It’s easy enough to grow by acquisition or launching a new line that increases revenue dramatically. Such growth initiatives, however, may not be as sustainable or profitable as those that are generated by taking a good and thorough look inside the company itself. These authors describe why enhancing a company’s existing competencies is a much better strategy than one that champions growth for growth’s sake.

“Growth for the sake of growth is the ideology of the cancer cell.”
Edward Abbey, Writer and environmental activist

Many people like to believe that Edward Abbey, despite his typically black humour, misjudged human nature. Unlike Abbey, we believe that growth for the sake of growth is what drives capitalism. However, without endorsing Abbey’s entire world view, we’d like to suggest that the truth of the matter is that growth for the sake of growth is overrated, shortsighted and addictive.

Today, growth-for-its-own-sake axioms are everywhere: “Growth creates shareholder value.” “The markets heavily reward growth, whether it’s organic or merger-related.” “Once the growth pedal is pushed, never back off from market expectations or your share price will be hammered.” Because many people believe these axioms to be true, they often serve as a foundation for a great deal of strategic thinking.

We say that such axioms are not always true, and that their truth depends on other factors. We believe that increasing shareholder value depends on a growth strategy that builds competencies in three areas:

  • Operations: becoming the lowest-cost, highest-quality competitor in your industry
  • Organization: breaking through growth barriers in your organization and building a growth culture
  • Strategic marketing: using the 4Ps of marketing—product, place, price and promotion—to meet customer needs profitably.

Indeed, absent these competencies, a strategy of growth for its own sake is a trap that’s hard to escape. It’s also overrated because it’s not necessarily attuned to the actual drivers of profitable, long-term growth. Abbey complained that too much economic growth destroyed the very natural beauty that made some places special. We believe that too much growth can sometimes destroy the very elements that make some corporations successful.

Indeed, absent these competencies, a strategy of growth for its own sake is a trap that’s hard to escape. It’s also overrated because it’s not necessarily attuned to the actual drivers of profitable, long-term growth. Abbey complained that too much economic growth destroyed the very natural beauty that made some places special.1 We believe that too much growth can sometimes destroy the very elements that make some corporations successful.

For example, consider the case of McDonald’s. Through the late twentieth century, the company was on a roll. You could measure its growth by the number of new restaurants, expanded menus and the “billions and billions served.” But this relentless focus on top-line growth eventually soured. As new stores cannibalized the market for older ones, franchisees couldn’t make money any more. Average revenues per restaurant fell from $1.3 million in 1993 to $900,000 in 2002. Meanwhile, capital expenditures in international markets reduced operating margins from almost 27 percent to 14 percent during the same period.

Franchisees started cutting corners. Food quality suffered, bathrooms got dirty and staff became surly. In 2002, for the first time ever, McDonald’s posted a quarterly loss. With share prices dropping to $16, the company fired its growth-fixated CEO. The new CEO, Jim Cantalupo, actually had the courage to tell Wall Street that McDonald’s was retrenching.

In 2003, McDonald’s began a new “Plan to Win” strategy. It focused on renovating existing stores, improving menus and slowing international growth. With a focus on cash flow rather than new store openings, it sought to revitalize its brand, facilities and service. Components of the strategy included brand and portfolio management (with a new, healthier choice menu and the “i’m lovin’ it” campaign) and a focus on operational excellence to ensure that bathrooms were clean and meals were served fast. Organizational focus and team leadership were so great, with every global employee invested in the turnaround, that the Plan to Win strategy thrived despite the untimely deaths of Cantalupo in April 2004 and his successor Charlie Bell nine months later. The stock price rebounded, in part because McDonald’s, by no longer focusing on growth for growth’s sake, had created the conditions for value-building growth to occur. After that loss in 2002, corporate revenues increased for more than 45 consecutive months.2

Now consider the example of Apple. Most people are familiar with the astonishing growth of its stock price, from $7 in December 2002 to $200 by December 2007. The common view is that the share price increase was driven by a fourfold rise in net sales, fueled by 100 million iPods sold since 2001, three billion iTunes downloads as of August 2007, new generations of computers, and the coming of the iPhone and Apple TV. What was the key to that growth? Not a boldly advertised, merger-heavy growth strategy. Instead, Apple emerged from its late-1990s slump by focusing on innovation and time to market. It identified a portfolio of products with an overlapping user interface, and saw how synergy among iPod devices, iTunes downloads and Mac computers could garner a greater share of each customer’s wallet. To top it off, Apple’s now-famous stores, staffed by self-avowed geeks, provide the perfect setting to view the technology at work and for browsers to be lured into major purchases. Apple, too, has excelled at operational excellence, strong leadership, focus, and outstanding innovation and brand management.

