementing an‘edge strategy’ creates value in a sustainable way. To presume it doesn’t apply to your industryor situation would be missing a great opportunity.”Kevin Mayer, Senior Executive Vice President and Chief Strategy Officer, The Walt DisneyCompany“We all need peripheral vision. Edge Strategy offers a clear and powerful framework foridentifying and leveraging opportunities for growth that can sometimes be hard to see—at theedges of your core business. A must-read.”Darrell Webb, President and CEO, Guitar Center“Refreshingly pragmatic advice for driving growth, with a strong ROI, in any business.”John Rainey, CFO, PayPal“Edge Strategy flips the conventional notion of strategy on its head and provides an insightfultake on where some of the best value-creating innovations come from.”Robin Hayes, President and CEO, JetBlue“Edge Strategy will help you and your business pull some of the most powerful levers at yourdisposal. Lewis and McKone outline a clear, smart approach to driving new—and greater—yieldfrom assets you already manage . . . and delighting customers in the process.”3Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Edge Strategy is a way to access high margin newrevenue availing of investments already made andrisks already takenWhatdifferentiatesedgeopportunitiesfrom othertypes of growthopportunities?Highly profitable because you’releveraging foundational assets youalready have in your core (e.g.,customers already in your store,tangible / intangible assets))Lower risk because your ability tooperationalize is quicker than launching anew business (which requires high upfrontinvestment)Higher probability of success becausethe increase in complexity to execute ismarginal relative to further afieldopportunities6Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

Some simple illustrations of edge thinkingRetailers who addwarranties to lowmargin high ticketitemsGrocers make x5times the profit bychopping andbagging lettuceFarmers get paid toallow energycompanies accesstheir fieldsAirlines allow somecustomers to pay tohave more leg room7Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Why does it work?Your CoreOfferingNewOfferingsOpportunityat the edge ofyour businessThe edge of your business is rarely a sharpperimeter but rather a nexus of opportunity8Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

Edge Strategy is A Discipline A Pattern A MindsetA sustainable andrepeatable way to take low,incremental risks and accessnew growthButWhile the goal is notdisruption, the benefits canbe transformational10Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

What is the Discipline? Using your existing business to create new revenue streams thatare incremental to your core offering today by: Challenging what permissions your customers’ give you All your customers all the time Challenging the value of your assets All of them to any company11Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

What is the Discipline? What fully encapsulates thepermission all yourcustomers give you? Has your target customermix Permission Set12Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

What is the Discipline?“Help me skip the line” How aligned is your coreoffering to this permissionset? Are there gaps?m that areCustomerPermission SetCore OfferingCopyright 2016 L.E.K. Consulting LLC. All rights reserved.13#EdgeStrategy

What is the Discipline?Elements of the coreoffering not universallyvalued are on the ‘insideedge’CoreOfferingOpportunities to upsellwhere you are misalignedto your customer needs:‘outside edge’CustomerPermission SetCopyright 2016 L.E.K. Consulting LLC. All rights reserved.14EdgeStrategyBook.com

What is the Discipline?“sell me a meal not justingredients” What is your customersultimate mission? What is your role inhelping them get there?CustomerPermission SetCustomerMission Set15Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

What is the Discipline? What are the foundationalassets you use to deliveryour core offer? Do they have value beyondyour current purposes?Core OfferingCulturePeopleDataEquipmentTechnologyReal Estate16Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

What is the Discipline?The edge of theenterpriseCore OfferingCulturePeopleData“I would pay you toaccess your data”New customerpermission setNew logyReal EstateReal Estate17Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

We ask three basic questions Would re-calibrating paid options around my core offering -withmy existing resources and capabilities - better unlock value witha sub-set of my customers? What mission is my customer ultimately hoping to accomplishwith my product and would they give me permission to helpmore toward this end? Who, besides a direct competitor, would pay for the rights to anyof my foundational assets?18Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

The benefits of edge strategyare Incremental revenue Not ‘zero sum’ Marginal economics More profit Less investment Lower risk Less learning curve Lower risk Better product alignment Happier customers19Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

What is the Pattern? We studied over 600 companiesEdgeStrategyiseverywhereacross 62 industries and foundedge examples in every one We found examples of edgestrategy in the railroads of the 19thcentury and in the newesttechnology start-ups today20Copyright ategyBook.com

What is the Pattern? Upsell Sell solutions Companies useedge strategy inmany situations Monetize Assets Deal with margin pressure Beat commoditization Seed new business Make better deals 21Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Upselling Royal Caribbean Lines (RCL) Operating 50 ships across 6 brandsaround the world, RCL is a leading globalcruise operator RCL and its peers have developedcomplex core offerings for their allinclusive model: in addition toaccommodation, all you can eat dining,and extensive onboard activities,including sports and shows, are all part ofthe price of a ticket The Insight Recognizing that not only are allcustomers not the same but their unmetneeds vary widelyCopyright 2016 L.E.K. Consulting LLC. All rights reserved.22EdgeStrategyBook.com

