CONFIDENTIAL

Grow or Die? Why growth is essential to companies and how to

achieve it

Lecture to the “Strategy and Strategic

Analysis” class

Brussels, November 22, 2012

This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organisation without prior written approval from

McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

1

Why growth is important?

“Growth itself contains the

germ of happiness”

- Pearl S. Buck

“All growth is a leap in the dark, a

spontaneous, unpremeditated act

without benefit of experience”

- Henry Miller

“I did not have implants, I just

had a growth spurt”

- Britney Spears

“All growth depends upon activity. There is no

development physically or intellectually without effort,

and effort means work”

- Calvin Coolidge

“The growth and development of

people is the highest calling of

leadership”

- Harvey S. Firestone

“He who moves not forward,

goes backward”

- Goethe

“Intellectual growth should

commence at birth and cease

only at death”

- Albert Einstein

“Without continual growth and

progress, such words as

improvement, achievement, and

success have no meaning”

- Benjamin Franklin

“Ever since I was a

child I have had this

instinctive urge for

expansion and growth.”

- Bruce Lee

2

Why and How to Grow?

Performance 3

Risks 4

Value creation

Growth and Value 1

2 Survival

2

Limit 5

Success vs. Failure 6

3

Where should you invest?

High starting ROIC

Low starting ROIC

Improve ROIC Grow

aggressively

Strategy

1

We are in 1996 and you have just received USD 200,000 to invest in four types of

companies (minimum 2 types of companies – USD 100,000 in each):

• Companies with low Return on Invested Capital (ROIC<6%) having as strategy either

to grow or to improve margins

• Companies with high ROIC (>20%) having as strategy either to grow or to improve

margins

As you want to maximize the return on your investment in 2006, what should you have

done? (where do you place your money in the matrix)

4

By choosing the right strategies, you would have generated USD

310,000 more than with the other one USD1

High

starting

ROIC

Low

starting

ROIC

Improve ROIC Grow aggressively

Strategy

180,000 340,000

160,000 310,000

+160,000

+150,000

1

Main reason is that growth

creates value as long as

ROIC > WACC or Value =

(ROIC-WACC)/g

1: Total return for Shareholder in 2006 of USD 100,000 invested in 1996 in each strategy

5

Higher

TRS exhibited in high

growth companies

Growth is essential to value creation Percentage of US top 100 companies

Total Return to Shareholders (TRS) 1984-2004

Annual, percent

11

14

+28%

Below GDP

growth ’84-’941

(59)

Above GDP

growth ’84-’941

(35)

1

1: US gross output growth ’84-’94: 5.5% CAGR

2: I.e. failed to survive independently due to bankruptcy or M&A

Source: Global Vantage, Datastream, McKinsey analysis

6

Why and How to Grow?

Performance 3

Risks 4

Value creation 1 1

Limit 5

Success vs. Failure 6

Survival 2 Grow or Go

7

Grow or go matrix: a 20 year view of large company growth First decade performance distribution 1984-1994, 100 Largest US Companies

High

Low

Revenue

Low High

TRS

S&P 500

GDP

Unrewarded Growth giants

Challenged TRS performers

11 29

33 27

2

8

Death rates2

6x higher in low

growth companies

Growth is essential to survival Percentage of US top 100 companies

Survival rate in 2004

Percent

63

94

+50%

Below GDP

growth ’84-’941

(59)

Above GDP

growth ’84-’941

(35)

2

1: US gross output growth ’84-’94: 5.5% CAGR

2: I.e. failed to survive independently due to bankruptcy or M&A

Source: Global Vantage, Datastream, McKinsey analysis

9

Why and How to Grow?

Performance

Risks 4

Value creation

To Move or Not To Move

1

2 Survival

2

Limit 5

Success vs. Failure 6

3

10 Source: McKinsey Granularity of Growth

Intro question: What are the key sources of growth for a

large company and how does that compare with GDP

growth?

