# Beyond margins *Sometimes the next point of margin is the wrong target.* --- You're running a business that earns 16% on capital. A year ago it was 14%. You restructured procurement, renegotiated two supplier contracts, automated a manual workflow. The board is pleased. They want 18% next. You're planning another round of cost work. Tighter headcount controls, maybe consolidating a warehouse. It'll take six months, some difficult conversations, and most of your attention. You think you can get there. But pull up the spreadsheet and run a different question. --- Your business earns £10m of operating profit on £62.5m of invested capital. That's your 16%. It grows at 5% a year. To grow 5% on a 16% return, you reinvest about 31% of earnings. That's £3.1m going back into the business each year, earning 16%. The remaining £6.9m is free cash flow. What's this business worth? A simple valuation: cash flow divided by the spread between required return and growth. Investors want 10%. You're growing at 5%. £6.9m ÷ (10% − 5%) = £138m. Now the same business with no growth. All £10m is free cash flow, nothing reinvested. £10m ÷ 10% = £100m. Growth at 16% returns adds £38m of value. Nearly 40% more, from the same base profit. --- Now run your cost programme. Six months of work, and you push returns from 16% to 18%. Same capital base, so profit rises to £11.25m. Same 5% growth. Reinvestment rate drops to 28% (5 ÷ 18), free cash flow rises to £8.1m. £8.1m ÷ (10% − 5%) = £162m. You created £24m of value. Real, and hard-won. Now forget the cost programme. Stay at 16% returns but find a way to grow at 8% instead of 5%. Reinvestment rate rises to 50% (8 ÷ 16), free cash flow drops to £5m. £5m ÷ (10% − 8%) = £250m. Same base profit, same returns. Three more points of growth added £112m. The margin improvement created £24m, the growth £112m. Nearly five times as much, without touching the cost structure. --- This only works because 16% is well above the 10% hurdle. The reinvested capital earns six points more than investors require, and growth multiplies that spread across a larger and larger base. If your returns were 10%, the maths collapses. You'd be reinvesting at exactly the hurdle rate, and growth would add nothing. A business earning 10% on capital, growing 5%, is worth the same as one earning 10% with no growth. The reinvested capital just treads water. At 22% returns, the effect intensifies. A business earning 22% and growing 8% is worth roughly three times the no-growth version. Each point of return above hurdle gets multiplied by every point of growth, compounding across time. Somewhere around 15% returns, the lever flips. Below that, margin improvement is the priority because you need a wider spread before growth creates value. Above it, growth becomes disproportionately valuable, and another point of margin makes almost no difference. --- Margin work feels controllable. You can see the cost line, name the initiative, measure the saving. Growth means finding new places to deploy capital at attractive returns, which is harder and less certain. Most businesses have fewer high-return opportunities than they think. [[Constellation|Constellation Software]] acquires dozens of small software businesses a year, each at returns well above 20%. [[Halma]] runs a similar model across safety and environmental niches. [[Heico]] across aerospace components. At some point each of these CEOs shifted from improving the existing business to finding more places to deploy capital. --- You're back at your spreadsheet, planning the warehouse consolidation. It might get you from 16% to 17%. Maybe 18% if everything goes right. Or you could spend that time finding one more place to deploy capital at 16%. ---