Stronger for longer, not strongest for shortest

Soon her eye fell on a little glass box that was lying under the table: she opened it, and found in it a very small cake, on which the words ?EAT ME? were beautifully marked in currants. ?Well, I?ll eat it,? said Alice, ?and if it makes me grow larger, I can reach the key; and if it makes me grow smaller, I can creep under the door; so either way I?ll get into the garden, and I don't care which happens!?

(?Alice's adventures in Wonderland?, Lewis Carroll) (1)

In Lewis Carroll's 1865 classic, the cake that Alice eats makes her grow so big that her head hits the ceiling. She wanted to be smaller again, but, alas, while using the White Rabbit's fan, she shrinks so much that she finds herself swimming through her own tears!

Over the past 30 years we have seen small moving to big and near moving to far with the advent of globalisation and the offshoring of manufacturing in particular.

A recent report from management consultants Kearney published in Forbes (2) noted that the US Manufacturing Import Ratio (MIR), a measure of the proportion of output from offshore production in value terms, steadily grew from 9.2 per cent in 2008 to 13.1 per cent in 2018.

While a central doctrine of classical liberal economics has it that economic interdependence leads to peace, the primary reason has been baser: cost.

Demand for cheaper consumer products, and hence cheaper manufacturing, drove a significant shift in offshoring. The main beneficiary was China with its very low labour costs, plenty of resources and political will to expand. Thailand, Vietnam and Mexico in recent years have also benefited from manufacturing outsourcing, while India has been more famous for drug manufacturing and IT services outsourcing.

2019, however, saw the first fall in MIR since 2011 down to 12.1 per cent or a 100 basis points drop. There are a number of drivers for this seeming reversal.

Firstly cost. According to Statista (3), manufacturing labour costs in China have risen more than 30 per cent since 2016 and more than 25 per cent in both Vietnam and Mexico.

Secondly, nationalism and its regular bedfellow isolationism. The US-China trade war is probably the most important issue at play, with the added governance concerns over factors like IP appropriation.  The current pandemic adds another dimension. And let's not forget Brexit.

Thirdly, environmentalism (4) and a broader ESG awareness among all stakeholders. More attention is being paid to the absolute level of consumption and the potential negative impact on climate change of transporting goods from one side of the planet to the other.

However, is a complete retrenchment to onshore necessarily the right move? Should the paradigm shift be not from globalisation to localisation but rather to diversification, thereby spreading risk and building resilience to shocks?

Of course, a consequence of diversification is the extra costs due to the need for redundancy in systems and potential overlap. This can ultimately lead to lower profits for shareholders.

Back in August 2019, nearly 200 CEOs from leading US companies signed a statement from the business roundtable (5), arguing that maximising shareholder profit should no longer be considered their overriding goal. Other stakeholders matter, be they employees, customers or society as a whole, where profit may not be a primary concern.

Is prioritising profits, however, a bad thing if it results in long-term shareholder value? (6) Given the interdependence of a business with the broader ecosystem, that should also be compatible with broader environmental concerns including climate change and sustainability and the concerns of all stakeholders.

That will in turn necessitate more attention being paid to peripheral risks so that risks and opportunities can be identified far enough in advance for strategic planning to be effective.

So has the real problem been the slippage of shareholder focus from the long term to the short term?

Would you prefer a five per cent growth rate or a 20 per cent growth rate? It depends. What if that five per cent growth was consistent every year for ten years, while the 20 per cent was only there for the first couple of years before flatlining and then becoming negative after that?

Stronger for longer, rather than the strongest for a short period of time.

Although earnings growth may be smaller, what if that multiple was more heavily waited to sustainability of earnings than the growth rate, as well as following sound ESG principles?

Cliff Asness, founder at AQR Capital Management, has argued that when it comes to ESG investing, sacrificing performance is the whole point of it all, accepting that there is a cost associated with doing good. (7)

So, with investor mindsets shifted, that should provide the right incentivisation to management teams to get their businesses into the right shape and size for long-term sustainability, sacrificing near-term growth for a lower, but more sustained growth. While the Covid-19 pandemic appeared to have put positive action on addressing climate change and social responsibility on hold, it would not be at all surprising for that focus to shift back as we begin to emerge from lockdown. Indeed, learned behaviours could accelerate the shift to a more sustainable future.

?The first thing I?ve got to do,? said Alice to herself, as she wandered about in the wood, ?is to grow to my right size again; and the second thing is to find my way into that lovely garden. I think that will be the best plan.?

Alice had the right idea.

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(1) Alice's adventures in Wonderland by Lewis Carroll really is 155 years old. You can read it online here  Project Gutenberg is a library of over 60,000 free eBooks. The focus on older works for which U.S. copyright has expired.



(4) Curation Collection: The Great Climate Crash

(5) Curation comment on Business Roundtable statement:

(6) Curation comment on the long term stock exchange

(7) Cliff Asness, Founder of AQR Capital Management article on ESG investing