Upselling RCLs Edge move: Rather than a ‘good-better-best’ upsell, RCLoffers a range of add on and expansionpackages (shore excursions, onboardservices, premium beverage programs) thatguests can purchase to tailor theirexperience The Outcome RCL’s edge based approach allows forindividual based upselling, driving greateroverall revenue per guest23Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Selling Solutions Best Buy A multinational consumer electronicsretailer Core business has traditionally beenconsumer electronics sales through bothstore and online The Insight Best Buy recognized their customers’journeys didn’t stop after they checkedout Customers had many further needs andBest Buy were even providingtroubleshooting services at no extra cost24Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

Selling Solutions Best Buy’s Edge Move: Best Buy made a small acquisition ofGeek Squad in 2002, rather than seedthis into a service business they usedtheir existing stores to offer services tocustomers as they shop The Outcome Best Buy accessed new revenue fromactivities that were already occurringand built a process to deliver them moreconsistently, which also improvedcustomer service By leveraging existing assets, theyreduced risk and upfront investment25Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Selling Solutions Whole Foods Began as a classic grocery businessspecialized in organic products The Insight Recognized that customers were ondifferent missions when they came to thestore, some were filling their pantry butsome were buying the ingredients of asingle meal26Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.comImage WIP

Selling Solutions Whole Foods’ Edge move Completing the customers’ journey with instore prepared foods Whole Foods leveraged many foundationalassets (e.g., stores, foot traffic, supply chain) Resisted the temptation to roll out newbusiness The Outcome Prepared foods has seen staggering resultswith sales of 2.7B in 2014, 20% of thecompany revenue27Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Monetizing Assets Walmart.com Global leading mass merchandiser Core business through supercentersaround the world; 2nd largest U.S. retailwebsite after Amazon.com The Insight Walmart recognized that as a leadingecommerce site, it had traffic equivalentto a media site, and was not monetizingover 95% of traffic A-B testing showed that modestadvertising on the site would be toleratedby consumers and not impact conversion28Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

Monetizing Assets Walmart’s Edge Move: Walmart partners with a 3rd party in themid-2000s to leverage the Enterpriseasset of their high website and mobiletraffic to build a business as a mediapublisher The Outcome Walmart has tapped into mediaspending budgets to build a new highmargin revenue stream Similarly, Amazon.com use their 1Badvertising revenue to subsidize productprices29Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Margin Pressure Smith & Nephew S&N is a medical device companyfocused on hip and knee implants As part of its core product offering, salesreps advise surgeons in the selection anduse of tools and devices Health care reform has led to increasingmargin pressure for S&N The Insight Providing a rep as part of the coreoffering was expensive (40% of total) Not all customers needed the support ofan expert rep30Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

Margin Pressure S&N’s Edge Move Rather than cede margin under the newprice pressure, Smith & Nephew decontented its core offering, launching aparallel “rep-less” program This involved selling past-generationproducts at 30-40% discounts The Outcome S&N is better able to maintain its originalcore offer and still profitably servecustomers with reduced budgets S&N estimated only 10% of customers wouldgo “rep-less”, thus the program avoidedmargin compression across the board31Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Beat Commoditization Air Products Air Products is a supplier of industrialgases, performance materials,equipment, and technology with morethan 10B in revenue Many of their products are prone tocommoditization pressures The Insight They focused on the customer andlearned about the needs their customershad around their commodity products They recognized their expertise inhandling and managing these productswas valuable32Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

Beat Commoditization Air Products’ Edge Move Air Products wrapped services around itscore business to focus on completesolutions for clients The company offers plant assessment,operations and maintenance, inventorycontrol, advisory, and safety training The Outcome By focusing on selling solutions, AirProducts accessed incremental revenuestreams and was also able to drive morecore products sales by establishing itselfas a expert partner33Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Seed New Business UnitedHealth United Health is the largest healthinsurer in the United States, with revenueof 113.9B in 2014 The Insight Through its core business of selling andmanaging health insurance,UnitedHealth has compiled a databaseof patient information on 114 millionpeople dating back to 1993 They recognized that their data hadunique value for drug companies in howview of patient’s use and response todrugs34Copyright 2016 L.E.K. Consulting LLC. All rights reserved.

