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Step 1. Step 2. Step 3. Step 4. Analyzing Growth. To analyze the growth of a company, we proceed in four steps:. Disaggregating growth into three main components - PowerPoint PPT Presentation
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Analyzing Growth
To analyze the growth of a company, we proceed in four steps:
Disaggregating growth into three main componentsGrowth can be disaggregated into three components: (1) portfolio momentum,
(2) market share performance, and (3) mergers and acquisitions.
Growth and valueGrowth translates into value when return on invested capital (ROIC) exceeds the cost
of capital. We discuss the major types of growth and the relative levels of value
creation.
Difficulty of sustaining growthSustaining high growth is much more difficult than sustaining ROIC. Despite some
variation in the patterns of growth, high growth is not sustainable, due to the natural
life cycles of products.
Empirical dataWe find that empirical data supports our intuition that high growth is unsustainable. In
addition, we find that high growth decays quickly, and large companies struggle to
grow.
Step 1
Step 2
Step 3
1
Step 4
Characteristics of Companies and Growth
• Portfolio momentum: organic
revenue growth a company
enjoys because of overall
expansion in the market
segments of its portfolio.
Components of Growth
2
• Market share performance:
organic revenue growth from a
company gaining (or losing)
share in a particular market.
• Mergers and acquisitions
(M&A): inorganic growth a
company achieves when it
buys or sells revenues through
acquisitions or divestments.
Types of Growth and Value Creation
3
Above-average value creation•Create new markets through new products.•Convince existing customers to buy more of a product.•Attract new customers to the market.
Average value creation•Gain market share in fast-growing market.•Make bolt-on acquisitions to accelerate product growth.
Below-average value creation•Gain share from rivals through incremental innovation.•Gain share from rivals through product promotion and pricing.•Make large acquisitions.
Va
lue
Cre
atio
n
Sp
ectr
um
Above-average value creation
4
1) Create new markets:
•No established competitors.
•Diverts customer spending.
2) Existing customers purchase more:
•All competitors benefit.
•Low risk of retaliation.
3) Attract new customers to the
market:
•All competitors benefit.
•Low risk of retaliation.
Example: Beiersdorf and L’Oreal (p. 85)
Consumer packaged-goods companies
Beiersdorf and L’Oreal accelerated growth in
skin-care products by convincing men to use
their Nivea and Biotherm products,
respectively.
Their competitors did not retaliate because
they also gained from the category
expansion.
Men’s skin-care products are not much
different from women’s, so much of the R&D,
manufacturing, and distribution cost could be
shared. The major incremental cost was for
marketing and advertising.
Average value creation
5
Example: IBM (p. 86)
IBM has been successful in bolting on
smaller software companies and
subsequently marketing their applications
through its existing global sales and
distribution system, which can absorb the
additional sales without too much extra
investment.
Because such acquisitions are relatively
small compared to IBM’s size, they boost
IBM’s growth but add little cost and
complexity.
1) Gain market share in a fast-growing
market:
•Competitors can still grow despite
losing share.
•Moderate risk of retaliation.
2) Make bolt-on acquisitions to
accelerate product growth:
•Modest acquisition premium relative to
upside potential.
Below-average value creation
6
Example: Amazon and Wal-Mart (p.
85)
As Amazon continued expanding into the
U.S. consumer-electronics retail market in
2009, Wal-Mart retaliated with price cuts on
key products, such as top-selling video
games and game consoles, even though
Amazon’s $20 billion in sales in 2008 were
a fraction of Wal-Mart’s $406 billion in sales
in the same year.
In concentrated markets, share battles
often lead to a cycle of market share give-
and-take, but rarely a permanent share
gain for any one competitor.
1) Growth by incremental innovation:
•Competitors can replicate and take
back customers.
2) Gain share through product
promotion and pricing:
•Competitors can retaliate quickly.
3) Make large acquisitions:
•High premium paid.
•Most value is diverted to shareholders
of acquired firm.
Sustaining Growth and Product Life Cycles
• Sustaining growth is difficult because
most product markets have natural life
cycles.
• The market for a product typically follows
an S-curve over its life cycle until
maturity.
