Yep, all Dennis's shots about ethical businesses are hitting the target. But it feels odd to be having a discussion about sustainability here in 2006. I thought the dangers of the quarterly reporting cycle and the pressures on management to deliver for the short-term had been laid to rest when Enron and WorldCom showed their investors how dangerous it was to ignore long-term business objectives.
The problem, of course, is the free movement of capital. If shareholders had to hold equity for a minimum of, say, five years, they'd pressurise management to deliver sustainable growth; businesses that had true "density" - and that means great relations with staff and customers - would win out both in terms of market cap and revenues. That enforced holding is impossible to engineer, of course. But some investors do it voluntarily - Warren Buffett, for instance.
As an aside, I once had a chat with John Rishton when he was CFO at British Airways. Oil was heading north at a rapid pace at the time, and I asked how his financial planning was going. He said they had a few more months of their forward buying to unwind, so they were OK for the moment. But he also told me what a lousy investment airline shares were. I said I was amazed - surely he could explain why BA was a good buy. Not to hold, he argued. No airline has ever really made any money over the long term and the professionals simply watch the yo-yo of the share price and sell on the peaks to make their money.
In other words, there is no incentive for the airlines, individually or collectively, to operate sustainably. They see the long-term investors as fools and the ones who make money on their stock as bandits. We all know how they view a majority of their customers (cattle - and DVT, did you now, is largely down to poor air quality in the cabin so they can save money). And they're having a tough time with staff, too. Not, then, the model of the open, honest and fair organisation that can deliver for the long term.
27 November 2006
China as a market
Just heard Alan Wood CBE, chief exec of Siemens UK and speaker at the CBI conference, on the Today programme. He was being interviewed about the trend for foreign companies to buy UK businesses and argued that while this was not a positive movement, legal barriers to overseas acquirers were not appropriate. Instead, he said, British business needs to get more outward facing, seeing China and India not as sources of cheap labour but as huge potential markets - and the government should lobby to ensure they are as open to UK exports as we are to their imports.
All motherhood and apple pie (at least for a capitalist - he could hardly call or less free markets, although the leader of the capitalist world, the US, has plenty of funny quirks and folds in its free trade eiderdown). But then he said, (and I paraphrase) "We have to look at China as the single biggest market in the world."
Hmm. I wonder. Is China really the single biggest market? One might successfully argue that England and Scotland are different markets (especially for services - in goods, it's still probably advisable to operate off the logisticians' approach to geographic proximity when discussing "markets"), let alone Britain and Italy. Is Shanghai the same market as Zhuzhou or Chonqing or Xi'an or Urumqi? Is doing business in Delhi the same as in Cochin or Calcutta or Patna? You'd treat Lahore differently from Amritsar, but they're relatively close neighbours.
Perhaps that's the key: start thinking of true markets and not nation states. Yes, the legal and regulatory borders are still significant. But if we think of peoples by our own, rather crude and dare I say imperialist, categorisations, we'll never really be able to sell to them properly.
One day I'll round to publishing my thoughts on the death throes of the concept of the nation state...
All motherhood and apple pie (at least for a capitalist - he could hardly call or less free markets, although the leader of the capitalist world, the US, has plenty of funny quirks and folds in its free trade eiderdown). But then he said, (and I paraphrase) "We have to look at China as the single biggest market in the world."
Hmm. I wonder. Is China really the single biggest market? One might successfully argue that England and Scotland are different markets (especially for services - in goods, it's still probably advisable to operate off the logisticians' approach to geographic proximity when discussing "markets"), let alone Britain and Italy. Is Shanghai the same market as Zhuzhou or Chonqing or Xi'an or Urumqi? Is doing business in Delhi the same as in Cochin or Calcutta or Patna? You'd treat Lahore differently from Amritsar, but they're relatively close neighbours.
Perhaps that's the key: start thinking of true markets and not nation states. Yes, the legal and regulatory borders are still significant. But if we think of peoples by our own, rather crude and dare I say imperialist, categorisations, we'll never really be able to sell to them properly.
One day I'll round to publishing my thoughts on the death throes of the concept of the nation state...
14 November 2006
Reporting: keep it simple, stupid
A rather lengthy response to a post over at Dennis Howlett's place.
I, too, find it strange that we're having the debate on IFRS now - when the damage has already been done. I can understand why fair value accounting was seen as a viable way of taking company reporting forward, but the tools just ain't there. (And although I sympathise with Dennis's finance/HR alliance ideas, the fact is that in the vast majority of companies, HR is a substandard function that just isn't up to managing its people well, let alone coming up with viable ways of communicating their value.)
My view - based on nine years of watching what FDs actually do and hearing how they feel - is that we need to ditch the whole idea of comparability. So I guess I'm actually siding with the Big Four - although I agree with Dennis that they've been a bit disingenuous in how they've gone about this. Here's my thinking.
Most good managers don't run their companies to engineer reported results anyway. We've seen what happens when they do (Enron, WorldCom, iSoft etc etc) and those of you with an accountancy qualification know how much leeway there is in the standards even when (in theory) we can all agree on what they mean. Instead, they use a set of targets and metrics – many of which are shared, like ROCE – to monitor their performance and produce better results. Knowing what those targets are and how management is performing against them is surely more use to investors that how they’ve been filtered into a set of accounting standards. It also means companies can focus on the real drivers of their particular businesses, not some arcane way of segmenting their accounts that fits a theoretical notion of how you uncover value.
I was talking to an M&A adviser at KPMG the other day about the market research industry. He pointed out that it was almost impossible to compare any two businesses in the sector. "Evaluating MR companies is tricky because it’s hard to find true like-for-like comparisons," he told me. "Even with an Ipsos or a TNS, where you have a big group mostly involved with MR, they present their results differently and the only way to really compare them is net margins. But even then, with so many M&A deals going on, it’s hard to make real comparisons between them on like-for-like basis."
