The Sales Model
2.5 Description and discussion of results
After conducting all the econometric estimators for the specified Models I and II and selecting the most adequate ones according to the different relevant tests, we can therefore describe and discuss the following results.
Market Situation. The Model I shows no contribution of the market growth to the sales of the companies, but Model II shows a positive contribution that can be explained by the annual change of the gross domestic product. This change, in constant 2002 US Dollars, was 3.29% during the period of 1995 to 2002, and it was 3.31% when looking at the original data between 1983 to 2002.
The evolution of the GDP in constant 2002 US Dollars shows a steady and continuous growth without any external shocks for the analysed period 1995 to 2002.
Resources. Both Models I and II show that the relationship between sales and resources has a negative trend. This negative evolution can be explained by five reasons:
1. IT Productivity growth. The huge investments in New Hardware, Software and Services grew very fast getting productivity out of the Organizations, and in consequence,
reducing the need of personnel in the Companies. Borrowing the evolution over time of the IT role in the companies from the Boston Consulting Group, they state that this process started in the 1970’s being IT a support back office, passing in the 1980’s to be a
support core business processes and finally in the 2000’s a source of differentiation and competitive advantage.
IT Invesments have an important contribution in the growth and firm performance.
Draca, Sadun, and Van Reenen45 state that “there is some reasonable evidence of a strong firm level association between IT and firm performance” and they also describe how the productivity growth has been growing in the US since 1995 and an important
contribution is due to the IT Investments.
The IDC Consulting (2004) is forecasting a strong growth in the US IT spending for the coming five years from a 3% growth in Health Care and Communications & Media to the 5.7-5.8% growth in Retail and Wholesale and Construction. The most important sectors for the IT spending are the Manufacturing and Financial Services both standing at 5% for the 5-year CAGR (%) growth.
2. The Selling General and Administration expenditures become less important in the mix of expenditures/investments contributing to the growth of the companies. The SG&A to Net Sales ratio was growing from 24.8% to 25.4% in the period 1995 to 2002, but the current Net Sales were growing from 6966.2 to 13044.7 million current US Dollars. This is an annual 9.38% growth rate for the period and near to double the Sales, on the other hand the SG&A to Net sales ratio was growing a small 0.6 percent points for the period.
3. Changing structures: The fact that the Organizations are becoming flatter is forcing the teams to do the same work with less people. See Roberts46 and Whittington47 for a description of how the organisational design is affecting the determinants of firm performance.
4. Changing boundaries: Outsourcing processes are becoming more important and impacting the Organizations with headcount reductions and
5. Changing processes like Variable Cost and Selling General and Administration Productivity. This item includes headcount reductions due to on-site cost cutting and relocations to low cost countries.
45 See Draca, M., Sadun, R., and Van Reenen, J., 2006, “Productivity and ICT: A Review of the evidence”, Center for Economic Performance, CEP Discussion Paper no 749, 30.
46 See Roberts, J., 2004, “The whole system”, The Modern Firm, Oxford University Press, 5, 241.
47 See Whittington, R., Pettigrew, A., Peck, S., Fenton, E., and Conyon, M.,1999, “Change and Complementarities in the new Competitive Landscape: A European Panel Study, 1992-1996”. Organization Science, Vol. 10, No 5, 583-600.
The last three items could be aggregated under the Corporate Restructuring concept, but we wanted to show them separately, because the first one is related to the Organisational design of the organization impacting performance, as described by Roberts, and Whittington, and the other two items are related to changing boundaries and processes.
Research and Development. Both Models I and II show a positive contribution of the stock of R&D capital to Net Sales, and Model II shows that the short-term expenditures in R&D are more important than the long-term ones, when looking at the whole panel.
This second item can be explained with the following arguments:
1. Operations Management. Companies in the high-tech sectors (intensive in R&D
expenditures) are very conscious about productivity spending, becoming very selective in choosing the projects, and favouring the short-term R&D expenditures to get the highest return on investment (or the shortest pay-back) per project.