Finally, consider Altria, the parent company of Philip Morris USA—the manufacturer of Marlboro and Virigina Slims cigarettes, among other brands. Everyone is familiar with the huge litigation problems that the tobacco industry has faced. Some may also be familiar with the company’s early-1990s struggles to get out of the growth-at-all-costs trap. Although still considered an unsavory business by many, different respected sources today rank Marlboro’s brand recognition between number 6 and 14 worldwide. It commands a U.S. market share of more than 45 percent and a global market share of more than 25 percent, despite legal restrictions on advertising. What are Altria’s success levers? Solid, global execution of the marketing basics, and the strongest management team in the industry.


Figure 1: Profitable growth depends on three competencies

Source: A.T. Kearney

As Figure 1 demonstrates, we’re not saying that top-line growth is irrelevant. Rather, we have consistently found that profitable growth is an outcome of critical competencies in several areas: scale and operational excellence, organizational focus and leadership, and management of marketing and the 4Ps.

When executive management focuses on building these capabilities, the results are growth and increased shareholder value. We’re not necessarily stating a provable correlation here: Call it a working hypothesis. We think it’s a valuable hypothesis—more valuable than those growth-for-its-own-sake axioms—because it has unexpected implications for management.

Consider the varied and sometimes radical approaches that companies have taken to spur top-line growth in the past. First, consider the examples of unrelated diversification, such as Avon’s 1979 purchase of Tiffany and the TimeWarner-America Online merger of 2000. Or, consider the example of bold-stroke consolidation in the face of breakthrough technology advances, such as Nortel’s Internet-bubble-driven buying spree. In these cases, the most radical aspect of the growth strategy has sometimes been its radically spectacular failure.

This hypothesis suggests that there’s nothing radical about profitable growth. Profitable growth results from successfully negotiating the complex set of tradeoffs between investing in top-line growth and investing in competitive advantage. Our perspective is that competitive advantage, as reflected by total shareholder return (TSR), should be the priority. Indeed, we believe that when you build and sustain competitive advantage, growth opportunities will not only present themselves but also evolve to become profitable. The reason is that investments made in building competitive advantage comprise a sort of “moat” that allows for the space and authority to manage growth actively.

For example, in its retrenchment, McDonald’s reduced complexity in its operations, in part by simplifying the menu. Any new item had to meet the company’s stringent test-kitchen demands for being simple to prepare time after time. It repositioned its brand, refined its pricing strategy and pulled the market segmentation lever, making sure it was targeting young adults and moms with kids.

Similarly, Apple’s growth strategy was to refine its brand positioning and then pull various levers for strategic growth: channel strategy (Apple stores), pricing strategy and, most importantly, customer experience management. By truly understanding how customers were using its products, Apple was able to maximize its manufacturing excellence and supply chain management through “stretch” innovations.

And just recently, in a bold-stroke move, Altria announced that it will spin off its international business, Philip Morris International, and launch new, innovative products around its flagship Marlboro brand to accelerate growth overseas.

Deep dive

To provide a more thorough understanding of the dynamics at work behind our profitable-growth hypothesis, we’d like to conduct an in-depth tour of a single sector: consumer packaged goods (CPG), with a particular focus on food manufacturing. To aid us in our tour, we’ll classify firms in a matrix based on growth and market returns (see figure 2). As you can see, companies in quadrant one, the upper right of the matrix, perform better than average in both sales compound annual growth rate (CAGR, a measure of top-line growth) and total shareholder return (TSR, the best measure of increased shareholder value). These quadrant-one companies are the most successful in growing both revenues and market returns; we call them competitive advantage growers.

Figure 2: Growth versus market returns

In the upper left quadrant, two companies are growth buyers. They’re growing revenues quickly, but that growth isn’t translating in to above-average share performance. Conversely, companies in quadrant three, the lower right, are doing well in the markets but are not growing fast; we call them annuity preservers. Finally, quadrant four, the lower left, reflects underperformers, companies for which both revenue growth and share performance are below average.

