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Why Growth is so central to Management
thinking
For financial economists, growth rate of the economy as
a whole is important and not that of any one company. But for a company and
it's executives, growth is the central to management thinking.
1.
Growth and Market share is central to most product-market strategies,
keeping pace with at least growth rate of primary demand in the industry and demonstrate
competitive superiority by gaining market share from the close rivals. 2.
Growth is also the environment that best promotes employment
opportunity, improved compensation, and upward mobility. 3.
Growing company creates an exciting work environment for all employees. 4.
Growth environment is an easier setting in which to manage: more
resources, more room to negotiate, easier to mask or excuse mistakes. Often times when the company's products mature and rate
of return begin to erode, executives see diversification as the next growth
engine. Diversification in a sense becomes essential to preservation of
management careers and for corporate survival. Often times a company struggling to cope with the
existing problems and mismanagement attempts to regain growth by
diversification. In private many top managers admit to boredom and being worn
down by another round with the same intractable problems. Diversification, for
them, offers the prospect of new and exciting frontiers. Personal
considerations often overrule corporate priorities in such diversification
decisions. E.g. Kodak venturing into Digital camera, printers etc. Warren Buffet wrote
in his 1984 annual report: "Many companies that show consistently good
returns have, indeed employed a large portion of their retained earnings
on economically unattractive, even disastrous, basis. Their marvelous
core business camouflage repeated failures in capital allocation elsewhere
(usually involving high priced acquisitions). The managers at fault
periodically report on lessons they have learned from latest disappointment.
Then they usually seek out future lessons. (Another Failure) In such cases, shareholders would be far better off
if the earnings were retained to expand only the high-return business, with
the balance paid in dividends or used to repurchase stock. Managers of
high-return business who consistently employ much of the cash thrown off by
those business in other ventures with low returns should be held accountable,
regardless of how profitable the overall enterprise is." A good example for the above would be Cisco's and
Intel's acquisition binge in 1999-2001. Intel
spent about $10 Billion on acquisitions and by 2003 it has very little to show
for it. Cisco has not fared far worse than Intel. Cisco's acquisition spree
exceeded $20 billion!! This implies that senior management is sometimes
tempted by self-interest to make decisions contrary to their shareholders.
Reinvesting cash flows without shareholder's approval is the corporate
equivalent of taxation without representation. BCG model & company growth? Decades ago, Boston Consulting promoted the concept of
investing cash flows from mature "Cash cows" into high-performing
"Stars". By making the company self-funding and self-perpetuating,
the BCG model appealed to corporate managers because it gave them the cover to
diversify and seek growth. It
also helped management circumvent the monitoring process of the capital
markets. Alternate view would be to allow the cash cows feed the
cash to the shareholders, while the "stars" & "question
marks" be dependent on the capital markets. Passing Value to Shareholders The common ways to pass on the value to shareholders
would be to: Ÿ
Repurchase shares Ÿ
Dividends Ÿ
Partial Public Offerings or spin-offs of subsidiary (or other
non-core activity) Strategic Acquisitions Acquisitions by nature are risky business. Instead of
using free cash from a profitable business for acquisitions, other
alternatives have be explored to protect shareholder value and create future
value. Two ways of funding an acquisition are:
Ÿ
Leveraged Acquisition Buy another
company like an LBO and keep that company as a separate entity. The cash flow
generated from the new business must be used to pay back the debt. If the
acquisition succeeds, (i.e., is profitable, pays of debt and had above the
average returns) then that company can be merged with the parent or can be
spun-off Ÿ
Partnerships Joint ventures in new business will not be a drain on the existing cash flows. The company can still realize synergy and reap the benefits without affecting the free cash flow from the existing operations.
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