Financial reporting: the demise of long-term viability

Author Geoff Barton Published 14 July 2009

We are currently in the midst of a severe recession, and we are seeing the demise of some much-respected companies. Why is this happening? Because MBA’s are running most companies, and using their skills to play with financial reports instead of managing their organisations.

Now don’t get me wrong. I have an MBA and I value it, but I also have engineering degrees. An engineering degree teaches you how to analyse user needs and use scientific breakthroughs to 'engineer' something good. But engineering good products takes time and money and is a long-term investment. There is an upfront investment in design, prototyping, assembly, testing, reviews and research. When done properly it produces long-term returns.

Organisations can be similarly engineered: develop a long-term vision, invest early and plan for returns down the track. Where Chrysler and General Motors—two of the stalwarts of US manufacturing and the US economy more broadly—continue to flounder even after their massive government bailouts Ford, Toyota and Porsche are performing well despite the downturn.

The difference is in management objectives. In my opinion Chrysler and GM (US) management lost their direction and passion for building cars. Instead, they have been managing the companies by the books: always striving to produce a better financial result than last year—and then leaving before their poor long-term choices affected their bonuses.

Kiichiro Toyota, Ferdinand Porsche and Henry Ford all set out to build companies that made and sold cars. Each took a different approach, but all could engineer any type of car that anyone wanted. Porsche, for example, also designed the VW Beetle; Henry Ford (II) the iconic Ford GT40 Supercar; and Toyota the BMW-quality Lexus. Each strove to make the best cars for the particular market segment that they were chasing. They all had plenty of ups and downs along the way, but their long-term goals kept them focussed. They invested in what they were doing and shareholders either agreed with their vision or sold their shares. As car sales increased it became clear that buyers also understood their products.

Toyota, Porsche and Ford have all become known particular types of cards: small family cars (Toyota Corolla), cheap all-purpose car (VW Beetle) and sports car (Porsche 911). This profile is enhanced by management continuing to invest their ability to make their product the best option available. Such investments have short-term impacts on financial results, but they have long-term impacts on the company's product line and capabilities.

In Australia GM (Holden) is well known for good quality large family cars. The Holden Commodore is Australia's largest selling car, but this is not a twist of fate or stroke of good fortune. Holden invested heavily in the Commodore in the late 1970s, and has continued to refine the Commodore every couple of years since. It set out to be the Australian family car market leader by producing the best product for the market it could—a vision it has maintained over the decades, despite some ups and downs.

GM (US) and Chrysler, on the other hand, produce a huge range of products that even the most devoted fan would agree lacks the design quality of modern Japanese or European cars. They are badly assembled (gaps, squeaks, rattles) and they are full of cheap plastic and ‘tinny’ metal. In the 1970s people referred to Japanese products as rubbish. Today the design quality of Honda, Toyota and Mazda cars is miles in front of their US equivalents.

The Japanese companies mentioned have spent 50 years improving their products, processes, tools, factories and staff. By contrast, when GM wanted to produce a new four-wheel drive, it didn’t seek to develop the best four wheel drive it could, it simply purchased the Hummer company (the maker of the US military vehicle) and then re-styled the outside of one of their current products to have what they call ‘Hummer DNA’. It looks like it might be tough but it's actually just a new cover on an old and flawed product. It achieved short-term sales and boosted that year's profits, but it contributed little else to the company.

So what has all this talk about cars got to do with MBAs? In a recent interview, a former GM executive indicated that the company basically never bothered to make any hard decisions or long-term changes that would negatively affect the company's short-term returns. Why? Probably because executives are increasingly assessed on their quarterly and annual financial performance. A ‘good’ CEO is one who is seen to improve the company's EBITDA each reporting period. To hell with the CEO’s vision or investments in the company’s ability to produce products in five years time—the bottom line now is what counts.

MBA’s learn financial management, and most are able to pull the right levers to make a change in one of the financial measures. However, too many are spending time doing this for all the wrong reasons. GM’s management have been seeking short term gains for too many years. GM’s fundamental infrastructure has decayed, and so has its competitiveness with Japanese and European firms. Forget what is written in their accounting records as ‘assets’—the company is effectively bankrupt and many of their accounting assets have no real worth on the second hand market. Their execs have taken one of the largest and most successful companies in the world and turned it into a tin veneer building—it might look okay on the outside but it's rotten in the middle and about to collapse. All of this while improving financial numbers and getting good bonuses. You can bet that most of them have an MBA.

I once worked with an exec earned more than $1 million per year. His philosophy was that his superior had taken care to structure the executive bonus scheme to drive the right outcomes, which meant that any outcome that achieved a bonus was what was wanted for the company. That exec loved his bonuses, and sometimes acted with impunity and moral certitude to get it. This is effectively a Gordon Gekko version of the Nuremburg defence: “Yes I was greedy, but I only did it because I was ordered to.”

Whether this exec did what his boss wanted or what some share market analysis wanted is irrelevant. Execs are paid to provide stewardship over a company and its assets. This does not mean improving headline numbers at the expense of the company’s future. A farmer, by comparison, has stewardship over their land, and they work for decades to improve their land and stock's long-term productivity. This means long-term investments in soil quality, breeding stock and dams, not short-term changes to produce more product than last month. A company's long-term viability requires execs to have the same long-term passion.