• Strategy
  • McKinsey & Co.

Managing for Improved Corporate Performance

Generating great performance requires a more dynamic approach to building and adapting a company's capabilities than merely squeezing its operations.

What does it mean for a company to perform well? Any definition must revolve around the notion of results that meet or exceed the expectations of shareholders. Yet when top managers speak with us privately, they often suggest that the gap between these expectations and management’s baseline earnings projections is widening. Shareholders tend to think that today’s earnings challenges are cyclical. Executives, who find themselves frustrated in their efforts to improve the performance of their companies no matter how hard they swim against the economic tide, increasingly see the problems as structural.

This anxiety is understandable. The overcapacity spawned by globalization shows no sign of easing in many industries, including manufacturing sectors such as aerospace, automotive, and high-tech equipment as well as service sectors such as telecommunications, media, retailing, and IT services. Combined with the increased price transparency provided by digital technology, this overcapacity has given customers greatly enhanced power to extract maximum value. The result — the ruthless price competition that rules today’s markets — has convinced many top managers that profits won’t rise dramatically even if demand picks up from the recession levels of recent years. In short, the performance challenge companies face isn’t cyclical; it will persist for years to come.

The stakes are high. The S&P 500, despite a 40 percent decline from its peak, still trades at a P/E multiple of 15, and consensus forecasts of earnings growth average 8 percent a year — about two to three times the growth of GDP. Lower expectations may well be warranted in a competitive, deflationary economic environment, but reducing expectations of earnings growth to 4 percent would imply a reduction in corporate equity values of no less than 15 to 25 percent.

So top managers have a choice. They can try to close the performance gap by scaling back the market’s expectations for future earnings — an approach that implies an acceptance of lower stock prices (and might get them fired). Or they can improve baseline earnings to meet or exceed the market’s expectations. Shareholders and managers alike prefer the latter course.

Companies can find additional earnings in two ways: they can try to improve operating performance by squeezing more profit out of existing capabilities, or they can improve corporate performance by organizing in new ways to develop initiatives that could generate new earnings. By pursuing both of these approaches simultaneously, companies can take a powerful organizational step toward meeting the challenges of today’s hypercompetitive global economy.

The Limits of Operating Performance

Top managers have traditionally chosen to rely on operating-performance tactics when times are hard and only during good times to undertake more fundamental performance-improvement initiatives. This predilection must change if, as we believe, the challenges facing companies are structural and persistent rather than cyclical and temporary. Companies that depend too heavily on improvements in their operating performance will run into real limits in the longer term.

To be sure, top management, pressured by intense global competition, has reacted correctly over the past few years by pushing operating performance ever harder to meet earnings expectations. Discretionary spending has been slashed, the least productive capacity eliminated, corporate overhead cut, marginal operations and businesses shed. Companies have become far more aggressive in purchasing. These steps, necessary to eliminate waste built up during the boom of the late 1990s, have bought time. But merely acting to secure increased returns from existing capabilities will yield diminishing returns and eventually become counterproductive.

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