Growth

cylinders

Total revenue

growth

The revenue growth your company

achieves through growth of the segments

in your portfolio

Portfolio

momentum

Growth achieved through gaining

or losing share from competitors Share gain

Net revenue growth achieved when

making acquisitions or divestments M&A

3

Description

11

On average, large companies do not grow by gaining share Revenue CAGR breakdown (average), Percent, 1999–20051

0.4

3.1

6.6

10.1

3

Growth

cylinders

Total revenue

growth

Portfolio

momentum

Share gain

M&A

Large company average

To be

compared

with 3.9%

GDP growth

1: 416 fully decomposed companies

Source: McKinsey Large Company Growth Decomposition Database

12

21

33

46

It’s about “where to compete”: Holding or Acquiring

the right cards 4x as important as playing your hand well Percent M&A

Portfolio momentum

Share gain

Overall sample1 … … and by sector

3

37 40 22

Retail and wholesale 29 43 31 26

High Tech 38 48 16

Healthcare 32 47 37 16

Telecom 32 53 29 18

Financial Institutions 51 46 32 21

Consumer Goods 72

36

Media & Entertainment 24 32 56 11

EPNG 28 43 43 14

1: 416 fully decomposed companies

Source: McKinsey Large Company Growth Decomposition Database

13

Decision on where to compete to be taken at granular level

35

18

12

8776555544443332

-1-2

Δ =37%

U T S F E D C B A R Q P O N M L K J I H G

Telecommunication companies

2

-5

-3

3

5

8

9

Product 2 12

Product 1 32

Product 3

Product 4

Δ=46%

Product 10 -14

Product 9

Product 8

Product 7

Product 6

Product 5

3

Market momentum of Telecom industry

CAGR 1999-2005, Percent

Momentum spread within one

company’s portfolio

14

Why and How to Grow?

Performance

Risks 4

Value creation 1

2 Survival

2

Limit 5

Success vs. Failure 6

3

Beware of the leverage mirage

15

Growth (or decline) leverage

As in

• Debt leverage

• Backward integration

• Use of "invariable" labor

• …

Break-even point

Profits

Revenues

Costs

Volumes

∆ Profits > > ∆ Revenues

Watch the

true risk

EXAMPLE 4

16

Assessing "good" growth

From To

Only margin (growth) matters • Margin and capital growth 4

Positive sales leverage • Positive and negative sales

leverage

1

Building fixed costs • Flexibilizing down fixed costs 3

Volume and price increases • Favorable and unfavorable

price/volume correlations

2

Business as going concern • Continuity and disruptive thinking 5

4

17

Why and How to Grow?

Performance 3

Risks 4

Value creation 1

Culture and Sustainability

1

2 Survival

2

Limit 5

Success vs. Failure 6

Culture drives growth (or limits it)

Time with customers

Generation of leads and sales

Time on admini-strative process and credit applications

Bankers prefer administrati-ve tasks to selling

Admini-strative tasks in most bankers’ comfort zone

Less pressure when doing “visible” admini-strative and credit tasks

Most bankers have introvert perso-nalities

Most bankers are less skilled at sales

Managers act as supervisors rather than coaches

Managers pay attention to “paper trail”

Ability to acquire new customers

Performance initiation Causes of performance limitation Cultural causes

▪Disconnect between bankers’ identity as technical/ product experts and the selling

▪Sense that one cannot be both a technician and a salesperson

Time with customers

▪Development involves mastering technical processes, not coaching on interaction quality

▪Management by defined and supervised activities (vs. results) cascades into an absence of trust and empowerment

Why aren’t bankers spending more face time with customers?

Why so much time doing credit and administration?

Why too little time coaching?

Why customer-facing time uncomfortable?

EXAMPLE

18

5

Retail banking branch network expansion

Low

Primary customer

market share by

micromarket

Number of branches/€

economic activity

Branch share

Number of bank’s branches/total branches

High

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.0 0.1 0.2 0.3 0.4 0.5

5

Source: McKinsey analysis 19

Companies do have a natural limit to how fast they can

grow

Environment and company specific characteristics :

NON EXHAUSTIVE 5

• Historical/embedded cultural elements of the institution

that prevent/limit growth

• Increasing risks you face / need to take to grow faster

(e.g., Insurance, banking) – “Things you don’t know that

you don’t know”

• Price elasticity in specific markets

• Investments required (long lead time in capital

intensive industries)

• Ability to manage large-scale or multiple smaller scale

acquisitions

• Development of talent and resources – the "learning

pyramid" in service industry

• Ability to generate cash-flows – the "EBITDA trap"

20

21

Why and How to Grow?

