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Picture two global companies, each operating a range of different businesses. Company A allocates capital, talent, and research dollars consistently every year, making small changes but always following the same broad investment pattern. Company B continually evaluates the performance of business units, acquires and divests assets, and adjusts resource allocations based on each division’s relative market opportunities. Over time, which company will be worth more? If you guessed company B, you’re right. In fact, our research suggests that after 15 years, it will be worth an average of 40 percent more than company A. We also found, though, that the vast majority of companies resemble company A. Therein lies a major disconnect between the aspirations of many corporate strategists to boldly jettison unattractive businesses or double down on exciting new opportunities, and the reality of how they invest capital, talent, and other scarce resources. For the past two years, we’ve been systematically looking at corporate resource allocation patterns, their relationship to performance, and the implications for strategy. We found that while inertia reigns at most How to put your money where your strategy is Most companies allocate the same resources to the same business units year after year. That makes it difficult to realize strategic goals and undermines performance. Here’s how to overcome inertia. Stephen Hall, Dan Lovallo, and Reinier Musters MARCH 2012 s t r a t e g y p r a c t i c e 2 companies, in those where capital and other resources flow more readily from one business opportunity to another, returns to shareholders are higher and the risk of falling into bankruptcy or the hands of an acquirer lower. We’ve also reviewed the causes of inertia (such as cognitive biases and politics) and identified a number of steps companies can take to overcome them. These include introducing new decision rules and processes to ensure that the allocation of resources is a top-of-mind issue for executives, and remaking the corporate center so it can provide more independent counsel to the CEO and other key decision makers. We’re not suggesting that executives act as investment portfolio managers. That implies a search for stand-alone returns at any cost rather than purposeful decisions that enhance a corporation’s longterm value and strategic coherence. But given the prevalence of stasis today, most organizations are a long way from the head-long pursuit of disconnected opportunities. Rather, many leaders face a stark choice: shift resources among their businesses to realize strategic goals or run the risk that the market will do it for them. Which would you prefer? Weighing the evidence Every year for the past quarter century, US capital markets have issued about $85 billion of equity and $536 billion in associated corporate debt. During the same period, the amount of capital allocated or reallocated within multibusiness companies was approximately $640 billion annually—more than equity and corporate debt combined.1 While most perceive markets as the primary means of directing capital and recycling assets across industries, companies with multiple businesses actually play a bigger role in allocating capital and other resources across a spectrum of economic opportunities. To understand how effectively corporations are moving their resources, we reviewed the performance of more than 1,600 US companies between 1990 and 2005.2 The results were striking. For one-third of the 1 See Ilan Guedj, Jennifer Huang, and Johan Sulaeman, “Internal capital allocation and firm performance,” working paper for the International Symposium on Risk Management and Derivatives, October 2009 (revised in March 2010). 2 We used Compustat data on 1,616 US-listed companies with operations in a minimum of two distinct four-digit Standard Industrial Classification (SIC) codes. Resource allocation is measured as 1 minus the minimum percentage of capital expenditure received by distinct business units over the 15-year period. This measure captures the relative amount of capital that can flow across a business over time; the rest of the money is “stuck.” Similar results were found with more sophisticated measures that control for sales and asset growth. 3 businesses in our sample, the amount of capital received in a given year was almost exactly that received the year before—the mean correlation was 0.99. For the economy as a whole, the mean correlation across all industries was 0.92 (Exhibit 1). In other words, the enormous amount of strategic planning in corporations seems to result, on the whole, in only modest resource shifts. Whether the relevant resource is capital expenditures, operating expenditures, or human capital, this finding is consistent across industries as diverse as mining and consumer packaged goods. Given the performance edge associated with higher levels of reallocation, such static behavior is almost certainly not sensible. Our research showed the following: • Companies that reallocated more resources—the top third of our sample, shifting an average of 56 percent of capital across business units over the entire 15-year period—earned, on average, 30 percent higher total returns to shareholders (TRS) annually than companies in the bottom third of the sample. This result was surprisingly consistent across all sectors of the economy. It seems that when companies disproportionately invest in value-creating businesses, they generate a mutually reinforcing cycle of growth and further investment options (Exhibit 2). Q2 2012 Resource allocation Exhibit 1 of 3 Correlation index of business units’ capital expenditures, year-over-year change,1990–2005 The closer the correlation index is to 1.0, the less the year-over-year change in a company’s capital allocation across business units. Companies’ degree of capital reallocation Low Medium High Capital allocations were essentially fixed for roughly one-third of the business units in our sample. 1.0 1991 1993 1995 1997 1999 2001 2003 2005 0.9 0.8 0.7 0.6 0.5 0 Exhibit 1 4 • Consistent and incremental reallocation levels diminished the variance of returns over the long term. • A company in the top third of reallocators was, on average, 13 percent more likely to avoid acquisition or bankruptcy than low reallocators. • Over an average six-year tenure, chief executives who reallocated less than their peers did in the first three years on the job were significantly more likely than their more active peers to be removed in years four through six. To paraphrase the philosopher Thomas Hobbes, tenure for static CEOs is likely to be nasty, brutish, and, above all, short. We should note the importance of a long-term view: over time spans of less than three years, companies that reallocated higher levels of resources delivered lower shareholder returns than their more stable peers did. One explanation for this pattern could be risk aversion on the part of investors, who are initially cautious about major corporate capital shifts and then recognize value only once the results become visible. Another factor could be the deep interconnection of resource allocation choices with corporate strategy. The goal isn’t to make dramatic changes every year but to reallocate resources consistently over the medium to long term in service of a clear corporate strategy. That provides the time necessary for new investments to flourish, for established businesses to maximize their potential, and for capital from declining investments to be redeployed effectively. Given the richness and complexity of the issues at play here, differences in the relationship between short- and long-term resource shifts and financial performance is likely to be a fruitful area for further research. Q2 2012 Resource allocation Exhibit 2 of 3 Total returns to shareholders, compound annual growth rate, 1990–2005, % Companies’ degree of capital reallocation (n = 1,616 companies) Companies with higher levels of capital reallocation experienced higher average shareholder returns. Low 7.8 Medium 8.9 High 10.2 Exhibit 2 5 Why companies ge
t stuck Why do so many companies undermine their strategic direction by allocating the same levels of resources to business units year after year? The reasons vary widely, from the very bad—companies operating on autopilot—to the more sensible. After all, sometimes it’s wise to persist with previously chosen resource allocations, especially if there are no viable reallocation opportunities or if switching costs are too high. And companies in capital-intensive sectors, for example, often have to commit resources more than five years ahead of time to long-term programs, leaving less discretionary capital to play with. For the most part, however, the failure to pursue a more active allocation agenda is a result of organizational inertia that has multiple causes. We’ll focus here on cognitive biases and corporate politics, but regardless of source, inertia’s gravitational pull is strong—and overcoming it is critical to creating an effective corporate strategy. As author and Kleiner Perkins Caufield & Byers partner Randy Komisar told us, “If corporations don’t approach rebalancing as fiduciaries for long-term corporate value, their life span will decline as creative destruction gets the better of them.” Cognitive biases Biases such as anchoring and loss aversion, which are deeply rooted in the workings of the human brain and have been much studied by behavioral economists, are major contributors to the inertia that prevents more active reallocation.3 Anchoring refers to the tendency to use any number, even an irrelevant one, as an anchor for future choices. Judges asked to roll a pair of dice before making a simulated sentencing decision, for example, are influenced by the result of that roll, even though they deny they are. Within a company, last year’s budget allocation often serves as a ready, salient, and justifiable anchor during the planning process. We know this to be true in practice, and it’s been reinforced for us recently as we’ve played a business game with several groups of senior executives. The game asked participants to allocate a capital budget across a fictitious company’s businesses and provided players with identical growth and return projections for the relevant markets. Half of the group also received details of the previous year’s capital allocation. Those without last year’s capital budget all allocated resources in a range that optimized for the expected outlook in market growth and returns. The other half aligned capital far more closely with last year’s pattern, which had little to do with the potential for future returns. And this was a game where the company was fictitious and no one’s career was at risk! 3 See Dan Lovallo and Olivier Sibony, “The case for behavioral strategy,” mckinseyquarterly.com, March 2010. 6 In reality, anchoring is reinforced by loss aversion: losses typically hurt us at least twice as much as equivalent gains give us pleasure. That reduces the appetite for taking risks and makes it painful for managers to give up resources. Corporate politics A second major source of inertia is political. There’s often a tight alignment between the interests of senior executives and those of their divisions or business units, whose ability to attract capital can significantly influence the personal credibility of a leader. Indeed, because executives are competing for resources, anyone who wins less than he or she did last year is invariably seen as weak. At the extreme, leaders of business units and divisions see themselves as playing for their own “teams” rather than for the corporation as a whole, making it challenging to reallocate resources significantly. Even if a reduction in resources to their division benefits the company as a whole, ambitious leaders are unlikely to agree without a fight. As one CEO told us: “If you’re asking me to play Robin Hood, that’s not going to work.” r2 is the measure of interdependence of 2 or more variables. Q2 2012 Resource allocation Exhibit 3 of 3 Correlation between each brand’s 2010 advertising budget and its average advertising budget for previous 5 years at one consumer goods company (n = 40 brands) Average advertising spending by brand over 5 years, 2004–09, % of corporate total Average advertising spending by brand in 2010, % of corporate total r2 = 0.87 Inertia may affect the distribution of other scarce resources, such as advertising spending. 5.0 0 0.5 1.0 1.5 2.0 2.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 Exhibit 3 7 Overcoming inertia Tempting as it is to believe that one’s own company avoids these traps, our research suggests that’s unlikely. Our experience also suggests, though, that taking steps such as those described below can materially improve a company’s resource allocation and its connection to strategic priorities. These imperatives apply not just to capital but also to other scarce resources, such as talent, R&D dollars, and marketing expenditures (as shown in Exhibit 3, for advertising spending by one consumer goods company). All of these also are subject to the forces of inertia, which can undermine an organization’s ability to achieve its strategic goals. Consider one company we know that prioritized expanding in China. It set an ambitious sales growth target for the country and planned to meet it by supplementing organic growth with a series of acquisitions. Yet it identified just three people to spearhead this strategic imperative— a small fraction of the number required, which is typical of the problems that arise when the link between corporate strategy and resource allocation is weak. Here are four ideas for doing better. 