Tuesday, April 22, 2008

Analogy #174: The Fall of Rome

There are a lot of different theories about why the ancient Roman Empire fell. My favorite theory has to do with the idea of the “plunder economy.” As it turns out, the Roman Empire was not the most transforming of societies. They did not bring a lot of value to the people they ruled over. Yes, they built better roads and knew how to move water via aqueducts, but that was about it.

Instead, the Roman Empire was built primarily on a plunder-based economy. They would go out and capture new territory and then plunder the new land, taking the riches back to Rome. When the plunder of the past conquests ran out, they would need to expand their empire, in order to find more territory to plunder.

Eventually, the math got to them. As the empire got exceedingly larger, it took ever more plunder in order to support it. They couldn’t find enough loyal soldiers to protect the massive base, so the Romans had to pay increasingly larger wages to increasingly less loyal soldiers. Eventually, the Romans could not find enough new plunder fast enough to fund the ever-larger demands of the ever-larger empire. Then, the barbarians decided to take back their plunder and the game was over.

Growth can be a tricky thing. Yes, growth brought the Romans more territory to plunder. But it also increased the costs of running an empire. The added costs of operating the larger base eat away at the benefits of the growth. Ever-larger conquests are needed to fuel the growing base. Eventually, the math runs out.

Growth was not only tricky for the Romans. It is tricky for corporations. Most corporate strategies include an element of growth. If growth is not managed properly, not only will it create problems, it could lead to your downfall, as it did for the Romans.

The principle here has to do with the foundation behind one’s growth. Is the foundation one of taking or of giving? Ancient Rome had primarily a “taking” foundation. They would strip the riches out of a new territory and take it back to Rome. That is why I refer to it as a plunder economy.

By contrast, a giving foundation focuses more on adding value. Rather than looking for ways to strip value out, it looks for ways to put more value in. Instead of plundering the new land, it renovates the new land, making it even more productive.

Depending on which foundation one uses, one will have a different impact on the mathematics of growth. For example, let’s say that you want to grow profits by 10% per year. Under a plunder foundation, that would at least require a sales growth of 10% per year. Ten years of 10% growth is not 100% growth. Due to the exponentially rising base, ten years of 10% growth is about 160% growth. Ten years of 15% growth would require you to become four times your current size in sales.

And this assumes that you can maintain current levels of profitability. As we saw with the Romans there can be some exponentially rising costs involved in running a large empire, so the top line may need to grow at an even faster rate to create the same level of growth on the bottom line. Usually, the most profitable business is the easy stuff right in front of you (the low hanging fruit). As you grow, there is less low hanging fruit left, requiring greater effort to get the same benefit. For example, to grow rapidly, one might have to expand further away from one’s operational comfort zone or take increasingly higher risks or pay extra for acquisitions in order to ensure that one gets the growth. All of these actions could lower profitability.

Let’s assume that you started with a 5% profitability rate and this plundering causes that rate to drop at a compounded rate of 2%. Now if you want to have that 10% increase on the bottom line over ten years, the top line needs to grow at 12.25% annually, for a total of 218%.

Now, let’s contrast that with the math of a giving foundation. Let’s assume that you want to grow profits by 10% per year. However, because of the value you can add to your conquests, you can improve your rate of profitability by 4% per year. And let us further assume that your starting rate of profitability is 5% of sales. Now, to achieve a ten percent annual increase in profitability, one needs only about a 5.75% annual sales growth. So instead of needing somewhere between 160% and 218% growth over ten years as in plundering, one only needs a 75% growth.

Here are some other points to consider:

1) The Plundered Want To Share in the Plundering
If your growth requires acquisitions, keep in mind that most of today’s acquisition targets are pretty sharp. They know their plunder value and they want you to pay most of that value to them in order to get the deal done. This is essentially what Yahoo has been saying to Microsoft. If you want to buy us, pay us the majority of the plunder value achieved by acquisition.

If you have to share most of the plunder with the one being acquired, there isn’t much gain left for you. This means that the rate of plundering must go up even faster. But that’s the deal if you are not adding much value. Your only real bargaining chip is money, so you have to pay more to get the deal done.

2) Adding Value Creates a Virtuous Cycle
There are many benefits to focusing on adding value versus just adding sales. First of all, the more value one adds, the stronger your value proposition becomes versus the competition. At a certain point, your value becomes so compelling that customers voluntarily shift their patronage from the competition to you. Therefore, instead of having to buy all those extra sales via acquisition, the added sales come all by themselves. Sure, it may cost a bit to add that value, but I’ll bet it pays a higher return than having to buy all those extra sales via acquisition (and having to share the plunder with the one acquired).

In the early days of Wal-Mart, they added so much value to the supply chain and so much value to the customer that they did not need to spend huge sums to acquire other firms. They also did not have to spend huge funds on advertising to acquire new customers. They could very efficiently grow internally, as customers flocked to their new store growth all on their own.

This benefit would be like Ancient Rome not needing to spend money on soldiers or conquests, because others would so like the added value of being within the Roman Empire that they volunteer to be taken over.

3) A Focus on Adding Value Creates More to Lever.
When you focus on adding value, you focus on creating skills and competencies. These skills and competencies can often then be levered in new growth directions. For example, 3M is very good at knowing how to turn certain types of technology into new products. This skill allows them to add great value to technology patents. This skill creates many new internal growth prospects, providing tremendous internal opportunities without having to resort to plundering others.

And even if you have to eventually go out and acquire businesses, the more value you can add, the more you can have left over once you share the plunder with the acquired one. Also, the acquisition target realizes that they are better off if they sell to the one who can add the most value to their business, so you are more likely to get the deal done if competing against others who want to buy the same company (but have less to offer).

The irony is that if you want to grow the top line, the best approach is often to focus less on the top line. Instead, focus on how to add more value. Look for ways to please the customer more, improve productivity, and build unique skill-sets. These will put you in a position where your firm becomes so desirable that the sales opportunities almost create themselves.

If you want to get more out of the marketplace, first look for ways to give more to the marketplace. This tends to create a far more efficient and dependable way to grow than through mere plundering of the success of others. With plundering, the math works against you and your empire could fall.

Near the end, the ancient Roman society had become rather lazy pleasure-seekers. Rather than earning their right to rule, they just lived off the plunder of others and had fun. Don’t ever get as complacent as the Romans. If you continue to plunder your own corporate reserves without ever putting any value back in, you will lose out as well. There’s a reason why there is so much scrutiny these days on executive pay. If it gets too excessive, the barbarians will overthrow you.

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