MoF Issue 17

McKinsey on Finance
Measuring stock market performance 1

Perspectives on
TRS doesn’t reflect a company’s performance or health. What does?
Corporate Finance
and Strategy
Reducing the risks of early M&A discussions 5
Used early in negotiations, a third-party clean team can help
Number 17, Autumn
companies assess a deal and protect sensitive data.
2005
Smoothing postmerger integration 11
It takes less time than you think for a clean team to make valuable
contributions to the integration of businesses.
Comparing performance when invested capital is low 17

Return on capital is the benchmark for comparing performance
between businesses. But new math is needed when a company’s
capital intensity is low.
What global executives think about growth and risk 21

As globalization creates new markets and competitors, hopes
contend with fears.
McKinsey on Finance is a quarterly publication written by experts
and practitioners in McKinsey & Company’s Corporate Finance practice.
This publication offers readers insights into value-creating strategies
and the translation of those strategies into company performance.
This and archived issues of McKinsey on Finance are available online at
www.corporatefinance.mckinsey.com.
Editorial Contact: McKinsey_on_Finance@McKinsey.com
Editorial Board: James Ahn, Richard Dobbs, Marc Goedhart, Bill Javetski,
Timothy Koller, Robert McNish, Dennis Swinford
Editor: Dennis Swinford
External Relations: Joanne Mason
Design Director: Donald Bergh
Design and Layout: Kim Bartko
Managing Editor: Kathy Willhoite
Editorial Production: Sue Catapano, Roger Draper, Pamela Kelly,
Scott Leff, Mary Reddy
Circulation: Susan Cocker
Cover illustration by Ben Goss
Copyright © 2005 McKinsey & Company. All rights reserved.
This publication is not intended to be used as the basis for trading in the
shares of any company or for undertaking any other complex or significant
financial transaction without consulting appropriate professional advisers.
No part of this publication may be copied or redistributed in any form
without the prior written consent of McKinsey & Company.
1
Measuring stock market performance performance improves, the expectations

treadmill turns more quickly. The better
these managers perform, the more the
market expects from them; they must
run ever faster just to keep up. This effect
explains why extraordinary managers
may deliver ordinary short-term TRS ;
TRS doesn’t reflect a company’s performance or health. conversely, managers of companies with
low performance expectations might find
What does?
it easy to earn high TRS. This predicament
illustrates the old saying about the
difference between a good company and a
Richard Dobbs and In the previous issue of McKinsey on good investment: in the short term, good
Timothy Koller Finance,1 we explored how investors can companies may not be good investments,
assess a company by examining its past and vice versa.
performance and its health—that is, its
ability to sustain performance over the Overcoming the limitations of TRS
long run. In an ideal world, we would need Companies can compensate for the
only to examine a company’s stock market shortcomings of TRS by employing
performance to see how well it was doing. complementary measures of stock market
Yet this third measure is anything but easy performance. One of them is market value
to interpret. added (MVA): the difference between
the market value of a company’s debt
The most common approach to measuring and equity and the amount of capital
a company’s stock market performance is invested. A related metric is the market-
to calculate its total returns to shareholders value-to-capital ratio—a company’s
(TRS) 2 over time. This approach has debt and market equity compared with
severe limitations, however, because over the amount of capital invested.
short periods TRS embodies changes in
expectations about a company’s future MVA and market-value-to-capital ratios
performance more so than its actual complement TRS by measuring different
underlying performance and health. aspects of a company’s performance. TRS
Companies that consistently meet high measures it against the financial markets’
performance standards can thus find it hard expectations and changes in them. MVA
to deliver high TRS : the market may think and the market-value-to-capital ratio, by
that management is doing an outstanding contrast, measure the financial markets’
job, but this belief has already been factored view of a company’s future performance
into share prices. relative to the capital invested in it, so they
assess expectations about its absolute level
One way to understand the problem is by of performance.
1 Richard Dobbs and Timothy Koller,
way of analogy with a treadmill whose
“Measuring long-term performance,” speed represents the expectations of future Let’s examine home-improvement giant The
McKinsey on Finance, Number 16, Summer performance implicit in a company’s share Home Depot and the other large retailers
2005, pp. 1–6 (www.mckinseyquarterly.com/
links/18226). price. If managers exceed them, the market in terms of their stock market performance.
2 TRS is defined as share price appreciation plus not only raises the share price but also The market value of Home Depot’s debt
dividend yield. accelerates the treadmill. As the company’s and equity (including capitalized operating
��
��
2 McKinsey on Finance Autumn 2005
��
��
��
��
economic profit, but it had very low TRS.
��
Evidently, Home Depot’s performance
��
over recent years wasn’t up to what the
�� market had expected at the start of the
�� measurement period (1999).
��

Exhibit 2 illustrates the “expectations
��
treadmill matrix.” The matrix plots market-
��
value-to-capital ratios on the horizontal
�� axis and TRS on the vertical axis, and the
�� dashed lines represent the median for both
�� measures. Companies in quadrant 1 have
��
both a high TRS and a high market-value-
to-capital ratio, while those in quadrant 3
��
are low on both measures. These quadrants
��
are easy to understand because both metrics
�� are high or low.
��
�� Recovering underperformers reside in

