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European Management Journal Vol. 19, No. 6, pp. 587–598, 2001  2001 Elsevier Science Ltd. All rights reserved 0263-2373/01 $20.00 S0263-2373(01)00084-6

How to Think About Corporate Growth? JORDI CANALS, IESE, University of Navarra, Barcelona Corporate growth has evolved into a challenge of undisputable and increasing interest among senior managers, in particular, after the bursting of the stockmarket bubble. Nevertheless, the available theories of corporate growth (resources, life-cycle, etc.) tend to focus on only one dimension of the growth process. In this paper, we argue why corporate growth is important, introduce the need for a more holistic view of corporate growth and discuss the drivers that growing firms use to keep growth going.  2001 Elsevier Science Ltd. All rights reserved. Keywords: Corporate growth, Strategy, Corporate renewal, Innovation-driven growth

Introduction The new competitive dynamics in recent years has brought about the stagnation of some legendary companies, such as Kodak or Digital in the United States, Thomson or Cre´dit Lyonnais in Europe, and Nomura or Nissan in Japan. These companies share a common attribute: at certain times during the last few decades they were leaders in their respective industries, in terms of profitability, innovation or market share. Some of them are recovering; others have been acquired by other competitors or are still fighting for their survival. Those companies have experienced – and some of them still do – the same disease: the erosion of their competitive advantages and, as a natural outcome, the lack of growth prospects. In other words, at some point in their history, their growth opportunities seemed to fade away. It is important to point out that the yardstick for growth should not be the increase in revenues in the short-term, but the increase in the firm’s value added in the long-term, which is the outcome of innovation and the development of sustainable competitive advantages. This has a clear implication: in most of the cases, growth is different from pursuing a larger scale or a higher market share.

An increasing interest in the growth of the firm seems natural. Restructuring processes of the early 1990s and the massive lay-offs they generated highlight the importance of thinking about corporate growth. In the second half of the 1990s, a bullish stock market and a dynamic US economy made corporate growth easier, both for US firms and non-US firms alike. The latter found in the US a vast and rich market for their products. Once the stock market bubble burst and the world economy is slowing down, the need to think about corporate growth becomes urgent again. The growth of the firm is not a goal ‘per se’. Firms are made up of people who seek to create value by serving customers through differentiated goods and services. Growth is not, therefore, the company’s key objective, nor is growth a guarantee of value creation. Nonetheless, a company that has not grown for many years or its growth is not financially healthy has a problem. Although the lack of growth over a long period of time does not necessarily mean decreasing profitability, it may be a signal of an inability to innovate or a lack of connection of the firm with its current or prospective customers. A company that is not growing may find a ready explanation for its problem by saying that the market is flat. However, in some cases the absence of growth may suggest that the company is unable to reach new customers or serve better their current ones. The new theory of economic growth also sheds some light upon the challenge of corporate growth (Romer, 1989). One of the key lessons of this new approach is that growth takes place when companies and individuals discover and implement new and better ways of doing things. In the new economy the key factor in growth is not capital or raw materials, but knowledge. Since ideas are the pillars of growth, their discovery and elaboration have few physical constraints. In other words, not only corporate growth is possible, but it depends on human creativity more than any other factor. This conclusion should encourage managers who operate in markets that seem to be mature and in which growth appears to be impossible. Important as it may be, corporate growth is still an 587

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elusive phenomenon for managers and scholars alike. Moreover, it can also be a lethal medicine. Unhealthy corporate growth – from a financial viewpoint – is tremendously harmful. Reckless diversification or the pressure to increase sales or market share at whatever cost, through price wars, indiscriminate promotions, unreasonable marketing expenses or incentives to the salesforce to increase short-term revenues are rarely satisfactory paths towards growth. The empirical evidence points out that corporate growth is idiosyncratic and firm-specific, depending upon each firm’s history and innovations.2 Firms may pursue growth relentlessly, but growth is a daunting challenge. Based upon the results of an international research project on corporate growth (Canals, 2000), in this paper we provide a framework that helps think about why corporate growth is important, present some theories on corporate growth and discuss a typology of the strategic decisions that growing firms make in order to foster healthy growth.

Sustained industry leadership requires corporate growth. Healthy growth is an indispensable dimension of corporate strategy and a challenge that senior managers have to tackle. Growth always involves risks, but the absence of growth might involve even higher risks. In this section we will show that corporate growth is critical in finding and developing talent, attracting capital, managing the risk of substitution and breaking the mature-industry mindset (See Table 1).

Recruiting and Retaining Talent: The Attractiveness of Growing Firms Successful companies are made of great people. No firm can achieve more than the combination of its people and their capabilities can offer. Although the empirical correlation between talent and corporate success is difficult to draw, many senior managers know from their experience that attracting, recruiting, developing and retaining talented people is their key task.3 Some manufacturing and financial services firms such as Nokia, Goldman Sachs or L’Ore´ al know this truth very well and their senior

Table 1 Why is Corporate Growth Important?

Recruit talent Retain talent Break the mature-industry mindset

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The time and attention that senior managers allocate to this process is an indispensable factor, but not the only one. Firms should also offer (among other factors like a friendly environment, a good career or an attractive compensation package) interesting professional challenges and new projects. In other words, projects that can have an impact in the firm, its people or its customers, and generate growth. This factor helps explain the success of new start-up’s among young university graduates. Firms that do not show enthusiasm about their future and the projects they have, or that do not develop new opportunities to grow will face a more difficult obstacle when trying to recruit the talent they need to guarantee their survival and future success.

