Short Termism vs. Long Termism - in The Week before This Week

Power to the People

It’s been a few weeks since I have been inspired to put digit to keyboard.  Whilst there has been plenty going on in the world most of it struck me as “same old same old”.   TWb4TW tries to spot an aspect of recent news stories from which we can all learn something useful.   My feeling about most of the news over the last few weeks has been more “when will we ever learn”!
However last week the Times published an article from Sir Charlie Mayfield, Chairman of John Lewis, in which he advocates the need for a “surge in alternative ownership” of businesses.   By this he meant, employee owned businesses like John Lewis, mutuals and family owned businesses where ownership is passed down the generations.  His argument was that different forms of business ownership drive different behaviours with regards to whether a business is being managed for the short or long term.  Sir Charlie believes this is largely caused by how value is realised from different forms of ownership. Even though long termism is regarded as a “good thing” and short termism a “bad or at least less good thing” for most owners the primary means of value realisation is to sell the business to another business or to the public market.   It is therefore not surprising that many businesses are managed for short term results.
Because employee owned businesses like John Lewis can never be sold Sir Charlie claims that “they have no alternative but to focus on future earnings. This means that every one of our 90,000 partners at Waitrose and John Lewis has an incentive to make this Christmas better than the last one. Because we don’t have the option of selling our shares and investing in another business, we have no option but to throw all our energy, passion and talent into making this one better. Year after year”.

Now you see it, now you don’t
Sir Charlie then goes on to make what for me is the most significant point in his article.  “That relentless focus on continuous improvement is a powerful competitive advantage …”.  However the point then disappears because he then asserts that only alternative ownership, employee owned, long-term family owned etc., fosters a culture of continuous improvement over the long term. Whilst I do agree that ownership models have an influence I do not agree that this means that one ownership model will lead inexorably to short-termism, whilst another will guarantee long-termism.
For example the Co-op had an alternative ownership model, being owned by its members/customers.  It did have a long term perspective but this unfortunately went backwards over its 170 year history, resulting in inevitable decline and near collapse.  Conversely here are examples of public market owned companies who practice and thrive on long termism.
Berkshire Hathaway - Warren Buffet ONLY invests for the long term.  30 years ago one share in BH would have cost you $1,000. Today one share will cost you over $200,000!  Many employees are millionaires and his shareholders think Buffet is a god.
ARM Holdings - a great British technology success story that took on the mighty Intel and won.  ARM chip designs power the world's mobile phones, tablets and many other technology products.  Winning long term is the only game to play in their world. 5 years ago their shares were less that £2, today they are nearly £10, in spite of analysts from leading financial institutions and banks consistently talking the shares down.  Employees who hold the shares and have become millionaires were delighted to prove them wrong.
Next - Simon Wolfson has consistently under promised and over delivered. Without a single acquisition and just sticking to its retail knitting in stores and online Next is now more profitable than M&S and shares have risen from less than £20 five years ago to over £70 now.  This continuously improving profitability has delivered special dividends and share buybacks that have made Next shareholders very happy.
Toyota – need I say more!
A “relentless focus on continuous improvement” is the common factor driving the success of Berkshire Hathaway, Arm Holdings, Next, Toyota and of course John Lewis itself.  The Co-op did not and got left behind.

The proof is out there
So it is not necessarily the ownership model itself that determines whether a business is managed for the short or long term.  I believe that the main reason and this is worrying, is just how few people understand just how powerful a “relentless focus on continuous improvement” actually is, just how big a competitive advantage this can create and just how much more profitable those few businesses that practice a “relentless focus on continuous improvement” can become.
You don’t need to take mine or Sir Charlie Mayfield’s word for that.  More than 30 years ago Robert Buzzell and Bradley Gale proved the link between “relative perceived quality” and superior financial performance.  This was not just their opinion or even their direct experience.  It was from an analysis of the performance of over 450 companies in the PIMS (Profit Impact of Market Strategy) database at the Strategic Planning Institute.  Read their book “The PIMS Principles” to find out more.
This analysis was reinforced by the work of Vinod Singhal, professor of Operational Management at the Georgia State Institute of Technology in Atlanta. Singhal studied the financial performance of 600 companies who had won the major quality awards – Baldridge, Deming, Shingo and best supplier awards from major US companies.  He compared financial results over ten years of these award winners with those of 600 similar companies who had not had won awards.  This involved the analysis of over 12,000 sets of accounts!  This study demonstrated conclusively that the quality award winners outperformed the non-award winners by over 100% and more on all key financial measures.  Yes more than 100%, twice as profitable, successful and sustainable!

