Grainger business model and strategy for growth

Generating Growth

Based on your readings and lectures this week, describe a few ways in which Amazon could generate topline (revenue) growth. What costs, systems, or capabilities would be necessary for this growth to materialize, and would you expect it to result in profitable growth?

Creating an Organic Growth Machine Operating units are typically left to manage for organic growth. Here’s why that has to change—and how CEOs can make sure it does. by Ken Favaro, David Meer, and Samrat Sharma

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Operating units are typically left to manage for organic growth.

Here’s why that has to change— and how CeOs can make sure it does. by Ken Favaro, David

Meer, and Samrat Sharma

2  Harvard Business Review May 2012 This document is authorized for use only by Familia Herring in Strategy at Strayer University, 2018.

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Creating an OrganiC grOwth MaChine High-growth companies become low growth all the time. Many CEOs ac-cept that as an inevitable sign that their businesses have matured, and so they stop looking internally for

big growth. Instead, they become serial acquirers of smaller companies or seek a “transformative” acquisition of another large business, preferably a high-growth one.

CEOs who give up on organic growth or cede re- sponsibility for it to the operating units are making a big mistake, for three reasons. First, to make acquisi- tions successful, acquirers must be able to stimulate organic growth in the businesses they buy. Yes, it is theoretically possible to make acquisitions that are justified by cost synergies alone, and to do this for-

ever. But research suggests that in only 36% of acquisi- tions do companies realize enough cost savings to cover the premium they’ve paid; in the other 64%, annual total shareholder returns are, on average, negative 2%. Investors can clearly distinguish between companies that have realized substantial organic growth from their acquisitions and those that have simply gotten bigger. Sooner or later, even the most dedicated acquirer must work out how to generate strong organic growth.

Second, a firm can quickly lose its focus when cor- porate leaders delegate the pursuit of organic growth. In most companies “corporate” works on the big stuff: doing M&A deals, dreaming up the next enterprise ini- tiative, devising the company’s mission and vision, and assigning targets to the operating units. Meanwhile, the job of growing organically is relegated to the managers

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of those units, even in firms whose CEOs claim to take organic growth seriously. Those managers gen- erally look for quick and easy incremental opportu- nities in market adjacencies: finding new customer groups, adding sales channels, and building product line extensions. They soon find out that such initia- tives not only generate returns that fall off rapidly but also vastly increase the company’s operational complexity. When each unit chases growth indepen- dently, large companies end up duplicating a lot of effort and investment as they struggle with an in- creasingly incoherent portfolio of businesses, prod- uct lines, and capabilities.

Third, the global economy will not experience a dramatic turnaround anytime soon. Interest rates cannot fall any further, consumers cannot start splurging again, and heavily indebted governments simply cannot afford to finance meaningful job cre- ation. Consequently, growth by acquisition will no longer be propelled by macroeconomic tailwinds of the kind we’ve felt for the past 30 years, and organic growth through the usual incremental approach will be anemic at best—certainly not enough to impress anyone.

What is the proper role for corporate leaders when it comes to organic growth? We’ve learned from our work with dozens of companies that ex- ecutives in the corporate center have a big impact on how much and how well operating units grow organically. In the following pages, we’ll set out four organic growth rules that engaged corporate leaders can follow to kick-start and calibrate their compa- nies’ internal growth engines. Leaders who have ap- plied these rules have uncovered opportunities for organic growth that were hiding in plain sight. More often than not, they were enough to double the com- pany’s underlying growth rate.

rulE 1 Keep an Eye on the big Picture There are some good reasons for delegating organic growth to the operating units: They are closer to the front line and so are well positioned to spot oppor- tunities. Moreover, organic growth initiatives typi- cally do not require big chunks of new capital, and, if they do, the budgeting and capital appropriations processes allow corporate to exercise its ultimate authority.

Although any one organic growth initiative may seem small from a corporate perspective, collectively

such initiatives are essential to realizing a return on a company’s capital base. Corporate executives should not lead the implementation of individual initiatives in the operating units, but they should actively part- ner with the units to decide where and how to place organic growth bets. That practice, however, is rarely followed. We’ve never met a CEO who says organic growth is not a priority, but we’ve met many who limit their involvement to setting targets for the op- erating units—typically through the budgeting pro- cess—and then monitoring progress against those targets.