The Need to Attract Capital The need to attract capital today, improve the prospects to attract it in the future and convince potential investors that the company has a future makes growth potential an important factor for both public and private firms.

Why is Corporate Growth Important?

Internal reasons

managers spend a good deal of time in interviewing and getting to know young graduates.

Investors make their decisions on the basis of some variables. One of them is the expected return on investment. This variable depends on many factors but there is no doubt that the company’s ability to ensure healthy and sustained growth is one of the most important. Essentially, the value that a company can create is a function of the new projects it tackles in order to maintain current sources of income, operate more efficiently and discover new sources of revenues. The stunning success that the privatisation of former State-owned companies has enjoyed in many European countries, particularly from the investors’ viewpoint, is related with the growth prospects that these companies have offered. From France Telecom in France to Repsol YPF in Spain, the vast majority of these companies have offered investors not only a change in ownership or, in some cases, a guarantee of a better management process, but also new growth opportunities. The same is true of the new investments made by European telecommunications firms to acquire a license to operate in the third generation of mobile phones. The offers are tantalising but investors seem to trust the growth plans of many of the winners. Growth expectations are a powerful driver of stock prices.

External reasons Attract capital Positioning in capital markets Manage the substitution risk

Managing the Risk of Substitution New products and services are platforms upon which firms build their future. If they are really good, they may even allow firms to grow quicker. Never-

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theless, current successful products have a limited life cycle and once a product has entered the maturity or stagnation phase, the possibilities of further growth – or steady revenues – are lower, unless, for example, the product is redesigned, its cost – price – value combination is changed, or an alternative distribution channel is found. Firms must not only try to prevent their products from entering into decline but also avoid the situation whereby other rivals make their products obsolete. Product substitution or imitation take place in all industries and may seriously endanger the stability of the company’s revenues.3 Thinking about new projects that can generate growth enables firms to tackle the challenge of substitution and imitation, by getting ahead of other firms or becoming different. The risk of substitution exists when a new product which is superior in quality and price appears on the market. This phenomenon may occur – but not only – during a product’s maturity phase. A classic case is IBM and its late entry into the personal computer industry. Once they are connected in a network, personal computers are able to carry out many of the tasks of mainframe computers on which the IBM’s business was based. The personal computer seems to match best the needs of small companies and, above all, reach individual customers. A leader of the computer industry, IBM was not the first company to enter into the personal computer business. Indeed, initially it spurned this emerging industry due to the potentially rapid erosion of mainframe sales and the substitution effect that personal computers could bring about. The risk of imitation is a similar phenomenon – although of a distinct nature. This risk emerges in industries where companies, with a substantial deployment of resources and effort, tend to behave similary. In the European automobile industry, companies have adopted similar capacity and product development strategies to improve their productivity. The result has been excess capacity, price wars and poor performance, due to the tendency to imitate competitors. Firms that systematically explore growth opportunities may find them easier than companies that do not do it, and through them they may offset or manage the risks of substitution and imitation. Goldman Sachs, Hewlett-Packard or 3M’s practice of developing new products that can generate growth with the explicit goal of cannibalising some of the company’s current products is a good example of how firms try to avoid substitution or imitation, face the renewal of their product range and, above all, how they can create a more solid base for value creation.

Beyond the Mature-Industry Mindset Maturity as one of the stages of a product’s life cycle is a concept that has been readily applied to the industry as a whole. Thus, some people inappropriately talk about mature industries, that is, industries that do not grow. Maturity, as a business concept, refers more to products than to industries. One can refer to companies or industries with mature products but not about mature companies or industries. Normally, a mature company is a company that is stuck in a rut. By developing a new business concept, Swatch, the Swiss watch manufacturer, offers a highly illustrative example of how to overcome this mentality by thinking about how to grow in a mature industry. The 1960s and 1970s were years of decline for the Swiss watch manufacturers. Their products ceased to be innovative, were considered expensive by many buyers, and their world market share fell against their US and Japanese competitors. By the end of the 1970s, it seemed that Swiss companies were doomed to have only a minority presence in this industry, perhaps confined to the top end of the market. Moreover, they were unable to penetrate the mass market segment – which was the segment that was growing. As the Swatch story highlights, the power of ideas is always superior to the inertia of the so-called mature industries or companies. When the Swiss watch consortium’s new president, Nicolas Hayek, took office in 1982, he set out to change a trend that many considered irreversible. The new strategy was based on certain factors. The first was to design production systems in which personnel expenses accounted for a tiny fraction of total costs. Part of the new competition for Swiss companies came from Japan, whose companies offered low-priced products, with low labor costs, that were typical of the country at that time. The second factor was to boost the Swiss watches’ image for design, quality and elegance against the cheaper products that were coming in from Asia. The third factor was to transform watches into a consumer product, with very attractive new designs. Swatch’s new marketing approach succeeded in creating in the consumer’s mind a product with different varieties and attributes to suit different circumstances. This approach led the company to implement the concept of watch collections having similar designs or features, thus creating fashion. Thus, Swatch not only succeeded in stopping the apparent decline of the Swiss watch industry, but it also transformed the way it produced and its marketing approach to reach customers, to the point that Swatch watches have become sought-after collection pieces. Its growth in the past 15 years has been remarkable. Swatch is not an isolated case of a growing firm in 589

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an industry that is not growing. Other companies like Dell in personal computers, Merrill Lynch in banking, Southwest in airlines, Nucor in steel or Toyota in automobiles are living cases of firms that keep growing even in industries that, as a whole, show very few growth opportunities.