��
quadrant 2: they have low market-value-
��
to-capital ratios, which were even lower
five years earlier. These companies have
a high TRS because they have improved
their performance relative to weak
leases) was $88 billion at the end of expectations—thus accelerating the
2003, when it had $29 billion invested treadmill, though their market-value-to-
in operating capital (working capital, the capital ratios remain below the median.
capitalized value of operating leases, and
property in plant and equipment). Home In quadrant 4 is Home Depot, with a
Depot’s MVA was therefore $59 billion and low TRS but a high market-value-to-
its market-value-to-capital ratio was 3.1. capital ratio, along with other retailers
such as Gap, Staples, and Walgreen.
The MVA of Home Depot was the Historically, these retailers have been
industry’s second highest, behind only some of the best in the United States.
Wal-Mart Stores and far ahead of the rest. What’s going on? It is impossible to
Home Depot’s market-value-to-capital ratio say whether their position results from
was also at the top end of the scale, though unrealistic market expectations at the
not as high as some other well-performing beginning of the period or from the
companies (Exhibit 1). inability of managers to realize their
company’s potential. The treadmills
What about TRS? For the five years ending may have simply been moving too fast
in 2003, Home Depot’s—at −2.3 percent for the companies to keep running at
annually—was near the bottom of the the required pace. But note that 1999,
group. The company did deliver the second- the beginning of our TRS measurement
highest MVA , a strong market-value- period, was near the top of the stock
to-capital ratio, and the second-highest market cycle, when large-capitalization
��
��
Measuring stock market performance 3
��
��
��
Home Depot’s market value at the end of
��
2003 was consistent with the assumptions
�� that it would continue to earn an ROIC
of about 18 to 19 percent a year (the
��
��
��
same as its 2003 ROIC , yet higher than
�� its ROIC range of 15 to 16 percent over
� �
the three prior years) and that its growth
��
�� would slow from its historically high rates.
�� Revenue growth averaged 16.5 percent
�� during the five years ending in 2003. Our
�� projection assumed declining growth
��
from approximately 12 percent in 2004 to
��
��
�� 5 percent annually by 2013.
��
� ��
��
�� Is the market value consistent with
� �� Home Depot’s intrinsic value creation
��
��
�� potential? First, let’s examine the required
��
��
�� growth. Using the growth rates in our
��
simple estimation leads to $83 billion
��
�� of new revenues by 2013. If Home
��
� � Depot achieves same-store sales growth
��
� � � � of 4 percent—a common assumption
��
among analysts—it would need to add
900 stores over the next ten years (about
50 percent of its current base). Given
estimates that the US market for home-
stocks had unreasonably high P/E ratios. improvement superstores was already
The gap has since closed, but this example nearly 80 percent saturated at the end of
demonstrates one of the pitfalls of using 2003, the growth rates in this scenario
TRS as a performance measure: the results are plausible but difficult to achieve.
are highly dependent on the starting date.
Second, consider whether Home Depot
Is a company’s market value in line can maintain its ROIC at 18 to 19 percent.
with its value creation potential? As Home Depot’s growth slows and it
The final step in assessing performance focuses on core operations, some of its
is linking the company’s market value to earlier challenges in managing growth
its intrinsic value creation potential. We should be easier to deal with. Competition
can do this by reverse engineering the with Lowe’s could intensify, however,
company’s share price, essentially by using and Wal-Mart has been selling more and
a discounted-cash-flow (DCF) model and more of Home Depot’s fast-moving items,
estimating the required performance— potentially siphoning off customers.
growth and returns on invested capital
(ROIC )—to calculate the current share In summary, the performance scenario
price. We can then evaluate how difficult consistent with Home Depot’s market value
it will be for the company to achieve at the end of 2003 appears to be challenging
this result. but not implausible.
��
��
��
��
��
in expectations for revenue growth. In
��
Home Depot’s case, growth expectations
�� declined significantly, accounting for a
$171 billion drop in value. At the end of
��
�� 2003, we estimated the revenue growth
��
consistent with Home Depot’s share price to
��
be about 8 percent annually for the next ten
years. Investors in 1998 would have had to
expect the company to grow at 26 percent
��
annually to justify the market value at the
�� time. Such high growth expectations would
have required Home Depot to triple its store
count over ten years—from 760 in 1998 to
more than 2,300 in 2008—with continued
�� healthy growth until at least 2013, far
��
�� beyond the saturation level predicted by
��
�� some market observers. From this analysis,
we are tempted to conclude that Home
Depot’s poor TRS since 1999 results more
from an overly optimistic market value
at the beginning of the period than from
ineffective management.
We return to the company’s negative five-
year TRS. Exhibit 3 shows an analysis of
the change in Home Depot’s value over Measuring a company’s performance in
the five years through 2003. We start with the stock market isn’t as easy as looking at
the market value in 1999 of $132 billion. TRS , which is driven as much by how the
If Home Depot had performed exactly company was valued at the beginning of the
as expected, its equity value would measurement period as by its performance.
have increased by the cost of equity MVA and the market-value-to-invested-
(less dividends and share repurchases), capital ratio help to put TRS in context,
to $197 billion at the end of 2003. The but to really understand a company’s stock
difference between that number and its market performance, its value must be
$80 billion market value is the result of linked to historical and projected growth
changes in the market’s expectations and returns on capital. MoF
of the company’s performance.
Richard Dobbs (Richard_Dobbs@McKinsey

Assume that in 1999 the market forecast .com) is a partner in McKinsey’s London office,
Home Depot’s margins and capital turnover and Tim Koller (Tim_Koller@McKinsey.com) is
to remain at 1998 levels. Since its operating a partner in the New York office. This article
margins actually grew, the market should is adapted from Tim Koller, Marc Goedhart,
and David Wessels, Valuation: Measuring and
have increased the company’s value by
Managing the Value of Companies, fourth
$50 billion. The cost of equity, capital
edition, Hoboken, New Jersey: John Wiley
efficiency, and the cash tax rate did not & Sons, 2005, available at www.mckinsey
change significantly during this period, so .com/valuation. Copyright © 2005
we attribute the remaining gap to changes McKinsey & Company. All rights reserved.
5
Reducing the risks of early a clean team. In the preannouncement