2. Financial. The pressure on Management to get short-term results is forcing a shift from the long to short-term R&D spending (innovation projects), and product based strategic acquisitions which allow quicker and less risky results as an alternative to the internal longer term New Product Development.
3. Managerial myopia. Short-termism is forcing a decrease in the annual R&D spending.
This is based on the following approach: Why do we need to invest and get the results for a new management team in place in the near future? Why do we need to harvest if a new Management team will be taking office and getting the future results? We are better off not investing and getting the results now. “This is obtaining good short-term results and appear efficient to Investors” as mentioned by Tirole48. In other words managerial myopia or short-termism is forcing a decrease in the annual R&D spending while sales are growing.
Our research shows how important is to invest and build a stock of R&D capital and that this stock must be higher than a certain threshold. This behaviour is highly impacting in a positive way in the long and short-term to grow Sales, but it is certainly a limitation not
48 See Tirole, J., 2006, “Takeovers and Managerial Incentives”, The Theory of Corporate Finance, Princeton University Press, 11, 430.
controlling for the innovative and imitative role of the R&D at the same time. This relates to the two faces of R&D, as mentioned by Griffith, Redding and Van Reenen49.
The fact that short-term innovations and new product launchings of the year are more important than the long-term ones means that, for the whole population of companies, the R&D process is becoming more a short-term process across the board.
It is very important to regress the panel data with specific coefficients by cross-section (or sector). We will be able to verify if the coefficients of the stock of R&D capital shows differences among the sectors clarifying the previous concept.
Investments. Both Models I and II show a positive contribution of Investments to the Sales. The annual Investments (M&A, P&E, etc…) very rarely show a success in the same year. This is the reason the long-term effect of the Investment is so important, and the short-term (1st-diff) was eliminated from the model II due to multicollinearity.
As described in the Methods and Directions matrix of the Corporate Development in the previous section 1.9: Strategic product based, geographical coverage of gaps, core business expansions and absorbing competitors are the main elements driving the high growth in Investments (M&A, etc..). This is the case when considering that it is more and more difficult to find good opportunities to merge or acquire companies. The period 1998-2001 shows the largest activity for M&A’s in the United States.
In general a merger or an acquisition is an easy and faster way of getting a product line, and a market share than via internal development. This activity may refrain management from investing free cash flow in new products or excess capacity, but quoting Tirole50: “it seems that takeovers did not have a large negative impact on long-term investments such as R&D expenditures”. This is true for a large population of companies, but when dealing with consolidated high knowledge intensity MNL-Multinationals the major motivations for M&A’s activities are completing the product portfolio gaps or industry consolidation by absorbing competitors. In these cases, the cash flow invested in a merger or acquisition will not be duplicated in internal developments. Additionally a merger or acquisition is faster, and
49 See Griffith, R., Redding, S., and Van Reenen, J., 2004, “Mapping the two faces of R&D: Productivity growth in a panel of OECD Industries”, The Review of Economics and Statistics, 86(4), 883-895.
50 See Tirole, J., 2006, “The rise of takeovers and the backlash: What happened?”, The Theory of Corporate Finance, Princeton University Press, 1, 50.
in consequence we can state that in the high end of companies in every sector there is a negative impact and the increase in M&A’s will restrict the internal investments in R&D.
The relationship between Investments and larger Sales and Profits is clear, but there is a high ratio of failure in terms of delivery shareholder value and the expected returns. 17% of the M&A deals created value for shareholders, 53% of them lost value, and 30% of them without any kind of improvement according to the KPMG Peat Marwick report (1999).
There is a wide literature covering this issue, but the foundation for success is to take care of the following stages: the synergies valuation, the integration plan, the due diligencies, experienced Management in place, integration of cultures, and open and flexible communication. Communicating the vision, Management alignment to execute the vision, and fast and focused execution of the Integration are the key elements of the execution plan.
An integration team must be deployed and focused execution is critical for the success of the project.
Finally the limited size of the home countries, the difficulties to compete in the global market due to the size of the companies and markets, internal operations and management struggling with the lack of organizational capabilities to go International, as well as the lack of family members to continue the business are the main causes argued by the companies to evaluate access to the M&A processes.