Greg Hackett has been a lot of things. Management consultant, founder of an eponymous research house and a university professor.

Then he became an angry investor.

Guys like Hackett have lots of money and inevitably make some lousy investments. But Hackett is smart enough, opinionated enough and curmudgeonly enough to think that he could figure out why some of his investments wound up doing so poorly.

Of course, being a university professor with access to a bunch of overeager grad students is also an advantage.

So he got scientific about his selfish quest. He started with the 1000 thousand largest companies in 1960 and tracked the top 1000 every year since (a total of 3225 companies), examining all their financial numbers and reading every issue of the major business magazines to try to figure out the patterns of success and failure.

Hackett contends that there is no correlation between company performance and stock price (remember, the stock market was pretty moribund before the Reagan years).

But the bigger surprise is that even during the recent boom years in stocks, companies really haven't been performing very well overall. In fact, they are failing at an ever-increasing rate. Here's some of the salient data from Hackett's research:

• Looking at the S&P 500 over time (1957 to 1997), only 15 percent of companies survived and only 16 percent outperformed the S&P average
• Average profits among the top 1000 reached a peak of 7.6 percent in 1965 and are now at 4.3 percent.
• Today roughly 18 percent of companies are unprofitable—3.5 times the number in 1960 (5 percent)—and small companies are twice as likely to be unprofitable as large companies.
• 75 percent of industries are trending downward in profitability
• Average lifespan for a big company since 1960: 23 years

So, what does all of this have to do with IT? Hackett asserts that any productivity gains from IT have been wiped out by the increased cost of IT over time. He goes so far as to claim that continued increases in IT costs will eventually wipe out what is left of companies' ever-shrinking profit margins—though he can offer no proof of a trend towards that end. I asked Hackett to explain his findings and his dark view of IT. (I have also attached a slide deck that goes into more specific details about the data and his solutions.) Here's our conversation:

KOCH:Your findings are pretty depressing. The only good news you found was that the cost of goods sold (COGS) is down 10 percent since 1960. How did that happen?

HACKETT:Purchasing agents have gotten aggressive in terms of getting the costs of raw materials and component parts down. Also, there have been improvements in terms of technology and using all sorts of tools to improve productivity and quality that keeps the cost to manufacture and produce products low.

KOCH: So you think IT really has improved productivity across all industries?

HACKETT: Oh I think it’s definitely proven. But then I also found that SG&A [Sales, General and Administration—essentially the costs of running a business] has gone up by 40 percent—canceling out the gains in COGS. And what’s driven SG&A overall has been a little bit of regulatory costs, but primarily IT costs. IT cost is the fastest growing cost in a corporation today.

I’m going to say something flip, and I can’t prove it to you, but my hypothesis is that IT costs are growing so fast that they are going to wipe out profitability completely in 20 years. If you look back before 1980, SG&A costs were somewhere right around 12-14 percent, and then they took off. And what happened in the early '80s? Everyone had to have a personal computer. Computers came out of the backroom from doing large-scale processing of payroll to using more applications for customers and taking orders.

KOCH: So do you think the IT piece is what’s been driving profits down?

HACKETT: Yeah. But I would add that SG&A costs leveled off a bit during the '90s, which I think shows that we are starting to get payback on the investments. In the '80s when we started swapping labor for technology, people didn't know how to re-engineer the processes to get the costs out of them. In the '90s, we [started getting better at it], so the [percentage increases in SG&A have] leveled off. But IT is still a pretty expensive infrastructure cost—you just didn’t have that much IT costs in a company 25 years ago.

So I think the productivity gains from technology have probably leveled out. We might get a little bit more, but we’ve got the bulk of it out right now. And until we get to the next big wave of technology, this is about what you’re going to get.

KOCH: So if COGS and SG&A cancel each other out, how do you account for the drop in average profits?

HACKETT: Today there are 3.5 times more unprofitable companies than there were in 1960. So I asked the question, Well, is it small or large companies? And what I found is that smaller companies are twice as likely to be unprofitable as the large. And my definition of a small company is under $1.4 billion in revenue.

