INVESTING SUCCESSFULLY FOR YOUR UTURE

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INVESTING SUCCESSFULLY FOR

YOUR FUTURE

"At the end of the day you get nothing for nothing."

Foreman in Les Mis?rables, musical by Alain Boublil, Claud-Michel Sch?nberg, lyrics by Herbert Kretzner, original novel by Victor Hugo

The Challenge We Face

It is the day after the day after. The party was great while it lasted, the hangover was painful and miserable, and the cleanup of the mess that companies made is nearly finished. Outrageous ideas for businesses no longer receive funding, and the previous decade's unfortunate combination of arrogance and youth in the business world is long gone. The basics are back in style, and talk of revolution is now a subject for history classes, not corporations.

Even the stock market has recovered. Although we are still far from the heights reached in early 2000, as early 2004, the NASDAQ

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MINDING THE CORPORATE CHECKBOOK

was up over 85 percent from its lows in October 2002. The Dow Jones Industrial Average hit a five-year low in October 2002, but since then it has risen by more than a third. Unemployment is also falling, and there is at least limited optimism about the future for many companies.

The challenge now is investing a company's resources successfully for the future while remembering some of the financial hurt from the past. A quick survey of the business press finds stories detailing failed IT investments, failed mergers and acquisitions, failed human resource management initiatives, failed products and service offerings, and failed research and development efforts from the late 1990s to today. A consistent theme for all of these failures is loss: loss of shareholders' money; loss of time, energy, career growth opportunities, confidence, and even jobs for employees and managers; and loss of management will and desire to invest resources in their corporations' futures. Today, it seems that managers don't just keep an eye on expenses; they have glued their checkbooks shut.

At the same time, companies must grow revenues and profits to survive, let alone prosper. Growth in revenue and profits starts with investments in capital goods (e.g., machinery, equipment, and computers) and people (new employee hires and training for existing employees that increases their productivity). Avoiding investments in capital goods and human capital entirely and indefinitely might be an extremely short-sighted way to manage a company.

The advances in the values of many publicly traded stocks in 2003 and early 2004 indicated that the stock market expects future growth and profitability from such investments, which is reflected in rising stock prices. The key to meeting these expectations is growth in revenue and earnings, but without investments in capital goods and people this growth is not likely. Little will be gained without the critical ingredients of more equipment and people.

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Data from the U.S. Department of Commerce indicates that many companies, both publicly traded and closely held, are not making investments for the future, or even attempting to improve efficiency today. Business capital spending fell from 11.8 percent in 2001 to 10.6 percent in 2002. Although data on spending for the last part of 2002 was very encouraging, anecdotal information, including surveys of executives, indicated that overall investment activity is likely to be sporadic and volatile, particularly when interest rates rise. Anecdotal evidence, including statements by business leaders that they are "still waiting" for capital spending to pick up and "don't see" the need to hire more employees, indicates that investment activity is likely to remain relatively low, particularly when compared to the late 1990s.

Yes, some companies, as reflected in recent government statistics, are beginning to invest, but these companies are the exception, not the rule. With the exception of a selected set of companies in a few economic sectors, companies are not investing in capital equipment and goods to enable greater efficiencies and growth. The decline involves much more than just technology-related investments; it is pervasive across nearly all types of capital goods and equipment.

Employment growth is similarly dismal. Whereas many of us once felt that we could leave our jobs and find something better relatively quickly, today most people are content to just have a job. Layoffs continue to loom, and even profitable companies are cutting back on employees. Indeed, many observers have taken to calling the current upswing in the economy a "jobless recovery."

You probably know someone (or are such a person yourself) who continues to get his or her old car fixed again and again rather than purchase a new one, no matter how cheap the financing terms offered by the automakers (zero-percent financing is about as cheap as you can get). Why does George Foreman, former heavy-

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MINDING THE CORPORATE CHECKBOOK

weight boxing champion and current spokesman for Meineke mufflers, tell us that he won't pay a lot for that muffler?

The reasons people offer for replacing exhaust systems and making other repairs to their old autos rather than letting the old cars die and buying new ones vary, but a key consideration for many people is a concern about the future, particularly after suffering the pain of a downturn in the economy. No one wants to waste their money while difficult economic times are still fresh in their minds. Nothing focuses the mind like fear, and the reminder of pain from recessions past is present in our thoughts.

Corporate decision makers apply the same logic to business investments--the hangover, long and painful, is still with us; it just seems to make sense to delay or avoid investments for growth and efficiency right now. The concern is survival, not growth. Finance departments at many companies seem to know only one word-- no--in response to funding requests.

Return on Investment and Finance Metrics Are Not Enough

The hesitancy at corporations to invest in growth or greater efficiencies is particularly curious given that many of these prospective investments pass the traditional finance metrics of return on investment (ROI) with flying colors. Put simply, following traditional finance metrics, a company should invest when the expected return from an investment is greater than the costs incurred to make that investment. From a strictly theoretical perspective, it makes sense to invest when your returns are greater than the costs of the investment. Obviously, companies should select

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investments that both fit within strategic objectives and provide the greatest return relative to costs, but even with these caveats, the data on capital spending and human capital clearly indicate that companies are not doing much investment of any kind, even in investments with high ROIs.

Like a child who shouts louder in response to an initial "no" answer, many vendors have raised their voices regarding ROI and other finance metrics to support the purchase of their products and services. Some companies even have ROI calculators on their Web sites. Try one--it can be fun to pretend that you are making an investment. Plug in different numbers and--surprise!--the calculator will likely give you a high ROI value. Check out sales literature, too; many companies in a wide range of industries--human resources management services, credit cards, technology products and services--claim high ROIs and short payback periods (how quickly you will get the money you invest back in returns). Several companies claim almost immediate financial returns, implying that an investment in their product or service is nearly equivalent to free cash pouring into your business. Unfortunately for vendors and people looking for work, the shouts of "high ROI" still do not work; companies just are not investing or hiring. There is an economic recession in spending for capital goods, and an economic depression in the labor market.

The Paradox

There is a paradox here. Senior managers know that they must grow revenues and profits. They recognize that low revenue and profit growth could mean the loss of their own jobs. Mid-level

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