GCC firms need to develop core capabilities to become world class

Following a period of growth, GCC companies must now focus on capabilities if they want to stay competitive. If not, they risk falling into ‘growth traps’, according to a recent study by management consultancy Strategy&, formerly Booz & Company. Growth traps are situations in which companies that grew quickly by taking advantage of favorable external market conditions face issues in sustaining their growth due to the absence of internal corporate capabilities. To circumvent these growth traps, GCC companies should develop powerful capabilities either through internal development, M&A’s or partnerships.

In their eagerness to grow, many companies in emerging markets, including some in the GCC, focus primarily on top-line growth or country-specific comparative advantages and neglect to build the foundations for future success. They initially benefit from being ‘first movers’ in their home markets but eventually have to play catch-up with more experienced multinationals in global industries and consequently fall into ‘growth traps,’ according to Strategy&. Multinationals for example have established brand names, advanced technologies, access to efficient financial and labor markets and a set of entrenched capabilities that have developed over time. Emerging market competitors, including some in the GCC, are consequently often behind.

Advising on the importance of avoiding growth traps, Per-Ola Karlsson, partner with Strategy&, said: “To circumvent these growth traps, GCC companies need to develop powerful capabilities through internal development, mergers and acquisitions, or partnerships. Each of these methods has advantages, drawbacks and potential trade-offs. Companies from the GCC that have succeeded in this endeavour have followed a deliberate and stepwise plan for moving from basic capabilities to more sophisticated ones that can support world-class innovation, technology and design.”

When building capabilities through M&A’s, GCC companies should ensure they pursue targets with a capability fit. In the assessment of the 75 largest acquisitions made by GCC companies between 2009 and 2014 revealed that one third resulted in the acquirer performing more poorly than the market average (based on total shareholder return). The same assessment also revealed acquisitions that were capability-driven (either enhanced or leveraged the capabilities of the acquirer) performed significantly better than deals with a limited capability fit (acquirer doesn’t improve upon or apply the acquiring company’s capabilities system in any major way).  The two year annualized total shareholder return of acquirers was 13.9% higher than the local market return on average for capability-driven deals, versus 9.4% lower than the local market return on average for limited-fit deals.

As companies transition from one phase to the next, not only do they find that the underlying sources of competitive advantage change, but they also confront new growth traps that they need to navigate. It is therefore important that GCC companies are able to develop fully integrated, differentiated capabilities systems designed for long-term, sustainable use, so that they can compete at world-class performance levels.

Further commenting on the importance of GCC companies adopting a capabilities-driven strategy, Rawia Abdel Samad, the director of the Ideation Center, the leading think tank for Strategy& in the Middle East, said: “Successful companies typically follow a four-phase process for improving capabilities cumulatively over time. This starts with enhancing basic production (know-how) and progresses all the way to acquiring world-class innovation capabilities (know-why).  These companies first identify opportunities to develop their basic capabilities, then they build their strength by refining their business models, scale up and consolidate through acquisitions, and finally move up and out to enter international markets. Each phase allows them to incrementally develop their capabilities by building on previous successes.”

Highlighting the need for GCC companies to become more capabilities-driven, John Jullens, a principal with the firm said: “For GCC companies to avoid growth traps and become world-class, it is imperative that they build the necessary organizational capabilities and resources to compete head-to-head with world-class companies. They can either spend the time and effort required to do so in-house, or they may be able to pursue acquisition and partnership opportunities to accumulate new capabilities and resources more rapidly. However, their M&A strategy itself needs to be capabilities driven if they are to absorb their acquired capabilities seamlessly and leverage them effectively. They need to recognize what might be called an organization’s “absorptive capacity” as an important organization capability in itself.”

Since many companies in the GCC are linked to the state, governments have a role to play in helping them become globally competitive. There are more than 550 state owned enterprises in the region and GCC governments are major or minor investors in 78 of the top 100 publicly listed companies and consequently could influence the capability-building process of these companies. Government leaders should take measures to upgrade corporate governance practices within these companies and help them reach their potential. In turn these countries would reap economic benefits from improved performance.

If companies in the GCC can effectively adopt capabilities-driven strategies to avoid growth traps, emerging world-class companies from the GCC – both state-owned and private – are capable of accelerating their countries’ economic diversification and transformation efforts through job creation and investments in local communities. This can make them an important contributor to economic development in the region.