An interview with Michael Treacy

An interview with Michael Treacy Interview by Daniel J. Knight Consultant and author Michael Treacy strongly believes that many organizations, not just a few industry leaders, can achieve double-digit growth year after year, if they become as disciplined about growth as they are about cost-cutting. From his research on the growth strategies of more than 130 companies, Treacy found that those with the fastest and most profitable growth took disciplined approaches to tapping five fundamental sources of revenue: retention of existing customers; market share gains; market positioning; penetration of adjacent markets; and investments in new lines of business. He makes this argument in detail in his latest book Double-Digit Growth: How Great Companies Achieve It No Matter What. A former professor at the MIT Sloan School of Management, he is the co-founder of Gen3 Partners, an R&D services firm based in Boston and St. Petersburg, Russia. Treacy is co-author (with Fred Wiersema) of The Discipline of Market Leaders (1997). How do describe your model for growth to executives? The ability to generate double-digit growth year after year is becoming a managerial discipline, just as cost cutting, process efficiency and quality improvement became disciplines over the last 15 to 20 years. But few management teams have mastered the discipline of double-digit growth. In fact, if you look at 30 of the most dominant companies in the US the companies that make up the Dow Jones Average their collective growth record in recent years is abysmal. From 1997 to 2002, their revenue increased only 4.9 per cent a year not much more than inflation. And their after-tax profits grew only 0.5 per cent. So 30 of the supposedly mightiest American companies as a group have a lousy track record in growth. Of course, there are exceptions in that bunch Home Depot, Merck, Microsoft, Wal-Mart and CitiGroup among them. So why do those companies grow steadily and most do not? Creating a management discipline of steady double-digit growth consists of two elements. The first relates to strategy and the second relates to capability. To create a strategy for double-digit growth, management needs to begin by adopting a common language system based on the five disciplines of growth-customer-based retention, market share gain, market positioning, adjacent market penetration, and pursuit of new lines of business. That is, an executive team needs a common understanding of the growth "levers" to pull. To build the capability to execute that strategy, management needs to develop both the talent for growth and a management control system that tells them where they are, what the potential for growth is, where the gaps are and what the action steps are. Combining the two, you have on one side an agreed upon language system and on the other side the talent, information and controls to make it happen. Your notion of the need for a strategy language system is not new. Right, any strategy framework provides a language for complex discussion take, for example, Michael Porter's Five Forces Model. It's a specialized language system to facilitate strategic conversations. I know that this may seem like common sense. But you'd be surprised at how superficial and vague many executive conversations are about growth. Everyone understands M&A and product innovation and other obvious ways to boost 1

revenue. But many companies don't understand or appreciate the other approaches to increasing revenue most of which do not involve the huge risks of M&A and product innovation. It is the less glamorous growth strategies that are overlooked. Related to growth, what represents the major concerns of senior management and why? In my conversations with executives, the first and foremost concern I hear about is the depth and quality of their talent base. I've started a research program with Hewitt Associates, and we're doing detailed case studies on the human resource practices of a dozen high-growth firms. Looking at longitudinal data of high-growth vs. low-growth, we were startled by the initial results of our research. For example, the average payout on bonuses for high-growth organizations was 84 per cent of bonus target while the average payout for the others was 104 per cent. Upon closer analysis, we realized that successful high-growth firms used bonuses for serious stretch objectives while the non-high growth ones used bonuses as nothing more than deferred compensation and a way to manage cash flow. I'm in the middle of this research now, but we already see other startling results emerging. For example, many senior executives say their key growth challenge is not about determining a growth strategy. It's about developing depth and breadth of talent they needed to grow their businesses. Could you give us some examples? Sure, let me give you several. First, in a $1 billion HR services firm that manages the human resource needs of small businesses, the CEO told me that after a remarkable growth period he needs to restock his company with the kinds of people who know how to drive growth. Second, the CEO of a very large processor of financial services told me that to jump-start growth, he needs to figure out how to create a supply chain of talent stronger than the one he's got. He says he's thinking about it like other companies think about physical inventory. He needs a recruitment, development and deployment process to handle all his various growth issues. Third, in a major restaurant chain with a real estate operation that is proficient at finding locations, developing sites, and building restaurants, the CEO told me he needs to build a talent supply chain of growth-minded professionals. For another example, a $2 billion marketing services firm, the CEO told me he has to change his whole recruiting and development strategy. He has learned a lot from one of his clients, the brokerage firm Edward Jones, which recruits and develops stockbrokers with a very clear and distinct profile of whom they want as a broker. Edward Jones has a very sophisticated training and development process. More importantly, it has a more sophisticated way of evaluating whether its training over a two- to three-year period hits the target for the rate of development expected. And once the brokers are trained, the company's very sophisticated incentive system keeps them focused on the right issues. The CEO of the professional development firm says it amounts to a whole system from start to finish. Right now he says his firm doesn't think like that, but it has to learn how to manage its talent that way. Notice that all these examples illustrate one thing a supply chain for talent. That's very high on the list for CEOs. What else concerns CEOs seeking high growth? Coming out of an economic lull, they emphasize accelerating organic growth. Most senior executives know how to grow through acquisition. It's a process they know how to manage. But most of them acknowledge that they fail to get rewarded for acquisition growth the way they get rewarded for organic growth. So, many of the executives I've talked to believe they have to focus more on organic growth. As a typical example, one CEO of a $2 billion firm says it grew 22 per cent last year, with 5.4 per cent of it organic growth, and the firm is only trading at a 20 multiple of its price-earnings ratio. In contrast, look at Paychex, a firm that processes payrolls for small businesses. It has a 20 per cent purely organic growth rate and trades at a 40 to 45 multiple on its P/E ratio. Why do you consider organic growth superior? First it's a less expensive way to grow because firms pay out a premium in capital costs acquiring another business. Second, organic 2

