In their recent article “Rev up your growth engine: Lessons from through-cycle outperformers,” two McKinsey partners report that roughly one in ten companies manages to outgrow its peers both during downturns and in the subsequent recovery. In a recent Inside the Strategy Room podcast, Rebecca Doherty, who leads McKinsey’s growth strategy practice globally, and Anna Koivuniemi, who heads up our growth analytics service line, explore what through-cycle outperformers do differently from everyone else. This is an edited transcript of the discussion. You can listen to the episode on Apple Podcasts, Spotify, or Google Podcasts.
Sean Brown: Rebecca, can you start by telling us how you define a through-cycle outperformer?
Rebecca Doherty: Companies don’t want growth for growth’s sake. They want value creation. We define growth outperformers as companies that grow faster and have higher profits than their peers. Those that outperform throughout an economic cycle generate three times the revenues during the downturn as others and have nine times higher profitability.
Their growth starts during the downturn and that turbocharges their ability to outperform in the recovery. In the last economic cycle, companies that managed to do this drove value creation in the form of 5.3 percent excess total returns to shareholders (TRS)—five times higher than the average company in our sample (Exhibit 1). It’s worth noting that our research covers the 15 years between 2003 and 2017 but we looked at other time periods as well, and the findings are consistent.
Sean Brown: Where do the companies you studied typically focus their growth initiatives?
Rebecca Doherty: We see four main directions: the core business, expanding geographically, integration or disruption of the value chain, and moving to adjacent fields. The majority of companies—a full 95 percent of the value-creating growers—looked at three or more directions of growth. That does not mean they place big bets in every single one. They leaned in hard into only one or two areas. The key here is not falling in love with one direction of growth but thinking about the entire portfolio. Most think about growing their core business. In a downturn, some rev up the commercial side, but they may also start to look a bit outside—into geographic expansion, value chain integration, and moving to adjacent markets.
Sean Brown: So what differentiates the approach of these outperformers from what other companies do?
Rebecca Doherty: Most important is leading with a through-cycle mindset. That does not mean completely redoing your strategy or putting the brakes on everything but being thoughtful about where you pull back and where you lean forward. How do I protect my innovation and sales capabilities, because those things will propel me in the future? Many leaders then make slight tweaks to their strategy in terms of where they accelerate and where they slow down.
We are not recommending blindly going toward growth. We are saying that if you have a strong balance sheet, a downturn like we have now is a great time to be opportunistic. In 2007, right before the financial crisis, our through-cycle growth outperformers had about 20 percent more excess cash than their peers. You play that forward to 2012 and they had 53 percent higher excess cash. These companies were doing multiple things, both around preserving this optionality and strategically placing bets.
Sean Brown: How did these companies manage to free up cash during a downturn so they could have these growth-investment options?
Anna Koivuniemi: Our sample of approximately 2,000 companies represented almost all industries. When we looked at how they freed up resources, we found something interesting. In the downturn, there is little difference in spending reductions between the through-cycle outperformers and other companies, although the outperformers’ spending was a little higher. When the recovery started, however, the outperformers increased their spending significantly, especially on capital expenditure (capex) and R&D—their spending was three or four times higher than the rest of the sample. They weighed where to invest and when the times started to improve, they were early in investing for the future.
Sean Brown: How did these companies know when to start investing? Were they just better than others at predicting when the recovery would begin?
Anna Koivuniemi: We talked to a few of the companies in our research sample and the outperformers were much more thorough in analyzing their existing directions of growth. So rather than knowing the exact moment of recovery, they understood their preferred growth focus and created the ability to invest when the opportunities started to emerge.
Rebecca Doherty: I would add that through-cycle outperformers also grew during the downturn, so even though they lowered their spending then, 95 percent of them were still making bets and growing. They ramped up in a bigger way during the recovery, but one of the lessons is that you should start placing some strategic bets while still in the downturn, then both broaden and deepen those investments when things start to improve.
You should start placing some strategic bets while still in the downturn, then both broaden and deepen those investments when things start to improve.
Sean Brown: Did these companies prioritize growth in their core businesses or expand into new areas?
