When top executives of the Procter & Gamble Company and the Gillette Company appeared at February 2005 analysts' meeting in Arizona—soon after announcing plans to combine their firms—the most interesting comments may not have been about the merger. Instead, P&G Chief Executive A.G. Lafley used the occasion to discuss why his company is no longer dependant on mergers to continue sales and profit growth. "Our growth has been quality growth because of organic growth," he said, according to a report in the Feb. 25 edition of the online Cincinnati Post --adding that non-merger related growth has averaged 8 percent in recent years.
Organic Growth Can Deliver Value
Lafley's not the only person to recognize the value of organic growth. GE specialists have also noted that organic growth continues to be a viable strategy for many companies, Some firms derive almost all of their expansion by building new customer relationships and enhancing existing ones, while others may follow a strategy of blending acquisitions and organically built business.
Either way, organic growth can be a key opportunity for many companies, offering long-term benefits that include deep, relevant and profitable relationships with customers, note Wharton specialists and others.
"Starbucks is one of the companies that has basically focused on organic growth," points out Wharton marketing professor David J. Reibstein. "While Starbucks has made some acquisitions, they're minor compared to the organic growth the company has experienced."
Commerce Bank, NA, the primary subsidiary of Commerce Bancorp, has also used a "build instead of buy" approach to grow, expanding from one location to more than 300 in 30 years primarily through organic growth.
Why are these and other companies tilting away from M&A?
"Organic growth is much more profitable," says Reibstein. "Companies turn to M&As when they can't achieve sufficient organic growth because M&A is a relatively easy solution, but M&A tends to be more top line than bottom line. Bottom line growth will only happen if there is some synergy or cost cutting that is achieved in the merger. Otherwise, the purchase price alone can wipe out the value of the acquisition."
The value-added of organic growth was recognized late last year at the annual BusinessWeek 50 Forum, which commemorates the 50 top-performing companies of the S&P 500. A press release touting the forum announced that, "The leaders of BusinessWeek 50 companies do more than juggle assets to buy their way to growth. More often, they manage their businesses for organic growth through well-planned diversifications around their core business."
Cendant Corporation was one of the companies honored at the October event, and about four months later, in a fourth-quarter and year-end earnings release, the company noted that its operations generated organic revenue and earnings before interest, taxes, depreciation and amortization (EBITDA) "well in excess" of the company's long-term targets.
"In our real estate vertical, the combination of our leading position in residential real estate, together with prolonged strength in that sector, enabled our Real Estate Franchise and Operations segment to generate organic revenue growth of 15% and organic EBITDA growth of 19%," noted Cendant's President and Chief Financial Officer, Ronald L. Nelson.
A Changing Market Calls For New Strategies
Today's domestic economy is posting slow growth as increased global competition drives down pricing and drives up raw material cost. As a consequence, note industry observers, investors are increasingly rewarding companies that pursue long-term strategic growth—the kind that's delivered organically. The torrid "buy your way to success" M&A activity that took place in the 1990s appears to be falling out of favor.
An increasing number of top-performing companies are shifting their focus away from pure deal-making and cost-cutting, and are instead pursuing new products, services, and markets, say GE observers and others. More are rotating away from such internal performance metrics as meeting bottom-line targets, and are instead linking executive compensation to the ability to generate ideas, quantify improvements in customer service, enhance cash flow and boost sales.
In a widely read book titled How to Grow When Markets Don't, Adrian Slywotzky, Richard Wise and Karl Weber noted that mergers and acquisitions were huge through the early 2000s--in 2000 alone, almost 11,000 mergers took place, generating a combined value that exceeded $1.4 trillion. But as the authors add, many companies used inflated stock valuations to make cheap acquisitions—and the numbers have since dropped back to more reasonable levels.
Wharton Marketing Professor George Day notes that there's more than just a "push" to organic growth— there's also a "pull" generated by the cost savings and other benefits it can offer. But he cautions that achieving them can take some work.
"The stock market values organic growth for a number of reasons," he says. "It's generally less expensive than an M&A approach—studies indicate that M&A only delivers value added about half time —organic can offer better returns, and it forces a company to build a platform for further growth. On the negative side, it's tougher to extract a high level of growth, and organic expansion requires creativity and a different management approach. Instead of simply shepherding existing process, you're constantly seeking to spark innovation."
Day also notes that such high-performing companies as Samsung, Cemex, and Google have focused their efforts on an organic growth model.
"An organic focus requires a company to stretch its boundaries and embrace innovation," he says. "It means moving away from such strategies as line extensions and upgrades, and instead looking for disruptive growth—new markets and products that carry bigger risks but also offer the prospect of better returns.'
Designing a Company to Take Advantage of Organic Growth
As an example he points to companies like Dell--which leveraged its core computer-market strengths to enter such adjacent markets as printers and televisions. He also cites Wal-Mart, which extended its mastery of logistics to enter such new markets as healthcare and financial services. And Apple, with its iPod, is another case of a company that successfully pursued disruptive growth.
On the other hand, a 2004 survey conducted by a CFO.com affiliate, the Economist Intelligence Unit, pointed out just how far many companies have to go.
Two-thirds of responding executives agreed that a key component of organic growth—"having the right information and insights to tell us what customers/consumers really want"—is very important. But only 16% said that their companies are doing a top-notch job of it.
"As a result, many companies are having trouble generating organic growth (also called internal growth), compared with growth from mergers and acquisitions," noted the magazine.
The survey pointed out that companies experiencing "superior organic growth" were less likely to encounter organizational barriers, compared to their less-successful counterparts. Among other findings:
- 78% of respondents at these "superior" companies [compared with 45% at average and belowaverage companies] said that organic growth was at the top of their company's agenda. Organic-growth leaders were also much more likely to say that growth is "always on the agenda," noted the survey.
- 73% of organic-growth leaders, compared with 55% [of non-organic] are more likely to increase investment in research and development 75% of organic-growth leaders [compared with 60% of non-organic ones] are more likely to invest in improving their innovation skills
- 69% of organic-growth leaders [compared with 55% of others] are working harder to shorten product-development-cycle time
"Using leadership to foster a consensus about organic growth is critical to a successful effort," explains Day. "A CEO must make it clear that the initiative is a priority, and must allocate sufficient human and capital resources to move the process along."
He says that C-level executives and others involved in an organic strategy must remain attentive to peripheral opportunities and challenges; they should be curious, and need to challenge their teams to explore new spaces, to take risks, and to learn from their mistakes.
GE, in fact, has launched a process for innovation called Imagination Breakthroughs. Each Imagination Breakthrough (IB) project has the potential for at least $100 million of incremental growth. It's about encouraging innovation, and backing up the commitment with an organization that encourages new thinking. And in a market that's characterized by increasing competition, the notion of incorporating organic growth in an overall expansion strategy is no longer just an option - it's now an imperative.