Growth

**Growth**:

## Market Share Gains

- Consistent market share accretion is attractive, especially when you can identify a reliable “share donator.”

- Gains become harder as share grows (easiest customers first) and less impactful for larger players (1% gain doubles a 1% holder’s reach, but only adds 2% for a 50% leader).

## Geographic Expansion

- One of the most challenging strategies; failed attempts can damage the original franchise.

- Past success in multiple markets increases odds of repeating it.

- **Unilever case** – derives ~60% of revenue from emerging markets. In India (Hindustan Unilever):

  - Brands like Sunlight soap (1888) considered home-grown due to longevity.

  - Direct coverage of 3M+ outlets, Shakti program with 70k+ women + 48k men distributing in rural villages.

  - Powerful distribution gives faster new product launches, better consumer insight, continued share gains.

- **What travels well**: premium brands (global media/travel), vertical-integration store operators.

- **What doesn’t travel well**: unique local distribution systems, localized scale advantages, favorable regulation (e.g., grocery retailers, hospitals, airlines struggle to globalize).

## Pricing, Mix, and Volume (Financial breakdown of revenue growth)

- **Price-driven growth** (pricing power) – rarest and most valuable: each extra dollar of price goes straight to pre-tax income. Requires customer insensitivity (luxury, “farm fresh” labels).

- **Mix-driven growth** – e.g., adding premium packages. Valuable, needs modest extra cost, but inferior to pure price growth.

- **Volume-driven growth** – least valuable: increases working capital and capex. Best for asset-light, high-margin, or high-operating-leverage businesses (pharma, software).

## Cyclical Market Growth

- Double-edged: strong growth in expansions, sharp reversals in contractions.

- Example: US hotel cycle after 2008 – Marriott’s EPS tripled from trough, share price up nearly 6x.

- Focus on: (1) companies that deliver real earnings growth *through* the cycle (peak-to-peak), (2) understanding specific cycles to avoid downside.

## Structural End-Market Growth

- Supposedly permanent trends (urbanization, aging, disease prevention). Be skeptical – many “structural” trends turn out cyclical.

- Cautionary examples: US golf (players fell 18% while population rose 6%); China’s consumer appetite for cognac/gambling reversed.

## Persistence of Growth

- Research (Little, Credit Suisse HOLT) shows earnings growth is weakly persistent, almost random year-to-year. High growth rates rarely sustain.

- But a significant minority *do* sustain, especially in the 10–15% earnings growth range (not hyper-growth).

- **Key link**: return on capital is highly persistent and reliably predicts future earnings growth. Companies with stable, high returns (e.g., CFROI) offer better growth predictability.

- Conclusion: forecasting growth is not entirely random – well-positioned companies with high, stable returns can buck the statistical trend.

Creating new S-curves - developing new engines of growth - ideally before the current cycle of growth reaches maturity.

Every business goes through the S-curve cycle of growth: 

• infancy (low growth), 
• expansion (rapid growth) and 
• maturity (slow growth).

No matter how successful the product is, growth must slow at some point (maturity phase), due to a number of reasons:

• increased competition, 
• market saturation, 
• technology disruption, 
• regulatory changes and 
• changing consumer preferences.

VALUE CREATION OR DESTRUCTION:  MANAGEMENT'S ROLE

Ultimately, whether a company remains VALUE CREATIVE OR DESTRUSTIVE, depends on how well management understand this inevitability, its mindset and how successful it is in creating new S-curves - developing new engines of growth - ideally before the current cycle of growth reaches maturity.

New S-curves could include 

• tapping into new selling channels and geographies for the existing products, or 
• it could be expansion into a related business - for instance, starting a new product line and going upstream or downstream, or 
• diversification into something entirely different and unrelated.

In short, the S-curve is dynamic over the company's life, that is, the company should continuously reinvent, reinvest and create new S-curves to start new growth cycles. 

We see real-life examples of how this is done every day.

Companies starting new S-curves to start new growth cycles:

QL started Family Mart

YTL Power entered a new S-curve selling power to Singapore and enters the AI related sector.

Padini started Brands' Outlets.

Scientex growing its manufacturing business organically and through acquisitions and entering the property development sector business successfully.

KGB supplying its products to many industries and to many countries.

Facebook promoting Metaverse (but unsuccessfully).

