Should profitability be the sole objective of companies?
Should profitability be the sole objective of companies?
One of the great challenges facing societies in the 21st century is certainly to find the right balance between the short and the long term, between the need for flexibility and sustainability. The economic environment has never changed so rapidly. Competition is intensifying, mainly as a result of technological developments, faster changes in consumer preferences, globalization and a faster flow of information and capital. In addition, there is hysterical attention to quarterly results amplified by the media and sell-side analysts.
A major McKinsey survey of 1,000 executives and directors worldwide, conducted in 2015 and 2016, shows that these short-term pressures have only increased [1]. When asked about the sources of these pressures, 40% of respondents identified themselves (boards of directors and executive committees) as one of the main sources of short-term pressure. This is an unexpected result when shareholders are generally identified as the main culprits. Too often directors and officers act on the basis of preconceived ideas of what the market expects of them. Too much emphasis is placed on whoever makes the most noise, be it an activist shareholder or a broker, rather than on the word of long-term shareholders. In their report, the authors of Focusing Capital on the Long Term (FCLT) explain that executives are locked into a vicious circle: they believe that investors expect immediate financial performance from them and therefore communicate short-term objectives and indicators, which push investors to align themselves with this horizon for which they have the data necessary for their analysis.
Managers also face psychological pressures and cognitive biases. We all, more or less consciously, have a preference for short-term certainty over an uncertain future. Moreover, the legitimacy of a manager also rests on the trust of his teams, who will often expect immediate results. In this environment it is essential that the board of directors serves as a bulwark and ensures that the leader stays the course.
The resilience and sustainability of a company requires a long-term vision where investments with sometimes distant returns are required. Investments in innovation and in the drivers of future production, the development of human talent, the building of stable and reliable relationships with suppliers are among the actions that will ensure the company’s ability to secure its future profitability. Those that do not are guaranteed to disappear. Companies must therefore have the courage to make long-term decisions even when these could have a negative impact in the short term.
A long-term strategy requires a clear vision, a detailed roadmap with medium and long-term objectives linked to value creation. The real challenge is to find the necessary balance between time horizon, degree of strategic formalization and need for flexibility and responsiveness to meet the challenges of today’s economy. It is essential to have a detailed long-term plan, but it must be periodically updated by the board and management to ensure its relevance by taking into account market developments.
We are in the midst of a cognitive dissonance: while the benefits of a long-term approach are recognized by all, fewer and fewer leaders are applying it. Strategic plans, when they still exist, rarely have a time horizon of more than three years and often less. A joint study by McKinsey and FCLT showed that companies with a long-term culture outperformed their peers on almost all financial measures [2]. Cumulatively between 2001 and 2014, long-term companies had on average 47% higher revenues and 36% higher profits. These companies created on average more than 12,000 jobs than other companies over the same period. They are characterized by more aggressive and continuous research investment policies, even in times of crisis. Like the founder who would like to leave his company to his children, a leader must reflect on his legacy.
[1] Jonathan Bailey, Dominic Barton, and Joshua Zoffer, Rising to the challenge of short-termism, FCLT Global, September 2016, fcltglobal.org. Voir aussi: Short-termism: Insights from business leaders,” survey commissioned by McKinsey & Company and the Canada Pension Plan Investment Board, January 2014, fclt.org.
[2] McKinsey Global Institute, Measuring the Economic Impact of Short-Termism, Discussion Paper, Feb. 2017.
Analysis by Edouard Dubois, Vice President-Corporate Governance & Responsible Investment of Black Rock