Published: Jul 12, 2006 in Knowledge@Emory
For some time, investor activists have complained that U.S. companies, unlike their European counterparts, sacrifice long-term opportunities for short-term results. This was starkly illustrated in late April when Ford Motor Company announced it posted $1.2 billion loss for the first quarter. In a conference call CEO William Clay Ford, Jr. said “We’ve been too dependent on a very few vehicles…every one of our vehicles has to be a contributor.”
That indicates Ford may finally try to wean itself off a dependency on trucks and SUVs, which deliver high profit margins in the short term but have seen sales slip in the face of rising gas prices. Of course investors and others might ask why the company waited until now to implement this strategy—more than 30 years after the first oil price shock in 1973, when fuel costs jumped fourfold in a year and consumers started a long march to smaller, fuel efficient vehicles. The answer, say faculty from Emory University’s Goizueta Business School and other experts, is more complex than a mere management decision.
“Many large American companies have a short-range strategic outlook, but management is not always the prime driver of this approach,” says Jagdish Sheth, a professor of marketing and corporate strategist at Emory University’s Goizueta Business School. “Instead, management is being pushed by the stock market, which was originally created for long-term investment but today is often focused on short-term trading.”
Sheth explains that the stock market was originally launched as a relatively quick and efficient way to raise capital for new and existing businesses—but that vision was sidetracked along the way. Now, he says, activity is driven by arbitrage, futures and day traders who are looking to make a quick profit by selling, buying or otherwise exchanging their existing shares.
“Beginning with the dotcom era of the 1990s and extending to the present, much of executive compensation is linked to a company’s performance [and directly or indirectly to its share price]. This means that investors’ trading patterns can put a great deal of pressure on management to deliver results on a quarter-by-quarter basis,” Sheth explains. “The tendency towards short-term trading is also influenced, at least to some degree, by fund managers who get their incentive compensation based on quarter-to-quarter results, and by derivative managers.”
This focus on the short-term is a significant problem, says George Easton, an associate professor of decision and information analysis at Goizueta.
“It implies a lack of commitment to a business space,” he observes. “To be good at something can require years of commitment, but analysts focus on near-term results and put pressure on companies. One consequence is that U.S. companies often abandon a segment as soon as the going gets difficult.”
Easton says that the U.S. has just about given up in such industries as machine tools and consumer electronics. Down the road, he says, it is possible that the U.S. also may bow out from automotive manufacturing.
“Pension and other healthcare costs could drag General Motors into bankruptcy, or we could see GM and others shrink, and just focus around some core, profitable lines,” notes Easton. He’s also concerned about another development: the increasing tendency of some car companies to rely on the lending division to generate profits. “Automotive operations drive a lot of technical innovation, and the country as a whole could suffer if we lose that.”
In the first quarter of 2006, General Motors reported a $529 million operating loss while its GMAC financing arm earned $605 million. Despite that, GM is shopping around for a buyer for about half of GMAC in an effort to raise capital. And in contrast to Ford’s overall billion-dollar-plus loss, Ford Motor Credit Company reported net income of $479 million for the first quarter.
Sheth’s earlier observation that the investment climate is a root cause of America’s fixation on the short term begs a follow-up question: are the European and Asian capital markets that different from the American markets? Yes, he replies, they are. And that also explains a key difference in the companies’ outlooks.
“Other than London, the European stock exchanges and especially their Asian counterparts tend to have limited liquidity because of family ownership and bank holdings. Therefore, they take a long term view for family succession planning reasons. So the biggest stock owners don’t see their shares as commodity items. Instead they’re something to be developed and passed on to the next generation.”
There’s also a significant difference in the mentality of the lending markets. Sheth says that in Asia, for example, dominant financial models include chaibols [in Korea] and keiretsu [in Japan], which are characterized by horizontally-integrated alliances across many industries.