The data for the packaged foods sector for 2002 to 2006 show that across the sector, strong revenue growth did not necessarily lead to higher shareholder returns (see figure 3). If it had, you would expect to see results cluster along a quadrant four-to-one diagonal. Instead, fast-growing companies such as J.M. Smucker and Del Monte were growth buyers, with below-average annualized TSR. Meanwhile, some of the most profitable companies, such as Nestlé, Kellogg and the Atlanta-based bakery company Flowers Foods, were annuity preservers.

Figure 3: Sales growth versus market returns in food manufacturing (2002-2006)

One company in quadrant one was Ralcorp Holdings, a leader in private-label foods, which had been spun off from Ralston Purina in the 1990s. After a late-1990s buying spree, Ralcorp spent the period examined here improving its execution. In 2007 (not included in these results), Ralcorp made news with its acquisition of Post cereals—a move that may prove to complement its years of organic growth.

We can best show the difficult choices leading to profitable long-term growth by exploring some of the larger, better-known companies in this sector. For example, Kellogg, an annuity preserver with growth rates almost strong enough to tip it into quadrant one, has a strong, well-managed brand portfolio, giving it pricing power in its breakfast and snack category niches. With an impressive direct-to-store delivery program, it leads its peer group in asset efficiency and operating and net margins. It has a well-focused strategy of reinvesting in brands in growing segments, and its growth is slowed only by its limited international presence.

Sara Lee, on the other hand, has had a tougher time restructuring its operations to improve performance. It continues to winnow a widely diversified portfolio, getting out of lingerie and underwear while retaining businesses in bakery, beverages, processed meats, body care, hair care, insecticides and shoe care. Most of these categories have little room for differentiation, and many of Sara Lee’s brands are not well-known. The company still has business units that operate quite independently, and that cause inefficiency and alignment issues. Also, its regionally fragmented brands prevent exploitation of scale economies. It thus has low asset productivity (especially given its large size) and low operating and net margins.

In other words, these three elements of competitive advantage—operational excellence, strong leadership and strategic marketing—do far more to explain performance at these companies than do commonplace analyses of growth strategies. The same holds true across the sector:

  • In quadrant two, Smucker’s innovation and focused portfolio have driven its sales growth, while its solid record of integration and consistent leadership raises hopes for future potential TSR gains.

  • In quadrant three, Nestlé has many strong brands with growth limited only by the maturity of the markets in which they operate. Its stable leadership is now looking to health and wellness categories to drive future growth and profitability, which also raises hopes.

  • On the other hand, although quadrant four ConAgra had some strong brands, it also had many second- and third-tier brands, which limited its retail pricing leverage. Its acquisitions have not yet been fully integrated, and it saw significant turnover in senior leadership.

In short, revenue growth alone does not explain shareholder returns. Growth for its own sake is not a meaningful strategy. Although some companies, such as Smucker, may be wise to pursue aggressive growth, this is an effect of the company’s market position and skill in integration rather than a cause. Indeed, some companies may be mired in a cycle of unprofitable growth (see sidebar: Managing Your Way to Profitable Growth).

Getting results

CEOs often deplore the level of sophistication their management teams use to manage growth. When a business unit head faces a 5 percent cost reduction target, he or she can generate a slick, thorough implementation plan. However, when the target is 3 percent more growth, the plan often seems little better than scribbles on a cocktail napkin and dreams of which competitor to acquire. One advantage of ceasing the focus on growth-for-its-own sake is that management actions become easier and clearer.

An effective guide to strengthening the three competencies is A.T. Kearney’s stretch growth model (see figure 4). The model identifies four steps for building a growth strategy; you can also use it as a series of questions that you can ask about your company.

Figure 4: The A.T. Kearney Stretch growth model

As you seek to develop a portfolio of growth initiatives, you may emphasize certain individual steps, depending on your competitive position. For a financial institution, it might be to reduce complexity, optimize selling, general and administrative (SG&A) expenses, and work on market segmentation. For a company with weak brands, much of the work might focus on optimizing the product portfolio and brand positioning. Individual corporate strengths and weaknesses, combined with market characteristics, determine how best to stretch for breakthrough growth.

The point is that rather than plunging into radical approaches to top-line growth, the stretch model suggests looking internally. Of course, insights into which areas require investment must be matched by flawless execution of initiatives in those areas. You may choose to link those internal goals to external growth metrics—for example, you might decide that a sales effectiveness initiative should drive 10 percent annual profitable growth for three years. That’s a far cry, however, from growth for the sake of growth.

