1. “Alas, the road to success is always under repair.”
Managing Growth
“Alas, the road to success is always under repair.”
–Anonymous
Dr. David Gligor

2. Introduction Is growth something to be maximized?
Many executives see growth as something to be maximized
As growth increases, firm’s market share and profits should rise
Growth is not always a blessing
Rapid growth can put considerable strain on company’s resources
=> Rapid growth can lead to bankruptcy
Rapid growth has driven almost as many companies into bankruptcy as slow growth has
These firms provide a product people want and fail only because they lacked the acumen to manage their growth properly
It is possible for companies to grow too slowly
Come under increasing pressure from shareholders, irate board members, and potential raiders
Growth needs to be managed => Operating manager responsibility

3. Outline Sustainable Growth Too Much Growth
What to Do When Actual Growth Exceeds Sustainable Growth
Too Little Growth
What to Do When Sustainable Growth Exceeds Actual Growth
New Equity Financing

4. A Typical Firm’s Life Cycle (1)
Startup phase
Firm loses money while developing products and establishing a foothold in the market
Rapid growth phase
Firm is profitable but is growing rapidly that it needs regular infusions of outside financing

5. A Typical Firm’s Life Cycle
Maturity phase
A decline in growth and switch from absorbing outside financing to generating more cash than the firm invested
Decline phase
Marginally profitable, generates cash than it can reinvest internally, and suffers declining sales
=> search for new investment opportunities

6. Sustainable Growth Sustainable growth rate?
Maximum rate it can grow without depleting financial resources
Increased sales require more assets of all types, which must be paid for
Unless the company is prepared to sell common stock or borrow excessive amount, this puts a ceiling on the growth in can achieve without straining its resources

7. The Sustainable Growth Equation
Let’s first assume:
Company has a target capital structure and a target dividend payout policy it wishes to maintain
Management is unable or unwilling to sell new equity
Consider a firm whose sales are growing rapidly
Sales growth requires investment in AR, inventory, and productive capacity

8. New Sales Require New Assets,
Which Must Be Financed
What limits the rate at which the company can increase sell?

9. Sustainable Growth Rate (g*)
What limits the rate at which this company can increase sales or, more generally, its overall expansion?
As equity grows, the firm can borrow more money without altering the capital structure
The growth of liabilities and the growth of equity determine the rate at which assets expand
g* is the ratio of the change in equity to equity at the beginning of the period (or growth rate in equity)
g* = Change in equity / Equitybop

10. Sustainable Growth Rate (g*)
If the firm pays out all of its earnings as dividends, it cannot grow equity
g* = Change in equity / Equitybop
= (R x Earnings) / Equitybop (where R is retention rate)
= R x ROEbop
= R x P x A x Tbop (or PRATbop)
(where Tbop is asset/equitybop ratio, A is asset turnover, and P is profit margin)

11. Levers of Growth g* = R x P x A x Tbop (or PRATbop)
There are 4 levers of growth: P, R, A, T
P and A summarizes the operating performance
R and T describes the firm’s financial policies
g* is consistent with these ratios
=> If a company increases sales at any rate other than g*, one or more of the ratios must change
A company that grows at a rate in excess of its sustainable growth rate needs to better improve operations or prepare to alter its financial policies

12. Too Much Growth (1)
Increasing operating efficiency is not always possible and altering financial policies is not always wise
=> A firm can grow too fast for its own good
This is particularly true for smaller firms, which may do inadequate financing
Such firms see sales growth as something to be maximized
Rapid growth has them on a treadmill – the faster they grow the more cash they need, even when they are profitable
Can meet needs for a time by increasing leverage, but eventually will reach debt capacity, and firm will find themselves without cash to pay bills

13. Too Much Growth (2)
Difficulties can be prevented if managers understand that growth above firm’s sustainable rate creates financial challenges that must be anticipated and managed
This DOES NOT mean that a firm’s actual growth rate should always equal its sustainable growth rate, or even closely approximate it
Management must anticipate any disparity between actual and sustainable growth and have a plan in place for managing that disparity

14. Balanced Growth ROA = Net income / Assets
= Profit margin x Asset Turnover (or P x A)
g* = R x ROEbop
= R x P x A x Tbop
= RTbop x ROA
g* is the product of RT and ROA, where RT reflects financial policy and ROA reflects operating performance
Given stable financial policies, sustainable growth varies linearly with ROA

15. A Graphical Representation of
Sustainable Growth

16. Ex) Medifast’s Sustainable Growth Rate

17. Medifast’s Sustainable Growth Challenges, 2006—2010

18. What To Do When Actual Growth Exceeds Sustainable Growth?
If growth is temporarily too fast, just borrow and wait for it to slow down
If not, then there is a laundry list of actions to take:
Sell new equity
Increase financial leverage
Reduce dividend payout
Prune marginal activities
Increase prices
Merge with a “cash cow”

19. Sell New Equity
If a firm is willing and able to raise new equity capital by selling shares, sustainable growth problems vanish
The problem with this strategy is that it is unavailable to many firms and unattractive to others
In many countries, equity markets are poorly developed or nonexistent
Even in countries with well-developed stock markets, many firms find it difficult to raise new equity
Even many companies that are able to raise new equity prefer not to do so

