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CONFIDENTIAL

Grow or Die? Why growth is essential to companies and how toachieve it

Lecture to the “Strategy and Strategic Analysis” class

Brussels, November 23, 2012

This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organisation without prior written approval fromMcKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

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1

Why growth is important?

“Growth itself contains thegerm of happiness ”

- Pearl S. Buck

“ All growth is a leap in the dark, aspontaneous, unpremeditated actwithout benefit of experience ”

- Henry Miller

“I did not have implants, I just

had a growth spurt ” - Britney Spears

“ All growth depends upon activity. There is nodevelopment physically or intellectually without effort,and effort means work ”

- Calvin Coolidge

“The growth and development ofpeople is the highest calling ofleadership ”

- Harvey S. Firestone

“He who moves not forward,goes backward ”

- Goethe

“Intellectual growth shouldcommence at birth and ceaseonly at death ”

- Albert Einstein

“Without continual growth andprogress, such words asimprovement, achievement, andsuccess have no meaning ”

- Benjamin Franklin

“Ever since I was achild I have had thisinstinctive urge forexpansion and growth. ”

- Bruce Lee

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2

Why and How to Grow?

Performance3

Risks4

Value creationGrowth and Value 1

2Survival

2

Limit5

Architecture6

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Where should you invest?

High starting ROIC

Low starting ROIC

Improve ROIC Growaggressively

Strategy

1

We are in 1996 and you have just received USD 200,000 to invest in four types ofcompanies (minimum 2 types of companies – USD 100,000 in each):• Companies with low Return on Invested Capital (ROIC<6%) having as strategy either

to grow or to improve margins• Companies with high ROIC (>20%) having as strategy either to grow or to improve

margins

As you want to maximize the return on your investment in 2006, what should you havedone? (where do you place your money in the matrix)

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By choosing the right strategies, you would have generated USD310,000 more than with the other oneUSD1

Highstarting

ROIC

Low

startingROIC

Improve ROIC Grow aggressively

Stra tegy

180,000 340,000

160,000310,000

+160,000

+150,000

1

Main reason is that growth

creates value as long asROIC > WACC or Value =(ROIC-WACC)/g

1: Total return for Shareholder in 2006 of USD 100,000 invested in 1996 in each strategy

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HigherTRS exhibited in high

growth companies

Growth is essential to value creationPercentage of US top 100 companies

Total Return to Shareholders (TRS) 1984-2004

Annual, percent

11

14

+28%

Below GDPgrowth ’84 -’941 (59)

Above GDPgrowth ’84 -’941 (35)

1

1: US gross output growth ’84 -’94: 5.5% CAGR 2: I.e. failed to survive independently due to bankruptcy or M&ASource: Global Vantage, Datastream, McKinsey analysis

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6

Why and How to Grow?

Performance3

Risks4

Value creation11

Limit5

Architecture6

Survival2 Grow o r Go

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7

Grow or go matrix: a 20 year view of large company growthFirst decade performance distribution 1984-1994, 100 Largest US Companies

High

Low

Revenue

Low High

TRS

S&P 500

GDP

Unrewarded Growth giants

Challenged TRS performers

11 29

3327

2

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8

How many “Growth Giants” survived in the 90s and how manyremained “Growth Giants”? Largest U.S. companies, 1984

EXIT

TRS grow th

Low High

R e v e n u e g r o w t

h

“Growth Giants”

“Challenged”

“Unrewarded”

“TRS Performers” GDP

S&P 500

2

Low

High

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9

How many “ TRS Performers” survived in the 90s and how manydid still beat the S&P 500?Largest U.S. companies, 1984

EXIT

2

TRS grow th

Low High

R e v e n u e g r o w

t h

Low

High “Growth Giants”

“Challenged”

“Unrewarded”

“TRS Performers”

S&P 500

GDP

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10

Death rates 2 6x higher in low

growth companies

Growth is essential to survivalPercentage of US top 100 companies

Survival rate in 2004

Percent

63

94

+50%

Below GDPgrowth ’84 -’941 (59)

Above GDPgrowth ’84 -’941 (35)

2

1: US gross output growth ’84 -’94: 5.5% CAGR 2: I.e. failed to survive independently due to bankruptcy or M&ASource: Global Vantage, Datastream, McKinsey analysis

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11

Why and How to Grow?

