I recently came across an article at Brookings that looks at how to deal with the overuse of short-term business strategies that have detrimental economic effects. It’s pretty common for a business to use these strategies (cutting costs, increasing shareholder dividends, and buying back their own shares) to survive tough economic circumstances. There’s nothing wrong with doing these things in the short term.
The research done by Kamarck and Galston shows that these short-term strategies are being used heavily by U.S. companies. And that’s certainly been my observation as well from working in the corporate world. These short-term strategies can be effective solutions to short-term problems, and they seem to help many companies in the short term. The cost-cutting strategy can also help non-profits stay afloat in the short term.
But what happens when they’re done over the long term?
“Since then, additional research on short-termism has emerged, and an increasing number of corporate leaders are expressing concern about the trajectory of U.S. firms. Last November, for example, the Boston Consulting Group documented a worrisome decline in the corporate activities and investments designed to discover and nurture future growth opportunities. This turn away from exploratory activities may not immediately affect investors, said the BCG report: in the short term, companies can maintain earnings and shareholder returns by “cutting costs, increasing dividends, and pursuing share buybacks.” (As Kamarck and I showed, this is what is happening across our economy.) But in the long run, BCG researchers found, firms that invest in exploration boost revenues and total returns far faster than do those who are content to exploit their existing lines of business and return most of their earnings to shareholders in the form of dividends and buybacks.”
Short-term solutions only help during the short term, but they are often utilized over and over again over the course of the long term because the same problems keep appearing and the short-term solutions keep “working” to maintain the status quo in which they are needed. So what happens is that companies remain stagnant.
The growth of companies, the creating of efficiencies that lead to lean operations, and the increased value of their products due to innovation is the result of effective investment rather than effective cost-cutting. If a company just wants to stay afloat short-term, then cost-cutting can work. But if they want to thrive in the long-term, then actively investing and taking risks is the course of action that works.
‘A few days ago, Laurence Fink, the chief executive of the world’s largest investment fund and a long-time foe of short-termism, sent a letter to the heads of S & P 500 companies and large European corporations. He noted that in the twelve months ending September 30 2015, buybacks had risen by 27 percent over the previous year, when buybacks already stood at record levels. “Today’s culture of quarterly earning hysteria,” he declared, is “totally contrary to the long-term approach we need.” And he warned corporate executives that in the absence of well-considered long-term plans for investment and growth, they would expose their firms “to the pressures on investors focused on maximizing near-term profit at the expense of long-term value.”’
Calling the current business culture “quarterly earning hysteria” is not hyperbole. That’s a very accurate reflection of just how unhealthy the emphasis on short-term profits has become throughout the process of a lengthy recession. Like the human body does when resources are scarce, the business world has in many areas gone into starvation mode. And just as it does with the human body, going into starvation mode and staying there has serious unhealthy effects on a business.
The way to keep a company healthy over the long term is similar to the way to keep the human body healthy over the long term. People sometimes wonder how I stay in good shape, and the answer is that I’m always finding new ways to improve my muscular strength. In order to lose a little bit of unnecessary weight, I can cut calories for a short while to help me stay in shape, but using that strategy over the long term would atrophy my muscles and make me weaker.
The rest of my body would need to consume part of my musculature in order to survive, which is obviously not good for my health in the long term. So what I do is eat plenty of calories, but I remain strategic about which calories I take in. I eat plenty of vegetables and lean meats and natural fats. I also take in a reasonable share of grains and natural sweets from fruits. These are my strategic investments.
This has kept me from having to go to a doctor for treatment for several years, and saved me an immense amount of money on medical costs. I could have just factored in high annual medical costs as a cost of living and cut food expenditures to offset those costs, but I made the healthier choice. And businesses can make the same choice to prioritize the long term health of their company over the short-term profits gained from constant cost-cutting.
I hope that Laurence Fink and those on his team are able to get many businesses back into a healthy routine of investment that will keep them and the jobs they provide around for a long time to come, because it takes a long-term solution to deal with a long-term problem.