Mckinsey on Finance

McKinsey on Finance

Measuring stock market performance 1 Perspectives on TRS doesn’t reﬂect a company’s performance or health. What does? Corporate Finance and Strategy Reducing the risks of early M&A discussions 5 Used early in negotiations, a third-party clean team can help Number 17, Autumn companies assess a deal and protect sensitive data. 2005 Smoothing postmerger integration 11 It takes less time than you think for a clean team to make valuable contributions to the integration of businesses.

Comparing performance when invested capital is low 17 Return on capital is the benchmark for comparing performance between businesses. But new math is needed when a company’s capital intensity is low.

What global executives think about growth and risk 21 As globalization creates new markets and competitors, hopes contend with fears. McKinsey on Finance is a quarterly publication written by experts and practitioners in McKinsey & Company’s Corporate Finance practice. This publication offers readers insights into value-creating strategies and the translation of those strategies into company performance. This and archived issues of McKinsey on Finance are available online at www.corporateﬁnance.mckinsey.com.

Editorial Contact: [email protected]

Editorial Board: James Ahn, Richard Dobbs, Marc Goedhart, Bill Javetski, Timothy Koller, Robert McNish, Dennis Swinford Editor: Dennis Swinford External Relations: Joanne Mason Design Director: Donald Bergh Design and Layout: Kim Bartko Managing Editor: Kathy Willhoite Editorial Production: Sue Catapano, Roger Draper, Pamela Kelly, Scott Leff, Mary Reddy Circulation: Susan Cocker Cover illustration by Ben Goss

This publication is not intended to be used as the basis for trading in the shares of any company or for undertaking any other complex or signiﬁcant ﬁnancial transaction without consulting appropriate professional advisers. No part of this publication may be copied or redistributed in any form without the prior written consent of McKinsey & Company. 1

Measuring stock market performance performance improves, the expectations treadmill turns more quickly. The better these managers perform, the more the market expects from them; they must run ever faster just to keep up. This effect explains why extraordinary managers may deliver ordinary short-term TRS; TRS doesn’t reflect a company’s performance or health. conversely, managers of companies with What does? low performance expectations might find it easy to earn high TRS. This predicament illustrates the old saying about the difference between a good company and a Richard Dobbs and In the previous issue of McKinsey on good investment: in the short term, good Timothy Koller Finance,1 we explored how investors can companies may not be good investments, assess a company by examining its past and vice versa. performance and its health—that is, its ability to sustain performance over the Overcoming the limitations of TRS long run. In an ideal world, we would need Companies can compensate for the only to examine a company’s stock market shortcomings of TRS by employing performance to see how well it was doing. complementary measures of stock market Yet this third measure is anything but easy performance. One of them is market value to interpret. added (MVA): the difference between the market value of a company’s debt The most common approach to measuring and equity and the amount of capital a company’s stock market performance is invested. A related metric is the market- to calculate its total returns to shareholders value-to-capital ratio—a company’s (TRS)2 over time. This approach has debt and market equity compared with severe limitations, however, because over the amount of capital invested. short periods TRS embodies changes in expectations about a company’s future MVA and market-value-to-capital ratios performance more so than its actual complement TRS by measuring different underlying performance and health. aspects of a company’s performance. TRS Companies that consistently meet high measures it against the financial markets’ performance standards can thus find it hard expectations and changes in them. MVA to deliver high TRS: the market may think and the market-value-to-capital ratio, by that management is doing an outstanding contrast, measure the financial markets’ job, but this belief has already been factored view of a company’s future performance into share prices. relative to the capital invested in it, so they assess expectations about its absolute level One way to understand the problem is by of performance. way of analogy with a treadmill whose 1 Richard Dobbs and Timothy Koller, “Measuring long-term performance,” speed represents the expectations of future Let’s examine home-improvement giant The McKinsey on Finance, Number 16, Summer performance implicit in a company’s share Home Depot and the other large retailers 2005, pp. 1–6 (www.mckinseyquarterly.com/ links/18226). price. If managers exceed them, the market in terms of their stock market performance. not only raises the share price but also The market value of Home Depot’s debt 2 TRS is defined as share price appreciation plus dividend yield. accelerates the treadmill. As the company’s and equity (including capitalized operating �� 2�� McKinsey on Finance Autumn 2005 ��

� � � � � � � � � economic proﬁt, but it had very low TRS. �� Evidently, Home Depot’s performance �� over recent years wasn’t up to what the

�� market had expected at the start of the

�� measurement period (1999).

�� Exhibit 2 illustrates the “expectations �� treadmill matrix.” The matrix plots market- �� value-to-capital ratios on the horizontal �� axis and TRS on the vertical axis, and the �� dashed lines represent the median for both

�� measures. Companies in quadrant 1 have both a high TRS and a high market-value- �� to-capital ratio, while those in quadrant 3 �� are low on both measures. These quadrants �� are easy to understand because both metrics �� are high or low. ��

�� Recovering underperformers reside in quadrant 2: they have low market-value- �� to-capital ratios, which were even lower ﬁve years earlier. These companies have a high TRS because they have improved their performance relative to weak leases) was $88 billion at the end of expectations—thus accelerating the 2003, when it had $29 billion invested treadmill, though their market-value-to- in operating capital (working capital, the capital ratios remain below the median. capitalized value of operating leases, and property in plant and equipment). Home In quadrant 4 is Home Depot, with a Depot’s MVA was therefore $59 billion and low TRS but a high market-value-to- its market-value-to-capital ratio was 3.1. capital ratio, along with other retailers such as Gap, Staples, and Walgreen. The MVA of Home Depot was the Historically, these retailers have been industry’s second highest, behind only some of the best in the United States. Wal-Mart Stores and far ahead of the rest. What’s going on? It is impossible to Home Depot’s market-value-to-capital ratio say whether their position results from was also at the top end of the scale, though unrealistic market expectations at the not as high as some other well-performing beginning of the period or from the companies (Exhibit 1). inability of managers to realize their company’s potential. The treadmills What about TRS? For the ﬁve years ending may have simply been moving too fast in 2003, Home Depot’s—at −2.3 percent for the companies to keep running at annually—was near the bottom of the the required pace. But note that 1999, group. The company did deliver the second- the beginning of our TRS measurement highest MVA, a strong market-value- period, was near the top of the stock to-capital ratio, and the second-highest market cycle, when large-capitalization �� Measuring stock market performance 3 ��

� � � � � � � � � Home Depot’s market value at the end of �� 2003 was consistent with the assumptions �� that it would continue to earn an ROIC of about 18 to 19 percent a year (the �� same as its 2003 ROIC, yet higher than �� its ROIC range of 15 to 16 percent over � � the three prior years) and that its growth �� would slow from its historically high rates. �� Revenue growth averaged 16.5 percent