1. Have a target corporate portfolio. There’s a quote attributed to author Lewis Carroll: “If you don’t know where you are going, any road will take you there.” When it comes to developing an allocation agenda, it’s helpful to have a target portfolio in mind. Most companies resist this, for understandable reasons: it requires a lot of conviction to describe planned portfolio changes in anything but the vaguest terms, and the right answers may change if the broader business environment turns out to be different from the expected one. In our experience, though, a target portfolio need not be slavish or mechanistic and can be a powerful forcing device to move beyond generic strategy statements, such as “strengthen in Asian markets” or “continue to migrate from products to services.” Identifying business opportunities where your company wants to increase its exposure can create a foundation for scrutinizing how it allocates capital, talent, and other resources. Setting targets is just a starting point; companies also need mechanisms for revisiting and adjusting them over time. For example, Google holds a quarterly review process that examines the performance of all core product and engineering areas against three measures: what each area did in the previous 90 days and forecasts for the next 90 days, its mediumterm financial trajectory, and its strategic positioning. And the company 8 has ensured that it can allocate resources in an agile way by not having business units, which diminishes the impact of corporate politics.4 Evaluating reallocation performance relative to peers also can help companies set targets. From 1990 to 2009, for example, Honeywell reallocated about 25 percent of its capital as it shifted away from some existing business areas toward aerospace, air conditioning, and controls (for more on Honeywell’s approach to resource allocation, see our interview with Andreas C. Kramvis, president and CEO of Honeywell Performance Materials and Technologies, in “Breaking strategic inertia: Tips from two leaders,” on mckinseyquarterly.com). Honeywell’s competitor Danaher, which was in similar businesses in 1990, moved 66 percent of its capital into new ones during the same period. Both companies achieved returns above the industry average in these years—TRS for Honeywell was 14 percent and for Danaher 25 percent. We’re not suggesting that companies adopt a mind-set of “more is better, a
nd if my competitor is making big moves, I should too.” But differences in allocation levels among peer companies can serve as valuable clues about contrasting business approaches—clues that prompt questions yielding strategic insights. 2. Use all available resource reallocation tools. Talking about resource allocation in broad terms oversimplifies the choices facing senior executives. In reality, allocation comprises four fundamental activities: seeding, nurturing, pruning, and harvesting. Seeding is entering new business areas, whether through an acquisition or an organic start-up investment. Nurturing involves building up an existing business through follow-on investments, including bolt-on acquisitions. Pruning takes resources away from an existing business, either by giving some of its annual capital allocation to others or by putting a portion of the business up for sale. Finally, harvesting is selling whole businesses that no longer fit a company’s portfolio or undertaking equity spin-offs. Our research found that there’s little overall difference between the seeding and harvesting behavior of low and high reallocators. This should come as little surprise: seeding involves giving money to new business opportunities—something that’s rarely resisted. And while harvesting is difficult, it most often occurs as a result of a business unit’s sustained underperformance, which is difficult to ignore. 4 For more, see James Manyika, “Google’s CFO on growth, capital structure, and leadership,” mckinseyquarterly.com, August 2011. 9 However, we found a 170 percent difference in activity levels between high and low reallocators when it came to the combination of nurturing and pruning existing businesses. Together, these two represent half of all corporate reallocation activity. Both are difficult because they often involve taking resources from one business unit and giving them to another. What’s more, the better a company is at encouraging seeding, the more important nurturing and pruning become—nurturing to ensure the success of new initiatives and pruning to eliminate flowers that won’t ever bloom. Consider, for example, the efforts of Google CEO Larry Page, over the past 12 months, to cope with the flowering of ideas brought forth by the company’s well-known “20 percent rule,” which allows engineers to spend at least one-fifth of their time on personal projects and has resulted in products such as AdSense, Gmail, and Google News. These successes notwithstanding, the 20 percent rule also has yielded many peripheral projects, which Page has recently been pruning.5 3. Adopt simple rules to break the status quo. Simple decision rules can help minimize political infighting because they change the burden of proof from the typical default allocation (“what we did last year”) to one that makes it impossible to maintain the status quo. For example, a simple harvesting rule might involve putting a certain percentage of an organization’s portfolio up for sale each year to maintain vibrancy and to cull dead wood. When Lee Raymond was CEO of Exxon Mobil, he required the corporate-planning team to identify 3 to 5 percent of the company’s assets for potential disposal every year. Exxon Mobil’s divisions were allowed to retain assets placed in this group only if they could demonstrate a tangible and compelling turnaround program. In essence, the burden on the business units was to prove that an asset should be retained, rather than the other way around. The net effect was accelerated portfolio upgrading and healthy turnover in the face of executives’ natural desire to hang on to underperforming assets. Another approach we’ve observed involves placing existing businesses into different categories—such as “grow,” “maintain,” and “dispose”— and then following clearly differentiated resource-investment rules for each. The purpose of having clear investment rules for each category of business is to remove as much politics as possible from the resource allocation process. 5 See Claire Cain Miller, “In a quest for focus, Google purges small projects,” nytimes.com, November 10, 2011. 10 Sometimes, the CEO may want a way to shift resources directly, in parallel with regular corporate processes. One natural-resources company, for example, gave its CEO sole discretion to allocate 5 percent of the company’s capital outside of the traditional bottom-up annual capital allocation process. This provided an opportunity to move the organization more quickly toward what the CEO believed were exciting growth opportunities, without first having to go through a “pruning” fight with the company’s executive-leadership committee. Of course, the CEO and other senior leaders will need to reinforce discipline around such simple allocation rules; it’s not easy to hold the line in the face of special pleading from less-favored businesses. Developing that level of clarity—not to mention the courage to fight tough battles that arise as a result—often requires support in the form of a strong corporate center or a strategic-planning group that’s independent of competing business interests and can provide objective information (for more on the importance of the corporate center to resource reallocation, see “The power of an independent corporate center,” on mckinseyquarterly.com). 4. Implement processes to mitigate inertia. Systematic processes can strengthen allocation activities. One approach, explored in detail by our colleagues Sven Smit and Patrick Viguerie, is to create planning and management processes that generate a granular view of product and market opportunities.6 The overwhelming tendency is for corporate leaders to allocate resources at a level that is too high—namely, by division or business unit. When senior management doesn’t have a granular view, division leaders can use their information advantage to average out allocations within their domains. Another approach is to revisit a company’s businesses periodically and engage in a process similar to the due diligence conducted for investments. Executives at one energy conglomerate annually ask whether they would choose to invest in a business if they didn’t already own it. If the answer is no, a discussion about whether and how to exit the business begins. Executives can further strengthen allocation decisions by creating objectivity through re-anchoring—that is, giving the allocation an objective basis that is independent of both the numbers the business units 6 See three publications by Mehrdad Baghai, Sven Smit, and S. Patrick Viguerie: “The granularity of growth,” mckinseyquarterly.com, May 2007; The Granularity of Growth: How to Identify the Sources of Growth and Drive Enduring Company Performance, Hoboken, NJ: Wiley, 2008; and “Is your growth strategy flying blind?,” Harvard Business Review, May 2009, Volume 87, Number 5, pp. 86–97. 11 provide and the previous year’s allocation. There are numerous ways to create such independent, fact-based anchors, including deriving targets from market growth and market share data or leveraging benchmarking analysis of competitors. The goal is to create an objective way to ask business leaders this tough question: “If we were to triangulate between these different approaches, we would expect your investments and returns to lie within the following range. Why are your estimates so much higher (or lower)?” Finally, it’s worth noting that technology is enabling strategy process innovations that stir the pot through internal discussions and “crowdsourcing.” For example, Rite-Solutions, a Rhode Island–based company that builds advanced software for the US Navy, defense contractors, and first responders, derives 20 percent of its revenue from businesses identified through a “stock exchange” where employees can propose and invest in new ideas (for more on this, see “The social side of strategy,” on mckinseyquarterly.com). Much of our advice for overcoming inertia within multibusiness companies assumes that a corporation’s interests are not the same as the cumula
tive resource demands of the underlying divisions and businesses. As they say, turkeys do not vote for Christmas. Putting in place some combination of the targets, rules, and processes proposed here may require rethinking the role and inner workings of a company’s strategic- and financial-planning teams. Although we recognize that this is not a trivial endeavor, the rewards make the effort worthwhile. A primary performance imperative for corporate-level executives should be to escape the tyranny of inertia and create more dynamic portfolios. The authors would like to acknowledge the contributions of Michael Birshan, Marja Engel, Mladen Fruk, John Horn, Conor Kehoe, Devesh Mittal, Olivier Sibony, and Sven Smit to this article. Stephen Hall is a director in McKinsey’s London office, and Reinier Musters is an associate principal in the Amsterdam office. Dan Lovallo is a professor at the University of Sydney Business School, a senior research fellow at the Institute for Business Innovation at the University of California, Berkeley, and an adviser to McKinsey.
THE McKINSEY QUARTERLY 1996 NUMBER 4 39 ONE THING ABOUT GROWTH IS CLEAR: the literature touting its importance keeps growing, and growing, and growing. What is less clear – and oƒten needlessly obfuscated in management jargon – is how companies grow. Take the tricky, potentially paralyzing, dilemma that confronts most senior executives contemplating growth. On the one hand there exists a chasm between their current inventory of institutional capabilities and those required to achieve their growth aspirations; on the other, taking a discontinuous, “bet-the-company” leap could send the company barrelling down a deep and dangerous crevice, ending in the thud of extinction. To provide some timely, practical advice on how companies can grow, we examined 40 of the world’s leading growth companies to find out how they approach, and more important, implement growth strategies (see the boxed insert, “About the research base” and Exhibit 1). These companies – in industries from basic materials to high technology based throughout Europe, North America, and Asia – clearly know how to grow: they average 25 percent compound annual growth in sales and 32 percent in shareholder returns (from dividends and capital gains). Their response to the question “How do I get from here to STRATEGY AND GROWTH With revenue increases of 25 percent a year, how do the world’s best growth companies do it? A few steps at a time, each bringing options and new capabilities No formulas, just astute bundling of competences, skills, assets, and relationships Mehrdad Baghai is a consultant in McKinsey’s Toronto oƒfice. Steve Coley is a director in the Chicago oƒfice. David White is a principal and Rob McLean is a director in the Sydney oƒfice. Charles Conn was formerly a principal in the Sydney oƒfice. Copyright © 1996 McKinsey & Company. All rights reserved. We would like to acknowledge the contribution of the McKinsey Growth Team to the ideas in this article. The team included Rajan Anandan, Anna Aquilina, Scott Berg, Wulf Böttger, Jeƒf Chan, Angus Dawson, Andrew Grant, Sallie Honeychurch, Aaron Mobarak, Annette Quay, Hugo Sarrazin, Houston Spencer, Stefanie Teichmann, and Bay Warburton. Mehrdad Baghai, Stephen C. Coley, and David White with Charles Conn and Robert J. McLean Staircases to growth there” would typically be “not by big bold leaps but by a series of measured steps.” Each step makes money in its own right; each is a step up in that it adds new institutional skills that better prepare the company to open up – and take advantage of – opportunities; and each is a step roughly in the direction of a broader vision of where the company wishes to be. When these companies look back at what they have achieved, they see not steps zigzagging all over the place but a distinctive pattern or “footprint” in the STAIRCASES TO GROWTH 40 THE McKINSEY QUARTERLY 1996 NUMBER 4 Exhibit 1 Retrospective performance of a sample of great growers Arvind Mills Barrick Gold Consolidated Paper CRH Great Lakes Chemicals Jefferson Smurfit Denim manufacturing – world’s 5th largest Gold mining – world’s 3rd largest Coated printing paper Building materials Specialty chemicals Paper and packaging India Canada US Ireland US Ireland 1988–95 1983–95 1980–95 1972–95 1977–95 1973–95 ConAgra Coca-Cola Amatil Frito-Lay Gillette Hindustan Lever Sara Lee Fila Packaged food Beverages, soft drinks Snack chip division of Pepsico Branded consumer products Consumer products, part-owned by Unilever Diversified branded packaged goods Sportswear and casual apparel US Australia US US India US Italy 1977–94 1985–96 1985–95 1985–95 1990–95 1977–95 1988–95 95 46 32 14 17 21 24 29 18 11 NA NA 19 8 25 22 25 24 18* Basic materials Consumer goods Enron Burmah Castrol Newfield Exploration Tejas Gas Gas and IPP Specialized lubricants Upstream oil and gas Natural gas pipelines US UK US US 1988–95 1986–95 1991–95 1988–95 Energy Hutchison Whampoa Lend Lease Samsung Globally diversified conglomerate Property and financial services Highly diversified conglomerate – largest chaebol Hong Kong Australia Korea 1986–95 1980–95 1975–95 Diversified Note: In addition to our case research on the companies listed, we have also examined selected aspects of the impressive performance histories of Columbia/HCA, The Home Depot, and Wells Fargo. 