period, such a team can serve as a neutral
M&A discussions and objective resource that supports the
executives of the companies involved
during the very earliest stages of their
discussions. The team conducts analyses
that neither party can complete by itself
Used early in negotiations, a third-party clean team can help (or complete as accurately) to assess a
potential deal. A clean team adds the
companies assess a deal and protect sensitive data.
greatest value in specific types of M&A
transactions, such as mergers of equals,
alliances and joint ventures in industries
Seraf De Smedt, Every executive knows what a high- with close regulatory scrutiny, or deals
Vincenzo Tortorici, and stakes game M&A talks can become. But involving more than two partners.
Erik van Ockenburg even before the formal negotiations start,
a one-on-one conversation that plants the When the use of a preannouncement clean
seed of a deal or a back-of-the-envelope team is appropriate, one major benefit is
sketch of the business case for it may present its ability, through its unrestricted access
deal makers with conflicts of interest and to the confidential data of all parties, to
strategic vulnerabilities. Who would get give executives greater clarity about the
what value from a deal? Who would govern potential value of consolidation long before
the new entity? What legal boundaries the companies make formal commitments
must prospective partners be careful not to or disclose sensitive information to
cross? Moreover, deal makers also know one another. A clean team often helps
that failing to close a transaction can turn companies to negotiate their agreements
today’s potential partner into tomorrow’s more quickly as well, by setting aside
better-informed competitor. the inevitable “win-lose” negotiation
items—where one party benefits more than
Tension often grows as each company the other—until the very end and focusing
increases its investment in time and instead on the “win-win” elements. Indeed,
advisers. The longer negotiations go on, analyses by a clean team that served the
the more anxiety builds to complete the steel companies Arbed, Aceralia, and
deal—if only to avoid the embarrassment of Usinor provided “the justification for the
failing to deliver it. Transaction costs rise, merger,” says Guy Dollé, chairman and
constraining a company’s ability to capture CEO of the merged company, now called
synergies and in some cases even causing Arcelor. “When the negotiations became
good opportunities to vanish. difficult,” he adds, the team’s analysis
“brought us back to reality.”
To successfully navigate the complexities
of even the earliest discussions about Setting the rules
mergers, acquisitions, and joint ventures, As a neutral party, a pre-deal clean team
some companies are borrowing an has access to privileged information from
approach that merger specialists all sides and can therefore conduct an early
sometimes use much later in the process assessment of a deal’s business rationale,
to expedite postmerger integration plans develop an integrated business plan for
and business strategies: they appoint the new entity, and ultimately support
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
the formal negotiation process. Since and to keep a potential deal fully reversible,
companies share confidential information with no harm to the parties involved, until
only through the clean team, this approach the transaction closes—the clean team
also reduces the risk of sharing too much of must operate under strict, mutually agreed-
it and of rushing into formal negotiations upon rules (see sidebar, “Clean-team
too early (exhibit). To achieve these goals— management: The rules of the game”).
Clean-team management: Successfully implementing a clean team requires At the outset, the parties should specify the team’s
The rules of the game meticulous preparation. In particular, the negotiating intended end products as clearly as possible. Details
companies must have an unambiguous shared (such as data aggregation and analytical methodologies,
understanding of all the conditions under which definitions, assumptions, and decision-making rules)
the clean team will work—and of what happens to should be resolved within the clean team’s governance
the members if a transaction isn’t concluded. Most structure—typically, a committee of executives from
important, a clean team must be structured so that each negotiating party. All parties must accept a
it doesn’t favor the interests of any one party over confidentiality and indemnification agreement that spells
the others. out the expected levels of disclosure, such as the handling
of data or the past connections of outside advisers with
A clean team doesn’t share confidential information with the companies involved in the transaction.
the companies involved in negotiations but rather uses it
only to develop recommendations and assessments that As in any other M&A setting that involves a data room
can be shared with all. It keeps a detailed log specifying with confidential information, the parties must agree on
which information has been shared with whom and clean-room guidelines and on a code of conduct subject
when. If questions arise about what can be shared, the to local regulation. Only clean-team members may enter
clean team always secures the consent of the parties or the room. Documents must be stored in a locked cabinet
their legal teams. and a list kept detailing what information about the
These strict rules allow a clean team to for setting transfer prices—an issue that
help companies verify their business plans otherwise could have become contentious
and assess the likely extent of synergies by during later negotiations, perhaps even
making it possible for the team to have free scuttling the deal. Once these common
access to sensitive data (such as customer principles were settled explicitly, no major
lists and raw-materials and production differences of opinion on this subject arose
costs) that companies can’t or don’t want to later on, and the deal’s champions on both
share, because of regulatory or competitive sides remained in alignment.
considerations. Instead of sharing sensitive
information directly, the companies provide Resolving such issues in the early stages
it to the clean team, which consolidates of a deal by ensuring overall adherence to
the analyses into figures and reports that agreed-upon rules and harmonizing the
can be presented without risk to the top assumptions behind the business plans of
management of all parties. the various parties are two fundamental
aspects of the clean team’s role.
The advantage of adhering to the rules
can’t be overstated. This point is most An adaptive approach
critical when companies focus on win-win Typically, a clean team can support three
issues, where an objective solution can phases of pre-deal discussions. Given the
be identified that is in the best interest of typical pressures and complexity of M&A
all parties. In the case of a joint venture transactions, the best approach is to use
involving two logistics companies, for a single team throughout all three. In
example, the clean team helped them the first phase, the clean team helps the
agree, very early in their discussions, on two (or more) parties to investigate the
a common, objective set of principles transaction in its early stages (for instance,
companies has been stored in which places. Making individual members of a clean team can’t work for any of
copies must be forbidden. the parties, at least in the business or function related
to the team’s work, for a specified time period—often
Managers and executives from the parties to the two years.
transaction must be involved in the process. But a
preannouncement clean team can’t include their own A preannouncement clean team doesn’t get involved
employees, who would by definition threaten its with the win-lose elements of negotiations, such as
neutrality, which is essential at the preannouncement splitting the value of synergies between the parties.
stage. By contrast, a clean team that supports Instead, the team flags these issues and returns them
integration efforts from the announcement to the closing to the deal’s steering committee for direct negotiations
may include employees of the negotiating companies— by the parties. This is typically less of an issue for
often recent retirees, people about to retire, or those integration clean teams, since the parties have an
who can be assigned to different business units should interest in maximizing the value of the newly combined
the deal fall through. company or joint venture.
The parties must also agree about what would happen Finally, to ensure full impartiality the parties involved
to the team (both their own employees and the outside should share equally the cost of outside advisers
advisers) if the deal were to fall through. Typically, working on a clean team.
following exploratory talks at the CEO ensure that they commit enough resources
level). At this point, the team focuses on to explore the merits of a potential deal
assessing the high-level strategic rationale, early on. Thus they ensure that its business
drawing on sensitive information from rationale gets evaluated adequately and
the parties involved. If the that they understand the critical issues
clean team’s analysis helps the while they are still in a cooperative phase
companies to confirm that the of discussion. Also, the appointment
deal’s business rationale makes of a clean team makes the process of
A clean team works with both
sense, the process continues investigating a potential deal more formal.
parties to establish contractually
as it would in any other M&A Typically, greater formality encourages
enforceable rules that protect transaction—typically, with champions to emerge naturally on both
sensitive information, ensure executives signing a nonbinding sides, even during this early stage, and
impartial treatment, and maintain letter of intent. In the second gives them a vested interest in moving the
a focused and transparent process phase, the clean team continues deal to completion once its merits have
to build the detailed business been confirmed.
case in preparation for the final
negotiations. In the third phase, In the case of the two logistics companies,
when negotiations inevitably turn to the the clean team’s access to all of their
deal’s more contentious elements, the confidential data made it possible to
clean team becomes less prominent but compute the deal’s cost and revenue
remains active as a neutral facilitator, synergies with a high degree of detail
answering specific questions about and accuracy. The clean team was also
the details of the business case. able to confirm for the prospective
partners that their respective business
Confirming the business rationale plans were based on similar expectations
In the absence of a clean team, the business about the impact of restructuring.
rationale for a deal is often scoped out only
in informal discussions between the CEOs Keeping the focus on an integrated
and a handful of other senior executives. In business plan
our experience, they often have little time In conventional merger or alliance talks,
to investigate the specifics. The risks of this companies typically appoint a joint team
approach are that momentum may slow to negotiate an integrated business plan. In
because no executive has sole responsibility our experience, such a team often spends
for pushing the deal through to completion a great deal of time reaching agreement
or that, conversely, the partners may rush on procedural issues, such as the business
into final negotiations too quickly. In any plan’s format, the alignment of valuation
event, the records from this crucial first assumptions (such as depreciation policies),
stage are often vague and incomplete, which and even the future positions of individual
may waste valuable time later on if issues managers. These secondary issues inevitably
must be reexamined. Sometimes, serious sidetrack the negotiations from a focus on
problems that turn into deal breakers developing a solid business plan for the
emerge late in the process. At worst, such a integrated entity.
deal might simply evaporate.
A clean team, by contrast, works with
By appointing a clean team, companies both parties to establish contractually
make the analysis more thorough and enforceable rules from the outset not only
to protect sensitive information and ensure and valued during the first and second
equal, impartial treatment of the companies phases among the merging companies.
involved but also to maintain a focused Resolving this issue is a matter solely
and transparent process. Such rules and for negotiations between the interested
processes prevent managers on all sides parties. As a neutral intermediary, the
from pursuing their personal agendas, clean team cannot take a stance.
so the members of the clean team can
quickly agree on or dispose of secondary During this phase, the role of the clean team
issues. Sticking tightly to the rules builds thus changes from facilitating discussions
trust in the process and in the clean team based on the results of its analyses to
and makes it possible for both the team supporting the negotiations. The team will
and the companies involved to focus on have completed most of the background
harmonizing the assumptions behind its work of justifying the rationale of the
analysis and on building a solid integrated transaction, building the business case for it,
business plan. and identifying its synergies. Now the team
usually works on responding to questions
After two midsize European banks that come up in the negotiations—for
had spent almost a year conducting example, the deal’s value if putative growth
negotiations on a wide-ranging cooperative rates or margins rise or fall.
agreement, for example, the talks broke
down over disagreements about the Typically, investment banks or other
structure of the complex deal and the counselors support the companies during
banks’ respective valuations. Frustrated this phase, whether or not a clean team
about the time, the money, and the energy is in place. But without a clean team’s
that would have been spent in vain if objective record of agreements and
the deal collapsed, the two institutions parameters, every aspect of the deal may be
appointed a clean team to help get their subject to lengthy discussion. A clean team
discussions back on track. Under the can therefore still add value in a supporting
leadership of a joint steering committee, role, if only by ensuring that the parties
the clean team helped executives on don’t reopen issues on which they have
both sides to set aside some of the more previously agreed.
complex aspects of the deal structure and
instead to concentrate on an analysis of Common structuring tools, such as the
the merits and implications of the business negotiation grid the logistics companies
case. Supported by the clean team, the two mentioned previously used in their effort
companies reached agreement in principle to form a joint venture, help a clean
within three months. The deal closed fully team to ensure that negotiations remain
about six months later. focused, timely, and on track. All of the
parameters (about 50, in this case) driving
Supporting negotiations the valuations of the respective companies
While win-win issues lie at the core of any were assessed, and for each parameter the
effort to develop an integrated business clean team helped to forge a consensus on
plan, win-lose issues take center stage in whether an identical value was required
the third and final phase of negotiations. for both parties (for example, an identical
One classic example is the problem of cost of capital to value the business plans
dividing the value of the synergies identified of both but different multiples to value
their subsidiaries). The team then indicated