�� during the five years ending in 2003. Our �� projection assumed declining growth �� from approximately 12 percent in 2004 to �� 5 percent annually by 2013. �� Is the market value consistent with � �� Home Depot’s intrinsic value creation �� potential? First, let’s examine the required �� growth. Using the growth rates in our �� simple estimation leads to $83 billion �� of new revenues by 2013. If Home �� Depot achieves same-store sales growth �� of 4 percent—a common assumption �� among analysts—it would need to add 900 stores over the next ten years (about 50 percent of its current base). Given estimates that the US market for home- stocks had unreasonably high P/E ratios. improvement superstores was already The gap has since closed, but this example nearly 80 percent saturated at the end of demonstrates one of the pitfalls of using 2003, the growth rates in this scenario TRS as a performance measure: the results are plausible but difficult to achieve. are highly dependent on the starting date. Second, consider whether Home Depot Is a company’s market value in line can maintain its ROIC at 18 to 19 percent. with its value creation potential? As Home Depot’s growth slows and it The final step in assessing performance focuses on core operations, some of its is linking the company’s market value to earlier challenges in managing growth its intrinsic value creation potential. We should be easier to deal with. Competition can do this by reverse engineering the with Lowe’s could intensify, however, company’s share price, essentially by using and Wal-Mart has been selling more and a discounted-cash-flow (DCF) model and more of Home Depot’s fast-moving items, estimating the required performance— potentially siphoning off customers. growth and returns on invested capital (ROIC)—to calculate the current share In summary, the performance scenario price. We can then evaluate how difficult consistent with Home Depot’s market value it will be for the company to achieve at the end of 2003 appears to be challenging this result. but not implausible. �� 4�� McKinsey on Finance Autumn 2005 ��

� � � � � � � � � in expectations for revenue growth. In �� Home Depot’s case, growth expectations �� declined signiﬁcantly, accounting for a $171 billion drop in value. At the end of �� 2003, we estimated the revenue growth � �� consistent with Home Depot’s share price to be about 8 percent annually for the next ten �� years. Investors in 1998 would have had to expect the company to grow at 26 percent �� annually to justify the market value at the

�� time. Such high growth expectations would have required Home Depot to triple its store count over ten years—from 760 in 1998 to more than 2,300 in 2008—with continued �� healthy growth until at least 2013, far �� beyond the saturation level predicted by �� some market observers. From this analysis, we are tempted to conclude that Home Depot’s poor TRS since 1999 results more from an overly optimistic market value at the beginning of the period than from ineffective management. We return to the company’s negative ﬁve- year TRS. Exhibit 3 shows an analysis of the change in Home Depot’s value over Measuring a company’s performance in the ﬁve years through 2003. We start with the stock market isn’t as easy as looking at the market value in 1999 of $132 billion. TRS, which is driven as much by how the If Home Depot had performed exactly company was valued at the beginning of the as expected, its equity value would measurement period as by its performance. have increased by the cost of equity MVA and the market-value-to-invested- (less dividends and share repurchases), capital ratio help to put TRS in context, to $197 billion at the end of 2003. The but to really understand a company’s stock difference between that number and its market performance, its value must be $80 billion market value is the result of linked to historical and projected growth

changes in the market’s expectations and returns on capital. MoF of the company’s performance.

Richard Dobbs (Richard_Dobbs@McKinsey Assume that in 1999 the market forecast .com) is a partner in McKinsey’s London office, Home Depot’s margins and capital turnover and Tim Koller ([email protected]) is to remain at 1998 levels. Since its operating a partner in the New York office. This article margins actually grew, the market should is adapted from Tim Koller, Marc Goedhart, have increased the company’s value by and David Wessels, Valuation: Measuring and Managing the Value of Companies, fourth $50 billion. The cost of equity, capital edition, Hoboken, New Jersey: John Wiley efficiency, and the cash tax rate did not & Sons, 2005, available at www.mckinsey change significantly during this period, so .com/valuation. Copyright © 2005 we attribute the remaining gap to changes McKinsey & Company. All rights reserved. 5

Reducing the risks of early a clean team. In the preannouncement period, such a team can serve as a neutral M&A discussions and objective resource that supports the executives of the companies involved during the very earliest stages of their discussions. The team conducts analyses that neither party can complete by itself Used early in negotiations, a third-party clean team can help (or complete as accurately) to assess a companies assess a deal and protect sensitive data. potential deal. A clean team adds the greatest value in specific types of M&A transactions, such as mergers of equals, alliances and joint ventures in industries Seraf De Smedt, Every executive knows what a high- with close regulatory scrutiny, or deals Vincenzo Tortorici, and stakes game M&A talks can become. But involving more than two partners. Erik van Ockenburg even before the formal negotiations start, a one-on-one conversation that plants the When the use of a preannouncement clean seed of a deal or a back-of-the-envelope team is appropriate, one major benefit is sketch of the business case for it may present its ability, through its unrestricted access deal makers with conflicts of interest and to the confidential data of all parties, to strategic vulnerabilities. Who would get give executives greater clarity about the what value from a deal? Who would govern potential value of consolidation long before the new entity? What legal boundaries the companies make formal commitments must prospective partners be careful not to or disclose sensitive information to cross? Moreover, deal makers also know one another. A clean team often helps that failing to close a transaction can turn companies to negotiate their agreements today’s potential partner into tomorrow’s more quickly as well, by setting aside better-informed competitor. the inevitable “win-lose” negotiation items—where one party benefits more than Tension often grows as each company the other—until the very end and focusing increases its investment in time and instead on the “win-win” elements. Indeed, advisers. The longer negotiations go on, analyses by a clean team that served the the more anxiety builds to complete the steel companies Arbed, Aceralia, and deal—if only to avoid the embarrassment of Usinor provided “the justification for the failing to deliver it. Transaction costs rise, merger,” says Guy Dollé, chairman and constraining a company’s ability to capture CEO of the merged company, now called synergies and in some cases even causing Arcelor. “When the negotiations became good opportunities to vanish. difficult,” he adds, the team’s analysis “brought us back to reality.” To successfully navigate the complexities of even the earliest discussions about Setting the rules mergers, acquisitions, and joint ventures, As a neutral party, a pre-deal clean team some companies are borrowing an has access to privileged information from approach that merger specialists all sides and can therefore conduct an early sometimes use much later in the process assessment of a deal’s business rationale, to expedite postmerger integration plans develop an integrated business plan for and business strategies: they appoint the new entity, and ultimately support �� 6 McKinsey�� on Finance Autumn 2005 ��

� � � � � � �

��

the formal negotiation process. Since and to keep a potential deal fully reversible, companies share conﬁdential information with no harm to the parties involved, until only through the clean team, this approach the transaction closes—the clean team also reduces the risk of sharing too much of must operate under strict, mutually agreed- it and of rushing into formal negotiations upon rules (see sidebar, “Clean-team too early (exhibit). To achieve these goals— management: The rules of the game”).

