Key Relationship between Global Economic Growth and Stock Returns. Why Is Good Growth So Difficult? Business Lesson for Senior Executives.
Who were the top richest people at the end of 2011? According to Forbes, “The World’s Billionaires,” , they include the names like: Warren Buffet, Carlos Slim Helu and family, William Gates III, Lakshmi Mittal, Mukesh Ambani, Anil Ambani, Ingvar Kamprad and family, K.P. Singh, Oleg Deripaska, and Karl Albrecht. An interesting list, but not one that most people would have predicted a decade ago!
Here are a few observations about what is most interesting:
The large number of rich people from the so-called “developing” nations. This number is expected to grow in the future as it is predicted that 86% of the world’s population will be residing in the emerging markets by the year 2050.
The number of people who have become rich with entrepreneurial activities in industries that were viewed as “commoditized” (read “dogs”!) just a few years ago.
What has made these people so rich is growth.
Two facts are striking about this global economic growth. First, it has come during a period of substantial political and military instability in the world. Second, quite a bit of this growth was achieved by industries that had previously been somewhat disparagingly classified as “commodity businesses.” Specifically, businesses in industries where money is made on volume, not margins. And since the margins are thin because of competitive pressures, there’s not a lot of money to be made. Yet, what did we see?
As Brazil, China, and India opened up segments of their economies, they created the conditions for foreign investment capital to flow in, and this stimulated economic growth. But even more important, it created fertile ground in which domestic entrepreneurs could plant their new ideas and flourish.
The other force that shaped these events is the enormous growth in highly educated young people in many countries, especially the emerging-market countries. China and India turn out millions of university-trained engineers every year. That’s what allows a company like IBM to set up shop in India with 80,000 employees and have most of its code writing done there.
The large number of educated people in foreign countries is what allows a company like Emerson Electric to shift some product development to China, where the plentiful supply of talented engineers permits “swarm engineering”—committing a large number of engineers to a specific project—and more rapid product development. It is what permits U.S. companies to outsource back-office functions to India and the Philippines. The net result? Lower costs, higher-quality products and services, and enormous benefits for everyone.
But all of this global growth has also created numerous tensions. As the developing countries have experienced rapid growth, they have increased their demand for natural resources. Oil, steel, food, and other natural resources are now in higher demand because they are needed to satisfy the ravenous appetites for them in the rapidly growing emerging economies. This has not only increased the prices of these commodities worldwide, but also has led to heightened price volatility. And the accompanying redistribution of wealth to resource-rich countries has generated political tensions.
Let us now take this notion of growth to organizations. What do we mean by “growth” for an organization? It can be many things. For example, it can mean getting bigger in terms of sales or assets. It can also mean doing and/or making new things without changing firm size. Or it can mean leaving old things behind for a while and repositioning for subsequent growth. It means all of these things.
Growth energizes. Growth liberates. Growth creates opportunities.
Good growth is not easy. There are typically far more examples of companies that achieved growth than there are of companies that achieved good growth. Why is good growth so difficult? Because it paradoxically requires the organization to move in two opposite directions at the same time. High growth requires change. High growth requires accepting risk. Delivering shareholder returns above the cost of capital requires stability within the firm. It requires discipline. It calls for avoiding gambles that don’t have a high likelihood of paying off.
Another reason why good growth is hard is that achieving it consistently requires organizational alignment. By this I mean that there is internal alignment—employees as well as the Board of Directors understand and agree with the mission, vision, and growth strategy of the organization and are committed to making the strategy a success. Such alignment is critical for employee motivation. By organizational alignment I also mean that there is external alignment—shareholders, creditors, and other key stakeholders also understand and agree with the mission, vision, and growth strategy of the organization.
If you are a senior executive in an organization, what can you learn from all this?
The key lesson is that the stock market rewards good growth. It is not enough to just deliver good operating performance and profits. The market needs to see prospects for growth as well. There are scores of companies that managed their assets with great care and delivered good returns on assets, but did not grow much. Many of these companies ended up being targets for acquisitions as others saw opportunities for growth that these companies themselves did not.
But growth has to enhance shareholder value—it has to be good growth. There are scores of companies that grew, but at rates of return on assets that fell short of the cost of capital, which destroyed value. They too became attractive acquisition targets or were subsequently forced to shrink or go out of business.
Recognize that there is no such thing as a commodity business when it comes to growth. Every business can be a growth business. Growth is a mindset.
Invest in developing the human capital in your workforce through continuing education. Growth often springs from unexpected sources. It is not always planned by your strategic planning staff. The more people you have who have the tools and knowledge to visualize possible opportunities for growth, the more ideas you will have to consider for adoption.
The fact that Brazil, China, and India are developing more rapidly than many other nations is not an accident. Among other things, they have the largest pools of educated young people. Education develops not only talent but also the motivation and determination of your people.
As former football coach Lou Holtz says in his book, Winning Every Day:
Your talent determines what you can do. Your motivation determines how much you are willing to do. Your attitude determines how well you do it.
Remove the obstacles to growth that are embedded in your organization—just the way the governments in India and China have begun to remove the impediments to entrepreneurial growth that for so long gripped their economies. We will spend quite a lot of time discussing how you can discover where these obstacles lie in your organization and what to do about them. A major obstacle is often lack of internal and external alignment. We will see some tools that can be used to improve alignment.
Understand that growth rarely comes without organizational tensions. Just as global growth has created its own tensions, so will the growth in your organization. Do you know what they are? These tensions impede alignment, so it is important to know how to anticipate, diagnose, and cope with them.