Investment Management across Business Cycles
Given that improving profitability and enhancing shareholder wealth are the main objectives of a listed company, simply put, it would only be fair to say that companies need to target growth. However, what tempers growth naturally is the current market and/or economic conditions prevalent in the country of operation and globally if the company has a sizeable presence abroad. A highly buoyant market or economy either domestically or internationally helps companies to easily argue the case for making investments for growth.
However, the question that continues to haunt most managers is whether a company needs to invest for growth when markets or economy are on the decline.
- Will a huge capex investment in an uncertain environment create capacity that may not be utilized at all?
- Will it create an unsustainable pressure on margins?
- What should a company (depending on whether it is manufacturing or otherwise) do from an investment standpoint in the above case?
The answer to the above questions, in the case of a manufacturing company, largely hinges upon whether:
- There is a continuing demand for its products in all the markets it operates currently or
- There is a likely demand in a new market for which capacities need to be upgraded and
- If the proposal is to introduce a futuristic product that will appeal to customer needs, is there a positive trade-off, if the new product cannibalizes the existing product?
If the answers to all or any of the above factors is a resounding YES, then obviously the decision would be to go ahead and make the investment. Of course, while making such investments, financial parameters such as payback period and IRR are relevant to determine the time it takes to recoup the investment and the ROI.
In the case of a service company, investments are largely based on how customers perceive their current servicing ability versus their peers in the market. The “speed to market” and “speed to customer” are key determining factors. This is also by and large applicable to manufacturing companies that are also in the business of providing after-sales-service to its customers.
Service companies whether financial or otherwise would usually have a standard offering for its customers. What determines its ability to capture the market is the use of technology and how technology makes it easier for its customers to use its services. So, investing in technology matters significantly. Front end customer interactions that help hassle free applications for credit or loans, ongoing servicing of customer accounts and related queries, others enabling ease of transactions either online or at stores, ability to credit accounts with payments, refunds on real time basis, ease of using promotional credits etc., are some of the” speed” aspects that help such companies to capture markets.
Investments in technology don’t come cheap. Companies invest millions of dollars to ensure they have cutting edge technology to retain customers and grow in the markets they operate. This is because any technology upgrades to improve customer experience not only requires investment in front end tools that enhance customer experience, but also in upgrading back end technology supports. Otherwise, the back-end support would not be able to support the front end and therefore businesses can collapse.
Disruptive technologies cause a huge headache for companies too as it suddenly alters their business models. New payment tools, virtual cards replacing plastic and other significant developments can throw a company’s growth trajectory out of track. Therefore, it is important to ensure that there is a constant focus on innovation within the company that enables it to stay ahead of competition. Innovation helps companies to set the tone at the marketplace not only in terms of technological advancements but also in respect of new products that it could introduce to generate multiple revenue streams, thereby de-risking itself from having a single/limited source of revenue.
What happens in a declining market? Should companies continue to make investments for growth? Using the technology example, one could argue that in a declining market where sales are down, and cost is rising adding pressure on margins, technological investments in Artificial Intelligence, Robotics and other such automation techniques will help in reducing the pressure on margins. Sales force effectiveness can also be improved through technology thereby helping the sales personnel to close deals quickly rather than wait for necessary data to be churned to them from the back-end.
In a manufacturing company too, introduction of robots in the plant will help not only improve production capacities but may also help safeguard employees from hazardous processes that endanger their lives. Employees may get an opportunity to upgrade their existing skills or add new ones that will help them get a better work environment and benefits. In fact, in today’s world a large part of the manufacturing is robotized.
As mentioned earlier, a large capex investment like plant and machinery, in an uncertain environment largely hinges upon the demand for the product either domestically and/or internationally or that a futuristic product provides enhanced customer experience and better margins. However, it is not as easy as it seems. This is because, once a commitment is made, then companies must go ahead full steam and usually there is no possibility of a ‘U” turn. Hence, it is advisable for companies to keep investing continually either organically or inorganically creating demand through forward or backward integration methodologies. One great example of how a manufacturing company created demand for its appliance products during the period of depression was GE. In 1932, GE set up its first GE Capital business by providing finance to its customers to help them buy its appliance products. They created a demand for their products through a sort of backward integration by creating a financial services wing. Of course, history has on record that GE Capital went on to become one of the largest financial services companies in the world and significantly contributed to the overall profitability of GE and to its dividend pool for a very long-time period.
Lastly, investment in talent is something companies, especially service companies, must not lose sight of. While technology upgrades like Artificial Intelligence and /or RPA is bound to impact employee utilization in the short term, it is prudent for companies to ensure that their employees are scalable to other jobs and are better utilized as a workforce. A significant upfront investment in this area will help the company reap dividends at a stage when adoption of technology becomes imperative. Early investments will ensure companies are able to overcome learning curve issues of their employees.
While we can’t shrink a business to greatness to manage costs, we cannot also deprive it of necessary investments that would continue to make it relevant to its stakeholders.
Note: The views expressed in this article are the personal views of the author and does not in any way represent the views of Synchrony Financial.