By Brian Lucas
This one is for my good friend Anthony to give his active mind a new opportunity for investing.
“When you get the majority of the economy predictable, you’re gonna get faster job growth, and companies investing more. But actually, the best return for companies is when things are really going the wrong way, and you’re willing to go against the tide.” “I would argue that your chance to break away is now as opposed to twelve months from now when hopefully governments get more predictable with their policies. In many of our industries, if you’re risk averse, you get left behind.” -John Chambers
Many of you have asked me to write more articles on agile thinking and the economy. Ok, here is the take away. Being agile is being adaptive. Being adaptive is being innovative. There is not enough innovation coming from CEOs today and that is hurting the economy!
Consider the United States (US) economy. The US economy is arguably the world’s largest single national economy. The US gross domestic product (GDP) was estimated to be $16.62 trillion in 2012, about a quarter of the global GDP. The US has a diversified economy and traditionally has maintained a stable overall GDP growth rate with moderate unemployment compared to worldwide rates. Best of all in the past we have boasted high levels of investment in research and capital formation. According to the National Bureau of Economic Research, the recovery officially started back in June of 2009. Why in August of 2013 is the current recovery still slow with the Federal Reserve pumping out so much money into the economy? Here are statistics that may surprise you.
Corporate profitability as a share of the economy recently hit a high of 11%. The normal average is only 5.5%. Corporate profits overall are 60% higher. The cash on corporate balance sheets is up from a normal average of 6.6% to 11% reaching $1.8 trillion at the end of 2012. Even the federal budget deficit is actually shrinking rapidly, from over 8% of GDP in March 2012 to less than 6% in March 2013.
Yet, the current expansion is the weakest in the post–World War II era. GDP is only 8% higher than it was when the recovery officially began. Recoveries since World War II averaged a GDP 16% higher than it is now. The Federal Housing Finance Agency‘s all-transactions home price index, showed two consecutive quarter increases at the end of 2012, but the index remains 7% below its June 2009 level. While payrolls increased over the past 31 months, adding 5.5 million jobs to the economy, there are still 2.6 million fewer nonfarm workers than there were at the start of 2008. Without doubt, the post 2008 period following this recession has been the weakest of the post–World War II era expansions.
So, why IS this recovery slow? The answer is it lacks capitalization. CEOs are being ultraconservative and this is impacting the economy negatively. Since the recession, too many CEOs have practiced a strategy of cutting costs across the board rather than investing. They are pushing the workforce as hard as possible to increase productivity without making any efforts to innovate. After all, the rate of manufacturing and industrial modernization and expansion is down 12% since 2006 and at its lowest rate in 60 years.
This is not a capital formation strategy. It is a short term tactic to maximize profits and has been the downfall of many an organization. This is directly hurting the economy because the potential growth rate in the economy is related to worker productivity as well as workforce growth. The capital base across the US is for the most part back where it was during the recession. This lack of capital formation negatively affects worker productivity. As a result the growth rate has reduced to 1.8% when the prerecession rate hovered at 4% it is expected to rise only to 2.5% at the current rate of capital formation. Workforce productivity is also fed by worker led innovation. This is starved when the workforce is dissatisfied with management. In the US, 32% said they would leave their current employer. Why are so many CEOs being so timid?
Among the rants and complaints are the cries of corporate taxes being too high. The numbers don’t support this. The current corporate tax rate is 35%. Yet the 10 most profitable U.S. companies only paid an average federal tax rate of only 9% last year. Among them were Apple, General Electric, Exxon Mobil, JPMorgan Chase and Microsoft. Exxon Mobil actually only paid 2%. In fact, the effective corporate tax rate is currently at a 40 year low. And as you saw previously corporate profits are high. The complaint about taxes just doesn’t stand the light of day. So what is the real reason a significant number of CEOs are not being innovative?
Today many large corporations are run by very risk avoidance thinking CEOs who grew up in business and made their way to the top by not being bold and innovative, but by being political survivors. They generally have great personal wealth from either from preexisting positions or heredity and take few risks with their own money. Many came into power just before the financial crisis or in the early part of the recession. This includes more than 60% of CEOs of Standard & Poor’s 500 index member companies who assumed their roles since 2007. They have allowed themselves to be governed by these negatives, rather than the opportunities before them.
