Want to grow faster? Double down on your real growth engine

Being ambitious means wanting to achieve more, not wanting to do more. Joe is graduating from high school and has exceptional talents. He is considering which career choice will benefit him the most. Because he is unsure, he plans to study medicine, law, physics, engineering, economics and computer science. That’s crazy, right?

Companies may not have the physical constraints of one person, but their investment capacity, talent and management attention are all in scarce supply.

While the student metaphor is of course too simplistic, it is good to stretch a point to preposterous extremes to highlight the human tendency for overconfidence and aversion to making choices.

Many executives feel bigger is better. But are they right?

Just how much do you grow and when does scale matter?

Look closely at the most spectacular examples of value creation and you will usually find they are concentrated in a single growth engine.

To create value, it's not enough to grow revenues

We at McKinsey have been studying about 3,000 of the world’s largest companies. We have found that it is imperative to grow to survive. Now, keep in mind that there’s a survivor bias here. Companies that don’t grow are a lot more likely to fail to survive, therefore it’s no surprise that almost all companies that survived from 2001 to 2015 grew 56 percent of them at least doubled over 10 years.

But a lot of this revenue growth didn’t translate to value creation and this is even truer for hyper-growers (many of whom had pursued ambitious M&A programs). Of about 430 companies that increased revenues by at least five times within a decade, 210 had negative economic profit during 2011-2015 in about half the cases despite having very positive economic profit (the profit surplus above the company’s cost of capital) 10 years earlier, when they were much smaller.

In all, out of about 1,500 companies that had an ROIC close to their cost of capital during 2001-2005, only 10 percent saw significantly higher ROIC between 2011-2015. We wanted to look deeper into these companies and understand if results would be different for individual business units. We had a smaller sample as many companies don’t show economic profit at the BU level, but we found sufficient data to analyze more than 1,200 BUs. Remarkably, the results were the same: Chances of breakthrough improvement in economic profit over 10 years across these BUs was about 10 percent.

This is not dumb luck. When you look at the companies and business units that made it, they disproportionately benefited from positive industry trends. Many made big moves: driving significant resource re-allocation, executing significant M&A and achieving major cost transformation.

How to Grow

In all likelihood, there are some parts of a company that enjoy better momentum than others. If resources and attention are concentrated on them, a true competitive advantage can be achieved, changing the company’s overall position.

Certainly there are enough reasons to look carefully at when general scale helps and where it hinders. Consider the following:

It takes courage to shrink the company, though this has been increasingly common. IBM under Lou Gerstner in the mid-1990s and Apple under Steve Jobs in the late 1990s famously starting turning around sick businesses by shrinking the company before resetting it for much healthier growth.

Walmart, the largest company in the world by revenues, is among the least diversified S&P 500 companies—76 percent of its sales are from its retail stores in the U.S. (including Sam’s Club at 12 percent of sales), where it has gotten so big that in some categories it accounts for more than 25 percent of consumer brand sales. As Walmart became more dominant, it could negotiate better with suppliers, offer better pricing and take more share.

As companies like Microsoft, Google, Facebook, Amazon and Uber attract users, the value increases for existing users who have more counterparts to collaborate with or see more complementary services on that platform. Metcalfe’s Law estimates the value of network is the square of the number of users.

Some companies monetize the same strengths or assets across various industries. I have written about how Disney and other companies expanded their cores. In addition, we are now seeing fascinating examples of companies trying to expand services on their platforms and disrupt a different industry often in tandem with focused tech disruptors, such as Uber trying to expand to food delivery or Amazon jumping in on video and music streaming.

From the above examples, notice that sticky supply-side issues of cost advantage and demand-side challenges of value advantages are not at the corporate level but at the business level. In many cases, the advantage doesn’t travel far. Some tech platforms are fairly global, but nearly all have big gaps such as in China. Walmart’s dominance has yet to extend much outside North America. Most luxury fashion brands exhibit different sales across different countries, states and cities. San Francisco, Dallas and New York have different mix of cars to each other and to Beijing, Shanghai and Chengdu. Some marketing may be national but car buyers are influenced by what they see on the streets, students by what their classmates are buying, and especially in emerging markets where word of mouth remains the most trusted source, most people prefer to buy what their friends and family recommend or appreciate. Once a brand has enough scale and positive word of mouth, it gets easier and cheaper to grow in that locality.

There are cross-business synergies with distribution, shared components, R&D, IT systems and the like. There are also softer benefits such as greater regulatory sway, better appeal to talent and cheaper cost of capital. But large multi-business companies also pay significant complexity costs, are more likely to become regulatory targets, and possibly offer a less exciting environment for talent. There are various examples of recent splits or major divestitures where investors were hoping to remove dis-synergies of scale by allowing the management team to focus more on their core performance engines.

Few people, and even fewer companies, are true polymaths. With the ever-increasing demands of value-adding growth, it is imperative to focus on the key driver that can keep your company a growing and value-adding concern.

This blog was previously published on LinkedIn.

Yuval Atsmon is a senior partner in McKinsey’s London office.

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