HANNAH BATES: Welcome to HBR On Strategy, case studies and conversations with the world’s top business and management experts, hand-selected to help you unlock new ways of doing business.

Is your growth strategy working consistently? Ken Favaro says creating AND sustaining growth isn’t rocket science. But you do have to understand the difference between organic growth and inorganic alternatives – that come through a merger or acquisition.

Favaro is the chief strategy officer at BERA Brand Management. In this episode you’ll learn why it’s important to focus on creating incentives for organic growth within your organization.  You’ll also learn why you should avoid “typecasting” your business units as “cash cows” or “growth engines,” if you want them to achieve ongoing growth.

This episode originally aired on HBR IdeaCast in April 2012.  And just a note – we recorded this by phone. While the audio quality is not great, the conversation is. I think you’ll enjoy it.

Here it is.

SARAH GREEN: Welcome to the HBR IdeaCast from Harvard Business Review. I’m Sarah Green. I’m talking today with Ken Favaro, a senior partner in Booz and Company. He’s the co-author of the HBR article, “Creating an Organic Growth Machine.” Ken, thanks so much for joining us today.

KEN FAVARO: Morning, Sarah, thank you.

SARAH GREEN: So, the basic idea here is this: companies need to kick-start their internal growth engines and maintain a high rate of growth, but how does that work? And when you call it an organic growth machine, what does that really mean?

KEN FAVARO: Well in the article, at least implicitly if not explicitly, we were drawing a distinction between organic growth and inorganic growth. So, by inorganic growth we mean growing a top line from making an acquisition or doing a merger. Organic growth means growing the top line without doing that. And we think it’s a big issue for companies, which is why we wrote the article.

Because the ability for companies to grow over next call it five years, maybe 10 years, is going to be much tougher than it has been over the last 30, primarily because of the macroeconomic headwinds that are prevailing at the moment due to things like interest rates, sovereign debt, and household debt. So, we thought it would be timely to write an article that would help CEOs and their corporate team to think about how they’re going to deal with how they can get better at organic growth so that they can better overcome the headwinds that they’re facing in trying to grow their company.

SARAH GREEN: One of the interesting little twists on that you have in the piece is you talk about how some companies can take something that’s traditionally seen as a cost-cutting measure, and actually use it to grow the top line. And I think you have examples in there like streamlining a process, or using fewer resources. How does that actually work to grow the top line?

KEN FAVARO: What we’re really talking about there is making it easy to fund organic growth. And the phrase I like to use is, make organic growth free to the organization. So, if you’re asking your operating units to take out costs in order to remove what has become costs that are no longer necessary, give them a bit of a reward for doing that. It’s not the most fun thing to do. But a reward for doing that can be– you know, we will give you the license to reinvest those cost savings in whole or in part into finding new ways to grow organically.

The problem, if I can put it that way, with organic growth is that most of the investment is P&L investment, REVEX, if you like, as opposed to CAPEX. And it hits the P&L immediately. And we all have short-term pressures in terms of driving profit growth. And so, it can be very difficult when you have to make investment such as in advertising or new product development or Salesforce training or more aggressive marketing in order to grow the top line. All of those things hit your bottom line before you get the top line benefit.

And so, if you can allow the operating units to fund their own organic growth by giving them the option to reinvest their cost savings, then I think you’ve reduced one of the many barriers there are to jump-starting your internal growth machines.

SARAH GREEN: So, that’s the sort of theory of how this works. What’s an example of a company that’s doing that in practice?

KEN FAVARO: A classic sample is Gillette when it was being led by Jim Kilts. He had several ways of making organic growth free to the company. One was that he had a policy, which is you the operating unit will be allowed to keep at least half of the cost savings from his continuous cost improvement philosophy for things that will grow the top line. For innovation, basically. That was one of the things he had.

Another program that he had was what he called a corporate scholarship program. This is a corporate account that he held the purse strings to, and which he made decisions on where he thought extra investment might be needed to fund organic growth initiatives that the operating units wouldn’t necessarily fund on their own. And so, he was willing to chip in, if you like, so that the operating units felt like they weren’t being penalized to invest in organic growth, which would hit their bottom line, as I said earlier, and interfere with their bonus program, for example.

SARAH GREEN: One of the things in the article that you caution against is typecasting in the business units. And as you’re talking there about things that hit us close to home, like our bonus program and stuff, I think one of those other things can be labeled something like, oh, that unit’s just the cash cow. How can that kind of typecasting have a really negative effect on a business?

KEN FAVARO: Yeah, we really feel strongly that it might be a good way to think about portfolio strategy, but it’s a really bad way of driving organic growth across the company. And we feel strongly that it’s self-defeatist. And we feel equally strongly that there are few businesses out there that have fully tapped in to new customers and fully tapped in to their potential to create new benefits for the customers they have. And those are the two fundamental ways in which you generate organic growth.

And so, to label a business as a cash cow is to invite them to stop looking for those opportunities to find new customers and opportunities to find ways to generate new benefits for your existing customers. And if you have cash cows and the so-called growth engines know that they therefore have the full responsibility of driving the company’s organic growth, it’s a heavy burden to play. Because not only do they need to generate growth for their own business, but they need to generate growth for the company overall. And it will cause them to overreach.

