Monday, July 7th, 2008
growth promises

There was one predictable reaction to the recent announcement that Starbucks would shutter six hundred stores and scale back on its expansion plans: The editorial cartoonists and humorists had a field day, since “we all knew” that it was just a matter of time until the strategy of ubiquity would fail.

If “we all knew” the end was near, the market didn’t show signs of it until the beginning of 2007, when the stock started its steep decline. The real estate strategy and the fallout from it were laid out in an article in the New York TimesThe New York Times | A great piece with a mixture of anonymous (they still want some Starbucks business) and direct quotes, and examples that support the conclusion that “location, location, location” drove the rise and fall of the firm., which examined the firm’s property decisions by talking to real estate professionals around the country. What they had to say was way too familiar:

“[The experts] say that the company was so determined to meet its growth promises to Wall Street that it relaxed its standards for selecting new store locations.”

Let’s review: A successful firm puts out a bold forecast. The market gets excited by the prospect and the shares of the firm are bid up. The firm seems to be meeting the forecast, but unbeknownst to the market it is getting the growth by cutting corners, changing standards, and, in some cases, emptying whatever bag of accounting latitude it had filled up. Then something happens, or the clock just runs out. The stock gets whacked.

In this example, it’s Starbucks, where a large proportion of stores of recent vintage haven’t worked and need to be closed, because the famed real estate expertise of the company lost its disciplined application in the face of a promise of growth that it likely felt it had to meet in order to avoid a hit to its stock. Isn’t this story line getting a little worn out? We know the end of the tale: The actions taken to support unsustainable growth end up being more damaging to the shares and to the company than just lowering the growth expectations to a reasonable level would have been.

We have seen it time after time. What can be done to avoid it?

If you run a company, get out of the business of hype. Aspirational goals have some benefit, but if they distort your operations and diminish your chances of long-term success, you have dealt yourself a losing hand. If you are able to cash some big bonus checks or exercise some options before showing your hand, you are a winner of sorts, but not of the game you were hired to play.

If you are an investor, you need to evaluate a firm’s post-promise growth for signs that it is different in some way from that which came before, or that seems unlikely for the macro environment that has emerged. The anomalies can be statistical or anecdotal or inferential, but they should never be ignored. Good growth investors must be willing to sell when the story that is believed is different than what can be achieved. Reviewing a list of promises that your portfolio companies have made sounds simple, but may be the place to start.

You might find that some that were touted as “grande” were really just “medium.”