Definition :

Profitable Growth, a term most often used by CEOs when describing their firm's strategic objective.
Profitable growth is the combination of profitability and growth, more precisely the combination of Economic Profitability and Growth of Free cash flows

Free cash flow

In corporate finance, free cash flow is cash flow available for distribution among all the securities holders of an organization. They include equity holders, debt holders, preferred stock holders, convertible security holders, and so on....

.
Profitable growth is aimed at seducing the financial community; it emerged in the early 80’s when shareholder value

Shareholder value

Shareholder value is a business term, sometimes phrased as shareholder value maximization or as the shareholder value model, which implies that the ultimate measure of a company's success is the extent to which it enriches shareholders...

 creation became firms’ main objective.

Profitable Growth stresses that Profitability and Growth should be jointly achieved. It is a break from previous firms’ development models which advocated growth at first to achieve economies of scale and then profitability (see BCG Growth-share matrix

Growth-share matrix

The BCG matrix is a chart that had been created by Bruce Henderson for the Boston Consulting Group in 1968 to help corporations with analyzing their business units or product lines...

).

The Profitable Growth Paradox

Profitable Growth hides in fact a contradiction in terms, one often speaks of the Profitable Growth paradox. Most growth investment will at first reduce the profitability, cost reduction efforts to boost the bottom line usually have a negative impact on future growth. This is especially true with mature products or services. The only way out of the Profitable Growth paradox is through innovation. It concerns not only technical innovation but mainly business model innovation, a new product-market space where there is no competition (see Blue Ocean Strategy

Blue Ocean Strategy

Blue Ocean Strategy is a business strategy book first published in 2005 and written by W. Chan Kim and Renée Mauborgne of at INSEAD. The book illustrates what the authors believe is the high growth and profits an organization can generate by creating new demand in an uncontested market space, or...

). An interesting piece of research by the BCG shows that no business model is able to achieve a sustainable competitive advantage for more than 10 years.

Economic Profitability

Economic Profit is the residual wealth calculated by deducting the cost of capital from the firm’s operating profit.
It is defined as: Net Operating Profit After Taxes (NOPAT) - Cost of Capital Employed

- NOPAT (Net Operating Profit After Tax)
NOPAT = EBIT x (1 - Tax Rate)
NOPAT measures a company's potential cash earnings.

- Capital Employed
Capital Employed is the amount of funds which has been used over the period by the company to generate the NOPAT.

There are 2 ways to measure Capital Employed (CE) :

- CE = Shareholders’ Equity + Net Financial Debt
Net Financial Debt is computed as: interest bearing Debt – Cash and Cash equivalents.

- CE = Fixed Assets + Net Working Capital
Net Working Capital is usually computed as: Account Receivables + Inventories – Account Payables.


Both definitions lead to the same measure of Capital Employed. One prefers the first one when computing Capital Employed at the firm level; the second one is more practical when focusing on a company’s business unit.

External links

- Shareholder Value Creation
- Shareholder Value Creation
- Video explanation
- Olivier Tabatoni