Performance

Risks4

Value creation

To Move or Not To Mov e

1

2Survival

2

Limit5

Architecture6

3

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12Source: McKinsey Granularity of Growth

Intro question: What are the key sources of growth for alarge company and how does that compare with GDPgrowth?

Growthcylinders

Total revenuegrowth

The revenue growth your companyachieves through growth of the segmentsin your portfolio

Portfoliomomentum

Growth achieved through gainingor losing share from competitorsShare gain

Net revenue growth achieved whenmaking acquisitions or divestmentsM&A

3

Description

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13

On average, large companies do not grow by gaining shareRevenue CAGR breakdown (average), Percent, 1999 –2005 1

0.4

3.1

6.6

10.1

3

Growth

cylinders

Total revenuegrowth

Portfoliomomentum

Share gain

M&A

Large company average

To becompared

with 3.9%GDP growth

1: 416 fully decomposed companiesSource: McKinsey Large Company Growth Decomposition Database

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14

21

33

46

It’s about “where to compete”: Holding or Acquiringthe right cards 4x as important as playing your hand wellPercent M&A

Portfolio momentumShare gain

Overall sample 1 … … and by sector

3

37 40 22

Retail and wholesale 2943 31 26

High Tech 3848 16

Healthcare 3247 37 16

Telecom 3253 29 18

Financial Institutions 5146 32 21

Consumer Goods 72

36

Media & Entertainment 2432 56 11

EPNG 2843 43 14

1: 416 fully decomposed companiesSource: McKinsey Large Company Growth Decomposition Database

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15

Decision on “where to compete” should be taken at granular level

Less granular(“Coarse -grained”)

More granular(“Fine-grained”)

3

GRANULARITY

• Not commonly used in business yet … but widely used in scientific andengineering circles

• Refers to the size of the components of a larger system

• Cuts through the tyranny of the “averaged view”

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16

Markets and companies are granular

35

18

12

8776555544443332

-1-2

Δ =37%

UTSFEDCB A RQPONMLKJIHG

Telecommunication companies

2

-5

-3

3

5

8

9

Product 2 12

Product 1 32

Product 3

Product 4

Δ=46%

Product 10 -14

Product 9

Product 8

Product 7

Product 6

Product 5

3

Market momentum of Telecom industryCAGR 1999-2005, Percent

Momentum spread within onecompany’s portfolio

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17

Why and How to Grow?

Performance

Risks4

Value creation1

2Survival

2

Limit5

Architecture6

3

Beware of th e leverage mirage

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18

Growth (or decline) leverage

As in• Debt leverage• Backward integration• Use of "invariable" labor• …

Break-even point

Profits

Revenues

Costs

Volumes

∆ Profits > > ∆ Revenues

Watch thetrue risk

EXAMPLE4

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19

Assessing "good" growth

From To

Only margin (growth) matters • Margin and capital growth4

Positive sales leverage • Positive and negative salesleverage

1

Building fixed costs • Flexibilizing down fixed costs3

Volume and price increases • Favorable and unfavorableprice/volume correlations

2

Business as going concern • Continuity and disruptive thinking5

4

Wh d H G ?

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20

Why and How to Grow?

Performance

3

Risks4

Value creation1

Culture and Susta inabi l i ty

1

2Survival

2

Limit5

Architecture6

C l d i h ( li i i )

5

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Culture drives growth (or limits it)

Time withcustomers

Generationof leads andsales

Time onadmini-strativeprocess andcreditapplications

Bankerspreferadministrati-ve tasks toselling

Admini-strativetasks inmostbankers’comfortzone

Lesspressurewhen doing“visible”admini-

strative andcredit tasks

Most

bankershaveintrovertperso-nalities

Mostbankers areless skilledat sales

Managersact assupervisorsrather thancoaches

Managerspayattention to“paper trail”

Ability toacquirenewcustomers

Performance initiation Causes of performance limitationCulturalcauses

▪Disconnect

betweenbankers’identity astechnical/productexperts andthe selling

▪Sense thatone cannot beboth atechnician anda salesperson

Time withcustomers

▪Developmentinvolvesmasteringtechnicalprocesses, notcoaching oninteraction

quality▪Managementby defined andsupervisedactivities (vs.results)cascades intoan absence oftrust andempowerment

Why aren’t

bankers spendingmore face timewith customers?

Why so much timedoing credit andadministration?

Wh y too littletime coaching?

Why customer-facing timeuncomfortable?

