Business in emerging markets rarely succeeds if it is subjected to the short-term criteria that companies in the less volatile developed world are often judged by. But many chief executives of listed companies are unwilling to adopt longer-term targets. Managing the expectations of senior management is one of the top three critical issues for developing a healthy business in emerging markets. We will try to explore strategies to overcome in-built short-term perspectives and to manage the expectations of not only board members but also investment analysts and the media, whose perceptions of a company are crucial in determining its reputation and share price.
If you look at how companies have gone about building and sustaining their business in emerging markets, two facts invariably emerge. A short-termist approach succeeds only in the short term. Private companies, or those not dependent on equity markets, almost always build stronger and more sustainable businesses than listed companies.
A short-term approach to building business in emerging markets is the most frequent cause of longer-term failure. When companies fall behind their more systematic competition, regional and country managers often criticise their CEOs for not releasing enough resources to build the business properly. Many privately accuse their CEOs of caring only about the next set of quarterly results.
That CEOs take a short-term approach is not surprising for two reasons. First, reward systems have increasingly favoured those who maximise short-term profits. Second, the complexity and pressure of running large corporations have steadily decreased the shelf-life of the average CEO.
To the detriment of the long-term well-being of their corporations, a number of CEOs have come to see their job as maximising short-term profits while in charge. This growing short-termism in the past two decades is one of the reasons that only 40% of Fortune 500 companies in 1980 are still on the list today. The stockmarket madness of the late1990s, where many tried to inflate profits via creative accounting practices, is just an extreme symptom of the same disease.
In the past two decades compensation systems for CEOs have largely been based on stock options and bonuses based on short-term profit maximisation. Rewards go to those who move the stock price up in the short term. Many CEOs choose not to miss a large annual bonus or a mega stock-option deal by investing in something that will bring returns 3-5 years later. In such companies, emerging-market business suffers the most. Success in emerging markets requires a passion for systematically building business and investments that will not bring in profits next quarter or even in the next three years. Unfortunately, investing for the medium to longer term has increasingly been viewed as a cost that squeezes the all-important short-term profits.
Short-termism reached its peak during the stockmarket bubble of the late 1990s. Many CEOs of listed companies, particularly in the United States and the UK, were under pressure to provide high short-term returns to their increasingly impatient shareholders. Managers operating in emerging markets found themselves (and many still do) impossibly pressured by the contradictions in overall policy. On the one hand they were being told to increase growth (and short-term returns); on the other hand they were being refused the resources to systematically build up business.
Many well-run companies' stock prices were (and continue to be) severely punished for missing expected quarterly earnings by an unforgiving Wall Street, as if such results really mattered for the overall soundness and future prospects of the business. Good decisions aimed at building a sustainable business are rarely rewarded by the herd-like behaviour of large institutional investors. Although this attitude has started to change following the bursting of the stockmarket bubble, short-termism among investors, and subsequently CEOs, remains alive and kicking. Fund managers and analysts are frequently rewarded on how well they do in one quarter and how well they predict quarterly earnings. This contributes to the steadily growing and damaging phenomenon of herd behaviour. "I buy because others do. I sell when I see that others sell," is how one youngish fund manager described how he worked.
Read the transcripts of CEOs' conference calls with stock analysts and it is clear that business decisions relating to the future development of publicly listed companies are largely irrelevant. A study reported in the Harvard Business Review, done by doctoral candidates at New York University's Stern School of Business, found that more than 90% of analysts' questions to CEOs during conference calls were about expectations for the next quarter's earnings. Investments were treated as factors that might jeopardise this "holy" quarterly number. Analysts' behaviour is unlikely to change. They cover many companies, and according to one analyst: "There is really no time to properly research, analyse and think.
"No wonder the managers who are in charge of real business decisions are immensely irritated by analysts. A senior executive from one of the 100 largest corporations in the world (and a rare highly successful company in emerging markets) said in a private conversation:
These 26-year-olds, who have never run any business, come to us and interrogate us like the Gestapo. They are not interested in how we build business or what we are trying to do. And the day after they reveal our plans on CNBC, another damaging influence by the way. Because we told them about our investments our share price went down 15 % in a few hours. We should do what XYZ does - give them a vague idea what the plans are and tell them to go to hell.
The impact of all this on business is clear. Many companies have postponed relevant or even crucial investments for their future, and some will have trouble surviving as years go by. One regional executive says:
We make an enormous number of business decisions thatIwould never do if I were a sale owner of this business. But our top management is more obsessed with the steady growth of quarterly earnings than investing for the future. We will soon run into severe problems.
Short-termism is problematic for sound business decision-making in general. But for decision-making in emerging markets it is disastrous. Many companies invest too little in preparing for market entry (relative to the best competition) or have inadequate resources to execute sound market entry and market expansionplans.
So how do emerging-market managers go about managing the expectations of senior management? First they shouldgo through the checklist and fight to get the resources to prepare each aspect of market entry properly. Without thorough preparation, any manager will have a hard time growing an emerging-market business, and the task of managing the CEO’s expectations will become monumental.
Emerging markets are often more volatile than developed markets. There are years that are spectacularly good but they usually do not last. How can emerging-market managers predict the sustainable annual growth of business over, say, the next five years? How do they explain the inevitable ups and downs, and how do they get senior management to accept that next year may not be as good as the previous one?
There is a tendency for CEOs to say: “Your business jumped 55% last year. You can do better than that or at least as well.” Emerging-market managers need to communicate constantly what is shaping their business, taking care to point out why a certain level of performance may not be sustainable and the factors and risks which might set things back. Equally, senior management needs to be made aware that there are years when sales fall to unexpectedly low levels, usually because of some kind of emerging-market crisis. As with good years, the circumstances that made a year a bad one usually do not last. Markets bounce back sooner or later. Many short-termist companies react to such crises by radically downsizing operations. Although this provides short-term protection, it may have negative implications in the longer term.
Many CEOs push regional managers to work to stretched budgets, which simply increases the stress of working in a volatile and difficult to predict market. Or it is counterproductive because managers simply ignore the budget as it does not take into account the realities of the market. The message from the top is often: “You claim there is a lot of potential in emerging markets, let’s see it.” And that is regardless of the fact that the risk and uncertainty as well as the potential have been pointed out.
One problem is that many companies push managers to deliver big returns before enough has been invested in establishing local market presence and securing brand recognition. But even in companies that do invest in what they need to, budget games are rampant. Those who meet and beat budgetary targets (regardless of how low they were set) are usually regarded as better managers than those who grow a business faster year on year but keep missing their unrealistic budgetary targets.
Many potentially productive hours of work are wasted on tactics for meeting budgetary expectations. As the regional manager of a large American company says: “I spend too much time managing the bottom line instead of managing the business.” Studies by Wharton Business School show that setting what managers perceive as overly ambitious goals distorts their behaviour and ultimately damages their companies. Managers start playing games. If they see they can exceed the stretch budget, for example, they try and delay end-of-year sales so they are booked in the next year. They fear that fantastic growth will earn them an even worse budgetary target next year, and they also want to have a good start to the year. Some managers even give up hard work “to prove that the target was crazy” and to play down expectations for the next year. As one manager who lost his job after proving that the target was crazy said: “I lost my job but at least I’ll stay sane.” The volatility of emerging markets makes the requirement to meet demanding budgets particularly stressful for local and regional managers, with the result that they are even more likely to behave in ways that are not in the best long-term interests of their firms.
Budget games are a fact of corporate life, but for emerging markets the following approach is a good one to adopt.