Corporate Transformations Are Risky, but Evidence Shows How Leaders Can Improve Odds of Success

Conventional Wisdom About Big Change Initiatives Is Often Wrong, but Too Many Companies Follow Their Gut Rather Than Seek Evidence of What Works, According to BCG Research Published in MIT Sloan Management Review

Boston, Massachusetts, UNITED STATES

BOSTON, Feb. 14, 2018 (GLOBE NEWSWIRE) -- Despite the frequent need for transformation—and the growing risk of failure—too many company transformations are guided by intuition, not by empirical evidence.

Research underpinning the design and execution of turnarounds and transformations is surprisingly thin, leading companies to commit to high-cost, high-risk initiatives without a clear understanding of the actions that will lead to lasting results. But a study by The Boston Consulting Group (BCG) and the BCG Henderson Institute has found several factors that increase the chances of success. The findings are published on the MIT Sloan Management Review website.

“Corporate transformations are often guided by beliefs, that, while seemingly plausible, are more anecdotal than empirical in nature,” said report coauthor Martin Reeves, a Senior Partner at BCG and Director of the BCG Henderson Institute. “It’s time for a more evidence-based approach.”

BCG studied US public companies and focused in on more than 300 with over $10 billion in market capitalization and with an urgent need to transform: their total shareholder return (TSR) had fallen 10 percentage points or more relative to their peers’ over a two-year period. The research covers the period 2004-2016.

The article points out that:

  • At any time during the study, a third of large US companies were experiencing a severe decline in their ability to create shareholder value, demonstrating a need for fundamental change.
  • Successful recovery is the exception, not the rule. Only one-quarter of the companies were able to outperform their industry in the short and long run after the point of TSR deterioration, and this trend has worsened: the transformation success rate was 30% in 2001, and only 25% in 2012.
  • The more severe and protracted the downturn, the worse the results. Of companies that suffered a two-year annualized TSR deterioration of more than 20 percentage points, 95% failed to return to their prior level of performance.

Five factors have proven to increase the odds of successful transformations, especially if used in combination

  • Cost cutting alone is not enough to start a transformation process. Most successful companies also focus on raising investor expectations with credible plans. Many companies that successfully recovered from severe TSR deterioration did indeed cut costs during the first year. But resetting investor expectations (as measured by valuation relative to earnings) was a stronger driver of short-run TSR recovery, accounting for 37% of outperformance. “Leaders must also regain investor confidence by showing how they will leverage their newfound flexibility,” Reeves said.
  • Revenue growth is the key driver of long-term success, so transformations must introduce a “second chapter.” After the first year of transformation, revenue growth became an increasingly important driver. By year five, it outweighed both cost cutting and investor expectations. “Transformation efforts cannot focus solely on short-term operational improvements,” said Reeves. “The second chapter requires that leaders challenge the foundations of the company’s business model, create a new vision for growth, and commit to see the program through.”
  • Long-term strategy and research-and-development (R&D) investment are correlated with success, especially in turbulent environments. Companies with an above-average long-term strategic orientation (as measured by an artificial intelligence algorithm developed by the BCG Henderson Institute that uses natural language processing to analyze company reports) outperformed those with a below-average orientation by 4.8 percentage points. In turbulent environments, the difference was even greater: 7 percentage points. In aggregate, companies with above-average R&D spending perform substantially better (5.1 percentage points) than those with below-average spending.
  • New leadership—especially when brought in from outside—can improve the odds of success. Only 24% of the companies launching a transformation program changed CEOs (compared with 19% at all comparable companies, including those not transforming). But, on average, companies that changed CEOs outperformed: they increased TSR by 9.2 percentage points over a five-year span, compared with 4.6 percentage points for those with incumbent CEOs. External hires performed better in the aggregate, but they had a wider range of both positive and negative outcomes than internal hires. “Companies that go to the outside need a tolerance for risk,” said report coauthor Lars Fæste, a Senior Partner at BCG and global leader of the BCG Transformation practice and BCG TURN. A similar dynamic extends to the leadership team. Only 20% of transforming companies had high executive turnover (more than 20% of officers), but those that did improved TSR by 4.4 percentage points more than others.
  • Formalized transformation programs perform better on average, as long as they’re big and ambitious enough. More than half (57%) of the companies announced a formal transformation program within a year of TSR deterioration. “Those that did, did better,” said Fæste. “In the short run, they boosted investor confidence, and in the long run they achieved sustainable improvements in the business—they increased TSR by 5 percentage points in a five-year period.” The most successful programs were generally long-term—at least five years—and ambitious.

While each of these steps led to positive performance, the companies that did best were the ones that took several of them, not just one. For example, companies that changed CEOs and also had formal transformation programs gained 7.7 percentage points in TSR, compared to just 1.4 percentage points when they had formal programs but kept their incumbent leaders. “When these success factors are used jointly, they have an additive impact, greater than the sum of its parts,” Reeves said. “Companies that used at least four of the success factors in their transformations achieved the largest increase in TSR: a gain of 17.4 percentage points over five years.”

“Not every factor will be relevant in every transformation,” Reeves explained. “But given the stakes, leaders need and deserve evidence-based recommendations. Empirical evidence shows the significant factors in transformation success and the advantages of combining them. Companies can’t afford to ignore it.”

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