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| Home - Industry Article - Dec 05 Issue |
The End of the Growth Run: What's a CEO to Do... |
By Jim Mackey, Director of Development, and Liisa Välikangas, Managing Director and Research Director, Woodside Institute
There are limits to corporate growth, which most CEOs will deny. Partly to blame are unrealistic investor expectations: when a company stalls, its market cap falls by 60%. Yet the liability of corporate size is an obvious numerical challenge. For Hewlett-Packard for example, whose 2002 merger with Compaq propelled it to $73 billion in revenue, sustaining the exceptional 17% annual growth rate it achieved over the prior 40 years, would have required adding $12 billion in revenue in '04 and $14 billion in revenue in '05 to put it over $100B today. Actual growth was only half this level slightly outpacing GDP to reach $87B in 2004.
Is this a failure? Historical evidence suggests it may be unavoidable. A study by Corporate Strategy Board found that of all Fortune 50 companies from 1954 to 1995, only 5% (including HP) were able to sustain a growth rate above GDP, and over half of these have stalled since the study. Once stalled, no U.S. company larger than $15 billion has been able to restart sustained double digit internal growth. Yet CEOs spend billions in the quest. Take Kodak (Fortune #18 in 1991 - #153 today), which invested in pharmaceuticals, copiers, batteries, disks, and is now investing $3 billion digital imaging. The result, today's revenues are 33% less than 1992. The odds that Kodak can reignite growth are not judged good: S&P has cut the company's debt rating deeper into junk status to BB- and said it may cut them again. Xerox (Fortune #21 in 1989 - #132 today) pursued entries into insurance, investment banking, publishing, software, and outsourcing services yet sales are below their 1988 level and still primarily from large copiers. IBM (Fortune #4 in 1986 - #10 today) has spent $100 billion on R&D since 1985, yet grown at an average of only 3.5% annually.
So what's a CEO at the end of a growth run to do? Many resort to big acquisitions, which distract from slowing internal growth but generally destroy more value than they create. However there are better strategies to explore including breakup, value transition, and management innovation.
Breakup
Breakups include AT&T's Baby Bells, Sears" Allstate, Pepsi's Yum Brands, GM's Delco, 3M's Imation, HP's Agilent, and Merck's Medco. J.P. Morgan discovered - consistent with corporate size being a liability - that such spin offs generally enhance stockholder value both at the time of the announcement and in the subsequent 18 months by about 20%. Smaller breakups also enhance performance, and the parent often does materially better than the market following separation.
Transition from Growth to Value
Reducing investments to grow earnings can help a company make a graceful transition from a high P/E growth stock to a moderate P/E value stock. Market cap may decline from unrealistic expectations, but this strategy avoids the dramatic post-stall crash or near bankruptcy that occurs when a former growth company suddenly delivers neither growth nor profit. Despite slow growth, Coca Cola and Gillette (now acquired by P&G) for example have maintained a healthy stock price partly because they pay half of their earnings as dividends and buy back stock. Other specific value-oriented tactics may include stabilizing earnings, strengthening the balance sheet and reducing R&D. IBM survived its growth stall eventually making this transition although it took the better part of a decade. (Gerstner cut IBM's R&D spending by 1/3 in 1992-93.) Microsoft's recent decision to begin paying dividends seems to recognize the need for an eventual growth-to-value transition.
Organizational Innovation
Just as in the early 1900s the divisional organization extended management capability beyond that of the functional organization, innovation around an even more decentralized organization might enable the next growth leap. Such new organizational forms may include internal markets for ideas and talent (such as Oticon's "spaghetti organization", Whole Foods" autonomous store teams, or Shell's GameChangertm innovation program). While there are no guarantees, history suggests structural innovation around new corporate forms may yet offer breakthroughs in managing the complexities of very large enterprises without a growth handicap. The open source operating system Linux, for example was developed by 120,000 volunteer engineers without any management of the kind most CEOs would recognize. eBay brings together 250,000 on-line stores, selling $34B of merchandise yet caries no inventory. Visa's integrated business system reached 3 trillion in transaction volume but is owned by over 21,000 member banks battling for customers. Lessons from these organizational innovations are mostly yet unexploited, offering pioneers a chance to gain potential breakthrough advantage much like Toyota has done with its lean manufacturing model, empowering every employee to address production problems in real-time.
Over the last 50 years the membership of the Fortune 50 has changed, but their combined revenues have always been about 30% of GDP. GDP tracks the economy's nominal growth rate averaging about 7% per year. Despite this past performance by the largest (and thus most successful) companies in history, it seems each high growth company in the Fortune 50 believes it can and should sustain double-digit growth without limit. Perhaps the CEO and board ought to reconsider the billions poured into mega-growth bets and R&D for product innovation. Might it be better to experiment in organizational innovation, to discover a potential breakthrough which overcomes the liability of corporate size and enables otherwise improbable growth?
Dr. Liisa Valikangas is Managing Director and Research Director of the Woodside Institute-a non-profit professional research organization dedicated to advancing innovative management practice and organizational resiliency in organizations of public interest. Her research on innovation, strategy and organizing has resulted in a number of high-profile publications (including articles in Harvard Business Review and MIT Sloan Management Review) and presented to various academic and executive audiences. For article feedback, she can be contacted at: lvalikangas@woodsideinstitute.org
Jim Mackey is director of development at the Woodside Institute. He is responsible for leading research into resilience, growth, and business creation and supporting management experiments to develop a networked laboratory for management innovation. Previously, Jim was managing director of the Billion Dollar Growth Network, a consortium of corporations, institutions, and experts exploring the challenge of growth in the Fortune 100. At Hewlett-Packard, Jim was manager of corporate strategy and planning, leading executive projects in growth and business creation. For article feedback, he can be contacted at: jmackey@woodsideinstitute.org
 
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