Deadly Disease of Management: Emphasis on Short-term Profitsby John Hunter
One of Dr. Deming’s 7 deadly diseases is:
Emphasis on short-term profits: short-term thinking
It is easy to focus on short term goals and use a somewhat simple short term figure to measure success. But just because it is easier to look at the quarterly profit figure than determine progress without such a clear measure doesn’t mean it is wise. And in fact it is not wise.
Also, the idea of quarterly profit being a simple measure of success is flawed in more basic ways than just short term versus long term thinking (the idea that boiling things down to 1 short term measure is an acceptable measure of future success). The games played to manipulate earnings are enormous (and no surprise to those who understand likely outcome of pressure to meet short term goals is a desire to manipulate the figure rather than improve underlying results). In Profit Beyond Measure by H. Thomas Johnson and Anders Broms, the authors provide many good thoughts on the problems of accounting measures and management.
In Warren Buffett’s 2010 annual letter to shareholders he mentions the advantage Berkshire Hathaway has because it doesn’t focus on short term results:
At GEICO, for example, we enthusiastically spent $900 million last year on advertising to obtain policyholders who deliver us no immediate profits. If we could spend twice that amount productively, we would happily do so though short-term results would be further penalized. Many large investments at our railroad and utility operations are also made with an eye to payoffs well down the road.
At Berkshire, managers can focus on running their businesses: They are not subjected to meetings at headquarters nor financing worries nor Wall Street harassment. They simply get a letter from me every two years and call me when they wish.
I wrote on my Curious Cat Management Improvement blog in 2007, Eliminating Quarterly Earnings Guidance: “It is good to see more people understand the bad practice of excessive short term focus on quarterly profits. It is also a bit amusing to see the Chamber of Commerce pushing an idea Deming was called unrealistic for proposing.”
The U.S. Chamber of Commerce is calling for companies to halt “earnings guidance,” or coaching analysts, toward a precise target for quarterly profit. “The incentive to meet that number is an incentive to manipulate,” says Robert Pozen, head of the MFS mutual funds.
Of course, unfortunately, still today quarterly earnings guidance is a common practice. It does seem to me more companies (Google is one example) are dropping the practice but I don’t have any data on that guess.
The Aspen Institute has also published a report on this topic, Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management. In that report they state:
In the absence of real changes in the focus of institutional investors and related intermediaries, the various corporate governance reforms currently being discussed are unlikely to reduce the likelihood of boards and managers responding to short-term pressures.
They seek to change the system to change the behavior. It is not surprising to see the Aspen institute take a systems view to addressing the problem.
We repeat, short-termism is not limited to the behavior of a few investors or intermediaries; it is system-wide, with contributions by and interdependency among corporate managers, boards, investment advisers, providers of capital, and government.
- Market Incentives: encourage more patient capital
- Fiduciary Duty: better align interests of financial intermediaries and their investors
- Transparency: strengthen investor disclosures
The Aspen Institute provides some sensible considerations for addressing the larger system. In my opinion it is possible for companies to act even though the larger system puts pressure on them to comply with the short term thinking encouraged by the larger system. And the company will be rewarded for doing so with better results.
The average holding time for stocks has fallen from eight years in 1960 to eight months in 2016. Almost 80 percent of chief financial officers at 400 of America’s largest public companies say they would sacrifice a firm’s economic value to meet the quarter’s earnings expectations.
Many people see that companies harm their own interests in order to meet short term goals. But they feel powerless to prevent such behavior and the subsequent losses imposed upon the company. But there are ways to change. First, the culture of the organization can adopt better management practices that reduce the focus on short term profits as many companies do already (see Amazon, Berkshire Hathaway, Google and many other examples). And second, we can work on changing the overall system in the ways the Aspen Institute mentioned. Also, adopting a management system consistent with Deming’s ideas will put in place systemic support for long term thinking and a natural skepticism for managing to influence short term measures – such as quarterly earnings (or monthly or quarterly goals inside the company).