A Focus On The Future

The Business Roundtable is looking to the future because recent issues have made them concerned that the current global economic system is not providing enough for future generations.

We agree. The root cause of the problem is not creating long-term value, but the opposite: short-termism. Both managers and investors tend to focus too much on short-term performance metrics (such as earnings per share) rather than on creating value over the long term.

Prioritizing shareholders’ best interests in the short term can make it seem like the financial system only cares about the present and ignores the future.

There is evidence that companies have been focusing more on short-term goals rather than long-term goals. This is shown by the median scores of companies tracked by McKinsey’s Corporate Horizon Index from 1999 to 2017.

Certainly, the roots of short-termism are deep and intertwined. Business leaders making a commitment to improve their value is encouraging.

Companies that try to increase shareholder value in the short term often end up hurting both shareholders and other stakeholders.

In the early 2000’s, some banks made a mistake of confusing two things which led to a financial crisis that caused billions of dollars of damage to shareholders.

Companies who focus on the short term and don’t care about the environment are not only destroying the environment, they are also destroying value for shareholders. Not only do these companies have to pay for environmental cleanup and fines, but they also have to deal with the damage to their reputation.

The best managers take safety into consideration, don’t make decisions that will lower the value of their company, and don’t use accounting or financial manipulations to make their company look more profitable than it actually is.

Actions that devastate shareholders and all other people who have a stake in the company are the direct opposite of creating value.

Value Creation is Inclusive

Companies that want to create long-term shareholder value must satisfy the needs of other interested parties. If you want to create long-term value, you need to take care of your customers, suppliers, and employees.

Sustainable growth is often linked with a strong economy, high living standards, and more opportunities for individuals.

The capitalism that creates value has served as a catalyst for progress. This is evidenced by the millions of people that have been lifted out of poverty, higher literacy rates, and innovations that improve the quality of life and lengthen life expectancy.

A company’s value to shareholders is increased when it has a strong environmental, social, and governance (ESG) foundation.

Alphabet Inc.’s Google Classroom is a free online education platform that helps teachers by providing resources and productivity tools. It can also introduce students in underserved communities to Google applications that they might not have access to otherwise.

Alphabet is not shy about choosing not to do business in instances where it believes that it would be harmful to vulnerable populations. For example, the Google Play app store now prohibits apps for personal loans with extremely high annual percentage rates, which are a common feature of predatory payday loans.

Like Lego, the company’s mission is to use the power of play to inspire children to build their tomorrow. The program helps children in rural China stay connected with their working parents.

Although programs like these definitely help improve Lego’s reputation in the communities it operates in and among its own employees (where motivation and satisfaction levels are 50% higher than 2018 goals), it’s not the only factor.

Sodexo is working to promoted gender balance among its managers. According to Sodexo, the program has not only increased employee retention by 8 percent, but also client retention by 9 percent, and operating margins by 8 percent.

Stakeholders For The Long Term

Time will tell how they act on this conviction. We suggest that leaders give priority to creating long-term value when there are decisions to be made about trade-offs. This is because it results in better allocation of resources and healthier economic conditions.

Consider employee stakeholders. A company that does not invest in its employees by providing a good work environment, paying them well, or offering good benefits will have trouble attracting and keeping high-quality employees.

If a company employs lower quality employees, the products they produce will be of lower quality. This will lead to decreased demand and could damage the company’s reputation.

More injury and illness can lead to greater regulatory scrutiny and more pressure from unions.

Higher turnover will inevitably increase training costs. A company that doesn’t offer a good work environment will have a hard time competing against other companies that do.

If the company earns more money than it costs to keep the company running, it can afford to pay more than other companies for its employees and still do well, and treating employees well can actually be good for business.

How well is well enough? To create value in the long-term, wages should be Enough to attract quality employees and keep them motivated and productive. Non-monetary benefits and rewards can also help to improve morale and productivity.

Even companies that have outsourced manufacturing to low-cost countries with little labor protection have found that they need to monitor the working conditions of their suppliers or face negative consequences from consumers.

Competition And Customer Value

The belief that the purpose of business is to beat the competition is incorrect and has become common in strategy literature.

Companies must be aware of competition and manage it to create value in the long run.

For example, a company may create value for customers and investors by creating goods that are better than their competitor’s goods. This would include creating goods that address a specific customer need in a better way than the competition.

In other words, if your product or service is not significantly better than your competitors’, customers are unlikely to pay more for it.

Competition should not take away from a management team’s primary objective, which is to please customers by knowing and predicting their needs, having excellent product and process innovation, and providing great service.

In other words, businesses should not aim to compete, but rather to create value despite competition being present.

Different firms’ responses to competition become critical, with some more likely to succeed than others, depending on the business environment.

In the information economy, the most successful responses to competition focus on innovation and understanding customer needs.

If a company’s success is contingent on winning at the expense of others, rather than creating something new or providing value, it is in a very precarious position.

This text is saying that many companies are more interested in making money than they are in keeping their customers happy, which will eventually lead to the company’s downfall.

