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 / Spring 2003 / Issue 30(originally published by Booz & Company)


Creating Chaos for Fun and Profit

No one likes risk. However, increased risk is integral to the higher level of performance that all of a company’s stakeholders — investors, workers, customers, and business partners — demand, and many companies are delivering. During the decade from 1992 to 2001, including the current recession and the bear market, the median above-average performer (75th percentile) grew earnings by 18.3 percent per year and revenue by 11.7 percent. Exhibit 1 shows the earnings and revenue growth rates of each quintile of the S&P 1000 during this period. To estimate the impact of improper accounting, we eliminated the companies that have subsequently made very large adjustments to their earnings and revenue, including Adelphia Communications, CMS Energy, Enron, Qwest Communications, Tyco, and WorldCom. The adjustment reduced the growth rate of earnings of the above-average performers by only one percentage point.

Since the annual growth rate of the U.S. economy during the 1992-to-2001 period was only 5.4 percent and the global economy 5.1 percent, companies with above-average performance for shareholders grew revenue more than twice as fast as the economy and earnings more than three times as fast. These extraordinary rates of growth aren’t the anomalous result of the long expansion during the 1990s, the bull market, or accounting irregularities: Above-average performers have grown both earnings and revenue much faster than the economy since at least the mid-1980s.

Companies that are top performers for investors also create superior value for customers and employees. Dell, pioneer in affordable computers and among the top 1 percent of performers for shareholders during the 1992-to-2001 period despite a slowdown in computer sales, grew its revenues by 43 percent, its earnings by 38 percent, and the number of employees by 30 percent. Michael Dell, CEO since he founded the company in 1984, is one of the longest-tenured CEOs of a major publicly traded corporation, and one of the richest men in the United States. Lowe’s Companies Inc., the building products retailer that lost its industry leadership to The Home Depot Inc. a decade ago, is now growing faster. Led by 39-year veteran Robert Tillman, Lowe’s was in the top 5 percent of performers for shareholders from 1992 to 2001, growing earnings by 65 percent per year, and revenue and number of employees by 22 percent.

The growth of the public equity markets and the expansion of private equity markets linked to the public markets (e.g., leveraged buyout and venture-capital investments that are cashed out in the public markets) drive extraordinary business performance because equity investors breed improvements in performance like oceans breed hurricanes. Since the price that an investor pays reflects a company’s expected future performance, a company that merely meets the market’s expectations yields average or below-average returns for its investors. To produce above-average returns for shareholders, companies must surprise the market with better performance. Each improvement is quickly reflected in the stock price, so above-average returns require an additional improvement in performance for tomorrow’s shareholders, and another for investors who purchase the stock next week, and so forth. This ratcheting up of company performance, replicated across the economy, increases the expectations of stakeholders and raises the bar of performance for all companies.

The breadth of the investor constituency in the United States ensures the ascendance of the investor view. And as long as regulations ensure a fair game for small investors and fraud is punished, a Marxist class war between owners and workers is unlikely. Politically, “investors” include the American middle class and most elected officials. For example, in a 1998 survey (its most recently published), the Federal Reserve found that 48.8 percent of households are equity investors, either directly through stock or mutual fund ownership or indirectly through individually directed retirement accounts like IRAs or Keoghs. Stock ownership extends broadly across income distribution, including 52.7 percent of families with annual incomes of only $25,000 to $50,000.

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