Kicking the Growth Addiction

Marshall Fisher The Wharton School

Vishal GaurCornell Johnson School

Herb KleinbergerNYU Stern School

Fisher, M.L., V. Gaur, H. Kleinberger. “Curing the Addiction to Growth,” Harvard Business Review, Jan-Feb 2017.

Contact email: vg77@cornell.edu

Retailer Lifecycle Stages

Walmart grew exponentially in first 20 years

$0

$2,000,000,000

$4,000,000,000

$6,000,000,000

$8,000,000,000

$10,000,000,000

$12,000,000,000

$14,000,000,000

$16,000,000,000

1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988

Revenue

43% CAGR

Growth was drive by opening new stores

-

200

400

600

800

1,000

1,200

1,400

$0

$2,000,000,000

$4,000,000,000

$6,000,000,000

$8,000,000,000

$10,000,000,000

$12,000,000,000

$14,000,000,000

$16,000,000,000

1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988

Revenue

Store count

Income also grew at 43%. They were scaling the business, not increasing its profitability

$0

$100,000,000

$200,000,000

$300,000,000

$400,000,000

$500,000,000

$600,000,000

$700,000,000

$0

$2,000,000,000

$4,000,000,000

$6,000,000,000

$8,000,000,000

$10,000,000,000

$12,000,000,000

$14,000,000,000

$16,000,000,000

$18,000,000,000

1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988

Revenue

Net income

Revenue growth has slowed in recent years, signaling maturity

What should a retailer do when they reach maturity?

$0

$50,000,000,000

$100,000,000,000

$150,000,000,000

$200,000,000,000

$250,000,000,000

$300,000,000,000

$350,000,000,000

$400,000,000,000

$450,000,000,000

$500,000,000,000

1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 2018

Revenue

2.8% CAGR in last 5 years

Management literature advice – figure out how to start growing again

Walmart is following this advice

• In last 5 years store count up 29%, sales up 14%

• Aggressive global expansion, mostly unsuccessful

• In the 1972 annual report, a year in which sales grew 76%, some form of the word ‘grow’ appears 4 times

• In the 2015 annual report, a year in which sales grew 2%, some form of the word ‘grow’ appears 114 times.

• 2016 annual report CEO letter, a year in which sales declined .7%: “We are a growth company; we just happen to be a large one.”

Are they right to continue to strive for top line growth or should they switch to a different strategy, and what would that strategy look like?

Primary data set

Sales growth rate , stock return and other metrics for 378 publically traded retailers in business at some point during 1993-2014

Sales growth rate of the 64 retailers active for entire period 1993-2014

92-97 98-02 03-07 08-12 10-14

Deep dive into this data

Classification of retailers: 2010-14 results

Winners and some losers

• 17 had >8% top line growth (12.7% average) and 18.1% average stock

return

• 37 had <8% top line growth and < 16% stock return, averaging 1%

• 10 had <8% top line growth and >16% stock return, averaging 23.4%

with average growth of 4.8%

Average values for 2010-14

Sales Growth Market Return Sales Growth Market ReturnTUESDAY MORNING 1.5% 33.7% WESTON LTD 6.4% 7.9%FOOT LOCKER 7.7% 28.9% NORTH WEST CO 2.3% 7.9%LIMITED BRANDS 5.7% 27.8% WAL-MART 3.5% 6.1%DILLARDS 1.7% 26.8% GAP 2.9% 5.9%MACY'S INC 3.6% 23.5% INGLES MARKETS 3.2% 4.3%TJX 7.2% 21.3% TARGET 2.1% 4.2%HOME DEPOT 4.6% 21.1% BIG LOTS 1.8% 0.9%LOBLAW 6.5% 20.1% VILLAGE SUPER MARKET 4.6% -3.3%EVINE LIVE 4.9% 19.3% AMERN EAGLE OUTFITTERS 1.9% -3.7%KROGER 6.9% 17.9% KOHL'S 2.0% -5.1%

PUBLIX SUPER MARKETS 4.6% -64.0%Averages 4.8% 23.4% Averages 3.2% -3.5%

Examined public info and interviewed the following

• Ken Hicks, CEO, Footlocker, 2009-2014, Exec Chairman until 2015

• Mark Holifield, Executive VP, Supply Chain and Product

Development, The Home Depot

• Terry Lundgren, CEO, Macy’s

• Karen Hoguet, CFO, Macy’s

• Chris Kung, VP for e-commerce Strategy, Macy’s

• Bob Marshall, VP, U.S. Operations, McDonald’s, 2005-2015

How did Foot Locker grow share price faster than revenue?

