Companies with a long-term strategy significantly outperform their rivals

29 March 2017 Consultancy.uk

Short-termism destroys long-term business value, a new study finds. Companies with a long-term strategy have outperform all other companies over the past fifteen years on a range of key fundamentals: generating 47% higher total revenues, 36% higher average company earnings, 81% higher average company economic profit, and creating total market capitalisation of $7 billion more on average. Long-term focused companies also created more jobs, at around 12,000 on average. The wider cost of short-termism, all things being equal, stood at $1 trillion over the past ten years.

The effects of the phenomenon of short-termism in the business world, whereby companies focus on delivering short term boosts to results often at the expense of longer term strategies, has seen considerable debate over the past thirty years across a range of institutions. The practice is contended to destroy value for businesses in the long-term.

Demand for short termism has increased in recent years however; a recent McKinsey & Company survey showed that 87% of executives and directors feel most pressured to demonstrate strong financial performance within 2 years or less, while 65% of executives and directors say short-term pressure has increased over the past 5 years. In addition, 55% of executives and directors at companies without a strong long-term culture say their company would delay a new project to hit quarterly targets even if it sacrificed some value.

In a new report from McKinsey Global Institute, the long-term effects of taking a short-term strategy are explored – providing further evidence that short-termism is not only bad for companies, but for the economy as a whole. The research is based on a data set of 615 large- and mid-cap US publicly listed companies from 2001-2015, the data is used to create a ‘five-factor Corporate Horizon Index’ that maps the difference in performance of long-term focused companies against the rest.

Aggregate gauge of short-termism

According to the study, the phenomenon of short termism has ticked up since the beginning of the reporting period as more and more companies across the economy started to focus on short term results in the early 2000s. From midway through the decade, economic conditions, particularly increases in fixed asset investment and strong earnings growth, saw companies increase their focus on the longer term. The crisis and the years the proceeded it have seen increased focus on the short term.

Average company revenue and average company earnings

The study also sought to identify in how far a number of key company fundamentals performed over time, in relation to following a long-term strategy or all other strategies. Up to 2014, the total average company size by revenue for long-term companies was 47% higher than all other companies. The faster pace in revenue growth was particularly noted following the financial crisis, as the average annualized rate of growth from 2009 to 2014 hit 6.2% for long term focused companies compared to 5.5% for the rest. In addition, companies operating long-term strategies tended to have less volatile revenue growth over the whole period, with a standard deviation of average revenue growth coming in at 5.6% compared with 7.6% for all other companies.

The research also found that companies with long-term outlooks had 36% higher average company earnings than all other companies by 2014. Average earnings were also faster to rebound following the crisis at long-term focused companies than all others.

Average company economic profit and average market capitalisation

The research also noted that companies operating on long term goals had considerably higher average company economic profit, which, by 2014 stood 81% higher than that of all other companies. The strong performance in the category shows not merely that long-term focused companies generate higher profits, but also that they are more effective in using capital to grow the business by allocating it to the best available opportunities relative to other options – the companies didn’t only deliver more value than other companies, but were able to grow their margin of value creation systematically over time.

Long-term focused companies were found to have been able to leverage their stronger fundamentals to drive market capitalisation. Market capitalisation at the companies was $7 billion higher than at all other companies. Although, during the financial crisis, long term focused companies were harder hit than all other companies. The study also looked at the economic impact of the higher performance of long term companies on the wider economy, finding that if all companies has taken a long term strategic approach, all things being equal, market capitalisation of US companies would be $1 trillion higher, or around 4% of total market capitalisation.

Average job creation

The research further found that long-term focused companies create considerably more value in the long-term for the wider economy. The growth of long-term focused companies was partly achieved by their hiring more people. On average, long term focused companies have generated almost 12,000 more jobs on average than all other companies from 2001. Extrapolating across all US companies, had they taken a long term position since 2001, this would mean that the US economy would have had 8 million more jobs available in 2015.

According to the consulting firm, based on these estimates of job creation, the potential value that could have been unlocked had all US publicly listed companies taken a long-term orientation exceeded $1 trillion over the past ten years, or 0.8% of GDP per year on average. The firm notes that, if the current trend were to continue, then the average differential would grow to about 25,000 jobs by 2025, amounting to $2.7 trillion (in 2015 dollars) in additional GDP growth if all companies perform as well as the long-term firms over the next decade.

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