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The power of momentum

(chinadaily.com.cn)
Updated: 2008-09-28 13:25

What conventional analysis probably would not have predicted was the performance of the pioneers. Despite having decreased their advertising-to-sales ratio, these momentum-powered companies created shareholder value 80 percent above the Dow Jones Index over the 20-year period.

As the limitations of the plodders' inertia are obvious, let's leave them aside. Understanding the difference between the pushers and the pioneers -- the "good" and the "great" in terms of growth in shareholder value -- was both more challenging and more rewarding.

The first clue to the difference in the strategic behavior of these two groups appears in the top-line growth of the pioneers. Over the 20-year period, using the pushers' performance as a reference, the pioneers' revenue growth was 93 percent better -- almost twice as high. They achieved this massive revenue growth despite decreasing their advertising ratio. And remember: This is in comparison not to underperforming firms but to firms that actually matched the Dow Jones Index.

If we compare the profitability growth of these two groups, we can see that the pioneers also did much better, with average earnings growth 58 percent superior to that of the pushers. A 58 percent advantage in earnings growth is very impressive, but it is noticeably smaller than the difference in revenue growth.

Despite the pushers' much poorer performance on revenue growth, and the fact that they were increasing their spending on marketing, they managed to claw back some lost ground: Their relative gap on earnings growth is less severe than one would expect. How did they manage that?

They cut down on other costs, especially in manufacturing and R&D. These combined cuts and efficiency economies more than compensated for the increase in advertising-to-sales ratio, and enabled the pushers to peg back some of the pioneers' huge top-line advantage when it came to earnings growth.

Despite this partial catch-up, there is little doubt about where one would like to invest or work when one compares these two types of companies. The stock market recognizes this: The share-price premium of pioneers over pushers -- 80 percent -- is significantly higher than the differential in their earnings growth.

The bottom line: Although the combination of pushing hard with marketing investments and slashing other costs can deliver growth, the pioneers' achievements demonstrates that there is a more creative, exciting, and smarter alternative that delivers even better results.

Obviously, it is not as simple as cutting the advertising-to-sales ratio. A straight cut in advertising would almost certainly result in a drop in growth. In fact, our study shows that the momentum-powered pioneers actually increased their total marketing expenditures in real terms.

But while their marketing budgets were increasing, the proportion of their revenue that this expenditure represented was decreasing. In other words, because of the pioneers' superior revenue growth, their advertising-to-sales ratio was coming down despite the fact that they were spending more.

In a world of increasing competition, marketing resources must also, inexorably, rise. But if they are to create sustainable, profitable growth, these expenditures must be invested in an effective manner. Compared to the pushers, the pioneers' increases in marketing investments were more effective: They got superior growth while reducing their marketing-to-sales ratio, thus improving profitability.

The question is: What was improving the efficiency of their marketing investments? This is not simply a case of great marketing, although marketing excellence is a key part of the mix. These firms achieved greater efficiency with their marketing because they found a different path to growth: They exploited the momentum effect. They created specific conditions that ignited an exceptional organic growth that feeds on itself: momentum growth.

We meet several firms that have managed to do this. They come from domains as disparate as banking and ball bearings, but the central fact that unites them is this: It is their brains, not their muscle or money, that create the force to power them from success to success. They are momentum-powered firms.

Momentum-powered firms

The results of this research might seem counterintuitive at first sight, but they are perfectly logical. Too often, companies invest more in marketing to compensate for something: an inferior product, a poor pipeline of new products, deterioration of growth prospects, or a general lack of creativity.

Firms with such a limited vision compensate for their less-than-spectacular offers by pushing them on an unconvinced market using heavy-handed marketing resources. Even more compensation is required when, to fund this expensive marketing, they are forced to cut costs on the very activities that could improve the attractiveness of their offer: operations and R&D. This kind of behavior eats up resources and destroys firms from the inside out. These businesses will never build momentum. They are momentum-deficient firms.

The pioneers show there is an alternative. These momentum-powered firms don't have to push so hard because they have built up a momentum that improves their efficiency. Rather than just better-than-average growth, they deliver exceptional growth. Their growth is exceptional on two counts: It is both higher and more efficient.

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