Microsoft branching into cloud computing and AI.

Amazon continues to reinvent itself, selling books initially, and now selling almost everything. (Many new S-curves)

Of course, growth comes with a price too. 

Some growths can be good and some can be very bad for the companies.

Shareholder wealth in a company is destroyed with failure to find new S-curve.

With no growth or business in decline, value of company shrinks (contracting PE x lower EPS); value is destroyed.

There are many companies in Bursa Malaysia in this category. 

The company's growth plans: Your approach as an investor.

Good growth is exciting for any company that you own.

Growth can be through organic growth or through mergers and acquisitions.

However, as an investor, you should assign little importance to growth plans of the company in your investing decision.

It is far more important the company sets out the right strategy, since growth will follow in due course.

Many short-term growth targets get in the way of taking the right long-term decisions.

As an investor, you should be willing to ride out patchy results, considering this to be part and parcel of business.

On mergers and acquisitions, the investors should have a very clear stance: it is important to avoid the urge to grow for growth's sake; the focus should be on acquisitions that make sense and not overpaying.  It is important to avoid watering down a quality business with inferior acquisitions.

Growth is often seen as the best measure of corporate success.

Growth is often seen as the best measure of corporate success.

A company growing at a rate of 15% per year is doubling in size every five years.

Rapid-growth companies can be defined as those with annual growth rates of 20% or more.

Super-growth companies show a compound growth rate of around 40% per year.

MARKET SHARE INFORMATION

Market share information can provide valuable support to the analysis and interpretation of changes in a company’s turnover.

The majority of companies provide turnover growth details in their annual report, but few offer any details of market share.

When turnover is known for several firms competing in the same market, it is possible to devise a simple alternative to market share information.

Company	A	A	B	B	C	C	D	D	TOTAL	TOTAL
Year	1	2	1	2	1	2	1	2	1	2
Sales ($bn)	2.5	2.9	16	16.3	5.9	5.5	17.2	18.8	41.6	43.5
Share (%)	6	7	39	37	14	13	41	43	100	100

How their share of the joint total market changes can readily be followed.  If this is done for a number of years, the analysis can form the basis for a performance comparison.

RAPID GROWTH COMPANY IS NOT ALWAYS A SAFE AND SOUND INVESTMENT.  RAPID GROWTH CANNOT ALWAYS BE SUSTAINED. 

A common view is that a rapid-growth company is safe and sound investment.

However evidence suggests that rapid growth cannot always be sustained.  There are of course exceptions.  

BE CAUTIOUS OF GROWTH THROUGH DIVERSIFICATION OR ACQUISITION, THROUGH INCREASING DEBT FINANCING AND THROUGH TURNOVER GROWTH WITHOUT PROFIT.

·         However, it is probably safer to assume that rapid growth, particularly if associated with diversification, often through acquisitions, will not continue.

·         If high compound growth rates are matched by increasing debt financing, extreme caution is called for.

·         For some companies, turnover growth is seen as the prime objective and measure of success, even when it is being achieved at the cost of profitability.  In the late 1990s, e-business provided many extreme examples of this.

ONE-PERSON COMPANY

• GROWTH THROUGH DIVERSIFICATION, COMMONLY THROUGH ACQUISITION.

Being pushed towards diversification to fuel continued growth is often the final challenge for the one-person company.  Having proved itself in one business sector it moves into new areas, commonly through acquisition.  More often than not its old skills prove not to be appropriate in the new business, attention is distracted from the core business, and it is viewed as having lost the golden touch.  Its survival may depend on new management and financial restructuring.

• WHEN A ONE-PERSON COMPANY’S GROWTH SLOWS AND CRITICISM MOUNTS

When a one-person company’s growth slows and criticism mounts, two scenarios may occur. 

• ·         In one, the individual running the company begins to take increasingly risky decisions in the hope to returning to previous levels of profit growth. 
• ·         In the other, recognising that there is little that can be done immediately to improve operating performance, the individual steps outside the law and accepted business practice to sustain his or her personal image and lifestyle.  Often in these companies other executives are reluctant to rock the boat and go along with the deception.

The distinction between Profit and Cash. A business can be profitable but short of cash.

Cash is completely different from profit, a fact that is not always properly appreciated.

It is possible, and indeed quite common, for a business to be profitable but short of cash.