Seed New Business UnitedHealth’s Edge Move They created a suite of products to allowdrug companies to access and use thisdata, outside of UnitedHealth’s corebusiness, called OptumInsight The risk in the new venture was heavilymitigated as most of the offering (i.e.,data) already existed The Outcome OptumInsight has evolved from an edgestrategy to a core business todaygenerating billions of dollars forUnitedHealth35Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

Make Better Deals Gilead Sciences Gilead Sciences is a major biotechfocused primarily on infectious diseasesthat built a highly successful franchise inHIV therapies The Insight While in the past big pharma companiesacquired outside of their core areas inpursuit of growth, many stumbled andfailed to create value buying assets inareas they didn’t have prior expertise orexecuting large deals that brought withthem unwanted assets costly to dispose of36Copyright 2016 L.E.K. Consulting LLC. All rights reserved.EdgeStrategyBook.com

Make Better Deals Gilead’s Edge Moves When the company decided to acquire, itstayed within their area of expertise,infectious disease, entering the hepatitis Bmarket with an acquisition of TrianglePharmaceuticals in 2002 The Outcome Gilead leveraged its knowledge (e.g.regulatory perspective, knowledge of howto produce combination therapies, andeffective tiered-pricing model) to increasethe speed and probability of success ingaining approval and commercializing theirnew hepatitis therapies37Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

What is the Mindset?Virtually allcompanies havethe potential toaccess edgeopportunitiesPrevalence of edge “achievers”that embody the “edge mindset”Percent of companies screened (N 585*)10080Some companiesmake repeatableuse of an edgemindset central totheir strategy604020Prevalence ofedge acrossindustriesCopyright 2016 L.E.K. Consulting LLC. All rights reserved.% ofEdge Achievers38EdgeStrategyBook.com

It’s a habit of highly successful companiesRisk-adjusted shareholderreturnThree-year revenue growth3-year Sharpe Ratio* (S&P 500 only)Indexed revenue growth rate (base 100; S&P 500 only)1800.6 15% esCopyright 2016 L.E.K. Consulting LLC. All rights Note: Sharpe ratio calculated using monthly returns from 01/01/09-01/01/14. The Sharpe Ratio is calculated as ((Average Portfolio Return - risk-freerate) / Portfolio Standard Deviation) Relative performance calculated as the unweighted average of (company performance / industry performance). Industry performance isunweighted. Only includes industries which contain Edge Achiever companies. This measure normalizes for inter-industry differences in revenuegrowth rates. **Industries experiencing negative average growth during this time period were excluded from the CAGR analysis39Excludes: General Electric, Honeywell, Berkshire Hathaway, Leucadia, Dow Chemicals, Du Pont Chemicals, 3M, Danaher, and Roper Industries.#EdgeStrategySource: Company websites and financials, S&P Capital IQ, L.E.K. analysis

Apple has an edge achiever mindset Apple’s core business isprimarily a hardware company,with 90% of revenue generatedfrom its devices Unlike historical peers like Sony,Apple captures outside productedges to address consumerneeds in everything it does“ Our belief was that if we kept putting greatproducts in front of customers, they wouldcontinue to open their wallets ”Steve Jobs, cofounder and CEO of AppleCopyright 2016 L.E.K. Consulting LLC. All rights reserved.40EdgeStrategyBook.com

Apple took ownership of theecosystem of accessories Purchasing a device is just the beginningof a relationship with Apple Accessories (case, speakers, headphonesetc.) provide incremental utility toconsumers and incremental revenue toApple Licensing additional accessories to be“brand compatible” is a high margin, lowrisk and low investment revenue stream41Copyright 2016 L.E.K. Consulting LLC. All rights reserved.#EdgeStrategy

iTunes and App Store provideedge platforms Both iTunes and App Store are product edgeplatforms that support the core deviceoffering Each download is an optional improvementEdges built and customers continue to open their walletson edgesgiven their evolving needs As both platforms avail of third partydevelopment, the incremental investmentrisk to Apple is minimized The App Store model has extended edgethinking even further allowing in apppurchases so that developers can employtheir own upselling, while Apple continuesto get a cutCopyright 2016 L.E.K. Consulting LLC. All rights reserved.42EdgeStrategyBook.com

AuthorsDan McKone and Alan Lewis have extensive experience helping clients drive shareholder value and growth througheffective corporate strategies, including Edge Strategy. They have led numerous client engagements that enabledleading companies to unlock the value that exists at the edge of their business.Lewis is a Managing Director and Partner in L.E.K. Consulting’s Boston office. He has spent the last twelve yearshelping companies large and small to identify new growth opportunities and realize the benefits. He started his careeras a professional engineer, commercializing new technologies in the chemicals sector.McKone is a Managing Director and Partner at L.E.K. Consulting and a member of L.E.K.’s Global Leadership Team. Hehas led hundreds of client engagements across many industries and has spent the last two decades advising oncorporate strategy and growth, business model evolution, and value-based decision making.Copyright 2016 L.E.K. Consulting LLC. All rights reserved.44EdgeStrategyBook.com

Edge Strategy: A New Mindset for Profitable Growth is a new business book by Alan Lewis & Dan McKone, published by Harvard Business Press in 2016 John Tague, President and CEO, Hertz Corporation "Alan Lewis and Dan McKone offer an alternate path to growth and show how implementing an 'edge strategy' creates value in a sustainable way.