Social Consequences

The lines are not always black or white. Mature companies that are in competitive industries have to decide if it’s worth it to keep plants that are losing them money open. This is done to prevent employees from becoming unemployed and to stop suppliers from going out of business.

It would be economically damaging to do this in an industry where globalization is occurring, even though there would be immediate, significant costs to the local community where a plant is closed.

Some politicians are putting pressure on companies to keep failing plants open even though it may not be beneficial for the company. The government is sometimes a major customer of the company’s products or services.

According to our experience, managers not only take the bottom line into account when making decisions, but also agonize over decisions that have a significant impact on workers’ lives and the well-being of their community.

If goods are produced at a lower cost, consumers will benefit, and if operations that are costing public resources are closed, it will benefit the economy. Employees will also benefit from this by moving to new jobs with more competitive companies.

It is true that employees cannot always just pick up and relocate, but it is also true that companies that create value create more jobs.

In looking at employment, we found that the US and European companies that have generated the most shareholder value over the past 15 years have shown stronger growth in employment.

Successful Value-Creation Strategies

Companies create real value when they develop products and services that offer unique benefits to their chosen customers, leading to long-term growth and profitability.

In order to remain leaders in the industry, companies need to establish a process of sustainable value creation.

When investors buy stock in Motorola, or when customers enter into a partnership with that company, they are not basing their relationships on a particular product or set of products. They are basing their relationship on the company’s ability to adapt and change.

Motorola will continue to develop processes to stay ahead of emerging technologies and changing market needs to create useful and profitable products and services.

The ability to make use of resources and effectively match them with opportunities is the most important thing to any organization that wants to be valued by customers and shareholders.

In order to create value, the company must have motivated employees with the necessary capabilities. Some of the major themes that underlie successful value creation strategies in the information economy are:

  • Product and process innovation
  • Detailed, real-time understanding of changing needs of well-defined customer segments (frequently database enabled)
  • Leveraging emerging technologies in existing markets (particularly information technology)
  • Leveraging technology or regulatory changes to create new markets • Reconfiguring company and industry value chains
  • Creating win/win partnerships with customers, employees, and suppliers

Pragmatic Idealism And Value Creation

The traditional win/lose model of business treats the interests of customers, employees, and investors as separate and opposed to each other.

Managers who think that the company should only focus on one thing are wrong. Trying to make the customer happy or to make sure employees are well paid Isn’t a futile cause, it will actually help the company.

We have seen that the exact opposite is true. If behaving in a way that is focused on values is idealistic, then the most practical way to manage a company is with idealism.

This idealism acknowledges that business cannot succeed in a vacuum and must work together with other parts of society to create value. It rejects the idea that there is a clear divide between “us” and “them”, instead recognizing that we are all part of an interconnected system. Here is a pair of principles for managing with this systems view of business:

  • Think first about creating the most value, then think about capturing part of that value as profit.
  • Think of the value of a product or service as being what the customer would pay for that product or service if he had perfect information, such as knowledge of the total life-cycle costs and benefits associated with the purchase.

There is a great irony for managers who reject these two principles.

Many managers who consider themselves the heroic guardians of shareholder interests and have a no-nonsense attitude may be running their companies into the ground and destroying the wealth of their investors without realizing it.

These managers are usually very competitive and think that concepts like “organizational culture” and “shared values” are unrealistic and created by academics who are not in touch with the business world.

An organization can either take a broad approach or a narrow approach to doing business. This company philosophy can be summed up by the term pragmatic idealism, which means striving to create value for customers, employees, and shareholders in a way that is mutually beneficial.

The company can either try to maximize its own self-interest even if it’s not in the best interest of other parties, or it can try to help the economy as a whole by pursuing a more narrowly defined self-interest.

The latter approach is not working as well as it used to, especially in the short run, because of how the economy is changing.

In an ever-changing world, it’s becoming more and more necessary to build long-term relationships and ventures based on trust, to have employees who are dedicated to providing excellent service and driving innovation, and to have customers who are well-informed.

The only way to succeed in this environment is to be pragmatic and idealistic, and to focus on creating value.

Conclusion

Institutional investors, such as pension funds, can play a critical role in supporting the financial futures of millions of people.

Investors who are worried about climate change and its effects on the environment, such as carbon emissions, water scarcity, and land degradation, are beginning to see the value in sustainable long-term investments.

Indeed, investor scrutiny has been increasing.

Companies that are focused on the long-term must pay attention to the long-term changes that will be required by both investors and governments. They need to be able to adapt their strategies over a period of five to twenty years in order to reduce the risk of having assets that are no longer usable because of environmental concerns or other issues.

The government’s role is to invest in long-term projects, but they don’t always do this effectively. Shareholder value and externalities can diverge when things go wrong.

If externalities are not priced or controlled, resources will not be allocated efficiently. The effects of climate change can put new strains on relationships between shareholders and other stakeholders, and sometimes cause these groups to completely disagree with each other.

About the Author Brian Richards

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