In the second of a two-part series, we analyse the value of organic business growth.
IT is well established that a record of organic growth is the main determinant of a company's share price. That is not really surprising.
Sustained organic growth is a reliable indicator of a sound business model, good management, quality products and effective operating systems. It not only draws heavily upon an organisation's core competencies but is also has the effect of reinforcing them.
Furthermore, commitment to the discipline of organic growth is clear evidence that managers think strategically about the future, believe that innovation is the key to competitive advantage and stay focused on creating value for customers. The sustained growth and market capitalisation trajectories of companies such as GE, Google, Samsung and Dell is highly instructive and a clear vindication of innovation-driven organic growth.
In his detailed analysis of 800 value-creating companies, corporate growth expert Ed Hess found that only 22 based their success on internal growth. The vast majority eschewed the rigorous discipline of executing challenging innovation strategies. Instead, they chose the easier, quicker and more spectacular route and flew in the face of the daunting data that documents the M&A failure rate. According to Mercer, in a study of 119 US and European M&A deals, 44 per cent of senior US executives estimated that between $US1-5 million had been lost or not realized and 43 per cent of senior European executives indicated between 1 million and 5 million euros had been lost or not realised. In both cases, these outcomes were simply the result of conflicting cultures. In 25-30 per cent of cases it was significantly more than $US5 million or 5 million euros.
Even more alarming is a Hay study of 200 major European M&As, which found that only 9 per cent of the participating senior managers judged the deal to be 'completely successful'. Hay concluded the major reason for underperformance was management's focus on tangible, short-term fixes in areas such as restructuring, cost-cutting and IT rationalisation and neglect of 'soft', long-term issues such as corporate culture, client loyalty and brand identity.
By contrast, attempts to generate growth through M&As in the majority of cases fail to achieve their objective. M&A is opportunism rather than strategy and frequently involves a quick fix approach to expansion and market share. According to research by PricewaterhouseCoopers (PwC) on M&As, 'far too often real shareholder value is lost, not gained'.
Only 44 per cent of respondents considered post-deal financial goals had been successfully realised and just 48 per cent reported a reduction in operating expenses.
PwC concludes that achieving market share, profitability, cash flow and reputation growth through M&A activity is much more difficult to achieve than most managers predict. Post-merger integration issues such as corporate culture, supply chain management and the rationalisation of operating systems tend to be taken for granted with the result that quality and service decline rapidly. In short, M&As tend to erode core competencies, stimulate internal rivalry and take the focus off customers.
As opposed to M&A, strategic alliances and partnerships are increasingly successful organic growth options, as the case of Australian medical device company Cochlear demonstrates (as discussed last week). Open innovation, working closely with customers, suppliers, service providers and other firms, is generally the most cost-effective method for identifying value creating opportunities, sharing knowledge, expanding into new markets and lifting competitiveness.
Companies such as Philips, IBM and Toyota have hundreds of inter-firm partnerships. Alessi, the global housewares design company, is a pioneer of open innovation and works with almost 200 external designers Groupings such as science parks and clusters (geographic concentrations of interconnected companies) offer the same benefits to SMEs, which tend to be nimbler and more innovative than their larger counterparts. Successful replications of the so-called 'Silicon Valley effect' can now be found in most parts of the world including Tromso in Norway, Cambridge in England, the Emilia-Romagna region of Italy, Malaysia's Cyberjaya and Doha's Education City.
Cochlear remains committed to continuous innovation and its founder, Graeme Clark, as director of the Bionic Ear Institute, has played a key role in cutting edge research to improve sound quality and reduce the risk of infection.
However, as the company has expanded globally, the effective integration of technology has become the dominant feature of its business model. The management of partnerships is now a critical core competency. With more than 300 suppliers and 80 collaborative research programs in 19 countries, to say nothing of the complex relationships with government agencies and professional bodies around the world, the management of critical issues such as coordination of partnerships, quality assurance and proprietary information has become the key to continuing success.
For all of these reasons, the effective leadership of high performance teams will be no less important than the management of the innovation process in assuring Cochlear's long-term future as the dominant market leader in its industry.
Organic growth based upon continuous innovation continues to be Cochlear's preferred strategy. Based on current performance, it is clearly on the right track and future prospects look promising. According to its latest annual report, the company estimates there are about 278 million people with moderate to profound hearing loss in both ears, and this figure will rise as the population ages and life expectancy increases. Apart from upgrades and repairs, Cochlear is developing increasingly specialised products for different types and degrees of hearing loss.
Given that it has become a global leader after serving only 100,000 recipients, a small fraction of the potential market, Cochlear already has a unique platform from which to become one of the world's most innovative, competitive and enduring medical technology companies.
n John Milton-Smith is emeritus professor at Curtin University's School of Management.
