Organic growth: seven principles that determine winners and losers

Organic growth is high on the agenda of both managers and shareholders. This is increasingly being reflected in financial reporting and the content of the dialogue that is occurring with investors. Most major consumer goods companies are reporting some measure of organic growth. Many are publicly announcing organic revenue growth targets alongside the traditional earnings per share (EPS) target. Some are shaping strategies very actively around organic growth targets and proving willing to exit low-growth businesses while focusing on high-growth areas.

Organic growth is important to marketers because it signals the success with which marketing is helping to grow the top line – ultimately the acid test of any good marketing department. With the increase in interest in organic growth and the corresponding improvement in the quality of reporting, the time seems right to review systematically what is being achieved, with a view to drawing some conclusions about what is driving good and bad performance.

We believe that we have created the first and authoritative database of organic growth performance in the consumer goods industry. We have then interrogated our data to attempt to answer seven important questions. What overall level of organic growth is being achieved?

• How does this vary by geography and product category?
• Who are the winners and losers?
• What determines good and bad performance?
• Is there a link between organic growth and shareholder returns?
• How well is organic growth reported?
• What are the issues and pitfalls for the investor and analyst in interpreting performance?

 OVERALL ORGANIC GROWTH PERFORMANCE

The objective of the Ingram Growth Index has been a simple one: to build a comprehensive factbase of the organic growth performance of the world's biggest consumer goods firms and, from this data, draw some inferences about the key success factors in determining organic growth performance.

From 21 companies, we have assembled what we think is an authoritative dataset. It analyses performance by company and by market, and throws some light on the dynamics of growth by company, category and region.

The growth rate 'league table' by firm (see Figure 1) demonstrates dramatically that, within the overall picture of low growth, there is a wide range of performance among individual companies. Firm-level growth rates vary by more than ten percentage points around the average of 5%, with the best performer, SAB Miller, just edging into double-digit growth. By contrast, the bottom-of-the-table company, Sara Lee, is actually declining in organic terms.

Three groupings by performance are discernible within the overall league table. The first group of six high-growth companies (SAB Miller, LVMH, Reckitt Benckiser, P&G, Danone & PepsiCo) have sustained growth rates more than two percentage points above the industry average. A second group of ten 'mid-growth' companies (Pernod Ricard, L'Oréal, InBev, Nestlé, Kellogg's, Colgate, Diageo, Cadbury Schweppes, Heineken and Henkel) have delivered performance within two percentage points either side of the average. A final group of five 'laggards' (Kimberly Clark, Kraft Foods, Unilever, Heinz and Sara Lee) have grown or declined by at least two percentage points less than the average. These may not sound large differences, but these are huge companies operating in essentially stable markets.

The picture at firm level corroborates the one at region and category level. High-growth firms are diverse in character and not systematically those that always compete in high growth markets. For example, P&G and Reckitt Benckiser are able to grow at rates of 7– 8% per annum from a similar mix of categories as Unilever and Henkel, who are growing at only 2–3% per annum. It therefore seems that it is something about individual firms' strategies, assets and capabilities that is driving growth, rather than the fortunes of specific markets. This is the nub of the organic growth challenge. A further important issue around growth performance is the impact of local market inflation on company-level results. Not all organic growth is 'good' growth.

A relevant example is SAB Miller, the best-performing firm in the league table. More than 50% of SAB Miller's revenues arise from the relatively high-inflation markets of South and Central Africa, Eastern Europe and Central America. Many countries in these regions have high single-digit or double-digit inflation rates and one or two, such as Zimbabwe, are experiencing hyperinflation. Our estimates suggest a sizeable proportion of SAB Miller's organic growth could be arising from local market inflation effects, an observation corroborated by the fact that most of SAB Miller's organic growth is price, rather than volume, driven.

The data again support the picture that it is firm strategy, not just underlying market conditions, that drives growth. Two examples serve to illustrate this conclusion. In household care, Sara Lee, Unilever and Henkel have all delivered low single-digit or negative growth. By contrast Reckitt has delivered 8%+ growth from the same category. In mature regional markets such as Europe and North America, the best performers, such as PepsiCo and Diageo, are extracting 5%+ growth, while the worst such as SAB Miller, Unilever and Heinz, are declining.

THE TAO OF ORGANIC GROWTH: SEVEN PRINCIPLES DETERMINING WINNERS AND LOSERS

The Index also starts to explore the important relationship between growth and shareholder value. The exercise has led us to formulate the 'Tao' of organic growth: seven principles that we think are helping to determine the winners and the losers in the global organic growth game. These are detailed below.

1 Having the Right Assets and the Right Strategy is More Important than Simply being in 'Growth Markets'

A common mistake made by many firms is to think that delivering growth is principally a question of participating in the right 'growth' markets. The evidence from the Index suggests the opposite. Firm-level performance within a market varies far more than the difference between market growth rates. What matters more is whether you have competitive advantage allied to a winning strategy where you choose to play.

