Shifting Sands Whilst Sifting for Profits: Volatile Markets & Crisis for Management
One of the central tenets of management and strategy is to increase firm profitability and in turn enhance share-holders wealth. This is what we have learned and been instructing to the would-be managers in business schools across the world. The world of management in terms of research, education and practice revolve around seeking, disseminating, and practicing best methods of managing manpower, raw material, suppliers, resources, capital, knowledge and technology to increase their productivity and in-turn enhance overall returns to invested capital and profits to shareholders.
Despite the achievement of remarkable sophistication in practice through several decades of research and dissemination of management techniques, businesses and industries one after other, however, are displaying increasing disconnect between the management/organizational antecedents and performance outcomes in terms of profitability - return on assets, return on sales, return on invested capital, and return on equity (ROE). Speaking of pragmatism, established management thumb-rules and practices are having lesser impact on firm performance and speaking academically the validity of management constructs and theories is becoming questionable.
Right from the days of industrial revolution, no stone left unturned by management scholars in search of sources for greater profits. You name it: scientific management of men, incentive designs, human relations and motivation techniques, training and specialization, CEO/Top management team compensation (stock options), organizational designs, TQM, maneuvering industry structure and competition, raising barriers to entry, innovation, competence building, mass production-now-mass customization, dynamic capability, and speed so on.
While there is no doubt management education have added tremendous value to the world of practitioners enhancing the quality of products, employee productivity, consumer surplus, and more importantly shareholder returns over the span of 5 decades from 1950s to 1990s. However, in recent times, the validity of theoretical connections between the management practices and intended performance has become ambiguous.
The organizational population appears to be facing a new state of demand, cost, competition and profit conditions, but their governance and strategies don't seem to reflect a good adaptation to these new conditions. The traditional industries like steel, automobiles, and industrial goods manufacturing that have seen the full life cycle of growth, maturity, and shakeout in the past 100 years are experiencing slow growth despite increases in population and global reach. The new age businesses such as computers, software, and pharma on the other hand, although realizing high growth due to globalization, automation, low-cost and outsourced production methods, the profitability and returns to invested capital are showing chaotic patterns and seem to be on a slow decline in recent time. And interestingly, the profitability performance of the Fortune 1000 firms – the wealthiest in terms of sales, assets and profits don’t seem to be stable, and their wealth creation does not correspond with their size.
Since the performance vary with respect to industry, we tested the relationship between performance and firm size in each industry.
In many industries, in addition to firm size and age, the Price-Earning Ratio (P/E) is negatively associated with performance ratios. This finding supports the argument that governance in many firms seem to be short-term focused giving more attention to the market value of the firm rather than intrinsic performance measures such as ROIC, ROA or ROE. On the other hand - one can speculate - market is not efficiently making investment allocation either. Please see the tables for financial performance in Banking, Electronics & Electrical manufacturing, and Software Companies over two decades (as test cases).
"It is apparent that for any firm these ratios will not be increasing or decreasing continually in one direction, nor they remain at the same level. They tend to fluctuate year to year, However, cumulative firm averages need to stay at a healthy level".
As a case in point, 2008 financial crisis experienced by entire global economy and particularly construction, real estate, steel, automobiles and manufacturing may be a culmination of this trend. The crisis experienced by GM, CITI Group, Lehman Brothers, AIG can be considered the tip of the iceberg. Not surprisingly, small cap and medium cap firms (Firms with less than $10 billion in market capitalization) seemed to have withered the storm and have performed relatively better than large cap firms.
Several factors can be juxtaposed as rationale for the trend which is posing challenges to business academe and the profession of management. Following are some rationale:
1) Global competition: Rise of competition among companies from leading economies as well as those from emerging economies.
2) Volatile industry life cycles, Shortened product life cycles, and disruptive new technologies reducing product life span.
3) Volatile financial markets and currency markets with unquenchable thirst for higher profits in the shortest time-frame forcing firms to seek quick short term gains rather than long-term sustainability.
4) Rise of bureaucratic complexity from both within and without for large corporations resulting in reduced effectiveness of business strategies and organization improvement methods.
5) Dynamic border-less markets that seem to be always looking for something new, and their insatiable quest for high quality and variety.
6) Possibly, industry environment and organizational climate across sectors have become entropic causing randomness, volatility, and in turn displaying disconnect between practice and performance. We will discuss a set of factors that have resulted in entropy and atrophy both within and without the industrial corporations in another section.
7) Markets, especially financial markets have reached a threshold of inefficiency due to the rise of untenable demand for abnormal returns in shorter terms and improper resource allocations fashioned by speculations and inducements; on the other hand, firm governance have become short sighted trying to meet the untenable market demands. Take for example, the role of hedge funds impact on the firm governance. We will discuss a set of conditions that have exacerbated the market inefficiency, and caused harm to firm governance and national economies in another section of this article.
8) Corruption and capricious practices that afflict the corporate boards and political layers across nations. This is altogether a different topic deserving a separate chapter.
9) Rise of agency costs and increased mistrust between board and stakeholders.
10) Cost of regulatory compliance and increased scrutiny from activist groups.
"In addition to industry life cycle, economic, technology, and national contexts, some of the very factors what academicians have identified as the source of profits maximization - such as economies of scale, size advantage, consolidation, financial engineering, and mergers or acquisitions – might have contributed to the ephemeral nature of profits and thus have triggered a crisis for management and strategy".