Jip Inglis / Strategic Marketing Practice
Businesses can increase enterprise value in three ways:
- Grow their top line revenue
- Improve profit margins by either raising prices or reducing costs
- Realize higher valuation multiples on revenue and/or profit
Care to guess which of these three is most important? The answer is grow top line revenue; and it’s really not a close call.
The Top Line Growth Mandate
Work by the Boston Consulting Group and Compustat on best performing S&P 500 companies show that that revenue growth accounts for fully 60% of the long term, 10 year enterprise value increase. Profit margin improvement and valuation increases combined account for only 40%.
The problem is that achieving growth in today’s economic environment is harder than it used to be.
Growing the Top Line Getting More Challenging
Consider this. From the the end of World War II in 1945 through 2000 U.S. GDP grew at an average annual rate of 3.2%. From 2001-2014 it has grown at only 1.8% per year, just over half the rate of the late twentieth century.
In the past corporate leaders enjoyed a brisk tailwind of overall economic expansion and if they could just keep pace with the general market, they could deliver at least modest growth levels. Today that’s no longer the case. Revenue increases of 1.8% aren’t going to make anyone wealthy quickly.
Additionally in a low inflation environment it is difficult, if not impossible, for companies to raise prices. Competitive and market factors therefore require companies to work smarter, be more innovative, and outsmart the competition if they are to take market share from competition and drive top line revenue.
You Can’t Cost Cut Your Way to Long Term Prosperity
It’s really no surprise, then, that increases in stock prices seen during the current bull market have been more a function of astute financial engineering (capital restructuring, cost reductions, stock buybacks) than of true top line growth.
In the shorter term these sorts of strategic financial management maneuvers can be effective. But, as the old cliche goes, “You can’t save or cost cut your way to profitability forever.” Over the longer haul the simple, hard truth is that if businesses want to create significant value they must be able to grow their top line better than average, and in many cases a lot better.
For corporate leaders this creates an uncomfortable and challenging situation.
Innovation and Strategic Thinking Increasingly Critical
Senior managers are charged with creating shareholder value. The best way to do this is to grow the top line. Yet, today’s environment is not very accommodating to growth. What’s needed now are smart, astute revenue creation strategies that can lead to exceptional results. What’s needed are ideas that marry proven best practices with cutting edge, out of the box approaches.
Look for more innovative growth ideas in future Ascension Top Line blog posts.