How does the CEO of a quoted company deal with the relentless, short-term pressure from the market? This is a question Fidelio frequently discusses with clients in the context of building and developing Boards. I am therefore delighted to welcome back a guest contributor to Overture, who has followed companies as an investor, a sell-side analyst and is now the CEO of an engineering company based in Herefordshire. In this thought-provoking edition of Overture, Stephen Cheetham synthesizes these three perspectives and suggests that the FTSE 100, and arguably the DAX 30, have much to learn from the German Mittelstand.
Gillian Karran-Cumberlege
The Backdrop
Recent events at Tesco, one of the UK’s largest and most successful companies, will doubtless occupy commentators and academics for some time to come. Yet as a former stock market analyst turned SME owner-manager, what strikes me most forcibly is the relevance to a large supermarket chain of lessons from the German Mittelstand.
This has its particular irony, since the major competitive threat in UK food retailing comes from two German supermarket chains (Aldi and Lidl), who, if now too large to qualify as Mittelstand companies, nonetheless derive significant portions of their DNA from that tradition. Neither is publicly quoted, and neither has ever worried about reporting earnings. Both have demonstrated admirable long-term strategic focus in their assault on the UK market, and both have notably frugal corporate cultures.
I believe that there are at least three significant lessons for UK quoted companies, and their DAX 30 counterparts, from the German Mittelstand:
1. Quarterly Earnings
For quoted companies the quarter (or the half yearly earnings statement) is a major focus which threatens to dominate corporate communication: but allowing it to do so is a mistake.
Companies like Unilever have demonstrated that is possible to take a much longer-term view and not be caught up in the game of quarterly earnings guidance. The stock market cares about near-term earnings, but it’s by no means the whole story. Investors will punish strategic incoherence and poor accounting much more than they reward short-term earnings growth, yet many companies spend too much time on the latter.
In extreme cases, “the quarter” develops its own dynamic and is pursued with macho fervour by company management. Missing the quarter becomes a sin to be avoided at all costs, and those with divisional P&L responsibility resort to “cookie jar” accounting, resulting in periods of eerie predictability followed by major blow-ups.
While there is clearly a credibility point here – a CFO who regularly springs bad surprises is likely to enjoy only a short tenure – sticking to targets in the face of adverse business performance is unlikely to end well. Absolute management control over even small businesses is an illusion – building credibility through frank communication and doing what you say you’ll do is preferable.
The lesson from the Mittelstand is clear: freed from the earnings treadmill, such companies have more space to focus on the longer term and can afford to take a more strategic view.
Of course, management teams at quoted businesses can only dream of this: the Faustian bargain of a stock market listing involves surrender of certain forms of privacy and freedom in exchange for access to capital. It sets the difficult task of finding the elusive balance between short and long-term communication: but in many cases the tendency can be to err on the side of the short-term.
You can’t grow long-term if you can’t eat short-term. Anybody can manage short. Anybody can manage long. Balancing those two things is what management is.
– Jack Welch, former Chairman and CEO of General Electric
I would encourage companies to have the confidence to resist the tyranny of the quarter, and articulate the longer term strategy.
BMW is a case in point: a quoted company but still family controlled, and with a sizeable helping of Mittelstand DNA, some years ago it announced its “Efficient Dynamics” programme to a chorus of disapproval from analysts. It was reported that the investment in fuel efficiency technologies would negatively impact earnings, and the share price suffered for a while.
Yet with this investment, BMW bolstered its leadership position in fuel efficiency, CO2 emissions, and compliance with EU legislation: the shares soon recovered and company remains one of the most highly rated of the European automotive groups.
2. Remuneration
In my view this is the most important lesson from the Mittelstand for those concerned with corporate governance. It is blindingly obvious: you will get the behaviour that your compensation system rewards. If you pay people for short-term financial results, that’s what you will get. Mittelstand companies benefit from a focus on long-term, in many cases on intergenerational, wealth transfer.
Owner-managers worry about the business they will hand on to their children. In cases where operational responsibility has been delegated to professional managers, remuneration and reward time horizons are kept similarly long-term. Time horizons in quoted companies in the Anglo-Saxon tradition are much shorter, in my view often too short.
Der Mittelstand ist in besonderer Weise Inbegriff für Leistungsbereitschaft, Fleiß und über den Tag hinausgehende gesellschaftliche Verantwortung.
– ‘The Mittelstand is, in a very particular way, the epitome of dedication, hard work and an exceptional commitment to social responsibility.’
– Helmut Kohl, 6. Bundeskanzler der Bundesrepublik Deutschland
Moreover, if the CEO – or indeed anyone else in a senior position – stands to gain multiple millions from the achievement of an EPS growth target, the internal pressure to achieve this target will become intense. Subordinates will understand the game, and those who want to be CEO themselves one day will do their utmost to make it happen. The organisation will become focused on achieving the target, lose sight of the bigger picture and, ultimately, accounting rules may be bent to fit.
3. The Competition
I am not a retailer, and would not presume to opine on what large UK supermarkets should do about the threat from Aldi and Lidl. Nonetheless the diagnosis is clear: UK firms face the risk of being “stuck in the middle” a competitive conundrum familiar from my days in the automotive industry.
Not “posh” enough to be Waitrose, but unable to match the prices of the German discounters, and with large out-of-town stores increasingly looking like white elephants, there are tough strategic choices to be made. Aldi opened its first UK store in 1989, so the threat is hardly new, yet it is striking how little response there has been from successive management teams at the major incumbents.
Here again the Mittelstand lesson is about the long-term: successful Mittelstand businesses focus obsessively on the competition, on adapting their business model to suit their customers. In the engineering sectors where they are strongest these companies aim to dominate not just today’s technology but tomorrow’s as well.
Businesses such as injection moulding machine manufacturer Arburg do not simply ensure that their current products are competitive. Rather, they also create chess pieces on the board to meet potential future threats – in Arburg’s case that from 3D printing. A technology attracting much breathless press commentary, 3D printing is currently not cost-competitive for most production volumes: nonetheless, Arburg is building competences in anticipation of a world in which it might be.
In our view this kind of long-term thinking provides a valuable lesson for many a quoted UK company.
Stephen Cheetham, author of this edition of Overture, is the Chief Executive of PK Engineering Ltd, an engineering company headquartered in Herefordshire, UK.
Fidelio High Notes – November 2014
- Fidelio builds and develops Boards and Executive teams that are effective at engaging with shareholders and stakeholders
- Chairmen turn to Fidelio for Board Search “beyond the usual candidates”
- Executive Search – Fidelio mandates focus on senior risk, compliance, treasury and public affairs roles
- Fidelio hosts Board Breakfast with the Director of Corporate and Regulatory Affairs, BAT, ‘Stakeholder Engagement and Corporate Reputation’
- Fidelio to explore the Board’s role in IR with SMEs
Please contact us with comments or for more information at info@fideliopartners.com