31 ~50 22 25 21 30 27 15 75 24 55 27 11 22 10 90† 50 19 9 7 7 Company Industry Growth period Country of origin Sales (CAGR%) Total returns to shareholders (CAGR%) form of a staircase of manageable steps. While few – if any – single steps are dramatic in and of themselves, linking them together as a staircase of sequential growth achieves results that definitely are. None of these companies will say that, looking forward, they had perfect foresight of where the steps would lead. On the other hand they will say that each time they climbed a few they felt they had institutionalized a new set of capabilities, created new business options, and carved a competitive position for themselves that was beyond their reach when they stood at the bottom of the staircase. STAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 41 Exhibit 1 Retrospective performance of a sample of great growers Financial institutions Entertainment Bertelsmann AG Disney Village Roadshow Publishing and media Films, theme parks, diversified entertainment Cinema operation, diversified entertainment Germany US Australia 1986–95 1984–94 1989–95 State Street Boston Charles Schwab Capital One GE Capital Investment custodial services Discount brokerage house Credit cards Financing and leasing US US US US 1982–95 1987–95 1990–95 1980–95 Healthcare Johnson & Johnson Diversified healthcare products US 1977–95 11 32 62 51† 20 17 31 30 13 12 33 53 61† 82 37 18 25 23 28 34 28 48 52 20 16 18 NA NA NA Manufacturing Bombardier Dover Federal Signal Illinois Tool Works Diversified manufacturing, incl. snowmobiles Diversified industrial products Signs and signals, specialized vehicles Specialized industrial components Canada US US US 1985–95 1977–95 1977–95 1985–95 Retail 7-Eleven Japan Convenience stores Japan 1980–95 Acer Lotus Kyocera Thermo Electron SAP AG Softbank Nokia PC manufacturing – world’s 8th largest Software development Hi-tech ceramics Diversified hi-tech products Software development PC magazine publishing and software distribution Telecommunications technology Taiwan US Japan US Germany Japan Finland 1990–95 1984–94 1980–95 1985–95 1988–95 1991–96 1991–95 Hi-tech 11 33 11 23 41 35 24 28 13 13 19 17 * Beverage division Average 25 † Since initial public offering Company Industry Growth period Country of origin Sales (CAGR%) Total returns to shareholders (CAGR%) The staircase approach of continuously compounding skills and options is consistent with the competitive reality of most industries. The competitive landscape is changing so rapidly that it is impossible to predict paths several years ahead. Building a staircase explicitly recognizes that the appropriate strategy for any company depends on where it is today and on the state of the world down the road. The best a company can do under these circumstances is to build appropriate capabilities and create strategic options and opportunities without pre-empting or constraining future flexibility. Staircase of initiatives Successful growers adopt a bifocal perspective which emphasizes both near term and long term: vision and tactics. Even though they plan within a clear strategy, they are not slaves to a mechanistic process for projecting a mediumterm budget. Many low-growth companies are. The focus on near-term steps takes advantage of the fact that, each time a company builds new skills, new opportunities open up. It means managers are able to move fast enough to exploit opportunities early, before competitors move in or conditions change. It also encourages managers to behave as entrepreneurs rather than bureaucrats, avoiding excessive deliberation and “paralysis by analysis.” This does not mean they act imprudently but, sim
ply, that they act. While great growers are focused on immediate steps, they are not capricious. They act with informed opportunism toward a clear vision of the kind of company they are building. The Walt Disney Company (Disney), for example, requires its groups to articulate five-, ten-, and fiƒteen-year directional plans. Enron, the Texas-based gas company, moves quickly to maximize STAIRCASES TO GROWTH 42 THE McKINSEY QUARTERLY 1996 NUMBER 4 The Growth Initiative is one of five global taskforces McKinsey has launched in the past year to undertake applied crossfunctional research and development. The initiative supplements McKinsey’s continuing R&D programs in specific industries (financial institutions and energy, for example), functions (including organization and operations), and geographies (China is one). The aim is to develop distinctive and practical perspectives that help our clients increase profitability. The research is based on academic thinking, practical insights from clients, and detailed case studies of 40 successful growth companies. The case studies involve reviews of company information, annual reports, SEC filings, newspaper and magazine articles and books, and, in the majority of the cases, interviews with a cross-section of managers. The case studies of success have been supplemented by 15 cases of growth failures. ABOUT THE RESEARCH BASE opportunities for its rapidly evolving gas businesses – originally toward its vision of becoming “the world’s first gas major,” and now with the aim of “creating energy solutions worldwide.” To achieve their aspirations, companies like these use a similar pattern over and over. The first step secures an option on an opportunity. If it shows promise, next steps test the concept further and help accumulate the con- fidence and skills for more steps. Aƒter a few years the concept is replicated and extended as the strategy gains momentum. Later, replication is accelerated to take full advantage of the successful formula. Coca-Cola Amatil (CCA) is a good example of a company that has bootstrapped itself to growth in this way (Exhibit 2). Now one of Coca-Cola’s flagship bottlers, in 1980 CCA was a diversified Australian conglomerate with a few small Australian Coke bottling franchises. In 1982, it bought bottling franchises in Vienna and Graz in Austria – a small step, but one that took the company into Europe. Over the next few years, CCA continued to build its Australian base by acquiring adjacent regional franchises, while divesting its interests in other businesses. By the mid-1980s, the company was in two countries, with a potential market of 25 million consumers. Having learned about the Austrian market from Vienna and Graz, and about the benefits of consolidation from its Australian acquisitions, CCA decided to go further. Between 1987 and 1991, it bought eight contiguous Austrian franchises, consolidating operations and achieving economies of scale. In 1988, it stepped into two countries adjoining its home market – Fiji and New STAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 43 Exhibit 2 Coca Cola Amatil’s staircase Secure option Test concept and build capabilities Replicate and extend Accelerate 2 countries, <25 million people 4 countries, 29 million people 9 countries, 240 million people 16 countries, 368 million people Vienna and Graz (Austria) Mödling and St Polten (Austria) Landegg, Steyr, Gmunden, Klagenfurt, and Dornbirn (Austria) Salzburg (Austria), Hungary, Czech Republic, and Slovak Republic Belarus, Slovenia, Ukraine, Croatia, Poland, Romania, and Switzerland Australia Build Australian franchise through acquisition and consolidation Fiji and New Zealand, further Australian acquisitions Indonesia and Papua New Guinea Further Indonesian operations EUROPE ASIA PACIFIC 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Zealand – and continued to consolidate Australian regional franchises. By 1991, this put CCA in four countries, exposed to 29 million people. Each step built CCA’s skills and confidence, and strengthened its reputation in The Coca-Cola Company’s eyes. All three became critical as CCA moved into the next stage of growth, extending its formula into other adjoining – but undeveloped – markets: Hungary and the Czech and Slovak Republics, and Indonesia and Papua New Guinea. Lacking modern production, distribution, and marketing skills, and with low per capita consumption, these markets oƒfered tremendous potential. By 1994 – now in nine countries, with 250 million consumers – CCA began moving into more and more contiguous markets: Belarus, Slovenia, Ukraine, Croatia, Switzerland, Poland, Romania, and new regions of Indonesia. In all, CCA is now in 16 countries, with a total potential market of 368 million people. Enron has followed a similar model. In 1985 the company identified the potential in independent private power generation (IPP), but its capability was limited to some gas reserves, a pipeline network, and conventional gas contracting skills. Enron secured an option in IPP by acquiring the rights to operate a small, gas-fired cogeneration plant in Texas in 1986. The company built a bigger plant in Texas the following year. Confident the concept was valid, it undertook three more IPP ventures in other American states. In 1990–91, the company took its first truly big step by developing Teeside in the UK, the world’s largest combined-cycle gas turbine plant. With its international reputation cemented by the project, and with skilled specialists on its staƒf, Enron expanded into India, Indonesia, Germany, China, Guatemala, and the Philippines – becoming a worldwide force in IPP. Neither CCA nor Enron relied on huge “bet-the-company” gambles to create growth. Each step was a manageable investment that built on established capabilities and oƒfered the potential to add new ones. Sometimes, however, it may be necessary to make large investments and stretch the company in order to preempt competitors – in scale-intensive businesses, for example. This was the case with News Corporation’s BSkyB satellite television network in the UK and with Li Ka Shing’s similar venture, StarTV, in Asia. Usually, however, the staircase approach enables a company to avoid such risks. The record of successful growers makes the idea of building staircases appealing.But when you are atthe bottom of yourstaircase, how do you begin? The constraints can seem unbreachable if you believe your opportunities are STAIRCASES TO GROWTH 44 THE McKINSEY QUARTERLY 1996 NUMBER 4 Successful growers adopt a bifocal perspective which emphasizes both near term and long term: vision and tactics limited and your skills poor. The companies in our sample teach valuable lessons about how to view opportunities and abilities in order to break through these perceived constraints. The opportunity pipeline Many executives feel nervous about their ability to grow simply because they do not see many opportunities; neither do they see their companies generating profitable growth ideas. Their managers oƒten tell them that markets are mature, core franchises under threat, and all paths to growth restricted. Much of the growth debate fails to address how to overcome these perceived limitations. Instead, advice focuses on one strategic option or another and claims that any company that adheres to a single path will grow. One view talks about product innovation, another about stepping out into emerging growth industries, another about globalization. This approach is reminiscent of the proverbial boy with a hammer, who runs around looking for things to hit with it. Each path is a legitimate hammer, but not every company is a nail, and the hammer may not break the shackles a company feels. No single strategy can oƒfer a complete view of how to grow, and any approach that overemphasizes one strategy also oversimplifies the manager’s challenge. Given that each company brings to growth a unique position and exposure to diƒferent kinds of opportunity, there must be many possible strategies for each to consider.