Table 2 Capabilities and Markets: A Dual Approach to Corporate Growth Market/customers Current New Resources and capabilities

Current

Corporate renewal

Innovation

New

Expanding capabilities

Expanding markets

What Do Growing Firms Do? Strategic Options Become Growth Drivers The growth experiences of some well-known companies that have been able to sustain high rates of healthy growth shed light on how firms grow. Past growth or success are not predictors of future growth or success. As it has happened with other firms, those companies are not free from threats and their growth can slow down. Nevertheless, one can learn from their experiences on growth, how they achieved it and reflect on the underlying factors, even if one cannot draw from them instant recipes. From the cases analysed, we can identify four basic strategic options for corporate growth: corporate renewal, innovation, expanding capabilities (through alliances and acquisitions) and expanding markets (Figure 1). These categories tear down the hypothesis that growth depends either on resources and capabilities or on the external context as some growth theories propose (see the Box: ‘Some explanations of corporate growth’ for a brief presentation of those theories). As the cases that we will discuss now underline, successful growth companies take simultaneously into account both dimensions. Table 2 presents those growth patterns and their relationship with resources and capabilities, on the one hand, and markets/customers on the other.

Table 3 Corporate Growth Patterns Corporate renewal

Banco Bilbao Vizcaya Swatch L’Ore´ al ABB Disney Lloyds

Innovation

Expanding capabilities

Exploiting external opportunities

SAP

Glaxo

Merck

Nokia HewlettPackard Reuters Canon

Volkswagen British Petroleum Dell General Electric Compaq

Telefonica Accor

Goldman Sachs

Bertelsmann Merrill Lynch Wal Mart

author studied, according to their growth patterns and the strategic options they have followed to speed up growth. The main message of the typology of growth patterns presented here is that they emerge out of the joint consideration of both the firm’s external factors (the industry, markets and customers) and internal factors (resources and capabilities). In the companies studied, managers try to take into account both dimensions, as we will show in the next sections.

Table 3 shows four groups of the companies that the

SOME EXPLANATIONS OF CORPORATE GROWTH

Figure 1

With the exception of a few authors who have argued that companies pursue growth to ensure their long-term survival (Donaldson and Lorsch, 1984), corporate growth has not received a great deal of attention. The most important work on this subject is that of Penrose (1959). She claims that the use and transfer of the firm’s resources – in particular, managerial resources – at a particular time are crucial for accounting for its subsequent development and growth. In the strategy field, corporate growth has been discussed only indirectly. The work of Chandler (1990) is one of the few exceptions. This author provides an excellent historical explanation for understanding the birth and growth of certain large companies in some countries, and the factors that have accounted for their development over time. Chandler has

Corporate Growth: Strategic Options

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without doubt defined the context of growth and some of the critical organisational decisions that growing companies have to make. More recently, there has been an increased academic interest in corporate growth. Ghoshal et al. (1997), based upon the observation that there seems to be a correlation between a country’s economic development and the number of its large firms, highlight that management competence plays a key role in the firm’s growth process. This notion is a refinement of Penrose’s hypothesis on the role of resources in corporate growth and adds a new dimension to understanding corporate growth. In the more popular management literature, some recent contributions (Gertz and Baptista, 1995; Baghai et al., 1999), have offered the experience of companies that have been able to adequately manage and sustain their growth. Their starting point is the general concern in many companies that some techniques and their emphasis on process reengineering and restructuring have been harmful for corporate productivity. This literature is more descriptive, contains useful ideas for reflection and, in any case, provides a beacon to remind people to think about the future and suitable ways of managing growth. We have recently proposed a more holistic model that tries to explain corporate growth and its process. Corporate growth depends on five interrelated factors (Canals, 2000): the firm’s external context; its internal context; its business concept; its resources and capabilities; and the strategic decisions and choices about growth options. This model extends Penrose’s work (based on resources), includes some new factors that turn out to be essential for corporate growth, like the business concept and highlights how interrelated those factors are in fostering and sustaining growth. The unique attributes of external and internal contexts that firms have faced at some point in their history have also shaped the four growth strategic options presented here. Corporate renewal as a growth driver happens when firms try to use and leverage their current resources and capabilities and deploy them in their current markets. Breakthrough innovation is pursued by firms that leverage these current resources and capabilities to reach new customers. Some companies try to grow by expanding their resources or capabilities through mergers, acquisitions or alliances in order to use them in their current markets. Finally, some companies aim at

expanding market opportunities or reaching new customers through acquisitions or alliances. We will discuss those strategic options and analyse some companies that have followed them.

