The Revenue Growth Gap and the Danger of Hurdle Rates
research@imaginatik.com.

We have learned two important lessons in working with leaders when dealing with the specific performance gap imparted by their growth objectives:

0 Leaders routinely do not apply simple mathematics to their goals: they announce we will grow 10% per year top line but never do the math. A 10% increase for a $1Bn company means you need $100M of new revenue; for a $10Bn company, you need $1Bn!! The first thing we do in working with companies is ensure the leaders understand the scale of their challenge. It always amazes me how their eyes begin to glaze over when they see the math.

0 Creating decision criteria is critical-- we call them the Ballpark Decision Criteria. They should be clearly articulated and broadly disseminated throughout the company to create the conversation leaders want and to enable a rapid, transparent decision making. Leaders must wrestle with how they want their company to grow. As outlined in this article, a key component of the Ballpark Decision Criteria is the potential size of the opportunities. This article deals with this issue.

Refer to the August 6, 2006 positing on Whirlpool to see how they used the Ballpark Decision Criteria.

Now the article:

To achieve growth targets, most companies need to find new sources of revenue, either through expansion into new markets or developing new products. This can be a challenging task. 30 - 50% of commercial launches fail to reach their expected revenue and profitability goals, and only one in four development projects succeed (Source: R. G. Cooper (2001) "Winning at New Products: Accelerating the Process from Idea to Launch").

At the same time, industry consolidation has led to the creation of mega-enterprises who struggle to maintain the same growth rates as their smaller, more nimble competitors. The absolute numbers are staggering. A 5% target growth rate for a $400m company is $20m - high, but not unrealistic depending on the market. Companies like Procter & Gamble, however, face a more daunting task. With $40bn in 2002 revenue, they would need to generate $2bn in new revenue each year, equivalent to creating a company the size of Williams-Sonoma or Siebel Systems.

The Growth Gap (see Research Note on "The Innovation Gap") can be closed partially through standard business operations, such as expanding distribution, and through mergers and acquisitions (for example, P&G's recent agreed purchase of Wella AG will add $2.57bn annual revenue). However, studies conducted by Imaginatik Research have found that 25% and 50% of a company's target growth will need to come through innovation.

Apart from acquisitions, the main innovation-related approaches to closing the gap are either:

The Big Win
- A company embarks on a search for high impact winners that will cover the bulk of the growth target. P&G calculate that their very best new products typically generate $200m - $250m in the first year, which would mean that their 2003 goal would involve finding 2 large scale winners.

Portfolio of Smaller Winners
- A company creates a basket of opportunities with a mix of expected return, risk, resource requirement and timescale. The portfolio is optimized to deliver the highest overall return on investment, with an outside hope that at least one project in the portfolio will become a big win.
Companies tend to blend the approaches. The returns from a big win are significantly larger than a basket of small-scale successes. The pharmaceutical industry in particular has shifted its approach through the 1990s away from generic drug manufacture to the search for $1bn blockbuster drugs, with a fair degree of success.

The key to both concepts are hurdle rates: are the products or markets large enough for warrant serious consideration. Companies therefore put in place framing activities to spot large potential markets, and use the tools within the Innovation Pipeline to develop offerings to meet these needs.

However, the hurdle rate can create some perverse effects. A market may appear too small initially, and often companies cede such niche markets to competitors who are sometimes able to grow the small market into a much larger one (see "The Innovators Dilemma" by Clayton Christensen). Companies also tend to forget their history, and fail to appreciate that the leading products often took years before they gained market traction.

Companies need a range of approaches to closing the Revenue Gap and innovation plays a large part, particularly in organic growth. Fortunately there are many methods to help companies find these large scale wins, and develop a portfolio of opportunities that can potentially become the successes of the future.