The Myth of Unbounded Growth

Imagine the CEO of a growth company telling its shareholders, “Henceforth we will be pursuing no risky new research, acquisitions or new business ventures. We will concentrate on being stewards of our existing business and will simply pay all profits as dividends.” This is an unlikely scenario, to say the least. The reality is that markets expect growth. There is a deeply held assumption that neither a company nor its management is viable unless it is able to grow. Growth gives investors a feeling that management is doing its job. Growth is typically perceived as a proactive (rather than a defensive) strategy. Or maybe, as the Red Queen says in Lewis Carroll’s Through the Looking Glass, “Here it takes all the running you can do to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

“The only way managers can deliver a return to shareholders that exceeds the market average,” Clayton Christensen and Michael Raynor wrote in The Innovator’s Solution, “is to grow faster than shareholders expect,” however irrational that may be.1 Indeed, a recent CSFB HOLT study found that 50% of the valuation of the 20 most valuable companies was based on expected cash flows from future investments.2 Nevertheless, it has become almost a national sport to suggest that there is a set of visionary, great or otherwise noteworthy companies that can grow indefinitely — only to have those companies, almost invariably, fall from grace shortly thereafter. “The golden company that continually performs better than the markets has never existed. It is a myth,” wrote Richard Foster and Sarah Kaplan in Creative Destruction.3 Indeed, of the companies on the original Forbes 100 list in 1917, only 18 remained in the top 100 by 1987 and 61 had ceased to exist. Of these highly respected survivors, Foster and Kaplan point to only two companies — General Electric Co. and Eastman Kodak Co. — which outperformed the 7.5% average return on the S&P 500 during this 70-year period, and they beat the average by only 0.3%.

The truth is, companies are successful until they are not.4 The consistent pattern of stalled or halted growth among the largest U.S. corporations over the last 50 years is eye-opening.

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References

1. C.M. Christensen and M. Raynor, “The Innovator’s Solution: Creating and Sustaining Successful Growth” (Boston: Harvard Business School Press, 2003).

2. M.J. Mauboussin and K. Bartholdson, “The Pyramid of Numbers,” The Consilient Observer (Credit Suisse First Boston Newsletter) 2, no. 17 (Sept. 23, 2003): 5. See also Christensen and Raynor, “The Innovator’s Solution,” 22, note 7, regarding methodology.

3. S. Kaplan and R. Foster, “Creative Destruction: Why Companies That Are Built To Last Underperform the Market — and How To Successfully Transform Them” (New York: Doubleday/Currency, 2001).

4. G. Hamel and L. Välikangas, “The Quest for Resilience,” Harvard Business Review 81 (September 2003): 52–63. See also Kaplan and Foster, “Creative Destruction,” 11, 14. Kaplan and Foster note that the turnover rate among Fortune 500 companies has accelerated —reaching nearly 10% in 1998 — implying that no more than one-third of today’s major corporations will survive in an economically important way over the next 25 years. Further, according to unpublished research done by the Woodside Institute in 2003, the number of S&P 500 companies that have suffered a five-year earnings decline has more than doubled in the last 30 years, suggesting a severe lack of strategic resilience.

5. Corporate Strategy Board, “Stall Points: Barriers to Growth for the Large Corporate Enterprise” (Washington, D.C.: Corporate Executive Board, 1998).

6. The stall range had increased over time slightly faster than inflation (pp. 20–21).

7. This is also true for service companies of equivalent scale.

8. See Corporate Strategy Board, “Stall Points,” 13. Wal-Mart, American International Group, Target, and United Parcel Service are still growing; 3M, Hewlett-Packard, PepsiCo and Procter & Gamble now appear to have stalled. In addition, this study by the Corporate Strategy Board cites six companies that stalled but then restarted growth to 1% over GDP. Of those, Chase, Coca-Cola, Fleming and Motorola appear to have stalled again. Only Johnson & Johnson and Merck are still growing. Thus only six out of 172 Fortune 50 (3.5%) are still growing relative to the economy.

9. A.J. Slywotzky, R. Wise and K. Weber, “How To Grow When the Markets Don’t” (New York: Warner Books, 2003), 14–15.

10. M.W. Meyer and L.G. Zucker, “Permanently Failing Organizations” (Thousand Oaks, California: Sage Publications, 1989).

11. M.H.R. Stanley, L.A.N. Amaral, S.V. Buldyrev, S. Havlin, H. Leschhorn, P. Maass, M.A. Salinger and H.E. Stanley, “Scaling Behaviour in the Growth of Companies,” Nature 379 (Feb. 29, 1996): 804–806.