the parameter’s impact (low, medium,
Clean teams can be as effective in
high) on both parties, thus ensuring
preannouncement discussions of an M&A
that precious time wasn’t lost on minor
deal as they often are in preparing
issues that had little impact on value. The
companies to integrate after the deal closes
members of the team, who attended the
(see the next article, “Smoothing post-
negotiating sessions only to take notes
merger integration”). Indeed, when used in
and to ensure that the parties had a
the very earliest stages of discussion, such
common understanding of its analyses,
teams increase the likelihood of closing
scrupulously sent back to the negotiators
valuable deals and help companies to strike
any questions it couldn’t answer by
better and stronger agreements—or,
using the results of its analyses in a way
alternatively, to conclude early in the
that was consistent with the previously
process that a deal’s business rationale
agreed-upon rules of engagement.
doesn’t stand up to scrutiny. MoF
A clean team delivers the greatest possible Seraf De Smedt (Seraf_De_Smedt@McKinsey

value if it can take a deal all the way .com) is a consultant and Erik van Ockenburg
(Erik_van_Ockenburg@McKinsey.com) is
through to this final stage. By then, the
an associate principal in McKinsey’s Brussels
team will have become the deal’s memory
office, and Vincenzo Tortorici (Vincenzo
and conscience, thus ensuring—together _Tortorici@McKinsey.com) is a partner in the Milan
with the champions on either side—that the office. Copyright © 2005 McKinsey & Company.
negotiations reach closure. All rights reserved.
11
Smoothing postmerger integration they worry that there won’t be enough time
for a clean team to accomplish anything
before a deal closes. Some of them express
concern that sharing confidential data
will expose their companies to undue risk
should the deal fall through—or that the
impact of the clean team won’t justify the
It takes less time than you think for a clean team to make valuable expense of assembling it.
contributions to the integration of businesses.

Such misplaced concerns often lead to costly
delays. We believe that a well-structured
clean team almost always makes it possible
Nicolas J. Albizzatti, In any merger, acquisition, or joint to capture a merger’s value more quickly
Scott A. Christofferson, and venture, the sooner managers integrate and can reduce the risk of failure. Such
Diane L. Sias their companies the faster they capture the teams address myriad issues that are well
expected synergies. So in the hectic days within the limits of the regulations—and
and weeks after a deal is announced, CFOs can help to resolve them well within the
face a daunting list of responsibilities, period between the announcement and the
such as managing the deal’s financial close of a deal.
aspects, justifying the strategy to investors,
negotiating with regulatory authorities, and Indeed, we find that managers consistently
ensuring compliance with the regulations underestimate how much time may be
that come into force once a deal is involved at this stage, which for the 455
announced. And CFOs must manage all this largest mergers in 2004 lasted an average
while essentially flying blind, without access of nearly three months (Exhibit 1).1 That is
to legally restricted data. plenty of time for a clean team not only to
conduct analyses and make decisions that
In our experience, establishing a clean team expedite postclosing integration but also
to support integration efforts before a deal to prepare the merged company to be fully
closes can help speed up the completion of operational from day one. Thus the team’s
critical tasks and improve the chances of work helps capture more of the merger’s
capturing the merger’s synergies. Working synergies before competitors have a chance
under confidentiality agreements, such to react.
a team has unrestricted access to data
from each of the companies involved— Moreover, clean teams can add value to
data legally off limits to the companies’ merger integration efforts in incremental
employees until the deal closes. After chunks—at first, quite small ones.
compiling and analyzing this information, Executives who anticipate having as little
the team can quickly deliver aggregated as a month between the announcement
findings that help decision makers plan and the close of a merger should be able
the structure and operations of the merged to assemble the most basic kind of clean
entity even before the deal has closed. team, which undertakes the critical work
1 The top 455 mergers, by transaction of gathering and harmonizing data and can
value, announced in 2004, excluding Given such virtues, it’s surprising that serve as the foundation for a more elaborate
withdrawn, pending, rumored, and
executives don’t set up integration clean team if time permits. And with a small team
intended deals as well as deals announced
and closed on the same day. teams more frequently. Many CFOs tell us in place, the parties to a deal can avoid
��
��
��
��
��
��
it’s useful to have a larger clean team that
��
takes a more active role in facilitating,
�� and even designing and planning, the
��
integration of the merging companies. And
while all clean teams operate under the
��
same assumptions of confidentiality (see
��
sidebar, “Clean-team management: The
�� rules of the game,” on page 6), different
�� models provide for the flexibility needed to
�� meet the demands of individual situations.
��
��
��
Library clean teams
��
�� When the time between the announcement
��
and the close of a deal is expected to be
��
short, the most basic type of clean team,
�� serving a library function, may well be
beneficial. Such a team can be deployed
quickly and meet its objectives in a matter
�� of weeks. Its primary work—gathering and
� ��
�� harmonizing data—is almost certain to be
��
��
useful in preparing businesses to integrate.
In addition, its records will help to give
regulators precise answers to questions
about divestitures or grandfathered
having to play an expensive catch-up game products and services. In 2003, some
after it closes. 40 percent of US deals involved second-stage
requests from regulators for information,
Three types of integration and nearly 4 percent ultimately faced a
clean teams legal challenge, so many deals are delayed
In theory, clean teams can handle a considerably beyond the target closing date.
broad range of pre-integration analyses Given such scrutiny, the ability to avoid
and planning if sensitive, proprietary, or risky and expensive guesswork is attractive.
legally restricted data would otherwise Furthermore, once the library team has
inhibit collaboration until after the completed its initial task, it can add
close. In practice, what these teams do analyses and functions that help it evolve
varies considerably, depending on time into new roles as time permits.
constraints, the level of public information
typically available in an industry, and A successful library clean team should be
any preexisting relationships between able to do three things. First, the team and
the companies. When time is as short as the decision makers ought to determine
one or two months, a smaller and more which data will be needed to integrate
targeted clean team—sometimes comprising the companies once the transaction has
only a few third-party advisers who limit closed. The data will vary, depending on
themselves to gathering and organizing the synergies expected from the merger.
data—is preferable. If the period between The team should also be able to gather
the announcement and the close is longer, and harmonize the data—organizing the
information into accessible formats so it financial-reporting and synergy-tracking

