Run on Numbers: Companies must Act their age
For companies to act their age, they should know in which phase of their lifespan they find themselves. The SA Post Office, for example, is at the end of its lifespan, be it for right or wrong reasons. They must now act like a company on the decline, the same as SAA and a host of other such public companies.
The Industrial Revolution was a period of scientific and technological development in the 18th century that transformed largely rural, agrarian societies, especially in Europe and North America, into industrialised, urban ones. Goods that had once been painstakingly crafted by hand started to be produced in mass quantities by machines in factories, thanks to the introduction of new machines and techniques in textiles, iron making and other industries.
According to Wikipedia, there are 5,586 companies older than 200 years in the world, but most of them are not on the Fortune 500 list. According to Fortune, the oldest company on the Fortune 500 list is DuPont, which was founded in 1802. There are only 12 companies on the list that are older than 100 years. The average lifespan of a US S&P 500 company has fallen by 80% in the last 80 years (from 67 to 15 years), and 76% of UK FTSE 100 companies have disappeared in the last 30 years.
In South Africa, Eskom is also dying. Established in March 1923, it just managed to make it to 100 years and will shortly be broken up into three pieces. Eskom’s debt burden of R420 billion is too much to handle, and it already struggles to meet electricity demand. The same goes for other SOEs, like SAA, the South African Post Office and Transnet, which struggle to fulfil their mandate and support the economy.
The next phases of a company’s lifespan are:
- At the initial/start-up phase of a company, the mortality rate is normally very high. In the early stages, it should not make use of debt, at least as little debt as possible. At this stage, companies are often referred to as being in a cash-burning stage. It is prudent to accept that there is cash that needs to be burned, but neither the company nor shareholders must accept the cash burning to continue unabated. The company must not earn returns that just go to repay interest and capital. It is also good for a company in its formative years to have a visionary leader, someone like Elon Musk or Mark Zuckerberg. Also key to survival is a forward-looking strategy. It must invest in growth assets and build with the future in mind. An example of longevity in the South African landscape is close to home; the Cape Times, established in 1876, the Cape Argus, established in 1857, and The Star, established in 1889, are all complemented by digital offerings. It often is a question of adapt or die.
- After a company survives its formative years, a company typically enters a growth phase. The company must decide on a business model that can convert ideas and concepts into bankable propositions ready for implementation with a focus on efficiency and productivity, attracting the right skilled workforce, training them, and aligning them with the company goals and mission. Tech companies grow much faster than the traditional manufacturing company. The reason for this lies in the fact that they need less capital to start with, and it is much easier to scale their business once it is established. It is now time to implement the visionary plans and put assets and all other resources in place to gain earnings growth. A company can now “afford” some debt as the risk of failure has been diminished, and the company becomes more attractive to risk-averse lenders. Debt becomes more available and a lot cheaper. A good example is the meteoric rise of Tesla. An individual with a credit score below 550 would have to pay 29% for a loan, whereas the same individual can pay prime less than 1%, which currently will result in a rate of 10,75%- substantially lower yet not conducive for a growing economy. The same principal applies to companies as many financial products and financial structured deals are available to them at this stage. Any debt accepted will only be accepted if the return the company can create substantially outperform the debt cost after a risk premium is added to the borrowing rate.
- The next phase of a company’s lifespan is all too familiar and like human lifespans. The mid-life crisis years arrive. The company has fewer new innovative products and fewer youthful workers with fresh, imaginative ideas. Things are running smoothly, with little stress, an established client base, an established and well-entrenched business model, and systems created at a huge cost in place which work and are efficient. A company may have a period of mature growth before things plateau. Initial growth of double digits may slow down to growth in line with inflation. What is there to worry about? Adaptability has become cumbersome and expensive, and there is a lot of resistance to change as things that have worked for a decade or longer are not easy to replace. The adage comes to mind, why change a winning recipe? The company is now mature, and as far as the ideal leader is concerned, the bright, innovative entrepreneurial type is not quite the right fit for the company. The shareholders prefer a person who concentrates on maintenance and tweaking here and there, but there is little appetite for risk. There would be some discussions on what the competitors are implementing, but the company is now no longer a leader and innovator but rather a conservative custodian of existing market share and product lines.Very little money is spent on research, and the company is inwardly focused, although their focus remains on their existing customers, product offerings and operational processes. The company would typically prefer to reduce debt levels during this stage.
- The inevitable decline eventually sets in. Currently, the average lifespan of a company is as short as 30 years. During this time, the very same concepts and circumstances that aided the company to thrive in its initial years are now working against them as new companies enter the market. New companies do not have legacy systems, processes, and products that they need to defend. New technology, whether in software developments or cheaper and more efficient machines or other competitive edges, gives new companies an edge, and they start to win over previous loyal customers from the older company. A good example in South Africa is to be found in the banking sector. The Big Four banks, Absa, Standard Bank, First National, and Nedbank, were well established with a huge footprint, consisting of expensive brick-and-mortar retail halls and offices. Capitec completely changed the competitive landscape with their smaller offices, smaller banking halls and their more efficient systems to open accounts speedily and efficiently with their initial offering targeting the entry-level customer. Soon, they moved up the ladder and gained market share in the previous loyal market. The untouchables became mere competitors, and in trying to catch up, they are going through very expensive cost-cutting measures.
- The End game. As every good chess player is familiar with, it is very important to know how to play the end game. Once the writing is on the wall, a company that finds itself to be uncompetitive and with a declining market share, there is still a dignified and prudent way to handle this phase of a business. The SA Post Office and SAA are very good examples of how not to manage this phase of a company’s lifespan. At this stage, a company is better off getting rid of the visionary leader, the entrepreneur, or the solid builder, the maintenance man. It is now time to appoint a leader that has the mindset of a liquidator.Someone who knows when and what there is to salvage and to reduce losses to shareholders. Once the company no longer produces returns more than the risk premium over the cost of capital, it is time to pay back the money. A timely acceptance of defeat is much better than throwing bad money after good money into a bottomless pit. Just think of a car; there is a time that the scrap yard offers the best value.
Any worker must ask him or herself at what stage the company for whom I work.
* Kruger is and independent analyst
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