That is certainly the view taken by successful growers: they believe neither their industries nor circumstances prevent them from considering opportunities along various paths. Indeed, companies in similar positions in a given industry may see their options very diƒferently and pursue strikingly diƒferent courses. We have seen the best companies consider seven distinct strategic degrees of freedom – and use most of them (Exhibit 3). 1. Maximizing existing customers. The first degree of freedom – and the one closest to home – is to sell more of the current product range to existing customers. This may simply mean using promotional programs to increase the frequency of purchase or use. However, it can also mean managing sophisticated cross-selling programs. State Street Boston is a good example of a company making the most of its existing customers. It has become the world’s leading provider of custodial services by acting as the “outsourced back oƒfice” to pension funds and mutual funds. While many customers start out with bulk “commodity” services, however, State Street grows with these STAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 45 Companies in similar positions in an industry may see options very diƒferently and pursue strikingly diƒferent courses existing customers by oƒfering them increasingly diƒferentiated and, therefore, higher value-added services. 2. Attracting new customers. A second way for a company to grow, still without stepping into new product ranges, is by attracting new customers to its existing product range, thereby expanding the size of its customer franchise. Gillette, for instance, paid little attention to women for years. By extending the marketing of its Sensor product to women, however, it has both expanded the women’s shaving market and taken 65 percent of it. 3. Innovation of products and services. Among the commonest ways to grow is the introduction of new products and services. Gillette continually moves customers up to new, improved razors that are better than competitors’ oƒferings: from coated stainless steel blades, to twin-bladed products, to a pivoting head shaver, to a pivoting head shaver with a lubricating strip, to its revolutionary Sensor, and now Sensor Excel. Gillette has also built on its razor brand to add grooming products such as aƒtershave lotion, deodorant, and shaving cream. 4. Innovation of the value-delivery system. Successful companies recognize the potential in redesigning the business system by which a product or service is delivered. The Home Depot has used this path, developing a fundamentally new retail system which is more appealing to most customers than the small local hardware store (because it gives better service and STAIRCASES TO GROWTH 46 THE McKINSEY QUARTERLY 1996 NUMBER 4 Exhibit 3 Seven strategic degrees of freedom Existing competitive arena Step-outs into new competitive arenas Existing geography Existing industry structure Acquisition and/or consolidation within current industry Existing value delivery system Innovation of value delivery system Existing products and services Maximization of existing customers Innovation of products and services Attraction of new customers Current business versus versus versus versus versus versus Expansion into new geographies wider choice) and cheaper (because of its buying power, eƒficient logistics, and capital productivity). In financial services, Charles Schwab pioneered the discount brokerage industry in the US aƒter deregulation in the mid- 1970s – oƒfering price-sensitive customers fast, accurate execution of sharetrading orders at substantially lower cost than full-service competitors. Schwab has continued to innovate with improvements to its delivery system such as automated telephone trading, personal computer trading, and, most recently, Internet trading. In India, Arvind Mills has redesigned the value-delivery system for jeans. Arvind, the world’s fiƒth-largest denim manufacturer, found Indian domestic denim sales limited because jeans were neither aƒfordable nor widely available. At $20 to $40 a pair they were beyond the reach of the mass market, and existing distribution systems reached too few towns and villages. In 1995, Arvind introduced Ruf and Tuf – a ready-to-stitch kit of jeans components (denim, zip, rivets, leather brand patch) priced at about $6. It distributed them through 4,000 tailors, whose self-interest motivated them to market the kits to create demand for sewing services. Ruf and Tuf are now the largestselling jeans in India by far, driving sales in Arvind’s main product, denim, and netting the company a potentially powerful consumer brand. 5. Improving industry structure. Improving industry structure is a degree of strategic freedom frequently exercised by great growers, because it involves growth close to the core, that is, in similar geographies and types of business. At its simplest, this can mean buying businesses to be improved on a standalone basis, and some types of greenfield capacity expansion. Both can change an industry’s cost and capacity dynamics. European industrial companies such as Jeƒferson Smurfit and CRH use this path, as do US consumer goods companies ConAgra and Sara Lee, specialty manufacturer Federal Signal, and high-tech innovator Thermo Electron. Multiple acquisitions enable companies to create economies of scale – CCA found this with its franchises in Austria and Australia. Again, it is a course that can add up to influence the competitive dynamic of a whole industry, as Columbia/HCA’s consolidation of the US hospital sector illustrates. Founded in 1987, Columbia/HCA’s principal strategy has been to acquire, and oƒten merge, hospitals in adjacent regions. Ten years later, it owns 343 hospitals, 135 outpatient surgeries, and 200 home health agencies, making it the largest healthcare services provider in the US. The same kinds of economic benefit could of course be achieved with alliances and joint ventures, removing the need to acquire the assets outright. Some industries can also be reshaped by influencing regulation. STAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 47 Successful companies recognize the potential in redesigning the business system by which a product or service is delivered 6. Geographical expansion. The fourth strategic degree of freedom is geographical expansion, which companies can pursue either by intensifying their coverage of regions in which they already operate – as 7-Eleven Japan, The Home Depot in the US, and Australian cinema and entertainment group Village Roadshow are doing with spectacular eƒfect – or by moving into new regions (the strategic path at the heart of globalization). Many companies in our sample have taken the latter course, including Arvind Mills, Sara Lee, Johnson & Johnson, Gillette, SAP, and Jeƒferson Smurfit. It can, however, be a diƒficult path to navigate. 7. Stepping out into new business arenas. Many successful growers grow by competing in new arenas. They seek opportunities vertically along their industry chain, or find areas of their existing operations in which to specialize. Enron vertically integrated from gas pipelines into gas-fired power generation. State Street Boston, on the other hand, started as a bank but spotted a chance to specialize, as already noted, in the provision of custodial, accounting, and information services to pension and mutual funds. Other companies step into new businesses to which they can apply established skills. Sara Lee has entered a range of consumer brand businesses from pantyhose to hot dogs. Federal Signal, which started in signs and signals, is now a leader in specialty vehicles too, including fire engines and street sweepers. Charles Schwab stepped from discount brokerage into the mutual fund agency business, defined contribution pension funds, financial advisory services and, most recently, direct selling of insurance. It is clear that truly great companies – those that are able to sustain growth – pursue growth along several of these paths, oƒten simultaneously. Many, such as Disney, use all
seven degrees of freedom. (See the boxed insert, “Disney’s use of seven degrees of strategic freedom.”) Resourcing processes to generate ideas Recognizing the strategic degrees of freedom available for growth is important, but not enough. Companies still have to identify specific opportunities. To do so, they pour resources and senior management time into generating ideas. In this way they produce so many that competitors are leƒt exhausted from the eƒfort of keeping up. Not all ideas will work, but one could be the next big opportunity. Johnson & Johnson, for example, has dozens of vice-presidents of licensing and acquisitions, many with doctorates in law or science or medicine. Their job is to identify and nurture opportunities by establishing relationships with STAIRCASES TO GROWTH 48 THE McKINSEY QUARTERLY 1996 NUMBER 4 Truly great companies – those that are able to sustain growth – pursue growth along several of these paths, oƒten simultaneously THE McKINSEY QUARTERLY 1996 NUMBER 4 49 Many wonder if, perhaps, Disney is a special case. While it may be, we see very similar patterns in most of our sample of growth companies. And one need only look back to its dark days in the early 1980s to note that Disney’s growth has not come as a natural birthright on the strength of its assets. Disney has driven growth since then by using all seven strategic degrees of freedom. Disney, as a world-class marketer, is very good at maximizing its current customer base. It also attracts new customers, however, by going after customer franchises beyond its traditional family orientation. It started Touchstone and Hollywood Pictures, and purchased Miramax, for instance, in order to tap the teenage and adult markets. Disney also constantly innovates with products and services. Its release of three animated feature films every two years is the starting point for the introduction of thousands of merchandising products, home videos, music cassettes and discs, attractions and rides at theme parks, live theatrical productions, and even computer games. Recently, it has also announced new theme parks, including Animal Kingdom and California Adventures. Disney has been at the forefront of most of the value-delivery system innovation in its industry. It was quick to adopt new channels for its entertainment – first television (with the Wonderful World of Disney), then cable television (with the Disney Channel), and eventually home video. It opened a new merchandising channel in the form of a chain of Disney Stores, then changed the way some people take vacations by building on its theme park business in Orlando to deliver a unique package: guests are offered day- and nighttime entertainment at the Magic Kingdom Park, EPCOT, and Disney-MGM Studios, as well as hotel accommodation, restaurants, and bars. Every part of a tourist’s stay can be catered for through a Disney package deal. Geographically, Disney has grown by distributing its films, videos, and merchandise worldwide. It expanded its theme park business first from Anaheim to Florida, then Tokyo, and then France with EuroDisney. It is now extending its stores globally. In order to improve its industry structure, Disney has largely eschewed big acquisitions (ABC excepted) in favor of more subtle vehicles. It creates cross-promotional relationships with McDonald’s and Mattel based on Disney characters, for example. The company shapes its regulatory environment by working with the Florida government to secure unique property ownership and development arrangements. Disney has a long tradition of stepping into new arenas when it sees an attractive opportunity. Its first step was from animated films into theme parks; more recently, it has moved into live entertainment (including theater and sports), cruise liners, resorts, and even residential communities such as Celebration, in Florida, and Val d’Europe, in France. Perhaps its biggest bet so far is its move to integrate vertically into television by acquiring ABC. DISNEY’S USE OF SEVEN DEGREES OF STRATEGIC FREEDOM medical entrepreneurs, venture capitalists and investment banks, research establishments, and universities. The institutions give Johnson & Johnson access to new medical technologies that might be good targets for acquisition. Aƒter development, these technologies become the products Johnson & Johnson distributes through its global salesforce. In other environments, the processes are more organic but the focus on generating opportunities is the same. Opportunities present themselves to the Hong Kong-based Li Ka Shing group, which includes Hutchison Whampoa, through the extraordinary network of contacts Li has cultivated. He has achieved unequalled presence in China by cultivating relationships with central and regional governments, state-owned enterprises, financial institutions, overseas Chinese entrepreneurs, and western multinationals. The process has been under way since the late 1970s. Li built the China Hotel in Guandong in 1980 before China opened up, then donated HK$850 million the following year to build Shantou University. He met Deng Xiaoping in 1986 and maintained contact aƒter the Tiananmen Square protest in 1989. The same year Li contracted China Aviation to launch the Asiasat I satellite for StarTV. He also shares business interests with government enterprises such as CITIC and Cosco. The resulting contacts have opened opportunities that account for much of the several billion dollars he has committed to the mainland. Assembling platforms of capabilities Finding even the most fertile growth opportunities does not mean a company will grow. Great growers know they will profit from an opportunity only if they are capable of exploiting and protecting it. Unfortunately, most advice about how to use capabilities to grow tends to be narrow and may reinforce managers’ perception that they are hindered by having limited capabilities. Perspectives such as “skills-based strategy” and “the core competence of the corporation” rightly emphasize the importance of the skills inherent in an organization’s people and processes. But neither considers what other capabilities a company might bring to bear. Great growth companies do. They recognize, and maximize, whole classes of capability ignored by traditional perspectives. They start with strong business-specific competences, but also acknowledge the importance of growth-enabling skills (in acquisitions and deal structuring, for example), privileged assets (such as infrastructure, patents, and brands), and special relationships (Exhibit 4). STAIRCASES TO GROWTH 50 THE McKINSEY QUARTERLY 1996 NUMBER 4 Exhibit 4 Potential elements of a capability platform Business-specific core competences Growth-enabling competences Privileged assets Special relationships Capability platform Acquisition Financing, risk management, and deal structuring Regulatory management Capital productivity enhancement Brands Networks Intellectual property Infrastructure Information Licenses Access-conveying Capability-complementing Business-specific competences. Successful growers are good at what they do and have skills that make them distinctive. Disney, for example, possesses unmatched competence in character design and animation; since 1928 and the first Mickey Mouse cartoon, Steamboat Willie, Disney has led its industry. This has been the foundation for growth in filmed entertainment from which the company has grown into merchandising, music publishing, and theme parks. Great growers do not only use such businessspecific competences to make more money from existing assets; they are also able to see more value in new opportunities for which those competences are required than others do. Canada’s Barrick Gold, which has quickly become the world’s most profitable and third-largest gold producer, has distinctive competence in its development and operation of gold mines, for example. It uses the biggest autoclaves in the industry, runs the largest dewatering system in the world, and has exceptionally low overheads and a unique approach to exploration and development of reserves nea
