The 2013 Fit for Growth Index study How ready are you for growth? Contact North America Siobhan Ford Director, Marketing +1-212-551-6234 siobhan.ford @strategyand.pwc.com This report was originally published by Booz & Company in 2013. For further information: Fit for Growth microsite page (www.strategyand.pwc.com/global/home/what-we-think/ fitforgrowth) 2 Strategy& Executive summary Since the 2008 economic crisis, many companies have been trying to figure out the best way to reposition themselves for growth and economic recovery. At Strategy&, working with many leading businesses across a variety of industries, we have gained deep insights into what winning organizations do to return to sustainable high performance. It’s a combination of three things: First, they create clarity and coherence in their strategy — being clear about how they’re adding value and articulating the differentiating capabilities they need to win in the marketplace. Second, they put in place an optimized cost structure and approach to capital allocation — continuously investing in the capabilities critical to success, while proactively cutting costs in less critical areas to fund these investments. Third, they build supportive organizations — redesigning structures, incentives, decision rights, information flows, skill sets, and other organizational and cultural elements so the collective actions of their people align more closely with their strategy. Such a Fit for Growth* approach builds competitive muscle while cutting the corporate fat that weighs a company down. Companies that follow this approach take proactive and strategic cost actions (as opposed to reactive and tactical ones), freeing up funds to reinvest in those parts of the business that are most important for growth. At the same time, they put in place an organizational fabric that guides employees to do the right things day in and day out, thus helping the entire enterprise build and sustain competitive advantage. Having seen these three elements create value in the market, Strategy& decided to actually measure the benefits of this Fit for Growth approach. * Fit for Growth is a registered service mark of PwC Strategy& Inc. in the United States. Strategy& 3 In order to do so, we created a quantitative metric — the Fit for Growth Index (“the index”) — that is built on these three elements, and analyzed how it correlates with company performance. Main findings of the study As part of the study, we analyzed almost 200 public companies across a wide range of industries, compiling their index score and determining their total shareholder return over the past two years. Here are the main findings from our study: 1)There is a clear correlation between the Fit for Growth Index score and market performance. Companies that focus on the three elements — strategic clarity and coherence, resource alignment, and supportive organization — generate higher shareholder returns. 2)High-performing companies tightly link their growth and cost agendas. They clearly understand which capabilities are truly critical for winning with their strategy, and they funnel the bulk of their resources to those differentiating capabilities. 3) Few companies are ready to grow. Although the three dimensions to focus on may seem clear and the positive impact is obvious, less than one-fifth of the companies (17 percent) seem well prepared to grow. Very few companies — only 6 percent of those included in the study — perform well along all three dimensions of the Fit for Growth Index. 4)Companies fall into a set of five “archetypes” with common characteristics. Depending on where their strengths and weaknesses lie, companies fall into one of five broad archetypes. Each of those company archetypes has its own characteristics and challenges, and we’ve identified a specific set of recommendations for each. Implications for management Few companies would disagree that robust strategies, solid cost management, and powerful organizations are critical to performance. But they may not be aware of how much these three elements need to reinforce one another. Combining them is the hard part: Our research shows that few companies are masters in integrating all three elements. Making improvements requires a dispassionate clear-headedness about one’s strengths and weaknesses, an understanding of where the links between strategy, resource management, and organization are broken, and the development of a clear plan of attack to reap the benefits. 