The material is derived from extensive original empirical analysis, the case archives of Bain & Company, interviews with CEOs and direct experience with clients who face the challenges of generating growth and shareholder value on a day-to-day basis.

The challenges of growth

Most growth strategies fail, even when they succeed. What do we mean by this? We mean that only a small minority of companies succeed in creating shareholder value over long periods of time, even when they manage to grow revenues. Many companies enjoy temporary spurts of growth, only to see their gains erode under the onslaught of competitors. And even those who achieve sustained revenue gains are often surprised to find no corresponding gain in shareholder value. Yet a handful of companies do succeed in growing revenues, net income, and most importantly, shareholder value for extended periods.

The facts about growth

Quality growth is rare. To prove it, we examined the performance of 1854 companies for a 10-year period (1988–1998) to see which generated sustained, profitable growth and created value for shareholders. The results, shown in Figure 1, are startling. Only 13% of companies in our database equalled or surpassed a reasonable set of growth targets (5.5% real annual revenue and income growth) and created shareholder value over the 10-year period.² (For the remainder of the text we will refer to these companies as sustained value creators, or SVCs.)

Many firms find these targets—5.5% revenue and net income growth and positive shareholder value creation—achievable for short periods of time, but nearly all stumble sooner or later (and mostly sooner). Figure 2 shows the percentage of companies that were able to meet these targets on average for multiple years.' Fewer than 51 % were able to sustain this performance on average for two years, fewer than 27% did it for six years, and only 13% succeeded for more than 10 years.

All growth is not created equal. Our analysis shows that revenue growth alone has little or no impact on shareholder value. In fact, companies that grew revenues were more likely to destroy value than create it! Instead, sustained revenue and net income growth is the only reliable way to create shareholder value. As Figure 4 demonstrates, companies that grew revenue and profits together grew shareholder value on average more than three times faster than companies that grew only revenue or profits.

Size has little bearing on a company's ability to generate sustainable, profitable growth and shareholder value. Our SVCs varied greatly in size, from companies with $500 million in revenues to those over $10 billion. However, these highly successful companies were distributed more or less proportionally to the composition of our original database. Only the largest companies, those over $20 billion in revenues, exhibited a retarding effect of size.⁴

A common misconception is that rapid, sustainable growth can only occur in "hot" markets markets that are growing rapidly—and that being in a hot market is the best way to generate high profit levels. Our data refutes that. A variance analysis of our database demonstrated that relative competitive position within an industry is more than four times as significant as the choice of industry in determining the economic returns of companies. In other words, it's how you play the game that matters, not which game you play. Highlighting this is the extreme concentration of profits in most industries. Of all the profits generated by the 2000 companies in our database over 10 years, over 90% were captured by just 20% of the companies. When we examined the distribution of profits within each industry, the same pattern held—one or two companies in each industry captured nearly all the profits. In other words, it is relative competitive performance within your industry that matters, not which industry you are in. Industries in which "a rising tide lifts all boats" are transitory phenomena.

This point is best made by examining the performance of SVCs relative to their respective industries. In each industry a major company—frequently the leader—grew at multiples of its industry growth rate. For instance, Nike's 27% growth far outpaced the 6% growth of the shoe market, its core business, over the period 1987–1997. Many of the other SVCs, such as Coca-Cola, Mattel and Harley-Davidson, grew in markets that were mature, even stagnant. Only 15% of our SVCs were in high growth industries such as semiconductors, software or IT services.

If industry choice, company size and revenue growth don't drive shareholder value, what does? Our research shows over and over the power of the purest form of business model—the single dominant and differentiated core business. The best stories of sustained and profitable growth almost always come from a company focusing on and growing its "profitable core" and then driving its greatest competitive advantage into adjacent areas around the core. Conversely, we find that diversification almost always destroys economic value. (Box 1 provides a further explanation of the profitable core.)

The power of a single, dominant core business cannot be overstated. Figure 5 shows a breakdown of a sample of SVCs. Over 80% of these companies had one or two distinctly and clearly defined profitable cores, and more remarkably, over 90% enjoyed dominance in their core business.

Mining growth from a strong core business

A further probe into the most successful growth strategies reveals two key elements: the first is a strong, or even dominant, competitive position in a core business or segment that has been managed aggressively to gain consistent market share, year in and year out, against key competitors. The second is an investment programme that reinvests in the core at a rate that sustains competitive advantage. To put it another way, winning companies often control the industry profit pool—even their competitors' profitability levels—and use that leverage to ensure that they invest at a higher rate than their competitors. Frequently, the result is even greater levels of market control and greater levels of competitive superiority, allowing even more investment to build positions in the "periphery" of the core business.

It has been said that the first imperative of business strategy is to discourage your competitor from investing in those segments or products that are central to your own business—just as focusing on enemy supply lines is a key principle in successful military campaigns.

