analyzing growth

Analyzing Growth

To analyze the growth of a company, we proceed in four steps:

Disaggregating growth into three main componentsGrowth can be disaggregated into three components: (1) portfolio momentum,

(2) market share performance, and (3) mergers and acquisitions.

Growth and valueGrowth 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 growthSustaining 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 dataWe 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.

Step 1

Step 2

Step 3

1

Step 4

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

2

• 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.

Types of Growth and Value Creation

3

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.

Va

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Cre

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Sp

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Above-average value creation

4

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.

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.

Average value creation

5

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.

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.

Below-average value creation

6

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.

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.

Sustaining Growth and Product Life Cycles

• 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.

Variation in Product Life Cycle

7

Patterns of Growth

8

• 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

Empirical Analysis of Growth—Three Takeaways

9

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.

Real Revenue Growth of 5.4 Percent

10

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.

REVENUE GROWTH FOR NONFINANCIAL COMPANIES

Source:Compustat; McKinsey & Company’s corporate performance database

3-year rolling average of real revenue growthPercent

CAGRPercent

15.4

6.3

-0.2

Growth across Industries

12

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

• 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

REVENUE GROWTH BY INDUSTRY GROUP*

*Based on S&P Global Industry Classification Standard**Geometric mean of annual median


Percent

1963-2003

9.3

8.5

8.3

7.7

7.6

7.4

6.3

6.3

5.9

5.4

5.1

4.8

4.5

4.3

3.9

9.4

9.9

10.5

13.1

15.4

19.9

Annual real revenue growth**

Software and servicesSemiconductors and semiconductor equipmentHealth 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

1994-2003

18.5

8.0

14.8

9.2

8.6

6.8

5.3

8.0

7.9

4.6

5.9

4.6

4.2

3.3

3.8

11.0

15.6

10.1

13.8

16.1

20.1

Sustainability of Growth and ROIC

14

• 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

REVENUE GROWTH DECAY ANALYSIS

*At year 0, companies are grouped into one of 5 portfolios, based on ROIC


Revenue growthPercent

>20

15-20

10-155-10<5

Median growth of portfolio*Percent

Number of years following portfolio formation

15.0

9.5 9.0

13.5

20.0

28.6

2.0 1.4

-0.7 -0.7

0.7 1.2 0.12.1 2.8

5.1 4.5

-1.6

-0.1

-3.9

REVENUE GROWTH RATE FALLS DRAMATICALLY FOR COMPANIES REACHING FORTUNE 50

Source: Corporate Executive Board, “Stall Points: Barriers to Growth for the Large Corporate Enterprise”, 1998

Average annual real revenue growth ratePercent

-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Before entrance to Fortune 50

After entrance to Fortune 50

Years from entrance into Fortune 50

REVENUE GROWTH TRANSITION PROBABILITY 1994-2003

Source: Compustat; McKinsey & Company’s corporate performance database

Revenue growth in 1994

Revenue growth in 2003

56

59

61

64

67<5

5-10

10-15

15-20

>20

<5

13

11

15

16

15

10

14

11

12

8

8

5

4

3

3

13

11

9

5

7 100

100

100

100

100

5-10 10-15 15-20 >20 Total

Three-year rolling average of real revenue growth ratePercent

THEORETICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH

WACC = 8%

*Assumes a competitive advantage period of 10 years, after which ROIC = WACC is assumed

0

1

2

3

4

5

6

7

8

9

10

0 5 10 15 20 25

Market value/capital ratio*

Revenue growthPercent

ROICPercent

15

12

9

6

EMPIRICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH

Sample of 563 North American companies

*Defined as market value of operations divided by invested capital including goodwill

**ROIC based on invested capital including goodwill

Revenue growth 1993-2003 CAGRPercent

0

1

2

3

4

5

6

7

8

0-5 5-10 10-15 15-20 20-25

<15

12-15

9-12

6-9

0-6

Market value/capital ratio, 2003* ROICPercent

P-value2

Percent

REGRESSIONS OF MARKET-VALUE-TO-CAPITAL WITH ROIC AND GROWTH

*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

0-66-99-1212-15>15

MV/IC*MV/IC*MV/IC*MV/IC*MV/IC*

93146124

61139

GrowthGrowthGrowthGrowthGrowth

0.250.763.222.147.99

0.520.822.831.433.18

6041

116

0

ROIC cohortPercent

Dependentvariable

Number ofobservations

R2

PercentNumber ofobservations

Dependentvariable

46 19.3 21.5 0563MVI/C*Full sample

Variable1 Slope1 t-Stat1

P-value1**

Percent

ROIC

Variable2 Slope2 t-Stat2

Growth 2.0 3.4 0

P-value1**

PercentVariable1 Slope1 t-Stat1

VALUE OF COMMODITY CHEMICAL COMPANIES DRIVEN BY ROIC AND GROWTH

*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

Market value/Capital ratio, 2002*

Below average Above average

ROIC

Sales growth

1.5 1.6

1.3 0.5Below average

Above average

analyzing growth

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