• Stages of the Product Life Cycle:
• Slow growth as product is utilized
by early adopters.
• Growth accelerates to the point of
maximum penetration.
• Sales decline upon market maturity
to population or GDP growth rate.
Variation in Product Life Cycle
7
Patterns of Growth
8
• While the pattern of growth is usually the same for every product and service, the amount
and pace of growth will vary for each one.
• Wal-Mart’s growth did not dip below 10 percent annually until the end of the 1990s, 35
years after founding.
• eBay saw its growth fall to below 10 percent annually after only 12 years, having grown to
reach maturity early. Wal-Mart and eBay: Growth Trajectories
Empirical Analysis of Growth—Three Takeaways
9
How does the intuition provided in the previous sections match up with empirical data?
Median revenue growth rate was 5.4 percent
(1963–2007).The median rate of revenue growth between 1963 and 2007 was 5.4
percent in real terms. The real revenue growth fluctuates more than
ROIC, ranging from 0.9 percent in 1992 to 9.4 percent in 1966.
High growth rates decay very quickly.Companies growing faster than 20 percent (real terms) typically grow at
only 8 percent within five years, and at 5 percent within 10 years.
Extremely large companies struggle to grow.Excluding the first year, companies entering the Fortune 50 grow at an
average of only 1 percent (above inflation) over the following 15 years.
Real Revenue Growth of 5.4 Percent
10
The 5.4 percent real revenue growth is much higher than U.S. real GDP
growth of 3.2 percent during the same period. Why?
•Self-selection: Companies with good growth opportunities need capital to grow. Thus, high-growth
companies are more likely to be publicly traded than privately held ones.
•Service providers grow without affecting GDP: As companies become increasingly specialized, they
outsource more services, contributing to the growth of service providers; this does not affect GDP
figures, because GDP measures aggregate output.
•Global expansion: Many companies create products and generate revenue outside of the United
Stataes, which will not affect U.S. GDP.
•Median growth rate: The median firm is typically small, and small public companies grow faster. In
contrast, the U.S. GDP is primarily driven by the growth of large companies.
•Other effects: The effects of M&A and currency fluctuations do not reflect organic growth. This effect is
dampened, but cannot be eliminated by using the rolling averages and medians method.
REVENUE GROWTH FOR NONFINANCIAL COMPANIES
Source:Compustat; McKinsey & Company’s corporate performance database
3-year rolling average of real revenue growthPercent
CAGRPercent
15.4
6.3
-0.2
Growth across Industries
12
Examples of varying growth rates
across industry sectors (p. 93)
Fast-growing sectors:
•Software
•IT services
•Health-care equipment
Slow-growing sectors:
•Auto components
•Food products
•Department stores
• The spread of growth rates across
industries varies dramatically.
• Unlike ROIC, the ranking of
industries by growth varies
significantly over time.
• Variation can be explained by
structural factors, such as:
• Changes in customer demand
• Competition from substitute
products
REVENUE GROWTH BY INDUSTRY GROUP*
*Based on S&P Global Industry Classification Standard**Geometric mean of annual median
Source:Compustat; McKinsey & Company’s corporate performance database
Percent
1963-2003
9.3
8.5
8.3
7.7
7.6
7.4
6.3
6.3
5.9
5.4
5.1
4.8
4.5
4.3
3.9
9.4
9.9
10.5
13.1
15.4
19.9
Annual real revenue growth**
Software and servicesSemiconductors and semiconductor equipmentHealth care equipment and services
Technology hardware and equipment
Pharmaceuticals and biotechnology
Commercial services and supplies
Telecommunication services
Hotels, restaurants, and leisure
Energy
Media
Retailing
Transportation
Food and staples retailing
Total sample
Automobiles and components
Household and personal products
Capital goods
Consumer durables and apparel
Utilities
Food, beverage, and tobacco
Materials
1994-2003
18.5
8.0
14.8
9.2
8.6
6.8
5.3
8.0
7.9
4.6
5.9
4.6
4.2
3.3
3.8
11.0
15.6
10.1
13.8
16.1
20.1
Sustainability of Growth and ROIC
14
• There is a weak case for sustained
growth of a firm over long periods.