12. R. Gibrat, “Les Inégalités Economiques” (Paris: Sirey, 1933).

13. G. Carroll and M. Hannan, “The Demography of Corporations and Industries” (Princeton, New Jersey: Princeton University Press, 1999). See also Mauboussin and Bartholdson, “The Pyramid of Numbers,” which describes mathematical distributions called power laws and their abundance in nature and social systems.

14. Christensen and Raynor, “The Innovator’s Solution,” 236–243. In this passage, including the section titled “The Death Spiral From Inadequate Growth,” the authors state that large targets and large investments paradoxically are “likely to condemn innovators to a death march” and that “capital becomes a poison for growth ventures.”

15. Market cap changes are measured relative to the Dow Jones Industrial Average from peak to trough within 10 years of stall.

16. J. Bandler, “Kodak Cuts Dividend by 72% To Finance Digital Shift,” Wall Street Journal Europe, Sept. 26, 2003, A4.

17. S. London, “Kodak Aims To Become a Model of Reinvention,” Financial Times, Sept. 27, 2003, 8.

18. W.C. Symonds, “Commentary: The Kodak Revolt Is ShortSighted,” BusinessWeek, Nov. 3, 2003, 38.

19. Kaplan and Foster, “Creative Destruction,” 3. However, of the 20 largest U.S. bankruptcies in the past two decades, 10 occurred in the last two years; see Hamel and Välikangas, “The Quest for Resilience.”

20. D. Sadtler, A. Campbell and R. Koch, “Breakup! How Companies Use Spin-Offs To Gain Focus and Grow Strong” (New York: Free Press, 1997), 4, 27–31.

21. Ibid., p. 30.

22. J.P. Morgan, “J.P. Morgan’s Spinoff Study” (New York: J.P. Morgan, June 6, 1995, updated August 20, 1997 and July 23, 1999); P.A. Gaughan, “Mergers, Acquisitions and Corporate Restructurings,” 3rd ed. (New York: John Wiley & Sons, 1997), 414–417; G.L. Hite and J.E. Owers, “Security Price Reactions Around Corporate Spin-Off Announcements,” Journal of Financial Economics 12, no. 4 (1983): 409–436; K. Schipper and A. Smith, “Effects of Recontracting on Shareholder Wealth: The Case of Voluntary Spin-Offs,” Journal of Financial Economics 12, no. 4 (1983): 437–467; and J.A. Miles and J.D. Rosenfeld, “The Effect of Voluntary Spin-Off Announcements on Shareholder Wealth,” Journal of Finance 38, no. 5 (1983): 1597–1606. Each study documents a mean abnormal spin-off announcement return of approximately 3%.

23. L. Dranikoff, T. Koller and A. Schneider, “Divesting Proactively,” McKinsey on Finance, summer 2002, 1, http://www.corporatefinance.mckinsey.com/_downloads/knowledge/mof/2002_no4/divesting.pdf.

24. Ibid. Also see L. Dranikoff, T. Koller and A. Schneider, “Divestiture: Strategy’s Missing Link,” Harvard Business Review 80 (May 2002): 74–83; and D.J. Ravenscraft and F.M. Scherer, “Mergers, Sell-Offs and Economic Efficiency” (Washington, D.C.: Brookings Institution Press, 1987), 167.

25. A.D. Chandler, Jr., and T. Hikino, “Scale and Scope: The Dynamics of Industrial Capitalism” (Cambridge, Massachusetts: Belknap Press, 1990).

26. For a description of the GameChanger program, see G. Hamel, “Bringing Silicon Valley Inside,” Harvard Business Review 77 (September–October 1999): 70–84.

27. M.M. Waldrop, “The Trillion Dollar Vision of Dee Hock,” Fast Company, October 1996, 75; and D.W. Hock, “Birth of the Chaordic Age” (San Francisco: Berrett-Koehler, 2000).

28. G. von Krogh, “Open-Source Software Development,” MIT Sloan Management Review 44, no. 3 (spring 2003): 14–18.

29. Refers to ongoing studies of Fortune 50 companies conducted by the Billion Dollar Growth Network. The work goes beyond the 50 growth-stall case studies developed jointly with the Corporate Strategy Board in 1997–1998, focusing instead on what happened after the stall — how the companies managed their transition to a lower growth value model. The studies generally examine companies over the past 20-year period, relying on annual reports, Compustat data, secondary sources and follow-up interviews.