Conventional wisdom suggests that the long-term is the clear path to success when it comes to investing and business strategy. However, the authors of a new study published by McKinsey demonstrate that short-term thinking is crippling the long-term success of firms. According to the study, managing for the next earnings call and making decisions based on pressure from Wall Street analysts will hinder long-term revenue and earnings growth. Or will companies that restrict short term thinking merely restrict competition and enable established firms to hide behind stasis?
First, let’s define what a company with long-term thinking does, according to McKinsey. The biggest point appears to be resisting the urge to make business decisions based on quarterly earnings reports. Companies that remain focused on their long-term goals will not make cost-cutting decisions to avoid short-term earnings losses. Investors and analysts, impatient to see growth, get nervous when expectations are missed for even one quarter. The pressure to deliver short-term results has increased—65% of CEOs surveyed believed that the focus on the short term has increased over the last 5 years.
In addition, companies that planned for the long term spent more money on research and development, about 50% more annually, than their peers. Investment into R&D continued even through the financial crisis. Finally, though the McKinsey report found companies with a long-term mindset lost significant market share during the financial crisis, they were able to gain it back quickly in the following years.
So how did these companies perform over the long term? Over the period studied (2001-2015), these firms, measured against their peers:
- Added 12,000 more jobs
- 47% higher revenue growth
- 36% higher earnings growth
The “right” thing to do is determine your long-range business plan and pursue it without giving too much credence to those shouting for short-term results. Or is it? The McKinsey report has been challenged in some high-profile publications. Larry Summers, in the Harvard Business Review, takes a dim view of the very concept of short termism:
“On the other hand, some of what is done in the name of managing for the long term may be unmonitored waste. The observation that many “unicorn” companies with no profits — and sometimes no revenues or even fully developed products — get valued so highly makes me skeptical of the idea that the capital market is systematically myopic.”
Summers is hesitant to accept the McKinsey results as the final analysis:
“Again, it may be that the long-termism hypothesis is right, and there may be ways of teasing causality out of the very interesting data set that McKinsey has created. But at this point, I think the issue is still unresolved.”
An article in the Schumpeter column in The Economist is even more skeptical and finds flaws in both the concept of short termism and the methodology in the study itself. The author points to both longer tenures of CEOs, the small market share held by short-term investors like activist hedge funds, and the large number of passive funds held. He or she believes that the flaw in the study lies with causality. Do firms become weak when they act in the short-term or are the companies already weak and likely to fail anyway even if they adapt short-term strategies? The writer believes that McKinsey fails to prove causality between company behavior and long-term results. The column ends with the statement that short-termism is merely a distraction from the real problem. The author believes “entrenched” firms will become more comfortable with the strategies McKinsey espouses, keeping their profits comfortable and making it more difficult for new companies to get in the game.
The dialogue has proven to be incredibly interesting but I believe that both sides of the discussion agree that companies and markets need to develop strategies that encourage growth. Innovation is the undercurrent here and it is the engine that keeps the economy moving. The disagreement about how to get there is one I will continue to watch.