r existing mines. These are the basis of the company’s growth formula: they mean Barrick is able to take mines that to others appear marginal and turn them into top performers. Growth-enabling skills. Focusing on core competences gives a limited view of the range of attributes required for growth. Great growers are also distinguished by their mastery of more generic “growth-enabling,” skills including making acquisitions, financing, risk management and deal structuring, regulatory management, and capital productivity enhancement. It has become the popular wisdom that acquisitions, especially large ones unrelated to a company’s main business, are risky and oƒten destroy value. Yet almost all the companies in our sample have used acquisitions as part of their growth strategies. More than half the growth of US food company ConAgra,for example, has been driven by acquisition.The company has made more than 45 significant purchases in the past ten years alone. One core skill that pervades ConAgra is the ability to find and secure acquisitions that meet growth/return targets. Not all companies’ acquisition programs are about buying established businesses, however. They can also focus on feeding the “opportunity pipeline,” with purchases aimed at patents and small businesses developing promising ideas. Great growers also commonly exhibit skills in financing, risk management, and deal structuring. While Barrick Gold’s core competence is in the operation of gold mines, Robert Wickham, then chief financial oƒficer, STAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 51 Great growth companies recognize, and maximize, whole classes of capability ignored by traditional perspectives 52 THE McKINSEY QUARTERLY 1996 NUMBER 4 Kickstarting and sustaining profitable revenue growth is tough. The harsh statistical reality is that only 10 percent of companies with above-average growth will sustain it for more than ten years. Executives who aspire to grow profitably and sustainably are therefore betting against the odds. A sound growth strategy is important. But it is a long way from a successful growth program. Why do so few growth programs succeed? And what can leaders do to change the odds in their favor? These are the questions we have sought to answer with research into 40successful growth companies (Exhibit 1, main text), supplemented by research into 15 failures. The first reason for failure is that many management teams do not integrate and balance the aspirational, strategic, and organizational imperatives of growth. Some executives begin in the wrong place, developing bold strategies before they have “earned the right to grow” by ensuring that current operations are profitable and competitive. Others invest in generating ideas before they have the people, incentives, and structure to move from concept to reality. Yet others focus on building ambition and entrepreneurship but neglect to impose the discipline of choosing between strategic alternatives. The second reason for failure is that executives find it difficult to concurrently manage initiatives with different pay-off horizons. It is not an easy job. Some companies protect and extend their core business well in the short term, but neglect to invest adequately to secure growth over the longer term. Not surprisingly, growth begins to stall after three to five years. Others get so excited by building momentum in the emerging growth engines that will underpin profitability three to six years out that they pay insufficient attention to today’s core – and begin to lose the ability to generate cash and the stakeholder confidence required to sustain the right to grow. LEADING GROWTH Exhibit A Dimensions of growth best practice The right to grow Commit to growth Stretch targets and values Expansive mindset Reinforcing systems and incentives Opportunity pipeline Staircase of initiatives Platform of capabilities Business builders Connected communities Cultivate entrepreneurship Build growth engines THE McKINSEY QUARTERLY 1996 NUMBER 4 53 Leadership across three dimensions Successful growth leaders balance and integrate their efforts across three dimensions. They build a stretching commitment to growth throughout their organization, drive development of new growth engines, and cultivate the environment of entrepreneurship in which growth thrives. All companies manage across these priorities to some extent. But the most successful are distinguished by the intensity and balance with which they pursue the nine actions that underpin the aspirational, strategic, and organizational imperatives (Exhibit A). Disney’s growth, for instance, has been driven by the skillful operationalization of all nine dimensions of strong growth programs (Exhibit B). Commit to growth • Earn the right to grow. Growers must earn the right to grow, then maintain it. They relentlessly pursue operational excellence to underpin their growth efforts, and divest underperforming or distracting businesses. They earn investors’ confidence through clear and consistent communication about growth programs. • Raise the bar through stretching targets and values. Growers aim high. Many set Exhibit B Three dimensions of Disney turnaround, 1984–88 Earn the right Raise the bar Embrace expansive mindset Began by securing shareholder support for 5-year turnaround program Executed short-term program to ramp up results Set vision to be world’s premier entertainment company Set tough targets (eg, “20/20” – 20% pa growth and 20% ROE) Redefined image as integrated entertainment company, not exclusively theme parks or films. Committed to creativity Emphasized unlocking value of latent assets (eg, film library) and driving synergies (eg, merchandising spin-offs from animated characters from Mickey Mouse to Roger Rabbit Commit to growth Fill opportunity pipeline Assemble platform of capabilities Climb a staircase Instituted processes to generate new ideas (eg, “gong show” presentations of script ideas by employees to Eisner and Katzenberg) Encouraged creativity in cross-promotions Leveraged Disney’s underutilized platform of capabilities (eg, animation characters and properties) Built new capabilities (eg, innovative financing, new animation skills, consumer marketing) Leveraged outsiders (eg, promotional partners such as Mattel) Pursued several new staircases and increased pace of steps on traditional staircases – including accelerated growth in resorts and vacation properties Build growth engines Breed business builders Create connected set of small communities Systems and reinforcing incentives Assembled new top team • Eisner (CEO) from Paramount • Wells (COO) from Warner Brothers • Wilson (CFO) from Marriott Restructured mid-level in first year • Brought in 30 new movie executives • Fired 400 people in first 12 months Drove accountability down the line to creative teams, projects, and groups Began capturing synergy across independent groups, eg, cross-promotion of Roger Rabbit merchandise Restructured salaries and bonus schemes to attract key executives (eg, Eisner earns 2% of any profit increase over 9% per annum) Shifted culture from “holiday camp” to “boot camp,” penalized poor performers Cultivate entrepreneurship 54 THE McKINSEY QUARTERLY 1996 NUMBER 4 profit targets well beyond industry averages. Others articulate and embrace stretching aspirations based on what they want their company to become. All balance targets and aspirations with strong corporate values. These can be critical to prevent an organization shaking apart under the strains of growth. • Embrace an expansive mindset. Growth companies do not believe their business environments limit growth. They reject traditional market definitions, challenge conventional wisdom, and break constraining mindsets so that they are less likely to miss opportunities a more orthodox mindset might obscure. They push their passion for growth throughout the organization to motivate employees. Build growth engines • Fill the opportunity pipeline. Growers gush with ideas, and recognize that they will need more and more to keep up the p
ace of growth. They understand there are multiple degrees of strategic freedom, and invest in the search for opportunities along as many of them as possible. • Assemble a platform of capabilities. Companies that think about their capabilities only in terms of business competences are missing much of their potential competitive advantage. Growers build from a broader platform of capabilities which includes privileged assets, special relationships, and growth-enabling skills. And if they are missing the capabilities they need to exploit an opportunity, they assemble them through partnerships, acquisitions, or internal development. • Climb a staircase of initiatives. Growers do not let themselves get stuck in a morass of strategic planning and medium-term budgeting. While they are committed to a long-term vision, they focus on near-term steps. They evolve by linking these small, manageable steps in series. Each builds new capability and opens new horizons. Cultivate entrepreneurship • Create a connected set of small communities. People in growth organizations do not sit in crowds; they run in teams. Growth companies organize around small accountable communities – such as independent operating companies – which replicate the speed and flexibility of small companies and foster a greater sense of ownership and pride in achievement. At the same time they achieve the reach and resources of a large corporation by sharing brands, infrastructure, relationships, people, and best practices. • Breed business builders. Growth requires entrepreneurs: people who want to build their own businesses regardless of the challenges. But they are scarce, and many companies’ greatest growth constraint is not having enough of them. So growers bring in new blood from outside and put in place systems to nurture new entrepreneurs and leaders from the inside. • Design reinforcing systems and incentives. Growth is hard work, so the pay-off must be clear. Growers reward success handsomely by giving top performers increased responsibility, variable compensation, and equity distributions. They also penalize mediocrity. They ensure that other systems reinforce their aspirations. Planning, budgeting, capital allocation, and performance yardsticks are designed to provide support and manage risk. LEADING GROWTH Exhibit C Concurrent management across three time horizons Value Time Horizon 1 Defend and extend current core Horizon 2 Build momentum of emerging growth engines Horizon 3 Create options for future staircases THE McKINSEY QUARTERLY 1996 NUMBER 4 55 Leadership across three time horizons Growth leaders manage concurrently across three time horizons (Exhibit C). They aim to defend and extend their current core business to pay off in the short term, work hard today to build momentum in new or emerging businesses which will underpin medium-term profit growth, and devote time and resources to explore and secure options for long-term profit growth (Disney example, Exhibit D). The number of years in each horizon will vary among industries. In slowly evolving, capitalintensive basic materials sectors such as pulp and paper or chemicals, the tail of the first horizon may be five or ten years out. Hyperevolutionary software, electronics, or Internet businesses may see their third horizon as close as five years away. The challenge is to balance today’s efforts across all three time horizons in proportions appropriate to industry context. Managing the tensions inherent in simultaneously attending to all three is easy to advocate, hard to do. The types of targets, strategies, people, performance metrics, and incentive systems appropriate to creating mediumor long-term options are often at odds with those needed to drive short-term performance. Bringing all this together across three dimensions and three time horizons takes judgment, courage, and tolerance of ambiguity. The right balance for any particular company, of course, depends on the industry and the company’s starting position. Companies whose growth has stalled must pay particular attention to initiatives to kickstart growth in the short term. Companies with sound core businesses but few long-term options may pay more attention to horizons two and three, particularly if their industries are changing quickly. Neither type, however, can afford to ignore any of the three. Exhibit D Leadership across three time horizons during Disney turnaround, 1984–88 Actions taken in first years of turnaround Pay-off from actions Horizon 1 Drive growth of current core Horizon 2 Build momentum of emerging engines Horizon 3 Secure options for future Dramatically boost theme park revenue Increase admission prices 45% Launch advertising and promotion campaign Build new attractions at existing parks Exploit latent assets in film library Release classics to home video market Syndicate classics to television Rejuvenate filmed entertainment growth engine Rejuvenate animation group (new people, new equipment, new projects) Raze and rebuild movie group (new people, new actors, new financing vehicles, new projects) Accelerate growth of resorts and vacation properties Plan/design Disney-MGM studios Open Grand Floridian Hotel Acquire Wrather Corporation assets Expand consumer products merchandising, eg, Mickey Mouse products for adults Increase cross-promotion with film, eg, 500 Roger Rabbit products Test new consumer product concepts First Disney store Direct mail experiments Take early steps in broadcasting Acquire K-CAL (TV station) Produce TV shows Evaluate music industry leading to Hollywood Records initiative Amazing short-term turnaround: Disney revenues more than doubled between 1984 and 1988, increasing net income from around $100 million to over $500 million in 1988 Filmed entertainment operating income from <$50 million in 1985 to >$1 billion in 1995 – driven by 34% pa revenue increase Theme park revenue and operating income growth of 12% pa from 1985–95 Consumer products group operating income now over $500 million on sales growth of 33% pa from 1985–95 Over 500 stores worldwide $15 billion of Disney licensed merchandise sold globally (Disney share = $2 billion) Broadcasting now one of Disney’s major businesses after recent ABC acquisition recognized in 1992 that larger gold companies would need to know as much about financing as they do about metallurgy.” Barrick has used gold bonds – which index interest to the gold price – to finance new mines, oƒfloading some of the risk of developing a mine. Li Ka Shing makes his capital go further and shares risk through clever deal structuring. He reduced the initial funding needs of StarTV, for instance, by securing upfront payment from founder advertisers while deferring StarTV’s payments to program suppliers, both in return for sharing the potential upside. Finally, exceptional capital productivity skills enable great growers to make commercial successes of projects that other companies might reject. Increasing the incremental productivity of capital investment, not only increases returns on individual projects but also expands capacity and resources for further growth. Hindustan Lever’s exceptional success in Indian consumer goods markets – it is the country’s largest packaged goods manufacturer – is partly due to its ability to achieve sales revenues per dollar of fixed assets that are double those of the Unilever company worldwide. Privileged assets. A company’s assets, if distinctive, can bring competitive advantage in current businesses, but they can also be important in future development. Privileged assets include brands, networks, infrastructure, information, and intellectual property, and may be as important in exploiting growth opportunities as people skills and company processes. Disney uses its proprietary intellectual property as a privileged asset. Its library of characters such as Mickey Mouse and the Lion King has underpinned development in home videos, musical recordings, merchandise retailing, and theme parks. Disney is not unique; many companies have similar intellectual property assets in the form of proprietary technology
