Growth Granularity 3228077417
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CONFIDENTIAL
Grow or Die? Why growth is essential to companies and how toachieve it
Lecture to the “Strategy and Strategic Analysis” class
Brussels, November 23, 2012
This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organisation without prior written approval fromMcKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.
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1
Why growth is important?
“Growth itself contains thegerm of happiness ”
- Pearl S. Buck
“ All growth is a leap in the dark, aspontaneous, unpremeditated actwithout benefit of experience ”
- Henry Miller
“I did not have implants, I just
had a growth spurt ” - Britney Spears
“ All growth depends upon activity. There is nodevelopment physically or intellectually without effort,and effort means work ”
- Calvin Coolidge
“The growth and development ofpeople is the highest calling ofleadership ”
- Harvey S. Firestone
“He who moves not forward,goes backward ”
- Goethe
“Intellectual growth shouldcommence at birth and ceaseonly at death ”
- Albert Einstein
“Without continual growth andprogress, such words asimprovement, achievement, andsuccess have no meaning ”
- Benjamin Franklin
“Ever since I was achild I have had thisinstinctive urge forexpansion and growth. ”
- Bruce Lee
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Why and How to Grow?
Performance3
Risks4
Value creationGrowth and Value 1
2Survival
2
Limit5
Architecture6
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Where should you invest?
High starting ROIC
Low starting ROIC
Improve ROIC Growaggressively
Strategy
1
We are in 1996 and you have just received USD 200,000 to invest in four types ofcompanies (minimum 2 types of companies – USD 100,000 in each):• Companies with low Return on Invested Capital (ROIC<6%) having as strategy either
to grow or to improve margins• Companies with high ROIC (>20%) having as strategy either to grow or to improve
margins
As you want to maximize the return on your investment in 2006, what should you havedone? (where do you place your money in the matrix)
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By choosing the right strategies, you would have generated USD310,000 more than with the other oneUSD1
Highstarting
ROIC
Low
startingROIC
Improve ROIC Grow aggressively
Stra tegy
180,000 340,000
160,000310,000
+160,000
+150,000
1
Main reason is that growth
creates value as long asROIC > WACC or Value =(ROIC-WACC)/g
1: Total return for Shareholder in 2006 of USD 100,000 invested in 1996 in each strategy
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HigherTRS exhibited in high
growth companies
Growth is essential to value creationPercentage of US top 100 companies
Total Return to Shareholders (TRS) 1984-2004
Annual, percent
11
14
+28%
Below GDPgrowth ’84 -’941 (59)
Above GDPgrowth ’84 -’941 (35)
1
1: US gross output growth ’84 -’94: 5.5% CAGR 2: I.e. failed to survive independently due to bankruptcy or M&ASource: Global Vantage, Datastream, McKinsey analysis
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Why and How to Grow?
Performance3
Risks4
Value creation11
Limit5
Architecture6
Survival2 Grow o r Go
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Grow or go matrix: a 20 year view of large company growthFirst decade performance distribution 1984-1994, 100 Largest US Companies
High
Low
Revenue
Low High
TRS
S&P 500
GDP
Unrewarded Growth giants
Challenged TRS performers
11 29
3327
2
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How many “Growth Giants” survived in the 90s and how manyremained “Growth Giants”? Largest U.S. companies, 1984
EXIT
TRS grow th
Low High
R e v e n u e g r o w t
h
“Growth Giants”
“Challenged”
“Unrewarded”
“TRS Performers” GDP
S&P 500
2
Low
High
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How many “ TRS Performers” survived in the 90s and how manydid still beat the S&P 500?Largest U.S. companies, 1984
EXIT
2
TRS grow th
Low High
R e v e n u e g r o w
t h
Low
High “Growth Giants”
“Challenged”
“Unrewarded”
“TRS Performers”
S&P 500
GDP
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Death rates 2 6x higher in low
growth companies
Growth is essential to survivalPercentage of US top 100 companies
Survival rate in 2004
Percent
63
94
+50%
Below GDPgrowth ’84 -’941 (59)
Above GDPgrowth ’84 -’941 (35)
2
1: US gross output growth ’84 -’94: 5.5% CAGR 2: I.e. failed to survive independently due to bankruptcy or M&ASource: Global Vantage, Datastream, McKinsey analysis
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Why and How to Grow?