And we mentioned in the article some pretty good examples of that, such as Viacom when it still owned CBS. And it was viewed as the cash cow for the cable channel business, the business that held MTV and Nickelodeon and other media properties. And the cable business was meant to be the growth darling, the growth engine. And CBS was meant to be the cash cow, and at the corporate level was managed accordingly. In effect, CBS was starved and the cable channel business was stuffed.

And low and behold, when you separated those two businesses and they were given the freedom to pursue their own growth path, CBS turned out to have much more growth potential than it was originally thought. And it’s just a great example of how self-defeating it can be to typecast different operating units with different, quote unquote, “portfolio roles” in the company.

SARAH GREEN: Yeah, it sounds like in that case you actually end up leaving quite a bit of money on the table, potentially.

KEN FAVARO: Always. And you do it in two ways. One is you push too hard, you overreach in those operating units that are labeled the growth engines, and end up wasting investment and adding unnecessary costs that won’t generate sufficient return. And the other way in which you leave money on the table is the foregone opportunities in the so-called cash cows who are being starved for that investment that’s being diverted.

SARAH GREEN: So, let’s talk a little bit about how you find the sweet spot between those two extremes. What’s the right growth target, and how do you know when you’re overreaching, and how do you know when you’re not being ambitious enough?

KEN FAVARO: There’s two ways to think about that. One is from a market back perspective. Jim Kilts, as I mentioned earlier, liked to think about what his philosophy was that you want it to be above average, year in and year out, relative to the market. But you never want to strive to be top of the pack in any given year. Because his view was that that would cause an operating unit to overreach.

So, you’d create a point of view. What do I think is the natural growth rate for the markets that I’m in? And then you’d pick some increment above that and say, that’s the right growth target. That’s one way to look at it.

I think there’s another way that I think is more fundamental, and potentially more helpful, which is to start with what you think your headroom is. So, you’ll recall in the article we define headroom as basically the market share you don’t have minus the market share you’re never going to get. And there’s nuances around that, but that’s not a bad place holder.

And you ask, OK, so what’s the true headroom for my business? And then I ask myself, what kind of investment do I need to make in order to enhance or add capabilities that I need to capture that headroom? Because after all, if I had the capabilities, I would already have the revenues and the headroom. So, there must be investment required to enhance or add capabilities to the business.

And you ask yourself, what kind of investment can we make? And that tells you how much of that headroom you think you can capture over some time frame. And you derive from that, therefore, the right growth target. So, it’s more like you start with your growth potential, and then you derive your targets from that, rather than the other way around.

SARAH GREEN: So, I wanted to finish up here by asking you, once you’ve come up with that growth target, once you’ve figured out ways to fund the growth for free by taking a close look at your processes and your resources and things like that, you’ve got to communicate it to your employees. And it seems to me that especially in the current environment– and you mentioned in the beginning of the interview lots of the economic headwinds that we’re still facing.

When economic growth is sluggish, I think it can seem to the people in the cubicles when management calls for growth that they’re asking for something impossible, or that they’re asking them to do more with less. And especially after several years into a sluggish economy, that can get really old. So, how do managers go about overcoming either resistance or fatalism and really make their people feel more excited about some of the stuff?

KEN FAVARO: Well, first of all, I don’t believe in asking people to do more with less. I believe in asking companies to do more with less. All companies have a certain amount of waste in them. It’s just a fact of life. And doing more with less is really about finding where the waste is and reinvesting that in where your true growth opportunities are, which in our jargon means where your true headroom is. So, I think that is dispiriting to the people in the cubicles when they’re being asked to do more with less. That’s not the same thing as asking a company to do more with less.

I’ll give an example. So, general merchandise retailer, huge business, struggling to get same-store sales growth, which, in that business, is what organic growth really means. Hundreds of initiatives ongoing– call to action. We must get more same-store sales growth. Therefore we must invest, and we must put those investments behind us, many initiatives as we can think of. Hundreds of initiatives.

You then look at, well, where’s the real headroom? Is it by getting more people into the stores? Is it by getting people who are already in the stores to cross the aisle, meaning if they’re already buying groceries should we encourage them to go down the apparel aisle and start buying clothes from us? Or is it about getting people who are already shopping in groceries or already shopping in our clothing lines or already shopping in our entertainment products pile to buy more of those things from us than they are from other people?

And it turned out for this retailer that, whereas they thought their big opportunity was getting more people in the store and getting in across the aisle, it was in fact getting people who were buying in their categories already to buy more in those categories. Out of these hundreds of initiatives, at least half of them were going after growth opportunity that they didn’t have.

So, imagine if you took the resources that were behind that and put them into the other half of the initiatives that really could create a return in terms of finding growth. You’re not asking the people behind the first half to do more with less. You’re simply saying, actually, we want you to be involved in these other initiatives where we think the potential is greater. And in fact, those initiatives are going to get more resources.

So, the company will be doing more with less, but you’re not asking any one individual in the company to do more with less.

SARAH GREEN: Well, Ken, lots of good advice there and in the article as well. Thanks so much for talking with us today.

KEN FAVARO: My pleasure. Thank you.

HANNAH BATES: That was Ken Favaro in conversation with Sarah Green on the HBR IdeaCast. Favaro is the chief strategy officer at BERA Brand Management.

We’ll be back next Wednesday with another hand-picked conversation about business strategy from the Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues, and follow our show on Apple Podcasts, Spotify, or wherever you get your podcasts. While you’re there, be sure to leave us a review.

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