To be sure, targets instill discipline and account- ability. But they don’t directly help the operating units grow organically. And by not playing a more active role in organic growth, a CEO subtly discour- ages watchfulness on the part of the very people who might be in the best position to spot opportunities. The CEO and other corporate leaders can take four important actions to help the entire organization keep an eye on the big picture.

Set the opportunity bar. If you leave organic growth to the front lines, they’ll tend to favor the projects they know they can do over the ones that represent the biggest opportunities. Manag- ers would rather succeed conservatively than fail bravely, which might be good for their careers but does little for growth. The best way to fight that tendency is for the corporate center to instill stan- dards and practices that make transparent the scale and source of growth opportunities. For example, at a financial services company we’ve worked with, each operating unit is required to track and report on three variables that encapsulate its organic growth potential: “headroom for growth” (the number of clients and the share of wallet the company doesn’t have minus the number of clients and share of wallet it is unlikely ever to have), “switchers” (the clients who could be enticed to switch to a provider with a better offering), and “needs-offer gap” (the differ- ence between the benefits that would cause those clients to switch their business and the benefits their current provider offers). The idea is to get unit man- agers to identify the highest-potential opportunities so that they will be less likely to propose investing in areas that would yield only small wins.

Get the data right. An engaged CEO and cor- porate center should have an enterprisewide data- base of organic growth opportunities, both those specific to individual operating units and those that cross internal boundaries. That information helps

average annual tsR of companies whose ac- quisitions led to organic growth that was lower than gdP growth

average annual tsR of companies whose ac- quisitions led to organic growth that was higher than gdP growth

HOw aCquisitiOns CrEatE ValuE

in a sample of 3,000 acquisitions by u.s. companies from 2001 to 2011, only the com- panies that generated robust organic growth from their acquisitions also created value, as measured by total share- holder returns (tsR).

13%

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a company put time, effort, and resources where they can be most productive. For example, the fi- nancial services firm mentioned above is organized around product groups, sales channels, and corpo- rate functions such as marketing, operations, IT, and HR. When corporate leaders created a database of organic growth initiatives, they found that the op- erating units were pursuing opportunities that had a great deal of overlap and so were requesting more investment than was actually needed.

If companies don’t get the data right, they can also look for growth in the wrong places. That was the case at a giant retailer struggling to squeeze more growth from its existing stores. It turned out that instead of focusing on increasing foot traffic and getting shoppers to make purchases in more catego- ries, the best opportunity was to get those who were already in the store to buy more in the categories in which they were already purchasing. In women’s ap- parel, for example, that meant offering greater size and fashion variety; in electronics, it meant offering more services for customers in rural areas. By focus- ing on such opportunities, the retailer dramatically reduced the number of initiatives to those that indi- vidually had much higher odds of success and collec- tively consumed far less of the company’s resources.

Build enterprise-level growth capabilities. Just as the corporate center has M&A capabilities (such as managing investment bank relationships, conducting due diligence, and integrating acquisi- tions), it can have organic growth capabilities. Nur- turing them is essential. Take, for example, Mani- towoc, a midwestern U.S. company that owns one business in heavy-lifting cranes and another in com- mercial equipment for the food service industry. The best growth opportunities for both businesses are in emerging markets, where local expertise is critical and managerial talent is scarce. Glen Tellock, the CEO, mandated that emerging market expertise was critical for all corporate functions—a move that gives

the two businesses access to a capability that neither could develop nearly as well on its own. While each has particular needs in emerging markets, the two businesses face common challenges, such as under- standing customs and governmental machinations. In addition, together the businesses give their parent company a bigger opportunity to present to authori- ties looking for direct investment in their countries. Tellock wants corporate leaders to own the continu- ing development and deployment of the emerging market capability, which offers economies of scale and scope to the company and a competitive advan- tage to each business.

idea in brief many Ceos believe that high- growth businesses inevitably become low growth, so they give up on organic growth or leave it to the operating units. that’s a mistake. Corporate leaders can kick-start their companies’ internal growth engines by following four rules.