And if you look deeper, you see that companies on average are only profitable for nine days out of the year. If you take all the profit—the net income—at the end of the year, and divide it by 365, and take the sales and divide it by 365, that’s all you’ve got, is nine days. So only nine days worth of sales, on average, go to profit.

That means that 356 days a year, you’re not making any money. It’s that razor-thin. It’s that damn thin. That’s scary. And if you go back and look at the year 2001, after 9/11, 40 percent of companies were unprofitable. So any one major thing that occurs to a company, it just wipes you out.

KOCH:But investment opportunities are much more fluid today with all the venture capital companies. And there's much more wealth chasing opportunities today. Lots of people are putting lots of money in really risky companies. Does that have any bearing on the profitability percentages, do you think?

HACKETT: Well, people are searching for yield returns. But very few companies actually pay dividends today [one-third fewer than in 1980], and the number is dropping. So if you want a return, you have to seek stuff that’s a lot riskier.

And if you look at the data, you'll see that nearly half of companies will [drop into the unprofitable category] half the time. In other words, nearly 50 percent of companies will be unprofitable for two out of the next five years. So now, you tell me where you want to stick all your money. Roll the dice.

KOCH:Okay, let's look at the issue of short-term cycles. You’ve got a lot more money today invested in short-term speculation on companies’ short-term profitability. Is that a factor?

HACKETT:I think short-term performance is one of the drivers. But I’ll tell you why they focus on short-term: They’re only making nine days profit. If you take your eyeballs off it for one moment, you’re cooked.

I actually did an analysis that tied stock price valuation to profits and found that the correlation between the two is less than one-tenth of one-thousandth percent. There’s no relationship whatsoever between the stock price and how much money a company makes—zippo.

Out of the 1000 companies that I looked at, about 80 percent are declining. In other words, 80 percent of all the large publicly held companies have either stagnated, meaning their net income is not growing, or they’re in a decline, and their net income is actually going down. 80 percent are headed in the wrong direction. Only 20 percent are up.

KOCH:What other factors are at work here besides the emphasis on short-term profitability?

HACKETT: Things are just happening so much faster today and that is affecting companies' ability to compete. Companies are failing at a faster rate today. For a company that was born in the early '60s, 25 percent were gone by 1980. For companies that were taken public in the '80s, 45 percent of them were gone in 16-20 years. For companies born in the '90s 20 percent of them were dead within five years.

KOCH: Why?

HACKETT: One factor is that they missed the external stuff. They’re so focused on the nine days, they can’t afford to have one mistake, one bad decision, one bad plan, one bad implementation. Then what happens is they get weak. And then, somebody comes along and just kicks the crap out of them.

Part of the problem is a result of corporations getting inflexible.

I think we're teaching the wrong stuff at business schools—and I'm a business school professor. We’re teaching students techniques, and processes, and ways of thinking that were basically designed by Alfred P. Sloan, who I consider to be close to the devil himself. And we’re still doing it the same way as he did at the beginning of the 20th century. We still plan the same way. We still report information the same way as we did in the '30s, when he came up with all these ways to do the planning.

KOCH: Why are those methods no longer viable?

HACKETT: There’s so much change going on: Product lifecycles have been cut in half, special interest groups put a lot of pressure on companies, and customers aren’t loyal. If you could go down to Best Buy and see a TV, the first thing you’d probably do is go back to the Internet and see if you could get it there cheaper. Yeah, and you'd buy it from the cheapest place, because you know it doesn’t matter. There's globalization. Offshoring. All these things are coming at companies faster and faster and faster.

And my premise is there’s nobody inside a company that has responsibility for standing on the roof with a pair of binoculars, looking over the horizon, and saying, “We’re going to get wiped out.”

KOCH: But that's what the strategic planning group is for, right?

HACKETT: No, they don’t have those any more. They got rid of strategic planning groups in the '80s when they went through and tried to cut costs. And so what they did instead, they went out and hired strategy consultants—I used to be a strategy consultant, too.

But what really was going at that period of time was the minimization of risk. They were trying to consolidate companies so that they could offset swinging business cycles.

And then, at the end of the '80s they got rid of all the overhead because profits were so crappy. And they just looked at those people and said, “We don’t need you.”