The real-world improvements

The good news is that pursuing the three competencies—increasing economies of scale through operational improvements, creating a winning organizational culture, and managing brands—is an endeavor an entire corporation can get behind. These are concepts lofty enough to become part of a vision statement that rallies the troops and yet still contains enough tangible, pragmatic mechanisms that can lead to significant real-world improvements. Pursuing competencies may not be as glamorous as announcing a high-profile merger or phenomenal increases in revenues, but it can be far more effective in creating shareholder value.

McDonald’s “plan-to-win” campaign was a rallying cry that all employees could remember and get excited about. Yet at its heart, the entire campaign was a vehicle to address the nitty-gritty details of execution. Ensuring that a special sauce meets its original specifications is about as unglamorous as you can get—with the possible exception of cleaning toilets. Yet such details of execution were exactly what that company and its position within its industry required at that time. It was simply a campaign to get everyone focused on the foundations for excellence rather than mere revenue growth numbers.

What were the long-term results of the move away from its growth-at-all-costs strategy at McDonald’s? The first full year of implementation, 2006, represented one of the most successful years in company history, and by the end of 2007 its share price had risen from a low of $16 to a high of $63.

Managing Your Way to Profitable Growth

If growth for its own sake isn’t really what creates shareholder value, then why do so many companies pursue it? Maybe because it’s easier than doing the hard work required to manage effectively.

For growth to be profitable, you need to go beyond the conventional wisdom on cost management and asset management. You need to get inside your costs to discover what levers to push to enhance your competitive advantage.

Figure A: Strong brands and operational efficiencies increase profitability

First, let’s take a look at cost management. The top of Figure A shows food manufacturing companies’ performance in gross margins—the relationship between the ability to command higher prices and the ability to control production costs. A figure like this can demonstrate the strengths your company needs to build on. For example, the lever for Nestlé and Kellogg to pull is pricing. These companies have strong brands that can control prices, leading to high gross margins through increased revenues. The lever for Flowers Foods is production efficiencies, leading to high gross margins through decreased costs.

The bottom of Figure A shows companies translating those gross margins in to profitability, highlighting another set of key levers. Take Sara Lee, for example: Because of high selling, general and administrative (SG&A) costs, its operating margins were well below the group average even though its gross margins were above average. What does Sara Lee need to do to achieve long-term profitable growth? Not necessarily increased top-line revenues—Sara Lee would be better off pulling a specific lever, in this case getting a handle on SG&A costs. Indeed, by comparison, companies such as Kellogg and Heinz have pulled that lever by using effective management to reduce their SG&A costs relative to gross margins. Their result has been profits.

Figure B: Not all companies take advantage of their scale

Asset management—the ability to translate size in to efficient use of operating assets—is another component of effective management that sets the foundation for profitable growth. Figure B shows that although Kraft and Nestlé have large revenues, they are nevertheless not very efficient in using their assets. Three relatively small companies—Kellogg, General Mills, and Campbell Soup, each with below-average revenues for the group—made better use of scale. Sometimes asset management is product-dependent, and in this case Kraft and Nestlé both produce asset-intensive dairy products.

Often the key issue in asset management is complexity. Kellogg, General Mills and Campbell Soup each have a narrow product focus. Smucker and Lancaster Colony are among the smallest companies in the group, with less than $5 billion in sales, yet they achieved above-average asset efficiency. For these companies, too, managers’ focus on a narrow product niche may have contributed to their profitability. Likewise, underperformers Sara Lee and ConAgra have struggled with unfocused product portfolios. That complexity has reduced their ability to leverage their size to gain efficiency. Again, the lever these companies need to pull is an internal management lever rather than one focused on top-line growth. With internal strategic initiatives aimed at reducing complexity, these companies can manage their way to more profitable growth.

1 The best-known works of Edward Abbey (1927-1989) are the novel The Monkey Wrench Gang (1975), which was widely viewed as a guidebook for eco-sabotage, and the journal Desert Solitaire (1968), in which Abbey argued that development had ruined southeastern Utah. The ideology quote is on p. 98 of A Voice Crying in the Wilderness (New York: St. Martin’s Press, 1990).

2 Michael Arndt, “McDonald’s 24/7,” BusinessWeek, 5 February 2007.