A lot of companies all over the world show a typical tendency of putting a lot of focus on cost cutting and improving the operational efficiencies during the times of economic crisis. These companies would have shown accelerating growth during the times of good economy and the growth would have come to a screeching halt at the onset of recession. The top line comes under heat due to lower demand in the market and increased price wars.
At this juncture the firms would want to atleast sustain the earnings for their share holders. The only way of doing this is to sustain or improve the profitability of the firm. For doing this the firm has only one lever and that is to reduce the costs by squeezing the low priority expenses (as deemed by the firm) and improving productivity and operational efficiencies.
This method works in the short run and results in increased operational efficiencies but in the long run there is only so much that the engine can be tuned and optimized. Beyond a certain point any attempts to improve the profitability by resorting to methods as mentioned above will result in overheating the engine. Also typically the firms resort to cutting down expenses in the areas of R&D and sales as these are seen as expenses that can be done away with.
Cutting down these expenses will have severe implications in the long term as R&D and Sales are the areas where the firm should continue making investments in the downturn as well as this is an area which will create competitive advantage and act as a clear differentiator for the firm in the long run. The firms that continue making investments in the downturn in strategic areas like R&D and Sales are the ones that will emerge victorious once the economy picks up.
Another related problem which hinders the firm from making strategic investments which will create a sustainable differentiation for the firm is the “Short term Vs Long term” conundrum. All the listed firms are driven by the pressure to show quarter on quarter growth and profits and the firm’s management is so engrossed in showing results in the short term that they ignore the bigger picture and do not have the long term canvas laid out in front of them. This is yet another challenge that could cripple the firm’s ability to create a sustainable competitive advantage in the long run.
However some executives argue that the ‘Short term-Long Term’ conundrum is akin to the mid-term exams and final exams in school. They say that students who show consistently high performance in the mid-term exams have a better chance of faring well in the final exams. Similarly the companies which perform consistently well quarter after quarter have a much better chance of succeeding in the long term. Long term is nothing but a series of short terms put back to back.
I believe that the firms should focus on the net earnings to the shareholders over a reasonable period of time (say 5 years) and not compromise this by resorting to short term ‘symptomatic’ responses to the problems ailing the firm. They should have the bigger picture and a long term canvas laid out in front of them and should take tough calls and make long term investments even though it means facing a beating at the bourses in the short run. Some firms focus on only ‘top-line’ or only ‘bottom-line’. A combination of the two is needed and the net earnings to the share holders over a reasonable period of time should be parameter that needs to be kept in mind while deciding on the firm’s strategy at any point in time.
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