TORONTO/NEW YORK (Reuters Breakingviews) - Covid-19 disrupted global business in ways that took many leaders by surprise. Systems that had been engineered for peak efficiency, such as global supply chains, came to a halt. Their lack of resilience underscored how important it is for managers to take a long-term view.
In certain sectors, businesses have seen unprecedented drops in demand and must now struggle to survive. Almost no amount of preparation could have helped them. But many other companies could have done more to anticipate and get ready for something like the coronavirus pandemic. Warning signs were all around. Even before Covid-19, the average company experienced a supply-chain shutdown of a month or more about once every four years.
Focusing on a company’s long-term prospects isn’t just important to guard against risks. It also has significant upside. McKinsey research on more than 600 publicly listed U.S. companies found that, on average, those that are managed for long-term performance added $7 billion more in market capitalization between 2001 and 2014 than their shorter-term peers. These companies also created an average of 12,000 more jobs between 2001 and 2015.
Nonetheless, business behavior focused on the short term is on the rise. FCLTGlobal, a non-profit organization that develops research and tools to encourage long-term investing, and McKinsey have identified a statistically significant increase in short-term behavior among large publicly traded U.S. companies from 2015 to 2019.
No single factor explains the trend, but a powerful one is outside pressure. In a survey conducted by FCLTGlobal and McKinsey earlier this year, executives said they face insistent demands from certain investors, and even board members, to put short-term results first. They also said that pay packages linked to the company’s earnings give them incentives to do so.
Most executives know better than to prioritize short-term performance, but feel they have no alternative. We’ve seen it happen too often. CEOs plan worthwhile long-term projects. Then their companies experience setbacks. Fearing that investors will complain, CEOs divert funds to prop up quarterly earnings. The long-term projects slow down or stall out.
Long-term investors pay a high price for such short-term management. They shouldn’t have to. As FCLTGlobal and McKinsey learned during a four-month research effort, there is a management formula for long-term business success. This formula, which we describe in a report published last Thursday, is built around behaviors that emphasize the fundamentals of value creation. Such behaviors can see companies through times as challenging as these.
Companies create sustained value by increasing their revenue and achieving returns on invested capital that exceed their cost of capital. Executives seeking to generate long-term value must therefore invest in initiatives that yield growth and make sure those initiatives collectively produce returns.
Once executives assemble portfolios of growth projects, they’re apt to continue supplying those projects with similar shares of the company’s capital and talent. That’s a mistake. Allocating resources in the same way, year after year, is how companies miss out on new opportunities.
Instead of standing pat, executives can reallocate capital frequently. This practice is linked with superior shareholder returns. Executives should also stick to their long-term plans. When challenges arise, they must resist the temptation to take actions that boost short-term profit.
Lastly, executives must attend to the needs of other stakeholders, not just those of shareholders. Companies create long-term value for investors only when they maintain good relations with customers, employees, communities and regulators.
Now is the moment for executives to take up these behaviors. CEOs and boards around the world, including those at companies whose futures are in doubt, are reimagining their businesses for a post-pandemic future. That exercise gives them a chance to orient themselves, their managers and employees, and their companies’ partners toward the goal of creating long-term value.
To initiate the shift, business leaders can make a few practical changes. They can spend more time devising strategies and overseeing their execution. For CEOs, that means getting more involved in allocating resources to long-term projects. Board members can review this work more closely and tie CEOs’ pay to how well they do it, not just to financial results.
CEOs can also make a habit of communicating more openly with stakeholders, particularly investors. Besides discussing each quarter’s results, CEOs should explain their long-term strategies and investments. When temporary performance disappoints, CEOs can ease some short-term pressure by putting this in context for investors.
Hubert Joly, the former CEO of Best Buy, knows the importance of engaging investors. As he said in a recent interview: “They want you to create long-term value, so if you’re logical and you follow through with a track record of delivering results, they’re very open to this.”
Similarly, CEOs should make a point of reporting non-traditional performance measures, such as employee satisfaction, in relation to their companies’ financial results. More and more investors recognize that good non-traditional performance helps companies create value, but they may not appreciate what it takes to achieve that performance. CEOs can make that connection clear.
We know it’s not easy for executives to manage for the long term. But the costs of short-term management are steep, as Covid-19 has reminded us. CEOs and directors can serve stakeholders better by taking the long view instead.
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