growth provides firms with a more sustainable growth engine by being more extendable it gives companies more options to move into other businesses. And third, the stock market values organic growth more than acquisition growth. Who benefits and who losses from the practice of better talent management and more organic growth? On better talent management, obviously the organization, its employees and customers win and the competition loses. On organic growth, the company that grows this way wins and perhaps the firms that service organic growth, such as recruiting and other human resource services, win too. However, the investment banks lose some M&A business. In your book on achieving double-digit growth, you give lots of examples to illustrate your points. What are your sources? I took the Standard & Poor 1000, which lists the 1,000 largest companies on the New York Stock Exchange. I filtered this list down for average compound growth rate for the last five years. I found 78 companies from 1997 to 2002 that had double-digit growth or better. I then took wellknown, highly admired companies like IBM, Intel and AT&T for comparison and found that these companies' growth rates were typically a lot lower. Because of bias toward publicly held companies, I also sought out examples like Mohawk Industries that were neither large nor public to add case examples and colour. Importantly, my screen was for companies that not only generated double-digit revenue growth but also double-digit profit and net income growth. I didn't want to study companies whose rapid revenue increases came at the expense of profits. How do you measure success in both talent and growth? In terms of talent, I'd say that when you look at the big growth stories you often find they become recognized exporters of talent. They create the capacity to acquire and develop talent faster than their competition companies like CitiGroup in banking, Fidelity in investment and GE in multiple industries. Experience with these companies is considered a major plus on resumes. On growth, first you look at the outcomes. I've developed what I call a "sources of revenue statement" that helps firms measure how well they perform on the five growth areas: customerbase retention; market share gain; market positioning; adjacent market penetration; and pursuit of new lines of business (see box "Growth model and measurement framework") You then ask, what constitutes the intermediate measures that show that you're on the right path? In other words, how do you know your growth capacity is improving in any of the five areas? This lets managers have a deeper, richer and more collaborative conversation so they can identify real opportunities for growth. What are the drivers and the drivers of drivers to achieve your desired outcomes? You track the answers to these questions on a monthly basis. From the answers you get insights from the perceptions of your customers and noncustomers of your value proposition, and how it compares to that of the competition. Moreover, you get insights on how to further exploit your advantages such as how to train your customers to realize value from your products and services. You do all you can to increase customerswitching costs and to enhance the drivers of customer loyalty. If you look at 30 of the most dominant companies in the US the companies that make up the Dow Jones Average their collective growth record in recent years is abysmal. From 1997 to 2002, their revenue increased only 4.9 per cent a year not much more than inflation. Next, you pay attention to and map the highgrowth areas in your core business and adjacent segments, and then you concentrate on them and exploit their growth opportunities. And finally you focus on what ultimately drives that capacity for double-digit growth your people. To attract and retain the best people, you have to manage them, 3