Clean-team management: Successfully implementing a clean team requires At the outset, the parties should specify the team’s The rules of the game meticulous preparation. In particular, the negotiating intended end products as clearly as possible. Details companies must have an unambiguous shared (such as data aggregation and analytical methodologies, understanding of all the conditions under which definitions, assumptions, and decision-making rules) the clean team will work—and of what happens to should be resolved within the clean team’s governance the members if a transaction isn’t concluded. Most structure—typically, a committee of executives from important, a clean team must be structured so that each negotiating party. All parties must accept a it doesn’t favor the interests of any one party over confidentiality and indemnification agreement that spells the others. out the expected levels of disclosure, such as the handling of data or the past connections of outside advisers with A clean team doesn’t share confidential information with the companies involved in the transaction. the companies involved in negotiations but rather uses it only to develop recommendations and assessments that As in any other M&A setting that involves a data room can be shared with all. It keeps a detailed log specifying with confidential information, the parties must agree on which information has been shared with whom and clean-room guidelines and on a code of conduct subject when. If questions arise about what can be shared, the to local regulation. Only clean-team members may enter clean team always secures the consent of the parties or the room. Documents must be stored in a locked cabinet their legal teams. and a list kept detailing what information about the Reducing the risks of early M&A discussions 7

These strict rules allow a clean team to for setting transfer prices—an issue that help companies verify their business plans otherwise could have become contentious and assess the likely extent of synergies by during later negotiations, perhaps even making it possible for the team to have free scuttling the deal. Once these common access to sensitive data (such as customer principles were settled explicitly, no major lists and raw-materials and production differences of opinion on this subject arose costs) that companies can’t or don’t want to later on, and the deal’s champions on both share, because of regulatory or competitive sides remained in alignment. considerations. Instead of sharing sensitive information directly, the companies provide Resolving such issues in the early stages it to the clean team, which consolidates of a deal by ensuring overall adherence to the analyses into figures and reports that agreed-upon rules and harmonizing the can be presented without risk to the top assumptions behind the business plans of management of all parties. the various parties are two fundamental aspects of the clean team’s role. The advantage of adhering to the rules can’t be overstated. This point is most An adaptive approach critical when companies focus on win-win Typically, a clean team can support three issues, where an objective solution can phases of pre-deal discussions. Given the be identified that is in the best interest of typical pressures and complexity of M&A all parties. In the case of a joint venture transactions, the best approach is to use involving two logistics companies, for a single team throughout all three. In example, the clean team helped them the first phase, the clean team helps the agree, very early in their discussions, on two (or more) parties to investigate the a common, objective set of principles transaction in its early stages (for instance,

companies has been stored in which places. Making individual members of a clean team can’t work for any of copies must be forbidden. the parties, at least in the business or function related to the team’s work, for a specified time period—often Managers and executives from the parties to the two years. transaction must be involved in the process. But a preannouncement clean team can’t include their own A preannouncement clean team doesn’t get involved employees, who would by definition threaten its with the win-lose elements of negotiations, such as neutrality, which is essential at the preannouncement splitting the value of synergies between the parties. stage. By contrast, a clean team that supports Instead, the team flags these issues and returns them integration efforts from the announcement to the closing to the deal’s steering committee for direct negotiations may include employees of the negotiating companies— by the parties. This is typically less of an issue for often recent retirees, people about to retire, or those integration clean teams, since the parties have an who can be assigned to different business units should interest in maximizing the value of the newly combined the deal fall through. company or joint venture.

The parties must also agree about what would happen Finally, to ensure full impartiality the parties involved to the team (both their own employees and the outside should share equally the cost of outside advisers advisers) if the deal were to fall through. Typically, working on a clean team. 8 McKinsey on Finance Autumn 2005

following exploratory talks at the CEO ensure that they commit enough resources level). At this point, the team focuses on to explore the merits of a potential deal assessing the high-level strategic rationale, early on. Thus they ensure that its business drawing on sensitive information from rationale gets evaluated adequately and the parties involved. If the that they understand the critical issues clean team’s analysis helps the while they are still in a cooperative phase companies to confirm that the of discussion. Also, the appointment A clean team works with both deal’s business rationale makes of a clean team makes the process of parties to establish contractually sense, the process continues investigating a potential deal more formal. as it would in any other M&A Typically, greater formality encourages enforceable rules that protect transaction—typically, with champions to emerge naturally on both sensitive information, ensure executives signing a nonbinding sides, even during this early stage, and impartial treatment, and maintain letter of intent. In the second gives them a vested interest in moving the a focused and transparent process phase, the clean team continues deal to completion once its merits have to build the detailed business been confirmed. case in preparation for the final negotiations. In the third phase, In the case of the two logistics companies, when negotiations inevitably turn to the the clean team’s access to all of their deal’s more contentious elements, the confidential data made it possible to clean team becomes less prominent but compute the deal’s cost and revenue remains active as a neutral facilitator, synergies with a high degree of detail answering specific questions about and accuracy. The clean team was also the details of the business case. able to confirm for the prospective partners that their respective business Confirming the business rationale plans were based on similar expectations In the absence of a clean team, the business about the impact of restructuring. rationale for a deal is often scoped out only in informal discussions between the CEOs Keeping the focus on an integrated and a handful of other senior executives. In business plan our experience, they often have little time In conventional merger or alliance talks, to investigate the specifics. The risks of this companies typically appoint a joint team approach are that momentum may slow to negotiate an integrated business plan. In because no executive has sole responsibility our experience, such a team often spends for pushing the deal through to completion a great deal of time reaching agreement or that, conversely, the partners may rush on procedural issues, such as the business into final negotiations too quickly. In any plan’s format, the alignment of valuation event, the records from this crucial first assumptions (such as depreciation policies), stage are often vague and incomplete, which and even the future positions of individual may waste valuable time later on if issues managers. These secondary issues inevitably must be reexamined. Sometimes, serious sidetrack the negotiations from a focus on problems that turn into deal breakers developing a solid business plan for the emerge late in the process. At worst, such a integrated entity. deal might simply evaporate. A clean team, by contrast, works with By appointing a clean team, companies both parties to establish contractually make the analysis more thorough and enforceable rules from the outset not only Reducing the risks of early M&A discussions 9