Performance
Risks4
Value creation
To Move or Not To Mov e
1
2Survival
2
Limit5
Architecture6
3
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12Source: McKinsey Granularity of Growth
Intro question: What are the key sources of growth for alarge company and how does that compare with GDPgrowth?
Growthcylinders
Total revenuegrowth
The revenue growth your companyachieves through growth of the segmentsin your portfolio
Portfoliomomentum
Growth achieved through gainingor losing share from competitorsShare gain
Net revenue growth achieved whenmaking acquisitions or divestmentsM&A
3
Description
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On average, large companies do not grow by gaining shareRevenue CAGR breakdown (average), Percent, 1999 –2005 1
0.4
3.1
6.6
10.1
3
Growth
cylinders
Total revenuegrowth
Portfoliomomentum
Share gain
M&A
Large company average
To becompared
with 3.9%GDP growth
1: 416 fully decomposed companiesSource: McKinsey Large Company Growth Decomposition Database
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14
21
33
46
It’s about “where to compete”: Holding or Acquiringthe right cards 4x as important as playing your hand wellPercent M&A
Portfolio momentumShare gain
Overall sample 1 … … and by sector
3
37 40 22
Retail and wholesale 2943 31 26
High Tech 3848 16
Healthcare 3247 37 16
Telecom 3253 29 18
Financial Institutions 5146 32 21
Consumer Goods 72
36
Media & Entertainment 2432 56 11
EPNG 2843 43 14
1: 416 fully decomposed companiesSource: McKinsey Large Company Growth Decomposition Database
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Decision on “where to compete” should be taken at granular level
Less granular(“Coarse -grained”)
More granular(“Fine-grained”)
3
GRANULARITY
• Not commonly used in business yet … but widely used in scientific andengineering circles
• Refers to the size of the components of a larger system
• Cuts through the tyranny of the “averaged view”
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Markets and companies are granular
35
18
12
8776555544443332
-1-2
Δ =37%
UTSFEDCB A RQPONMLKJIHG
Telecommunication companies
2
-5
-3
3
5
8
9
Product 2 12
Product 1 32
Product 3
Product 4
Δ=46%
Product 10 -14
Product 9
Product 8
Product 7
Product 6
Product 5
3
Market momentum of Telecom industryCAGR 1999-2005, Percent
Momentum spread within onecompany’s portfolio
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Why and How to Grow?
Performance
Risks4
Value creation1
2Survival
2
Limit5
Architecture6
3
Beware of th e leverage mirage
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Growth (or decline) leverage
As in• Debt leverage• Backward integration• Use of "invariable" labor• …
Break-even point
Profits
Revenues
Costs
Volumes
∆ Profits > > ∆ Revenues
Watch thetrue risk
EXAMPLE4
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Assessing "good" growth
From To
Only margin (growth) matters • Margin and capital growth4
Positive sales leverage • Positive and negative salesleverage
1
Building fixed costs • Flexibilizing down fixed costs3
Volume and price increases • Favorable and unfavorableprice/volume correlations
2
Business as going concern • Continuity and disruptive thinking5
4
Wh d H G ?
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Why and How to Grow?
Performance
3
Risks4
Value creation1
Culture and Susta inabi l i ty
1
2Survival
2
Limit5
Architecture6
C l d i h ( li i i )
5
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Culture drives growth (or limits it)
Time withcustomers
Generationof leads andsales
Time onadmini-strativeprocess andcreditapplications
Bankerspreferadministrati-ve tasks toselling
Admini-strativetasks inmostbankers’comfortzone
Lesspressurewhen doing“visible”admini-
strative andcredit tasks
Most
bankershaveintrovertperso-nalities
Mostbankers areless skilledat sales
Managersact assupervisorsrather thancoaches
Managerspayattention to“paper trail”
Ability toacquirenewcustomers
Performance initiation Causes of performance limitationCulturalcauses
▪Disconnect
betweenbankers’identity astechnical/productexperts andthe selling
▪Sense thatone cannot beboth atechnician anda salesperson
Time withcustomers
▪Developmentinvolvesmasteringtechnicalprocesses, notcoaching oninteraction
quality▪Managementby defined andsupervisedactivities (vs.results)cascades intoan absence oftrust andempowerment
Why aren’t
bankers spendingmore face timewith customers?
Why so much timedoing credit andadministration?
Wh y too littletime coaching?
Why customer-facing timeuncomfortable?
