Thursday, January 24, 2013

Penny Wise, Pound Foolish- Short Term Success, Long Term Failure

I love the game of tennis. The ATP (Association of Tennis Professionals) releases tour rankings of its players at regular planned intervals. There is formula which is used to calculate the rankings of the players. To keep it simple, the rankings are based on the quality of tournaments played and quite obviously on the quality of players.
The emphasis in ATP rankings are based on tenacity, longevity and consistency. Very clearly, the rankings are not based on the score sheet of each match i.e. the difference in points between players in a match. Interestingly rankings in all the sports are based on similar parameters. The key in giving rankings to such people/ teams are those who give a sustained performance (over a defined time period). Blemishes like losses are evened out as the scoring is based on a certain time period.  By that extension, players and teams, if they are to maintain or climb the rankings have to consistently perform and cannot afford to be short term winners or a flash in the pan.
Taking this principle to the world of business. Akin to the ranking, the emphasis is on the long term growth of a business/ organisation. Prolonged respect and success comes from performing consistently over a longer period of time.
However the quarter to quarter approach has taken a toll on the long term success of the business. Catering to the stock market seems to be more the norm. Quarter to quarter guidance seems to be the only benchmark which CEOs seem to acknowledge.
Since the stock markets define the parameters, the shareholders dictate the demands and expectations. Maximizing shareholder value is an idea which comes from short- sighted people and is probably one of the most stupid ideas I have encountered.  Maximizing shareholder value in the short term leads to disastrous results and this is exemplified by many companies for example - HP.
Using the tennis ranking analogy, the short term outlook of business implies that the rankings are based on the score-line of each match rather than the number of matches won. Otherwise a player can play on surfaces comfortable to him/ her and boost her rankings which the ATP rankings do not allow. Likewise businesses will have to navigate different seasons, competition and conditions over a long period of time.
What are the pitfalls of such a myopic outlook? They are multiple. Some of them are listed here.
  • Innovation
One of the first things to suffer is innovation. Once the question, “How do we make the most money?” is asked, whether it’s for the short term or the long term, decision-makers discover that innovations that add value to customers are inherently more risky than cutting costs. Everything becomes an immediate ROI based approach which also reduces the apparent value of even large, long-term benefits. Creatvity is stifled.
  • Risk Taking
With larger risk taking comes the possibility of larger losses. Risk taking can become a liability and a very cumbersome process. From an executive perspective, cost cutting is an easier tool to work with. There are very little qualitative considerations when slashing of costs are involved. It is important to note that most companies which have grown have been companies which have launched innovative products. The chances of the long term success of a ‘me to’ company are limited.
  • Cutting Corners
Toyota, has had to recall cars simply because they started focussing on costs rather than quality. With unfaling regularity,  every year they have  been  recalling cars. Cost cutting seems to be a disease and even the President Akio Toyoda has had to publicly apologise for the wrong focus. Customer focus has taken a back seat. This when personnel ask, “What’s in it for us” rather than, “What’s in it for the customer?”
  • Lack of Customer Focus
When any organization looks too much inwards and loses track of its customer then it is sounding it's own death knell. The top brass of any organization should take judicious calls and be aware that the customer is king. That is one gospel will not change. If customers are happy and satisfied then the finances will be taken care of. Profitability is a result of customer focus and not the only goal. As Peter Drucker noted, “the only valid purpose of a firm is to create a customer. “
  • Executive Compensation
Unfortunately the compensation of the C-suites is inextricably linked to the stock market. That itself creates an imbalance and this translates into the adoption of short term measures. Executives start taking measures which gets in the way of creating long-term shareholder value. Al Dunlap and even Hurd are typical examples of such CEOs.
  • Shift from Best to Biggest
Being “the best” is basically focusing on the customer. Being “the biggest” is essentially focusing on making money. There may be a slight dichotomy here but the point is that when an organisation is only focused on making money rather than being the best at what they do, there will be compromises. HP is a very clear example. From being the best at what they do, they focused on being bigger than being the best.
  • Real Market Vs Expectations Market
The “real market”, is the world in which tangible products and services are created, produced and marketed. Revenues are earned based the sale of these products/services. All expenses are paid from these revenues. There is a realism of sorts. Assuming that all the products/ services are sold, the executives can control this—at least to some extent.
The "expectations market' rides on expectations or conjectures, however scientific or mathematical they maybe . People asses the real market activities and form expectations on how the company will perform in the future. This expectation is traded by people in other words, investors in a venue called the stock market. What drives the expectation market is further expectations. 
Unfortunately if there is one person who is wrongly held responsible for the shareholder value/ expectation concept is Jack Welch; during his tenure as CEO of GE from 1981 to 2001, as a result of his capacity to grow shareholder value and meet his numbers. When Jack Welch retired, the valuation of GE had risen from $14 billion to $484 billion. Since Welch retired in 2001, however, GE’s stock price has not fared so well: GE has lost around 60 percent of the market capitalization. Contrary to popular beliefs, he has never been a proponent of focus on shareholder value. Infact he has rubbished it - “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal. … Short-term profits should be allied with an increase in the long-term value of a company.”
Not all companies are following a short term focus.
  • Starbucks had infact even refused to share year on year store sales. And needless to say Starbucks has been going from strength to strength.
  • Steve Jobs was very clear that shareholders didn't matter much and that they certainly wouldn't interfere with Apple’s pursuit of its original customer-focused purpose: ‘to make a contribution to the world by making tools for the mind that advance humankind.’ Infact Jobs detested shareholder meetings! Needless to say, I don't need to talk about the success of Apple.
That is why we all love a Borg, Federer or closer home Tendulkar. They are famous for their consistency, class and excellence over a long period of time. Was Pat Cash as famous as anyone of them? Not a chance.
There is only one valid definition of a business purpose: to create & nurture a customer. Stick to it.