to protect sensitive information and ensure and valued during the first and second equal, impartial treatment of the companies phases among the merging companies. involved but also to maintain a focused Resolving this issue is a matter solely and transparent process. Such rules and for negotiations between the interested processes prevent managers on all sides parties. As a neutral intermediary, the from pursuing their personal agendas, clean team cannot take a stance. so the members of the clean team can quickly agree on or dispose of secondary During this phase, the role of the clean team issues. Sticking tightly to the rules builds thus changes from facilitating discussions trust in the process and in the clean team based on the results of its analyses to and makes it possible for both the team supporting the negotiations. The team will and the companies involved to focus on have completed most of the background harmonizing the assumptions behind its work of justifying the rationale of the analysis and on building a solid integrated transaction, building the business case for it, business plan. and identifying its synergies. Now the team usually works on responding to questions After two midsize European banks that come up in the negotiations—for had spent almost a year conducting example, the deal’s value if putative growth negotiations on a wide-ranging cooperative rates or margins rise or fall. agreement, for example, the talks broke down over disagreements about the Typically, investment banks or other structure of the complex deal and the counselors support the companies during banks’ respective valuations. Frustrated this phase, whether or not a clean team about the time, the money, and the energy is in place. But without a clean team’s that would have been spent in vain if objective record of agreements and the deal collapsed, the two institutions parameters, every aspect of the deal may be appointed a clean team to help get their subject to lengthy discussion. A clean team discussions back on track. Under the can therefore still add value in a supporting leadership of a joint steering committee, role, if only by ensuring that the parties the clean team helped executives on don’t reopen issues on which they have both sides to set aside some of the more previously agreed. complex aspects of the deal structure and instead to concentrate on an analysis of Common structuring tools, such as the the merits and implications of the business negotiation grid the logistics companies case. Supported by the clean team, the two mentioned previously used in their effort companies reached agreement in principle to form a joint venture, help a clean within three months. The deal closed fully team to ensure that negotiations remain about six months later. focused, timely, and on track. All of the parameters (about 50, in this case) driving Supporting negotiations the valuations of the respective companies While win-win issues lie at the core of any were assessed, and for each parameter the effort to develop an integrated business clean team helped to forge a consensus on plan, win-lose issues take center stage in whether an identical value was required the third and final phase of negotiations. for both parties (for example, an identical One classic example is the problem of cost of capital to value the business plans dividing the value of the synergies identified of both but different multiples to value 10 McKinsey on Finance Autumn 2005

their subsidiaries). The team then indicated the parameter’s impact (low, medium, Clean teams can be as effective in high) on both parties, thus ensuring preannouncement discussions of an M&A that precious time wasn’t lost on minor deal as they often are in preparing issues that had little impact on value. The companies to integrate after the deal closes members of the team, who attended the (see the next article, “Smoothing post- negotiating sessions only to take notes merger integration”). Indeed, when used in and to ensure that the parties had a the very earliest stages of discussion, such common understanding of its analyses, teams increase the likelihood of closing scrupulously sent back to the negotiators valuable deals and help companies to strike any questions it couldn’t answer by better and stronger agreements—or, using the results of its analyses in a way alternatively, to conclude early in the that was consistent with the previously process that a deal’s business rationale agreed-upon rules of engagement. doesn’t stand up to scrutiny. MoF

A clean team delivers the greatest possible Seraf De Smedt (Seraf_De_Smedt@McKinsey value if it can take a deal all the way .com) is a consultant and Erik van Ockenburg through to this final stage. By then, the ([email protected]) is an associate principal in McKinsey’s Brussels team will have become the deal’s memory office, and Vincenzo Tortorici (Vincenzo and conscience, thus ensuring—together [email protected]) is a partner in the Milan with the champions on either side—that the office. Copyright © 2005 McKinsey & Company. negotiations reach closure. All rights reserved. 11

Smoothing postmerger integration they worry that there won’t be enough time for a clean team to accomplish anything before a deal closes. Some of them express concern that sharing confidential data will expose their companies to undue risk should the deal fall through—or that the impact of the clean team won’t justify the It takes less time than you think for a clean team to make valuable expense of assembling it. contributions to the integration of businesses. Such misplaced concerns often lead to costly delays. We believe that a well-structured clean team almost always makes it possible Nicolas J. Albizzatti, In any merger, acquisition, or joint to capture a merger’s value more quickly Scott A. Christofferson, and venture, the sooner managers integrate and can reduce the risk of failure. Such Diane L. Sias their companies the faster they capture the teams address myriad issues that are well expected synergies. So in the hectic days within the limits of the regulations—and and weeks after a deal is announced, CFOs can help to resolve them well within the face a daunting list of responsibilities, period between the announcement and the such as managing the deal’s financial close of a deal. aspects, justifying the strategy to investors, negotiating with regulatory authorities, and Indeed, we find that managers consistently ensuring compliance with the regulations underestimate how much time may be that come into force once a deal is involved at this stage, which for the 455 announced. And CFOs must manage all this largest mergers in 2004 lasted an average while essentially flying blind, without access of nearly three months (Exhibit 1).1 That is to legally restricted data. plenty of time for a clean team not only to conduct analyses and make decisions that In our experience, establishing a clean team expedite postclosing integration but also to support integration efforts before a deal to prepare the merged company to be fully closes can help speed up the completion of operational from day one. Thus the team’s critical tasks and improve the chances of work helps capture more of the merger’s capturing the merger’s synergies. Working synergies before competitors have a chance under confidentiality agreements, such to react. a team has unrestricted access to data from each of the companies involved— Moreover, clean teams can add value to data legally off limits to the companies’ merger integration efforts in incremental employees until the deal closes. After chunks—at first, quite small ones. compiling and analyzing this information, Executives who anticipate having as little the team can quickly deliver aggregated as a month between the announcement findings that help decision makers plan and the close of a merger should be able the structure and operations of the merged to assemble the most basic kind of clean entity even before the deal has closed. team, which undertakes the critical work of gathering and harmonizing data and can 1 The top 455 mergers, by transaction value, announced in 2004, excluding Given such virtues, it’s surprising that serve as the foundation for a more elaborate withdrawn, pending, rumored, and executives don’t set up integration clean team if time permits. And with a small team intended deals as well as deals announced and closed on the same day. teams more frequently. Many CFOs tell us in place, the parties to a deal can avoid �� 12 McKinsey�� on Finance Autumn 2005 ��

� � � � � � � � � it’s useful to have a larger clean team that �� takes a more active role in facilitating, �� and even designing and planning, the �� integration of the merging companies. And while all clean teams operate under the �� same assumptions of conﬁdentiality (see �� sidebar, “Clean-team management: The �� rules of the game,” on page 6), different �� models provide for the ﬂexibility needed to

�� meet the demands of individual situations. �� Library clean teams �� When the time between the announcement �� and the close of a deal is expected to be �� short, the most basic type of clean team, �� serving a library function, may well be beneﬁcial. Such a team can be deployed quickly and meet its objectives in a matter