Among the differences are the following:

1. Money may be collected from customers more slowly (or more quickly) than money is paid to suppliers.
2. Capital expenditure (unless financed by hire purchase or similar means) has an immediate impact on cash.  The effect on profit, by means of depreciation, is spread over a number of years.
3. Taxation, dividends and other payments to owners are an appropriation of profit.  Cash is taken out of the business which may be more or less than the profit.
4. An expanding business will have to spend money on materials, items for sale, wages, etc. before it completes the extra sales and gets paid.  Purchases and expenses come first.  Sales and profit come later.

Growing versus Non-growing company. Value Investing versus Growth Investing.

A growing company versus a non-growing company


Given the choice, you should choose to invest in a company that is growing its revenues, earnings, and free cash flows over time.  This company continues to grow its intrinsic value and over time, you will be well rewarded for investing in it.


Is investing into growing companies the same as growth investing?

Let us illustrate using company Y.  Company Y is a company that is growing its revenues, and earnings 15% per year, consistently and predictably for the last 10 years.   

At certain times, Company Y is available at a P/E of 10.  Buying Company Y at this stage is a bargain.  It is available at a bargain price.  This is value investing.  If you use PEG ratio of Peter Lynch, it is available at a PEG ratio of 10/15 which is < 1.   

At other times, Company Y is available at a P/E of 20.  Buying Company Y at this stage is not value investing.  Those who buy at this P/E may feel they are also buying a bargain, as they projected that the earnings of Company Y is going to be great and the growth in earnings higher than the 15% per annum in the past.  Maybe they projected that the earnings will be growing  30% per year.   This is growth investing.  If you use PEG ratio of Peter Lynch, it is still available at a PEG ratio of < 1 (= 20/30).

Thus, is there a difference between value investing and growth investing, from a bargain perspective?   There appear to be 2 sides of the same coin.  Those buying into the stock using these strategies are of the opinion they are buying a bargain.   

However, there are differences too.   Historically, value investing has outperformed growth investing when assessed over a long time frame of investing.  But beware of such analysis.   Among the value investing stocks selection, many of the companies did not perform as expected and the fundamentals tanked.   Likewise, those stocks in growth investing, projected to grow at high rate and bought at high P/E, failed to deliver the growth and did not perform as expected.  

Let us learn from Buffett.  Stays with the company that you understand.  This company must have business with durable competitive advantage.  Its management must have unquestionable integrity.  Finally, buy them at a fair price.  

Yes, search out for the growing companies.  I too love such companies.   Above all, emphasizes the quality of the growth of business and its management.   Finally, look at the price (valuation).   Whether it is value or growth investing, buy growing companies at reasonable price (GARP). 

Look at growth from the perspective of investment required to support the growth. Profitable Growth Occurs Only Within a Franchise.

Summary 
Now to summarize about growth:

1. growth at a competitive disadvantage destroys value,
2. growth on a level playing field neither creates nor destroys value, and
3. it is only growth behind the protection of barriers to entry that creates value.

Growth 
 

The standard view of short term analysts is that growth is your friend. Growth is always valuable.  That is wrong!  
 

Growth is relatively rarely valuable in the long run. And you can see why with some simple arithmetic.  I am not going to look at growth from the perspective of sales, I am going to look at it from the perspective of investment required to support the growth. 

• Now the investment required to support the growth is zero then of course it is profitable—that happens almost never (For Duff & Phelps or Moody’s perhaps). 
• At a minimum you have A/R and other elements of working capital to support growth. 

Suppose the investment required is $100 million, and I have to pay 10% annually to the investors who supplied that $100 million dollars.   The cost of the growth is 10% of $100 million or $10 million dollars.   

1.  Suppose I invest that $100 million at a competitive disadvantage. 

• Suppose I am Wal-Mart planning to compete against a well-entrenched competitor in Southern Germany, am I going to earn 10% on that investment?  Almost never.  In that case, I will be lucky to earn anything; perhaps I earn $6 million. 
• But the net contribution of the growth is the $10 million cost of the funds minus the $6 million benefit which is minus $4 million dollars for every $100 million invested. 
• Growth at a competitive disadvantage has negative value.  

 

2.  Suppose it is like the automotive industry or like most industries with no barriers to entry, it is a level playing field so the return will be driven to 10% cost by the entry of other competitors. 