EXAMPLE
21
5
I i t i k lt B St ll SIMPLIFIED5
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Inappropriate risk culture - Bear Stearns collapse
Case summary• Consolidation of power in a core leadership team led to a lack of internal challenge and fostered
overconfidence in the organisation, leading to its eventual collapse
SIMPLIFIED
• Subprime exposure,large writedowns in‘07, sale to JPMorgan3/08 at $10/share(from $172 in Jan ’07)
• Crisis precipitated bycollapse of twosubprime hedgefunds, requiring$3.2bn bailout by Bear
• Several class action
suits launched byinvestors ongoing, twohedge fund managersin jail awaiting trial
• Close-knit seniormanagement in placefor years, 3-4 peopleeffectively ran bank
• Strong belief in bank,‘us vs. the Street’renegade culture
• Didn't understandrisks in super-seniortranches of CDOs
• ‘Sharp practice’created enemies whoabandoned Bear ascollapse began
NoChallenge
Fear of
bad news
Over-confi-dence
PoorCom-
muni-cation
UnclearTolerance
Beat the system
Gaming
Indif-feren-ce
SlowResponse
Respon-siveness
RespectTranspa-rency
Acknow-ledge-ment
Lack ofinsight
Ignorance&
Disregardfor Risk
Primary factorSecondary factor
5
Retail banking branch network expansion5
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Retail banking branch network expansion
Low
Pr imary cus tomermarket share by
mic romarke tNumber of branches/ € economic activity
Branch sh areNumber of bank’s branches/total branches
High
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.0 0.1 0.2 0.3 0.4 0.5
5
Source: McKinsey analysis 23
Companies do have a natural limit to how fast they can NON EXHAUSTIVE
5
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Companies do have a natural limit to how fast they cangrow
Environment and company specific characteristics :
NON EXHAUSTIVE5
• Historical/embedded cultural elements of the institutionthat prevent/limit growth
• Increasing risks you face / need to take to grow faster(e.g., Insurance, banking) – “Things you don’t know thatyou don’t know”
• Price elasticity in specific markets
• Investments required (long lead time in capitalintensive industries)
• Ability to manage large-scale or multiple smaller scaleacquisitions
• Development of talent and resources – the "learningpyramid" in service industry
• Ability to generate cash-flows – the "EBITDA trap"
24
Why and How to Grow?
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Why and How to Grow?
Performance3
Risks4
Value creation1
Granular i ty and scale
1
2Survival
2
Limit5
Architecture6
Applying the ideas of granular growth at scale to organizational6
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Applying the ideas of granular growth at scale to organizationalwork
6
First set the direction and the pace at which the company wants togrow
Clearly identify what success is and implement ways to track it
Develop a plan across multiple time horizon – see next page
Implement an organizational model that supports growth
Attract the different talents that are required to drive growth
I
II
III
IV
V
26
The Growth map TM maps the strategic direction and ILLUSTRATIVE6
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The Growth map maps the strategic direction anddetermines the actions and capabilities required for success
Share gain
Portfoliomomentum
M&A
Commercial and
operationalexcellence
Refresh valueproposition
Disrupt businessmodel
Shift resources White spacesNew markets
Fill-in acquisitionsand divest
Bolt on M&A Learningacquisitions
Horizon 1Extend and defendcore businesses
Horizon 2
Build emergingbusinesses
Horizon 3Create viable
options
ILLUSTRATIVE
• Profit• ROIC
• Business
maintainers
• Revenue• NPV
• Business
builders
• Option value
• Champions and
visionaries
Metrics
Talent
Source: McKinsey analysis
6
27
Growth Remains an Art: More than one way to move6
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Growth Remains an Art: More than one way to move
Beginning"Virgin Tour"
VogueEvita
Pensive/PopRetro
"Sex"Childrenbooks
Var-ious
Evita
Author
Model
Actress
Designer
Musician
RollingStones (old)
Some solos
Rolling Stones(reunified)
A few smallroles
Actor
Musician
6
Growth staircase – Mick Jagger Growth staircase - Madonna
Source: Wikipedia, Rob Verhoest photos, Morrisonhotelgallery.com, McKinsey 28
Wrap up
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Wrap up
Value creationGrowth and Value 1
Survival2 Grow o r Go
Performance
To Move or Not To Mo ve
RisksBeware of th e leverage mirage4
LimitCulture and Susta inabi l i ty
ArchitectureGranular i ty and Scale
3
6
5