�� of weeks. Its primary work—gathering and � �� harmonizing data—is almost certain to be �� useful in preparing businesses to integrate. In addition, its records will help to give regulators precise answers to questions about divestitures or grandfathered having to play an expensive catch-up game products and services. In 2003, some after it closes. 40 percent of US deals involved second-stage requests from regulators for information, Three types of integration and nearly 4 percent ultimately faced a clean teams legal challenge, so many deals are delayed In theory, clean teams can handle a considerably beyond the target closing date. broad range of pre-integration analyses Given such scrutiny, the ability to avoid and planning if sensitive, proprietary, or risky and expensive guesswork is attractive. legally restricted data would otherwise Furthermore, once the library team has inhibit collaboration until after the completed its initial task, it can add close. In practice, what these teams do analyses and functions that help it evolve varies considerably, depending on time into new roles as time permits. constraints, the level of public information typically available in an industry, and A successful library clean team should be any preexisting relationships between able to do three things. First, the team and the companies. When time is as short as the decision makers ought to determine one or two months, a smaller and more which data will be needed to integrate targeted clean team—sometimes comprising the companies once the transaction has only a few third-party advisers who limit closed. The data will vary, depending on themselves to gathering and organizing the synergies expected from the merger. data—is preferable. If the period between The team should also be able to gather the announcement and the close is longer, and harmonize the data—organizing the Smoothing postmerger integration 13

information into accessible formats so it financial-reporting and synergy-tracking can be compared and aggregated easily. systems. It took less than two weeks to Finally, the team should be able to brief the gather the data and only a month after the decision makers after the close about what close to validate the deal’s synergies. the data mean and to point out problems in harmonizing the data between companies. Facilitator clean teams If executives expect at least six weeks to In general, it is relatively easy to elapse between the announcement and the decide which data are needed to make close of a deal, the merging companies decisions. Harmonizing the data—a should consider expanding the team’s bigger challenge—has the side benefit of role from librarian to facilitator. A bringing into stark relief any differences facilitator clean team’s work goes a couple in the way the two businesses define of critical steps beyond that of a library and use them. The key is to get started; clean team. Once the data have been a library clean team’s efforts can easily gathered and harmonized, the facilitator be pushed further if time permits. team and the merging parties reach an agreement about the specific analyses, One packaged-goods company, which was assumptions, and decision-making rules pursuing a hostile takeover of a competitor, needed to determine how the expected began working even before it was clear synergies will be captured. The team then that the takeover would go through. The supports both companies as they develop company created an informal clean team recommendations and draft action plans. during the time between announcing its intentions and reaching the legal threshold Before a deal’s close, the team can typically of ownership for compulsory acquisition. divulge only high-level information, such as This team was charged with deciding what the value and timing of anticipated synergies technology would be used to validate the or the total number of displaced employees company’s outside-in synergy estimates and from each company. After the closing, with creating a series of data templates for the team reviews its work with the new the target company to complete immediately management, which can either implement after the close. As a result, the same data in the recommendations immediately or the same format would be readily available modify them. A facilitator clean team from both companies. typically doesn’t include staff from either company, so if the transaction falls through The informal team of the acquiring no valued employee must be displaced. company then populated the templates with its own data and created detailed glossaries Consider a merger between two IT so that it would be very clear what data hardware manufacturers, where three the team was seeking. Once it became months elapsed between the announcement obvious that the acquisition was inevitable, and the close. The clean team was small, shortly before the close, managers from with only five members, all third-party the acquired company joined the effort in advisers. Its task was focused: to review a formal clean team. Thus, the integration the merged companies’ supply base, so that managers understood their real targets, when the transaction closed the executives without any need for a time-consuming and staff of the newly consolidated and error-prone manual reconciliation of purchasing function would be able to 14 McKinsey on Finance Autumn 2005

review the team’s recommendations and negotiations with regulators as well as supporting analysis and begin negotiations analyzing budgets and financial plans to almost immediately. confirm and further develop the merger’s synergy and growth targets. Its other roles By the time the deal closed, the clean include reviewing the companies’ business team not only had analyzed the prices plans to identify key short-term issues that and terms of the current contracts (as must be resolved urgently after the merger well as the supply market dynamics) for wins regulatory approval, auditing the the most important commodities but terms of suppliers and customers to identify had also recommended specific tactics the source and scale of opportunities or for purchasing them. In addition, it problems, and developing postmerger provided a detailed, consolidated spending strategies in sensitive areas such as pricing database reconciling differences in the and channels. data definitions of the two companies; validated opportunities to save money A designer-planner clean team set up by two by combining their purchasing volumes, financial institutions was developed over using price arbitrage, and cutting the total the six months between the announcement cost of ownership; and drafted detailed and the close. It eventually expanded to plans (including the negotiating strategy) include a total of 600 staff members from for each key commodity. In the end, the both organizations—most of the people team’s support enabled the companies to who would staff the combined business unit accelerate their integration effort by at after the merger. To meet the goal of hitting least two months, so they could move more the unit’s full synergy run rate a mere five quickly to capture cost-saving synergies that months after the close, the team built an executives valued at $400 million a year. information system that not only allowed the two institutions’ communications Designer-planner clean teams and support systems to interact as soon Designer-planner clean teams are the as the deal closed but also let executives hardest for CFOs to deploy: they require transfer assets to their new home quickly. the most resources, the largest budget, and In addition, the team made all systems the greatest number of people from both infrastructure and applications choices organizations. Such teams therefore also and supported the process for selecting the involve some risk if deals don’t go through. merged unit’s leadership. While they can complete their work successfully in only two to three months (if When management decides to establish a companies feel comfortable about the risks), designer-planner clean team, it is critical we have seen them take as long as six. to provide for the right kind of interaction Despite the investment and the risks, they between the clean team, on the one can capture more of a merger’s synergies hand, and the integration team, the line more quickly after the close than can the manager accountable for execution, or other kinds of clean teams. both, on the other. This approach ensures that line managers don’t hesitate before At this level, the team starts the real executing recommendations or delay work of planning the integration of two the integration effort by studying them, companies—for example, by valuing which would reduce or even eliminate assets and modeling scenarios to support the value of the whole investment in the �� Smoothing�� postmerger integration 15 ��

