How to Tell Good Growth from Bad Growth

How to Tell Good Growth from Bad Growth

All top-line growth is not created equal. History has shown that most mergers and acquisitions do little to help the long-term health and revenue growth of an organization. Growth that uses capital inefficiently is not the way to go.

How can you tell good growth from bad?

How good growth builds value

Growth of any kind increases revenues. Good growth not only increases revenues but correspondingly improves profits and is sustainable over time. It is primarily organic (internally) generated from the ongoing operations and business of the company and is based on differentiated products and services that meet new or previously unmet consumer needs.

Good growth is thus growth that is profitable, organic, differentiated, and sustainable (PODS). Good growth builds shareholder value over time. In contrast, bad growth destroys shareholder value.

Mergers and acquisitions, a primary example of bad growth, are often based on myopic visions of synergy that have no basis in the reality fo the market place. Instead of 4 plus 4 equaling 10, as promised when the deals are announced, more often than not 4 plus 4 winds up equaling 5 or 6. It is true that a large number of mergers and mega-acquisitions result in one-shot cost synergies - usually cost savings from the elimination of duplication with the merged enterprise - but seldom in an improved rate of revenue growth that is sustainable for the long run.

Compared with growing through a string of major acquisitions, good growth offers better returns over time, is less risky, and saves companies from crippling high debt and cash crises such as those faced by Vivendi and AOL Time Warner.

Vivendi acquired (among other things) Universal Studios, Blizzard Entertainment, and Def Jam. The problem? Vivendi overpaid and used debt to pay for most of those high-priced acquisitions. While the companies it bought were making money, Vivendi as a whole plunged into the red, after taking into account the repayment of interest on the billions of dollars it borrowed. The financial condition of the company became so acute that many wondered if it would survive.

Of course, not all acquisitions are bad. There are times when scale (i.e., your overall size in relation to competitors) matters and it can be impossible to compete against industry giants without it.

Phillips and Conoco were both relatively small fish in the energy market. They were both growing but they were at a huge competitive disadvantage versus ExxonMobil or BP. The Conoco-Phillips merger in 2002 (the new company is called ConocoPhillips) took out costs, and the integration of the two companies has been extremely successful. They have built on each other's strengths.

Similarly, there are times when an industry goes through a consolidation wave. At those moments, you either get bigger or find yourself at a disadvantage.

But, overall, organic growth remains the way to go. It results in a better price-earnings ratio so that when an industry undergoes consolidation, this strength provides a company with the upper hand in making appropriate acquisitions against its competition. The end result is a company with additional scale and scope and greater credibility to go to the next level.