measure their output and reward them for performance. How do you plan and implement a double-digit growth strategy? How do you organize to implement it? I have a strong point of view on that. First, I recommend you establish a sources of revenue statement (SRS) that immediately focuses the firm on the areas demanding everyone's concentration. For instance, an amazing number of CEOs don't know their customer churn rate. They don't know whether their growth comes from share gain or a growing market. By obtaining an accurate and shared view of the sources of your revenue, you can more effectively shape priorities and make better decisions. Next, you perform a strength, weakness, opportunities, and threat (SWOT) analysis of the five sources of revenue to create an inventory of the issues and the opportunities to pursue. It usually takes six months to do this correctly, but the insights gained more than justify the time and effort. It also takes time and practice to develop fluency in the language of growth. Do you recommend the establishment of a core team to facilitate the process? I don't think you necessarily need a core team. Let me give you a different approach. Start with a good dose of education. Get offsite with the company's top 50 or 60 people for a couple of days. Make it a Berlitz course on the language of growth. Afterwards, each business unit goes back and applies the disciplines and principles of growth. They build a sources of revenue statement and perform a SWOT analysis on the sources of revenue, then prioritize and take action. Whether you need a core team varies by organization. In a company like GE where the line organizations drive order, they'll naturally incorporate growth strategies into their operations. But in organizations with loose control, they may need a team to keep the effort on track. Do you view growth as a zero sum game? In other words, for every winner there's a loser. I view share gain as a zero sum game but not growth. So what would be some examples of non-zero sum growth? The cell phone industry. Cell phone revenues have been growing 14 per cent per year. Cell phone competitors have no need to butt heads. Instead they can pursue healthy organic growth to get their fair share of an expanding pot. On the other hand, segments of the chemical industry have not grown in three years. To grow there, you'll have to take it from another company. It all depends on the nature of your market. Is it growing or not? Another key piece of the growth picture is customer-switching rates. Banks have low customer churn, but wireless phone companies have a 30 per cent churn rate. Your opportunities to exploit churn vary depending on whether you find yourself in a high churn or low churn market. The levels of market growth and of customer churn are two variables to exploit in your growth strategy process. You say any organization can grow at double digits. What are the limits to this kind of growth? A natural limit caused by complexity and confusion sets in for companies that grow faster than 20 per cent. And it's hard to imagine a company growing by 100 percent year after year. In essence, a firm's ability to absorb change is a key issue. Limits in the size of a market don't stop a firm from growing. Dell, for example, hit the wall in 2001 when PC revenues dropped. It knew that if the PC market continued to stagnate, the throat slitting among PC manufacturers would get ugly. So in a four-month period, Dell moved into printers and other products where its business model had power and applicability. The lesson is, you should never be resigned to low growth even in a low-growth market. If you learn how to play the retention, adjacency and other growth discipline games, the real limit to growth is how fast you can build a management capability for growth. Most firms fall short there. In other words, do you have the depth and breadth of talent to effectively execute growth strategies? It's a myth to say that large companies like Wal- Mart can't continue to grow. They can grow at a 4

reasonable rate relative to their size. It's simply a matter of talent and creative energy. Can you think of anything more important to growth than innovation? No. Innovation makes growth happen. The impact of innovation on growth will be my next writing project. How do you innovate for growth? organizational growth into five disciplines, each with its related source of revenue. And each related source of revenue stands independent from the other four. Because each source is distinct, companies can address it separately. In other words, each discipline with its related source of revenue can be used as a separate growth strategy and its results are additive to total organizational growth. Second, he provides six key principles as a guide to action for doubledigit growth. See Exhibit 1 for a summarization of his model. To facilitate the measurement and management of the outcomes from the five sources of revenue, you can use a sources of revenue statement (SRS). A SRS for a "XYZ Corp" is shown in Exhibit 2. Steps to prepare an SRS are shown in Exhibit 3. That's a long story with no quick answer. I draw a fine line between innovation and deviant behaviour. The judge is the marketplace, not the firm. That is, you have to bring innovation to market when the market wants it - not when you want it. There are lots of stories of huge sums spent on innovations that nobody wanted. You could build a very large museum and stock it with product concepts that companies bet heavily on and lost. That said, innovation that the market wants is the rocket booster for growth. And yet innovation doesn't always have to be the type that shoots for the moon, as people like Geoffrey Moore, Clay Christensen and Gary Hamel suggest. They talk about "swinging for the fence," "breakthrough innovation," and "next generation innovation" to drive growth. They introduce selection bias by writing about the one firm in a 100 that actually made big innovation happen, and they ignore the rest. Exhibit 1: Growth model This kind of grandiose innovation contains huge risks. Even when companies succeed they can't base a steady growth strategy on it. The one success in 100 does not represent the kind of innovation that really drives growth. Instead it's the other 99 that take innovation one step at a time product enhancements and customer service improvements that reduce churn, adjacent markets that are easy to pursue with a company's existing products and capabilities. Exhibit 2: XYZ Corp sources of revenue statement These are the singles and doubles of innovation that drive growth. They are the incremental improvements to both the product and business model that can go a long way without putting the company at risk. Growth model and measurement framework Michael Treacy proposes five growth disciplines and six key principles to help organizations grow at double-digit rates. First, he breaks down total Exhibit 3 The steps used to develop the SRS 5