Why grow? This is a question that nobody asks, let alone answers. It's taken for granted in organizations that growth is good and non-growth is bad. Yet you can easily imagine a situation, growthless but not seriously declining, that is highly agreeable.
Suppose that you own a debt-free, private business - My Goldmine, Inc. - that earns an effortless, steady $1 million in after-tax profits, representing a much higher return on capital than any safe financial investment could provide. You and those family members who work or share in the business draw handsome incomes from this lucrative cynosure. Why grow?
One answer is that earning $2 million a year is twice as agreeable as earning a million - other things, like the strain of running the business, being equal. In fact, effort will be required to double up, which is why many privately owned businesses rest content with My Goldmine, Inc. But there are no guarantees. These relatively tiny lodes can be easily destroyed by the avalanche of change - and thousands are.
GROWTH EQUALS CHANGE
For growth, read change. The usual ways of defining and measuring growth mislead and misrepresent. These yardsticks are mostly financial: above all, expanded sales and/or higher profits. You can understand such an emphasis in a public company. If its financial profile doesn't change, the share price (in theory) won't rise. Time was when investors bought shares for dividend income. That notion has long since been superseded by the cult of the equity. Investors want capital gains. That's another financial definition of growth - an increase in "shareholder value".
The value of a share, however, as the sage Warren Buffett has explained tirelessly, is founded on the intrinsic value of the underlying business. That ultimately derives from non-financial performance. Does My Goldmine Inc. have a strong and improving customer franchise? Is the management able, up-to-date and up to the mark? Are operational efficiencies continuously rising? Is the company investing and planning well for the future? Is it stronger than the competition on every count that matters to customers?
This list could be longer. But all the questions revolve round another. Is the company geared to change? My Goldmine only makes lasting sense in an unchanging environment. But even in less turbulent times than the 21st Century, change is omnipresent. Societies change, technologies change, markets change, competition changes. My Goldmine's strategy - not changing at all - is not just ill-advised. It's impossible.
If others change and you don't, your relative position alters. So you change - or worse, are changed. A good illustration is price. If the competition lowers a price and you don't, you have changed the only price that counts - the relative price. The customers care only for the best value for money. If the competition raises a price, and you don't, you have cut your price. That may or may not be a great idea. As for prices, so for every other component of the business model. If the technology changes, and you stay put, for obvious example, the results will be catastrophic.
BIGGER ISN'T BETTER
But what about size? Among financial services executives surveyed on behalf of Unisys, a thumping 86.8% agreed that their companies had to grow. Yet 48.1% "specifically disagreed that bigger is better". Strategic planners were the parties pushing most strongly for growh and size, and chief executives apparently follow, sometimes reluctantly, in their wake. One way or another, though, size wins. CEO Sir John Browne was only typical in deciding that giant BP was merely "medium-sized" and that its future demanded vastness - hence the Amoco and Atlantic Richfield super-mergers.
The contrast with businesses like My Goldmine couldn't be greater. They mostly have an in-built resistance to growth and scale. Put the arguments for expansion to an audience of owner-managers - Goldmine bosses - and they will see the force of the logic. Acting on that logic is another matter entirely. In 1999, the Year of the Dot.com Boom, I talked to a thousand or so proprietors up and down Britain, courtesy of the accountancy giant Ernst & Young. The numbers considering themselves to be Visionaries (as opposed to Pragmatists or Conservatives) were very small.
The Pragmatists dominated - this is the Wait-and-See brigade, the people who prefer to let others try new things first and to act only when it is demonstrably necessary. Actually, the Pragmatists are mostly closet Conservatives: both types are averse to change, tend to deny its importance, and really hope, even against hope, that they will be able to avoid action altogether. I was able to prove this uncomforting assertion with a simple test - an exercise in How to Become a Visionary.
Just get a sheet of paper, I told the audiences, and write at the bottom a short, succinct description of where your business is now - using absolute and if necessary hurtful honesty. At the top of the paper, write down where you want the business to be in x years time - the period is not important. Then write down the major steps that you think will be necessary to get from the bottom to the top of the paper. Congratulations: you're a Visionary.
Ever the optimist, I asked how many of the audience would go home and invent their futures, expecting a clear majority. I got a miserable collection of a few raised hands. Those people, no doubt admirable at business in many ways, hankered after My Goldmine, a company that would fly into the future on autopilot. In their minds, they understood that this would almost certainly not work. In their hearts, they shied away from the inexorable consequences of change.