Corporate Renewal-Based Growth: The Case of Banco Bilbao Vizcaya (BBV) Product innovation is a tangible way that a firm has to show technological and managerial prowess. A more complex and thorny way to reinvent a company is internal renewal. Its process includes several ingredients that, if aligned in an innovative and practical way, can spur growth. This is the case of Banco Bilbao Vizcaya, the largest Spanish bank and the fourth in Europe by market capitalisation by April 2001, when it had completed its merger with Argentaria. In 1988, Banco de Bilbao and Banco de Vizcaya, the third and fifth largest banks in Spain, respectively, decided to merge, thus forming the largest Spanish banking group, Banco Bilbao Vizcaya (BBV). However, the instant growth provided by the merger did not deliver the desired results in terms of profitability. In fact, between 1988 and 1993, the bank’s performance remained below expectations. The crisis that the bank fell into was the spur it needed to pull itself out of its state of mediocrity. BBV designed and started to implement the so-called 1000 Days Program in 1994. This Program was not a classic strategic plan. It was, above all, a plan for revitalising the bank. Its goal was to make the BBV the best investment alternative for shareholders within the Spanish banking industry, using the resources and capabilities that already existed within the firm. About 100 specific action plans were defined for execution during the next 1000 days in order to achieve that goal. These plans were organised around ten key issues for the bank: corporate growth, the development of new profitable businesses, consolidation of the international strategy, the restructuring of weak businesses, adaptation to the euro, product innovation, the improvement of information technology, organisational responsiveness, the development of a BBV culture, and the creation of a corporate atmosphere of high commitment and high performance. Between 1994 and 1998, its performance was exceptional, particularly if one considers that growth in the European banking industry was almost flat. Thus, in that period the group’s assets more than doubled, revenues increased by 115 per cent, ROE went up from 12.1 to 21 per cent, and market capitalisation increased by 353 per cent, from 4.5 billion euros in 1994 to 14 billion euros by the end of 1998, becoming one of the largest European banks in terms of market 591

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capitalisation. By way of reference, the Spanish banking industry’s market value increased 110 per cent during the same 5-year period. These growth rates were among the highest in the world banking industry in 1998. Moreover, from a qualitative viewpoint, the strong consolidation of the bank’s international strategy enabled BBV to become a leading bank in Latin America, acquiring well-positioned banks in Mexico, Peru, Colombia, Argentina and Venezuela, with a total investment in these countries exceeding 2.5 billion euros. BBV’s growth patterns are all the more astonishing when one considers the slow growth shown by the banking industry as a whole in industrialised countries. What explanation can be given for this performance? The answer is complex but a number of hypotheses can be put forward. The first is that the plan succeeded in awakening unique capabilities that were lying dormant within the BBV group due to the lack of definition that prevailed until 1993 on the group’s strategy, market positioning and future plans. The second hypothesis is that, with this program, BBV developed a vision about customers’ needs and a way to serve them, organised a series of projects around this vision and invested in them. In other words, BBV turned the 1000 Days Program into a catalyst for the bank’s change to focus on better customer service. The third hypothesis is that any growth option implies new projects and business plans. BBV decided to be stronger in the financial markets area, increase market share in Latin America and chose not to increase its presence in Europe or Asia. These choices – which imply discarding other alternative options – are essential for understanding the processes of corporate growth.

The firm’s turnaround was achieved in less than five years and since then the Swiss manufacturer has become an icon of innovation worldwide. The awakening of dormant capabilities, a refocus on some customers’ dominant needs and more efficient manufacturing or service systems are ingredients of the corporate renewal pathway to corporate growth.

Innovation-Driven Growth: SAP AG The idea that innovation is essential for growth is widely accepted. Nevertheless, there have been many innovative firms whose growth performance has not been very impressive (like Siemens, Hitachi or J.P. Morgan). Innovation alone is not sufficient, as the case of SAP highlights. SAP AG (Systems, Applications, Programs in Data Processing), a German software company, was the leader of the enterprise information systems market at the end of 1998, and also the fourth-largest software maker, behind Microsoft, Oracle and Computer Associates. Its application R/3 ran the operations of about half the world’s 500 top companies in 1998. Its revenues grew 10-fold between 1990 and 1998, up to 5.1 billion euros in 1998. Growth at SAP has been explosive. How has it achieved it? The explanation has to do with perceiving new corporate needs in the enterprise information systems market and the development of new products to address those needs. SAP’s managers and engineers develop visions of the future in terms of new products and services and translate those visions into new products or software systems. They also count on partners to implement the products.

The experience of BBV shows that corporate renewal growth can put into motion a change process that enables firms to embark upon growth paths at rates exceeding the industry average, even in industries with low growth rates such as retail banking.

New product development is related to the firm’s large annual investment on R&D – about 20–25 per cent of total revenues – the recruitment of young and creative engineers and programmers, an intense training culture to help new engineers better understand customers’ needs and SAP’s vision and culture better, a flat organisation with very loose and informal relationships, and a rather conservative approach to financial management, with low debt.

Swatch offers another case of a dormant company with great resources and capabilities that was dithering over a corporate crisis in the early 1980s. As we have discussed in the previous section, the Swiss firm seemed unable to compete with Japanese manufacturers. Swatch certainly adopted the pathway of product innovation but the first step was to stimulate corporate renewal by introducing more efficient manufacturing processes, boosting Swatch’s image and focusing on product development. This combination of factors gave an important boost to the employees’ morale.

Their first product, launched in 1979, was R/2, especially designed for mainframe computers. It was a success, especially among European firms, because it addressed a pressing need large companies had with their different software programs that run their activities. Nevertheless, the founders of SAP did not stop there. On the one hand, they started their international operations very quickly, choosing the US as a key market for them. The management of the US subsidiary was tough and rivalry very intense, but it provided a uniquely valuable experience for the future of SAP. On the other hand, in the mid-1980s

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they decided to design a new software destined to link all the firm’s operations. A breakthrough that helped bring about that vision, happened in the early 1990s, with the so called ‘client – server’ revolution. These were cheaper servers that delivered information to PCs. This technological breakthrough allowed firms to slice information and repackage it in new different ways. SAP took advantage of this innovation and linked it up with its idea of integrating functions and activities. The outcome was the launching of R/3 in 1992, a program especially designed to work in the new server environment. The program was an instant success, selling more than $500 million that year and more than $2 billion in 1997.

implement the software. This scenario was somehow beyond the capabilities of SAP at that point. On the other hand, its executive committee decided to strengthen its internal consulting group, which would operate as a unit to provide support to key customers and external consultancy firms that would enter this new market. It would assist them with the installation of the software package. The target the board set was to pursue about 20 per cent of the implementation business and leave the rest to other consultancy firms. The success of this option depended on how consultancy firms would evaluate this new opportunity that SAP was offering them. Eventually, SAP built up a web of alliances with distinguished companies such as Andersen Consulting, Arthur Andersen, PriceWaterhouse Coopers and Deloitte and Touche.