Op expense grew by 1.3% less than revenue.

1.3% is 13.3% of 9.8% ave op income so adds 13.3% to op income growth

Understanding Operating Leverage

Suppose a retailer has an operating margin of 10% in Year 1. In Year 2, its sales revenue grows by 5% and operating expenses grow by 4%.

What would be the growth rate in operating profit?

July 2015 – March 2016 interviews with Ken Hicks

• Confirmed that his strategy was exactly to grow expenses slower than sales– Grow inventory half as fast as sales– Grow controllable expenses 70% as fast as sales

• Leverage inventory, store associates & real estate

• Ken: “I can leverage as little as a 2% sales increase.

• By implication, need at least 2%, so this is a ‘low’, but not ‘no’, growth strategy. Ken: “A retailer with declining sales will not survive.”

• Karen Hoguet: “Terry and I debate the planned growth rate each year. He’s thinking 3-4% and I’m thinking 2-3%” (Macy’s averaged 3.6% growth in last 5 years)

Leveraging inventory, store associates & real estate

• Closed and redesigned stores. Net closed stores but increased total square footage putting new space where it would do the most good.

• Grew .com business• Better hiring criteria for store associates and put best people in most

important hours• Eliminate non productive work in stores to allow more time for selling

– Example: Going back and forth to back room. 5 trips = 15-20 mins.– With Motorola, developed ‘scan badges’ that tell an associate what’s

in the backroom, and also on line and in other stores, so he can dialog with customer and bring from back room shoes most likely to work.

– Refined over 6 months in a few pilot stores– Deloitte estimated 2% plus sales from this

• 20-30 projects like this going on at any time• Process: Ideas, pilot, test, rollout

• Not sexy – this is Vince Lombardi does retail• What you say ‘no’ to even more important than what you say yes

to• Example – Macy’s offered Footlocker and Finish Line a store within

a store opportunity• Footlocker evaluation

– How much would this cannibalize their existing stores– Evaluated at 5%, 10% and 15% cannibalization– Marginal at 5%. Even 5% reduced sales might make many

stores unprofitable– Might have worked in 200 stores, but Macy’s wanted all store– To be conservative, Footlocker passed

• “Two pigs at a trough can do ok, but with 3 pigs at the trough (Macy’s, Nike and Footlocker or Finishline), one will go hungry

What’s hard about this?

Indianapolis Business JournalFinish Line expects sales to leap in Macy’s dealApril 12, 2013 Scott Olson

Finish Line’s deal with Macy’s, which begins Sunday, calls for it to become the exclusive athletic footwear partner of the national department store chain—a move that executives think could increase annual revenue by as much as 30 percent.

That translates to an additional $350 million on top of the company’s yearly sales of $1.4 billion.

“This is probably the most exciting thing Finish Line has done in 30 years,” CEO Glenn Lyon said in a conference call in March. “We are going to have an unbelievable run with this business.”

Foot Locker

Finish Line

Foot Locker vs Finish Line share appreciation

What happened?

Expenses grew faster than revenue!

Finish Line Fiscal YearMillions of USD 2012 2013 2014 2015Revenue 1,369 1,443 1,670 1,821COGS 889 959 1,123 1,237SG&A 344 366 425 459Total Operating Expense 1,235 1,331 1,550 1,700Operating Income 134 112 120 120Comp store sales increase 9.2 5.8 4.2 3.2

AverageOperating Income as % of Revenue 9.8% 7.8% 7.2% 6.6% 7.8%

Annual growth ratesRevenue 9.5%COGS 11.0%SG&A 9.7%Operating Expense 10.7%Op Income -3.6%

1.2% is 15.4% of 7.8%

Dickens was a retail expert

"Annual income twenty pounds, annual expenditure nineteen [pounds] nineteen [shillings] and six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

Revenue increase 8%, expense increase 6.7%, result happiness.

Revenue increase 9.5%, expense increase 10.7%, result misery.