can be compared and aggregated easily. systems. It took less than two weeks to
Finally, the team should be able to brief the gather the data and only a month after the
decision makers after the close about what close to validate the deal’s synergies.
the data mean and to point out problems in
harmonizing the data between companies. Facilitator clean teams
If executives expect at least six weeks to
In general, it is relatively easy to elapse between the announcement and the
decide which data are needed to make close of a deal, the merging companies
decisions. Harmonizing the data—a should consider expanding the team’s
bigger challenge—has the side benefit of role from librarian to facilitator. A
bringing into stark relief any differences facilitator clean team’s work goes a couple
in the way the two businesses define of critical steps beyond that of a library
and use them. The key is to get started; clean team. Once the data have been
a library clean team’s efforts can easily gathered and harmonized, the facilitator
be pushed further if time permits. team and the merging parties reach an
agreement about the specific analyses,
One packaged-goods company, which was assumptions, and decision-making rules
pursuing a hostile takeover of a competitor, needed to determine how the expected
began working even before it was clear synergies will be captured. The team then
that the takeover would go through. The supports both companies as they develop
company created an informal clean team recommendations and draft action plans.
during the time between announcing its
intentions and reaching the legal threshold Before a deal’s close, the team can typically
of ownership for compulsory acquisition. divulge only high-level information, such as
This team was charged with deciding what the value and timing of anticipated synergies
technology would be used to validate the or the total number of displaced employees
company’s outside-in synergy estimates and from each company. After the closing,
with creating a series of data templates for the team reviews its work with the new
the target company to complete immediately management, which can either implement
after the close. As a result, the same data in the recommendations immediately or
the same format would be readily available modify them. A facilitator clean team
from both companies. typically doesn’t include staff from either
company, so if the transaction falls through
The informal team of the acquiring no valued employee must be displaced.
company then populated the templates with
its own data and created detailed glossaries Consider a merger between two IT
so that it would be very clear what data hardware manufacturers, where three
the team was seeking. Once it became months elapsed between the announcement
obvious that the acquisition was inevitable, and the close. The clean team was small,
shortly before the close, managers from with only five members, all third-party
the acquired company joined the effort in advisers. Its task was focused: to review
a formal clean team. Thus, the integration the merged companies’ supply base, so that
managers understood their real targets, when the transaction closed the executives
without any need for a time-consuming and staff of the newly consolidated
and error-prone manual reconciliation of purchasing function would be able to
review the team’s recommendations and negotiations with regulators as well as

supporting analysis and begin negotiations analyzing budgets and financial plans to
almost immediately. confirm and further develop the merger’s
synergy and growth targets. Its other roles
By the time the deal closed, the clean include reviewing the companies’ business
team not only had analyzed the prices plans to identify key short-term issues that
and terms of the current contracts (as must be resolved urgently after the merger
well as the supply market dynamics) for wins regulatory approval, auditing the
the most important commodities but terms of suppliers and customers to identify
had also recommended specific tactics the source and scale of opportunities or
for purchasing them. In addition, it problems, and developing postmerger
provided a detailed, consolidated spending strategies in sensitive areas such as pricing
database reconciling differences in the and channels.
data definitions of the two companies;
validated opportunities to save money A designer-planner clean team set up by two
by combining their purchasing volumes, financial institutions was developed over
using price arbitrage, and cutting the total the six months between the announcement
cost of ownership; and drafted detailed and the close. It eventually expanded to
plans (including the negotiating strategy) include a total of 600 staff members from
for each key commodity. In the end, the both organizations—most of the people
team’s support enabled the companies to who would staff the combined business unit
accelerate their integration effort by at after the merger. To meet the goal of hitting
least two months, so they could move more the unit’s full synergy run rate a mere five
quickly to capture cost-saving synergies that months after the close, the team built an
executives valued at $400 million a year. information system that not only allowed
the two institutions’ communications
Designer-planner clean teams and support systems to interact as soon
Designer-planner clean teams are the as the deal closed but also let executives
hardest for CFOs to deploy: they require transfer assets to their new home quickly.
the most resources, the largest budget, and In addition, the team made all systems
the greatest number of people from both infrastructure and applications choices
organizations. Such teams therefore also and supported the process for selecting the
involve some risk if deals don’t go through. merged unit’s leadership.
While they can complete their work
successfully in only two to three months (if When management decides to establish a
companies feel comfortable about the risks), designer-planner clean team, it is critical
we have seen them take as long as six. to provide for the right kind of interaction
Despite the investment and the risks, they between the clean team, on the one
can capture more of a merger’s synergies hand, and the integration team, the line
more quickly after the close than can the manager accountable for execution, or
other kinds of clean teams. both, on the other. This approach ensures
that line managers don’t hesitate before
At this level, the team starts the real executing recommendations or delay
work of planning the integration of two the integration effort by studying them,
companies—for example, by valuing which would reduce or even eliminate
assets and modeling scenarios to support the value of the whole investment in the
��
��
��
��
��
��
��
��

��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
��
clean team. In a recent merger in the to fall through. And clean teams are just
chemical sector, a clean team was set up impractical when the closing is imminent,
to segment customers by profitability. in auction situations, and in most hostile
Biweekly interactions between the clean takeovers, among other occasions.
team and the integration team ensured the
proper alignment, focus, and direction. The trick for executives heading up a
merger is to balance the costs and risks
Deciding to use a clean team of establishing a clean team, including
Of course, in some situations the use of the cost of outside advisers and the risk
integration clean teams doesn’t make of including employees, against the risk
sense. If the value of projected synergies of delaying integration planning until the
from a merger is small, for example, the deal closes and the cost of delaying the day
clean team’s effort may not be worth the when synergies can be captured. In such
expense. A company may also have good cases, it may help to analyze some of the
business reasons for not sharing its sensitive basic opportunities and risks (Exhibit 2).
information too openly—for example, when Overall, though, companies may have more
sharing technical specifics such as patents, time to set up a clean team and may gain
R&D project portfolios, formulas, or oil more in eventual synergies than most of
exploration locations would create too them realize. Not surprisingly, however,
much of a risk to its business if a deal were managers often resist a CFO’s efforts
to support these teams. Such managers it merely makes the peak workload after
claim that they need all of their time and the close even worse. And the budget for a
resources just to manage the company’s clean team is generally immaterial compared
current workforce and don’t have the with the overall cost of getting the deal done
management bandwidth, the people, or and of the integration effort—a cost that
the budget to staff a clean team. Their can be as high as two times the value of
resistance may be well intended, but it the expected synergies. Finally, clean teams
can cost a company dearly during the can have the added benefit of allowing the
integration process. partners in a future merger to work together
in an unbiased way that creates the trust
First, without the answers a clean team can necessary for success going forward. MoF
provide, the uncertainties (and hence the risk
to ongoing business) will continue long past Nicolas Albizzatti (Nicolas_Albizzatti@McKinsey
the final closure of the transaction. Second, .com) is a consultant in McKinsey’s Atlanta office,
Scott Christofferson (Scott_Christofferson
while it is true that management must review
@McKinsey.com) is a consultant in the
the clean team’s output and that some staff
Washington, DC, office, and Diane Sias (Diane
members will get involved in providing data _Sias@McKinsey.com) is a partner in the New Jersey
and in undertaking analyses, this work will office. Copyright © 2005 McKinsey & Company.
have to be done eventually anyway; delaying All rights reserved.
17
Comparing performance when to small changes in capital, and highly

volatile and thus often inappropriate as
invested capital is low a tool for comparing the performance of
business units or companies. What’s more,
executives who continue to use ROIC as
their main point of comparison are likely
to measure and manage performance
Return on capital is the benchmark for comparing performance unproductively. They might hesitate to
between businesses. But new math is needed when a company’s invest additional resources in low-capital
capital intensity is low. businesses (Exhibit 1) or, still worse,
ignore capital altogether and focus
on margins alone as the primary
Mikel Dodd and Executives and investors have reliable performance metric.
Werner Rehm tools for measuring performance in capital-
intensive sectors such as manufacturing, A more useful way to measure performance
retailing, and consumer goods. In general, is to divide annual economic profit by
the math is simple: when managers generate revenue.2 Grounded in the same logic as
returns on invested capital (ROIC ) above conventional ROIC and growth measures,3
their cost of capital, they create value. That this metric gives executives a clearer
formula makes it relatively easy to compare picture of absolute and relative value
the creation of value among business units creation among companies, irrespective of
or between companies. a particular company’s or business unit’s
absolute level of invested capital, which can
But what if the invested-capital side distort more traditional metrics if it is very
of the equation approaches zero, as it low or negative. As a result, executives are
increasingly does among companies that better able to evaluate the relative financial
use outsourcing and alliances and thus performance of businesses with different
reduce the capital intensity of parts of capital-investment strategies and to make
their businesses? Other businesses, such as sound judgments about where and how to
software development and services, also spend investment dollars.
1 This statistic is based on a McKinsey analysis have inherently low capital requirements
of more than 600 companies with sales greater or take advantage of atypical working- In application, this approach will vary
than $100 million. The classification of a
company as an industrial one is based on the capital dynamics, including prepayment from business to business, depending on
Compustat CIGS classification system, jointly by customers for licenses and payment by what is defined as volume and margin. In
launched by Standard & Poor’s and Morgan
Stanley Capital International (MSCI ) in 1999. suppliers for inventory. Even traditional a people business, such as accounting, the
2 Economic profit is typically defined as a businesses are shedding capital: the margin would likely best be broken down
company’s posttax operating profit minus a median level of invested capital for US into the number of accountants multiplied
capital charge, calculated as the company’s
weighted average cost of capital ( WACC )
industrial companies dropped from around by the economic profit per accountant. In
multiplied by the operating invested capital. 50 percent of revenues in the early 1970s a software business, however, it would be
See Tim Koller, Marc Goedhart, and David
Wessels, Valuation: Measuring and Managing to just above 30 percent in 2004.1 better calculated as the number of copies
the Value of Companies, fourth edition, of software sold times the economic profit
Hoboken, New Jersey: John Wiley & Sons,
2005, pp. 182–8, for more information about When a company’s or a unit’s business per copy of software; in this case, deriving
calculating ROIC and economic profit. model doesn’t call for substantial capital the margin from the number of employees
3 The present value of economic profit plus or even involves negative operating capital, wouldn’t make sense. But in all cases, this
invested capital yields the same enterprise
the ROIC is usually extremely large approach can provide a more nuanced
value as formulas based on ROIC and growth
and discounted-cash-flow models. (whether positive or negative), very sensitive understanding of performance across
��
��
��
��
��
to pay in advance for software development
��
moved the level of operating invested capital
�� below zero.
��
�� But while the move made strategic
�� sense, operational reviews among the
�� conglomerate’s business units became
��
meaningless. Executives insisted on
��
comparing them only on the basis of ROIC
��
�� and growth performance, which meant
�� that much time was spent arguing about
�� the negative ROIC of the new business
�� and whether it created or destroyed value
��
and was on track to become a profitable
��
�� undertaking. Nobody could assess the
��
�� performance of the software business
�� against that of the conglomerate’s
�� traditional businesses. Discussions about
�� the allocation of resources became heated—
��
in particular because the growing software
��
business needed to hire staff while older
units were cutting back.
��
��
Since business models within a single
industry may diverge, similar problems
bedevil many executives trying to compare
overall corporate performance. A US
businesses or companies with divergent high-tech manufacturer that pursued an
levels of capital intensity. aggressive facility-outsourcing strategy
combined with a just-in-time inventory
Same company, different economics system eventually drove its invested capital
A large European industrial conglomerate below zero. As a result, the company’s
provides an example of the difficulties ROIC was negative and therefore
of using ROIC to compare business units meaningless. A direct competitor also
with different levels of capital intensity. acted to improve its efficiency but kept
The company’s executive board decided its manufacturing assets in house. This
to take advantage of a trend in traditional decision left it with significantly higher
industries toward adopting the next levels of invested capital but also with
generation of process automation software higher margins. It thus had a substantial
and services by launching a business unit positive—and meaningful— ROIC , which
that exclusively offered software solutions made apples-to-apples comparisons
based on standard off-the-shelf hardware. between the two companies impossible.
The new business naturally had a low level Furthermore, the ROIC of the first company
of invested capital, since its assets were fluctuated wildly, as minor changes in its
essentially people and no manufacturing invested capital sharply altered the results of
was involved. The willingness of customers the ROIC calculations.
��
��
Comparing performance when invested capital is low 19
��
��
��
in revenue (Exhibit 2, part 1). Two newer
��
business units—a software business and
a services business—have very low or
��
negative invested capital. The company’s
�� more asset-heavy traditional business
��
can extract a profit margin of 12 percent
��
(compared with 7 percent for the other
�� units) because it doesn’t outsource any parts
�� of the value chain and has an established,
captive customer base that faces high
�� switching costs. It is growing more slowly,
�� however—by 4.5 percent a year, compared
� �� with 6 percent for the new businesses.
��
�� Using these data, the return on capital for
��
the software business is a negative 700 per-
cent while the ROIC of the services
�� business is a positive 700 percent, even
��
��
though the actual difference in the
invested capital of the two units is only
2 percent of revenue. The traditional
business has a 30 percent ROIC . A
Board members and investors of this first conventional evaluation of performance
company frequently wondered if it was would compare the two newer businesses
outperforming its competitor and wanted on the basis of their margins (because
to know how management was judging the their capital is so small as to be deemed
performance of its strategy and business meaningless) and scold the traditional
model. In frustration, the company’s business for its high capital intensity.
executives and board increasingly focused
on margins as their key operating metric. That kind of approach can lead to serious
But the appropriate level of margins for misjudgments of the value created by the
their low-capital strategy was difficult to three units and to the misallocation of
judge. They recognized that a business resources among them—as indicated by
whose capital intensity was low as a result the fact that the traditional business has
of outsourcing should have lower margins the highest value of the group, even though
than one that retained its manufacturing it has the lowest growth rate (Exhibit 2,
assets and thus substantial capital, but they part 2). How can this result be reconciled
struggled to determine how low a level with the observed returns on capital in
was reasonable. order to compare the true fundamental
performance of the three units? It turns
A different measure out that in this case, ROIC tracks the
To understand how a metric based on creation of value much less accurately
economic profit and revenue can eliminate than does economic profit divided by
such distortions in measuring value, revenue. According to that measure, the
consider a hypothetical company with economic performance of the three units is
three business units, each with $1 billion remarkably similar. All are creating value in
��
��
��
��
��
performance of the US high-tech
��
manufacturer with that of its direct
�
�� competitor (Exhibit 3). Owing to the high-
�� tech company’s negative invested capital (a
��
result of the outsourcing strategy), ROIC
comparisons were meaningless. Margin
��
�� comparisons were also tricky; a company
��
that outsources would be expected to have
�� lower margins than one that holds on to
�� all parts of the value chain. But an analysis
��
using economic profit divided by revenue
��
��
made it clear that the outsourcing strategy
as implemented wasn’t as successful as had
been hoped; the high-tech company was
still generating less value per unit of revenue
than its competitor.
absolute terms (all the ratios are positive),
and they are creating value at a similar rate, Executives of the large European industrial
with the traditional business slightly ahead. conglomerate mentioned previously
ultimately decided to use economic profit,
Equally important, economic profit combined with value targets based on
divided by revenue avoids the pitfalls economic-profit-discounting models, as its
of ROICs that are extremely high or measure for success. While this approach
meaningless as a result of very low or required a significant investment in training,
negative invested capital. Economic profit, the change reflected management’s goal of a
in contrast, is positive for companies with consistent measure for value creation across
negative invested capital and positive capital-light and capital-heavy units.
posttax operating margins, so it creates
a meaningful measure. It is also less
sensitive to changes in invested capital. If Returns on capital will always be an
the services business mentioned previously essential metric for managers. Yet in
doubled its capital to $20 million, its businesses with low levels of invested
ROIC would be halved. But its economic capital, replacing ROIC with economic
profit would change only slightly and profit divided by revenue will make
economic profit divided by revenue hardly internal and peer comparisons much
at all (to 6.8 percent, from 6.9 percent), more meaningful. MoF
thus more accurately reflecting how
small an effect this shift in capital would
Mikel Dodd (Mikel_Dodd@McKinsey.com)
have on the value of the business.4
is a partner and Werner Rehm (Werner
4 Economic profit in the example falls by WACC
_Rehm@McKinsey.com) is a consultant in
times the change in capital, or $1 million. The
Using the same approach, consider McKinsey’s New York office. Copyright © 2005
value of the business falls to $1.720 billion,
from $1.735 billion, on this change. again attempts to compare the operating McKinsey & Company. All rights reserved.
21
What global executives think about developing economies as an important