� � � � � � � � �

��

clean team. In a recent merger in the to fall through. And clean teams are just chemical sector, a clean team was set up impractical when the closing is imminent, to segment customers by proﬁtability. in auction situations, and in most hostile Biweekly interactions between the clean takeovers, among other occasions. team and the integration team ensured the proper alignment, focus, and direction. The trick for executives heading up a merger is to balance the costs and risks Deciding to use a clean team of establishing a clean team, including Of course, in some situations the use of the cost of outside advisers and the risk integration clean teams doesn’t make of including employees, against the risk sense. If the value of projected synergies of delaying integration planning until the from a merger is small, for example, the deal closes and the cost of delaying the day clean team’s effort may not be worth the when synergies can be captured. In such expense. A company may also have good cases, it may help to analyze some of the business reasons for not sharing its sensitive basic opportunities and risks (Exhibit 2). information too openly—for example, when Overall, though, companies may have more sharing technical speciﬁcs such as patents, time to set up a clean team and may gain R&D project portfolios, formulas, or oil more in eventual synergies than most of exploration locations would create too them realize. Not surprisingly, however, much of a risk to its business if a deal were managers often resist a CFO’s efforts 16 McKinsey on Finance Autumn 2005

to support these teams. Such managers it merely makes the peak workload after claim that they need all of their time and the close even worse. And the budget for a resources just to manage the company’s clean team is generally immaterial compared current workforce and don’t have the with the overall cost of getting the deal done management bandwidth, the people, or and of the integration effort—a cost that the budget to staff a clean team. Their can be as high as two times the value of resistance may be well intended, but it the expected synergies. Finally, clean teams can cost a company dearly during the can have the added beneﬁt of allowing the integration process. partners in a future merger to work together in an unbiased way that creates the trust

First, without the answers a clean team can necessary for success going forward. MoF provide, the uncertainties (and hence the risk to ongoing business) will continue long past Nicolas Albizzatti (Nicolas_Albizzatti@McKinsey the final closure of the transaction. Second, .com) is a consultant in McKinsey’s Atlanta office, while it is true that management must review Scott Christofferson (Scott_Christofferson @McKinsey.com) is a consultant in the the clean team’s output and that some staff Washington, DC, office, and Diane Sias (Diane members will get involved in providing data [email protected]) is a partner in the New Jersey and in undertaking analyses, this work will office. Copyright © 2005 McKinsey & Company. have to be done eventually anyway; delaying All rights reserved. 17

Comparing performance when to small changes in capital, and highly volatile and thus often inappropriate as invested capital is low a tool for comparing the performance of business units or companies. What’s more, executives who continue to use ROIC as their main point of comparison are likely to measure and manage performance Return on capital is the benchmark for comparing performance unproductively. They might hesitate to between businesses. But new math is needed when a company’s invest additional resources in low-capital capital intensity is low. businesses (Exhibit 1) or, still worse, ignore capital altogether and focus on margins alone as the primary Mikel Dodd and Executives and investors have reliable performance metric. Werner Rehm tools for measuring performance in capital- intensive sectors such as manufacturing, A more useful way to measure performance retailing, and consumer goods. In general, is to divide annual economic proﬁt by the math is simple: when managers generate revenue.2 Grounded in the same logic as returns on invested capital (ROIC) above conventional ROIC and growth measures,3 their cost of capital, they create value. That this metric gives executives a clearer formula makes it relatively easy to compare picture of absolute and relative value the creation of value among business units creation among companies, irrespective of or between companies. a particular company’s or business unit’s absolute level of invested capital, which can But what if the invested-capital side distort more traditional metrics if it is very of the equation approaches zero, as it low or negative. As a result, executives are increasingly does among companies that better able to evaluate the relative ﬁnancial use outsourcing and alliances and thus performance of businesses with different reduce the capital intensity of parts of capital-investment strategies and to make their businesses? Other businesses, such as sound judgments about where and how to software development and services, also spend investment dollars.

1 This statistic is based on a McKinsey analysis have inherently low capital requirements of more than 600 companies with sales greater or take advantage of atypical working- In application, this approach will vary than $100 million. The classification of a company as an industrial one is based on the capital dynamics, including prepayment from business to business, depending on Compustat CIGS classification system, jointly by customers for licenses and payment by what is defined as volume and margin. In launched by Standard & Poor’s and Morgan Stanley Capital International (MSCI) in 1999. suppliers for inventory. Even traditional a people business, such as accounting, the businesses are shedding capital: the margin would likely best be broken down 2 Economic profit is typically defined as a company’s posttax operating profit minus a median level of invested capital for US into the number of accountants multiplied capital charge, calculated as the company’s industrial companies dropped from around by the economic profit per accountant. In weighted average cost of capital (WACC) multiplied by the operating invested capital. 50 percent of revenues in the early 1970s a software business, however, it would be See Tim Koller, Marc Goedhart, and David 1 Wessels, Valuation: Measuring and Managing to just above 30 percent in 2004. better calculated as the number of copies the Value of Companies, fourth edition, of software sold times the economic profit Hoboken, New Jersey: John Wiley & Sons, 2005, pp. 182–8, for more information about When a company’s or a unit’s business per copy of software; in this case, deriving calculating ROIC and economic profit. model doesn’t call for substantial capital the margin from the number of employees

3 The present value of economic proﬁt plus or even involves negative operating capital, wouldn’t make sense. But in all cases, this invested capital yields the same enterprise the ROIC is usually extremely large approach can provide a more nuanced value as formulas based on ROIC and growth and discounted-cash-ﬂow models. (whether positive or negative), very sensitive understanding of performance across �� 18�� McKinsey on Finance Autumn 2005 ��

� � � � � � � � � to pay in advance for software development �� moved the level of operating invested capital �� below zero.

�� But while the move made strategic �� sense, operational reviews among the �� conglomerate’s business units became �� meaningless. Executives insisted on �� comparing them only on the basis of ROIC �� and growth performance, which meant �� that much time was spent arguing about �� the negative ROIC of the new business �� and whether it created or destroyed value �� and was on track to become a proﬁtable �� undertaking. Nobody could assess the �� performance of the software business �� against that of the conglomerate’s �� traditional businesses. Discussions about �� the allocation of resources became heated— �� in particular because the growing software �� business needed to hire staff while older units were cutting back.

