Study: Careful Allocation of Capital is No Longer a Source of Sustained Competitive Advantage

For most of the past 50 years, disciplined management of financial capital was seen as the key to business success. Today, financial capital is abundant and cheap.

According to new research from Bain & Company, Strategy the Age of Superabundant Capital, the average company would have to increase long-term profitability by more than 3 percent to offset a decline of just 1 percent in long-term growth – purely as a result of today’s low capital costs. Careful allocation of financial capital is no longer a source of sustained competitive advantage.

Those executives who continue treat it as if it were risk lagging irrecoverably behind their rivals and falling far short of their full potential over the next 10-20 years.

As financial capital has become more abundant, its cost has fallen precipitously due to a combination of historically low debt and equity costs. Bain’s Macro Trends Group estimates that global financial capital has more than tripled in the last three decades and now stands at roughly ten times global GDP.

Bain suggests this growth will continue, albeit at a slower rate, for the foreseeable future as a result of: sluggish economic growth; maturing financial markets in emerging economies; and an expanding number of ‘peak savers’ – those 45-to-59 year-olds who are critical in determining the level of savings (vs. consumption) in the global economy.

“Taken together, these factors lead us to conclude that for the balance of the next decade – at least – markets will continue to grapple with superabundant capital,” said Karen Harris, managing director of Bain’s Macro Trends Group.

“Too much capital will be chasing too few good investment ideas for many years, requiring a fundamental shift in how companies implement their business strategy and manage capital.”

Era of relative capital scarcity

The long-accepted, standard method for managing capital and prioritizing strategic investments is rooted in an era of relative capital scarcity. It focuses on narrowing the field of potential projects and encouraging investment in only a few “sure bets” that clear high hurdle rates.

Now, at a time when most companies are desperate for growth, this approach unnecessarily closes the door on many potentially viable options. It encourages executives to remain committed to investments long after it’s clear that they are not paying off. Finally, it leaves companies with piles of cash for which executives often find no better use than stock buy-back.

The solution, advises Bain, is to challenge the ‘unspoken’ rules of business success by recalibrating three tenets of strategy: 1) lower hurdle rates and relax other constraints that reflect the bygone era of scarce capital; 2) move away from making a few big bets over the course of many years and make multiple smaller investments in a portfolio of ideas (or options), knowing that many will not pan out; and 3) learn to spot losing investments – and get out of them – quickly. And double-down on the winners, nurturing them into successful new businesses.

“This new strategic model fits an era of cheap capital. Perhaps more importantly, it gives companies the speed and agility they need to compete in today’s rapidly evolving markets,” said David Harding, advisory partner at Bain.

“Undoubtedly, capital management will remain a business imperative even in a time of superabundance – waste is waste. But, the new bedrock on which winning strategies will be built is the quantity of valuable ideas an organization’s people can generate and leadership’s ability to successfully commercialize them.”

Five rules of the new strategy game

Companies that have already begun incorporating capital abundance into the way they think about strategy and investments are building an impressive lead. Based on its work with many of these organizations, Bain has identified the five rules of the new strategy game:

  1. Set a high bar for share repurchases. Leaders have a strong bias towards reinvesting earnings in new products, new technologies, and/or new businesses. It is the only way for companies that have bought back shares to grow into their new multiples and for other companies to fuel innovation and accelerate profitable growth.
  2. Think of investments as experiments, not commitments. Executives replace the long-held view that the primary goal of any assessment process is to winnow the field of investment ideas to focus the company’s precious capital on a few, select opportunities. The new approach should be to test a large field of ideas before diving in.
  3. Focus on continuous expansion, not just continuous improvement. Leaders focus as much (or more) on identifying new growth opportunities as they do (or have) on optimizing the current business.
  4. Open a lot of doors before walking through. With superabundant capital, companies no longer have to “pick winners.” Instead, they have the opportunity to make more bets, double-down on those that perform well, and cut their losses on the rest.
  5. Treat human capital as the true scarce resource and the key source of competitive advantage. The time, the talent and energy of a company’s workforce is the foundation of great performance.

“Human capital, not financial capital, is the source of differential productivity. Yet, companies devote far too little attention to ensuring that their organization’s scarcest resources – time, talent and energy – are put their highest-value and best use,” said Michael Mankins, a partner in Bain’s Organization Practice and co-author of the forthcoming book, Time | Talent | Energy: Overcome Organizational Drag & Unleash Your Team’s Productive Power.

“The best companies manage human capital with more precision. Their employees work smarter, not harder, enabling them to devote more of their energy to customers and the company’s success.”

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