SPECTACULAR CHANGE
The same phenomenon can be seen with even more clarity much higher in the corporate world - at the very top. Among the world's largest companies, only General Electric has consistently shown an appetite for change, not just through mergers and acquisitions, but through processes and people. The recent, huge Honeywell buy will test the true quality of CEO Jack Welch's work to the limit. But the record to date shows that ardent pursuit of progressive change can pay off in spectacular rises in shareholder value.
For the opposite end of the change spectrum, look at IBM, once the most admired company in the US and the world, renowned for its management, its technology, its products, its sales and marketing drive, and its innovation. The company abounded with plans and planners, but it was no longer driven by Visionaries in the 1980s. The Pragmatists were in command and control. Wait-and-see had worked brilliantly for them in the past. Fourteen years after Digital Equipment produced the first mini-computer, IBM entered the market. Eventually, its AS400 caught up and spun money by the billions. Four years after the Apple II launched the era of true personal computing, IBM crashed into the market. Its PC swept past Apple.
In laptops, IBM lagged five years behind Toshiba. But the world and the industry had changed - and IBM hadn't. Today time-lags have become irreversible. Confident that it would catch up, IBM never came near its leading laptop rivals. Far worse: market share in PCs collapsed because IBM's thinking was locked into the large mainframe computers that had made the company's fortunes and its awesome reputation. The unthinkable became reality. IBM went ex-growth.
Its fabulously rewarded CEO, Lou Gerstner, imported from American Express, has achieved stardom for his feats in arresting the company's decline. But in 1989, IBM's sales were $63.4 billion and its profits $3.8 billion. In 1999, despite a fantastic boom in industry-wide computer hardware and software sales, IBM's sales were up 38% - the kind of gain Cisco and Microsoft have been recording in a year, let alone a decade. True, IBM profits have doubled in the decade: but the new superstars do that in a couple of years.
WHAT SHARE PRICES SAY
The IBM share price has also recovered handsomely from the doldrums. But the share price measures only one thing: the share price itself. That is the net result of the balance between buyers and sellers of the stock. It has a relationship to underlying values, but that relationship is tenuous, volatile, unpredictable, unreliable, irrational, often downright silly. As a measure of corporate performance, the share price is meaningless. Yet this is the standard to which corporate chieftains committed themselves hook, line and sinker, in the Nineties.
Their task, they declared nobly, was to grow the aforementioned "shareholder value". The message sped round the world. In Germany, Jurgen Schrempp was its foremost advocate. Under that banner, his company, Daimler-Benz, destroyed 60% of shareholder value in a single year, thanks mainly to a horribly bungled acquisition of Chrysler. It may be that at some future point happy investors will applaud Schrempp's strategies as masterstrokes. More likely, the mistake will be buried by history.
Managers (and the stock market analysts who feed their vanity) have been led up a deceptively attractive garden path. All equity investors seek value: they buy a share in the hope or expectation that at some time or other they can realise that value by selling the share at a higher price. That chance clearly depends on how much they pay in the first place.
If the price is less than the underlying value of the business, well and good. If future increases in value are already recognised ("discounted") in the share price, how is management going to oblige? All these issues have been patiently explained over the years by Buffett, probably the greatest pure, straight investor of all time. He has laid down some unarguable precepts.
1. Every business has an intrinsic, underlying value - the worth of its future earnings, discounted for the passing of the years.
2. Business value arises from the strength of the customer franchise and of the market that those customers represent.
3. Acquisitions only grow business value if the buy is fairly priced - which is unlikely, because the buyer is normally forced to pay a premium.
4. Management's job is to increase the intrinsic value, not the share price, which is evanescent.
ORGANIC GROWTH
This is an unassailable case for organic growth, ultimately the only kind worth having. Even mergers must pass the organic test. Welch's purchase of Honeywell will be justifed only if the results include organic improvement in either Honeywell's or GE's performance, or both.
The growth issue is as simple as Buffett suggests. What is the present worth of the business? What creates that worth? How good is management at protecting its current strengths and creating new ones to take advantage of change? The basic exercise which I recommended to those thousand managers applies. Where precisely is the business now? Where do you want it to be then - at a chosen date in the future? What must you do to move from now to then?
Even if "you" are the entire owner of the company, others depend for their lives and livelihood on its business, and "you" depend on them for the essential contribution to its value. Indeed, they are a major part of that value. How well are "you" using that valuable asset and increasing its worth? Without their full contribution to the plan, it is far less likely to be either good or well executed. Treat the company as everybody's My Goldmine, and that makes it far more likely to start growing genuine, organic nuggets for everybody - and especially you.
