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November 1, 2008

THE BUSINESS EQUIVALENT OF COMMITTING SUICIDE

Every company has a long-term strategic plan but accepts the status quo—the dirty little secret that they're not actually growing.

In a boom economy, growth is often an illusion. Everyone is doing so well that few pay attention to the fact that a lot of companies—big, well-respected, household name companies— are not growing. Growth at Caterpillar is an anemic 2% a year. Procter & Gamble vowed to double its business in seven years. That was in 1997. With only 2.4% annual growth over the next five years, at that rate, P&G wouldn’t have hit its target until 2033. Every company has a long-term strategic plan, but they accept the status quo, i.e., the dirty little secret that they’re not actually growing. And that is the business equivalent of committing suicide.

Lots of companies, those in the metals industry among them, blame this on unpredictability. When times are good, we all enjoy what I call the “virtuous cycle” of a strong economy, momentum due to high commodity demand and prices, and the high morale that comes from doing well. In bad times, we blame uncertainty for our lack of growth.

In good times and bad, however, the way to find growth is to take the fundamental unpredictability of this industry and embrace it, accept it. Metals profits have traditionally been impacted by energy costs and commodity prices. These days, you add the phenomenal demands of China and India. The marketplace cannot fathom what will happen next.

If you look at the things that have given such a boost to metals in recent years—innovation that’s lead to greater efficiency, China and India driving up commodity prices—more of the success is due to factors outside our control. And if you look at the things threaten the business— the meltdown on Wall Street spreading to the broader economy and the soaring cost of energy— those things are also out of our control. How do you take the luck out of the equation when planning for profitable growth?

You have to embrace portfolio theory, to look at a lot of things because the chance of hitting the big bet is low. The more uncertain the market and your future, the broader you spread your bets on growth initiatives. Don’t just load up on the one big bet—for instance, that commodity prices will continue to soar to the sky— because if your assumption turns out to be wrong, you’ll be more than unhappy.

With a portfolio of growth initiatives diversified by type, timeframe and risk, you have to invest progressively. Feed the initiatives that show progress and starve those that don’t. It’s straight out of poker: You put up some money to get in the game, the ante. Then you watch what others bet, i.e., you gather more information. You bet your cards, i.e., you make more investment. You dribble out investments and earn more. When you’re desperate, it’s tempting to put everything on red, to go for the big bet. That works just as often in business as it does in Las Vegas.

Developing a portfolio of diversified growth initiatives fed and pruned through progressive investing is the foundation of what I call “progressive improvisation.” You compound the effects of rapid, small improvements to achieve larger gains; the vision is long term, the actual improvements are short term. You shorten the plan-dolearn cycle to accelerate the pace of improvement.

This is not an industry that has embraced the idea of portfolio theory. The metals industry needs to learn more about asset management in all senses. It needs to understand that if you diversify across initiatives and over time, you get a steady return out of an unsteady set of initiatives. You have to go up the value chain—forward into services that are less capital intensive. If you move into design, for instance, and things turn down, you can lay off 20 designers instead of being stuck with $8 million worth of inventory.

Metals companies are not badly run businesses. But they have badly run balance sheets. Their leaders are typically good operators but not good strategists. They are immature at asset management, not yet fully equipped to run a lean balance sheet. Because the capital has been bought and paid for by previous generations, it has put less pressure on the business to be efficient asset managers. But oftentimes you’re not actually making a fair return on the capital that has been put at risk in the business.

This is a capital-intensive industry, with naturally high fixed costs. That’s the reality even if you haven’t earned a penny. In an unpredictable market such as metals, you have to move more of the cost structure toward variable cost so that you have greater room to maneuver in a downturn. This can be done by moving into “asset-light” offerings such as services, but also by getting better at supply chain management.

For too long in the metals industries, consolidation has substituted for organic growth. Those companies that are relentless about performance improvement—in service, asset management, customer service— can generate organic growth and better control their future.

The metals industry is chronically risk averse because decades of unpredictability, of cyclicality have taught it that the good times inevitably will end, that a good run at the table is never something you can count on for long. It’s good that the industry runs scared. It’s is a powerful survival instinct. But a more powerful response to an uncertain marketplace is to learn how to embrace unpredictability with better planning and relentlessly improve operating performance so that you better control your destiny.

Michael Treacy is the author of Double-Digit Growth: How Great Companies Achieve It— No Matter What, co-founder and chief strategist of GEN3 Partners, a company dedicated to creating science-based product breakthroughs, and a former professor of management at MIT