They have pushed this negative psychology down through the management structure, driving their corporate decision makers to operate in a very defensive posture. They not only keep a considerable cash balance, they also focus on increasing both dividends and repurchase of stock. In 2012, these companies in the S&P 500 bought back more than $400 billion worth of their own stock. This was generally great for CEO pay and temporarily boosted the per share reported earnings. In 2013, Goldman Sachs maintains this rate has doubled. With cheap debt due to the Feds action, high stock prices and record profits CEOs should be looking for growth from mergers and acquisitions. However, the number of offers in the US for mergers and acquisitions is down 10% so far in 2013, while 2012 was 20% below historical normal percentage of total stock-market value. Ultimately this decreases the company’s overall strength.
The average CEO of a large corporation has been in the position for six years. The normal life of this type of CEO is 7 to 8 years. Naturally these CEOs are conditioned to avoid risks rather than seek out new opportunities. So it is understandable why they are behaving this way, even though it is not ultimately good for their enterprise or helping build the future of business or the US economy. CEOs are being geared to short term paybacks rather than strategic growth. As I said in my article Why CEOs Fail in Today’s Agile Business Environment, CEO compensation is at an all-time high in America with top bosses enjoying pay hikes of between 27 and 40%. This is amazingly disingenuous since compensation for the majority of Americans is flat.
So what should CEOs do? The answer is they need to invest in innovation and partner with their workforce as never before. The strategy of belt-tightening is not conducive to innovation. Innovation and workforce productivity come from motivated and engaged employees. That doesn’t happen when the enterprise does not invest in the future of the company while the CEO is raking in record compensation and employee compensation is at best flat. These employees will show little loyalty to the company and leave at the first opportunity and opportunity it beginning to happen. Every business person should know that it is costly to onboard a new employee, particularly when it is replacing an experienced technical employee. How will your company run if 32% of your employees leave?
But it does not have to be that way. Look at what Ford Motor Company has done. Ford encourages innovation with constant brainstorming sessions on designs and creativity. Ford proves this works by developing some of the top rated vehicles in the United States. They also pride themselves on having initiatives to stimulate future growth. They introduced 100% post-industrial material in the Ford Escape back in 2008 and it is estimated to conserve 600,000 gallons of water during production. Their new painting process is also estimated to reduce CO2 emissions per vehicles by 10% and would reduce a factory footprint by 15%. They use an innovative EcoBoost technology which combines dual turbo chargers and direct fuel injection giving a V-6 the feel of a V-8 engine.
Ford has not stopped there. Ford supports research by pairing up with some of the world’s brightest university professors and students to explore a wide range of new ideas and technologies. In 2010 alone, Ford awarded 13 University Research Program grants to 12 different universities, including Wayne State University in Detroit and Stanford University in Palo Alto, California. They are all championed by Ford research teams and range from testing the properties of thermoplastics modified with nano-materials to developing an in-vehicle safety alert system for diabetic drivers.
There are other examples, of course, but I have great deal of respect for William Clay “Bill” Ford, Jr. and Alan Mulally. Bill Ford has done a truly amazing job since he took over as Chief Executive Officer in 2001, from Jacques Nasser. Nasser had the same short sightedness many CEOs have today. He focused on maximizing corporate profits and shareholder value. Bill Ford has a proven record of valuing people and innovation. In 2006, Ford stepped down as President and CEO, naming former Boeing senior executive Alan Mulally as his replacement. Bill Ford remains the company’s Executive Chairman.
Ford is a true American success story coming back from the precipice without the aid of government bailout money. This could never have happened if Ford’s leadership continued the path of narrow minded cost cutting and maximizing short term stock prices. It took a CEO of courage, vision, an appreciation of people and an understanding of the need to innovate and invest in the enterprise’s future to save them. In other words, Bill Ford was agile. The results are undeniable, 2012 was one of Ford’s most profitable years in North America. Bill Ford is a man who knows how to take responsibility, is not afraid to adapt to a changing circumstance and does not whine about trouble. I leave a message for every executive manager in America from one of my favorite Presidents, Theodore Roosevelt, “If you could kick the person in the pants responsible for most of your trouble, you wouldn’t sit for a month.” Remember till next time – Keep Agile!
 See http://www.sfc.hk/web/doc/EN/research/stat/a01.pdf, Sohl, Jeffrey (March 31, 2010). “Full Year 2009 Angel Market Trends”. University of New Hampshire Center for Venture Research.
 In the interests of brevity, I am setting aside the uncertain health care costs for a later post.
 The numbers would have been considerable worse except for several large deals such as Dell Inc.’s privatization, Berkshire Hathaway Inc.’s purchase of H.J. Heinz Company and the buyout of BMC Software Inc.
 FYI Bill Ford donates most of his compensation to charity.