• So I am going to pay $10 million, I am going to make $10 million so the growth has zero value.   

3.  Profitable Growth Occurs Only Within a Franchise 

• The only case where growth has value is where the growth occurs behind the protection of an identifiable competitive advantage. 
• Growth only has value where there are sustainable competitive advantages. 
• And in that case, usually, what barriers to entry means is there are barriers to companies stealing market share from each other.
• There is usually stable market share which is symptomatic of that last situation that means in the long run, the company will grow at the industry rate. 
• And in the long run, almost all industries grow at the rate of global GDP.   

So in these three situations, the growth only matters in the last one where its profitable (growing within a franchise) is.

• And the critical issue in valuation is either management or the G&D approach will tell you the extent to which that is important or you have a good reliable valuation and there is no value to the growth because there are no barriers to entry. 
• Or it is down here (growth is profitable) and there obviously you want to get the growth for free.
• You could pay a full earnings power value and get a decent return. (Buffett with Coke-Cola in 1988).  

Introduction to a Value Investing Process by Bruce Greenblatt at the Value Investing Class Columbia Business School 
Edited by John Chew at Aldridge56@aol.com                           
studying/teaching/investing Page 27

Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf

Growth or the lack of it, is integral to a valuation exercise

The value of a business, a share of stock or any other productive asset is the present value of its future cash flows.

However, value is easier to define than to measure (easier said than done).

Valuing a business (or any productive asset) requires estimating its future performance and discounting the results to present value.  The probable future performance includes whatever GROWTH (or SHRINKAGE) is ASSUMED.

SO GROWTH (OR LACK OF IT) IS INTEGRAL TO A VALUATION EXERCISE.

This supports the point that the phrase value investing is redundant.  Investing is the deliberate determination that one pays a price lower than the value being obtained.  Only speculators pay a price hoping that through growth the value  rises above it.

Growth doesn't equate directly with value either.  

Growing earnings can mean growing value.  But growing earnings can also mean growing expenses, and sometimes expenses growing faster than revenues.  Growth adds value only when the payoff from growth is greater than the cost of growth.

A company reinvesting a dollar of earnings to grow by 99 cents is not helping its shareholders and is not a value stock, though it may be a growth stock.

Value investing is conventionally defined as buying companies bearing low ratios of price-to-earnings, price-to-book value, or high dividend yields.  But these metrics do not by themselves make a company a value investment.  It isn't that simple.  Nor does the absence of such metrics prevent an investment from bearing a sufficient margin of safety and qualitative virtues to justify its inclusion in a value investor's portfolio.

Is Growth Always A Good Thing?

Rapid growth in revenue and earnings may be top priorities in corporate boardrooms, but these priorities are not always best for shareholders. We are often tempted to invest large amounts in risky or even mature companies that are beating the drum for fast growth, but investors should check that a company's growth ambitions are realistic and sustainable.

Growth's Attraction
Let's face it, it's hard not to be thrilled by the prospect of growth. We invest in growth stocks because we believe that these companies are able to take shareholder money and reinvest it for a return that is higher than what we can get elsewhere.

Besides, in traditional investing wisdom, growth in sales earnings and stock performance are inexorably linked. In his book "One Up on Wall Street," investment guru Peter Lynch preaches that stock prices follow corporate earnings over time. The idea has stuck because many investors look far and wide for the fastest-growing companies that will produce the greatest share-price appreciation.



Is Growth a Sure Thing?
That said, there is room to debate this rule of thumb. In a 2002 study of more than 2,000 public companies, California State University finance professor Cyrus Ramezani analyzed the relationship between growth and shareholder value. His surprising conclusion was that the companies with the fastest revenue growth (average annual sales growth of 167% over a 10-year period) showed, over the period studied, worse share price performance than slower growing firms (average growth of 26%). In other words, the hotshot companies could not maintain their growth rates, and their stocks suffered.

The Risks
Fast growth looks good, but companies can get into trouble when they grow too fast. Are they able to keep pace with their expansion, fill orders, hire and train enough qualified employees? The rush to boost sales can leave growing companies with a deepening difficulty to obtain their cash needs from operations. Risky, fast-growing startups can burn money for years before generating a positive cash flow. The higher the rate of spending money for growth, the greater the company's odds of later being forced to seek more capital. When extra capital is not available, big trouble is brewing for these companies and their investors.