trend, the respondents are divided over
growth and risk the impact these systems will have on the
profitability of their own companies; the
answer depends on which side of the cost
divide they occupy. Likewise, while many
company leaders think that the aging of the
As globalization creates new markets and competitors, hopes developed world—and the resulting decline
in its workforce—will be an important
contend with fears.
economic factor, they disagree about the
consequences: those in consumer-facing
industries see opportunity, but those in
Steven D. Carden, A recent McKinsey Global Survey of labor-intensive ones see risk.
Lenny T. Mendonca, and Business Executives tells a two-sided story
Tim Shavers of growth and risk. On the one hand, rising On the whole, global business leaders are
affluence in developing economies and bullish about the impact of key trends
the increasingly fast pace of technological on profitability. Of the ten trends we
innovation present new opportunities for studied, seven garnered more positive
growth. Yet these same forces are driving than negative responses—some by a wide
the emergence of low-cost business systems margin (Exhibit 1): for example, 71 percent
that make global markets increasingly of the respondents expect technological
competitive, thus accelerating the rate at innovation to have a positive impact on
which companies lose their leadership profits, while only 5 percent expect it
positions. The survey quizzed some to have a negative impact. The trends
9,300 business leaders around the world perceived as threats to global business
on the most important trends influencing are growing geopolitical instability,
the global economy in the next five years, increasing risks to the supply of natural
with a particular focus on growth and the resources, and mounting environmental
constraints to it.1 hazards. Many of the executives in the
survey think that these three will have
Eighty-one percent of the executives a negative impact on profitability.
surveyed think that increasing affluence and
growing demand for goods in developing In addition, the survey explored the
economies will be important during the next actions that executives intend to take
five years. Some 70 percent believe that these in response to the trends. How will the
factors will buoy the profitability of their respondents expand the businesses they
own companies. Technological innovation manage? What markets are they seeking?
and the corresponding proliferation of new What constraints are most likely to
technologies emerged as an equally critical limit growth? And what capabilities do
trend, which 81 percent of the executives companies require to prosper given the
1 The respondents live in more than 130
consider important and 71 percent see as a trends at work in the global economy?
countries and represent a wide swath of significant driver of profitability.
geographies and industries as well as a broad Sources of growth
mix of large, midsize, and small companies.
Approximately half of the respondents are “C- The survey also highlights key differences When asked about the geographical sources
level” executives—board members or major
of opinion. While most executives view of growth, executives point to both the
decision makers in their businesses, including
274 CFO s and finance-related executives. the rise of low-cost business systems in developed and the developing world. Some
��
��
��
��
��
��
��
41 percent of the companies with more
��
than $5 billion in revenues expect it to be
�� their biggest growth market. This focus on
�� China reflects the substantial investments
��
that many large companies have made there
��
already. Perhaps less obvious, it also shows
��
�� the growing realization that demographic
�� trends are slowing growth in the developed
��
�� world and forcing growth-hungry
�� companies to look elsewhere.
��
��
��
��
�� As for the growth prospects of sectors,
��
��
the executives say that health care
��
has the greatest top-line potential in
��
the next five years, with energy- and
��
�� natural-resource-related industries
��
coming in second. Information
��
technology and telecommunications
�� are tied for a distant third.
��
Optimism about the health care sector’s
��
��
�� growth prospects may reflect an increasing
��
awareness of demographic trends affecting
the developed world—in particular, the
�� fact that older households will control
��
an increasing share of total spending and
��
will devote a growing proportion of their
income and accumulated wealth to health
care. This view of the health care sector’s
27 percent believe that the relatively slow- future probably results from other factors
growing but vast market of the United as well, including its historical growth and
States will account for the bulk of future profitability, rapid innovation in health care
expansion. China, a close second, was the technologies, and the brisk expansion of
choice of one-quarter of the executives— basic health care services in the developing
little surprise given that country’s meteoric world. Indeed, respondents from developing
rate of expansion. The United Kingdom markets pick health care as the third most
came in third, at 7 percent, but no other important growth sector, behind energy and
country registered above 5 percent. telecommunications.
Interestingly, the key factor differentiating Constraints on growth

