I've spent the last bit going through an old issue of the McKinsey Quarterly hence my second post on an article from them. This article is titled "The Granularity of Growth" and is authored by Mehrdad Baghai, Sven Smit and S. Patrick Viguerie and is in their issue #2 in 2007.
Unlike my prior post on the McKinsey M&A article which contradicted itself, this one has an underlying premise/approach which is sound and actually quite useful. Unfortunately, the results are completely unbelievable and 100% contrary to our own very similar research.
First, let's discuss the portion that makes some sense - the methodology. Revenue is disaggregated into its three components: revenue from market growth in segments in which it competes, revenue gained through M&A and the revenue gained/lost through market share gain or loss which is effectively organic growth. So breaking up revenue into its components makes total and complete sense. Companies spend a ton of effort understanding expenses but the revenue side is often not as carefully studied or broken down. Their methodology is fairly sound, but I'd recommend breaking up the organic component into revenue attrition (customers who leave or who are asked to leave the franchise) and organic revenue growth (for example, revenue from new customers to the organization or gained through deepening relationships with existing customers).
I actually utilize this method in my recent article in Business Finance Magazine entitled "The Care and Feeding of Plus-Sized Portfolios." (To see a .pdf of the article as it appeared in the magazine, click the following link to download the article. Download business_finance_magazine_article_anand_sanwal_corporate_portfolio_management.pdf)
With a sound methodology in place, the authors disaggregate revenue to deliver their findings as follows:
- "A company's growth is largely driven by market growth in the industry segments where it competes and by the revenues it gains through mergers & acquisitions"
- "These two elements explain nearly 80% of the growth differences among the companies we studied."
- "Whether a company gains or loses market share - the third element of corporate growth - explains only 20% of the difference."
They conclude that "executives ought to complement the traditional focus on execution and market share with more attention to where a company is - and should be - competing." They in the sentences prior also comment that "although good execution is essential for defending market share in fiercely contested markets and thus for capitalizing on the corporate portfolio's full-market-growth potential, it is usually not the key differentiator between companies that are growing quickly and those that are growing too slowly."
Here is where I disagree quite vehemently. First and foremost, the hint that execution maybe less important strikes is a half-baked idea. Also, from an analytical, data-driven perspective, we've completed a similar study which found that companies that control attrition and grow organically (both functions of resource allocation and the management of the corporate portfolio) actually outperform their peers on a shareholder returns basis. Our findings reveal that not all dollars of top line growth are created equal and that in fact, the market favors a dollar of organic growth more than one from M&A. Part of the discount for M&A revenue maybe that it is risky. Look at the history of M&A deals and it is obvious they are inherently and highly uncertain.
What about the market growth piece you might ask? As I speak about in the aforementiond article, "Market growth in the near term is really not under an organization's control. If you happen to be in an industry growing at double-digit rates, good for you. Conversely, if you are in an industry that is growing at a slow rate or even shrinking, too bad. The short of it in either case is that there is not much you can do in the immediate term to juice market growth."
The short of it is that portfolio repositioning strategies are sexy as is M&A, but both are uncertain, costly and time-consuming. To deliver better returns, the component of growth most under an organization's control is what should be optimized and that is organic growth. Furthermore, the organic growth can come from a variety of sources including from existing customers as well as the creation of new services & products through innovation. It is likely that these are more controllable and hence the value per unit of risk that is possible is higher. Companies like AmEx and P&G have realized this and continue to be rewarded by the market for this.
Execution matters the most and drives the most important lever of revenue growth - organic. M&A is a miserable way to grow revenue and portfolio positioning, while important takes time and is not something that can be changed quickly. Additionally, positioning your portfolio in higher growth segments also means you will compete with others head on who've also realized the growth in this segment.