If it’s not long term it will be short term
Whilst there are many individual examples, experiences and anecdotal evidence that a “relentless focus on continuous improvement” creates powerful competitive advantage these are backed by solid in depth research and analysis that proves this to be a fact.  However actually achieving a “relentless focus on continuous improvement” and reaping the rewards takes time, hence long termism.
My view is that the biggest influence on whether a business is managed for the short or long term is not the ownership model but whether the leadership, investors and other direct influencers of the business strategy actually understand that “relentless focus on continuous improvement creates powerful competitive advantage” and know why this works.  Without this it is highly likely that the business will be managed for the short term, leading inevitably to underperformance and then failure over the long term.
Unfortunately not a lot of people know that, or more significantly understand that.  Hence short termism rules!

So that was something from  the week before this week that caught my attention. I hope you found some of the above thought provoking and useful for you and your business. I trust you had a good weekend and hope you have a great week this week - and through continuous improvement an even better week next week.

Week ending 22nd March 2013

The budget dominated the business, economic and political news last week.  You will be pretty fed up with reading about it by the time this week’s TWb4TW is published.  So apart from a small mention at the end this is a budget free zone.

Cunning Foxtons

One positive sign that maybe an economic recovery could be stirring is a revival of interest from investors in Initial Public Offerings (IPO) or “floating a company on the stock market” to you and me.  Investors are encouraged that both Esures and estate agents Countrywide’s IPOs got away smoothly last week and have even begun trading above their float price, which is a first for some time.

This has prompted reports that another high profile firm of estate agents, Foxtons, are considering a potential £780m IPO.  You may remember Foxtons prospered during the London property boom and became famous for the brightly painted Minis it provided to its staff which promoted its brand as they hurtled round the streets of London.  Foxtons expanded rapidly on the back of the London property boom.  However, whilst it was high profile it was not very highly thought of by people who had bought or sold property with them.  Over optimistic valuations and putting sold signs on properties that were not yet sold to boost their apparent sales success were just two examples of practices their clients complained of.

In 2007 BC Partners (BCP) paid £375m for the business of which £300m went to Jon Hunt the founder.  Then the London residential property collapsed and so did Foxton’s profits.  The deal had loaded the company with debt and initially the banks involved took control with a debt for equity swap and BCP writing off a significant proportion of their investment.  However, surprisingly BCP then decided to buy back both the debt and the equity.

Perhaps not so surprisingly.  The buy backs were achieved at an advantageous price as the banks were happy to get rid of the problem.  The timing was good as the London residential property market recovered and Foxton’s high market share enabled them to deliver record sales and profits.  So it would not be surprising if the next stage of BCP’s cunning plan for Foxtons is an IPO.  If they were to achieve £780m this would be a pretty good return despite the earlier problems.  But what would investors be getting?

Now even my dog knew that the first property market to recover would be London.  So, on the face of it you would be investing in the dominant player in a resurgent London property market which sounds pretty good.  However Buzzel and Gale in their book “The PIMS Principles” demonstrated that whilst high market share is indeed highly beneficial to profitability, it depended on “how” that market share had been achieved as to whether that profitability could be sustained.  Market share achieved through delivering “superior relative quality” of product and service to the customer would sustain high profitability.  Market share achieved through other means, such as opening lots of estate agent offices, contains inherent weaknesses which eventually become detrimental to profits.

This was backed up by Zook and Allen in their examination of the long term performance of over 2,000 companies in 2001 and then repeated in 2011.  They concluded that:

“A common misconception is that rapid, sustainable growth can only occur in “hot” markets—markets that are growing rapidly—and that being in a hot market is the best way to generate high profit levels. Our data refutes that. A variance analysis of our database demonstrated that relative competitive position within an industry is more than four times more significant than the choice of industry in determining the economic returns of companies. In other words, it’s how you play the game that matters, not which game you play”.