Keep an eye on the big picture by ensuring that oper- ating units pursue organic growth in the right places, look for opportuni- ties that cross inter- nal boundaries, and build enterprise- level capabilities.

Help operating units fight short- term business- cycle pressures by establishing the right performance standards and by earmarking local cost savings and corporate funds for local investment.

Resist typecasting by avoiding the use of self-defeating labels such as “cash cow” and “growth engine” and by helping the operat- ing units escape the high-growth or no- growth mind-sets.

Create a language for growth to mini- mize overlapping initiatives, wasted effort, and unpro- ductive investment, and to make it easier to discuss how best to foster organic growth.

Just as the corporate center has m&a capabilities, it can have organic growth capabilities.

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Look across businesses and markets. Alert leaders who engage with operating units to pursue organic growth can often recognize when small opportunities that make no sense by themselves can be bundled to create a big opportunity. A good example of this can be seen with Guinness’s very successful creation, in the late 1990s, of a bottled version of its popular draught beer. At the time, Guinness was available in retail stores only in cans, which used a small device to release nitrogen, es-

sential to producing the smooth taste and foamy head for which Guinness is known. The company’s Americas unit saw bottled

Guinness as a growth opportunity, espe- cially in the United States, where the increas-

ing number of beer aficionados preferred bottled beer. But a bottled version of Guinness required the development of

a nitrogen capsule and changes to the dis- tribution system; the numbers in the United

States didn’t quite justify those investments. The breakthrough came when the corporate

center realized that bottled Guinness would work in at least one other big beer-consuming country: Ire-

land. Whereas the Irish had traditionally consumed Guinness when seated in pubs, younger people there increasingly drank beer while standing in livelier, more crowded venues. The “aha” was that beer in a bottle would be less prone than beer in a glass to slosh around and spill when people were shoulder to shoulder. The upside from this benefit in Ireland combined with the export potential justified the in- vestments. Today bottled Guinness is made at a sin- gle factory in Ireland, and some of the output goes to the United States. The opportunity was not apparent when Guinness operated in geographic silos; it came to light only when the corporate center saw the big- ger picture of the two market units together.

rulE 2

Fight the business Cycle It’s the MO of most big public companies: In the boom part of the business cycle, they invest aggres- sively in growth; in the bust part, they turn cost- conscious and zero in on profitability. But by ampli- fying the cycle in this way, leaders can do great harm to their operating units’ organic growth efforts.

At the top of the cycle, the approach encour- ages unit managers to believe in overly optimistic business forecasts (who wants to be gloomy when things are going so well?), which makes it easy for managers to justify adding unnecessary head count or to pay too much for an asset they think they need. When the cycle inevitably turns, they then have to reverse course, at a significant cost in time, money, and attention to growth. At the bottom of the cycle, pessimistic signals from the center can make unit managers reluctant to fund new products, upgrade critical aspects of customer service, or invest in mar- ket building. The damage from such inaction often takes longer to materialize, but the impact can be just as big.

Fighting the business cycle takes a lot of fortitude. No one wants to hear about “investing for growth” in hard times or about “steady, measured growth” dur- ing a boom. But resisting the drumbeat of business cycles is an essential role of the corporate center and one of the key tests of executive resolve, particularly for CEOs. We’re not talking here about being coun- tercyclical; that is something different. But senior leaders can help their organizations invest in a way that is largely independent of the business cycle. James Kilts, the CEO of Gillette from 2001 to 2005, provides a good example of the various ways corpo- rate leaders can do this.

no one wants to hear about “investing for growth” in hard times or about “steady, measured growth” during a boom.

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Establish the right performance standard. Kilts often toned down the targets his operating managers proposed. He would remind them and the company’s shareholders that in every industry, the winner over a five-year period is usually a company that has been in the top third for revenue growth and profitability each year. By contrast, being number one or two in a year, Kilts would say, is not neces- sarily correlated with long-term industry leadership, and the quest to occupy those top positions creates a yo-yo effect (a finding based on research Kilts had commissioned). His purpose was not to get manag- ers at Gillette to rein in their ambition; it was to keep them from worrying about the wrong things at the wrong time, such as obsessing over growth at the top of the business cycle and then forgetting about it at the bottom.

an organic growth assessment for the Ceo your company’s ability to grow organically depends a lot on you and your corporate team. if you can’t answer yes to two of the questions in each category below, your company is not realizing its organic growth potential.

