The McKinsey Quarterly:

Learning to grow again

Companies should ask three critical questions as they shift from cost-cutting to expansion mode.

Ian Davis
The McKinsey Quarterly, 2004 Number 1

If 2004 proves to be a year of recovery, then the challenges faced by management will be very different from those of the past few years. In recession, most companies know what they need to do: cut costs. But in recovery, corporate muscles that have gone unexercised must be flexed anew. In preparation, boards and top managers would do well to ask three basic questions.

What is success?

In earlier eras, the success of a company was judged by a mixture of measures, including its fundamental economic performance, its reputation with customers and employees, its stock price, and its responsibility to society at large. That changed in the 1980s and 1990s. Academic theory, the takeover boom, and shareholder activism led to a focus on share-holder value, all too often measured through the narrow prism of short-term movements in stock prices. This raises troubling questions as companies look to manage the next era of growth while avoiding the pitfalls of the last.

First, are we rewarding and punishing management teams for something over which they have relatively little control? Research suggests that the relationship between a company’s fundamental economic performance and share price over the near term is loose at best. Factors outside management’s control, such as investor sentiment and overall market conditions, can have a major impact on share prices. Did all those CEOs really deserve to get rich from the rising tide of the 1990s? Likewise, some strong management teams have doubtless been punished unfairly during the downturn.

Second, how do we reconcile the different time frames of shareholders and management? The average stock is held for less than a year by institutional investors and for even shorter periods by hedge funds. Yet the investments managers make, and the payoffs from their decisions and strategies, occur over much longer periods. There needs to be closer alignment and understanding not just of objectives and expectations but of timing too. We should ask whether a more multidimensional definition of success is required. Management should be evaluated on what it can control—the fundamental economic performance of the business and the institutional strength of the organization. It should set financial and nonfinancial goals and assess risks with an eye toward the long-term total value of the enterprise. A more balanced view of success, and the time over which it is measured, would ultimately serve shareholders (and society) better by encouraging more innovation and growth.

How can we nurture talent?

The world is not short of capital looking for opportunities. As recovery comes, the scarce resource for most companies will not be capital, but talent.

Many management teams thought they could win the war for talent during the 1990s boom by throwing stock options and perks at their employees and letting employees wear jeans to work on Fridays. When the downturn came, there was an abrupt shift from "we value talent" to "you are a disposable cost." The options evaporated, the perks were withdrawn, and the layoffs came swiftly—in some cases, brutally. This tore the social fabric of many firms and left employees cynical. Trust will have to be earned again and a new compact forged between companies and employees.

Employees recognize that it is unlikely they will have the "jobs for life" of their parents’ generation, but managers also need to recognize that the requirements of the most coveted employees are evolving. Money is important, as always. But people increasingly seek meaning, social connection, and identity from their work.

The best companies will create jobs and roles where employees feel they have some control over what they do, where professional relationships are valued, where more than lip service is paid to the work-life balance, and where there is a real belief in the social and ethical responsibility of the employer. The companies that translate these principles into concrete practices and build the social and knowledge capital of the organization will establish a source of competitive advantage not easily displaced.

What is the role of business in society?

During the 1990s boom, business was viewed generally not just as a source of wealth creation but also as the engine of growth and jobs around the world—a positive force. With the crash came scandal, backlash, and a loss of faith. The pressures are coming not just from rock-throwing protesters but also from the mainstream media, politicians, and well-organized nongovernmental organizations.

Some of these criticisms are clearly valid. Market economies depend on integrity to function; companies should adhere to the values and norms of the communities in which they operate, as the great majority of businesses do. The drive for growth need not be at odds with environmental and other societal concerns. Defensiveness, however, only provides ammunition to the rock throwers. Business leaders should demonstrate more confidence in their moral position as creators of wealth, opportunity, and rising living standards and should work proactively to build trust between their organizations and society at large.


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These three questions ought to be high on management’s strategic agendas. By grappling with these issues more thoroughly than happened in the previous cycle of boom and bust, businesses can generate more durable growth.

Notes:

Ian Davis is McKinsey’s managing director. This article originally appeared in The Economist’s annual publication The World in 2004, dated November 20, 2003, and is reprinted here by permission.