4 Strategy& Key highlights • Strategy& has found that sustainable company performance is driven by the extent to which companies are able to link their growth and cost agendas. • We developed the Fit for Growth* Index, a composite measurement of a company’s “health” along three critical dimensions: strategic clarity and coherence, resource alignment, and supportive organization. • There is a clear correlation between high Fit for Growth Index scores and market performance. Doing well on the three attributes of the index matters. • To maximize performance, companies need to be strong on all three index dimensions — doing well on one or two dimensions only will lead to suboptimal performance. • Companies fall into five archetypes, each with its own unique symptoms, challenges, and management priorities. • Executives need to recognize their current archetype, understand where they are weak, what they must change in order to become ready for growth, and develop a credible road map to link their growth and cost agendas. * Fit for Growth is a registered service mark of PwC Strategy& Inc. in the United States. Strategy& 5 Now that the global recession has subsided, how do we best position our company for growth? Should we continue to push for cost cutting, or should we release funds to invest in growth? How can we get our initiatives and priorities to be in line with our strategy? What are our highest-priority areas to invest in? 6 How do we know whether we’ve cut too much, whether we’ve cut the muscle rather than just the fat? Is there still fat in our organization … and where shall we look for it? Why can’t we seem to make cost discipline sustainable? Strategy& The Fit for Growth Index The Fit for Growth Index measures how well a company connects its cost and growth agendas. It assesses companies in three key areas: strategic clarity and coherence, resource alignment and supportive organization. Fit for Growth framework Strategy & way to play Enable & sustain reductions Release funds Strategic clarity and coherence • Clearly articulated and coherent strategy • Sustainable and differentiating capabilities for growth • Presence in critical product, market, and customer segments • Clear articulation of how the business creates differentiated value for customers Resource alignment Invest in highervalueadded priorities • Lean cost structure in low-criticality areas • Proactive and tailored cost reduction actions • Systematic investments in differentiating capabilities Supportive organization • Organizational structure that is market-back and tied to the basic characteristics of the business • Coherent and supportive incentives, decision rights, skill sets, culture Key dimensions of Fit for Growth Index Strategy& 7 A company’s Fit for Growth Index score is a weighted average of the company’s fitness (on a scale from 1 to 5) along each of those three dimensions. We developed the Fit for Growth Index so we could: • Determine how important the three elements — strategic clarity and coherence, resource alignment, and supportive organization — are for a company’s performance • Assess which of those elements is most important in driving performance • Identify common characteristics among companies that would allow us to formulate recommendations for how they can improve their readiness for growth. 8 Strategy& Companies with a high Fit for Growth Index perform better To measure the connection to corporate performance, we determined the Fit for Growth Index score for close to 200 companies and compared it to the company’s total shareholder returns over the two-year period from August 2010 to July 2012. We found a strong correlation between companies’ shareholder returns and their Fit for Growth Index scores. Correlation between Fit for Growth Index score and two-year normalized TSR score n = 197 Normalized TSR score Capital One Financial Corporation 100 Comcast Corporation Limited Brands Inc. 90 Whole Foods Market Inc. BlackRock Inc. U.S. Bancorp 80 70 Diageo 60 50 Time Warner Cable Inc. Luxottica Group SpA Wal-Mart Stores Inc. 40 30 20 10 0 1.0 1.5 2.0 2.5 3.0 3.5 Fit for Growth Index score Strategy& 4.0 4.5 5.0 Source: Capital IQ database; Strategy& analysis 9 • 73 percent of companies with high index scores had high or medium-high TSR scores, and companies scoring lower on the index also had lower TSR scores. • The strength of the relationship between index score and TSR score varies by industry, but it is present in each of the 17 industry sectors we have analyzed. Percentage of companies in specific TSR score band by Fit for Growth Index score band n = 197 High Fit for Growth Index score TSR score 64 companies 107 companies 19% 16% 34% 27% 45% 26 companies 42% 31% 47% 12% Low & medium-low (1 - 3) Medium-high (3.1 - 3.7) Fit for Growth Index score band 10 Low (0 - 25) Medium-low (25 - 50) Medium-high (50 - 75) High (75 - 100) 27% High (3.8 - 5) Note: Width of bars corresponds to number of companies in each Fit for Growth Index score band. Source: Capital IQ database; Strategy& analysis Strategy& The most important drivers of performance Once we had established the link between index scores and market returns, the next logical question became: What specific elements, if any, in the index framework best explain strong performance? Some of the factors within each of the three key building blocks — strategic clarity and coherence, resource alignment, and supportive organization — appear to have a particularly powerful impact on TSR scores. These include: Strategy& 11 Index building blocks and sub-factors the particularly strong TSR impact Starting questions for managers Strategic clarity: Coherent strategy • Does the strategy represent a differentiated way to play in the market? • Is the strategy reflected in a