The new system that SAP developed allowed companies to run their operations and scrutinise their business in an integrated way, from purchasing to distriThe attractiveness of the cooperation between SAP bution and customer service. At the same time, the and each of the partners was that R/3 was a great program would allow compainitiative that would create new nies to discard a maze of differvast possibilities for systems SAP was not just a ent and incompatible software applications, and SAP would systems, each of them created not compete with them in company, it was a new to run a small part of the firm’s implementing the package. total operations. This might That was their business opportindustry seem a small step, but it was unity. SAP would exclusively very difficult to be able to manage an international focus on developing even better products. The basic or global company without knowing the level of principles of those alliances were three: they could inventories in different countries or the manufacturnot be exclusive, they had to be beneficial to both ing capacity available at any given point in time. parts, and there would not be a financial tie between SAP and the partner. For all the advantages of R/3, its implementation was complex and expensive. Around the new program, The lesson one can draw from SAP is not that innoSAP has generated a new industry of high-price convation is important in fostering growth. That is true, sultants whose expertise was to apply and implement but the opposite may also be true, as other innovative the new software in each company. As some people companies like Hitachi or Motorola that seem to have put it, SAP was not just a company, it was a new lost touch with the market show. SAP has been industry. innovative, not just in terms of the product, but in other aspects, some of them internal to the firm and In 1991, the discussion about whether SAP should some external. remain a product company – that is to say, a company that designs new software packages – or SAP’s approach to its industry has been very innovbecome a consulting or solutions company was conative, along several dimensions. The first is its controversial. ception of new software packages that could integrate different systems and functions, a real product breakthrough. The second is its early international The first option – remaining a product company – approach, which is very intriguing if one takes into would involve designing great products and selling account the size of the German or the Western Euroas many copies of them as possible. The second pean market. The third is how SAP detected and took option – a solutions company – would involve advantage of the new generation of customer servers. becoming a consulting company whose mission The fourth is the option to remain focused and conwould be helping firms implement software packcentrate on designing better products, when the ages. In this option, revenues would come from the temptation to grow in a completely new business was services provided. very attractive. The fifth is its approach to forge alliances with consultancy firms and manage them in The top management made the decision to remain a a way to keep partners pleased with the agreement product company and implement it in such a way as and opening up for them new business opportunities. to make R/3 the standard infrastructure for With these experiences, SAP has proved that innoenterprise applications. One of the reasons to support vation, supported by a good organisational structure, that option was that the alternative would have linked up to customer service, pays off and that it involved hiring thousands of consultants to 593

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could become a sustained driver of corporate growth. It also shows that European companies can be innovative when they develop a unique business concept and give their innovations an adequate organisational support. SAP has been banking on the growth of this industry and its challenge will be to sustain the rhythm, especially with the explosion of Internet-based software. Nevertheless, nobody doubts that SAP and its innovative products have made a substantial contribution to the growth of this industry. The experience of Nokia, the world leader manufacturer of mobile phones in 1999, highlights the relevance of innovation for corporate growth. Until the late 1980s, Nokia was an industrial conglomerate with a vast array of companies in different industries. In the early 1990s, a sea of change was introduced at Nokia. The new CEO, Jorma Olilla, bet the future of the firm on the cellular phone division. He realised that Europe would have a digital standard for cellular phones that could be a blessing for the companies which were ready to supply the right products. Since uncertainty about future demand and product attributes was very high, Nokia joined other manufacturers like Alcatel, to pave the way for harmonised product standards. At the same time, Nokia increased its R&D budget to develop a variety of products targeting different market segments, and decided on a substantial expansion in manufacturing capacity. Those organisational innovations coincided with the adoption of the new GSM standard in Europe and Japan, and Nokia – with its investment in products and manufacturing capacity – could benefit early from it. Cellular phones became the most important division at Nokia and Nokia the world’s leading manufacturer. Nokia’s case also highlights the importance of innovation not only from a product viewpoint, but also in developing new business concepts, that is to say, a perspective about how a firm plans to deliver customer value and the specific organisation of its activities. Both product and business concept innovation have had a profound impact on Nokia’s growth, beyond the mere cyclical push that the adoption of a new digital standard for cellular phones had on Nokia and other European manufacturers. As in the case of SAP, innovation is at the heart of the process that propels corporate growth. The distinguishing dimension that innovation shows here is that it is not only the outcome of internal capabilities, but of the interaction between those capabilities and how firms anticipate future customers’ needs. 594 EMJ: European Management Journal