Companies often try increasingly big - and risky - deals to push up growth rates. Consider the serial acquirer WorldCom. In the 1990s, the company racked up growth rates of more than 20% by buying up little-known telecom companies. It later required larger and larger acquisitions to show impressive revenue percentages and earnings growth. In hopes of sustaining growth momentum, WorldCom CEO Bernie Ebbers agreed to pay a whopping $115 billion for Sprint Corp. However, federal regulators blocked the deal on antitrust grounds. WorldCom's prospects for growth collapsed, along with the company's value. The lesson here is that investors need to consider carefully the sustainability of deal-driven growth strategies.

Being Realistic About Growth
Eventually every fast-growth industry becomes a slow-growth industry. Some companies, however, still pursue expansion long after growth opportunities have dried up. When managers ignore the option of offering investors dividends and stubbornly continue to pour earnings into expansions that generate returns lower than those of the market, bad news is on the horizon for investors.

For example, take McDonald's - as it experienced its first-ever losses in 2003, and its share price neared a 10-year low, the company finally began to admit that it was no longer a growth stock. But for several years beforehand, McDonald's had shrugged off shrinking profits and analysts' arguments that the world's biggest fast-food chain had saturated its market. Unwilling to give up on growth, McDonald's accelerated its rate of restaurant openings and advertising spending. Expansion not only eroded profits but ate up a huge chunk of the company's cash flow, which could have gone to investors as large dividends.

CEOs and managers have a duty to put the brakes on growth when it is unsustainable or incapable of creating value. That can be tough since CEOs normally want to build empires rather than maintain them. At the same time, management compensation at many companies is tied to growth in revenue and earnings.

However, CEO pride doesn't explain everything: the investing system favors growth. Market analysts rate a stock according to its ability to expand; accelerating growth receives the highest rating. Furthermore, tax rules privilege growth since capital gains are taxed in a lower tax bracket while dividends face higher income-tax rates.

The Bottom Line
Justifications for fast growth can quickly pile up, even when it isn't the most prudent of priorities. Companies that pursue growth at the cost of sustaining themselves may do more harm than good. When evaluating companies with aggressive growth policies, investors need to determine carefully whether these policies have higher drawbacks than benefits.


Read more: http://www.investopedia.com/articles/fundamental/03/082003.asp#ixzz2KA5lFtVB

Growth can either ADD or DETRACT from an investment's value/

Growth in sales, earnings, and assets can either add or detract from an investment's value.

Growth can add to the value when the return on invested capital is above average, thereby assuring that when a dollar is being invested in the company, at least a dollar of market value is being created.

However, growth for a business earning low returns on capital can be detrimental to shareholders.  For example, the airline business has been a story of incredible growth, but its inability to earn decent returns on capital have left most owners of these companies in a poor position.

Have an opinion on future growth - How can the company increase its earnings?

It is only rational to have an opinion on future growth.  Otherwise, how could you ever choose a stock?

When forming that opinion, back up quantitative information with qualitative factors.

For example, ask what management is doing to make a positive impact on earnings.

According to Peter Lynch, there are 5 basic ways a company can increase earnings:

• reduce costs; 
• raise prices; 
• expand into new markets;
• sell more of its products to the old markets; or
• revitalize, close or otherwise dispose of a losing operation.

When management is enacting growth-promoting activities, earnings may be temporarily flat.  They often soon take a giant step up.

Benjamin Graham saw a vulnerability in a high growth rate and in high returns on capital - the two normally go together.

So what's there to worry about in good earnings?  Exceptionally high earnings often attract rough competitors.  

The good part is that high earnings lure enthusiastic new investors, who often bid the share into the stratosphere.


Comment:
Buy good quality growth companies.
Assess the quality of the business and the management.
Then do the valuation.
These are the basics of the QVM or QMV approach to investing.

Good growth is profitable, organic, differentiated and sustainable.

Good growth is profitable, organic, differentiated and sustainable.

Profitable

Good growth is profitable.

It is also capital-efficient, that is, it needs to earn a return on its investment greater than what the company could have received by putting its money in something ultra-safe, such as a Treasury bill.

There is growth in revenues and steady improvement in profitability. Gross margin is an important indicator of a company's profitability and often not given the due it deserves.

