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 a formula that 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 is 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 period). Blemishes like losses are evened out as the scoring is based on a certain 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/ organization. Prolonged respect and success come from performing consistently over a longer period.

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 that CEOs seem to acknowledge.

Since the stock markets define the parameters, the shareholders dictate the demands and expectations. Maximizing shareholder value is an idea that 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.

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 riskier than cutting costs. Everything becomes an immediate ROI based approach which also reduces the apparent value of even large, long-term benefits. Creativity 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 few qualitative considerations when slashing costs are involved. It is important to note that most companies that have grown have been companies that have launched innovative products. The chances of the long-term success of a ‘me too’ company are limited.

• Cutting Corners

Toyota has had to recall cars simply because they started focussing on costs rather than quality. With unfailing regularity, every year they have been recalling cars. Cost-cutting seems to be a disease and even President Akio Toyoda has had to publicly apologize 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, it is sounding its 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 that get in the way of creating long-term shareholder value. Al Dunlap and even Hurd are typical examples of such CEOs.

• The shift from Best to Biggest

Being “the best” is 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 organization 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 on the sale of these products/services. All expenses are paid from these revenues. There is the 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 may be. People assess 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 per cent of the market capitalization. Contrary to popular beliefs, he has never been a proponent of focus on shareholder value. 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 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 contribute to the world by making tools for the mind that advance humankind.’ 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. Was Pat Cash as famous as any one of them? Not a chance.

There is only one valid definition of a business purpose: to create & nurture a customer. Stick to it.