Results for all 37 retailers

The formula for success (with apologies to Dickens)Revenue increase 4.7%, expense increase 4.3% - happinessRevenue increase 4.6%, expense increase 5% - misery

Retailer Lifecycle Stages

Retailer Lifecycle Stages

Denial

Home Depot Lifecycle

Nardelli starts

Blake replaces Nardelli

Growth/scaling

Denial

Maturity/leverage

Company run by

founders Blank and Marcus

Nardelli initiatives• Replaced full time hardware experts with

part time ex military• Increased store count 89%• Aggressively expanded Home Deport

Supply through acquisitions • Moved into Mexico

Share price under Nardelli

Lowe’s grew operating income faster than Home Depot

Home Depot 2000 2001 2002 2003 2004 2005 2006Revenue $45,738 $53,553 $58,247 $64,816 $73,094 $81,511 $90,837Total Operating Expense $41,547 $48,621 $52,417 $57,970 $65,168 $72,148 $81,164Operating income $4,191 $4,932 $5,830 $6,846 $7,926 $9,363 $9,673Comp sales increase 4% 0.00% -0.50% 3.70% 5.10% 3.10% -2.80%Number of stores 1,134 1,333 1,532 1,707 1,890 2,042 2,147Sales/employee 0.201 0.209 0.207 0.217 0.226 0.236 0.249

Lowe’s 2000 2001 2002 2003 2004 2005 2006Revenue $18,368 $21,714 $26,112 $30,838 $36,464 $43,243 $46,927 Total Operating Expense $16,967 $19,424 $22,969 $26,902 $31,909 $37,609 $40,613 Operating income $1,401 $2,290 $3,143 $3,936 $4,555 $5,634 $6,314 Comp sales increase 1.00% 2.50% 5.80% 6.70% 6.60% 6.10% 0.00%Number of Stores 624 718 828 952 1,087 1,234 1,385Sales/employee 0.196 0.202 0.216 0.210 0.225 0.233 0.223

Annual growth rates

Home Depot Lowe's

Revenue 11.4% 15.6%Op Income 13.9% 25.1%Operating Expense 11.2% 14.5%Sales/employee 3.6% 2.2%

Home Depot Lifecycle

Nardelli starts

Blake replaces Nardelli

Growth/scaling

Denial

Maturity/leverage

Company run by

founders Blank and Marcus

Share price under Blake

Key elements of Blake strategy• Much of revenue growth had come from acquisitions. Got rid of those.• Were opening lots of new stores that weren't accretive to earnings.

Stop those, including many in the pipeline. Had to write off asset.• Difficult to do because had a team whose job was to open new stores.

It's in the culture. It's looking in the mirror and saying we're somebody different today.

• Focus on improving existing stores: refreshing stores, catching up on deferred maintenance, and supply chain initiatives

• All about comp sales, generating increased leverage, which is the secret to the story.

• Very disciplined capital allocation with central annual planning process. • Increase operating margin and return on invested capital. Announced

to the investor community & met: first 10/15, then 12/24. 14.5/35 is next.

• Return half of annual cash generated each year to shareholders via dividends and share buyback

• Can improve gross margin with private brands, but plan to keep gross margin the same and pass savings to customers thru price cuts, which drives revenue and helps leverage. If gm too high, invites competitors.

Recent article uses Home Depot under Blake as an example of a ‘growth’ story.

Huh?!

How do you know when you’ve reached maturity

Denial

Revenue growth has slowed in recent years, signaling maturity

What should a retailer do when they reach maturity?

$0

$50,000,000,000

$100,000,000,000

$150,000,000,000

$200,000,000,000

$250,000,000,000

$300,000,000,000

$350,000,000,000

$400,000,000,000

$450,000,000,000

$500,000,000,000

1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 2018

Revenue

2.8% CAGR in last 5 years

Walmart Revenue

Ave market return 2010-2014 – 6.1%

Maturity reached when investment in new stores (or other top line growth initiatives) no longer show a return

Some conclusions• Alternative retail strategies for growing earnings

• Scaling – open stores to scale without incremental increases in profitability

• Leverage – leverage assets and expenses by driving more sales thru existing stores

• What are the warning signs that it’s time to switch strategies. The temptation to deny those warnings. Happened with both HD and Walmart

• Small differences in revenue vs expense growth have big impact on profit growth

• Disciplined process for allocating capital to leverage projects• Does it improve RoIC?• Need discipline to not over reach on revenue growth – carefully

consider 2% vs 3%, but need some growth – 2% at least• Return excess capital to shareholders. These stocks resemble bonds,

but better• Things you don’t do more important than things you do. Bias towards

caution vs bias towards speed and action in scaling/growth mode• Not sexy. Vince Lombardi does retail. Needs a different style of

management. Ken Hicks inability to recognize that there even was another way to manage.