EXAMPLE

21

5

I i t i k lt B St ll SIMPLIFIED5

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22

Inappropriate risk culture - Bear Stearns collapse

Case summary• Consolidation of power in a core leadership team led to a lack of internal challenge and fostered

overconfidence in the organisation, leading to its eventual collapse

SIMPLIFIED

• Subprime exposure,large writedowns in‘07, sale to JPMorgan3/08 at $10/share(from $172 in Jan ’07)

• Crisis precipitated bycollapse of twosubprime hedgefunds, requiring$3.2bn bailout by Bear

• Several class action

suits launched byinvestors ongoing, twohedge fund managersin jail awaiting trial

• Close-knit seniormanagement in placefor years, 3-4 peopleeffectively ran bank

• Strong belief in bank,‘us vs. the Street’renegade culture

• Didn't understandrisks in super-seniortranches of CDOs

• ‘Sharp practice’created enemies whoabandoned Bear ascollapse began

NoChallenge

Fear of

bad news

Over-confi-dence

PoorCom-

muni-cation

UnclearTolerance

Beat the system

Gaming

Indif-feren-ce

SlowResponse

Respon-siveness

RespectTranspa-rency

Acknow-ledge-ment

Lack ofinsight

Ignorance&

Disregardfor Risk

Primary factorSecondary factor

5

Retail banking branch network expansion5

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Retail banking branch network expansion

Low

Pr imary cus tomermarket share by

mic romarke tNumber of branches/ € economic activity

Branch sh areNumber of bank’s branches/total branches

High

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.0 0.1 0.2 0.3 0.4 0.5

5

Source: McKinsey analysis 23

Companies do have a natural limit to how fast they can NON EXHAUSTIVE

5

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Companies do have a natural limit to how fast they cangrow

Environment and company specific characteristics :

NON EXHAUSTIVE5

• Historical/embedded cultural elements of the institutionthat prevent/limit growth

• Increasing risks you face / need to take to grow faster(e.g., Insurance, banking) – “Things you don’t know thatyou don’t know”

• Price elasticity in specific markets

• Investments required (long lead time in capitalintensive industries)

• Ability to manage large-scale or multiple smaller scaleacquisitions

• Development of talent and resources – the "learningpyramid" in service industry

• Ability to generate cash-flows – the "EBITDA trap"

24

Why and How to Grow?

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25

Why and How to Grow?

Performance3

Risks4

Value creation1

Granular i ty and scale

1

2Survival

2

Limit5

Architecture6

Applying the ideas of granular growth at scale to organizational6

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Applying the ideas of granular growth at scale to organizationalwork

6

First set the direction and the pace at which the company wants togrow

Clearly identify what success is and implement ways to track it

Develop a plan across multiple time horizon – see next page

Implement an organizational model that supports growth

Attract the different talents that are required to drive growth

I

II

III

IV

V

26

The Growth map TM maps the strategic direction and ILLUSTRATIVE6

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The Growth map maps the strategic direction anddetermines the actions and capabilities required for success

Share gain

Portfoliomomentum

M&A

Commercial and

operationalexcellence

Refresh valueproposition

Disrupt businessmodel

Shift resources White spacesNew markets

Fill-in acquisitionsand divest

Bolt on M&A Learningacquisitions

Horizon 1Extend and defendcore businesses

Horizon 2

Build emergingbusinesses

Horizon 3Create viable

options

ILLUSTRATIVE

• Profit• ROIC

• Business

maintainers

• Revenue• NPV

• Business

builders

• Option value

• Champions and

visionaries

Metrics

Talent

Source: McKinsey analysis

6

27

Growth Remains an Art: More than one way to move6

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Growth Remains an Art: More than one way to move

Beginning"Virgin Tour"

VogueEvita

Pensive/PopRetro

"Sex"Childrenbooks

Var-ious

Evita

Author

Model

Actress

Designer

Musician

RollingStones (old)

Some solos

Rolling Stones(reunified)

A few smallroles

Actor

Musician

6

Growth staircase – Mick Jagger Growth staircase - Madonna

Source: Wikipedia, Rob Verhoest photos, Morrisonhotelgallery.com, McKinsey 28

Wrap up

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29

Wrap up

Value creationGrowth and Value 1

Survival2 Grow o r Go

Performance

To Move or Not To Mo ve

RisksBeware of th e leverage mirage4

LimitCulture and Susta inabi l i ty

ArchitectureGranular i ty and Scale

3

6

5