the United States and China as the market When asked about constraints on growth,
of choice appears to be company size. the executives say that the shifting nature
Of the respondents from companies of their markets—the competitors and
with revenues of less than $250 million, the consumers alike—will create the
30 percent choose the United States as the biggest challenges. Seventy-seven percent
key growth market. Larger players, by believe that intense competition will be
contrast, anticipate more growth in China: an important constraint on the growth of
��
��
��
What global executives think about growth and risk 23
��
of managing rapid growth. As China
�� and India rise to global stature, local
companies with relatively little experience
�� managing large-scale organizations
��
�� suddenly face the difficulties of handling
a vast, newly employed workforce.
��
��
�� The constraints on growth that seem

��
most serious to the executives vary
widely by region—not surprising,
��
given the vast differences among local
��
business environments. North American
��
executives are more concerned than
�� their counterparts elsewhere about rising
�� health care costs. Indian executives see a
�� lack of infrastructure as a key limitation.
��
Executives across developing economies
worry about the rising cost of natural
��
resources—a concern that probably reflects
��
both an increasing demand for energy and
the greater manufacturing orientation of
�� these economies relative to those in the
��
��
developed world.
Executives from different industries also

disagree about the relative importance
their companies. Sixty-four percent cite of various constraints. Financial-services
the challenges of satisfying an increasingly executives see a hostile regulatory
sophisticated consumer market. Sixty environment as a potentially key problem.
percent worry that competitors will Respondents from heavy industry, reacting
introduce new products that could displace to the recent double-digit price hikes
theirs. Large companies, which may be less across most commodity categories as
confident of their ability to innovate and Asian demand strains global supply, are
to stay ahead of rivals, fear the growing significantly more concerned about the
competitiveness and sophistication of their rising cost of natural resources.
markets more than smaller companies do.
Other potential concerns barely register
Another constraint preoccupying with the respondents. European executives,
the executives is the high cost and for example, are among the least worried
low availability of talent; 73 percent about rising health care costs, despite
consider this problem a key limitation on the region’s rapidly aging population and
growth (Exhibit 2). Interestingly, even the potential strain it places on national
executives in labor-rich China and India health care systems. US executives express
are quite concerned about talent, with relatively muted concern for the risks posed
71 percent and 81 percent, respectively, by environmental hazards, notwithstanding
seeing it as a constraint—a response the global, if uneven, tendency to worry
that may reflect the inherent challenges about and regulate them more vigorously.
��
��
��
��
��
��
��

��
��
��
��
��

��
��
��
��
��
��
��
��
��
��
��
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��
��
��
��
��
��
��
��
��
��
These responses and others like them 63 percent say that they plan to meet
suggest a tendency to assume that their goals in their most important
current local conditions will persist. This growth markets by expanding existing
assumption creates potential blind spots operations. Only 12 percent and 11 percent,
about what trends are likely, over time, to respectively, say that acquisitions and joint
upset the status quo. ventures are their most important growth
strategies (Exhibit 4).
Methods for growth
When the executives were asked how they Coupled with the emergence of developing
plan to promote growth in the current economies such as China and India, the
environment, they overwhelmingly pointed pace of technological innovation creates
to innovation, which some 43 percent a paradox of growth and risk for today’s
describe as the capability their companies global executives. The way companies
most need in order to grow. Asked what cope with the double-edged sword of low-
specific action is most necessary to achieve cost business systems that make markets
growth, one-quarter said innovation within increasingly competitive will do much to
current product lines and 22 percent said determine which companies prosper—and
the development of new ones (Exhibit 3). falter—in a rapidly globalizing world. MoF
Interestingly, financial-services executives,
while seeing innovation as important, Steven Carden (Steven_Carden@McKinsey
also regard better distribution as crucial, .com) is a consultant and Tim Shavers (Tim
probably in response to the challenge of _Shavers@McKinsey.com) is an associate principal in
trying to deliver financial products in new McKinsey’s New York office, and Lenny Mendonca
(Lenny_Mendonca@McKinsey.com) is a partner in
and growing markets.
the San Francisco office. This is an excerpt from an
article by the same name in The McKinsey Quarterly,
A majority of the respondents think that 2005 Number 2. Copyright © 2005 McKinsey &
their companies will grow organically; Company. All rights reserved.
A mst erda m
A n t w erp
At hens
Atl a n ta
Auckl a nd
Ba ngkok
Ba rcelona
Beijing
Berlin
Bogota
Boston
Brussels
Budapest
Buenos Air es
Ca r acas
Ch a rlot t e
Chicago
Clev el a nd
Cologne
Copenh agen
Dall as
Delhi
Det roit
Dubai
Dublin
Düsseldorf
Fr a nkfurt
Geneva
Got henburg
H a mburg
Helsinki
Hong Kong
Houston
Ista nbul
Jak a rta
Joh a nnesburg
Kual a Lumpur
Lisbon
London
Los A ngeles
M adrid
M a nil a
Melbour ne
Me xico Cit y
Mia mi
Mil a n
Minne apolis
Mon t r é al
Moscow
Mumbai
Munich
New Jersey
New York
Or a nge Coun t y
Oslo
Pacific Nort h w est
Pa ris
Phil adelphia
Pit tsburgh
Pr ague
Rio de Ja neiro
Rome
Sa n Fr a ncisco
Sa n tiago
São Paulo
Seoul
Sh a ngh ai
Silicon Valley
Singapor e
Sta mford
Stock holm
St ut tga rt
Sydney
Taipei
Tel Aviv
Tok yo
Toron to
Verona
Vienna
Wa rsaw
Washington, DC
Zagr eb
Zurich
Copyright © 2005 McKinsey & Company

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McKinsey on Finance

Measuring stock market performance 1

Comparing performance when invested capital is low 17

What global executives think about growth and risk 21

Editorial Contact: McKinsey_on_Finance@McKinsey.com

Copyright © 2005 McKinsey & Company. All rights reserved.

Measuring stock market performance performance improves, the expectations

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Richard Dobbs (Richard_Dobbs@McKinsey

Reducing the risks of early a clean team. In the preannouncement

their subsidiaries). The team then indicated

A clean team delivers the greatest possible Seraf De Smedt (Seraf_De_Smedt@McKinsey

contributions to the integration of businesses.

information into accessible formats so it ﬁnancial-reporting and synergy-tracking

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Comparing performance when to small changes in capital, and highly

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