Case study: P&G in China

As the Index demonstrates, mere presence in developing and emerging markets is no guarantee of growth. In order to prosper, firms need to develop a competitive strategy. And because emerging markets are so different in terms of social and cultural norms, distribution systems and spending power, firms need to be highly adaptive in order to win. While an exemplar on most dimensions of our 'Tao' of organic growth, it is P&G's commitment to success in developing and emerging markets that is perhaps most impressive.

First and foremost, P&G has allocated resources commensurate with the scale of the opportunity: 30% of the company's $1.9bn R&D budget is now committed to low-income markets, a 50% increase in five years. Second, P&G has successfully deployed its consumer observational techniques initially pioneered in developed markets. Instead of commissioning surveys and focus groups, the firm has spent days and even weeks closely observing consumers in their homes. This has led to innovations such as Tide Clean White, a low-cost washing powder without water softener, reflecting the fact that poor and unemployed Chinese would rather work harder on washing by hand than invest in washing machines.

Third, the company have recognised the importance of engineering products to (low) price points rather than the implicit developed market mindset of constant 'premiumisation'. P&G is therefore trying to produce a disposable nappy (diaper) for the Chinese market that costs about the same as a fresh egg: 10 cents. These sorts of price points are being hit via a combination of product despeccing and locally constructed, low-cost manufacturing lines. The result is that while P&G's organic volumes are growing, unit price realisation is falling as developing markets increase their importance in the mix (source: Financial Times).

2 Scale, Leadership and Focus are Important Building Blocks of Success ...

The majority of the winners in the Growth Index are leaders in their chosen markets. Leadership tends to be a benefit of focus – the decision to concentrate on a limited number of markets where one can sustain a leadership position. But the market must be sensibly defined: pursuit of leadership in markets that are either too wide or too narrow is unlikely to pay off.

Case study: Sara Lee – desperately seeking focus

Sara Lee emerges as the clear growth laggard in the Index and is the only company in the Index to have actually declined in organic terms over the most recent three years. A new management team under former Pepsi executive Brenda Barnes is now attempting to rationalise and focus a business that lost its way in the late 1990s pursuing a competences-based strategy.

In 1997, Sara Lee embraced the concept of 'weightlessness' and announced a $3bn restructuring plan under which it planned to sell many of its factories and become an 'asset light' operation around a core competence in 'brand management'. Decision-making was actively decentralised to local managers and brands. 'Selling L'eggs pantyhose in a department store is no different from selling Ball Park Hot Dogs from a stand,' opined former CEO Steve McMillan.

In 2000 the company had 200 individual profit centres and was apparently comfortable making near-simultaneous acquisitions in coffee (Chock full o'Nuts) and apparel (Courtalds). Under Barnes, Sara Lee is now attempting to unwind this legacy with the sale of Chock full o'Nuts and its entire apparel business, among others. The aim is to reduce the size of the group by 40% via divestment of peripheral businesses. This will give Sara Lee a presence in a more manageable five categories: meats, bakery, beverage, household and body care.

Marketing is being centralised at the firm's Chicago HQ and marketing investment in the new core categories is being increased. In its own words Sara Lee is 'narrowing our scope so that we can expand our horizons (sources: annual reports; The Economist).

3 ... but Need to be Exploited by the Right Structures, Frameworks and Processes

The benefits of scale, leadership and focus will be evanescent unless they are made to count. Successful organic growers are companies who have put in place the organisational culture, structures and processes that enable them to make the most of their underlying assets and strategy. There are no right or wrong answers about which structures, processes and frameworks should be adopted, but there are some clear choices to be made.

4 Successful Innovation is more likely to Emerge from a Patient and Persistent Focus on Core Categories, rather than from 'Blue Sky' Opportunities Outside the Core

The conventional wisdom is that driving growth depends on a lot of 'blue sky' thinking and exploitation of 'white space' and 'blue ocean' opportunities. We think the evidence suggests otherwise. High-growth companies tend to be those that focus intensively on their core markets and core consumers, and who do a lot of 'incremental' innovation.

Case study: Reckitt Benckiser – 'crazier than most people'

With turnover of barely $7bn, Anglo-Dutch Reckitt Benckiser is one of the Growth Index's relative minnows. However, the company is a giant in terms of its ability to grow via innovation. It lies third in the Index league table with close to 8% average growth in the last three years and in the last six years it has never posted less than a 6% organic growth rate. Reckitt's strategy is based on three pillars, as described below.

First, an exclusive focus on a tightly and meaningfully defined category: household cleaning outside detergents. So while the two 5001b gorillas P&G and Unilever slug it out in soap powders, Reckitt has been able to prosper in the adjacent but less competitive sub-categories of surface care, fabric care, automatic dishwashing and home care. With this obsession with what most people would regard as relatively unglamorous categories, Reckitt is 'crazier than most people' says CEO Bart Becht.