4 comments:

Nisheeth Srivastava said...

This is a very nicely researched and articulated article and I actually agree with the point raised. Dell wanting to take the company off the bourses back into private hands is another example of how the entire principle of short term shareholder value enhancement occasionally inhibits innovation and execution of long term vision for a company's growth. Enjoyed reading this article Vejay, cheers!

Gopal Swaminathan said...

Great article Vejay - with so many examples from all over... great point too - the point of a business is to nurture its customer. You are bound to do only incremental stuff if you do not break your business model - you cant break the biz model without short term calamity in the stock market. This is true even for personal careers.

virgovim said...

Nice read, thanks for sharing. I have 2 points to contribute:

1. Hind sight is always 20/20. Simply to use Jack Welch from your own example - today we look back and almost unanimously agree he was visionary and worked for GE's long-term interests. The real point is - DURING his tenure, how many people gave him the same credit? How was he criticised or judged while working on his long-term vision?

I think human nature and the reality of business cycles vis-a-vis the average productive human life span causes what you call "myopia" or short-term success to be more valued than longer-term thinking. I'm not sure we'll ever be able to overcome this - nor whether we should overcome it completely given the uncertainty and lack of knowledge of what's going to happen down the road.

And what exactly is "short" or "long"-term anyway? 1yr, 5yrs? 10, 15? Should that relate to business and tech cycles?

2. Quality of leadership and its inherent motivations - let's not throw this consideration out of the window. CEOs and board members are human, driven by profit motives and other very personal expectations. To suggest that one can easily overcome such issues as greed, lust for power or recognition etc. is misplaced. To this extent, perhaps tying in leadership to short-term performance is not necessarily a bad thing - it could provide less room for them to scheme and maneuver, more transparency of governance and performance etc.

I think the bigger issues we need to grapple with are the real indicators of performance. Is it really about the number of coffees sold (Starbucks) or do we somehow need a better matrix of metrics to judge the performance of a company and its leadership?

S Vejay Anand said...

Thanks Nisheeth, Gopal & Vimal. My idea of short term is 1-2 years and lesser. (Nowadays it even seems quarter to quarter).
Leadership needs to be bold like a howard Schultz who belled the cat or as Nisheeth pointed out Dell who has decided that he will go private. Human frailities will come in the way, but it is for the same human to differentiate what is good for the company and what is good for company, customer and himself altogether.
Pandering to the stock market seems to be a fashion however bad it is. It is good to have a short term indicator but it cannot be a goal. It can be a means to attain a larger, longer sustainable goal.

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