clearly stated list of firm-wide strategic priorities? • Is the strategy aligned with the changes in the market? • Is the strategy well documented? Resource alignment: Systematic investments in differentiating capabilities • Is there an objective and disciplined resource allocation process that focuses on strengthening differentiating capabilities? Supportive organization: Speed and decisiveness in response to market or internal challenges • Does the organizational structure enable nimble governance? • Are mechanisms in place to enable cross-business unit collaboration? • Is the organization efficient, flexible, and lean? 12 Strategy& Five company archetypes When analyzing how companies performed along the three dimensions of the Fit for Growth Index, we discovered a clear clustering of companies into five archetypes: five types of companies, each with its own set of characteristics. For each archetype, we developed recommendations for improving readiness to grow. Strategy& 13 Strategically adrift “Strategically adrift” companies have: – An unclear strategy and critical priorities that are not widely understood, even among top management. – A lack of clarity as to the capabilities that are essential for them to win in their markets. – A reactive approach—their strategic decisions are easily swayed by external events, and competitors’ actions can easily propel them in new directions. Strategic Resource Supportive clarity and alignment organization coherence Action: “Strategically adrift” companies should focus on identifying their differentiating capabilities and develop a strategy that leverages those competitive advantages. Distracted “Distracted” companies have: + Moderate effectiveness and efficiency. – Some critical capabilities present as “table stakes” for the industry, but they are not distinctive enough to serve as a competitive advantage. – A strategy that is not focused enough to mobilize investment. Action: “Distracted” companies should sharpen their strategic focus and align the company around those capabilities that give them a right to win. Strategic Resource Supportive clarity and alignment organization coherence Capability constrained “Capability constrained” companies have: + A big-picture understanding of what it takes to win, but they need more discipline in execution. + Terrific strategies, and a coherent and clearly articulated set of capabilities. – Cost structures and approaches to investment management that aren’t keeping pace with their intent. – Strategies and capabilities systems that aren’t as effective as they could be; and inadequate practices, processes, or technologies that often hold them back. Strategic Resource Supportive clarity and alignment organization coherence Action: “Capability constrained” companies should be very clear about what exact capabilities they need and then work on processes, systems, skills, behaviors, and organization—all together—to become world-class at what’s most important for them. In the game “In the game” companies have: + Strategic focus. + A diligent approach to capability building. + Good market effectiveness. – Suboptimal organization, e.g., complicated matrix structures and onerous governance processes that undermine speed and effectiveness. Strategic Resource Supportive clarity and alignment organization coherence Action: “In the game” companies should focus on internal structures and processes. They need to realign their management structures, decision making, and talent to support strategic priorities. Ready for growth “Ready for growth” companies are firing on all three cylinders. They have: + Well-developed strategic capabilities that also are well understood throughout the organization. + Systematic ways to direct resources to initiatives with the highest strategic and financial returns. + Organizational structures that support key capabilities, with talent in the right places and efficient decision making. Strategic Resource Supportive clarity and alignment organization coherence 14 The market success of “ready for growth” companies rests on a foundation of coherent, proven, and sustainable capabilities, not transitory factors like managerial talent or favorable market conditions. Strategy& • Among the 197 companies that we studied, only 17 percent were classified as “in the game” or “ready for growth” and thus well equipped for expansion. Distribution of archetypes across sample companies Strategically adrift Distracted 14% 49% Capability constrained 20% In the game 11% Ready for growth 6% 100% Strategy& Source: Strategy& 15 What a “ready for growth” company looks like Every company is different; however, our analysis revealed a set of charac­te­r is­tics that are common to many of the companies in the strongest (“ready for growth”) archetype. Consider these elements across the three building blocks of the Fit for Growth framework: • Strategic clarity and coherence — “ready for growth” companies … –– Have specific and actionable strategic priorities that are widely understood at all levels of the company –– Make clear choices, striving for best-in-class status only in the few distinctive capabilities that create sustainable competitive advantage, and accept “good enough” in other areas –– Are able to keep their strategies relevant by sensing and rapidly adapting to market changes –– Are quicker to innovate, willing to make calculated big bets –– Feel no qualms about killing investments that aren’t paying off. • Resource alignment — “ready for growth” companies … –– Employ a disciplined process that ensures adequate funding for high-growth, core activities –– Have clear and objective investment criteria that prevent department rivalries from interfering with allocation of funds to top corporate priorities –– Manage spending strategically, making rigorous trade-offs based on cost transparency and a deep understanding of how they make money. 