Why Organic Is Better

Can you still grow?

Despite it all — the economic murk, strangled credit markets, slumping consumer demand — can you formulate a strategy to maintain profitability and even potentially nudge revenue upward to create some value for shareholders?

The odds don't look good on the M&A side. Just a few months ago, some observers were thinking that savvy strategic buyers and a few nimble private equity players might seize the opportunity to snag some bargains. The ongoing turmoil seems to have spooked all but the most stout-hearted. According to the ZEPHYR quarterly M&A report, published by Bureau van Dyke Electronic Publishing (BvDEP), the deal numbers and dollar volume for companies based in the United States and Canada tumbled in the third quarter. Deal values fell by 16 percent over the three months, while the number of transactions reached a low for the year at 2,480.

That's probably just as well. The evidence that mergers and acquisitions actually destroy shareholder value keeps mounting. Earlier this year, consulting firm A.T. Kearney analyzed 175 mergers and found that while return on sales increased slightly, sales growth and EBIT growth slowed by 6 percent and 9.5 percent, respectively. In addition, shareholder value creation, as measured by market cap, declined by 2.5 percent. In last month's issue of Business Finance, a feature exploring trends in mergers and acquisitions shared data from a study of 33 large M&A transactions in Europe, Canada, and the United States from 2002 to 2007. According to the article, these megadeals destroyed value more than 60 percent of the time, and they raised acquirers' risk profiles, resulting in a higher cost of capital.

Cost synergies are the traditional focus of M&A projects. But they can be hard to realize, notes Alan Gallo, CFO, global consumer business, American Express. While some potential merger synergies, such as back-office savings, are straightforward, others are “famously elusive, such as the ability to leverage each other's customer base or intellectual property for incremental revenue. History suggests that there's good reason to be skeptical, and finance professionals should play that role, stepping back to compare purchase price to realistic estimates of incremental revenue, earnings, customers, and market share.”

With debt financing likely scarce for the foreseeable future, the only way forward for most growth-minded organizations is via internally generated profitable revenue expansion — the organic route.

It's not as glamorous as M&A, and stakeholders may not perceive it as transformative in the way that they might perceive an acquisition (although companies that routinely generate organic growth usually find that they generate plenty of resources for transformative initiatives in other areas). And organic growth has the rather daunting reputation of being dependent on charismatic leadership and the ability to create a “culture of innovation.”

But success in generating growth internally may be less dependent on exceptionally skilled managers than on the careful optimization of a portfolio of growth options. What's more, companies that succeed in managing organic growth efficiently create, rather than destroy, shareholder value. This, in a way, is not surprising; organic growth is the hallmark of true managerial excellence. It's prized by the markets, and there's much to be learned from companies that excel at it.