Performance 3

Risks 4

Value creation 1

Rigor in execution

1

2 Survival

2

Limit 5

Success vs. Failure 6

22

-1.7

1.3

2.0

2.0

Large Deal

Tactical

Organic

Selective

Programmatic 2.8

Global 1000, median excess TRS1, Dec 1999 – Dec 2010

Percent

High volume M&A yields higher returns with a

lower risk than relying exclusively on organic

growth or any other approach to M&A

M&A is a central element of the achieved growth

of the highest return companies

1 Outperformance against global industry index for each company

SOURCE: CPAT, Dealogic, TPSI database v73 2011

Average and

95 confidence

interval

23

Beating the odds takes not only luck, but execution effectiveness

in strategy, transaction and integration

Focus on 2-3 themes and address each theme

Invest in sourcing and clearly defined

screening process

Toolkit for relevant deal types with feedback

loop for learning

Clearly define roles, responsibilities and

decision-making

Size, structure and reflect the strategy

Early, early, early, plus role clarity and a

culture of accountability

Strategy 1

Sourcing and

screening 2

Tools and

learning 5

Governance 3

M&A

organization 4

Integration 6

SOURCE: Transactions service line

IBM’s Transformation and Growth Journey: M&A Strategy to Integration

24

Strategy 1

▪ Strategy to move from hardware to software and services business

▪ Divestitures and M&A used for this transformation & growth

▪ Over 125 transactions in 10 years drove strategic & financial objectives

▪ 2015 roadmap growth themes for M&A: Cloud, Analytics & Smarter Planet

Sourcing and

screening 2

▪ Corporate & Bus Units (BU) have specific targets to meet growth strategy

▪ Corporate & BU Sourcing & Selection are proactive to meet strategy GAPS

▪ SVP M&A Strategy Forum every 6 weeks to align senior leaders on M&A

Governance 3

▪ Corporate Deal Committee meets weekly all year and hosted by CFO

▪ Corporate & BU’s have clear roles & responsibilities in M&A process

▪ M&A delegation levels to Corporate and BU’s are issued by BoD

M&A

organization 4

▪ Corporate Development has three teams: Strategy, Execution, Integration

▪ Corporate Development an enabler to the BU’s with fudiciary responsibility

▪ BU’s have own BD organizations with clear roles & responsibilities in M&A

Tools and

learning 5

▪ Playbooks relevant for multiple deal types with feedback loop for learning

▪ Collaborative M&A end-to-end tool used globally by over 5,000 members

▪ Bootcamps for all Integration Leaders including Sales Fast Start

Integration 6

▪ Leadership focused on Integration Leader, Acquired Leaders & Alignment

▪ Execution focused on Value Driver Plans, Fast Start & Culture & Change

▪ Enablement invested in dedicated teams, global tools, lessons learned

▪ Performance process drives sponsor accountability, focus & results

SOURCE : Interviews

25

Wrap up

Value creation

Growth and Value 1

Survival 2 Grow or Go

Performance To Move or Not To Move

Risks Beware of the leverage mirage 4

Limit Culture and Sustainability

Success vs. Failure Rigor in Execution

3

6

5

Growth Remains an Art: More than one way to move

Beginning

"Virgin Tour"

Vogue

Evita

Pensive/Pop

Retro

"Sex"

Children

books

Var-

ious

Evita

Author

Model

Actress

Designer

Musician

Rolling

Stones (old)

Some solos

Rolling Stones

(reunified)

A few small

roles

Actor

Musician

Growth staircase – Mick Jagger Growth staircase - Madonna

Source: Wikipedia, Rob Verhoest photos, Morrisonhotelgallery.com, McKinsey 26