Capabilities, Acquisitions and Growth: The Case of Glaxo Growing companies stand out for their flexibility. Thus, in addition to growing through internal development, they take all of the opportunities to improve and strengthen their current capabilities. The case of Glaxo and the acquisition of Wellcome is a good illustration of this growth pattern. In 1995, the European pharmaceutical industry was highly fragmented and there were no truly pan-European pharmaceutical companies. One of the few exceptions was Glaxo, the largest European pharmaceutical firm. During the 1980s, Glaxo changed the face of the industry, thanks to the vision of its CEO, Sir Paul Girolami, who encouraged research in new products such as Zantac and boosted the company’s marketing efforts. Glaxo’s sales were led by what had been until then the world’s highest-selling drug, a genuine blockbuster, Zantac, an anti-ulcerative drug introduced in the early 1980s. Against advice, Paul Girolami decided that Zantac should be positioned as an extremely high-quality and high-price premium drug, which would set it apart from other anti-ulcerative drugs and provide resources to finance other R&D projects. This approach proved to be right. In 1994, Zantac had achieved record sales of 2442 billion pounds sterling, with a 35 per cent share of the anti-ulcerative market. Glaxo had staked a large part of its growth on this product’s success and the strategy had worked out. The problem was that Zantac’s patent expired in 1997. From then on, the market would be invaded by cheaper me-too generics and the sales of Glaxo’s original would probably drop sharply. In 1994, Glaxo’s senior management felt the time had come to accelerate growth and started to study the possible acquisition of Wellcome. There were doubts within the pharmaceutical industry about Glaxo’s ability to successfully see the merger through. All of Glaxo’s growth in recent years had been internal. However, the potential benefits of the merger were considerable. Glaxo was not pursuing instant growth with the merger, but the scale, resources and capabilities to strengthen its R&D and speed up new product development. Its managers were convinced that a powerful range of innovative products, in various treatment areas, would enable it to achieve significant growth in market share. The range of products that would emerge from the merger with Wellcome seemed to be much broader and more competitive because they would be able to complement areas of expertise and knowledge and the new R&D projects could be endorsed by bigger resources. Glaxo’s presence in certain treatment areas that had remained

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untapped until then (antivirals, for example) could be increased and synergies would be found between the two companies’ products. For the treatment of AIDS, for example, it had been found that Glaxo’s 3TC and Wellcome’s AZT could provide an effective combination. The same was true with other products. Furthermore, with the acquisition of Wellcome, Glaxo would acquire a valuable brand. It was often said in industry circles that patients preferred to be treated with drugs that had a well-known brand rather than with generics even if the latter were cheaper. The Wellcome brand was highly respected in the United Kingdom and also in the United States. Another advantage was Wellcome’s expertise in the OTC market. Thanks to its alliance with WarnerLambert, Wellcome could effectively help in turning some of Glaxo’s star products into products for the OTC market and thus increase the group’s sales. The changes that were in the offing in the pharmaceutical industry in 1995 (the entry of generic drugs, strong pressure on costs, OTC drugs, etc.) seemed to indicate that future growth would require larger size in order to be able to take on more costly R&D projects. In 1995, Glaxo’s managers perceived the need to expedite the company’s traditional growth based on innovation and new product launches, with an ambitious move – the acquisition of Wellcome – that would enable Glaxo to increase the R&D budget and make a better use of the capabilities of both firms. The two companies’ boards approved the merger in 1995. The new group’s performance at the end of 1998 seemed to confirm the soundness of the strategy followed, and the success of the process of integrating both firms. The growth rate in the rest of the areas between 1995 and 1998 was about 17 per cent, and Return on Assets was above 30 per cent, which indicates that some of the financial goals intended with the merger had been achieved, especially if one takes into account the loss of nearly £800 million in sales of Zantac and Zovirax in 1998, due to patent expiration. Too often, mergers seem to be driven by cost-cutting and they pave the way for instantaneous growth, which is not always sustainable. Only when mergers allow the firms involved to combine capabilities, develop more and better products or serve new customers, can they become growth engines. This seems to have been the case of the new Glaxo Wellcome. It is also the case of Volkswagen. In the early 1990s, the German automobile manufacturer invested heavily in the acquisition of two local European carmakers: Seat in Spain and Skoda in the Czech Republic. With those acquisitions Volkswagen intended not only to increase capacity and lower production costs, but also to learn how to manufacture small cars with a new manufacturing platform. Volkswagen used to have an inefficient centralised production system in Wolfsburg (Germany). Low

productivity and increasingly expensive manufacturing costs were driving Volkswagen out of the market. The introduction of modern manufacturing techniques in Germany became a huge and discouraging effort because of the total size of the main plant in Wolfsburg and its organisational inertia. On the contrary, those efforts became more fruitful with the smaller plants of Seat and Skoda. Those two companies offered Volkswagen access to the local market and their dealers’ network, lower manufacturing costs, additional capacity in Europe and ground to test new manufacturing concepts. With these acquisitions, Volkswagen could leverage its engineering and product development capabilities across a larger volume of cars. Those investments paid off. Volkswagen found the way back to the profitability it had lost in the early 1990s and became market leader in Europe. Moreover, its total productivity in Wolfsburg between 1992 and 1998 increased by about 30 per cent. As in the case of Glaxo, the key factor to translate acquisitions into corporate growth was not the acquisition itself, but the new combination of resources and capabilities that this acquisition allowed to develop.