Anna Koivuniemi: One of the key choices that companies make is where to grow. Core is the first focus, and through-cycle outperformers did look at their core. In the last downturn, for example, a Finnish manufacturer actively invested in its services business, building it up during the crisis because the demand there was still high. Companies need to service their existing equipment even when they reduce capital spending. This manufacturer redesigned its services portfolio, making the services more modular so it could offer them more flexibly, and invested heavily in capabilities to deliver and sell those services.
Another major focus for growth among through-cycle outperformers was in adjacencies. Many looked at parts of their portfolios that gave them buffers against cyclicality of their core business. For example, one company had a portfolio of construction and engineering services at the start of the last crisis and it decided to diversify its industry exposure by moving into environmental services. It also went into oil and gas equipment. The contracyclical part of its portfolio grew substantially after the crisis.
Rebecca Doherty: A South American retail company did something similar. When the downturn hit, the management asked, what customer segment could we go after? They decided to create a financing business aimed at low-income customers, and the growth of this business skyrocketed. It was a great example of looking at the customer landscape to identify a need and finding capabilities that enable you to move the core portfolio into an adjacency to capture the new opportunity.
Sean Brown: What about geographic expansion? Was that a path many outperformers chose in the last economic downturn?
Anna Koivuniemi: We found that during the down cycle, the outperformers expanded to other geographies at a rate that was 1.5 to two times greater than the rest of our sample. For example, in 2007, a Portuguese retailer concluded that the Polish market was healthier, in terms of GDP and retail activity, than any of its other regions, and made targeted acquisitions, doubling its store presence in the country.
Sean Brown: Did you see any big differences between sectors in terms of the strategies the growth outperformers pursued?
Anna Koivuniemi: We did find some sector differences. Rebecca mentioned earlier that 95 percent of the outperformers grew in the downturn as well as in the recovery. This was the case in almost all sectors except three: basic materials, consumer packaged goods, and energy. But those sectors then picked up enormously in the recovery. The idea is that you have to accelerate your growth in the recovery. Don’t wait until things settle down because you lose the momentum you could capture from moving throughout the cycle.
Sean Brown: What about M&A? Did the outperformers have specific approaches to acquisitions and divestitures?
Anna Koivuniemi: M&A was a core strategy to get growth. The through-cycle outperformers did 1.8 times more deals during the downturn. They spent $238 million on M&A while the median of the others was $135 million (Exhibit 2). Now, this does not mean the outperformers did just one or two big deals. Many did multiple deals using a programmatic M&A strategy. Interestingly, in the recovery the disparity leveled out. The outperformers averaged 1.3 deals while the rest did 1.17 deals.
Sean Brown: Was digital M&A a major focus of the deal making during and after the last downturn?
Anna Koivuniemi: We looked into digital M&A from 2003 to 2019, so slightly longer than the last economic cycle. The capital deployed in digital M&A during that period grew 11 percent per year. Also, the size of these deals increased. What we found interesting is the share of what we called nondigital buyers—companies whose business models were not fully digital—also grew enormously in that period. These nondigital buyers did 30 percent more deals.
Rebecca Doherty: Another interesting point is, those companies that did multiple digital deals using a programmatic strategy achieved higher excess TRS. But while non-digital acquirers are growing their digital M&A, they are still behind digital acquirers. Many have not bought digital companies before or are just starting and do not feel as confident in this space.
Sean Brown: Many companies have realized the importance of digital capabilities during the COVID-19 crisis but, as you say, it is a challenging arena for traditional companies. How should they approach these acquisitions?
Rebecca Doherty: One of the key success factors around digital M&A is understanding the strategic rationale. It is very important to be clear up front about what you want from the acquisition. The second point, particularly for nondigital acquirers, is to do thorough diligence on the commercial and technical aspects. On the technical dimension, do you understand the road map and the technical capabilities of the team? How do you plan to accelerate that to achieve a strategic objective? On the commercial side, some of these companies are following go-to-market strategies in industries that are rapidly evolving, so understanding the likely direction of that evolution is very important.
The third point is about how you value the target. Most acquirers are comfortable doing a discounted cash flow valuation and a few comparisons. That may work in some cases, but a lot of digital M&A is with prerevenue companies, so how do you assess their growth trajectory? The successful acquirers think in terms of planning not just one acquisition but building a new business or a new capability. That business or that capability is worth X. And if we think about this target, what is its contribution to that business’s value based on the capabilities and revenue synergies it brings? How do we think about that holistically? Because often these acquisitions can be very much one plus one plus one equals ten.