Increasing gross margin and at the same time growing revenues at a rate better than the overall market is what makes for a great growth company. There is a direct relationship between improved productivity and profitable growth.

The improvement in gross margin also reflects the company's ability to innovate ahead of its competitors.

A company's rapid growth attracts the best managers in the industry - managers who are committed to growth.

Organic

Organic growth is the most efficient way to create revenue growth.

When people work with customers in the search for new ideas, translating those ideas into reality requires them to cut across silos and come together to make trade-offs and decisions in launching new products. It also builds the organization's self-confidence. Knowing that it has created a successful growth project makes it easier to tackle the next challenge, and the momentum feeds on itself.

Organic growth can also be based on filling an additional customer need and/or exploiting an organization's existing expertise in products, customer segments, or geographic regions, to capture new markets.

While good growth is PRIMARILY organic, there are times when it makes sense to supplement organic growth with smaller "bolt-on" acquisitions to fill strategic gaps, such as gaining a beachhead in a geographic region, obtaining a new technology, filling an adjacent need, or adding a new distribution channel.

Differentiated

No matter how "commoditized" your business is, good-growth companies find a way to differentiate themselves.

Winners in the quest for profitable growth pay attention to differentiation, however razor-thin.

To do that, they see things through the eyes of their customers and potential customers, detect what these buyers prefer, and hook the customer through products, services, and relationships that are better differentiated than those of the competition.

Dell offers a commodity: personal computers. Yet Dell differentiated its product line by making sure its product are reliable, low-priced, and customizable - that is, customers can design their PCs exactly the way they want.

Lexus truly differentiated itself in the post-purchase experience and in mechanical reliability.

Differentiation can also take place in the service that a manufacturer provides to retailers like Wal-Mart. By helping the customer increase its sales, the manufacturer has differentiated itself from being just another firm that the customer does business with.

Sustainable

Good growth continues over time. It has a sustainable trajectory.

It is not a quick spike upward in revenues, caused by cutting prices or by throwing substantial resources against a one-shot opportunity. The goal is to have the growth continue year after year.

-----

The only way this growth is going to occur is if everyone in the organization believes in it to be possible. It is up to the organization's leadership to create the right mind-set.

Good Growth

Good Growth

The best companies, those that will thrive over the long run, grow both the top and bottom lines consistently over time, developing a cumulative competitive advantage that creates shareholder value. They may not turn in the best numbers in the industry when measured over any one short-term period, but their cumulative performance is stellar, thanks to the way they approach increasing their revenues.

Their good growth also strengthens the company's DNA by creating new competencies and strengths, thereby building the skills of its people and confidence in the psyche of the organization.

What makes up good growth?

It is profitable, organic, differentiated, and sustainable. (PODS)

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.

Sustainable Growth

Sustainable Growth



Good growth continues over time. It has a sustainable trajectory. You are NOT looking for a quick spike upward in revenues, caused by cutting prices or by throwing substantial resources against a one-shot opportunity. The goal is to have the growth continue year after year.



For example, the growth of Southwest Airlines has been based on a consitent set of actions. New routes are carefully vetted - the goal is to have them be profitable in less than a year - and turnaround times (the period from when a plane pulls into a gate until it pushes back on another flight) are substantially faster than the industry average, allowing Southwest planes to fly more trips a day than its competitors.



If you look at one of the suppliers to the airline industry, you can see another example of sustainable growth. In this case, the move toward sustainability was prompted out of necessity.



When the airline industry declined in the early 1990s, it led to a decerease in the revenues of firms that sold aircraft engines. GE Aircraft Engines redefined the needs of its airline customers to include not just the engines themselves but also servicing them on a regular basis. Up to that point, a major airline would use the service shop of one company in, say, Chicago and that of completely different companies in its other locations around the world. Some also did the service themselves in their own shops.



GE's new value proposition was to provide total service around the globe. Through innovation, use of information technology, and managerial ability to provide better maintenance, the result would be less downtime for the airlines and lower costs.



For example, doing a major overhaul on its own might have required an airline to fly its plane back empty to its service facility. With service operations around the world, GE can do the work wherever a plane is, which gets the plane back in the air, generating revenues sooner. And because it specialises, GE can do the necessary service work faster, increasing productivity for the airlines once again. Scores of airlines took advantage of the chance to outsource the maintenance part of their business to a single supplier.



