Investments in organic growth are often in R&D, sales-force expansion or restructuring, marketing, and advertising. These investments are often called revex (revenue expenditures) because they hit the income statement, whereas capex (capital expenditures) hit only the balance sheet.
In the chase for bottom-line growth, revex creates a dilemma for most companies: The more they invest in revex to grow the top line, the more their bottom line suffers in the short term (other things being equal). Conversely, the more they skimp on revex, the more their top-line growth will eventually suffer.
No company is ever perfectly efficient, so there are almost always ways to take out costs and reduce other investments in order to fund more productive revex. Often, however, these opportunities are difficult to see, and companies are thus faced with real tension.
Many leaders of public companies, such as Robert Walter when he was CEO of Cardinal Health, have addressed this tension by setting up a corporate investment account that their company’s business units could tap into to fund organic growth investments. In Walter’s case, this was a way of not letting the accounting for organic growth get in the way of the need to invest in growth.
PE firms face the same tension, even though they are privately held, which makes us think they may have to do something similar in the future. Perhaps an “organic growth investment charge” could be taken when the investment is made, creating a cash account that could be drawn upon over time for investing in organic growth with less short-term accounting impact on the bottom line.
— K.F., J.N.
Reprint No. 11208
- Ken Favaro is a senior partner with Booz & Company based in New York. He leads the firm’s work in enterprise strategy and finance.
- J. Neely is a Booz & Company partner based in Cleveland. He specializes in mergers and restructurings in the consumer products, retail, and industrial sectors.
- Also contributing to this article was s+b contributing writer Rob Hertzberg.
- For a podcast on this subject, in which author J. Neely explores the private equity industry in light of Carlyle Group's recent IPO announcement. visit: www.booz.com/global/home/what_we_think/multimedia/podcasts/mm-podcast_display/49841952.