On top of the worry of delivering quarterly earnings is another force pressuring firms to focus on the short-term: the pace of technological change.
The rapid evolution of technology, and its effect on economic development, is making it harder for firms to plan for the future. In most five-year plans, years three, four and five are little more than guess work. This naturally makes companies gun-shy about investments that might become obsolete in just a few years. That approach can stunt the long term growth of the whole economy.
Managers must still plan for the long term, but they have to be willing to think differently.
The Duke University Global Business Outlook has been surveying CFOs for their perspectives on their own firms and the economy every quarter for more than 20 years. CFOs told us in 2013 they felt confident in their ability to plan 3.5 years into the future. Now, just five years later, these same companies indicate they can effectively plan only 2.3 years out.
"...like driving a sports car down a mountain road in thick fog"
The natural effect of this is that firms focus on projects with shorter horizons. CFOs say the projects they adopt now have an expected life 18 months shorter than projects they initiated just five years ago.
For managers, steering a company through intense global competition when your key product may be obsolete in two years is like driving a sports car down a mountain road in thick fog. So rather than taking a chance and investing now, it can be tempting for companies to delay, hoping to double down when the next big tech innovation drops.
The new reality is that firms must understand how they innovate, or how they relate to innovation.
In biotechnology, for example, traditionally the biggest firms don’t do much basic research. Instead they wait to see which technologies are promising, buy the small startups involved and then turn that innovation into a product. There is evidence the pace of technological change is causing this to happen in other industries, with the rapid and frequent acquisitions of small startups by the likes of Google and Facebook.
Larger firms looking to capitalize on the innovation coming from new small firms can improve their chances by creating a corporate venture capital division dedicated to watching small firms. Becoming known as a provider of funds to innovative firms encourages innovators to initiate contact with your firm, and can lead to an option on right of first refusal for new technologies.
"... a willingness to experiment"
Even firms not looking to obtain new technologies are organizing their business models around the latest developments, such as banks contending with new advances in mobile banking. Long-term planning has traditionally allowed these firms to spend the time necessary to gain experience – to learn by doing – to lower costs and make processes work smoothly. It may be more difficult to make those long-term, cost saving decisions now, but all is not lost.
Flexible investing requires a willingness to experiment. Entrepreneurship circles argue new firms have to experiment to learn about their business. In industries where businesses can do more experimenting, we find more new firms enter.
Established firms can incentivize employees to experiment. Economists have shown that people whose pay is based on output may concentrate on short term performance and not experiment in ways that might lead to lower performance in the short run, but better performing solutions long-term.
Organizational structure also plays a role in employees’ abilities to experiment. Imagine an employee wanted to tweak the corporate website to increase clicks. Who would they have to contact to get that change approved? Who would make the actual updates? Who collects the data on website traffic? Would this person have access to that data? What kinds of experiments might a firm want to forbid? Firms need to make clear which types of experiments are allowed by their policies and make them easier to implement.
In the old days, firms could make a decision and then turn their attention to other matters for a few years. But now, lightning-fast technological change isn’t going away, and apparently neither are political and environmental uncertainties. Managers must regularly re-evaluate their plans, adjust for new technology, and – crucially – be prepared to kill plans when they no longer make sense. Evolving plans are better than no plans.
John Graham is the D. Richard Mead professor of finance at the Fuqua School of Business at Duke University, where Victor Bennett is an assistant professor of strategy.