and patents. To be valuable, however, intellectual property must be recognized as such and put to use. But in emphasizing the importance of knowledge-based assets, it is easy to overlook the contribution physical infrastructure can make. In the petroleum industry, adding gas fields to existing trunk pipeline routes is a recognized way of growing at minimal incremental cost. Some mining companies are similarly able to turn established infrastructure into a growth asset. By controlling the heavy-haul freight railroads and port infrastructure required for remote mines, they are able to develop other proximate deposits – that would not on their own justify construction of new infrastructure – at incremental cost. In gasoline retailing, oil companies have come to see their outlets as prime real estate upon which to build convenience stores and fast-food outlets. STAIRCASES TO GROWTH 56 THE McKINSEY QUARTERLY 1996 NUMBER 4 Established distribution networks enable their owners to piggyback new products into the market at lower cost than competitors Networks and information can similarly be a basis for growth. Established distribution networks enable their owners to piggyback new products into the market at lower cost than competitors. Hindustan Lever possesses a powerful base in the form of its distribution network into thousands of Indian villages. This has garnered the company an advantage that is particularly hard to emulate; it has better maps showing village locations and road quality than even the government mapping service. And information – databases of customers, or exclusive knowledge of markets – is increasingly used to gain advantage. Capital One, for instance, prefers to define itself as an informationbased marketing company rather than as a credit card issuer. Special relationships. Relationships are one of great growers’ most important – but least talked about – capabilities, as Li Ka Shing’s unrivalled position in China demonstrates. They may provide access to deals and financing, or bring complementary skills needed to develop an opportunity. The access that carefully cultivated relationships open up is important not only in emerging markets. Bombardier, a Canadian snowmobile maker that has become the world’s fourth-largest aircraƒt manufacturer, owes much to the strategic importance of its relationships. Building on a platform of operational excellence in other transportation manufacturing markets, Bombardier’s staircase of growth in aerospace has relied on strong strategic partnerships with other aerospace technology leaders. This network allows Bombardier to share project risk and concentrate on its own strengths as designer, assembler, and marketer. Relationships also enable companies to pool skills for the purpose of exploiting opportunities one company could not pursue alone. Village Roadshow has combined its expertise in cinema operation with Warner Brothers’ European cinema sites to accelerate both companies’ growth in Europe. At the same time, Village’s Australian knowledge and Warner’s theme park expertise have fuelled growth in Australian theme parks and resorts. A web of complementary relationships is at the heart of the growth formula pursued by SAP, the German soƒtware maker. The complexity of SAP’s products requires technical expertise at every stage of implementation. Rather than provide that itself, SAP uses partnerships – with the makers of the hardware that runs its soƒtware (IBM, Compaq, Bull, or NEC, for instance), with the vendors that sell the product and provide technical support, with the systems consultants that implement the product (Price Waterhouse, Andersen Consulting, or Ernst & Young, for example), and with the soƒtware developers that provide complementary business- or industrySTAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 57 Relationships enable companies to pool skills for the purpose of exploiting opportunities one company could not pursue alone specific functions. It is in the interests of each partner to increase SAP’s sales: widespread adoption has made SAP R3, its leading product, the worldwide standard in integrated business soƒtware. Breaking constraints by assembling new capabilities It can appear that companies like these were always more capable than their competitors. Oƒten that is not the case. Many managers setting out to grow face a gap between the abilities they have and those they need to net opportunities. By assessing their skills like a laundry list, they can only conclude that they do not have what it takes to bag the prize. But great growers shiƒt their attention from what they have to what they need, and go out and get it. Consider Bombardier. It won its position of the fourthlargest aerospace manufacturer in the world – dominating the market in smaller regional aircraƒt – by assembling and then developing the skills it needed in just ten years. It started in 1986 by acquiring Canadair. In the late 1980s, it launched improved versions of its Challenger business jet. In 1989, it bought Shorts Brothers. Shorts, the nacelle manufacturer for the Fokker 100, was a technical leader in composite materials and had underutilised manufacturing capacity. In 1992, Bombardier added 51 percent of de Havilland, another Canadian aircraƒt maker that brought with it a state-of-the-art paint shop and a marketing and salesforce with access to 60 commercial aircraƒt customers in 22 countries. When the company launched its first regional jet it was from an already established market position. Similarly, Samsung assembled the wherewithal to enter the semiconductor business from scratch. It is a story of capability building that is daring in terms of size and strategic risk. Having studied the idea’s potential in 1982, the company established an R&D centre in California the following year to collect technology information, recruit engineers, train Korean staƒf, and conduct initial product and process development. It also hired fresh, high-calibre Korean engineers from US high-tech companies. It licensed design technology from Micron Technology and process technology from Sharp, and then acquired the latest equipment, sending more than 70 engineers to the suppliers for training. Samsung also retained Japanese technical consultants and retired engineers to “moonlight” in technology transfer and troubleshooting. In 1986, the company also joined an R&D consortium with LG and Hyundai to conduct new basic research. Between 1987 and 1994, it invested more than $4 billion in facilities and another $300 million in product development. In this way the company gradually closed the gap on competitors. It was four years behind Japanese rivals in entering the 64Kb DRAM market, but it STAIRCASES TO GROWTH 58 THE McKINSEY QUARTERLY 1996 NUMBER 4 Many managers setting out to grow face a gap between the abilities they have and those they need to net opportunities STAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 59 launched its 256Mb DRAM chips in 1994 at the same time as industry leaders did. While the jury is still out on whether Samsung will earn exciting returns – it depends on your view of the industry’s cyclical character and the cost of the company’s capital – there is no debate about the remarkable speed and eƒfectiveness with which the company accumulated the skills for a worldclass semiconductor business. Not all capability assembly is so dramatic. Charles Schwab’s California pilot program in direct insurance sales, for example, combines the life insurance products of Great West Life with its own telephone sales representatives and customer relationships. If successful, the business could be extended to all Schwab customers across North America. One key to putting together skills is to combine them in bundles that are tough for competitors to copy, because if competitors can imitate them, you cannot protect the value of your businesses. At Disney it is the combination of competences (animation, financial management, and theme park operation), privileged assets (cartoon characters, brand names, and resort p
roperties), and special relationships (with promotional partners, entertainment talent, and the Florida government) that distinguish it. A company need not possess strengths in all areas of a business – just in the areas important to making money. Growers distinguish between attributesthat garner value and those that are simply necessary to play the game. Enron became a world leader in international private power generation because itsaw that profit did not depend on construction and operation skills, but on dealstructuring and risk allocation. So in the early yearsit was unimportantthatthe company was not distinguished at building and operating power stations, because instead it was good at coordinating and negotiating fuel supply contracts, electricity sales contracts, financing packages, government guarantees, and construction contracts – skills few utility competitors possessed. Operating skills, on the other hand, could be acquired through tender. Flexible evolution of a business Not all combinations of opportunity and capability lead to successful longterm staircases. In fact, the flexibility to cut short an unsuccessful series of steps is an attractive feature of the staircase approach. Consider Lend Lease, a consistently growing Australian company. Having started in construction and property development, by the early 1980s Lend Lease had developed expertise in fund management through its wholly owned property trust. In 1982, the company spotted an opportunity in the approaching deregulation of The flexibility to cut short an unsuccessful series of steps is an attractive feature of the staircase approach financial services. It began with two modest steps: it bought 25 percent of Australian Bank, the first new trading bank established in Australia for 50 years, and a minority stake in MLC, a poorly performing insurance and fund management company. The investment in Australian Bank, while profitable, proved fruitless as a step into retail financial services, and Lend Lease sold its stake in 1988. MLC was a diƒferent story. Lend Lease has built it into the fourth-largest fund manager in Australia through a staircase of profit improvements and acquisitions. Such flexibility provides one ofthe main advantages ofthe staircase approach. Overthe medium term, itis possible for companiesto transform theirrange of skills and business portfolio with limited risk. Indeed, it is a recurring theme among our sample of companies: they evolve their businesses over relatively short periods by pursuing optionstheir new skills have opened up. Many low-growth companies, in contrast, feel held back by advice to “stick to their knitting” and remain “focused.” But no one disputes the evolution of Disney’s knitting from cartoon animation into theme parks and television programming (Exhibit 5), or from theme parks into resorts, even though such STAIRCASES TO GROWTH 60 THE McKINSEY QUARTERLY 1996 NUMBER 4 Exhibit 5 Disney’s evolution Animation Character licensing Music publishing Book publishing Animated feature films Television shows Motion pictures Disney stores Direct mail Hollywood records Disneyland Walt Disney World EPCOT Software development Touchstone films, home video Hollywood pictures Miramax acquisition Disney channel K-CAL TV ABC TV network Live theater Hockey Baseball Tokyo Disneyland Disney-MGM Studios EuroDisney Animal Kingdom, Disney America Hotel development Resorts Disney Institute vacations Planned communities Cruise lines VACATIONS, RESORTS, AND PROPERTY DEVELOPMENT THEME PARKS LIVE ENTERTAINMENT BROADCASTING FILMED ENTERTAINMENT MERCHANDISING, MUSIC, AND PUBLISHING 1920 1930 1940 1950 1960 1970 1980 1990 Illustrative an evolution might seem to fly in the face of advice to focus. Moreover, Disney’s evolution shows few periods of unmanageable stretch. Many other great growers have evolved in a similar way. Hutchison Whampoa has developed from Hong Kong-based container terminals to electricity generation, retailing, and telecommunications in China, Canada, and the UK. Bombardier grew from a specialized manufacturer of snowmobiles into a world-leading maker of regional business jets and regional aircraƒt. Johnson & Johnson has extended into an extraordinary array of medical technologies. Gillette has added grooming products, small electrical appliances, and toothbrushes, and now batteries, to its core razor business. Federal Signal started in electrical signage and signals, and is now also a leading maker of specialized vehicles. Lend Lease, from its origins in construction, became a fully integrated international property company with a strong domestic financial services business. Charles Schwab has extended from discount brokerage into selling a range of financial products and services. The records of all of them suggest that truisms such as “stick to the knitting” and “focus on core competences” are prescriptions that require careful interpretation. STAIRCASES TO GROWTH THE McKINSEY QUARTERLY 1996 NUMBER 4 61
Perspectives from Kenneth W. Freeman, George Nolen, John Tyson, Kenneth D.Lewis, and Robert Greifeld How Manage Growth endas Introduction by Ranjay Gulati 124 HARVARD BUSINESS REVIEW struggles, and successes in pursuit of top-line growth. B usiNESSPEOPLE acFoss a wide range of industries have increasingly begun to identify maturation and commoditization as emerging challenges. Whether because of globalization, maturing technologies, ease of imitation, decreasing barriers to entry, open standards in technology markets, or pressures from customers who are themselves being squeezed, more and more companies are feeling the intensity of price competition, leading many to describe their businesses as commodity markets. It’s one thing if you have an inherent cost advantage, like Dell or Wai-Mart. But most companies don’t, and for them, commoditization is a deadly game. When you’re constantly scrambling to make your margins, you have to strain to think about the top line. Everyone wants to find ways to grow, but real power lies in doing so profitably-and that takes serious work. This is a theme common to the essays that follow. Five years ago, everyone talked about top-line growth; then the focus became tightening the belt; and now it’s back to growth-but this time with profitability. Executives are raising the bar on themselves, which is a good thing. To meet their goals, however, they must find ways to distinguish their offerings. The authors of these essays discuss three interrelated approaches to differentiation; innovation, deepening of customer relationships, and bundling of products and services. Innovation has long been the primary basis of advantage. Indeed, if you have a unique, first-mover product or service, you can get far ahead of the competition. Every one of the essays in this collection points to the need for innovation. John Tyson, CEO of Tyson Foods, discusses his company’s expanding line of protein products, for example, and Quest Diagnostic’s Kenneth Freeman is going as far as handing over the CEO title to a scientist who can drive the company toward invention and organic growth. Robert Greifeld, Nasdaq’s CEO, tells us that the most dramatic top-line growth opportunities come from finding new ways to make, do, or sell. TOP-LINE GROWTH JULY-AUGUST 2004 125 How CEOs Manage Growth Agendas But it’s getting harder to stand out through product innovation alone-and the advantages, when they occur, are becoming more ephemeral-so we come to the second differentiation tactic: sharpening organizational focus on customers. This approach can help a company distinguish itself in a number of ways, from creating new products or services for specific customer segments to personalizing service. A shift in emphasis from products to customers can be challenging, as it might entail fundamental changes in a company’s structure, processes, and, ultimately, culture. Nonetheless, even industries that have relied primarily on product innovation are discovering the importance of gearing their organizational processes more directly to the needs of end customers. For instance, although the pharmaceutical industry has traditionally been driven by the development of unique drugs, marketed primarily to physicians, companies such as Eli Lilly and Pfizer have begun investing heavily in consumer outreach. Becoming more customer oriented is in vogue in other industries as well. Bank of America CEO Kenneth Lewis highlights how he focused his company’s operations on quality to lift customer satisfaction scores. Freeman describes hospitals as a long-underserved customer segment; he says that Quest Diagnostics grew quickly once it started treating them as a distinct market And George Nolen, CEO of Siemens USA, explains how the needs of telecommunications clients are driving innovation. Stemming from this greater focus on consumers, the third approach to differentiation is to blend products and services, thus providing “solutions” to concrete customer needs. In some organizations, the concept of solutions is little more than a marketing ploy. Yet companies such as IBM – which has combined its hardware, software, and consulting services – have found bundling complementary offerings into a solution to be an effective way to stand out from the crowd. By providing value that is more than the sum of its parts, an integrated offering can defiect the price pressure that arises when you compete with others on product or service attributes alone. While initiatives to provide solutions are gaining popularity in a range of industries, the organizational adjustments required can be monumental. Many companies are stumped by the inability of their internal units to coordinate tasks among themselves, as well as with external suppliers, to deliver customer solutions. Nonetheless, executives see no other way to compete in commoditizing markets. Tyson hints at this in his discussion of developing value-added poultry, beef, and pork: By cooking or flavoring many of its products, the company is moving away from the commodity meat business. Ranjay Gulati (email@example.com) is the Michael Ludwig Nemmers Distinguished Professor of Strategy and Organizations at Northwestern’s Kellogg School of Management in Evanston, Illinois. For any of these differentiation vehicles-as the essays in this collection make clear-execution is critical. In many companies, unfortunately,”innovation,””customer focus,” and “solutions” are rhetorical claims lacking substance. But organizations that have moved from rhetoric to action have found that delivering on these claims can be quite a stretch. If your company is organized by product, for example, how do you reorient employees to think more broadly about customer needs? How do you train a sales force that’s accustomed to selling transactions to sell bundled products and services? Lewis talks about realigning incentives to encourage cross selling, while Tyson addresses the challenge of face-to-face interaction with the customer. Finally, it’s important to remember that growth comes in many forms and takes patience; it is episodic in nature. You may make a big jump forward through an acquisition and then grow slowly and steadily through internal innovations or alliances. The key is to be ready to act on whatever types of opportunities arise. Kenneth W. Freeman Chairman of the Board, Quest Diagnostics My education in growth began with a negative experience. More than 30 years ago, 1 worked as a financial analyst in the part of Coming that made glass for color televisions-the richest division in the company at the time. We had a tried-and-trusted strategy for boosting revenue: raising prices every year. And the division’s largest customer, RCA, threatened every year to build its own glass factory. Eventually, RCA stopped threatening and just did it In response, Corning was forced to adopt a variable pricing policy that quickly reduced its profits from strong to nonexistent. Around 20 years later, 1 had another lesson in the wrong way to grow-this time from Coming Clinical Laboratories (which, along with Coming Nichols Institute, was spun off in 1996 as a separate company. Quest Diagnostics). As the new CEO of Coming Clinical Laboratories, starting in May 1995-and later, as the CEO of Quest Diagnostics-1 was expected to tum around an organization that had grown rapidly through acquisition. It had devoured roughly 300 independent testing laboratories over a 13-year period. Immediately before my arrival on the scene, the business had done three major deals and was ramming through integration to get to “synergy” as soon as possible. At the same time, the entire industry had major compliance problems with Medicare. Business fled as our service and our reputation suffered. The government, customers, and employees vied over who disliked our company most. We were unprofitable and going nowhere fast. 126 HARVARD BUSINESS REVIEW How CEOs Manage Growth Agendas As 1 saw it, we had to eam the right to grow. So I froze acquisitions and kept them frozen for three years, from mid-1995 to mid-i998, while we c
oncentrated on building discipline into our processes. We engaged every employee in the tumaround, first establishing a set of core values and clear, consistent goals for everyone. We also created ground rules and best practices for integrating acquisitions. These guidelines were based on rigorous metrics for customer retention and employee satisfaction, as well as ambitious financial targets. Finally, we walked away from a number of our existing customers – most notably, our largest customer-because we weren’t willing to engage in the destructive cycle of price competition that was then rampant in our industry. In essence, before we could grow, we had to shrink. By 1998, Quest Diagnostics became profitable (barely) and started looking for new acquisition opportunities. We continued the old strategy of geographic expansion, which made the most sense in our industry. (Testing facilities must be reasonably close to doctors’ offices and hospitals to quickly tum around lab work.) But we moved more deliberately than we had in the past, acquiring fewer businesses and expending far more effort on those we did buy. We were assuming fewer risks while preparing culturally and organizationally to take a huge step forward. I don’t believe in big deals for their own sake. But when there is an opportunity to change an industry, you have to seize it SmithKline Beecham Clinical Laboratories (SBCL) presented such an opportunity for Quest Diagnostics. With revenues of $1.6 billion, SBCL was slightly larger than we were and far, far larger than any company we had ever pursued. Indeed, this acquisition-if consummated-would be the largest ever in the medical-testing world and would transform the industry by creating, for the first time, a clear market leader. (The industry is highly fragmented, comprising about 4,500 independent lab companies, most of which do no more than $5 million a year in revenues, as well as thousands of labs in hospitals and physicians’offices.) To get ready after our long freeze, I wanted to make sure we had the integration process down pat. As a sort of practice run, we acquired a midsize lab in Connecticut. The integration went well, so in August 1999, we acquired SBCL. Once again, I called a moratorium on acquisitions until digestion was essentially complete – that is, until employees and customers gave us positive feedback and we’d accomplished the heavy lifting inherent to the acquisition, such as consolidation of facilities and changes to information systems. The whole process took about two years. In the past, major acquisitions had routinely pushed down our revenues by io% or more. Because of our new processes and the attention we paid to each customer and employee, our organic revenue growth during the assimilation kept pace with the industry, at 4% to 5% per year. Since then, although we have continued to match – and in some years beat-the industry’s growth rates, we haven’t consistently exceeded them, which I view as a disappointment. An important reason, I think, is that while we have fine-tuned our geographic-expansion skills, we have focused too little on market segments, particularly the hospital market. Hospitals have different needs from those of physicians – by far our biggest customer segment-in part because their patients are usually so much sicker. For example, hospitals often require faster tumaround times, a more-specialized menu of tests, a higher degree of responsiveness, and answers to more-technical questions. It’s only recently that we’ve created a separate sales force for hospitals and begun dedicating labs to that segment. There’s little doubt that had we treated hospitals as a distinct market all along, we would have grown more rapidly. Since 1998, we have more than tripled our revenues, from $1.5 billion to $4.7 billion. More than half of that, $2.6 billion, came from M&A; organic growth accounted for only $0.6 billion. We still selectively acquire on the basis of geographic location, but we see enormous new opportunities to accelerate organic growth in areas like genomics and a number of esoteric tests that are currently ordered infrequently but whose use is growing quickly. Organic, of course, doesn’t necessarily mean homegrown: We are now getting many of our new product offerings from large and small companies on the outside. These relationships and joint ventures will play as important a role as R&D in our future growth. Different growth strategies require different kinds of leaders. Over the past nine years, ours was a turnaround-and then a roll up-kind of company, with process discipline and geographic expansion driving growth. In retrospect, I can say that I brought the right talents to the job of CEO. I had led a number of tumarounds, and I’d gained the financial and leadership skills I needed to execute a successful acquisition strategy, whether we sold lab tests or jellybeans. Today, Quest Diagnostics is a health care company prepared to grow organically through new offerings in medical science and technology. My succession-planning Before we could grow, we had to shrink. – Kenneth W. Freennan TOP-LINE GROWTH JULY-AUGUST 2004 127 How CEOs Manage Growth Agendas effort sought the person who could best capitalize on our rapidly evolving business model. I’ve recently passed the CEO baton to our former COO of five years, Surya Mohapatra, who holds a PhD in medical physics and has more than 25 years of experience in the health care industry, including diagnostic imaging. George Nolen President and CEO, Siemens USA Acquisitions have been an extremely important source of top-line growth for Siemens, enabling us to expand quickly into major electronics markets like the United States. When we’ve integrated those acquisitions into a solid strategic platform, they have worked well; when we’ve tried to simply buy our way into the market, they have failed. For example, back in the late 1980s, we bought a large U.S.-based distributor of telephone systems, hoping to sell products that Siemens manufactured in other parts of the world to customers in the United States. But the acquired company was a distributor, not an innovator-and the people developing the products at Siemens didn’t understand the needs of U.S. customersso we were not able to gain any traction in the market, and the business languished. We then opened a manufacturing facility in the United States and established a much better market position. Today, with 65,000 employees in North America, Siemens dedicates more than $700 million and 6,500 employees to R&D in the United States alone. The company’s net U.S. income suffered a lossof $553 million in 2001; by 2003, however, the U.S. operations earned a profit of $561 million. When you have both solid market knowledge and the right distribution channels, acquisitions are often the best way to break into a new geographic location. In the late 1990S, we spent around $8 billion on acquisitions over about four and a half years, in most cases to establish a local presence. Westinghouse Power Generation, one of the businesses we bought during that period, is shaping up as an excellent acquisition for Siemens; it positioned us in the NAFTA market just before the U.S. power boom and provided us with a premier American management team. I don’t believe you can be successful without the combination of strong local presence and talent. Acquisitions have also helped us continue to diversify, which has always been key to our success. In the late 1990s, Siemens was counseled by financial analysts and others to concentrate on telecommunications and information technology, and to get out of transportation, health care, and power generation. Other diversified companies did just that, but we didn’t. If you compare the stock progression of those other companies with ours, it’s very clear that we made the right decision. I can’t say that we knew the power boom was coming, but we have always believed that diversity in our portfolio is a strategic advantage. These days, some are suggesting that we get out of telecommunications – it’s a tough business
right now. But our customers say they still depend on us. AT&T, for example, is relying on us to build the next generation of optical networks, an initiative of strategic importance to AT&T’s future. We know there’s going to be some fallout in telecommunications, but our involvement in these next-generation networks around the globe indicates we’re well positioned in that market. Because our portfolio is diverse, we can also look across businesses to find new ways to apply existing technologies. For example, sensor technology that we developed for the automotive industry can also be used in security and health care. And medical imaging has proved to be quite relevant to homeland security. In 2003, the Transportation Security Administration awarded Siemens and Boeing a $1.37 billion joint contract to install and service bomb detection devices for scanning checked baggage in all U.S. commercial airports. We got the work because of our expertise in airport logistics, building security, baggage handling, and X-ray imaging. We were then able to use our knowledge of airports to develop other products When you have both solid market knowledge and the right distribution channels, acquisitions are often the best way to break into a new geographic location. -George Nolen 128 HARVARD BUSINESS REVIEW How CEOs Manage Growth Agendas and services – information technology, building controls, fire protection, and so forth. Our success in acquisitions can be attributed in part to our close customer relationships. In April 2004, for instance, Siemens bought DaimlerChrysler’s automotive electronics business in Huntsville, Alabama, which immediately boosted our revenue by $1 billion. In addition, the acquisition has expanded our product offerings, enabling us to increase our business with existing customers. DaimlerChrysler’s executives didn’t want to sell the business to just anyone. They approached us because their company has had a long relationship with Siemens. Furthermore, since most advancements in automotive technology will eventually be derived from electronics, DaimlerChrysler’s managers wanted to get the innovation and quality that Siemens could provide. Of all the factors driving successful growth-a strategic platform, market knowledge, good distribution, a diverse product portfolio, customer relationships-the one that’s most critical to success in a mature industry is a progressive attitude toward inventiveness. Companies must consistently find new, more-effective, and creative ways to help both existing and potential customers be more competitive. Whether it’s through strategic acquisitions, internal research and development, venture capital investments, or partnerships, business leaders need to see beyond the current way of operating and quickly adapt to fiuid market situations. It may be easier to generate that level of change in younger companies operating in growth industries. Nonetheless, for the veterans, nothing can replace the unrelenting pursuit of meaningful innovation. John Tyson CEO,Tyson Foods As businesspeople, we need to accept that top-line growth is a challenge and that it doesn’t happen in a linear, constant way. You might grow one quarter, plateau the next, and then maybe shrink as you prune the business so you’re ready to grow again. Tyson is a company that has grown through acquisitions and the dedication of its many team members. We’ve done 30-plus deals since the mid-1960s – most prominently, the merger with IBP several years ago that virtually doubled our size and brought us into the beef and pork businesses. Integrating the companies was more straightforward than you might think, because everyone wanted to move away from providing commodity meats and toward creating value-added products. Tbe common goal, in other words, was to enhance the meats – to cook tbem, slice them, or add sauces or flavors, for instance – before selling them. That’s going to be a major source of growth for us in the coming years. If you can sell a pound of protein for a dollar instead of 50 cents because you’ve added convenience or value, you get both top- and bottomline growth. My father used to say, “Don’t do more protein; do more to the protein you have.” At the time of