Such chaibols as Samsung and keiretsus, including Mitsubishi, are centered around a large bank that lends to the member companies and also holds equity positions in them. In contrast to the U.S., where some companies browbeat their lenders into a submissive position by threatening to go bankrupt (Donald Trump comes to mind), European and Asian banks often have significant control over the companies in the keiretsu and chaibols, and they act as an advisor as well as a source of emergency funds.
“The influence of banks and cross-industry ownership means there’s less trading mentality and more of an investment mindset,” says Sheth. “In Europe and Asia, banks tend to be the biggest investors, and they’re in it for the long term. The risk, of course, is that in a downturn the interlocking ownership makes it more difficult for an investor to implement an exit strategy.”
There’s more, he notes. Perhaps unwittingly, even legislation like the Sarbanes-Oxley Act of 2002—which was supposed to clean up corporate behavior—may be pushing domestic companies to concentrate on near-term issues, instead of the far horizon.
“The Sarbanes-Oxley Act was passed to address certain perceived abuses by giving corporate boards more clout and holding them to a higher standard,” he says. “But along with the goal of accountability, there’s an unintended consequence since it effectively tells CEOs that their continued employment depends on meeting short-term goals. That’s because Sarbanes-Oxley has made boards less hesitant to dismiss CEOs, and the boards themselves serve at the pleasure of shareholders and their institutional fund managers, who are increasingly looking at short-term results.”
But not everyone says that a short-term outlook is necessarily bad. While Douglas L. Long, an Emory alum, says that companies need to focus on the long term, he adds that a short-term focus can sometimes make sense. Long is the founder and principal consultant at New Endeavors Consulting Inc. in New York City.
“A short-term outlook can be useful for certain goals, like achieving a quick cash injection,” says Long. “But it’s easy to stumble if management uses short-term planning to try to realize long-term goals.”
He says, for example, that U.S. car makers look at quarter-to-quarter results, instead of considering developments in the operating environment and responding appropriately.
“Selling a car may bring in funds right now on a one-shot basis, but how do you extract revenue from the customer two years later?” he asks. “Automakers and others need to understand their market, and what drives their customers.”
That’s what happened when Cadillac scored a hit by moving away from designs that were perceived as stodgy and developed sporty models like the STS that have drawn buyers from a younger generation.
“Businesses need to keep in mind that today’s generation sees value in quality, design and appeal,” adds Long. “If products don’t meet their standards, they won’t make the purchases.”
While long-term planning is essential, companies also should consider their ability to respond to sudden shifts in their environment, notes Easton.
“The extent to which companies can react to sudden market changes depends, to a certain extent, on the industry and the nature of the production processes they use,” he observes. “However, most companies can do much better than they do. Companies have to plan for how they will handle sudden market changes. The more flexible the production process, for example, the faster the production cycle time, and the less the inventory, the better the company can react to sudden changes. Just in time production (JIT) aids in all of this.”
Easton says that many companies lock into very inflexible production processes because they believe that they will reduce cost.
“However, they often fail to consider the cost of obsolescence associated with these processes in the event of market change or loss of a key customer,” he warns. “Planning for flexibility basically gives the company the option to change. Such options have value in a world with volatility. The value of flexibility, however, is often ignored in the financial calculations that are used to justify capital expenditures for highly efficient but very inflexible equipment.”
Regardless of the risks that they face, Sheth doesn’t see American companies changing their focus anytime soon.
“Before the 1970s, U.S. companies had more of a long-term outlook,” he says. “But since then, the environment has become more volatile, and it’s a lot tougher to set plans in stone.”
In fact a lack of flexibility carries its own dangers.
“The world is not linear, and over the long-term very few assumptions will be validated,” he notes. “Forces like globalization and technology are disruptive, not evolutionary, and can easily throw off an enterprise’s plans. Instead of simply forecasting, businesses need to engage in scenario planning, which continually asks ‘what if’ something happens; and continually checks assumptions against occurrences and trends. There are methodologies for this approach. The question is whether or not companies will embrace them.”
