Leaders from companies around the world are probably hearing a common message: No CEO should underestimate the shifts taking place in their industry, even if business is good today. A stream of CEO changes at companies like China Petroleum and Coca-Cola underscore this reality.
One message that can help CEOs prepare for these shifts is, “If it ain’t broke, fix it anyway.”
Why do we hold this view and make this recommendation? We see a mismatch between today’s robust corporate profits and the level of investment in the business.
{mosads}That level is low, even though rising volatility make investment in the future and reinvention real imperatives. For example, while profit margins are up 21 percent since 2010, investment in research and development (R&D) has been flat and capital expenditures almost even.
Too many leadership teams, it seems, have become “trapped” by investors’ expectations for non-stop quarter-to-quarter improvement. Companies need to fix the core business and maximize performance there, but then use sufficient resources for reinvestment.
For most companies, their current source of cash will not stay constant, and if CEOs wait until evidence of disruption is visible on the profit and loss statement, it may well be too late to recover. So for many companies, lowering their reported earnings — as controversial as it sounds — is the right medicine for securing the future.
Businesses are in a dangerous situation. Public companies have a one-in-three chance of failing within the next five years, up from a one-in-20 chance 50 years ago, according to Boston Consulting Group (BCG) research. The same research shows that large companies’ future growth options are waning.
One Scandinavian industrial products company we know well serves as an example of a path forward — a way to stay ahead of changing markets and a way out of the profit trap.
The company’s earnings before interest and taxes (EBIT) rose to 14 percent from 6 percent over the last several years. But two years ago, leadership decided that 10 percent EBIT was sufficient. Owners and management set about reinvesting the remainder in forward-looking programs and initiatives.
They include efforts to reach new customers, developing an online platform that lets buyers customize their orders, developing digital sensors to incorporate into their products and acquiring smaller companies that can help the company step into the future.
This company’s experience suggests that leaders, especially those with all-time high profits, might do well to consider lowering earnings.
This approach could apply to many, many companies: The average S&P 500 industrial makes 16 percent EBIT. Of course, companies that adopt this strategy need to communicate with shareholders, make them understand and marshal their support.
What to do with the profits that are set aside for reinvestment in the future? BCG research shows that innovations in business models can be twice as effective as innovations in products. So, companies should focus on testing new business models: Invest in new ways to reach customers and in enhanced services and offerings based on data and tech-enabled solutions.
With the extra leeway to invest, the best leaders will, we believe, adopt some of the traits of start-ups and create entrepreneurial environments. This will allow new initiatives to win or fail fast. Speed is key, as the pace at which the ground shifts increases. More and more, new talent is attracted to environments with a sense of ownership, speed, autonomy and a no-nonsense atmosphere.
Winning CEOs constantly balance short- and long-term goals. They deliver top-quartile performance in the core business and produce excellent results in the short terms. At the same time, they reinvent their business model and offering. This kind of strategic “ambidexterity” is one of the most valuable and important capabilities today — and also one of the hardest.
Lars Fæste is a senior partner and managing director at The Boston Consulting Group, a management consultancy that advises over two-thirds of the Fortune 500. He is based in Copenhagen and is the global leader of the firm’s transformation practice.