I enjoy studying the mega-cap companies like ExxonMobil, Johnson & Johnson, and Nestle that have delivered excellent results for shareholders over a multi-decade stretch. Unlike many other companies that are constantly flipping brands, taking on debt here, laying off employees and slashing jobs there, these businesses actually undertake the task of making a business work.
I’m not saying they’ve never done any of the above-mentioned activities, but rather, if you look at a business line like Tylenol under the Johnson & Johnson umbrella, the company had to answer what I call the “then what?” question. Say you load up the company with debt, lay off workers, and engage in other cost-cutting measures, what do you do then to grow the business? The answer is (1) make sure the product is in the best shape it can be delivered in; (2) arrange for its distribution accordingly; and (3) market the product as necessary.
And of course, it is necessary to have the right people in place that are capable of doing this. Peter Drucker, the management expert who understood opportunity cost better than nearly all, often spoke of “feeding the problems and starving the opportunities.” He said that too many leading companies would send their top talent to the worst subsidiaries to fix the problems there, offering high bonuses for doing so.
Peter Drucker’s advice was that corporations should send their top talent to the best performing units because growing an excellent business line would lead to an ultimately higher volume of sales and profit than fixing a suffering line.
Johnson & Johnson is famous for giving its best-performing management talent the opportunity to seek out the units they want to run, and most of them gravitate towards the the Medical Devices & Diagnostics unit because that is the business segment that is naturally growing the fastest (in fact, that is unit that current CEO Alex Gorsky came from).
Since 1990, profits at Johnson & Johnson have octupled. Over a shorter time frame, they have quadrupled since 2000. The crazy part? It was one of the thirty largest companies in the United States in 1990, and the same was true in 2000. Despite its size, it average annual earnings per share growth of over three percentage points on the balance over the S&P 500 during these respective time frames.
Since Johnson & Johnson is one of my five largest investments, I pay attention to the esoteric details, including how it incentives its management team. If you are a Johnson & Johnson sales executive, you receive stock options and bonuses that are based on a combination of profit growth and sales growth. The basis for including each is self-evident; but the basis for not relying upon one or the other may not be. If a business only focuses on profits, it can do things like layoff employees and cut short-term costs in a way that shortchanges the overall growth of the business. On the other hand, if the compensation is solely based upon sales growth, the product could be “given away” without proper focus on the returns on capital–i.e. cutting someone’s lawn for $5 is not the path to wealth.
In short, Johnson & Johnson is decentralized into all of these different business lines where the executives that successfully run the business lines can choose to keep growing the business lines they manage, or receive priority to run another business line when it arrives based upon their track record of performance. This strategy maximizes Johnson & Johnson’s opportunity cost because the fastest-growing businesses are run by the best executives. Nestle and ExxonMobil do the same thing. It is not a coincidence that these three companies have been super-sized businesses forever while at the same time delivering high earnings per share growth over the decades since becoming ginormous entities.