External Opportunities, Market Expansion and Corporate Growth The growth of the firm speeds up not only through innovation, but also through the identification of external opportunities, like a potential acquisition or the entry into a new market. By acquiring Medco in 1993, Merck seized upon one of those external opportunities. In 1993, Merck was the largest pharmaceutical company in the United States. This position was the result of a combination of factors that had made Merck one of the industry’s leaders during the 1980s and 1990s. In this discussion, we will highlight some of those factors (see Figure 2). First, a research capability for discovering revolutionary medicines (‘blockbusters’ to use the industry’s terminology) that was far superior to that of other pharmaceutical companies. This capability was a direct consequence of its high expenditure in R&D, amounting to about 11 per cent of its total sales in 1993. Merck’s second distinctive capability was marketing. The company was reputed to be one of the industry’s most efficient in communicating directly with prescribing doctors, specialists, researchers and managed-care firms. For many years, pharmaceutical companies had focused their efforts on research and manufacturing. The effort spent on these tasks was 595

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The second trend was the emergence of PBM (‘Prescription-Benefits Management’) companies. Through an ambitious research program, these companies sought to promote the use of drugs that were more efficient for the patient, the progressive substitution of branded drugs by generic drugs and the establishment of an information system on the patient’s health and evolution. This approach was immediately welcomed and had an enormous impact on pharmaceutical companies which, obviously, wished to have their products on the list of drugs recommended by those organisations.

Figure 2 Chain

The

US

Pharmaceutical

Industry:

Value

totally out of proportion with the effort spent on marketing. Together with Glaxo, Merck was one of the few companies that saw the need for a change in the marketing approach. This change came about not only for obvious reasons related with the need to sell but also because of the advantages associated with a close connection with doctors, prescribers and researchers. Indeed, as a result of this interaction, certain pharmaceutical companies succeeded in focusing their research activities with greater effectiveness and improving the efficiency of the new drug research and development processes. Both Merck’s differential approach to R&D and its superior marketing capability were related to a third, highly important capability: Merck was reputed to be one of the pharmaceutical industry’s best managed companies. For many years, many pharmaceutical companies viewed themselves as businesses that were in a separate category, where the discovery and development of medicines seemed to release them from other obligations. However, by the early 1990s, the US pharmaceutical industry found itself in a climate of intense change. There were two main forces driving this change. The first consisted of the growing importance of generic drugs as a means for obtaining cost savings in the US, whose health system was considered very expensive by any international comparison. This trend seemed to weaken companies such as Merck which based their strategy on blockbuster products whose patent would last for many years. The authorities would be more inclined to shorten the patents’ period of validity. 596 EMJ: European Management Journal

These companies basically specialised in purchasing generic products which they would then distribute among their customers, such as large hospitals, medical partnerships or insurance companies. They therefore kept in close contact with prescribing doctors to advise them of the most suitable products. As a result, these companies were able not only to influence the price but also the type of drug that was considered suitable for the treatment of a particular disease. This, in turn, could contribute to eroding or strengthening a drug’s value over time. These industry changes led to a transformation in the industry’s value chain and Merck’s external context. In response to these changes, the company proposed the acquisition of Medco Containment Services in July 1993. Medco was one of the largest PBM companies and ran the largest US mail-order pharmacy. The price offered by Merck was 6.6 billion dollars, considered by some to be too high as it was equivalent to almost 50 times Medco’s net income in 1992. In 1993, Medco ran a network of about 48,000 pharmacies and its membership amounted to 38 million patients. This was somewhat below the industry’s largest company, PCS Health Systems, which had about 45 million member patients. Medco had an excellent reputation for highly efficient management of databases with the patients’ medical profiles, the treatment patterns followed and the drugs’ impact on the patients’ subsequent recovery. Medco also had a major advantage over other similar companies: the direct sales system. This was the largest system of its kind in the US and enabled it to establish direct contact with the patient and, by this means, grow its database. The reasoning for Merck was that the business concept that had driven the company’s growth in previous years, based on blockbusters, was still right, but it might not be enough to cope with the increasing uncertainty surrounding the industry. By the acquisition of Medco, Merck sought to improve future growth possibilities and its competitive position along several dimensions. The first dimension was distribution. The industry was changing; the distributors’ bargaining power – which until

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then had been virtually non-existent – was increasing and would continue to increase over the next few years. Nobody exactly knew how important this would be in the future, but Merck decided to acquire the option to capitalise on it. The second dimension consisted of redefining Merck’s role as a leader in the development of revolutionary new drugs. The industry’s R&D process itself was going to be changed dramatically as a result of the emergence of companies such as Medco which, due to the business’s intrinsic requirements, had developed enormous databases on patients and the course of their diseases during and after treatment. Companies such as Merck considered that this information was extremely valuable for a more efficient management of the pharmaceutical laboratories’ research processes and, in general, for a more effective management of new product development. Third, the acquisition of Medco would provide Merck with an outlet for the generic products which it would have to offer if it was to gain a significant market share in this emerging segment. The way to increase market share was by ensuring a good access for distribution of these products. Companies such as Medco were the best positioned to offer this service to Merck. Finally, Medco would enable Merck to broaden its access to end patients through the direct sales service. This business would undergo enormous growth in forthcoming years, particularly in generic products. By this means, Merck would be able to expand its customer base through access to new forms of distribution that were previously unavailable to it. To summarise, Merck’s decision to acquire Medco was the answer to an external opportunity, aimed at strengthening Merck’s competitive position in several directions as well as enhancing its growth potential: improve the new product development process and gain access to new distribution channels and new customers. At the end of 1999, the new Merck-Medco had 52 million clients and had become the leading firm in the PBM industry. Drug spending on behalf of its customers went up from about $5 billion in 1994 to $18.1 billion in 1999, and the number of prescriptions more than doubled in the period, up to 370 millions in 1999. Merck’s sales went from $11 billion in 1993 to $32.7 billion in 1999. The acquisition of Medco was an opportunity that had contributed to about 20 per cent of the growth of Merck in that period. Beyond the quantitative impact of the acquisition of Medco, Merck is now the leading PBM company in the industry and is capitalising on the increasing demand for health care efficient management and control of drug spending. Moreover, its sales and marketing approaches have served Merck to tap into the internet and led to the development of the pion-