�� Since business models within a single industry may diverge, similar problems bedevil many executives trying to compare overall corporate performance. A US businesses or companies with divergent high-tech manufacturer that pursued an levels of capital intensity. aggressive facility-outsourcing strategy combined with a just-in-time inventory Same company, different economics system eventually drove its invested capital A large European industrial conglomerate below zero. As a result, the company’s provides an example of the difficulties ROIC was negative and therefore of using ROIC to compare business units meaningless. A direct competitor also with different levels of capital intensity. acted to improve its efficiency but kept The company’s executive board decided its manufacturing assets in house. This to take advantage of a trend in traditional decision left it with significantly higher industries toward adopting the next levels of invested capital but also with generation of process automation software higher margins. It thus had a substantial and services by launching a business unit positive—and meaningful—ROIC, which that exclusively offered software solutions made apples-to-apples comparisons based on standard off-the-shelf hardware. between the two companies impossible. The new business naturally had a low level Furthermore, the ROIC of the first company of invested capital, since its assets were fluctuated wildly, as minor changes in its essentially people and no manufacturing invested capital sharply altered the results of was involved. The willingness of customers the ROIC calculations. �� Comparing performance when invested capital is low 19 ��

� � � � � � � � � in revenue (Exhibit 2, part 1). Two newer �� business units—a software business and a services business—have very low or �� negative invested capital. The company’s �� more asset-heavy traditional business �� can extract a proﬁt margin of 12 percent �� (compared with 7 percent for the other �� units) because it doesn’t outsource any parts �� of the value chain and has an established, captive customer base that faces high �� switching costs. It is growing more slowly,

�� however—by 4.5 percent a year, compared � �� with 6 percent for the new businesses. ��

�� Using these data, the return on capital for

�� the software business is a negative 700 percent while the ROIC of the services business is a positive 700 percent, even �� though the actual difference in the �� invested capital of the two units is only 2 percent of revenue. The traditional business has a 30 percent ROIC. A Board members and investors of this first conventional evaluation of performance company frequently wondered if it was would compare the two newer businesses outperforming its competitor and wanted on the basis of their margins (because to know how management was judging the their capital is so small as to be deemed performance of its strategy and business meaningless) and scold the traditional model. In frustration, the company’s business for its high capital intensity. executives and board increasingly focused on margins as their key operating metric. That kind of approach can lead to serious But the appropriate level of margins for misjudgments of the value created by the their low-capital strategy was difficult to three units and to the misallocation of judge. They recognized that a business resources among them—as indicated by whose capital intensity was low as a result the fact that the traditional business has of outsourcing should have lower margins the highest value of the group, even though than one that retained its manufacturing it has the lowest growth rate (Exhibit 2, assets and thus substantial capital, but they part 2). How can this result be reconciled struggled to determine how low a level with the observed returns on capital in was reasonable. order to compare the true fundamental performance of the three units? It turns A different measure out that in this case, ROIC tracks the To understand how a metric based on creation of value much less accurately economic profit and revenue can eliminate than does economic profit divided by such distortions in measuring value, revenue. According to that measure, the consider a hypothetical company with economic performance of the three units is three business units, each with $1 billion remarkably similar. All are creating value in �� 20�� McKinsey on Finance Autumn 2005 ��

� � � � � � � � � performance of the US high-tech �� manufacturer with that of its direct � �� competitor (Exhibit 3). Owing to the high- �� tech company’s negative invested capital (a

�� result of the outsourcing strategy), ROIC comparisons were meaningless. Margin �� comparisons were also tricky; a company that outsources would be expected to have �� lower margins than one that holds on to �� all parts of the value chain. But an analysis �� using economic profit divided by revenue �� made it clear that the outsourcing strategy �� as implemented wasn’t as successful as had been hoped; the high-tech company was still generating less value per unit of revenue than its competitor. absolute terms (all the ratios are positive), and they are creating value at a similar rate, Executives of the large European industrial with the traditional business slightly ahead. conglomerate mentioned previously ultimately decided to use economic profit, Equally important, economic profit combined with value targets based on divided by revenue avoids the pitfalls economic-profit-discounting models, as its of ROICs that are extremely high or measure for success. While this approach meaningless as a result of very low or required a significant investment in training, negative invested capital. Economic profit, the change reflected management’s goal of a in contrast, is positive for companies with consistent measure for value creation across negative invested capital and positive capital-light and capital-heavy units. posttax operating margins, so it creates a meaningful measure. It is also less sensitive to changes in invested capital. If Returns on capital will always be an the services business mentioned previously essential metric for managers. Yet in doubled its capital to $20 million, its businesses with low levels of invested ROIC would be halved. But its economic capital, replacing ROIC with economic profit would change only slightly and profit divided by revenue will make economic profit divided by revenue hardly internal and peer comparisons much

at all (to 6.8 percent, from 6.9 percent), more meaningful. MoF thus more accurately reflecting how small an effect this shift in capital would Mikel Dodd ([email protected]) have on the value of the business.4 is a partner and Werner Rehm (Werner 4 Economic profit in the example falls by WACC [email protected]) is a consultant in times the change in capital, or $1 million. The Using the same approach, consider value of the business falls to $1.720 billion, McKinsey’s New York office. Copyright © 2005 from $1.735 billion, on this change. again attempts to compare the operating McKinsey & Company. All rights reserved. 21

What global executives think about developing economies as an important trend, the respondents are divided over growth and risk the impact these systems will have on the profitability of their own companies; the answer depends on which side of the cost divide they occupy. Likewise, while many company leaders think that the aging of the As globalization creates new markets and competitors, hopes developed world—and the resulting decline contend with fears. in its workforce—will be an important economic factor, they disagree about the consequences: those in consumer-facing industries see opportunity, but those in Steven D. Carden, A recent McKinsey Global Survey of labor-intensive ones see risk. Lenny T. Mendonca, and Business Executives tells a two-sided story Tim Shavers of growth and risk. On the one hand, rising On the whole, global business leaders are affluence in developing economies and bullish about the impact of key trends the increasingly fast pace of technological on profitability. Of the ten trends we innovation present new opportunities for studied, seven garnered more positive growth. Yet these same forces are driving than negative responses—some by a wide the emergence of low-cost business systems margin (Exhibit 1): for example, 71 percent that make global markets increasingly of the respondents expect technological competitive, thus accelerating the rate at innovation to have a positive impact on which companies lose their leadership profits, while only 5 percent expect it positions. The survey quizzed some to have a negative impact. The trends 9,300 business leaders around the world perceived as threats to global business on the most important trends influencing are growing geopolitical instability, the global economy in the next five years, increasing risks to the supply of natural with a particular focus on growth and the resources, and mounting environmental constraints to it.1 hazards. Many of the executives in the survey think that these three will have Eighty-one percent of the executives a negative impact on profitability. surveyed think that increasing affluence and growing demand for goods in developing In addition, the survey explored the economies will be important during the next actions that executives intend to take five years. Some 70 percent believe that these in response to the trends. How will the factors will buoy the profitability of their respondents expand the businesses they own companies. Technological innovation manage? What markets are they seeking? and the corresponding proliferation of new What constraints are most likely to technologies emerged as an equally critical limit growth? And what capabilities do trend, which 81 percent of the executives companies require to prosper given the consider important and 71 percent see as a trends at work in the global economy? 1 The respondents live in more than 130 countries and represent a wide swath of significant driver of profitability. geographies and industries as well as a broad Sources of growth mix of large, midsize, and small companies. Approximately half of the respondents are “C- The survey also highlights key differences When asked about the geographical sources level” executives—board members or major of opinion. While most executives view of growth, executives point to both the decision makers in their businesses, including 274 CFOs and finance-related executives. the rise of low-cost business systems in developed and the developing world. Some �� 22��McKinsey�� on Finance Autumn 2005 ��

� � � � � � � � � 41 percent of the companies with more �� than $5 billion in revenues expect it to be �� their biggest growth market. This focus on �� China reﬂects the substantial investments �� that many large companies have made there �� already. Perhaps less obvious, it also shows �� the growing realization that demographic �� trends are slowing growth in the developed �� world and forcing growth-hungry �� companies to look elsewhere. �� As for the growth prospects of sectors, �� the executives say that health care �� has the greatest top-line potential in �� the next ﬁve years, with energy- and �� natural-resource-related industries �� coming in second. Information �� technology and telecommunications

�� are tied for a distant third.

