Tuesday, September 13, 2011

Why Growth is so Difficult

Ninth in a series on the evolution of economic growth in the United States

There is a notion in this country that more is the only outcome that is worthwhile – that bigger is almost certainly always better. That an entity can and should grow forever. People do not grow forever. Plants do not grow forever. Products and brands do not grow forever (Kodachrome, Pontiac, Max Factor). Businesses do not grow forever (AOL, Blockbuster, MySpace). Industries do not grow forever (auto, newspaper, postal).

If none of the individual components of an economy grow forever, why do we believe that an aggregate economy will forever grow? Is it because whenever an important measure of economic “progress” begins to fade we change the means of measurement, simply prolonging the illusion? The Dow Jones Industrial Average is losing steam? Just swap out mature, weak performing companies with younger, stronger performing companies to infuse some new energy. GDP is slowing? Then just identify and impute the value of services like that of a bank teller and simply add it to GDP.

I will never forget the assertion of an infamous cable-TV investment analyst one holiday season a few years back. A colleague asked him if holiday sales in the important fourth quarter might ever shrink one day as opposed to always growing from one year to the next. “No, it’s not possible for holiday sales to shrink,” was his immediate and rather indignant response.

This is our perspective today. This is what we have taught our business school students. This is the expectation that we have created. That there is no top. This is the disturbing pathology that is at the core of a bigger is better mentality – a belief that without growth we cannot possibly live full and satisfying lives.

But here’s the problem with growth:

1.    The more you grow and the bigger you become, the harder it is to grow even more. It was far easier to grow a $29 billion General Electric in 1990 than a $182 billion General Electric in 2008.
2.    The more you push for more growth, the faster you will reach saturation and the faster your growth will slow down. We are already seeing this with the number of Facebook users – well in advance of its planned IPO.
3.    The more product variations you introduce, the more likely you are to cannibalize existing products. Crest has 41 different variations of toothpaste – yes you read that correctly – 41 variations. Adding a 42nd variation will not increase the aggregate sale of toothpaste.

Austrian-American economist Joseph Schumpeter coined the term Creative Destruction in his 1942 book Capitalism, Socialism and Democracy which described a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one while incessantly creating a new one.” In other words, one of the natural outcomes of innovation is the development of products, services, processes that are better, faster, and cheaper than those that already exist – all at once creating something new while effectively destroying or at least initiating the decline of something that already exists.

Many of us witnessed the creation of audio-tape which led to the destruction of vinyl records followed by the creation of CDs which led to the destruction of audio-tapes and followed by the creation of digitized music which led to the destruction of CDs.

So in a culture that is constantly introducing new innovations it becomes harder and harder to create net growth – or accretive growth because as the innovation of new products accelerate, so too does the destruction of existing ones.

This is not to say that growth is impossible – it is just to say that it is getting harder and harder to introduce products and services that are simply added to existing consumption resulting in 100 percent incremental addition and no subtraction whatsoever.

There are effectively 11 sectors that make up the U.S. economy. Most of the products and services that make up U.S. GDP fall somewhere inside of these existing sectors:

1.    Healthcare (Johnson & Johnson, Pfizer, GlaxoSmithKline)
2.    Financial (JP Morgan, Citigroup, BankofAmerica)
3.    Energy (ExxonMobil, ChevronTexaco, BP Amoco)
4.    Utilities (Southern, Duke Energy, Exelon)
5.    Capital Goods (General Electric, United Technologies, Catepillar)
6.    Basic Material (Dow Chemical, DuPont, Alcoa)
7.    Transportation (UPS, FedEx, Delta Airlines)
8.    Consumer Staples (Coca-Cola, Pepsico, P & G)
9.    Telecom (AT&T, Verizon, Vodfone)
10. Technology (Apple, Microsoft, Google)
11. Consumer Staples (Walmart, McDonald’s, Home Depot)

While there are new companies constantly joining each sector, there are also mature or failed companies constantly exiting each sector. The youngest of the sectors is Technology, but even that sector is beginning to mature.

Some say it’s only a matter of time before a new sector is introduced. That may be so, but I am definitely not smart enough to even venture a guess at what the next new sector might be. And here’s the thing about a new sector: unless it introduces products and services that are simply added to what we currently produce and consume without cannibalizing existing products and services (like technology did with personal computers), it is unlikely to help economic growth.

Others say that green initiatives or new energy initiatives that can cut across and positively impact all sectors will provide new economic growth. But unless green initiatives translate into a new ways to raise revenues or to cut costs, don’t look for GE or IBM or any existing public entity to sign up for initiatives. While green initiatives might be the right thing to do for the environment, unless they provide a bottom line benefit for shareholders, don’t expect the slaves of Wall Street to sign up to pay a premium for ethical behavior. So it’s more likely that significant green and/or non-carbon-based initiatives will be driven by start-ups and for those with a bigger appetite to risk what little R & D funds they may have left.

Unless the introduction of new products and services results in a net gain to aggregate consumption (accretive growth) then the economy will not grow. Can it happen? Sure. But it is getting harder and harder to accomplish. Our economy is already huge. Our consumption has already reached record levels by almost any measure. Our lives and homes are full of products – in many cases duplicated several times over. And yes, the replacement of existing products happens all the time – but the trend of sales cycles for products such as cars, homes and even cell phones are lengthening every year. Instead of buying a car every three years we are now buying cars every six or seven years. Instead of replacing our cell phones every year and a half, we are now replacing them every two to two and half years. These types of behavioral trends result in fewer sales each year spreading sales out over a much longer period of time and negatively impacting consumption.

And here’s the thing: most conventional wisdom suggests businesses need to spend more time and resources trying to convince people to drink 48 servings of Coke a month instead of 24, buy cars every 24 months instead of every 72, good luck with those quests. And if you believe you have a real shot at influencing those macro-consumption trends, then maybe you believe that your home will appreciate this year too.

It was a whole lot easier to grow the economy in 1950 than it is today because most Americans did not own a home, most of us did not own a washing machine or dryer, an oven, or a television, a car, or a telephone. Now many of us own multiple homes, multiple televisions, multiple cars, multiple telephones.

The generations right behind the Boomers – Generations X and Y – are unwilling and in some cases will be unable to live life like their parents did – in a world where more and bigger was better. This dose of sanity is a good thing for us and for the planet on which we live. But not for the bigger-is-better economy.

We need to realize that - as much as we want to believe that ours is an economy without limits – we are wasting time and money trying to live up to that lie instead of trying to figure out what we really need to live satisfying lives. It is possible. But we need to first realize that our current more and bigger path is far more destructive than it is creative. From there, perhaps, we can finally begin to explore, and perhaps redefine a new and achievable American dream that is far less about quantity and much more about quality.


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