Sunday, April 30, 2006

Why "double-digit" growth?

The concept of “double-digit” growth is ubiquitous in business talk. At work my employer talks about “double-digit” revenue growth or “10% increase in income growth.” This often makes me wonder why “double-digit” growth? Why not “single-digit” or “triple-digit” growth? What is the fantasy with growth?

My explanation of why “growth” is important should be taken as is with no guarantee of being correct (if there is a correct answer). As of this writing I’ve never taken a formal economics course and am only ¼ through an MBA program. That all being said, I’m open for debating my answer with all those willing to contribute.

Let’s start with the basics. It’s fairly well documented and agreed upon by most economists that the U.S. economy experiences inflation between 2 and 3% per year. For the laymen (like me) this means one year from now, one U.S. dollar has only 97-98% buying power as it has today. If you’re like me and hate to lose money, you figure this is not a good deal! What do we do?

For the purpose of this discussion let’s assume you have two options. The first is to take the dollar and put it in a piggy bank and lose 2-3% a year. The second option is to temporarily give it to someone on the agreement they pay you 2-3% return per year. What do you do?

Well that is a rhetorical question if there ever was one. Even a dummy like me can conclude getting 2-3% a year is better than losing 2-3% a year in the piggy bank.

Now let’s say this “someone” you give a dollar is a company called “Small Safe Gain Co.” With “Small Safe Gain Co.” you give them a dollar and next year they give you $1.02 (i.e. 2% return), which is nice. After a few years of receiving your new flashy returns, you come across a company called “High Risky Gain Co.” who promises 100% return after one year. Holy buckets you say!!! Give them one dollar and get two back! Goodbye “Small Safe Gain Co.” and hello “High Risky Gain Co.” Sure enough “High Risky Gain Co.” delivers and in one year you get two dollars. The next year you line up your friends and pour numerous dollars into “High Risky Gain Co.” Things are great. Cocktails fly and Country Club memberships flourish. Then reality sets in and when it’s time to collect you find “High Risky Gain Co.” out of business. How can this be you proclaim? They owe me two bucks for every dollar I gave them. Unfortunately “High Risky gain Co.” didn’t return 100%, but lost 100%.

So how does this all factor into why we hear so much talk about “double-digit” growth? Let’s start with why you decided to migrate your money from “Small Safe Gain Co.” to “High Risky Gain Co.” Companies and people have ideas and ideas cost money to implement. There is fierce competition when looking for money to finance ideas. In order for “High Risky gain Co. “ to get your money they compete and offer you more return (i.e. 100%). The competition creates a “market” for money. “Small Safe Gain Co.” gives you a less risky 2% return with a higher probability paying. “High Risky Gain Co.” gives you a risky 100% return with a lower probability of paying. You pick!

My conclusion; companies and/or people must offer an incentive to attract money to implement ideas. Currently, the incentive for established ideas with a reasonable chance of paying is in the lower “double-digits.” Typically, to pay a return in the lower “double-digits,” revenue and profits must increase, you guessed it, “double-digits.” From what I’ve heard, the popular S&P 500 stock index averages 10% returns over the course of so many years. From my perspective, the S&P 500 is a benchmark people often use when deciding where to invest money. And there we have it, want money to fund your idea? If so, offer to pay the lender “double-digit” incentives most likely around 10%.

2 comments:

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