Counting the cost - Growth-hungry companies could learn a thing or two from reindeer and ants


Jamie Lowry

Jamie Lowry

Fund Manager, Equity Value

“We need to grow.” It is a refrain The Value Perspective hears all the time from company management and one any investor worth their salt should immediately counter with two questions – “why?” and “what is it going to cost you to grow?” Having just read Breakpoint by Jeff Stibel, however, the next time we hear it, we may also throw in the story of the reindeer – and maybe the ants as well.

First of all let’s return to Swiss chocolate producer Barry Callebaut’s recent acquisition of the cocoa division of Petra Foods, which we first discussed in ‘Sweetening the deal’. In that piece, we suggested that, to achieve a 10% return on the transaction, the company would need to grow revenue by 12% but at the time, for the sake of simplicity, we deliberately played down the cost of growth involved.

Within our equation, we completely excluded capital expenditure costs but in fact the cocoa business cannot grow – let alone achieve a compound annual growth rate of 12% – unless a new factory is built. We know this because Petra Foods has stated one of the reasons it wanted to sell was because of the business’s “substantial investment requirements”. That is quite a significant cost of growth.

Maybe Barry Callebaut’s senior management should have considered the reindeer – specifically, the ones on St Matthew island, a narrow strip of land in the Bering Sea between Alaska and Russia. In his book, Steinveld relates the story of how the US coastguard delivered 29 reindeer to the island in 1944 but, by 1963, there were more than 6,000 of them.

Evidently the head reindeer had decided the herd needed to grow but the problem with that was, just one year later, almost every reindeer was dead. Although the experts are still debating the details of why this happened, two broad clues were the large number of reindeer skeletons and a complete absence of lichen, the main source of food on the island. The reindeer had eaten their entire ecosystem.

To be clear, we are in no way suggesting growth is a bad thing but companies need to ask themselves – or be asked by investors – why they are going for growth. What are they trying to do? What should they be trying to do? They should be looking for profit maximisation rather than growth for growth’s sake. They should be looking for a natural equilibrium, beyond which there is no point in growing.

Additionally, management need to think through the sort of growth they are considering. Are they, for example, looking to grow within their own market? That could well be a good idea but equally it may risk saturating that market – something we touched upon in ‘Developing story’ when we considered the fate of camera retailer Jessops’ 187 stores in the eight months since it went bust.

Or are they looking to grow outside their area of expertise to achieve growth? Again, that can work but the textbook cautionary tale is Coca Cola buying the movie studio Columbia Pictures in 1982 because it was generating so much cash from its core business it did not know what to do with it all. It took Coca Cola some seven years to extricate itself from that particular venture.

Or do they look to grow into a new area but one supposedly within their area of expertise? Apparently ants are the example to follow here – whenever a colony reaches its optimum size, a number of male and female ants are sent out to start a new one, doing exactly what was done before only a suitable distance away.

On the other hand, say, British supermarkets expanding into the US have proved less successful in their endeavours because they come up against established competitors who know exactly what they are doing. Sometimes the cost of growth is worth it, sometimes it is not – the trick is to work that out in advance.


Jamie Lowry

Jamie Lowry

Fund Manager, Equity Value

I joined Schroders in 2004 as an equity analyst in the European Equity Team initially specializing in the Industrial sectors before moving on to Consumer-based companies and finally Insurance. In 2007, I became a co-manager on a fund investing in undervalued European companies and took on sole responsibility for the fund in May 2010. Prior to joining Schroders, I worked at Hedley & Co Stockbrokers and Deutsche Asset Management as a trainee analyst.

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