You can see this dynamic at work in Figure 6, which illustrates the comparative reinvestment rates of top and bottom quartile companies in each of eleven industries which we studied. In many instances, the leader's reinvestment rates were more than double those of its competitor, fuelling both a higher rate of growth and more profitable growth for the leader.

Boeing, for example, maintained a reinvestment rate for more that a decade that was twice that of McDonnell Douglas. This has resulted in a steady widening of Boeing's leadership in commercial aircraft, as demonstrated most recently by McDonnell Douglas's decision to stop investing in the development of the next generation of commercial aircraft, by American Airlines' recent decision to commit to Boeing for all fleet purchases until well into the next century, and finally by the Boeing-McDonnell merger announcement.

As a corollary to this principle, we find that the most common way for a company to fall short of the growth it might achieve is by underestimating the potential of its core business, declaring it infertile ground prematurely. An example: in the US in 1988 Enterprise RAC and Agency RAC each had approximately half of the market for insurance replacement care rentals. In this basic, seemingly sedate industry, Agency attained a place on a shortlist compiled by Business Week of the "most competitive companies in America." But in the ensuing years, its management concluded that the company's basic rental business lacked the potential for growth and, accordingly, moved Agency into other lines of business. Enterprise, which started from the same position as Agency, is today the largest car rental company in the US even bigger than Hertz. The company has been growing at 12% a year with 10% margins. Agency, by comparison, is about a tenth the size of Enterprise and was recently sold to new owners.

Sherwin Williams offers a similar example in US house paint. In the mid-1980s the company was only marginally profitable, with 200 company owned stores at a point when competitors were withdrawing from this segment of the market. Today Sherwin Williams has over 2000 stores, has been growing at 8% to 10% per year, and has a shot at doing in paint what Anheuser-Busch has done in beer. All this with a core business that others judged fallow.

The key, again, is reinvestment. As Figure 7 illustrates, by reinvesting in a strong competitive position, a company can create a self-perpetuating cycle of ever-widening out-performance of competitors, a cycle that sees the level of the company's game increase on each dimension critical to the business system—market share, product quality, capacity to attract the best customers and the ability to keep the best employees.

Working with our clients we have developed a variety of ways to achieve profitable growth from a strong core business. Strategies include:

1. Identify and quantify customer defections, and then determine their true root cause. In industries like insurance and stock brokerage, the defection rates experienced by different competitors turn out to be the best predictors of their profitability relative to one another. In most industries, the average company loses half of its customers every five years, yet typically executives don't know the rate at which this is happening in their own businesses. If you can improve retention of your best customers by as little as 5%, you can increase your growth rate by several percentage points.

2. Re-segment your customer base periodically based on actual buying and usage behaviors rather than on standard industry demographic data. Companies such as Callaway golf clubs, Dell Computer and Oakley sunglasses have used a strategy focused on emerging market segments to outflank larger competitors.

3. Tracking investment by segment and by channel to make sure that your are not being outinvested in your target segment by a key competitor.

4. Understanding better than your competitors the cost and service gaps perceived by your, as well as their, core customers and using this in account targeting and product investment.

Two implications follow: If your company's relative competitive position in a particular business is weak, you would be well advised to strengthen it first, before launching into a new growth initiative or diversification. This sounds simple and obvious, but is violated all of the time. If you do have a strong position though, even in what might seem like an unpromising industry, you can grow profitably, providing you pursue and implement the right strategy.

Expanding into business adjacencies

Overall, during the course of our work, we have identified at least five dominant patterns of sustained corporate growth:

1. Organic growth, into a range of surrounding "adjacent" businesses

2. Development and implementation of a new, superior business model (usually superior economics)

3. Industry consolidation followed by leveraging the new, higher market share

4. International expansion

5. Positioning and control of new, fast growing distribution channels

By far the most successful growth strategy is rapid organic growth to adjacent business from a position of economic strength, akin to the growth recorded in the rings of tree's trunk. Over 70% of companies that grow in a sustained profitable manner do it in this way, rather than by acquisition. They may, for example, expand by increasing their coverage of the market, going after customers they never reached before. Or, they may increase their market penetration, seeking 100% of the business of existing customers. Champion growth companies are also expert at identifying and moving into businesses adjacent to their own. They are prepared to enlarge their business definition, but only one 'ring' at a time. Great examples of this inexorable organic progression of a company are CocaCola, Fidelity, Motorola and Disney.

There are three steps that businesses can take to expand into adjacencies:

1. Clearly identify the "strategic assets" that can be built upon to move into new business areas. These can be brands— Nike's move into clothing or Dunhill's move into premium merchandising—or capabilities—Gillette's capabilities in managing 'checkout counters' leading to the acquisition of Duracell batteries.

2. Rigorously map out all of the business adjacencies surrounding your core business, just as a general maps out the full battlefield terrain for his army to exploit. Companies that do such mapping, gauging the size of these adjacencies and estimating their true profit potential, invariably find more directions for growth than they had initially thought possible. Witness the experiences of companies like Servicemaster, 3M, USAA or Microsoft. Each has achieved sustained growth by proceeding from adjacency to adjacency, while continuing to invest to protect the original core of their business.

