Short-term, short-sighted

2012

Management consultants, authors and commentators have long advocated the need for organisations to take a longer-term view rather than the short-term approach taken by many.

In the 90s in particular, developing a strategic vision or direction was seen as a business imperative (with for example, processes such as the Balanced Scorecard and Weighted Strategy Maps). Whilst this view might still be appreciated and indeed talked about by senior managers, the reality may be quite different.

For example, a colleague working in a large multi-national firm told me of the strategy towards "Operational Excellence" introduced two years ago - this amongst other things included quite a few thousand redundancies. The strategy has not brought the results hoped for. Guess what? The latest strategy is to re-employ many thousands of people to provide the organisation with a "re-birth".

Think about some of the current decisions being made in your own organisation – are they moving the organisation towards achieving its strategic goals? Or do they appear to be made in haste to achieve short term results?

Now at last we have a research study that clearly demonstrates the value of long term thinking, strategy and decision making. In a paper titled Short-Termism, Investor Clientele, and Firm Risk, published in Social Science Research Network (Feb 4, 2012), authors Brochet, Loumiti and Serafeim (all of Harvard Business School) using conference call transcripts, measured the time horizon that senior executives emphasize when they communicate with investors.

They showed that firms focusing more on the short-term have a more short-term-oriented investor base. Moreover, they found that short-term-oriented firms have higher stock price volatility, and that this effect is mitigated for firms with more long-term investors. Overall, their evidence suggests that corporate short-termism is associated with greater risk and thus affects resource allocation.

Here's a summary of their findings:

Short term firms Typically Outcomes

  • Face greater risks, including a higher cost of capital and a lower return on assets.

  • Have a base of like-minded short-term investors.
  • Show a higher likelihood of barely beating analyst forecasts.
  • Show a higher likelihood of reporting very small positive earnings.

  • Higher stock-price volatility.
  • Vulnerable to the violation of loan covenants.
  • Mixed results in the short term as well as risks to long-term performance.

  • Stress near sighted projects over research and development and other capital investments, misallocate resources.
  • Are more oriented to the short term than the long term, and they disclose more information related to the near future.

  • Are fuelled by the pressure from stock analysts and investors to deliver good news in quarterly earnings reports.

  • Stunts future development.

  • Have a more tumultuous business model.

  • Have higher cash-flow volatility and a longer operating cycle (that is, the time it takes to sell goods or services).

  • Results are negatively correlated with return on assets, leverage, rank in the S&P 500, and market-to-book ratio.

  • Executive compensation is typically tied to current performance and stock prices.

  • Incentivize managers to overweight the short-term.

  • Results are often mixed and mask greater risk for the long term than other companies face.

So the evidence from this research is quite compelling – there are clear business and financial reasons for favouring the long term over the short term. But the question remains – why do so many firms continue in this vein?

I immediately thought of three possible reasons:

  • Short term emphasis exacerbated by the speed of technology driven communication – everyone wants something now and they need to see results now – through Twitter, Facebook, etc. and of course the ubiquitous quarterly reporting of financial results,
  • Short termism has also been heightened by the move from a focus on relationships to a focus on transactions – i.e. a concentration on an immediate win/lose mentality rather than the long term win/win of an ongoing relationship,
  • And finally, the process of providing executives with short term incentives tied to current performance and stock prices.

Then I went further into the paper. There's another really interesting finding from the research that may provide some clues. It seems as though there are certain types of companies and industries that tend to invite short-term focusing.

Types of short term organisations are more likely to be . . . Types of Long term organisations are more likely to be . . .
  • In business services and supplies, computers, and electronic equipment, banking, energy, export trading, insurance, and wholesale industries.
  • Companies that sell products to other businesses.
  • Companies whose performance is driven by efficiency of execution.
  • In apparel, automobiles, beverages, consumer goods, pharmaceutical products, and recreation services, construction, medical equipment, and utilities.
  • Companies that sell products to individual consumers.
  • Companies whose performance is driven by branding and innovation.

So, for those of us who offer advice to senior managements or who may be charged with managing the direction of an organisation, there could be some new questions to answer:

  • What type of industry or business are we in? Is a short-term business strategy (with all its inherent risks) a viable option?
  • Who are our customers? Other businesses or individuals? Will this impact our strategic thinking and decision making?
  • Is our performance driven by innovation and branding or efficiency of execution?

Now, perhaps these are not "either/or" questions. However, they would be a really good start to a discussion on setting a firm's strategic direction.

As a post script to this article, my colleague mentioned earlier, works for one of the types of organisations deemed to be in the "long term" category. The organisation sells to individuals rather than other businesses and their performance historically has been driven by innovation and branding. Hmmm.

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About The Author

Bob Selden
Bob Selden

Bob Selden is MD of the Australian National Learning Institute and author of What To Do When You Become The Boss. He has been a boss many times over. He's also worked for many. Some of these relationships have been fantastic and some did not work as well as they might have.