In praise of organic growth vs. financial engineering

Research shows that mergers & acquisitions don’t produce the expected financial bonanza. But “organic growth” does.

The Batten Institute, part of the University of Virginia’s Darden School of Business, has released the latest results of a decade-long study of corporate earnings, establishing a correlation between organic growth and outperforming stocks. Using an Organic Growth Index (OGI), Darden professor Ed Hess compiled a list of “Organic Growth All-Stars” for the period 2003-2006. The conclusions:

In addition to consistent growth in underlying earnings, as measured by the OGI, the all-star companies’ share prices have outperformed the S&P 500 by a factor of 10 over the past 10 years.

Actual 10-year returns (1996-2006) for the OGI All-Stars were over 1,368% vs. approximately 130% for the S&P 500 Index and 144% for the Dow Jones Industrial Average.

“These companies have shown that they can grow in good times and bad. It’s not about the economic cycle. It’s about the business model,” Hess says. “Organic growth is growth the old-fashioned way: more customers, more products, better operating efficiencies,” he says. Not financial engineering or manipulation.

Hess identifies four key attributes of strong organic-growth companies:

  • Simple, focused business strategies, implemented by managers who are are “execution champions”;
  • Top management is home-grown and made up of “humble, passionate operators”;
  • A highly-engaged workforce characterized by a strong degree of loyalty and productivity; and
  • A “seamless, self-reinforcing internal growth system”

The study — and the list of 27 All-Stars — is available at this link. For some reason, the all-star list includes a couple of “dollar stores,” a couple of casual restaurant chains, a couple of big-box retailers, and the maker of Spam.

CEOs need a “sensor network” to anticipate disruptive competition

Competition can pop up in many unexpected places, including college dorms, startups, Asian outposts and various disruptive technologies. A new study of the intensifying competition in high-tech industries finds that companies are OK at identifying market-altering changes but aren’t as good at anticipating such changes or acting on their observations.

My personal view: Companies need forward-looking staffers — some combination of futurists, competitive intelligence professionals and strategic planners — to help them anticipate their future business environment and get them to think beyond their traditional competitors and core markets.

The joint study by Deloitte Consulting LP and the Business Performance Management (BPM) Forum includes a survey of 181 company strategists (e.g., chief marketing officers, top strategic planners) in the high-tech industries (semiconductors, electronics, telecom, IT and Internet). The summary is here, and the downloadable report (.pdf) is here.

When asked which tools and processes they use to identify and analyze course-altering market changes, 95% of respondents indicated that they participate in industry forums and associations (i.e., they focus on their traditional competitors).  “A large majority also participates in an annual strategic planning process that incorporates competitive benchmarking and competitive intelligence reviews. However, these activities are not providing the forward-looking market view necessary to anticipate market-altering change,” the report says.

In an interview, John Ciacchella, a principal with Deloitte Consulting and leader of its technology industry group, told me that companies need a “sensor network” that helps the CEO discover new market entrants and new market opportunities.

The study also identifies the roadblocks to actually doing something about new market forces.

What issues prevent you from executing course-correcting actions?

  1. Management focus on near-term profitability
  2. Inadequate size of opportunity in the near term
  3. Management focus on established businesses and customers
  4. Metrics (e.g., lack of easily quantifiable business case)
  5. Risk-averse culture
  6. Entrenched interests
  7. Management hubris or arrogance

Base: 181 strategic executives at high-tech companies
Source: “Competition at the Crossroads,” Deloitte Consulting LP and BPM Forum, June 2007

What resource issues prevent you from executing course-correcting actions?

  1. People (e.g., insufficient strategic planning talent)
  2. Cash (e.g., insufficient funding to identify changes and assess options)
  3. Information (e.g., insufficient market data, insufficient competitive intelligence)
  4. Technology (e.g., rigid or insufficient IT systems)

Base: 181 strategic executives at high-tech companies
Source: “Competition at the Crossroads,” Deloitte Consulting LP and BPM Forum, June 2007

Taken together, you can see that myopia — management focus on the short term, and insufficient strategic planning talent — are big concerns.

The study concludes by saying companies should ask themselves the following questions:

  • Do you have the right strategic planning resources in place, in terms of people, processes and technology, to drive effective decision-making and better anticipate the changing landscape?
  • Are your indicators forward-looking?
  • What is your risk profile? How are new investments and growth opportunities assessed versus traditional models and business lines?
  • Is your corporate culture ready for change? Does it support exploration and identification of new models and business opportunities?
  • Are the processes in place, across your organization, to adequately react to change?
  • How much are you willing to bet, and is your strategic-planning process designed to consider risks and opportunities at a corporate level, outside of current product lines, customer markets and technologies?

Related: New CIO role: Spot disruptive technologies and help develop new products