Wednesday, July 11, 2007

Management by Growing

Once upon a time, the there was a small little boy who hated being so small. “Nobody pays any attention to me or gives me any respect because I am so small,” he lamented to himself.

One day, a fairy godmother came to visit the little boy and offered to grant him any one wish. Well, that was an easy choice for this boy. “I want to grow and grow and become BIG!” he replied.

The next day, the boy woke up and was big and tall, like an adult. The boy was ecstatic! People, finally paid attention to him and gave him respect. It felt great.

Unfortunately, his growth did not stop there. Every day he grew a little bigger. At first, it wasn’t such a big deal. But eventually he was so big that he was taller than large buildings. Everywhere he stepped, he ended up crushing something with his gigantic feet. The respect he used to get from others turned to fear, as people were afraid to be near him for fear of being crushed. It made him feel like the monster Godzilla.

“I guess it’s possible to grow a little too much,” the boy finally admitted.

One of the most popular phases in a business life cycle is the growth phase. It can be a lot of fun. Your position is relatively well set and desired by a lot of consumers. Your only problem is growing the company fast enough to take advantage of all the great potential you have. It feels like you can do no wrong.

Shareholders seem to love growth companies as well. They give the stocks high multiples. Suddenly, the company is worth a whole lot of money, and everyone is smiling.

It’s like the boy in the story. When he was small, he was ignored and not given any respect. However, once he started growing, everything started to change for the better. He started receiving the love and respect of others.

It feels so good that you want it to continue forever. However, as we saw in the story, sometimes too much emphasis on growth for too long can backfire on you. Continuing the push for growth long after you’ve reached your optimal size can cause all of your friends to turn on you.

In the business world, maturity will eventually come, causing additional rapid growth to no longer be appropriate. Too much growth for too long can result in investments which are no longer needed in the marketplace, causing returns below your cost of capital. You may be merely spreading your relatively constant sales over a larger, more costly infrastructure, which reduces overall profitability.

Growth is good, but other factors also need to be considered in your strategic planning, so that your company does not turn into a hideous monster like Godzilla.

In the last three blogs, we talked about how different companies require a different approach to strategic planning depending on where they are in their lifecycle and how many barriers there are to entry/exit in their industry. In the blog “Same Title, Different Jobs”, we said that there are three major steps in strategic planning:

1) Positioning: Determining what you will stand for (own) in the marketplace—the solution you are providing, the place where you can win.

2. Pursuit: Determining the path to achieve (or improve) your desired position. This usually involves acts which allow you to gobble up market share so that you can build a strong claim to your position.

3. Productivity: Discovering ways to leverage your position so that you can optimize the return on your investment.

During the rapid growth phase of an industry, most of the attention is on growing the business (I guess that’s why it’s called the growth phase). The key area of strategic focus in this period is on pursuit. The idea is to grab as much of the market potential as fast as you can, so that nobody else can gain a stronger foothold at that position.

The success of your position is what is making the growth possible, so there is not much need to reassess the position. Regarding productivity, you greatest contribution at this point is the productivity which is a natural outcome of rapid growth—economies of scale. Hence, if you focus on the growth, productivity will be a natural byproduct at this stage of the lifecycle.

That being said, one still needs some balance. Positioning and productivity cannot be ignored. Success usually causes imitators to crop up. These imitators may create a need to tweak your positioning strategy in order to stay one step ahead of them.

In addition, the growth phase usually leads eventually to a consolidation of the industry, as a greater percentage of a company’s growth comes from acquiring competitors. If you are not an efficient, productive operator, it is likely that you will be the one being acquired rather than being the one doing the acquiring. Efficiency helps give you the edge when the intra-industry warfare begins, to see who will survive and make it to the mature stage. When the sporting goods retail industry recently went though its consolidation phase, it was the blander, but more efficient Dick’s Sporting Goods which acquired the flashier, but less productive Galyan’s.

Thus, although pursuit is the most important concern at this stage, the other factors should not be ignored.

The pleasure which comes in the growth phase causes pressure to want to continue the growth phase, long after that phase in the industry is over. It seems like everyone wants to be a growth stock forever.

If you want to be a growth stock forever, one probably needs to abandon industries as they mature and move on to new evolving industries. This is pretty much what GE has done over the decades. The growth comes from shifting one’s position, rather than continuing growth in an industry that no longer requires it. At that point, it is an emphasis on positioning, rather than pursuit which continues the growth (We’ll talk more about that in a blog at a later date).

Last month, Wal-Mart finally started coming around to seeing this conclusion. They announced that they were cutting back on new store growth, because it was no longer as productive as in the past. The sales for the new stores were coming largely from other Wal-Marts, so the net increases were shrinking.

Here is what the Wall Street Journal had to say about it on June 2nd:

“Wal-Mart Stores Inc. plans to sharply curtail future U.S. store openings, amid disappointing results for the world's largest retailer and growing investor pressure to curb its aggressive domestic expansion. Friday, it promised to cut more than a third of this year's planned store additions, delay some openings and restrict future U.S. store expansion.

“The move will cut the retailer's capital expenditures by $1.5 billion in 2007 to $15.5 billion for the year and help fund a large share buyback that investors also have been urging the company to pursue. Wal-Mart has been under pressure on Wall Street to slow its U.S. expansion and use the savings to prop up its stock price.

“Wal-Mart, based in Bentonville, Ark., isn't the only retailer to retreat on its store-building boom. AutoZone Inc., Home Depot Inc. and McDonald's Corp. have pulled back on expansion in recent years to improve store operations and boost shareholder returns. 'This is what everyone's been clamoring for,' said Goldman Sachs retailing analyst Adrianne Shapira.

“News of the capital-spending cutback and share repurchase cheered investors, who sent Wal-Mart shares up 3.9%, or $1.87, to $49.47 in 4 p.m. composite trading on the New York Stock Exchange Friday.”

So as you can see, sometimes it is wise get out of a single-minded approach to planning focused only on growth and move to a balance which includes productivity (such as stock buybacks or reinvestments in making current assets more productive, as McDonald’s has done).

Growth is good, but too much of the same kind of growth for too long is often not one’s wisest move. One needs to have a balanced approach which also looks at potential repositionings or focuses on productivity in order to keep the profit wheels moving.

For some people, the thought of no longer being a growth stock is like a fate worse than death. Trust me, there is life after rapid growth. By no longer pumping all that money into pursuit, those years can be some of your most profitable. Yes, the stock might initially fall when growth-minded shareholders leave, but keep this in mind. Those same people will also leave if they see your rapid growth as no longer productive. And in that case you have nothing.

At least if you stop the unnecessary investments and start doing things like buying back stock or raising dividends or improving efficiencies, you can attract other shareholders who will still reward you. All of the retailers mentioned in that Wall Street Journal article saw their stock rebound when then quit the unnecessary growth. And finally, keep in mind that Warren Buffett did pretty well refraining from the lure of rapid growth, and instead focusing his investments in a lot of more stable businesses.

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