How good are we at keeping an eye on the big picture? 1. do we maintain an enterprisewide data- base on the size, scope, and nature of organic growth opportunities?

2. do my corporate team and i look across the operating units to find opportunities that no unit can see or pursue on its own?

3. does my company have distinctive enter- prise-level capabilities that enable operating units to achieve more organic growth than our competitors do?

How well do we fight the short- term pressures of the business cycle? 4. do we give operating units the right perfor- mance standards for the long run?

5. do operating units constantly generate cost savings in order to fund their organic growth?

6. do i have a corpo- rate account for funding initiatives in and across the operating units?

Do we successfully resist business unit typecasting? 7. does our company avoid labels such as

“cash cow” and “growth engine”?

8. do we require oper- ating units to find new ways to boost organic growth?

9. do we also require them to find new ways to fund it?

Do we have an effective language for growth? 10. do we have a clear definition of “organic growth opportunity”?

11. do we have a glos- sary that establishes our company’s organic growth language?

12. does that language enable my corporate team and me to help each operating unit identify its growth op- portunities and decide how best to realize them?

Earmark local cost savings for local investment. Kilts was unrelenting in removing unneces- sary costs. The goal of his pervasive, intrusive, and continuous effort was zero overhead growth (ZOG, as he dubbed it). But he plowed much of the savings back into the units that had achieved them in the form of investments for organic growth. Be- cause people tended to cut a lot more overhead in hard times, this practice had the effect of boosting the operating units’ growth initiatives when they would normally be least likely to invest in growth.

Create a corporate organic growth fund. Kilts used cost savings for what he called “corporate scholarships,” which funded, for example, the red razor: a simple packaging change, initially resisted

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by the Global Grooming unit, that ended up being a blow-

out success. At between $5 million and $15 million,

the fund was not very large, and Kilts didn’t intro- duce a lot of process to allocate it; in fact, he made most of the decisions himself. The aim was to dem- onstrate that good ideas for boosting organic growth would always find resources at Gillette, even at the bottom of the cycle.

Joseph Scalzo, who ran Gillette’s global business unit for personal care products, says he benefited from all three of Kilts’s practices. “Jim didn’t have low expectations,” Scalzo said in an interview. “But he didn’t want you to try to perform heroically, ei- ther. He knew that could lead to all sorts of destruc- tive behaviors.” Kilts’s ability to make trade-offs be- tween expense reduction and investment allowed Scalzo to reinvest a portion of $70 million in savings

he had identified in his unit. “I’ve worked for other people who would have said, ‘I’ll take all $70 million on the bottom line,’” Scalzo

noted. The corporate scholarship money, he said, occasionally let him research or test a promising opportunity. “People were more ag- gressive about finding growth because they had an active collaborator at the top who would listen to ideas,” Scalzo said.

When Kilts joined Gillette, the company was stalled. Its revenues had declined by 4% a

year for five years, and its earnings had been flat during that period. By the end of Kilts’s tenure, Gil- lette’s top line was growing by 9% a year and its bot- tom line was increasing by 16% annually. By seeking

steady growth of sustainable earnings instead of heady

growth of current earn- ings, Kilts made Gil-

lette an organic growth machine—

and a very profit- able one at that: Under his lead- ership, the com- pany’s return on

capital rose from an already high

level of nearly 20% to more than 30%. Procter

& Gamble then bought the company at 5.5 times

revenue and almost 19 times EBITDA—multiples normally reserved for high-growth companies.

rulE 3

resist typecasting Managers like labels; they simplify the complex task of management. Thus, we often see units designated as “growth engines” that get the lion’s share of in- vestment capital, while others are the “cash cows” that fund the growth engines. The problem is that these labels shape beliefs about growth, affect the operating units’ behavior, and ultimately become self-defeating.

Multibillion-dollar companies with multiple di- visions often fall prey to business typecasting. At Gillette, for example, Kilts encountered resistance within the Global Grooming business unit to the idea that it needed to grow organically at all. Razors, after all, had made the company; Gillette still had market share of more than 70% in that category, 4.7 times the share of its nearest competitor. The im- plicit message to Kilts was, Look at Duracell—man, did we overpay for that. Look at Oral-B. They’re the ones you should be looking to for growth. We’re performing.