The last point I would make is on integration. In digital M&A, there is often a high focus on talent retention, so how will you set up the incentives? You also need to think hard about your culture and ways to make it attractive to the target company’s employees.
Sean Brown: On that culture point, when non-digital companies buy digitally focused organizations, there is often a significant culture clash. How can acquirers mitigate that risk?
Rebecca Doherty: That is something everyone battles. What we have seen work well is spending a lot of time during diligence on culture—things you can do outside-in and conversations you have with the top team. Talk frankly about the expectations of leaders you want to keep and really listen to them. “Ring-fencing” is a term thrown around to mean preserving the culture of the acquired company; sometimes that works and sometimes it doesn’t, depending on the acquisition rationale. If it is about market access and little interaction is needed between the target and the acquirer, ring-fencing can work. If you are integrating two engineering teams, that looks different. You need to think through the engineering culture you want to promote and the key people to keep. If they are in different locations, how do you address rotation and setting up attractive career paths?
Anna Koivuniemi: These days, when digital is radically changing the way we buy, sell, have meetings, corporate cultures are already changing. That makes it an opportune time to integrate digital natives, since all of us need to learn digital tools.
Sean Brown: To return to the point about acquiring digital capabilities, which ones are the biggest focus for companies trying to grow?
Rebecca Doherty: With so much of sales being remote right now, many companies are thinking about innovating how they go to market. In some cases, they are looking to invest in the front end of digital, in terms of reaching more consumers, while others are prioritizing the back end, to make processes more efficient.
Anna Koivuniemi: I found what happened in Asia in January, February, and March, when they entered lockdowns earlier than Europe and America, particularly interesting. Companies there rapidly reallocated spending from traditional to online channels to capture market share and the traffic that shifted online. One skin care manufacturer had salespeople posting their own videos with skin care tips. They paid influencers to drive demand. They live-streamed Valentine’s Day events. They reallocated resources, but they also innovated how they reached customers.
Sean Brown: What role do divestitures play in outperformers’ growth strategies?
Rebecca Doherty: One of the key pieces in assessing your portfolio is finding the granular pockets of growth. What are the attractive businesses that you want to keep, and which ones should you drop? Programmatic acquirers that do a few deals a year along specific themes also use selective divestitures. They sell business segments that no longer fit the portfolio or make strategic sense to gain the dry powder, if you will, to make moves that make more sense.
The idea that now is a cheap time to buy so we should buy something is dangerous. The acquisition targets you consider should fit your long-term strategy and the value-generation principles you follow.
Sean Brown: With many companies under stress from the economic impact of the pandemic, is this a particularly good time to grow by acquiring businesses?
Anna Koivuniemi: The idea that now is a cheap time to buy so we should buy something is dangerous. The acquisition targets you consider should fit your long-term strategy and the value-generation principles you follow. You should not go looking for bargains.
Sean Brown: We covered a lot of ground today. What are the most important points that companies trying to position themselves for post-COVID-19 growth should keep in mind?
Anna Koivuniemi: First, set the bar high. One reason we did the through-cycle outperformer research is to inspire companies to put their growth aspirations high enough against their peers. The second point is to make sure you are not stuck on your core business. Through-cycle outperformers systematically look at multiple directions of growth to make sure they are ready in the right markets when opportunities emerge. Consider making big moves outside of the core, into new geographies and adjacencies. The last point is that 95 percent of through-cycle outperformers prove themselves in the downturn. If you are not able to grow then, double down in the first two years of recovery.
Sean Brown: How do I take this back to my office—or my home office—in the morning and align the leadership team around the importance of focusing on growth now?
Rebecca Doherty: Having your CEO on board is absolutely critical. That high aspiration needs to come from the top—the decision that this is how we will think about growth and strategically allocating our portfolio. The second thing that is necessary is to not think about strategy in incremental ways, as just tweaks to the budget from last year. The executive team needs to adopt a bolder mindset. If that mindset is there, everything else is doable. You can put in the processes, you can bring in the facts, and you can do the critical thinking that will get you there. But getting that alignment is sometimes the toughest part.
You can download a full AI-generated transcript of this Inside the Strategy Room podcast here.