All the commentary around the possibility of a Foxtons IPO centres on the “hot” London residential property market as the key to success.  If Foxtons have also upped their game on the quality of service they provide their clients, the acid test being would most of their clients definitely recommend them to others, then you would have the best of both worlds, a quality company dominating a currently hot market.  However if not much has changed at Foxtons then an IPO would be no more than an opportunity to have a punt on the London residential property market.  Each is a valid proposition provided it is clear which one you are being offered.  Is it real "competitive strength" or just high and possibly temporary market share advantage?  So beware the cunning Foxtons and look carefully at the other IPOs being lined up for launch this year.

ARM – keeping cool in a hot market

In case anyone has not heard of ARM they are a Cambridge based company that designs microchips and generates its revenues from licensing these designs to those that wish to incorporate them in their products.  Its chip designs are used in nearly all the world’s mobile phones and you won’t find a hotter market than that.

ARM was created from a spin off from Acorn computers, a company that prospered for a while but just could not keep up with the big boys in PCs.  However what they did know was that could design better micro chips than Intel and others.  Because they did not have experience or facilities for manufacturing they came up with the licensing model.  This has proved to be spot on and so resilient that ARM safely worked its way through the dotcom boom and volatility in semi-conductor markets.  In 2012 they achieved £577m of sales and £221m of profit.

ARM is an outstanding example of how "competitive strength" creates the "changeability" that delivers even more "competitive strength".  They demonstrated this again last week when their CEO Warren East announced he would be leaving after 12 years in charge, handing over to Simon Segars who has been with ARM even longer than East.  Given that the opportunities for ARM to go for another major phase of growth have never been better it is perhaps surprising that East has decided to go now.  His reasoning is that as it will take 6 years for ARM’s next design blueprints to be in products and with the company being in a strong financial and market position now is the right time to make this change.

This is a superb example of clear thinking and the understanding that it is not the “hot” market that really matters but the company’s ability to successfully exploit the opportunities.  East has ensured ARM can do this in every respect, right down to deciding that a change of leadership was required.  We don’t have enough people like him in top positions in UK businesses.

Italian Job

The financial crisis in Cyprus was a big economic and political story last week.  The Cypriot government is trying to raise the €6bn it needs to secure an EU bailout and proposed to do this by taking a slice out of citizens and exp-pats’ bank accounts.  Tactically actually having a government is where the Cypriots may have put themselves at a disadvantage in their negotiations with the EU.  Let me explain.

By contrast it is now more than a month since the Italian elections and they still haven’t actually got a government.  In fact as 25% of the vote went to a party that said it would not be part of any government Italian voters in effect voted not to have government and that’s what they got, or didn’t get.  This confirms the observation of a previous UK ambassador to Italy that “it is not difficult to govern the Italians, it is simply unnecessary”.

So Italy is probably a country that can get by perfectly well without a government. When it comes to negotiating with the EU (or Germany to be more accurate) this puts them at an advantage as the Italians have contrived a situation where there is no one for the EU to talk to.  This leaves the EU with little choice but to carry on as before which suits the Italians, both voters and politicians perfectly.  Cyprus and maybe Spain take note!

Rhyming slang

Briefly on the budget I was struck by George Osborne’s little catch phrase, “aspiration nation”.  This sounded like a trial run for the Tory election slogan in 2015.  Ed Milliband countered with “a degraded budget from a degraded chancellor”.  However without the little rhyme it isn’t memorable enough to be an election slogan.

However the overall reception from UK business to the budget was that we are an “anticipation nation”.  In other words we are still waiting for George Osborne to redress the balance between just making announcements and actually doing something.  Even some of the things that sounded like they might be about to doing something are not planned to happen for 12 months or more.  A bit less of the politics and a bit more focus on the day job of getting the UK economy moving is what business is still looking for.

So that was some of the week before this week. We hope you found some of the above thought provoking and useful for you and your business. We trust you had a good weekend and hope you have a great week this week.