Before its chief competitor, Pratt & Whitney, woke up, GE Aircraft Engines captured 70% of the airplane-service market. And, of course, the service contracts tied customers more closely to GE, giving it a leg up in selling the core product -engines - and developing a sustained trajectory of growth by having a built-in-revenue stream, the money that comes in month in and month out from the service contracts.



In this case, the "single" and "double" of adding a service coponent to a product created a platform that is a home run in terms of a sustained, decades-long trajectory of growth. The recurring revenues from the service work are extremely reliable. Not only has GE Aircraft Engines otgrown the competition - its model of adding service to products became a best practice for other GE businesses, which are now adding high-margin service work into their product mix.



It is also an example of building both scale and scope and then learning how to leverage for growth. GE Aircraft's number-one position in the marketplace, combined with organic growth and simultaneous productivity, gave it the leverage to make acquisitions in the service area.



But the only way this growth is going to occur is if everyone in the organization believes it to be possible. It is up to the organization's leadership to create the right mind-set.

Profitable Growth

Good growth has to be not only profitable but capital-efficient - that is, it needs to earn a return on its investment greater than the company could have received by putting its money in something ultra-safe, such as a Treasury bill. Colgate-Palmolive's growth is definitely profitable.



For more than a decade, Colgate has been on a sustained march to becoming number one in the oral-care consumer-products market, and, as mentioned, has edged out both Procter & Gamble and Unilever. As important as its growth in revenues has been Colgate's steady improvement in profitability. Its gross margin has increased from 39% in 1984 to close to 60% in 2003, an improvement of almost one point per year.



Gross margin - your revenue less what it costs to make the product to obtain those revenues - is an important indicator of a company's profitability and often not given the due it deserves. Increasing gross margin and at the same time growing revenues at a rate better than the overall market is what makes for a great growth company. It is here that you can directly see the relationship between improved productivity and profitable growth. Colgate for more than a decade has been able to find ways to consistently enhance its competitive position by making its operations more productive and streamlining its processes.

The improvement of Colgate's gross margin also reflects its ability to innovate ahead of its two chief competitors. Colgate has created a corporate "growth group" with two major responsibilities.

1. The first is to be continuously focused on developing new products, extending existing products, and improving packaging.


2. The second, equally important, job is to concentrate on logistic, production, delivery, and speed and responsiveness to retailers through the effective use of data warehousing, information technology, and cost productivity.

Again, it is an example of a top company recognizing that it must simultaneously improve productivity costs and grow.



Both processes resulted in Colgate's winning shelf space. It also meant lowering costs not only for Colgate but for retailers as well. Colgate reduced what it cost retailers to stock and sell its products while increasing retailers' inventory turns of Colgate products, thereby reducing the retailers' cost.



Colgate grew and grew more profitably than the competition, despite the huge lead that Procter & Gamble and Unilever had at the beginning of the race. It did so by continually focusing on the core business and findinng ways to make it better. It emphasized "singles and doubles." Colgate obsessed about what was happening to its brands in each retail outlet, focused on :

• the needs of retailers,


• created consumer awareness,


• continued to improve its products, and


• persuaded the consumer to prefer its products.

The growth path that Colgate chose has been good for shareholders and employees. The company's rapid growth has allowed it to attract the best managers in the industry - managers who are committed to growth.

****Seek good growth and avoid bad growth

I love to invest in good quality long-term profitable growth businesses available at reasonable or bargain prices. Yet, growth can be good and can also be bad. Let's take a look.

A framework for distinguishing good from bad growth is a crucial element in generating revenue growth.

Good growth:

• not only increases revenues but improves profits,
• is sustainable over time, and
• does not use unacceptable levels of capital.
• is also primarily organic (internally generated) and
• based on differentiated products and services that fill new or unmet needs, creating value for customers.

The ability to generate internal growth separates leaders who build their businesses on a solid foundation of long-term profitable growth from those who, through acquisitions and financial engineering, increase revenues like crazy but who create that growth on shaky footings that ultimately crumble.

Many acquisitions provide a one-shot improvement, as duplicative costs are removed from the combined companies. But few, if any, demonstrate any significant improvement in the RATE of growth of revenues.