3. Explore second or third generation adjacency moves as part of the initial business opportunity. Companies that think more than one move ahead in planning adjacency moves make more effective investments. For example, Disney's move into retail opened up far more merchandising opportunities and is now having a profound effect on how its characters are developed and marketed.

Our research found that over two-thirds of chief executives thought part of their growth problem was that they did not have an adequate flow of credible growth ideas being put forward by their organisations. Would idea flow be the problem if these companies mapped out a full set of adjacencies for each business? We don't think so.

Creating the growth-oriented organization

Ultimately, growth management must not only change what companies do (focus on core, expand into adjacencies) but also who they are. Growth can only come from a management team focused on and motivated by growing the top line of their companies. It is much harder to form a growth-oriented team than it is to develop a growth-oriented strategy. Changing who you are, though harder, will have far greater rewards. It is no accident that some of the best cases of sustainable growth emerge from venture capital firms. They know the power of creating a motivated management team with plenty to gain from growth and plenty more to lose if they fail to grow.

Conclusion

Our findings raise a call to arms for any company serious about creating significant shareholder value. Consider what the facts demonstrate: First, profitable growth is the single most effective way to consistently create shareholder value, yet only one in seven companies achieves reasonable revenue and income growth rates for extended periods of time. Second, neither a company's industry nor its size has any significant bearing on the success or failure of its growth strategy. Third, the most successful companies are almost always those that start by maximising their existing advantages first—in other words, focusing on the profitable core and driving it to leadership.

Partly in response to the heightened interest in growth, fads and "silver bullet" approaches have proliferated—idea generation exercises, elaborate scenario planing, the search for new industry models and the use of the Internet, to name a few. These may have their role, but Bain & Company's review of hundreds of business situations leads us to conclude that these superficial approaches are not the drivers of most sustained profitable growth.

The most effective way to increase your company's rate of growth begins with refreshing your understanding of the business dynamics and microeconomics of your best core businesses. At least that is what the actual data show.

Chris Zook, James Allen and John Smith together lead Bain & Company's Worldwide Strategy practice.

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BOX 1: The profitable core

The profitable core is the unique, and by definition, highly profitable combination of business assets, skills, products and relationships that distinguishes a company from its competitors and allows it to provide a unique value proposition to a segment of customers. The profitable core may be a distinct business, a subset of a business, or it may be composed of elements of several businesses. Over the long term, the profitable core is a company's primary engine of growth and value creation.

For Guinness PLC, the profitable core has always been the brewing business in Ireland. Even after the acquisition in the 1960s and 1970s of more than 250 diverse businesses, the brewing business still accounted for over two-thirds of Guinness PLC's cash flow. At Disney, the profitable core is the ability to create and market endearing cartoon characters to a highly loyal group of customers. All of Disney's most successful expansion initiatives can be traced in some way to this original core.

The core can be an extremely durable engine for profitable growth and value creation, driving a corporation for many decades. Baxter Healthcare was founded in 1931 to sell the first commercially manufactured intravenous (IV) solutions to hospitals. Over the next twenty years, these basic IV products provided the platform for the development of 'sterile fluid bags', or plastic containers for storing human blood and other fluids. The sterile fluids business (with its follow-on products such as dialysis, drugs, pumps, etc.) has accounted for the vast majority of profits and value creation for Baxter since its inception in 1931, despite a long series of expansions, diversification and acquisitions.

In many companies, however, the profitable core is buried beneath layers of underperforming businesses. Frequently the profitable core generates only a small portion of company revenues, yet provides the bulk of a company's profits. The most successful companies have one or two clearly defined profitable cores and out-invest their competitors in that core, leveraging it for highly profitable growth.

Notes

1. Our analysis derives from a database of nearly 2000 companies, built up from The Worldscope

Database and Datastream International, and includes financial data on all public companies in seven countries (US, UK, Japan, Australia, Germany, Italy and France) with 1996 revenues greater than US$500 million for whom data was available over the 10-year period 1988–1998.

2. 5.5% revenue and income growth targets were compiled by averaging the growth targets in a random sample of corporate strategic plans. Actual growth rates by individual companies were adjusted for their country's inflation rate. Companies whose average annual total shareholder return (TSR) exceeded their cost of equity (Ke) over the 10-year period were deemed to have created shareholder value. TSR is defined as returns to shareholders from stock price appreciation plus dividends. Average annual TSR is calculated assuming dividend reinvestment in the stock. Companies who exhibited average real revenue and earnings growth of 5.5% per year and positive shareholder value creation over the 10-year period were considered to have met the targets. Exceeding targets in consecutive years was not a necessary condition. Allowances were made for one-time events.

3. Percentages shown are of companies who met these targets on average for multiple years. Exceeding the targets for consecutive years was not required.

4. The Corporate Executive Board, with Hewlett Packard, documented this phenomenon extensively in their excellent 1998 study on Stall Points in growth.