In fact, many professional investors already take a case-by-case approach. They get close to companies to understand them beyond the accounts – that’s what gives them an edge as professionals. Some like to focus on a couple of key metrics – Terry Smith once told me that all he was interested in was cash, and talking to management was just a distraction! I suspect many analysts and institutions already operate more like private equity managers now – they’re looking way beyond IFRS and into their own set of either unambiguous or tailored value drivers.
A majority of private investors don’t read the annual report and accounts anyway – or if they do, they’re more likely to be steered by the marketing bumpf at the front than the crowd of figures at the back. And a really smart investor looks at things they can see – joking aside, if you want to know which retail shares to buy, spend an afternoon in Bluewater or your High Street. If M&S is packed… well, you’re in possession of intelligence that won’t be in the accounts for another six months. Buy.
Bottom line: whatever happened to caveat emptor? By scaling back the accounting standards to a bare minimum that allows the banks, investors and the tax man to see a couple of key metrics presented objectively (cash! net margin!), you force companies to compete for finance on their own terms. And you force finance providers to take a much harder look at the companies they invest in. If that means some people get burned because they choose to believe outrageously optimistic statements or shonky metrics from management – well, that’s their look-out. Even my old mum knows that if something looks too good to be true, it probably is.
But the companies that do engage in transparency, the managements that have a track record of good risk management and delivering results – they’ll get the lower cost of capital that, it has been suggested, is the big benefit of these increasingly complex and prescriptive accounting standards. (Of course if FDs, analysts, investors and regulators all think accounts are more confusing under IFRS - and they are - then cost of capital will rise...) And if investors think management isn’t transparent? Big flashing warning signs should go off and that obfuscatory management should be removed.
The one glimmer of hope might be that the ASB and the IASB pursue the international FRSSE for all non-“public interest entities”. But they’d have to take some bold steps to simplify it still further. FDs and investors, I believe, would breath a sigh of relief.
I, too, find it strange that we're having the debate on IFRS now - when the damage has already been done. I can understand why fair value accounting was seen as a viable way of taking company reporting forward, but the tools just ain't there. (And although I sympathise with Dennis's finance/HR alliance ideas, the fact is that in the vast majority of companies, HR is a substandard function that just isn't up to managing its people well, let alone coming up with viable ways of communicating their value.)
My view - based on nine years of watching what FDs actually do and hearing how they feel - is that we need to ditch the whole idea of comparability. So I guess I'm actually siding with the Big Four - although I agree with Dennis that they've been a bit disingenuous in how they've gone about this. Here's my thinking.
Most good managers don't run their companies to engineer reported results anyway. We've seen what happens when they do (Enron, WorldCom, iSoft etc etc) and those of you with an accountancy qualification know how much leeway there is in the standards even when (in theory) we can all agree on what they mean. Instead, they use a set of targets and metrics – many of which are shared, like ROCE – to monitor their performance and produce better results. Knowing what those targets are and how management is performing against them is surely more use to investors that how they’ve been filtered into a set of accounting standards. It also means companies can focus on the real drivers of their particular businesses, not some arcane way of segmenting their accounts that fits a theoretical notion of how you uncover value.
I was talking to an M&A adviser at KPMG the other day about the market research industry. He pointed out that it was almost impossible to compare any two businesses in the sector. "Evaluating MR companies is tricky because it’s hard to find true like-for-like comparisons," he told me. "Even with an Ipsos or a TNS, where you have a big group mostly involved with MR, they present their results differently and the only way to really compare them is net margins. But even then, with so many M&A deals going on, it’s hard to make real comparisons between them on like-for-like basis."
In fact, many professional investors already take a case-by-case approach. They get close to companies to understand them beyond the accounts – that’s what gives them an edge as professionals. Some like to focus on a couple of key metrics – Terry Smith once told me that all he was interested in was cash, and talking to management was just a distraction! I suspect many analysts and institutions already operate more like private equity managers now – they’re looking way beyond IFRS and into their own set of either unambiguous or tailored value drivers.
A majority of private investors don’t read the annual report and accounts anyway – or if they do, they’re more likely to be steered by the marketing bumpf at the front than the crowd of figures at the back. And a really smart investor looks at things they can see – joking aside, if you want to know which retail shares to buy, spend an afternoon in Bluewater or your High Street. If M&S is packed… well, you’re in possession of intelligence that won’t be in the accounts for another six months. Buy.
Bottom line: whatever happened to caveat emptor? By scaling back the accounting standards to a bare minimum that allows the banks, investors and the tax man to see a couple of key metrics presented objectively (cash! net margin!), you force companies to compete for finance on their own terms. And you force finance providers to take a much harder look at the companies they invest in. If that means some people get burned because they choose to believe outrageously optimistic statements or shonky metrics from management – well, that’s their look-out. Even my old mum knows that if something looks too good to be true, it probably is.
But the companies that do engage in transparency, the managements that have a track record of good risk management and delivering results – they’ll get the lower cost of capital that, it has been suggested, is the big benefit of these increasingly complex and prescriptive accounting standards. (Of course if FDs, analysts, investors and regulators all think accounts are more confusing under IFRS - and they are - then cost of capital will rise...) And if investors think management isn’t transparent? Big flashing warning signs should go off and that obfuscatory management should be removed.
The one glimmer of hope might be that the ASB and the IASB pursue the international FRSSE for all non-“public interest entities”. But they’d have to take some bold steps to simplify it still further. FDs and investors, I believe, would breath a sigh of relief.
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