In the aftermath of Covid-19 we have been pleasantly surprised to see that most of our investee companies have accelerated their earnings growth to 25%+ (i.e. significantly faster than pre-Covid level) and our fund managers have published newsletters seeking to rationalise this (see here and here). Now we highlight a rigorous study from BCG which drills into why is it that only a small minority of companies (27% of the companies in the BCG study) are able to benefit from adversity and launch a growth transformation which, both, accelerates their earnings growth and creates wealth for shareholders. In fact, 23% of the companies in the BCG study accelerated growth but destroyed shareholder value, a phenomenon widely seen in India in sectors like metals, real estate, telecom and infrastructure. So how do the best companies leave behind the rest? “Given the long odds of success for growth transformations, it is important to understand what can be done to improve them. The seven factors that we identified as characterizing successful growth transformations in a measurable way span the categories of leadership, strategy, and culture.” Under the first heading of “Leadership”, the BCG team lists two critical success criteria: “1. Take a fresh look at your business. Transformations are not often accompanied by a CEO change. Only 14% of transformations coincide with a change in top management…however, we found that starting a transformation with a new CEO in place can boost the odds of a successful growth transformation by 7 percentage points, rising to 10 percentage points if the new CEO is also an external hire. Many incumbent CEOs do lead successful transformations—our finding describes an aggregate pattern, not a rule. But this pattern suggests that an outsider’s perspective can be helpful when identifying growth opportunities and impediments… For example, Satya Nadella, who was hired as Microsoft’s CEO in 2014, described himself as an “insider-outsider” because of his background in the company’s Cloud & Enterprise Division rather than the then-dominant Windows division. That outsider perspective helped Nadella identify Microsoft’s existing Windows-first strategy and internal silos as obstacles to the growth potential of new offerings, which led him to initiate a transformation of Microsoft to “mobile first–cloud first”… 2.Ensure leadership continuity after the transformation starts. Although new leadership at the start of a transformation increases its chance of success, we found that CEO churn during a transformation is linked to an 11 percentage point lower chance of success. Such change midstream can foster a sense of directionlessness that reduces the odds of a growth transformation’s success…” Then under the second heading of “strategy”, the BCG team lists 3 key factors: “3. Take a long-term perspective on strategy. To understand the extent to which companies take a long-term perspective on strategy rather than focusing on immediate issues, we used a proprietary natural language processing algorithm to score the degree of long-term thinking expressed in companies’ annual reports. We found that companies taking a long-term perspective on strategy are 5 percentage points more likely to successfully transform for growth…. 4. Prioritize exploration over exploitation. Companies can pursue growth in different ways. They can exploit existing products and services, for example, by selling more of them to existing and new customers, or they can explore new revenue opportunities. Capital expenditure (CAPEX) investments generally suggest a company has the intention of exploiting existing opportunities by expanding capacity. In contrast, R&D is generally focused on exploring new possibilities and generating new product and service offerings. We found that growth transformations accompanied by high CAPEX spend versus industry averages are 11 percentage points less likely to succeed, while those with high R&D spend versus industry averages are 29 percentage points more likely to succeed…. 5. Treat transformation as an ongoing capability. Of the firms in our sample, 45% began multiple transformations between 2006 and 2019. We found that firms with a track record of at least one successful growth transformation were 23 percentage points more likely to succeed with subsequent growth transformations. This finding suggests that companies should think of transformation as an ongoing capability… Consumer credit reporting agency Equifax Inc. did just that in 2008 and the 2010s, following one successful growth transformation after another. During the 2008 transformation, the company delayered the organization and improved company processes to increase agility. It created a growth council to encourage an innovative mindset, improving the company’s response to change. As a result, Equifax was able to transform digitally in the 2010s and develop strong data and analytics capabilities, accelerating growth by serving new customer needs….” The final heading for the BCG study is “culture”. This appears to be bolted on to the study as a bit of an afterthought. The headings under culture are Dilbert-esque: “6. Becoming a purposeful organisation” and “7. Think Biologically:” Overall, the BCG study is a super read with the added bonus of the LOL section on culture tacked on.

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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.

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