The Four Disciplines of Superior Value Growth
Ron Langford & Richard Steele
As companies plot their strategies for postrecession
expansion, it is worth revisiting a
basic principle of shareholder value creation
that fell by the wayside during the last recovery:
revenue growth and shareholder value growth
do not always go hand in hand. Rather, as
investors in companies such as Vivendi and
Tyco learned recently, revenue growth that
does not deliver growth in economic profit
(earnings less a charge for the cost of capital)
produces mediocre and even disastrous results.
In our work with many of the top value
creators in North America and Europe over
the last 20 years, we have observed that four
core management disciplines are required to
deliver both revenue and profit:
- When establishing growth ambitions,
successful companies set shareholder
value growth targets and link them to all
levels of the organisation;
- When developing strategies, they strive for
opportunities to be distinctive and
profitably different from industry peers;
- When allocating resources, they make
highly selective decisions about where to
focus time and money rather than
spreading their bets;
- When looking for new opportunities, they
seek options that not only will increase
their bottom line, but also will create value
for their customers.
1. Set the right ambition
Many companies establish stretch revenue
growth goals with the intention of stimulating
their organisations to look harder for growth
opportunities. But unless goals are set
carefully, they can actually hinder value growth
or even destroy value outright. Often senior
managers specify top-line growth goals or
customer acquisition goals regardless of the
underlying economic profit margin of the
business or product. The received wisdom is
"book the revenue now, figure out how to make
money later". We also find that managers set
the same growth goal for each organisational
unit in the company (e.g., "double-digit growth
in every business"). The belief is that the
benefits of simplicity and perceived fairness
outweigh the costs of adapting goals and
targets to different units. However, the result
is that some units are "understretched" while
others are hopelessly "overstretched".
Perhaps most dangerous, though, are those
managers who set "BHAGs" - big, hairy,
audacious goals that motivate some people,
but either discourage others or push them to
unnecessary risk-taking and ultimately value
destruction. One consumer products company
with which we are familiar had in place a goal
to increase the number of customers it served
by 10 million over five years. Needless to say,
such goals can wreak havoc if new customers
are targeted without concern for the costs of
acquiring, retaining and servicing them.
Companies that are serious about
translating revenue growth into value growth
tend to take a different, more considered
approach to target setting. Instead of focusing
on a number of "line item" goals that are hard
to isolate and control (e.g., revenue growth of
10%, gross margins of 35%, turn working
capital four times), they invest their time in
accelerating and sustaining the growth in
economic profit. For example, to rank in the
top quartile of shareholder value growth
performers, companies need typically to
double the price of their stock in four years.
This objective can be directly (and
mathematically) translated into specific
economic profit targets for businesses, making
it clear to each group within the company the
level of economic profit growth they will have
to earn to contribute to the corporate value
creation goal.
When Matt Barrett became chief executive
of Barclays in 1999, he implemented a similar
approach to target setting throughout the
business. The overall objective was to set
targets that would double the value of the
company in four years. To do so, Barrett
assigned ambitious economic profit targets to
reflect the different markets and competitive
situations of each of the business units. Figure
11
shows how businesses can be given different
types of goals depending on their track record
and the difficulty they will have meeting the
group's overall objective. By taking this
approach to target setting, CEOs can be sure
that new goals will raise significantly the odds
of achieving higher levels of sustainable
profitable growth.