16 Strategy& • Supportive organization — “ready for growth” companies … –– Are organizationally efficient, flexible, and lean –– Align their power structures and allocate decision rights in ways that best serve strategic priorities and business realities –– Create nimble mechanisms for governance and collaboration across business units –– Have talent management practices that support key capabilities by moving the best people into pivotal roles –– Have a coherent culture that sets norms and expectations that reflect the requirements for success in the marketplace –– Have an ethos of excellence and continuous improvement that is reinforced by meritocratic systems. Strategy& 17 Coherent strategy Strategic clarity and coherence Supportive culture Strong leadership in key roles Strong capabilities “Ready for growth” company Strong and coherent product portfolio 18 Decisiveness with respect to market & internal challenges Improvement initiatives aligned with strategy Presence in critical markets Systematic investments in differentiating capabilities Supportive organization Thoughtful cost reduction Resource alignment Strategy& Industry case study: Fit for Growth Index in the consumer packaged goods sector We conducted a deep-dive on the consumer packaged goods (CPG) industry to assess how the Fit for Growth Index impacts company performance in a specific industry. The Fit for Growth Index and consumer packaged goods Financial performance (normalized TSR score) 100 Constellation Brands Brown-Forman Anheuser-Busch InBev 80 Church & Dwight Kimberly-Clark Mattel Colgate-Palmolive Whirlpool 60 Diageo Newell Rubbermaid Coca-Cola ConAgra Foods PepsiCo Molson Coors Brewing 40 Clorox J.M. Smucker Tyson Foods American Greetings General Mills Kellogg Campbell Soup 20 Avon Products 0 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 Fit for Growth Index score Strategy& 19 • Consistent with the cross-industry findings, our analysis in the CPG sector showed close correlation between companies’ Fit for Growth Index scores and their shareholder returns: –– Companies such as the Kimberly-Clark Corporation, Mattel Inc., and the Brown-Forman Corporation have demonstrated an ability to produce sustained shareholder value. They also score high on the Fit for Growth Index. –– Consumer products manufacturers with low index scores, such as Avon and American Greetings, have also produced lower two-year total shareholder returns. • The data also revealed which components of the index have the greatest impact on shareholder returns: –– Differences between high- and low-performing companies were greatest in factors related to strategic clarity and coherence, and resource alignment. –– Differences between high- and medium-performing companies were greatest in the supportive organization category. 20 Strategy& For deeper insight, we examined two particularly strong performers that embody the key principles of the Fit for Growth approach. • Diageo: Diageo is a global alcoholic beverages company with global brands including Johnnie Walker, Smirnoff, and Guinness. Diageo sells in more than 180 countries and derives 40 percent of its sales from emerging markets. Overarching growth strategy: Expanding leading brands into new markets, with a tailored approach for each market that capitalizes on Diageo’s supply chain and distribution channel advantages. Strategic clarity Resource alignment Supportive organization • Diageo relies on a small set of differentiating capabilities: marketing; supply chain, and distribution channel efficiencies; innovation; and joint business planning with customers (known as the “Diageo Way of Selling”). Diageo manages costs and investments to strengthen these key capabilities, in part by seeking efficiencies in other areas, e.g. • Diageo has built a fit-forpurpose, efficient, and effective organization. • Capabilities are adapted to meet the needs of local markets. For example, Diageo cultivates a premium image, and emphasizes product innovation to middle-class consumers in emerging markets. Strategy& • careful strategic sourcing of ingredients and other direct materials • operational optimization • alignment of supply footprint with growth opportunities • use of value-enhancing routes to market in emerging markets • Diageo’s geographic organization maximizes brand value by combining a focus on individual growth markets with a global marketing support system. • Employee satisfaction scores are high, with many praising Diageo for its meritocratic culture, focus on results over “face time,” strong leadership, social responsibility, diversity, and work/life balance. 