Give them a fish or teach them to fish?

Posted by Marc Hodak on September 10, 2007 under Economics | Comments are off for this article

McKinsey people strike me as real smart. And they dress well. And they make impressive presentations. And then they come up with this stuff:

How to choose between growth and ROIC:

One key to creating value is understanding how to manage the subtle balance between growth and returns on invested capital. Empirical evidence suggests that companies enjoying strong ROIC can afford to let it decline over the short term to pursue growth—and that companies with low returns are better off improving ROIC than emphasizing growth.

Duh. They presumably let us in on this Finance 101 factoid as a way of letting managers know that maximizing either on growth or on returns is not necessarily optimal. Presumably, you can hire McKinsey to find out which one–growth or returns–is your best bet right now.

Or, you can choose to maximize EP. That always gets you the right answer. EP is the excess return scaled up by the amount of investment:

EP = (Return on capital – Cost of capital) x Capital.

EP provides the perfect balance between growth and returns. If your growth (in Capital) is associated with returns less than your cost of capital, your growth may or may not be enough to compensate for your lower returns. All you have to do is check the EP formula. Similarly, if your returns go up because of a drop in Capital (i.e., negative growth), it’s not obvious if your ahead or not. Check the EP formula. EP always gives you the right answer, even in a changing environment, even with a changing business model. You don’t have to hire McKinsey for this.

So, is McKinsey stupid? Don’t they know this? Of course they do. But telling clients whether to pursue growth or returns is like giving them a fish. Giving prospective clients the right measure that balances growth and returns so they can figure it out themselves is like teaching them to fish. McKinsey didn’t become the biggest fish by teaching their clients how to fish.