UConn Professors Find Evidence that Short-Sighted Business Planning Costs Companies Money
When executives are committed to the long-term viability of their corporation, and invest money in future growth and technology that will not pay off right away, does that give the company a strong competitive advantage?
For years conventional wisdom said yes, even as many companies seemed focused on short-term results instead. New research by UConn management professors David Souder and Greg Reilly, and their colleagues, offers evidence that longer payoff horizons are indeed more profitable.
The researchers looked at equipment purchases since the early 1990s by 2,342 manufacturing companies. They selected manufacturing firms because they invest in equipment and have to amortize it. That provided the researchers with a telescopic view of how many years into the future the managers were investing in the business.
“We suspected companies were leaving profits on the table that could be theirs if they would opt for more durable, longer-lasting equipment,” Souder said.
“You might have to wait a few years, but the data provide hard evidence that it pays off for companies to be long-term oriented,” Reilly added.
The research also broke new ground by establishing limits on the benefit of long-term investing. Companies with very long horizons already have little to gain from planning even farther into the future. A small number of companies in the study – less than 1 percent – could even be described as “too long-term.” But this pales in comparison to the 55 percent of manufacturing businesses that averaged much lower profits associated with short-sighted investment policies.
Their findings in “A Behavioral Understanding of Investment Horizon and Firm Performance,” which is pending publication in Organization Science, resulted from collaboration with Philip Bromiley of the University of California at Irvine and Scott Mitchell of the University of Kansas.
There isn’t a one-size-fits-all approach to investing in the company’s future, they said. In fact, it differs from industry to industry. “Our work suggests companies have an opportunity to figure out where they are compared to their peer-group,” Reilly said. “In our analysis, about 44 percent of companies were in the right ballpark, but others have the opportunity to increase profits.”
The study only analyzed U.S. businesses.
“Although short-termism is seen throughout the world, it is especially associated with American companies,” Souder said. Although the researchers focused on equipment investment, Reilly said he believes that a corporate investment extends to other initiatives, including research and development, supply chain infrastructure and employee training.
Souder, who worked as a consultant prior to his academic career, said managers often want to embrace a long-term plan but are constrained by investors and demands for short-term profit.
“It’s not easy to focus on the future. It takes discipline, and it can be tough to convince stakeholders that it is the right thing to do,” Souder said. “But the companies that adhere to it, are seeing good returns. Taking a long-term approach to business isn’t just a moralistic tale but one that has practical benefits.”
Souder has presented the findings over the years to corporate executives in the U.S. and Canada and is planning to speak in October at Waseda University in Japan.
“This is a topic of particular interest in business and in the past we had only anecdotal evidence of its importance,” Souder said. “Now we’ve been able to show a systemic relationship between the opportunity to make higher profits if one makes longer-term investments in a company.”