But today, no one stands on the roof and says, “We’re going to get it.” There’s no formal mechanism in a company to collect all this risk information on what’s coming at us.

Can you imagine sitting in the conference room at Sears when [Wal-Mart] went public? “Oh, they’ll never do anything. What do they know? They’re a bunch of hill jacks.” But they changed the model. Microsoft changed the model. Toyota changed the model. Every one of these companies changed the model.

Most of these trends take 20 years to emerge. Tell me that people couldn’t see globalization coming 20 years ago. But today people still act like they're surprised. “Oh my God. We have to go to China?” No one stood up on the roof. And the reason being, you only got nine days profit. You take your eyeballs off that, you’re sunk.

KOCH: Well, to me, it gets down to a more human element. We are social mammals that avoid risk. If you want to get Hobbesian about it, this is what drives us—aversion to risk. Should we consider that this is a natural cycle? Is it an arrogance of human intellect to say that we can change this core fear of risk?

HACKETT:I actually think it’s arrogant to think we can’t change it.

Yes, I think we’re inherently risk-averse. Success breeds risk-aversion. Once you find a formula that works, you keep hammering away at it. Any time we’re under threat or under pressure, we go back to what worked for us before. Companies reward predictability.

KOCH: What do you mean by that?

HACKETT: What they do is they set up a budget or plan and say, this is what we’re going to make in revenue. Here are our improvement targets. And if you come in on the target, you get a bonus.

Now take a look at the stock market. You’ve got 10,000 analysts that set everybody’s expectation. I believe most of them should be quartered and hung on the sides of barns. If you meet the expectation, if they say you’re supposed to make a dollar a share this quarter, and you make a dollar a share this quarter, what happens to your stock price?

It goes down.And if you fall short of your stock price, they murder you. And if you exceed the thing, your price goes down because they were embarrassed. And so management becomes built around predictability and minimizing the risk.

KOCH:To what degree would you say that the financial analysts are really causing this?

HACKETT:They set expectations, but here’s what’s going on. You’re actually starting to see private equity and venture capitalists try to take companies private, because they don’t want the short-term pressures. They don’t want to have to answer to the expectations. They don’t want the volatility that goes along with this. People are starting to say, you know what? This volatility from month to month and quarter to quarter is killing us. We can’t run this thing as an ongoing venture, because we have to worry about what somebody thinks about us. And we’re going to run into short-term problems. We cannot have a rosy day every day, and the [constant attention is] just killing us."

KOCH:Do you have any numbers on the increase in companies going private over time?

HACKETT:Historically, about two percent of public companies eventually do leveraged buyouts (LBOs) and go private. I don’t know what the number is now, but if you read The Wall Street Journal every day, you’re seeing the equity firms come in and trying to push these companies to the private side.

KOCH:You also say that public interest groups are a factor in the decline of companies—how big a factor?

HACKETT:Well I think they're huge, and they’re getting bigger. The Internet gives a voice to anybody. Anyone who wants to complain about something, they can get online. And anybody who thinks that social injustice is going on, however they define social injustice, can get on the bandwagon and immediately connect to a gazillion other moonbats if they want to.

KOCH:You mention that 65 percent of companies that get acquired were unprofitable or slipping fast. So is M&A really about grave-robbing?

HACKETT:I’ve never thought of that word before, and if you don’t mind, I’m going to steal it. They’re grave robbing. Two out of three companies that are acquired are grave-robbed. They’re basically taking unprofitable companies and cutting them up.

And the formula’s pretty clear. If you go unprofitable three out of five years, you’re as good as cut up and gone. Someone will sweep in and pick up your assets, and take the assets that are good, and throw the rest away.

KOCH:You also say that companies are managing themselves too much. What do you mean by that?

HACKETT: People pick up these management fads and think they will save them. Today, for example, everyone’s hunkered down with balanced score cards. I was actually at a conference not too long ago where I heard a company that makes ice slushes talking about their management information system and how if the CEO wanted to, he could drill down and look at the individual performance of thousands of their slush machines every day.

