Here’s a provocative question for CFOs to consider: Are you paying attention to the right performance metrics? According to one expert, no. And that oversight could be costing companies significant value over the long term.
Organizations are much too focused on the short term and misplace their energy into becoming faster and cheaper at all the things they’re already doing, John Hagel, founder of consulting firm Beyond Our Edge LLC and a former partner at Deloitte, told attendees of the RIMS enterprise risk management (ERM) conference during a keynote address earlier this week.
Hagel said he considers return on assets (ROA), instead of return on equity (ROE), as “the most fundamental measure of corporate performance,” but he sees the indicator headed in the wrong direction in the digital age. Citing some of his previous research, Hagel said ROA declined by 75% among public companies between 1965 and 2019.
“If you want a good indicator of mounting performance pressure, that’s a pretty good indicator, not only of the pressure but our increasing inability to respond to it,” he said.
In Hagel’s view, companies’ obsession with “scalable efficiency” is to blame for deteriorating ROA. Rather than take a long-term view on what they should look like in one or two decades, businesses are focused on doing “the same things faster and cheaper, and return on assets begins to deteriorate.”
Hold up. But why focus on ROA? Hagel said he’s found many corporations are adept at “cushion[ing] the blow to investors” through actions like stock repurchases, increasing debt ratios, and increasing dividend rates. This keeps investors happy and ROE looking healthy even while ROA lags, which Hagel argued is “not sustainable; that’s short term.”
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Hagel said organizational strategic planning that emphasizes ROA shouldn’t focus on the coming quarter, or year, or even five years out. Instead, leaders should look even further out, to the next 10 to 20 years, and imagine what their organizations will look like then. To reach those long-term, audacious goals, they should identify incremental changes over the next six to 12 months.
Leaders may pooh-pooh this idea, saying they have no money for these pie-in-the-sky ideas and that they’re under pressure to perform here in the now—in time for next quarter to look good, Hagel said. And there could be resistance within an organization to a shift toward ROA. The risk organizations run by not doing this, according to Hagel, is their eventual obsolescence.
“My one piece of advice to leaders who are pursuing fundamental change in large organizations is never, ever underestimate the power of the immune system and the antibodies that exist in every large organization,” he told the audience. The immediate immune response, he added, will be to “mobilize to crush that change.”
But once that resistance (from well-meaning people, mind you) is pulled back, amazing things can happen, Hagel said.
“What we need to do is find ways to overcome the fear and help [business leaders] get more excited about the opportunities that are available in the future.”