David Kirkpatrick

December 1, 2009

Deloitte’s Shift Index finds return-on-assets woes

Filed under: Business — Tags: , , , , — David Kirkpatrick @ 12:56 pm

Received mail from Deloitte today on the sequel to its Shift Index report from June. What is the Shift Index you ask? I’ll let boilerplate from Deloitte do the explaining:

Deloitte’s Shift Index pushes beyond cyclical measurement and looks at the long-term rate of change and its impact on economic performance. The Shift Index tracks 25 metrics across three sets of main indicators: foundations, which set the stage for major change; flows of knowledge, which provide more powerful ways to drive productivity; and impacts, which help gauge progress for firms, customers and creative talent. The Shift Index will continue to be updated to track changes over time and compare performance trends across countries.

For a deeper look at the Shift Index methodology and findings, please go towww.deloitte.com/us/shiftindex.

The key thing to focus on up there is “long-term.” This report is looking at and creating a much more broad picture than a lot of the economic news out there starting with the media’s obsession with the daily Dow numbers and moving on to corporate policy that emphasizes stock valuation over sustained business success.

With that in mind, the Shift Index is finding a lot of business sectors wanting when looking at the big operational trends, particularly in return-on-assets.

Here’s an overview of the sequel to the Shift Index from John Hagel, co-chairman of Deloitte’s Center for the Edge:

The sequel to the original Shift Index report breaks apart the data for the US economy into fourteen different industry segments and includes an in-depth analysis of nine of these industries.  The results are eye-opening and contradict much conventional wisdom about management practices:

  • We found that the long-term erosion in return on assets is widespread across virtually all industry segments.  The four industries that have experienced the most severe erosion in return on assets are technology, telecommunications, media and automobiles. The fact that three of these four industries are so intimately linked to the development and deployment of digital technology infrastructures reinforces our view that these infrastructures are a key driver of performance pressures.  Only two industries escaped this erosion in return on assets – Aerospace & Defense and Healthcare.  We do not think it is accidental that these are two of the most regulated industries in the US, reinforcing our view that public policy is the other key driver of performance pressures.
  • Our analysis indicates that there is no correlation between labor productivity improvement and return on assets performance across industries.  In fact, some of the industries with the most significant improvement in labor productivity also experienced the most substantial erosion in return on assets. This finding challenges conventional management views that labor productivity is a key factor in driving profitability improvement.  While improvements in labor productivity are certainly necessary when facing increasing economic pressure, these improvements are clearly not sufficient.
  • Here’s another counter-intuitive finding.  Many executives believe that innovation – conventionally defined as product innovation – is the key to escaping profit pressures.  Yet, the technology industry, widely viewed as one of the most innovative industries, in the US, has also experienced some of the most severe profit erosion of any industry.  Again, product innovation may be necessary, but it certainly does not appear to be sufficient to sustain profitability.
  • Not all participants are suffering.  While firms face increasing economic pressure, customers appear to be benefiting from increasing market power and flexibility in moving from one brand to another across many industries.  Creative talent also benefits – total cash compensation to creative talent is rising substantially in most industries.
  • Intensifying competition appears to be driving much of the erosion in profitability for firms, but traditional measures of competitive intensity, especially measures of industry concentration, appear to significantly understate the growing economic pressure coming from outside traditional industry boundaries and from both customers and creative talent.
  • This intensifying competition is shifting the focus of value creation from protection of proprietary knowledge stocks to more effective participation in a broader and more diverse range of knowledge flows that will help firms to more rapidly refresh their knowledge stocks.  The problem is that our institutions are optimized for protection of knowledge stocks at the expense of participation in knowledge flows.  As a result, the most powerful form of innovation may be institutional innovation – re-thinking the rationale of firms and re-defining roles and relationships across large numbers of institutions.

These findings reinforce our belief that the increasing focus of executives and policy-makers on short-term, cyclical results and trends has blinded them to more fundamental, long-term trends that are re-shaping our business landscape.  In particular, their understandable concentration on the current economic downturn has lulled many participants into a false sense of complacency.  No matter how bad the current environment is, many are reassured that these conditions are only temporarily and that we will sooner or later return to the conditions that prevailed before the downturn.  The Shift Index suggests that such hopes are misguided and dangerous – they obscure the long-term growth of economic pressures that will continue well beyond the current economic downturn.  Until and unless executives begin to focus on these longer-term pressures, we are likely to see continuing deterioration in performance.

Hit this link for Deloitte’s press release on the Shift Index.