• Empirical data suggests that high
growth rates decay very quickly:
• Within three years, differences across
companies reduces considerably
• By year 5, the highest-growth portfolio
outperforms the lowest-growth portfolio
by less than 5 percent.
• In contrast, advantages in ROIC are
fairly stable over time:
• Top companies still outperform bottom
companies by more than 10 percent
after 15 years.
Wal-Mart and eBay: Growth Trajectories
REVENUE GROWTH DECAY ANALYSIS
*At year 0, companies are grouped into one of 5 portfolios, based on ROIC
Source:Compustat; McKinsey & Company’s corporate performance database
Revenue growthPercent
>20
15-20
10-155-10<5
Median growth of portfolio*Percent
Number of years following portfolio formation
15.0
9.5 9.0
13.5
20.0
28.6
2.0 1.4
-0.7 -0.7
0.7 1.2 0.12.1 2.8
5.1 4.5
-1.6
-0.1
-3.9
REVENUE GROWTH RATE FALLS DRAMATICALLY FOR COMPANIES REACHING FORTUNE 50
Source: Corporate Executive Board, “Stall Points: Barriers to Growth for the Large Corporate Enterprise”, 1998
Average annual real revenue growth ratePercent
-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Before entrance to Fortune 50
After entrance to Fortune 50
Years from entrance into Fortune 50
REVENUE GROWTH TRANSITION PROBABILITY 1994-2003
Source: Compustat; McKinsey & Company’s corporate performance database
Revenue growth in 1994
Revenue growth in 2003
56
59
61
64
67<5
5-10
10-15
15-20
>20
<5
13
11
15
16
15
10
14
11
12
8
8
5
4
3
3
13
11
9
5
7 100
100
100
100
100
5-10 10-15 15-20 >20 Total
Three-year rolling average of real revenue growth ratePercent
THEORETICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH
WACC = 8%
*Assumes a competitive advantage period of 10 years, after which ROIC = WACC is assumed
0
1
2
3
4
5
6
7
8
9
10
0 5 10 15 20 25
Market value/capital ratio*
Revenue growthPercent
ROICPercent
15
12
9
6
EMPIRICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH
Sample of 563 North American companies
*Defined as market value of operations divided by invested capital including goodwill
**ROIC based on invested capital including goodwill
Revenue growth 1993-2003 CAGRPercent
0
1
2
3
4
5
6
7
8
0-5 5-10 10-15 15-20 20-25
<15
12-15
9-12
6-9
0-6
Market value/capital ratio, 2003* ROICPercent
P-value2
Percent
REGRESSIONS OF MARKET-VALUE-TO-CAPITAL WITH ROIC AND GROWTH
*Defined as market value of operations divided by invested capital including goodwill**P-value represents the probability that the tested relationship does not hold, with a P-value of 5% used as the threshold of statistical significance
0-66-99-1212-15>15
MV/IC*MV/IC*MV/IC*MV/IC*MV/IC*
93146124
61139
GrowthGrowthGrowthGrowthGrowth
0.250.763.222.147.99
0.520.822.831.433.18
6041
116
0
ROIC cohortPercent
Dependentvariable
Number ofobservations
R2
PercentNumber ofobservations
Dependentvariable
46 19.3 21.5 0563MVI/C*Full sample
Variable1 Slope1 t-Stat1
P-value1**
Percent
ROIC
Variable2 Slope2 t-Stat2
Growth 2.0 3.4 0
P-value1**
PercentVariable1 Slope1 t-Stat1
VALUE OF COMMODITY CHEMICAL COMPANIES DRIVEN BY ROIC AND GROWTH
*June 2002 (based on Invested Capital 2001)
Source: T. Augat, E. Bartels, and F. Budde, “Multiple Choice for the Chemicals Industry,” McKinsey on Finance, Number 8 (Summer 2003), pp. 1-7
Market value/Capital ratio, 2002*
Below average Above average
ROIC
Sales growth
1.5 1.6
1.3 0.5Below average
Above average