But allowing managers in established businesses to think like that is extraordinarily wasteful. Every business has the potential to create new benefits for current customers or to find new customers for the benefits it already provides. What’s more, if manag- ers give up on organic growth, they won’t look as hard for the innovations and enhancements that will keep them ahead of the competition. Typecasting units as growth businesses is equally dangerous. If a unit’s managers feel solely responsible for the parent company’s organic growth, they’ll take on more risks, investment, and costs than they should.

The Wall Street Journal offers an example of just how false and defeatist labels can be. In 2000 the paper was Dow Jones’s biggest and most profitable business, but it was in a downward slide because of the rise of online media and its inability to attract young readers, whom advertisers coveted. Dow Jones could have bought into the conventional wis- dom that newspapers were dying and managed the paper strictly for cash—by cutting costs and mini- mizing reinvestment—in order to fund the growth of other businesses.

Instead, at the behest of Rich Zannino, Dow Jones’s CEO at the time, corporate leaders worked with the Wall Street Journal’s management team

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invests time in developing sound concepts and ar- ticulating them with well-chosen words, the po- tential for muddle and confusion is greatly reduced. Corporate leaders are best placed to create a compa- ny’s language for growth because they are the only ones who oversee the entire enterprise and have the responsibility to disseminate ideas and concepts across the organization.

Dow Jones again provides an example. When the company was modernizing the Wall Street Journal, it wanted everyone—art directors, direct market- ers, circulation managers, salespeople, and manag- ers of the online edition—to focus on how changes would be received by readers and advertisers, and, by extension, how those changes would affect Dow Jones’s ability to grow organically and profitably. Corporate leaders faced substantial resistance from the paper’s employees, however, who believed that

to modernize the paper’s look and introduce more entertainment, lifestyle, and general-interest cover- age, changes it had concluded would attract young readers who hadn’t formed loyalties elsewhere. It also added a Saturday edition to increase circulation and advertising revenues. The result was double- digit revenue growth in a declining industry, which turned the paper into a national newspaper-of- record competing head-to-head with the New York Times. Initially, the Wall Street Journal resisted the changes on the grounds that the paper could never be a growth engine; success, many argued, would be not allowing core circulation to fall too quickly. For- tunately, the corporate center did not let that type- casting prevail.

One way for a business to shake off a label is to break away from the rest of the company. CBS is a case in point. As part of Viacom, CBS was designated a “slow growth” business by Viacom’s chairman, Sumner Redstone. When he decided to break up the company, in 2006, his aim was to unlock the value of “high-growth” businesses such as cable networks VH1 and Nickelodeon, which he felt weren’t getting the valuation they deserved. But once separated from Redstone’s growth darlings, CBS got a new lease on life. It aggressively pursued international syndication, internet, wireless, DVDs, and video- on-demand in its core TV business and new revenue growth in its outdoor signage, publishing, and radio businesses—all of which would have been difficult to do in the role of Viacom’s ATM. Investors had been told that Viacom’s growth would accelerate once the company shed CBS. But CBS came out of the blocks reporting higher than expected growth, while Viacom immediately fell short of its growth expectations and has been struggling to meet them ever since.

Typecasting operating units is a little like type- casting children: This is the smart one, that’s the am- bitious one, and that one over there—she can just sit there and be pretty. Mightn’t it make more sense to hold all three to a high standard of achievement and see what happens? The pretty one might turn out to have more potential than the other two combined.

rulE 4 Create a language for growth George Orwell wrote that “the slovenliness of our language makes it easier to have foolish thoughts.” Like him, we believe that a tidy language for growth makes for a tidier, wiser pursuit of it. If a company

Corporate leaders at a financial services firm found that developing and disseminating a clear, concise language for organic growth made it easier to identify and pursue the best opportunities.

One Company’s Organic growth glossary

HEadrOOM FOr grOwtH the clients we don’t currently have minus those we are unlikely to get; and the business we don’t currently have with existing clients minus that which we are unlikely to get.

switCHErs Clients who use multiple providers or would switch if they found a provider with a better offering.

nEEds-OFFEr gaP the difference between what would induce clients to switch and what they are getting from their current provider (or providers).

