Is financialization right?
17 October 2014
Pakit Iamopas, Human Capital Alliance Senior Advisor looks at the global “financialization” phenomena.
The recurring financial crises of the past two decades forces many people to ponder whether the global financial sector’s unbalanced power has resulted in a detrimental financialization of our economies.
Gautam Mukhunda, a Harvard Business School assistant professor said in his recent June 2014, Harvard Business Review (HBR) article “The Price of Wall Street Power” that the financial sector’s enormous and disproportionate power must be curbed because it forces many businesses to act against their own interests.
“There are lots of situations in which people – and countries – act against their own interests. One of the most important – and most dangerous – is when a single sector or group is so powerful that it dominates how an entire society thinks of itself.”
Detrimental to US manufacturing
The finance industries’ penchant to judge managers and companies primarily on their ability to meet financial metrics such as Return On Net Assets (RONA), Mukhunda said forces many company managers to undertake actions that have been detrimental to their long-term success.
He cites Boeing’s troubled 787 launch as a prime example. “….the 787 was developed with an unprecedented level of outsourcing, in part, the engineers believed, to maximize Boeing’s RONA.”
By outsourcing large parts of manufacturing, Boeing boosted its RONA because it would need fewer assets to develop the plane. However, Mukhunda noted that it also made “…. the 787s supply-chain so complex that the company couldn’t maintain the high-quality an airliner requires.”
Another company, Sara Lee, that was known for manufacturing clothing and food also placated Wall Street by selling much of their manufacturing entities and sticking solely to brand management.
“Wall Street can wipe you out. They are the rule-setters…and they have decided to give premiums to companies that harbor the most profits for the least assets,” said Sara Lee’s CEO.
Hollowing out US semi-conductor industry
In an accompanying HBR article, “Capitalists dilemma” Clayton Christensen and Derek Van Bever said current financial success metrics dictated by Wall Street allow a minority to determine what industries’ can invest in and perhaps most egregiously ignores the fact that today’s world is awash in capital.
“Over and over, high value placed on RONA, IRR (internal rate of return and EPS (earnings per share) has led to innovations to squeeze costs and reduce non-cash assets.”
In 2009, Christensen interviewed Morris Chang, who left Texas Instruments after 25 years as a successful semi-conductor business executive and founded Taiwan Semi-Conductor Manufacturing Company (TSCM) in 1987. Chang perceived value in US companies’ outsourcing their chip manufacturing capabilities to Asia.
TSMC quickly became one of the world’s largest chip makers and today every significant chip manufacturing other than Intel has outsourced its manufacturing to TSMC.
Following Wall Street’s metrics, Christensen said US chip manufacturers peeled manufacturing assets from their balance sheets and reduced asset-ratio calculation denominators.
At the same time, Chang added the manufacturing assets to TSMC’s balance sheets. TSMC’s return on assets (profitability ratio) was consequently much lower than the US companies that designed the chips.
“You both can’t be making the right decision,” Christensen asked.
Chang said depending on how success is measured, both parties are right. The Americans he said linked success to RONA, EVA (economic value added and ROCE (return on capital employed) ratios etc where hiving assets off balance sheets drive-up performance ratios. “I keep looking but I’ve not found a single bank that accepts deposited in ratios. They only take currency.” Moreover, Chang noted that capital was abundant everywhere. “….so why are Americans afraid of capital.”