If low interest rates and low investment returns are permanent, how should corporate strategy change? A recent Harvard Business Review article, Strategy in the Age of Superabundant Capital, argues that returns are going to stay low and then explores business implications.
I concur that we (probably) are in a world where capital is at least abundant, if not superabundant. Last year I wrote “Returns on Capital–And Interest Rates–Will Be Low In The Future,” with two main arguments. First, business needs less capital to create value for customers. Compare the physical capital of a Google or Snap to what last generation’s companies (GE or 3M, say) needed. Second, global savings is rising due to greater growth in emerging countries, which have high savings rates because of their weak social safety nets. The HBR authors mirror those arguments using different data sources.
Interest Rae on Baa Corporate Bonds
What should business do differently in this environment? The HBR article suggests lowering hurdle rates for new projects, an idea I also expressed: “Firing managers who don’t meet unrealistic expectations is a strategy for even poorer results.”
Aiming for growth rather than cost savings is HBR’s second suggestion, and it’s tempting but with some danger. They present data suggesting that a growth orientation will be more successful than a profitability goal. My worry is that companies will move outside of their expertise in the search for growth. Sticking to one’s knitting is generally good advice. I’d be OK with moving into crocheting, and maybe macramé. But a knitting company that moves into emoji production risks pretty big losses.
The authors also make a mistake when they write:
“Improving margins by 1% would increase the average company’s value by only 6%. By contrast, increasing the long-term growth rate by 1% would drive up value by 27%—four and a half times as much bang for the buck invested.”
Their implicit assumption is that it would cost exactly the same number of bucks to boost margins by 1% as to increase long-term growth by 1%. I see no evidence for that, and I suspect it’s nowhere close to true. Increasing long-term growth rates is certainly valuable, but also certainly hard.
The final strategy for a world of low returns is experimentation, and it’s an idea I like a lot. In The Flexible Stance I argued for something like this, borrowing from Micheal Raynor’s The Strategy Paradox. Raynor argues for what he calls “strategic options,” an investment that is small but gives the company the ability to expand if the sector grows. The challenge with this approach is management attention. Let’s say that a $10 billion corporation is looking to make a number of $10 million investments as experiments. The executive team should oversee the process, but they don’t have the time to oversee too many little projects. The solution that a number of companies have used is to set up a separate division that can make venture capital investments or acquisitions. This allows the corporation to learn more about different sectors without distracting top executives from their major responsibilities.