A Small Business Consultant Is Investigating The Performance Of Several Companies – Success or Struggle: ROA as a True Measure of Business Performance by John Hagel III, John Seely Brown (JSB), Michael Lewis
Success or Struggle: Business Performance Report 3 of the ROA 2013 Shift Index Series
A Small Business Consultant Is Investigating The Performance Of Several Companies
A negative return on assets (ROA) generally does not match the reported narratives about firm performance and the business environment.
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Today’s news paints a cheerful picture on many fronts. The corporation posted record profits. 1 The economy has recovered at a steady pace of 1.8-2.4 percent over the past three years. 2 Stock market rallies have restored major indices to previous levels and beyond. Home prices have stabilized and are starting to rise nationally. 3 Manufacturing activity is showing signs of expansion. All 4 signs together indicate positive results at present.
However, other metrics tell a different story, adding stress and strain to companies, executives and employees. The increasing rate of decline suggests that US companies are struggling to maintain their leadership positions, as revenues and market share may suffer.
Over the past four years, Chapter 11 business bankruptcies have been at levels not seen since the mid-1990s.
High-profile bankruptcies such as Linen N’ Things and Blockbuster, and the automobile industry crisis of 2008, demonstrate the ability of successful companies to withstand rapid, irreversible decline. Even without the 2008 recession, rapid technological change and increasing global economic liberalization over the past few decades have put pressure on traditional business models. Executives chasing profitable growth and workers who need to stay relevant as technology and business models change feel these pressures. Long-term changes transforming the global business economy, the combined effects of digital technologies and public policy changes constitute an era we call the Big Shift.
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We developed the Shift Index to help executives understand and harness the long-term forces of change shaping the US economy. The Shift Index tracks 25 metrics over 40 years. These metrics fall into three areas: 1) market changes underlying technological and political foundations, 2) capital flows, information and talent changing the business landscape, and 3) competition, volatility and the effects of these changes on performance across industries. Together, these factors are contributing to what we call the Big Shift in the global business environment.
This narrative is embedded in the economy-wide, secular decline in return on assets (ROA) over the past 47 years. Attrition reflects the diminishing ability of firms to find and capture attractive opportunities relative to the assets they hold. Companies lack a clear vision or the ability and commitment to execute a long-term strategy. The long-term trajectory of ROA, rather than a snapshot in any quarter or year, shows how effective a company has been over time in capitalizing on business opportunities in a highly uncertain environment.
ROA is not a perfect measure, but it is the most effective, widely available financial measure for evaluating a company’s performance. It captures the fundamentals of business performance in a holistic manner, looking at both income statement performance and the assets needed to run the business. Commonly used metrics such as return on equity or return to shareholders are vulnerable to financial engineering, particularly through debt leverage, which obscures business fundamentals. ROA is also less vulnerable than income statements because it includes many assets such as property, plant and equipment and long-term asset decisions that are very difficult to change. less time
This period of technological change began in 1965 – a few years before the invention of the microprocessor. Soon after, the oil shocks of the early 1970s caused another major disruption. During this period, changing government policies fueled global competition. The result: negative returns to shareholders and a permanently altered landscape for executive decision-making. A school of thought has emerged that a firm’s primary objective is to maximize returns to shareholders; When companies focus on shareholder returns, everything else falls into place. A side effect of this thinking is to establish a culture of short-term decision-making at the highest levels of the business.
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In truth, operational execution has always been fundamental to business health. A company’s ability to enforce established commitments increases its credibility with customers, suppliers, and creditors. The risk comes when the assessment of the environment, and policy direction, depends too much on the short term. One way to take the long view is to consider the supply and demand impacts of fundamental changes such as globalization, greater consumer choice, and disruptive business models. Both established competitors and new players may lose customers. A fundamental question for companies is how their products and services can provide more value to their customers. In this context, it should be questioned whether the companies are making the necessary investments with long-term preparation.
The lasting legacy of this short-term focus is not increased certainty, but greater uncertainty and risk, which can destroy value. Today’s technology allows information to travel more seamlessly within and across organizations. It magnifies the consequences and risks of every decision. Decisions that focus disproportionately on short-term shareholder returns can reduce or prevent a company from creating long-term value. The recession that began in 2008 is an example of the financial services industry, an industry considered adept at managing risk. A risk model designed to predict the downsides of the most popular new financial product — the mortgage-backed securities created by collateralized debt obligations (CDOs) — includes only recent, short-term performance to predict the sensitivity of future performance. Instead of challenging the basic assumptions of this practice, many financial institutions have adopted these practices, realizing quick profits without concern for systemic market implications.
An example of a company that focuses on a long-term strategy is Starbucks. The company has weathered several recessions and continues to grow. Despite the temptation to increase short-term returns for single group components, Starbucks maintains policies designed to satisfy workers, such as providing health care to all employees regardless of weekly hours. While adjusting to the economy during the recent recession and understandably cutting back on investment, Starbucks took a long-term view and upgraded its expensive espresso machines to improve the customer experience.
The confusion and uncertainty created by the current era of rapidly improving technological efficiency shows no signs of abating.
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In this environment, the long-term trajectory of ROA is the best financial scorecard of a company’s health and an indicator of how well its decisions are working. Understanding expectations provides a foundation for taking a long-term perspective that helps companies create successful strategies.
A decline in ROA generally does not match the reported narratives about firm performance and the business environment. This paper first addresses four of these apparent paradoxes: increasing corporate profits, long-term economic growth, increasing labor productivity, and greater consumer choice. It then studies the effects of the Big Shift on key components of ROA. Finally, it exposes the dangers of short-term thinking and charts a course for long-term thinking.
To better understand this year’s Shift Index, as well as learn about ways to create and capture value in this environment, we invite you to take a deeper look at our 2013 Shift Index research report:
Most economic and market indicators suggest that all is well; It’s tempting to believe that companies will find ways to grow when the economy recovers. However, beneath the surface, consumer needs, workforce capabilities and expectations, and the nature of work are changing. Companies, especially large companies, have yet to address the implications of these fundamental changes. Because organizations’ policies, structures, and practices are increasingly ill-suited to a world of technology-enabled flows, they face conflicting evidence and short-term performance, making it easier for leaders and investors to dismiss long-term signals. Weakness of word performance. We begin by exploring four of the most fascinating paradoxes and why good numbers aren’t always good news.
Decision Making Unit (dmu): B2b & B2c Buying Center [+ Example]
Part of the answer lies in the company’s ability to generate returns and profits. As the true measure of mass media, the income statement focuses on profits—after all, isn’t that the most important? However, overall profitability is very low—at least, profitability must be considered in relation to total revenue to understand whether profits are growing faster or less than revenue. But that analysis still ignores a crucial part of business activity: the assets needed to run the business. After all, companies need a healthy return on those assets to stay in business. ROA captures how well a company uses its assets to create value. Therefore, ROA is a more effective measure of basic business performance. The long-term trend of ROA has been declining across economies and industries over the decades (see Figure 1).
Another part of the answer is how long companies can manage