Now if a CEO is sitting there looking at the performance of individual machines in South Houston, they ought to shoot that guy. But the information has come to the point where you collect everything nowadays and you’re watching this internal stuff so closely that you don’t see that there’s an attacker out there that’s changing the game, and you’re wiped out that way. Boom!

Operational efficiency isn't the issue anymore. Do you know of any company that died because it couldn’t produce its product at a decent price? No. GM’s in trouble because it made decisions back in the late '60s about health care benefits. And they’re paying for those retirement programs now, which will haunt them forever. They’ll never get out of them. It’s those big decisions that wipe you out, not the fact I can’t polish the apple any better.

KOCH: But isn't that how Toyota beat them, by polishing the apple of quality? The cars certainly aren't any more fun to look at or drive.

HACKETT: Toyota came over here in the '50s and '60s and Ford and GM was glad to show them how we do it. Didn’t they know those guys were going to steal their ideas and go back and redo it, and potentially do it better? Of course they did. They just weren't able to change.

I keep coming back to the idea that no one’s looking out over the future. There should be a staff of people that are looking out and asking, how are we going to get wiped out? Or better yet, of all these dozen things that we see occurring in the market, how are we going to leverage them so we can wipe out our competitor?

KOCH: But you would need to have so many buffers around those people to keep them objective and keep them from getting fired. You know, they’ll immediately be painted as a Chicken Littles by all the people who have an investment in the status quo. And as you said, as soon as profits went sour in the '80s, CEOs got rid of all these people. So how do you prevent this from being just another management exercise?

HACKETT:It will take a CEO [who's brave enough to] step out and be the one that says, you know what? I’m going to take a million dollars and hire 10 people over here to do this for me, and keep my eyes open. You know, in a $40 billion dollar company, a million dollars is a rounding error.

KOCH: Well most CEOs and CIOs would say this is the failure of the McKinseys and Bains. They were supposed to be doing all this for us. So have they failed?

HACKETT: Yeah, [they have]. I actually think what they did was take clients through management trends. We’re going to diversify. We’re going to do Six Sigma. We’re going to do the World Wide Web. We’re going to do the E-I-E-I-O. They get on these bandwagons and they think that’s what’s going to save their clients.

But what’s wiping companies out is not little stuff like improving the quality by 300 percent—yeah, you probably have to have good quality—but so many of these things are taken care of. The biggest threat [is not looking ahead].

KOCH: If the strategy consultants can’t do it, then how can you be sure you'll have someone inside your company that can?

HACKETT:I don’t think it’s a matter of intelligence, I think it’s a matter of intelligence. It’s a matter of collecting information. If you look—and this brings us back to the IT—If you look at what’s going on in IT today, the bulk of the information is internal.

And that’s, to me, is the real rub. We’re collecting all this stuff, like how we’re doing with the slushy machines. If the slushy machine in South Houston is down on a rainy day, who cares? What matters is whether you’ve got a competitor coming along that’s trying a new technique, a new technology, a new channel, or something like that.

And what happens is the information technology people are collecting a lot of stuff that’s easy to collect, because we’ve got our fingers on it. But who’s out there digging up all the external information and organizing it in such a way inside the company that people can actually put it into their plans and into their thinking and put it into the very mechanics of how they run a company?

The decision making has to change in the company, and it can’t change until information switches from inside to outside. We’ve got enough inside information. In fact, we’ve got so much information now that we’re afraid to go to the bathroom because we might miss something that’s flying across the screen.

KOCH:What would you say to CIOs? What should they do today? And what should they do tomorrow?

HACKETT:I think the biggest challenge for CIOs are going to be to establish that information infrastructure that collects vast amounts of information from the outside and assimilates it and gets it to management in an organized form. Enough of trying to collect all the information inside and do the balance score cards—it’s done.

But it will be difficult because CIOs have been almost exclusively focused internally.

I think IT needs to take a portion of its horsepower and brain power and start to look at how it helps the CEO assimilate these external threats. I think if I was a CEO that would be the most valuable CIO I could have: Somebody who could actually look out there and help me see what I can pick up from the rotating world.

You do not have flash or javascript support.

Average (4 votes)

Reply