�� Optimism about the health care sector’s �� growth prospects may reﬂect an increasing

�� awareness of demographic trends affecting the developed world—in particular, the fact that older households will control �� an increasing share of total spending and �� will devote a growing proportion of their income and accumulated wealth to health care. This view of the health care sector’s 27 percent believe that the relatively slow- future probably results from other factors growing but vast market of the United as well, including its historical growth and States will account for the bulk of future proﬁtability, rapid innovation in health care expansion. China, a close second, was the technologies, and the brisk expansion of choice of one-quarter of the executives— basic health care services in the developing little surprise given that country’s meteoric world. Indeed, respondents from developing rate of expansion. The United Kingdom markets pick health care as the third most came in third, at 7 percent, but no other important growth sector, behind energy and country registered above 5 percent. telecommunications.

Interestingly, the key factor differentiating Constraints on growth the United States and China as the market When asked about constraints on growth, of choice appears to be company size. the executives say that the shifting nature Of the respondents from companies of their markets—the competitors and with revenues of less than $250 million, the consumers alike—will create the 30 percent choose the United States as the biggest challenges. Seventy-seven percent key growth market. Larger players, by believe that intense competition will be contrast, anticipate more growth in China: an important constraint on the growth of �� What global executives think about growth and risk 23

� � � � � � � � � of managing rapid growth. As China �� and India rise to global stature, local companies with relatively little experience �� managing large-scale organizations �� suddenly face the difﬁculties of handling a vast, newly employed workforce. ��

�� The constraints on growth that seem

�� most serious to the executives vary widely by region—not surprising, �� given the vast differences among local �� business environments. North American �� executives are more concerned than �� their counterparts elsewhere about rising �� health care costs. Indian executives see a

�� lack of infrastructure as a key limitation.

�� Executives across developing economies worry about the rising cost of natural �� resources—a concern that probably reﬂects �� both an increasing demand for energy and the greater manufacturing orientation of

�� these economies relative to those in the �� developed world.

Executives from different industries also disagree about the relative importance their companies. Sixty-four percent cite of various constraints. Financial-services the challenges of satisfying an increasingly executives see a hostile regulatory sophisticated consumer market. Sixty environment as a potentially key problem. percent worry that competitors will Respondents from heavy industry, reacting introduce new products that could displace to the recent double-digit price hikes theirs. Large companies, which may be less across most commodity categories as confident of their ability to innovate and Asian demand strains global supply, are to stay ahead of rivals, fear the growing significantly more concerned about the competitiveness and sophistication of their rising cost of natural resources. markets more than smaller companies do. Other potential concerns barely register Another constraint preoccupying with the respondents. European executives, the executives is the high cost and for example, are among the least worried low availability of talent; 73 percent about rising health care costs, despite consider this problem a key limitation on the region’s rapidly aging population and growth (Exhibit 2). Interestingly, even the potential strain it places on national executives in labor-rich China and India health care systems. US executives express are quite concerned about talent, with relatively muted concern for the risks posed 71 percent and 81 percent, respectively, by environmental hazards, notwithstanding seeing it as a constraint—a response the global, if uneven, tendency to worry that may reflect the inherent challenges about and regulate them more vigorously. �� 24 McKinsey on Finance Autumn 2005 ��

� � � � � � � � � � � � � � � � � �

��

� ��

��

These responses and others like them 63 percent say that they plan to meet suggest a tendency to assume that their goals in their most important current local conditions will persist. This growth markets by expanding existing assumption creates potential blind spots operations. Only 12 percent and 11 percent, about what trends are likely, over time, to respectively, say that acquisitions and joint upset the status quo. ventures are their most important growth strategies (Exhibit 4). Methods for growth When the executives were asked how they Coupled with the emergence of developing plan to promote growth in the current economies such as China and India, the environment, they overwhelmingly pointed pace of technological innovation creates to innovation, which some 43 percent a paradox of growth and risk for today’s describe as the capability their companies global executives. The way companies most need in order to grow. Asked what cope with the double-edged sword of low- speciﬁc action is most necessary to achieve cost business systems that make markets growth, one-quarter said innovation within increasingly competitive will do much to current product lines and 22 percent said determine which companies prosper—and

the development of new ones (Exhibit 3). falter—in a rapidly globalizing world. MoF Interestingly, ﬁnancial-services executives,

while seeing innovation as important, Steven Carden (Steven_Carden@McKinsey also regard better distribution as crucial, .com) is a consultant and Tim Shavers (Tim probably in response to the challenge of [email protected]) is an associate principal in trying to deliver financial products in new McKinsey’s New York office, and Lenny Mendonca and growing markets. ([email protected]) is a partner in the San Francisco office. This is an excerpt from an article by the same name in The McKinsey Quarterly, A majority of the respondents think that 2005 Number 2. Copyright © 2005 McKinsey & their companies will grow organically; Company. All rights reserved. Amsterdam Antwerp Athens Atlanta Auckland Bangkok Barcelona Beijing Berlin Bogota Boston Brussels Budapest Buenos Aires Caracas Charlotte Chicago Cleveland Cologne Copenhagen Dallas Delhi Detroit Dubai Dublin Düsseldorf Frankfurt Geneva Gothenburg Hamburg Helsinki Hong Kong Houston Istanbul Jakarta Johannesburg Kuala Lumpur Lisbon London Los Angeles Madrid Manila Melbourne Mexico City Miami Milan Minneapolis Montréal Moscow Mumbai Munich New Jersey New York Orange County Oslo Pacific Northwest Paris Philadelphia Pittsburgh Prague Rio de Janeiro Rome San Francisco Santiago São Paulo Seoul Shanghai Silicon Valley Singapore Stamford Stockholm Stuttgart Sydney Taipei Tel Aviv Tokyo Toronto Verona Vienna Warsaw Washington, DC Zagreb Zurich Copyright © 2005 McKinsey & Company