1 / 21

Analyzing Growth

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

tala
Download Presentation

Analyzing Growth

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. 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 • Growth can be disaggregated into three components: (1) portfolio momentum, (2) market share performance, and (3) mergers and acquisitions. • Growth and value • Growth 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 growth • Sustaining 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 data • We 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.

  2. 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 • 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.

  3. 1 2 3 Types of Growth and Value Creation • 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. Value Creation Spectrum

  4. 1 Above-average value creation 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. • 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.

  5. 2 Average value creation • 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. 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.

  6. 3 Below-average value creation • 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. 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.

  7. Sustaining Growth and Product Life Cycles Variation in Product Life Cycle • 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.

  8. Patterns of Growth • 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

  9. 1 2 3 Empirical Analysis of Growth—Three Takeaways 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.

  10. 1 Real Revenue Growth of 5.4 Percent • 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.

  11. REVENUE GROWTH FOR NONFINANCIAL COMPANIES 3-year rolling average of real revenue growth Percent CAGR Percent 15.4 6.3 -0.2 Source: Compustat; McKinsey & Company’s corporate performance database

  12. 2 Growth across Industries • 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 • 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

  13. REVENUE GROWTH BY INDUSTRY GROUP* Percent Annual real revenue growth** 1963-2003 1994-2003 Software and services Semiconductors and semiconductor equipment Health 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 * Based on S&P Global Industry Classification Standard ** Geometric mean of annual median Source: Compustat; McKinsey & Company’s corporate performance database

  14. 3 Sustainability of Growth and ROIC • 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

  15. REVENUE GROWTH DECAY ANALYSIS Revenue growth Percent Median growth of portfolio* Percent >20 15-20 10-15 5-10 <5 Number of years following portfolio formation * At year 0, companies are grouped into one of 5 portfolios, based on ROIC Source: Compustat; McKinsey & Company’s corporate performance database

  16. REVENUE GROWTH RATE FALLS DRAMATICALLY FOR COMPANIES REACHING FORTUNE 50 Before entrance to Fortune 50 After entrance to Fortune 50 Average annual real revenue growth rate Percent -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years from entrance into Fortune 50 Source: Corporate Executive Board, “Stall Points: Barriers to Growth for the Large Corporate Enterprise”, 1998

  17. REVENUE GROWTH TRANSITION PROBABILITY 1994-2003 Three-year rolling average of real revenue growth rate Percent Revenue growth in 2003 <5 5-10 10-15 15-20 >20 Total <5 100 5-10 100 Revenue growth in 1994 10-15 100 15-20 100 >20 100 Source: Compustat; McKinsey & Company’s corporate performance database

  18. THEORETICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH WACC = 8% ROICPercent Market value/capital ratio* 15 12 9 6 Revenue growthPercent * Assumes a competitive advantage period of 10 years, after which ROIC = WACC is assumed

  19. EMPIRICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH Sample of 563 North American companies ROICPercent Market value/capital ratio, 2003* <15 12-15 9-12 6-9 0-6 Revenue growth 1993-2003 CAGRPercent * Defined as market value of operations divided by invested capital including goodwill ** ROIC based on invested capital including goodwill

  20. REGRESSIONS OF MARKET-VALUE-TO-CAPITAL WITH ROIC AND GROWTH Dependent variable Number of observations R2Percent P-value1** Percent Variable1 Slope1 t-Stat1 Full sample MVI/C* 563 46 ROIC 19.3 21.5 0 P-value2Percent Variable2 Slope2 t-Stat2 Growth 2.0 3.4 0 ROIC cohortPercent Dependent variable Number of observations P-value1**Percent Variable1 Slope1 t-Stat1 0-6 6-9 9-12 12-15 >15 MV/IC* MV/IC* MV/IC* MV/IC* MV/IC* 93 146 124 61 139 Growth Growth Growth Growth Growth 0.25 0.76 3.22 2.14 7.99 0.52 0.82 2.83 1.43 3.18 60 41 1 16 0 * 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

  21. 1.5 1.6 1.3 0.5 VALUE OF COMMODITY CHEMICAL COMPANIES DRIVEN BY ROIC AND GROWTH Market value/Capital ratio, 2002* Sales growth Below average Above average Above average ROIC Below average * 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

More Related