What companies must do to sustain long-term growth

January 29, 2018 10:00
To ensure sustained growth, corporate leaders must adopt a business model that prioritizes long-term vision over short-term financial engineering. Photo: Reuters

It is perhaps time for corporations and their shareholders to design a more sustainable long-term business model that emphasizes transformative research and development.

In recent years, investors have grown enamored of FANG firms (a reference to Internet giants Facebook, Amazon, Netflix and Google) and other mostly tech-driven disruptors. Their phenomenal investment returns have pushed financial markets to all-time highs, helped along by an unprecedented environment of sustained low interest rates. The ascent of such stocks has shone a light through the slow-growth, high-debt gloom that envelops much of the post-financial crisis world – even as government and consumer scrutiny grows of their practices and market dominance.

But has the success of these lighthouse companies distracted us from the need to drive growth across the global economy? How can more businesses – both new and established – build sustained success? We argue that the answer lies in – one that preserves companies’ core missions and competitiveness, rather than incentivizing underinvestment.

A better business model

In some respects, the FANGs and their ilk offer some good lessons. Tech firms prioritized operating cash flow over profits – to invest in those endeavors that would help them retain a competitive edge. But we can all play a part in ensuring that stellar growth is not the preserve of only the few, and a good place to start would be with these all-too-common failings:

1. Misallocation of capital
Zero and negative interest rates have arguably prolonged excess capacity and prevented well-run firms from seizing an advantage over the over-leveraged. As a result, access to easy money has created legions of zombie banks and zombie-like borrowers. Fortunately, the gradual normalization of monetary policy should make it more expensive to fund these broken institutions. As investors, it is important to be on the right side of this shift.

2. Wrong incentives for managers
Instead of making wise capital expenditures, too many management teams are incentivized to conduct stock buybacks that inflate their stock options. Yet share buybacks can actually diminish medium-term returns by starving investments that boost competitiveness.

3. Zero-based budgeting that encourages underinvestment
Starting budgets from scratch every year to justify expenses frequently turns into a pure cost-cutting exercise. In turn, this can encourage companies to underinvest in the essential fabric of their businesses – especially their people – while over-accentuating their cash flows to service their enormous debts.

4. Growth powered by excessive debt
Since the 1980s, a credit boom has fuelled the world's growth – with the knock-on effect that we collectively over-consume and under-save. Someone must repay the world’s sky-high levels of debt – otherwise we risk defaulting – but who will shoulder the burden? High-earning baby-boomers are retiring and millennials are struggling to enter the marketplace with good jobs and affordable housing.

Shifting from short-term thinking

To fix such deeply ingrained problems, the world clearly needs a new business model that emphasizes decisions taken for the long term, not the next few years. Myopic thinking is leading to ever-shorter corporate lifespans: research by Credit Suisse indicates that the average age of an S&P 500 company is less than 20 years – down from 60 years in the 1950s.

Is it any wonder, then, that so many R&D efforts seem to be designed for short-term payoffs? Instead, governments and companies need to step up their commitment to fundamental research to create the kind of seismic shifts in innovation that are socially, economically and environmentally transformative. Our analysis of productivity’s decline shows that an R&D-focused approach may be the only way to escape the current slow-growth economic trap.

It may sound radical, but a wholesale shift in thinking would in fact be welcomed by both electorates and shareholders alike. Voters know that economic change takes time, and they are crying out for political leaders who have a vision of the future.

The boardroom seems to be the perfect place to start making this switch. As owners of their companies, shareholders can insist on good corporate governance and reward smarter decisions. They have the power to encourage initiatives that emphasize R&D and boost long-term competitiveness – not balance-sheet maneuverings designed to inflate earnings and stock options.

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As Global Strategist at Allianz Global Investors, Neil Dwane is responsible for presenting strategic house views and overseeing the Economics and Strategy Research teams.