OrganiC grOwtH OPPOrtunity the dollar amount of headroom for growth that could become revenue if we closed a needs-offer gap for clients or potential clients who are the most likely switchers.

rEturn On EFFOrt (rOE) the contribution to organic growth of a given level of effort. there are three ways to increase Roe: reduce effort but achieve the same level of organic growth, maintain effort but increase organic growth, and increase effort in ways that increase organic growth even more.

CrOss-buy to buy multiple products and services from us because each provides superior value. this term describes our clients’ behavior, whereas pushing additional products and services to clients—cross-selling—describes our behavior.

OPEratiOnal sEgMEntatiOn the division of market-facing opera- tions, such as branches, into groups defined by distinctive client and competitor dynamics. this is different from customer segmentation, which divides our clients into groups that often do not line up well with our market-facing operations.

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they were already producing the world’s best newspaper. To break the stalemate, the CEO introduced the term “relative customer value,” in which “cus- tomer” included readers and adver-

tisers. The term gave everyone a way to discuss how best

to modernize the paper and led to some changes that had long

been impossible even to contem- plate. For example, when the company

tested the relative customer value of a smaller, more profitable format, it found that,

contrary to the belief of most editors, the ma- jority of readers actually preferred it. And al-

though the editorial staff had long thought put- ting advertising on the front page to be a crime, readers didn’t care. As Zannino says, “Having a

common term for thinking and talking about growth really helped us all get on the same page and clarify what was most important as we looked for new and coherent ways to grow the business.”

As another example, the financial services com- pany whose “opportunity bar” we described earlier

compiled a glossary of terms to make it easier to decide how best

to drive organic growth through- out the company. The glossary in-

cluded not only “headroom for growth,” “switchers,” and “needs-offer gap” but

also “return on effort,” “cross-buy,” “operational segmentation,” and

a precise definition of “organic growth opportunity.” This terminol-

ogy is used throughout the com- pany and has helped transform the corporate center’s dialogue

with the operating units. Instead of asking only questions such

as, How are you doing against your targets? Where can we save? What can we elimi- nate? How can we become more productive?, cor- porate leaders also ask,

Where’s our headroom to grow? Who are the most likely

switchers? What would it take for them to switch? Where are our biggest needs-offer gaps? The

latter questions are far more likely to help operating units realize their organic growth potential for the least amount of investment. They certainly helped the financial services company reduce its investment constraints by eliminating duplicative efforts and gave leaders

the confidence to raise their or- ganic growth goal only 18 months after establishing the first target.

Clarity around language also prevents companies from confusing

ends and means, a common trap for managers. In many companies we find that people use the word “opportunity” to describe an action, such as adding salespeople, building a new plant, increasing IT capacity, raising (or dropping) trade promotions, or installing a CRM system. Although such actions may enable a company to realize an opportunity, they are not themselves opportunities. Assuming that they are may well cause managers to ignore the real opportunities in front of them. More- over, measures of success in hiring salespeople or installing a CRM system are not good proxies for a company’s success in generating organic growth.

If companies have a clear language for organic growth, they will be less likely to overestimate growth potential, which wastes time and effort, and more likely to develop more targeted initiatives, fewer overlapping initiatives, and far more coherent and higher-performing pipelines of opportunities.

OrganiC grOwtH is not the inevitable result of a suc- cessful business model. All companies can become more skilled at growing organically with the busi- ness models they already have. But that requires active, engaged corporate leadership. The CEO and other senior executives don’t need to impose a lot of new processes or exercise a heavy hand. They just need to help the operating units keep an eye on the big picture, lead the fight against the business cycle, resist typecasting, and establish a common, rigorous language for organic growth. Respect those rules, and you will transform your company’s internal growth engine. Hbr reprint R1205F

Ken Favaro, a senior partner at Booz & Company in new york, leads the firm’s work in enterprise strategy.

david Meer, a senior executive adviser at Booz & Com- pany in new york, leads the firm’s Consumer insights and demand analytics practice for north america. samrat sharma is a principal at Booz & Company’s Cleveland office.

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