eer project ‘The pharmacy of the future’. In a nutshell, Merck’s acquisition of Medco was an option to expand market opportunities, as well as a vertical merger to control a new contribution channel. A very similar approach to expanding market opportunities can be observed in Telefo´ nica, the fifth largest European telecommunications firm in terms of market capitalisation by the end of April 2001. This Spanish company was a local player protected by regulation. With the deregulation process speeding up in Europe in the mid-1990s, the firm realised that it could only survive on a larger scale. Taking advantage of its cultural ties with Latin America, Telefo´ nica started a spending spree and acquired the leading local operators in many Latin American countries. By the end of 2000 it had become the largest operator in that region and one of the most dynamic European operators. The stream of corporate acquisitions not only created new market opportunities for telecommunications services developed in Spain, but also deployed new marketing competencies. Telefo´ nica became the industry innovator in many countries in services such as cellular phones, Internet service provider and data transmission. Telefo´ nica’s bold move in Latin America led the way to larger-scale operations and faster growth, since the penetration rate of services in those countries were low. Between 1994 and 1999, both revenues and profits grew at an annual rate close to 20 per cent and the company’s market capitalisation increased by 700 per cent. These figures are impressive by industry standards. As in the case of Merck, Telefo´ nica’s acquisitions have been key in turning the company into a leading and innovative player in the industry.

Some Conclusions After years of downsizing and re-engineering firms rediscovered the taste for growth in the 1990s. Nevertheless, as the world economy slows down, managers have come to terms with a harsh reality: GDP growth is too slow. The questions of why and how firms grow still puzzle managers and academics alike. In this paper we discussed why corporate growth is important and presented a framework to show what firms need to do to grow. Some of those options may seem obvious, like innovation or acquisitions. Nevertheless, many innovations flop and many acquisitions fail to deliver the value they promised. Among the growth experiences that we discussed, we highlight some learning points. The first is that growth is an indispensable and manageable challenge, even in stagnant industries, such as Banco 597

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Bilbao Vizcaya and Swatch show. The search for growth opportunities in those industries should start with a corporate renewal process. Second, senior managers need to look at corporate growth from a dual perspective: the internal dimension of resources and capabilities and the external dimension of markets and customers, as summarised in Table 2. Focusing too much on one or other of them may be the reason why new product development or acquisitions founder. A dual perspective sharpens the way managers look at growth as we have seen in the case of SAP, Nokia, Glaxo and Telefo´ nica. The dual perspective does not provide an instant recipe for success, but offers a more comprehensive approach to growth decisions. Finally, a specific growth pattern is not relevant, because different firms (even in the same industry, like Glaxo and Merck) can grow along different pathways. What matters is that the options chosen by a firm strengthen the link between its capabilities and customers’ needs in current or new markets, as we saw in the cases of SAP, Nokia, Swatch and Volkswagen.

Notes 1. This paper is based on the author’s Book, Managing Corporate Growth, Oxford University Press, Oxford, 2000. 2. See Geroski and Machin (1992). By using a large set of

empirical data, those authors explain that corporate growth tends to follow a random walk. Geroski (1999) offers a more conceptual explanation of this result. 3. Among others, Schein (1985) and Pfeffer (1994) offer some compelling arguments that support this view. 4. Ghemawat (1991) discusses product substitution and imitation in the context of the firm’s strategy.

References Baghai, M., Coley, S. and White, D. (1999) The Alchemy of Growth. Orion Business, London. Canals, J. (2000) Managing Corporate Growth. Oxford University Press, Oxford. Chandler, A. (1990) Scale and Scope. Harvard University Press, Cambridge, MA. Donaldson, G. and Lorsch, J. (1984) Decision Making at the Top. Basic Books, New York. Geroski, P.A. and Machin, S. (1992) The dynamics of corporate growth. Working Paper, London Business School. Geroski, P.A. (1999) The growth of firms in theory and practice. Centre for Economic Policy Research, Discussion Paper no. 2092. Gertz, D. and Baptista, J. (1995) Grow to be Great. Free Press, New York. Ghemawat, P. (1991) Commitment. Free Press, New York. Ghoshal, S., Hahn, M. and Moran, P. (1997) Management competence, firm growth and economic progress. Working Paper, INSEAD. Penrose, E. (1959) The Theory of the Growth of the Firm. John Wiley, New York. Pfeffer, J. (1994) Competitive Advantage through People. Harvard Business School Press, Boston. Romer, P.M. (1989) Capital accumulation in the theory of long-run growth. In Modern Business Cycle Theory, ed. R.J. Barro. Harvard University Press, Cambridge, MA. Schein, E.H. (1985) The Organizational Culture and Leadership. Jossey Bass, San Francisco.

JORDI CANALS, IESE Business School, Universidad de Navarra, Av. Pearson 21, 08034 Barcelona, Spain. E-mail: [email protected] Dr. Jordi Canals is Dean and Professor of Economics and General Management at IESE, Barcelona. He has published thirteen books and many journal articles on strategy, international management and banking. His most recent book is Managing Corporate Growth (Oxford University Press, 2000).

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