Second, dedication to tangible, consumer-led innovation. Reckitt is now meeting its self-imposed target of 40% of its sales accruing from products launched in the last three years. Its rate of R&D investment is unremarkable but, like P&G, it focuses very hard on observing and listening to consumers around the cleaning problems they encounter in their daily lives. This has inspired a steady flow of innovation in products as diverse as hair removers, air fresheners and mosquito coils. Reckitt's culture is one that nurtures problem-solving innovation rather than image-led branding. Says Becht: 'We tend to be very good when there is a clear functional benefit behind the product. We would not be very good at selling perfume.'

Third, there's the high rate of marketing investment behind 'power brands'. Reckitt's advertising:sales ratio is among the highest in the consumer goods industry. However, the bulk of this investment is concentrated behind the company's 15 designated 'power brands', which have the margin structure and economies of scale to maintain the high levels of marketing investment necessary to communicate functional benefits and deter competitive entry. Reckitt's power brand portfolio has therefore grown even faster than the company as a whole: +12% in 2005 (sources: annual reports; Accenture Outlook; Financial Times).

5 Don't Ignore the Importance of Sticking to the Marketing Knitting

In an industry that is growing its revenues by 5% per annum on average, the good news is that small changes to this performance will make a big difference. Before leaping towards risky innovation and new product development, the best companies think hard about things like consumer and trade marketing effectiveness and sensible resource allocation.

Case study: improving trade marketing effectiveness at Gillette

For most major consumer goods firms, trade marketing is a big and inflating item. For many, the trade marketing budget is now exceeding that of traditional consumer marketing as retailers are demanding ever-higher levels of listing fees and promotional funding. The effect is to limit severely firms' ability to improve unit price realisation, as headline price increases get dealt back into more promotional funding.

Historically this area has been under-managed, but the major players are waking up to the benefits of taking more control. A good example is Gillette's price/deal realignment programme in its Duracell Batteries business in North America. Facing intense price competition and eroding margins, Gillette decided to try to stop the rot and launched the programme in early 2003.

Duracell's volume sold on promotion fell from 49% in 2002 to 44% in 2003, the level of free battery giveaways fell by 60% and the average price of an AA battery, the most significant in terms of volume, stabilised for the first time in four years. The results have been impressive. Gillette has simultaneously managed to stem price erosion at Duracell and increase volumes, doubling net margins over a four-year period. These are key performance indicators at Gillette's Duracell Division.

6 The Idea that 'Organic Growth is Good and Acquisitive Growth is Bad' is a False Distinction – Winners Deliver on Both

Conventional wisdom would have it that organic growth is good and acquisitive growth is bad. We disagree. For the firms in this Index, both organic and acquisitive growth are positively correlated with shareholder value creation. What matters is having an effective growth strategy and not overpaying – not just for acquisitions (where the risk is obvious) but also for value-destroying organic growth.

Case study: Pernod/Seagram and Cadbury/Adams – Coming 'home'

Well-targeted acquisitions have an important role to play in accelerating organic growth. One important circumstance in which this can happen is when a business owned by a 'distant' parent finds itself in the arms of a more 'loving' one who is better able to realise its untapped potential.

When Pernod-Ricard acquired Seagram's gin and whisky brands in late 2000, it brought to an end a saga of changes of ownership that had seen the original Seagram drink business merged with the Universal/MCA Entertainment business, followed by acquisition of Universal/Seagram by Vivendi, a French utility company. Perhaps not surprisingly, the drinks brands suffered from these disruptions and in Pernod found their first stable home for several years. In 2002, the first full year of Pernod ownership, the former Seagram portfolio grew organically by 5.4%, after allowance for one-off de-stocking effects. Subsequently the brands started to surge, powered by increased marketing investment, access to Pernod's route to market and committed ownership. In the latest half-year, former Seagram brands Martell, Chivas Regal and The Glenlivet are growing by 23%, 18% and 12% per annum respectively.

When Cadbury Schweppes acquired Adams chewing gum in late 2003, there was a similar change in parenting style. Adams was an unloved outpost of pharmaceutical giant Pfizer to the extent that many of its managers felt that they had 'come home' once Cadbury acquired it. In the year prior to its acquisition the Adams business grew organically by 5%. In the latest year (2005) it has grown by 11% – more than twice the pre-acquisition rate. The drivers of this improvement have been similar to Pernod/Seagram: innovations such as centre-filled gum, access to a superior route to market and ownership by a company for whom confectionery is a core category (sources: annual reports; sales reports; CNBC interview).

7 Setting the Right Level of Expectation is Important

Consistent with the above is the need to set and communicate targets that are consistent with delivering value and that can be achieved.

Successful CEOs executing growth 'turnaround' strategies have been careful to manage down expectations in pursuit of sustainable, achievable growth.

This is a highly edited version of a longer and more detailed report entitled: 'The Ingram Growth Index: organic growth performance amongst the world's leading consumer goods companies'.

This article featured in Market Leader, Spring 2007.

FIGURE 1: GROWTH RATE ‘LEAGUE TABLE’ BY FIRM