neil woodcock’s marketing blog

Short-term earnings vs. long term sustainability

CEOs know there is an uncomfortable relationship between the need for short-term returns, to appease the demands of shareholders, and the requirement for long-term investment and sustainability. When we first wrote about this in 2002, we learned from the Enron, Worldcom and Equitable Life scandals that the balance sheet can be misleading. Sadly, in 2008 we now have a host of examples of this. A company can make excellent profits this year and look good on the balance sheet even though it acquires high risk customers, acquires a competitor which confuses its core business, cuts customer service standards to decrease costs, fires 30% of its staff, encourages a hard-sell policy to existing customers, reduces its marketing budget by half, fails to invest in product development and cuts all of its IT development budgets. There is one US publicly listed company we worked with who, against advice, did all of this and received a triple A investment rating. Subsequently they were acquired at a knock down price by a smaller competitor. Analyst reports and their interpretation of P&Ls can give a false picture of ‘business performance’.

In public companies, the relentless drive for profit growth to please analysts and stockbrokers (the ’shareholders’) quarter after quarter usually results in an increasingly desperate drive to increase revenues and decrease costs, which invariably leads to increased risks and a decreased chance of sustainable corporate profit.

Despite the irony in the comment box, if the company stops growing profit, the institutional shareholders, city analysts and other experts (who, by the way, have typically never run a company in their lives) start worrying and will mark it down, making it a ‘less attractive’ company to invest in – when actually the opposite may be true. CEOs know this, are generally measured on market capitalisation (in some form) and gear their organisations to maximise this. Therein lies the problem – a mis-alignment of objectives you may say.

“The irony is that private shareholders or employees, you and me, do not require the company to make more and more profits. If a company makes, say, $1bn a year, does it really need to make $1.2bn the next year, and $1.4bn the year after that? At $1bn a year, we’re probably receiving a comfortable return on our investment, we know the dividend is reliable and probably low risk. ”

In mature markets, continual quarter on quarter growth is, over a number of years, impossible without taking great risk. We have witnessed this at first hand recently in the global economy. Trying to achieve this may mean taking wholly unnecessary risks; for instance in acquiring customers at any price, in deflecting corporate resource (time and budget) to acquire companies to create ‘false value’ [*1], in reducing investment required to underpin future returns or moving into areas which are not the company’s core competency (e.g. financial services companies moving into property management). Late 20^th century corporate strategy encouraged companies to fund this expansion by ‘leveraging assets’, borrowing against earnings and other assets. It is easy to see now that this strategy can be mis-interpreted and can leave companies very exposed, underpinned by both a precarious balance sheet and a business model far removed from their core business competencies. Leveraging is a fairly late 20^th century phenomenon – IBM did not issue their first leveraged debt until 1979. In 2008, leveraging in this way was commonplace for many large corporations (and private individuals). As one example, Wall Street investment houses had a leverage of around 35:1 – that means that they had $35 of debt for every $1 of asset [*2].

“Richard Branson floated Virgin on the stock market in the 90s and said how excited he was that the public could participate in the success of the brand, and how access to more capital could help Virgin become the world’s leading airline. Sometime later, he bought the company back of the stock market stating that it ‘is impossible to manage this business in a way that the City requires, making increased quarterly profits is unrealistic and forces me to make short term decisions I would not ordinarily make. I’m in the business of building sustainable value and this may mean taking decisions now which reduces short term profitability’”

Recent studies on the financial crisis have concluded that companies, in their desperation to receive a positive response from city analysts, have lost sight of and moved away from the business competencies that underpin any good business; that is the ability to appeal to your target customer base more than your competition, and set up your organisation to do this effectively and efficiently. We have shown in previous articles [*3] that companies that do this well perform better than companies that don’t. Customer management (as described by the CMAT model) correlates very closely with a number of financial performance indicators. In fact we can relate the in-depth CMAT studies directly to the global crisis we find ourselves in. Take the troubled banking sector. Our extensive global CMAT research while at QCi put Canadian banks top of the list in terms of the way they manage customers. Reflecting on the current crisis, it is no co-incidence that Canadian banks have also come out on top of the recent list of the banks who have performed best in the current crisis.

We have spoken with city analysts and brokers over the years about the basic driver of company profitability; customers and the importance of understanding the competence of companies in managing customers. We have noticed an increasing interest, amongst leading city analysts, in this, especially recently. However, it is true to say that most still do not get it. We commented in previous articles [*4] that if analysts showed interest in customer management, they tended to focus on the ‘easier’ indicators of ‘customer’ performance (which do not underpin sustainable profit); ‘growth in customer numbers’; ‘high customer satisfaction’ and ‘high customer retention’, for instance. This remains the case today. Experienced managers know that these indicators may be misleading and certainly do not predict business success.

Our plea to analysts, stockbrokers and economists
is to read this article and others like it and work with us to find a way to better value companies using this customer dimension. The better companies manage customers, the more solid their underlying profitability. Analysts should use this as an important component of their company valuations.

Our plea to CEOs and other directors
of large enterprises is two-fold. Firstly, take a fresh look at your business from your customers’ perspective and improve the effectiveness and efficiency with which you manage customers. There will be a significant prize there worth looking for, which may well carry you more comfortably through the recession and enable you to come flying out of it, leaner and meaner. Secondly, be strong and confident in your discussions with the City that good customer management is the core competency of a business, and underlies sustainable business performance.