Transcript Creating a Robust Pricing Strategy to 2010 – EC Presentation

Analyzing Growth
To analyze the growth of a company, we proceed in four steps:
Disaggregating growth into three main components
Step 1
Growth can be disaggregated into three components: (1) portfolio momentum,
(2) market share performance, and (3) mergers and acquisitions.
Growth and value
Step 2
Step 3
Step 4
Growth 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 growth
Sustaining 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 data
We 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
0
grow.
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
• 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.
1
Types of Growth and Value Creation
Value Creation Spectrum
Above-average value creation
1
2
•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
3
•Gain share from rivals through incremental innovation.
•Gain share from rivals through product promotion and pricing.
•Make large acquisitions.
2
Above-average value creation
1
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.
3
Average value creation
2
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.
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.
4
Below-average value creation
3
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.
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 giveand-take, but rarely a permanent share
gain for any one competitor.
5
Sustaining Growth and Product Life Cycles
• Sustaining growth is difficult because
most product markets have natural life
cycles.
Variation in Product Life Cycle
• 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.
6
Patterns of Growth
• 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
7
Empirical Analysis of Growth—Three Takeaways
How does the intuition provided in the previous sections match up with empirical data?
1
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.
2
3
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.
8
Real Revenue Growth of 5.4 Percent
1
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.
9
REVENUE GROWTH FOR NONFINANCIAL COMPANIES
3-year rolling average of real revenue growth
Percent
CAGR
Percent
15.4
6.3
-0.2
Source: Compustat; McKinsey & Company’s corporate performance database
Growth across Industries
2
• 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
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
11
REVENUE GROWTH BY INDUSTRY GROUP*
Percent
Annual real revenue growth**
1963-2003
1994-2003
Software and services
Semiconductors and
semiconductor equipment
Health care equipment and services
19.9
15.4
10.1
9.9
Commercial services and supplies
9.4
Telecommunication services
9.3
Hotels, restaurants, and leisure
8.5
Energy
8.3
Media
7.7
Retailing
7.6
Transportation
7.4
Food and staples retailing
6.3
Total sample
6.3
Automobiles and components
15.6
11.0
18.5
8.0
14.8
9.2
8.6
6.8
5.3
8.0
5.9
Household and personal products
5.4
7.9
4.6
5.1
4.8
Utilities
4.5
Food, beverage, and tobacco
4.3
Materials
13.8
10.5
Pharmaceuticals and biotechnology
Consumer durables and apparel
16.1
13.1
Technology hardware and equipment
Capital goods
20.1
3.9
* Based on S&P Global Industry Classification Standard
** Geometric mean of annual median
Source: Compustat; McKinsey & Company’s corporate performance database
5.9
4.6
4.2
3.3
3.8
Sustainability of Growth and ROIC
3
• There is a weak case for sustained
growth of a firm over long periods.
Wal-Mart and eBay: Growth Trajectories
• 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.
13
REVENUE GROWTH DECAY ANALYSIS
Median growth of portfolio*
Percent
Revenue
growth
Percent
>20
15-20
10-15
5-10
<5
Number of years following portfolio formation
* At year 0, companies are grouped into one of 5 portfolios, based on ROIC
Source: Compustat; McKinsey & Company’s corporate performance database
REVENUE GROWTH RATE FALLS DRAMATICALLY FOR
COMPANIES REACHING FORTUNE 50
Before entrance to Fortune 50
After entrance to Fortune 50
Average annual real revenue growth rate
Percent
28.6
20.0
15.0
13.5
9.5 9.0
2.1 2.8
0.7 1.2 0.1
2.0 1.4
5.1 4.5
-0.1
-0.7 -0.7
-5
-4
-3
-2
-1
0
1
2
3
4
5
-1.6
6
7
8
9
10
11
12
Years from entrance into Fortune 50
Source: Corporate Executive Board, “Stall Points: Barriers to Growth for the Large Corporate Enterprise”, 1998
13
-3.9
14 15
REVENUE GROWTH TRANSITION PROBABILITY 1994-2003
Three-year rolling average of real revenue growth rate
Percent
Revenue growth in 2003
<5
5-10
<5
5-10
Revenue
growth in
1994
67
64
10-15
61
15-20
59
>20
56
10-15
15
8
15-20
>20
Total
3
7
100
5
100
16
12
3
15
11
4
9
100
5
11
100
13
100
11
13
Source: Compustat; McKinsey & Company’s corporate performance database
14
10
8
THEORETICAL RELATIONSHIP BETWEEN
MARKET VALUE, ROIC, AND GROWTH
WACC = 8%
ROIC
Percent
Market value/capital ratio*
10
9
15
8
7
12
6
5
4
9
3
2
1
6
0
0
5
Revenue growth
Percent
10
15
20
* Assumes a competitive advantage period of 10 years, after which ROIC = WACC is assumed
25
EMPIRICAL RELATIONSHIP BETWEEN MARKET
VALUE, ROIC, AND GROWTH
Sample of 563 North American companies
ROIC
Percent
Market value/capital ratio, 2003*
8
<15
7
6
5
12-15
4
9-12
3
2
6-9
1
0-6
0
0-5
5-10
10-15
15-20
Revenue growth 1993-2003 CAGR
Percent
* Defined as market value of operations divided by invested capital including goodwill
** ROIC based on invested capital including goodwill
20-25
REGRESSIONS OF MARKET-VALUE-TO-CAPITAL
WITH ROIC AND GROWTH
Dependent
variable
Full
sample
Number of
observations
R2
Percent
Variable1
Slope1
t-Stat1
P-value1**
Percent
563
46
ROIC
19.3
21.5
0
Slope2
t-Stat2
P-value2
Percent
2.0
3.4
0
Slope1
t-Stat1
P-value1**
Percent
0.25
0.76
3.22
2.14
7.99
0.52
0.82
2.83
1.43
3.18
60
41
1
16
0
MVI/C*
Variable2
Growth
ROIC cohort
Percent
Dependent
variable
0-6
6-9
9-12
12-15
>15
MV/IC*
MV/IC*
MV/IC*
MV/IC*
MV/IC*
Number of
observations
93
146
124
61
139
Variable1
Growth
Growth
Growth
Growth
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
VALUE OF COMMODITY CHEMICAL COMPANIES
DRIVEN BY ROIC AND GROWTH
Market value/Capital ratio, 2002*
Sales growth
Below average
Above average
Above
average
1.5
1.6
Below
average
1.3
0.5
ROIC
* 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