20. Sources of Capital to U.S. Nonfinancial Corporations, 2001—2010

21. Increase Leverage
If selling new equity is not a solution, two other financial remedies are possible:
Cut dividend ratio
Increase financial leverage
Increasing leverage is a “default option”
When management does not plan ahead, firm will find there is too little cash to pay creditors and AP will rise by default
Creditors will eventually balk at rising debt levels and force firm into default – step one on the path to bankruptcy
Need to identify an appropriate degree of financial leverage for a firm and ensure this ceiling is not reached

22. Reduce the Payout Ratio
Just as there is an upper limit to leverage, there is a lower limit of zero to a firm’s dividend payments
Most of companies are already at this limit
Saves cash that can be used to build up equity
Can anger shareholders who respond by selling their stock, thereby driving down stock price

23. Profitable Pruning
Firms have limited resources and limited ability to manage disparate activities
=> extremely difficult to be important competitors in different markets at the same time
Profitable pruning is the opposite of conglomerate merger
This strategy recognizes that when a firm spreads its resources across too many products, it may be unable to compete effectively in any
Reduces sustainable growth problems in two ways:
Generates cash directly through sale of marginal businesses
Reduces actual sales growth by eliminating some of the sources of growth

24. Outsourcing
Involves decision of whether to perform an activity in-house or purchase it from an outside vendor
A firm can increase its sustainable growth rate by outsourcing more and doing less in-house
When outsourcing, it releases assets that would otherwise be tied up
Increases asset turnover and therefore ROA
Key to effective outsourcing is:
Determine where the company’s unique abilities (or core competencies) lie
Identify activities that are candidates for outsourcing
=> If it can be performed by others without jeopardizing the firm’s core competencies

25. Pricing Inverse relationship exist between price and volume
If a firm’s sales growth is too high, firm can raise price to reduce growth
If higher prices increase profit margin, price increase will also raise sustainable growth rate
Very effective way to cut growth

26. Merger
When all else fail, it may be necessary to look for a partner with deep pockets
Two types of companies are capable of supplying needed cash:
Mature company (or cash cow) – Looking for profitable investments for its excess cash flow
Conservatively financed company – Would bring liquidity and borrowing capacity to the marriage
A drastic solution to growth problems, better to make the move when a firm is still financially strong than to wait until excessive growth forces the issue

27. Too Little Growth
Slow-growth firms have growth management problems too
Face dilemma of what to do with profits in excess of firm’s need
Might appear as a trivial problem, but this is a real and occasionally frightening problem to increasing number of firms

28. Ex) Jos. A. Bank’s Sustainable Growth Rate

29. Jos. A. Bank, Inc. Sustainable Growth Challenges, 2006—2010

30. What Did Jos. A. Bank Clothiers Do?
Reduced financial leverage
From 2006 through 2010, financial leverage fell by 30%
Sat on the money
Modest decline in asset turnover
Cash and marketable securities have risen to 41% of total assets
What do think about the firm’s growth rates and returns?
Great place to be were it not for the fact they continue to generate more cash than necessary to run the business
What do you think the firm should be thinking about next?

31. What To Do When Sustainable Growth Exceeds Actual Growth?
First step is to decide whether the situation is temporary or not
If yes, build up cash in anticipation of future growth
If no, ask if the phenomenon is industry-wide, or within the firm
If within the firm, look for possible sources of new growth within the firm
Look carefully at its performance to identify and remove internal constraints on company growth
Potentially painful process involving organizational changes
When a company is unable to generate sufficient growth from within, it has three options to seek

32. Ignore the Problem This response takes one of two forms:
Continue investing in its core businesses despite the lack of attractive returns
Sit on an ever-larger pile of idle resources
Consequences of firms that poorly utilized resources:
Depress a company’s stock price
Make the firm an attractive target for a raiders
Incumbent managers likely find themselves reading help-wanted ads
Raiders redeploy resources and first are usually managers
Unsatisfied shareholders are likely to give the boot to underperforming managements

33. Return The Money To The Shareholders
Most direct solution to the problem of idle resources:
Increase dividends
Repurchase shares
This solution is becoming more popular, but still not the strategy of choice among many executives
Many executives appear to have a bias in favor of growth, even when growth creates little or no value for shareholders
Fear that it will appear as failure – for the company to return the money suggest an inability to yield competitive returns

34. Buy Growth
Managers often respond to excess cash flow by attempting to diversify into other businesses
Usually motivated by pride in their abilities
Concern to retaining key employees
Fear of raiders
Buy other businesses, especially ones that need cash because they are growing rapidly
History suggests that returning the money is the better option
Superior growth prospects of potential acquisitions are fully reflected in the stock price
After paying a substantial premium to acquire another firm, buyer is left with a mediocre investment or worse

35. New Equity Financing
Net New Equity Issues 1975—2010

36. Why Don't US Companies Issue More Equity?
In recent years, companies in the aggregate simply did not need new equity
Retained profits and new borrowing were sufficient
Equity is expensive to issue
Issues costs commonly run about 5-10% of the amount raised
The percentage on smaller issues is even higher
Many managers have a fixation with Earnings per Share (EPS)
Than that whatever increases EPS must be good and whatever reduces EPS must be bad
Fear of diluting EPS in the short-run

37. Why Don't US Companies Issue More Equity?
“Market doesn’t appreciate us” syndrome
Concern that their stock is undervalued in the market
Believe that stock prices would be higher in the near future and hesitant to issue shares
Many managers perceive the stock market to be an unreliable funding source
Complicated compared to borrowing money from banks
Frequent changes of regulation