The clarion call to increase shareholder value—and the intense scrutiny of investors and analysts—has compelled many companies to focus on quarterly earnings to the point of obsession. Unfortunately, the temptation to downsize and cut costs can lull even the most astute managers into a profit trap that may generate respectable returns in the short run, but fail to exploit the company’s potential to generate shareholder value over the long term. At the other extreme, unbridled growth cannot be viewed as the sole key to creating value.
Zenger was intrigued by the possibility that complex or unique strategies are systematically ignored by analysts or undervalued by capital markets. He and two colleagues undertook to investigate the question by examining all 7,630 companies that were publicly traded in U.S. capital markets from 1985 through 2007. They devised a way to measure uniqueness and complexity and counted the number of analysts covering each company. Their analysis determined that although many factors—such as company size and trade volume—influence analysts’ decisions about what companies to cover, the greater effort required for a complex or unusual strategy discourages coverage. And although their uniqueness measure is actually associated with higher market value, this premium is, on average, lower than it would be if the company got more coverage.
CEOs who face the uniqueness challenge have two options: They can make strategic information more accessible—by issuing tracking stocks, marketing directly to investment banks, or paying for independent equity research—or they can find sympathetic investors who believe in the company, which may mean taking it private.
ANALYZING GROWTH ON A GLOBAL SCALE
An overriding issue for today’s CEO is strategic balance. What is the correct balance between top-line and bottom-line growth? What roles do growth and profitability play in the creation of shareholder value?
Recognizing this importance, A.T. Kearney launched a global initiative to investigate the characteristics of successful growth. We analyzed more than 1,100 companies (drawn from a database of more than 20,000 companies) worldwide over a 10-year period, covering 24 industries in 34 countries and including more than 80 in-depth case studies. In addition, our consultants interviewed more than 50 CEOs and senior executives of leading companies including Bayer, Ericsson, Federal Express, General Electric, Gehe, Mitsubishi Chemical, Norsk Hydro and Sprint (The Value Growers, A.T. Kearney, McGraw Hill, 2000).
Our final analysis challenges traditional thinking about the way top-line growth should be viewed and understood. In particular, it reveals an attractive kind of growth that we call value-building growth. The conscious pursuit of value-building growth has helped a select group of companies create levels of shareholder value above and beyond what conventional, complacent or bottom line-oriented companies in their industries generate. Between 1988 and 2000, these “value growers” significantly outperformed their peers in the growth of both revenue and shareholder value.
To claim that value growers merely emphasize growth over profit in their balance would oversimplify and misinterpret the point. We wanted more precise reasons: Why do value growers outperform other rapidly growing companies? Why do equity markets consistently prefer these companies to those that focus heavily on profit-oriented parameters, the so-called profit seekers? And what else does growth do for a company besides maximize shareholder returns?
Selling Strategies in a Lemons Market
In a lemons market the quality of goods and services cannot be directly observed or measured. A classic example is the used car market (which has changed considerably in recent years), in which buyers usually don’t know the quality of the cars. Sellers, who do know, can exploit this situation by selling low-quality cars. Sellers with high-quality cars have no way to credibly signal that to the market, so high-quality cars are simply withheld, to the point where the market consists only of “lemons” with prices that reflect their lower quality.
Managers face an analogous problem when they attempt to sell their strategies in the capital markets. The quality of a strategy is extremely difficult to assess—even for the manager proposing it—and is revealed only as strategic actions are pursued and results observed. Accordingly, managers can at least temporarily disguise a low-quality strategy as one of high quality. And those that actually have high-quality strategies have difficulty convincing the capital markets of this.
The dot-com boom (and bust) illustrates this nicely. During the late 1990s scores of internet start-ups developed websites, articulated strategic messages connecting their websites to future value creation, and put those messages in IPO prospectuses that solicited investors. Many of these companies had no revenue. Few had profits. Nearly all had only vague theories about their path to cash flow growth. Historical accounting methods provided no real basis for evaluating their quality.
Consequently, market analysts focused on the few available “performance” measures—in particular, the number of hits a company’s website received. Unsurprisingly, management teams, in turn, focused on generating web traffic quickly instead of thinking about how to actually make money from their sites. When the party was over, it became clear just how deficient many of these dot-com strategies were. What’s more, because good strategies were equally difficult to discern, companies that had them suffered sharp discounts for a long time.
To be sure, this is an extreme example. Yet decision makers in companies of all types and sizes confront the challenge of selling difficult-to-evaluate strategies in a market with a restricted ability to evaluate. And the more unusual and complex the strategy, the harder is the task of selling it. The solution seems obvious: Sell the market a simple and familiar strategy, and the discount goes away.
But short-term logic doesn’t sustain long-term performance. As Amazon and Apple have proved, the most valuable strategies are almost of necessity the most unusual, and therefore more costly to evaluate. Indeed, all paths to value creation require discovering unique positions and exploiting unique assets—uniqueness that managers must sell to the capital markets.
The Dimensions of the Challenge
A good way to understand the challenge this poses is to categorize strategies along two distinct dimensions: quality, measured by a strategy’s ability to generate cash over the long run, and ease of evaluation, measured by the effort required to estimate this future performance.
These two dimensions generate four potential strategy categories. Two of these categories are likely to be poorly populated and therefore of limited interest: Type 4 strategies are low in quality and difficult to assess, making them universally unattractive. Type 1 strategies are high in quality and easy to assess and are rare, because a strategy that is easily evaluated is typically easy to replicate—which quickly undermines its value. That leaves most strategy makers with a choice between high-quality strategies that are difficult to assess (Type 3), and lower-quality strategies that are easier to assess (Type 2).
The Two Dimensions of Strategy
Who Should Guide the Ship?
The task of the CEO is to compose a strategy or vision—what I have called a corporate theory that provides ongoing direction for the enterprise, and then to solicit the financing to pursue that strategy. The challenge is that investors have their own theories about the optimal strategic path. That means CEOs sometimes have to decide whether to maintain the course they have set or the one demanded by the markets.
In deciding, they often end up asking themselves, Is my task simply to please the markets, or is it to be creative and clairvoyant, envisioning and executing a path to value creation that investors cannot see? Yes, the strategies most valuable over the long term are also the most unusual and difficult to evaluate, and they are therefore discounted in the present. But what if the crowd really is wise in this case? And how can CEOs know whether their vision is correct?
The answer, of course, is that they cannot. All they can do is build on the resources available to create value and a good theory about how to navigate. And the longer they can keep performing on the basis of that theory, the more the markets will appreciate it.
THE PROBLEM: YOUR BUSINESS ISN’T GROWING AS FAST AS IT SHOULD!
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