21 • Church & Dwight: Church & Dwight has assembled a strong portfolio of home-care and personal-care brands in both the premium and value categories. The approach has paid off for shareholders. Church & Dwight’s total shareholder returns have ranked among the consumer products industry leaders for most of the past decade. Overarching strategy: Identifying and acquiring niche brands with untapped residual equity, and mining this value by giving the brands wide distribution and prominent shelf space, then cross-pollinating and extending the brands into adjacent categories Strategic clarity Resource alignment Supportive organization • This strategy requires superior capabilities in areas such as brand extension, innovating in categories where a brand is the market leader, and “fast following” in niches where it is a value player. • Investments focus on brand development and marketing for a small set of “power brands” that drive growth at the company. • Church & Dwight fosters a highly performance- and results-focused financial culture, supported by aggressive cost management. • Church & Dwight develops these capabilities through resource alignment. 22 • Innovation investments are intentional, focusing on breakthroughs in areas of market leadership (e.g., Trojan), and closely following market leaders in value niches (e.g., Arm & Hammer). Strategy& Methodology • • Our survey sample comprised 197 companies in 17 industries. Companies were chosen to yield a balanced sample including high, low, and moderate financial performers in each industry, based on their total shareholder returns over a two-year period (November 2010 – November 2012). strategy (15 percent), strong capabilities (10 percent), strong and coherent product portfolio (10 percent), presence in critical markets (15 percent) • Resource alignment: systematic investments in differentiating capabilities (10 percent), thoughtful cost reduction (15 percent), improvement initiatives aligned with strategy (5 percent) The Fit for Growth Index was designed such that it assesses companies in three key areas: strategic clarity and coherence; resource alignments; and supportive organization. NJNJ Each company received a composite score on a scale of 1 to 5 based on its “fitness” in each of these areas. NJNJ In calculating the Fit for Growth Index score, we weighted the three factors as follows: strategic clarity and coherence (50 percent), resource alignment (30 percent), supportive organization (20 percent). The second and third factors — the aligned resource base and the supportive organization — together make up a company’s execution capability. Thus, a company’s index score is derived in equal parts from its strategy and executional fitness. These weightings reflect our belief that strategy and execution are equally important in determining performance. NJNJ The three factors were, in turn, made up of several components, each with its own weighting. These components are: • Supportive organization: speed and decisiveness (10 percent), strong leadership (5 percent), supportive culture (5 percent) NJNJ • To supplement our own knowledge of the companies, we examined information from research databases, analysts’ reports, earnings call transcripts, and business periodicals. For each company, we determined a normalized TSR score. NJNJ TSR scores are between 0 and 100, with 100 representing the company with the highest returns in its industry segment, and 0 representing the lowest. NJNJ This form of normalization allows us to insulate TSR results from external factors that might affect some sectors more than others — for example, higherthan-usual exposure to declines in spending due to the recession. • Strategic clarity and coherence: coherent Strategy& 23 Strategy& is a global team of practical strategists committed to helping you seize essential advantage. We do that by working alongside you to solve your toughest problems and helping you capture your greatest opportunities. These are complex and high-stakes undertakings — often game-changing transformations. We bring 100 years of strategy consulting experience and the unrivaled industry and functional capabilities of the PwC network to the task. Whether you’re charting your corporate strategy, transforming a function or business unit, or building critical capabilities, we’ll help you create the value you’re looking for with speed, confidence, and impact. We are a member of the PwC network of firms in 157 countries with more than 184,000 people committed to delivering quality in assurance, tax, and advisory services. Tell us what matters to you and find out more by visiting us at strategyand.pwc.com. This report was originally published by Booz & Company in 2013. www.strategyand.pwc.com © 2013 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. Disclaimer: This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.