Wall Street ruins many sound business models

Have you ever observed the energy that leaders of publicly traded companies exert to announce and then deliver promised quarterly financial results?  Surely, like me, you’ve wondered how multi-billion dollar companies composed of multiple divisions, and even more business units, achieve their financial forecasts – exactly.

My concern is not just about the non-value added time leaders spend pulling orders forward into the quarter and costs back into the next quarter so that reported results match predictions, lest stock prices plunge.  I am far more concerned about the value-destruction set in motion by yet another prevalent dysfunctional behavior – promising unrealistic growth, which appears to also happen a lot.

A recent analysis of earnings trends by strategy firm McKinsey & Company shows that earnings growth is much lower than many companies’ publicly announced growth targets. From 1997-2007 (go-go years in the economy), large non-financial companies’ median growth was only 5.9%, and this included growth due to acquisitions.  Only one-third of the sample grew more than ten percent. Over the longer period 1965-2008, median growth was only 5.4%, rising and falling with the business cycle.  Furthermore, 44% of the companies growing at rates above 15% in the late nineties were slow growing just ten years later.

In spite of these lackluster growth rates, CEOs continue to set higher and therefore unrealistic growth goals. It must to be in the DNA of the CEO, all members of a tribe both optimistic and hard charging by nature. When the management team needs to “make” the unrealistic growth goals, what happens?

Some unit managers feel forced to milk their business before it matures and should be milked. Others fail to invest in great ideas that would pay off royally in the future, leaving the opportunities to their competitors.  Or, the business development team engages in acquisitions that hide organic growth issues, but do little to jump start future rates of growth. All these strategies to “save the year” set into motion a vicious downward cycle that will destroy company value, not to mention jobs

If growth rates fall short of targets, there are only so many ways to close the gap short of lowering the target, including:

  • Grow market share at a faster clip.
  • Expand geographically into faster growing markets.
  • Move into a faster-growing adjacent category.
  • Bring large groups of new buyers into your industry.
  • Target a market (you do not currently serve) that’s growing faster than your own.
  • Create a brand-new fast growing category, like Apple did with IPad.

Many of these strategies require investments – new products, new channels, new capabilities or acquisitions – that do not pay off in the same year. These and still other requisite business model innovations require money and time. As a result, once a company’s revenue growth falls short of promises to Wall Street, a company often needs a short reprieve from prior expectations to redesign business models and invest for faster growth down the road.

If more CEOs were publicly forthright about their businesses, what factors slowed growth and the time required to get growth back on track, they’d create that reprieve and start building long term value. Instead, CEOs demand their teams do whatever it takes to make the quarter, setting in motion changes that make future growth that much harder to achieve.

The lesson here is to not fall behind the growth curve. Regularly examine your portfolio of business models to make sure some fast-growing ones have entered to replace the truly matured ones. Feed growth businesses the money they need to grow by harvesting those in commodity-like industries. Invest in more than one business – a healthy portfolio of emerging, growing and maturing businesses is more likely to generate steady growth than placing all your money in one high-risk bet.

The only way to get this delicate balance right is to focus on micro-markets – disaggregated views of the markets leaders typically discuss in monthly operating mechanisms.  Micro-markets show the significant variability in growth rates across markets once they are defined more narrowly. (For an excellent article on micro-markets, see “Is Your Growth Strategy Flying Blind?” in Harvard Business Review, May, 2009.)

I admire Amazon’s CEO, Jeff Bezo. He never avoids telling Wall Street the truth about what his business needed to thrive over the long term. How honest are you about your business?

Kay Plantes is an MIT-trained economist, business strategy consultant, columnist and author. She served as chief economist for former Wisconsin Republican Gov. Lee Dreyfus. Plantes provides expertise in business model innovation, strategic leadership and smart economic policies.

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