the merger, the old Tyson had been making a shift toward value-added poultry products for maybe ten or 15 years. And over the previous couple of years, IBP had acquired 14 companies that specialized in value-added products. Since those organizations hadn’t been integrated into IBP yet,there was really a three-way merger among IBP, its 14 acquisitions, and the old Tyson. All three contributed insights into how to run operations, and we were able to spread and blend that knowledge throughout the newly combined organization. And we If we can bread or batter chicken, what’s to say we can’t bread or batter pork and beef? -John Tyson had a common foundation: an agriculture-based, operations-focused culture in the business of managing and processing animal products. M&A doesn’t always go so well. In tbe 1990s, we tried to get into the fish business, but that’s different from producing poultry, beef, and pork. We thought regulators might quickly move to quotas based on catch history, but it took tbem much longer to do so than we’d anticipated. If everyone’s competing for the same loo tons offish, there are incentives to send boats into rough water and put your fishermen into other dangerous situations, and all of this makes operations difficult. We tried for three or four years and then sold the fish business. But most of our acquisitions have been successful because of my predecessors’ ability to anticipate trends, like tbe demand for food away from home. Currently, we see our next opportunities for top-line growth coming from three key categories – food service, retail, and international markets. In food service and retail, our growth will be largely organic in the near future, and a lot of the work will be TOP-LINE GROWTH JULY-AUGUST 2004 129 How CEOs Manage Growth Agendas in tactical execution-on the street, face-to-face, one customer at a time. We need to figure out how to get a poultry consumer to buy beef and pork, and how to extend our existing capabilities. If we can bread or batter chicken, what’s to say we can’t bread or batter pork and beef? In the IBP acquisition, we got beef and pork luncheon meats, so we’li find ways to add chicken and turkey to that iine. We’re also dealing with the fact that there are so many different places where people can feed themselves and their families. They can get food just about anywhere – at the ballpark, from a street vendor, or from a machine, for instance. We need to come up with products that fit these delivery systems. In other words, we need to make sure our foods are in front of people any time they decide they’re hungry. Wherever you look, you can see a snack or beverage. Can you see a protein product? Probably not-at least not now. Since Tyson’s international operations aren’t yet fully developed, our international growth will mostly come from a combination of joint ventures and acquisitions. One way we can enhance our capabilities with local knowledge in various places outside the United States is to get involved in animal production, working with countries (such as Brazil, China, and Russia) that have the large-scale agricultural capacity to yield grain for feed. Another possible approach follows a marketing model: We can get in at the back end of the production system, buying raw material that’s already processed-the cuts we need in order to make value-added products. The strategy we choose will depend to some extent on agricultural trade policy. Whether a company is growing organically or through acquisition, three factors are critical to its success. The first is a knack for anticipating trends, as I have mentioned. The second is the ability to act and react quickly. If you get a call from somebody who’s ready to sell, you need to be able to move fast – within a week – if you’re interested. Otherwise, it’ll be too late; you’
ll miss out on the deal. (I’ve seen this happen many times.) If you’re not interested, you should tell the seller right away, so you don’t damage the relationship. And that brings us to the third factor: connections with others in the industry. Protein is still largely a family business, and there’s not a lot of turnover; you see the same people, spanning several generations, when you go to industry and trade shows year after year. If you make a practice of establishing and maintaining solid relationships, you’ll have early access to important news-for instance, that a company might soon be for sale-and therefore to critical opportunities. Kenneth D. Lewis CEO, Bank of America Bank of America has been in the news lately as a result of its acquiring FleetBoston Financial. After roughly two decades of growth through acquisitions made by my predecessor, Hugh McColi, we have spent the past five years emphasizing organic growth. The Fleet deal, however, has prompted a lot of questions about whether we’re changing our strategy. Believe it or not, I really don’t see this as a departure. Our decision to focus on organic growth has paid offwe grew more than 10% last year, in a time when it wasn’t easy to get revenue. As of early 2001, we were basically running even on net new customer accounts. We’re now on pace to gain more than two million of them this year, not including new accounts that came with the merger. And we continue to grow our core business; we’ll be building about 500 new branches in the next three to four years. That’s a long term investment in top-line growth, because it takes about 18 months to realize gains from a new branch. But the reality is, at some point you have to be opportunistic. Why Fleet, and why now? It was available. We looked at it as you might look at the last piece of attractive beachfront property. There’s The merger was a classic example of spreading ourselves too thin.The resulting glitches in systems and processes caused significant customer dissatisfaction. -Kenneth D. Lewis 130 HARVARD BUSINESS REVIEW How CEOs Manage Growth Agendas a tremendous base of wealth in New England, and acquiring Fleet will broaden our opportunity to achieve longterm organic growth. Furthermore, Bank of America’s focus on holistic customer relationships will help us connect with many of Fleet’s customers; we can recommend financial solutions that fit their needs. In integrating the companies, we’ll apply lessons from past mergers. We learned a lot when we merged with Barnett Banks in 1998, back when we were NationsBank.The major problem we had in that merger was that we tried to do too much at once. Both hanks had branches in Florida, so we got rid of the overlap by closing about 200 branches. At the same time, we were installing a new transaction-processing system and rebranding the remaining branches. We did all the work very quickly, much of it over a single weekend. That was in October 1998; on September 30,1998, NationsBank and the old Bank of America had merged, later to become the new Bank of America. In hindsight, it was a classic example of spreading ourselves too thin. The resulting glitches in systems and processes caused significant customer dissatisfaction and runoff. We also made some miscalculations in our branch closings. Our business models indicated that people would go to the bank that was closest to them and most convenient, but many customers ended up driving right past a new NationsBank branch, looking for a Barnett branch because they were familiar with the brand. Ultimately, the merger put us where we are today in terms of understanding customer needs, so I’m glad we did it. But the integration process took a toll on our brand, our customer loyalty, our financial results, and our associates. With Fleet, the degree of difficulty is lower because we’ve learned from past experience and there’s no branch overlap. However, we want to avoid focusing the whole company on this integration. A key message we’ve been trying to convey is this: If you’re not involved in the merger, don’t get involved. We won’t succeed if the other 75% of tbe company doesn’t continue witb business as usual, A commercial-banking executive in the Midwest doesn’t need to come to New England to work on the Fleet merger; he or she needs to focus on making plan. I’ll be doing both, though I expect that my participation in tbe merger will he much heavier early on and will lessen as more people emerge as leaders in their segments. When we announced our intention to focus on organic growth, five years ago, we knew we’d have to concentrate on three aspects of how we run the company: placing the right people in the right roles, matching our operations to our rhetoric, and emphasizing quality and productivity in every part of the business. These continue to be our top priorities as we move forward with the Fleet merger. When it comes to people placement, the primary concern is whether you have the right staff for the business you want to pursue. Because Fleet outsourced its home loans, walk-in customers inquiring about mortgages had to call a toll-free number for assistance. We’re filling the gap in service by assigning mortgage brokers to each of the old Fleet branches. As for matching rhetoric to operations, we’ve improved the connection between strategy and incentives. A few years ago, when we began asking our branch managers to hand off qualified customers to our premier and private bank segments, we didn’t offer adequate rewards for compliance. Why would associates turn over their best customers, even for the good of the entire company, if doing so ran counter to their own incentives? We had to provide a financial rationale for branch managers to share those names. And finally, our focus on quality and productivity is aimed at reducing errors – which is critical to retaining customers and staying profitable. Only customers who give us high satisfaction scores-nines and tens on a oneto-ten scale-are likely to stay with us, buy more products, and recommend our services to other people. To make our processes more efficient, all of our managers have completed individual Green Belt projects. (Green Belt is a certification level in the Six Sigma discipline.) We now bave hundreds of process improvement projects in the works at any given time. Since 2001, our payments error rate has gone down 22%, and we have increased payment speed tenfold in the same time frame. And since eariy 2003, we have reduced our deposit error rate hy 83% and increased customer delight-those nine and ten scoresfrom a baseline of 41% to almost 52%. All of these improvements have contributed to the addition of more than 2.5 million customers during this period. I expect that our future long-term growth will continue to be largely organic, but we might occasionally complement it with strategic fiil-in acquisitions. Companies can always grow the top line by improving relationships with old customers and attracting new ones, hut it’s necessary to keep sustainability in mind. Our goal at Bank of America is to balance short-term and long-term strategies and tactics. 1 believe that our willingness and ability to take advantage of an opportunity like acquiring Fleet, as well as our commitment to organic growth in all our businesses, will serve us well in the foreseeable future. Robert Greifeld President and CEO, the Nasdaq Stock Market Companies seeking nonlinear top-line growth must innovate. That lesson has been reinforced repeatedly throughout my career. In the early 1990s at Automated Securities Clearance, when I was CEO there, we were the first company on the market with an electronic order management system for Nasdaq stocks. Our product was unique rOP-LINE GROWrH JULY-AUGUST 2004 131 How CEOs Manage Growth Agendas and provided considerable added value; as a result, we could extract an innovator’s profit margin. We also created one of the first electronic communications networks (ECNs), the Brass Utility – a precursor to the Brut ECN, which is still a vigorous competitor in the transactions business. Today I am l
earning the value of innovation again, only this time my instructors are Nasdaq’s listed companies. Those with the most dramatic top-line growth are, almost without exception, the businesses that have discovered a new way to make, do, or sell something. Innovation creates first movers who reap first-mover profit margins. It shakes up competitive stasis and propels even mature businesses forward, and it is mercifully novation leaders. We have gleaned a number of practices from our listed companies. From Terry Semel at Yahoo, we’ve learned to use teams to generate and then rigorously review new ideas. From H.K. Desai of QLogic, we’ve adopted the tactic of staging town hall meetings at every company location after every earnings call. Other changes include putting an electronic suggestion box on our intranet, holding regular meetings with all our vice presidents in which each presents a new idea for discussion, and engaging in a very detailed form of analysis that measures the profitability of each of our products. Our renewed emphasis on innovation has produced two offerings that we think will boost our top line. First, Today I am learning the value of innovation again, only this time my instructors are Nasdaq’s listed companies. -Robert Greifeld tolerant of mistakes. For companies focused on organic growth, failure – in reasonable proportion to success – is a sign of health. Mergers and acquisitions, by contrast, must be implemented meticulously, according to an exhaustive plan. M&A is a poor growth strategy for companies harboring even the slightest doubt about their ability to execute. So innovation, not surprisingly, is the incendiary we are using to ignite growth at Nasdaq itself. A key target for such change is the transaction part of the stock market business, an area that is approaching commoditization. Competition is tough, not only brandwise from the New York Stock Exchange, but also technologically from the ECNs. The past few years have been difficult for us, as they have been for many businesses; we are aggressively competing for market share in an environment that has seen declines in trading volume relative to historic highs, coupled with price compression. As a stock market, we face certain industry-specific challenges. For instance, we must work within stricter parameters than other organizations. Our corporate charter compels us to put the interests of investors above our own profit, which often means we can’t implement innovation as quickly as we’d like. But what’s good for investors is good for our market and, ultimately, for our business. We also, however, have advantages that other types of organizations don’t, including access to thousands of inwe’ve expanded our listings business. Traditionally, companies have chosen between Nasdaq and the NYSE. ln January, though, we introduced a dual-listing service, and since then, seven companies representing more than $157 billion in market capitalization have elected to list on both exchanges. Second, to compete aggressively with NYSE and others, we are putting in place a new sales team to win exclusive listings. In addition, we have developed the Closing Cross, a new type oforder facility that will provide investors with more transparency and price discovery at the market close at 4:00 PM. The Closing Cross brings together buy and sell interests in specific stocks and executes all shares for each stock at a single price, one that refiects the true supply and demand for Nasdaq securities. An increase in transparency and accuracy gives the industry greater certainty in pricing major transactions, as well as making it possible to more accurately set net asset values for mutual funds. And it fuels our business growth by providing revenue on both sides of the transaction at the close. Nasdaq has one of the most recognizable indexes in the world, yet our stock market business and our index are not the same thing. We must make sure that our business mirrors the businesses listed on our market. In other words, we can never stop innovating. 9 Reprint R0407K To order, see page 191. 132 HARVARD BUSINESS REVIEW Harvard Business Review Notice of Use Restrictions, May 2009 Harvard Business Review and Harvard Business Publishing Newsletter content on EBSCOhost is licensed for the private individual use of authorized EBSCOhost users. It is not intended for use as assigned course material in academic institutions nor as corporate learning or training materials in businesses. 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