A friend of mine was planning a long trip outside of Canada and didn’t really have a definite date as to when he’d be back. He was thinking a good six months to a year. I remember asking him about what he would do with his car; where he planned to park it. He thought it would cost too much to put it in long-term parking, somewhere around $200-$300 a month. He was, as he saw it, just going to park it on the street.
You may detect where this story is heading.
A few months into the trip his car was impounded. As he wasn’t back in the country yet, he asked me if I could go to the lot on his behalf. About $2,500 in fees and several (not so enjoyable) hours later, his car was finally retrieved.
By choosing not to pay long-term parking up front, my friend may have enjoyed the short-term benefit of not having to put effort into making arrangements or paying any money. But the inherent risk in that decision played out; the car ended up in the impound lot and he had to pay quite a significant amount of money—not to mention the embarrassment of asking a friend to go for a long, impromptu visit to the lot on his behalf.
Short-term gratification can hurt in the long run
This story reminds me of how some of the highest-return investments in life are investments of time, where the payoff comes from the avoidance of loss.
We often see the tradeoff between short-term and long-term thinking in our interactions with management teams. For example, a company can really inflate its current earnings and make the latest report or annual release look a lot better by under-investing in intangibles, such as marketing.
Marketing is an expense that will hit the income statement every quarter, but often doesn’t provide a benefit until two, three, four or ten years down the road. The same thing goes with investments in R&D. The management team that focuses too much on optimizing current period earnings will often do so to the detriment of future profitability and competitive positioning. This is one of the reasons we encourage managers to adopt incentive plans that are based on long-term performance rather than short-term earnings targets or share price movements.
When in conversation with management teams, we try to understand where their priorities lie by asking questions like, “what are the most important operational KPIs that you track?” If they say, “Quarterly EPS,” that can be a red flag that managers are too short-term oriented. We find the management teams that are incented on things like NPS (net promoter score, a measurement of customer satisfaction), or long-term wealth creation are more likely to make decisions that improve the company’s position over time, which can help further tilt the investment odds in our favour.
A strong workplace culture is also another crucial element we look for in companies, one that requires time and effort from their management teams to set up in a thoughtful way. Some of the best businesses have decided to adopt the typical Berkshire-Hathaway approach of getting “the right people on the bus” and empowering people to make their own decisions within a well-defined framework of values. (We too believe in making a culture of empowerment an internal focus at Mawer.) The long-term payoff is that a company’s culture becomes ingrained; people don’t have to be micromanaged. We see that with Constellation Software (CSU), a larger holding of ours. Mark Leonard’s team at Constellation was very deliberate in their process of who to hire and how to incent and educate these hires—all of which now allows the company to operate in a very decentralized and effective manner.
Two of our holdings that come to mind that we believe have the ability to suffer short-term pain (e.g., depressed current period earnings) as a part of realizing a long-term vision are Tikkurila and Heineken Malaysia. Tikkurila, a paint company based in Scandinavia with a portion of their business in Russia, continues to invest in marketing and capacity within the currently contracting/difficult Russian market because they understand Russian per-capita paint consumption is half of that in more developed regions. We believe over a longer-term they’ll benefit from this strategy—but it’s definitely painful in the short term. You can see it in their depressed earnings. Heineken Malaysia is in a similar situation. Consumer sentiment in the country is close to 2008/2009 levels right now—really bad. Regardless, they continue to invest in their brand and do efficiency programs, both of which we expect to improve the company’s long-term competitive position within its market.
Rather than receive a short-term payoff by cutting back on the expenses that don’t yield immediate, quantifiable results, these companies are saying, no, these are actually very important investments that are more important than just this year’s earnings. During most periods of economic hardship, companies that are willing to make these long term investments often eventually find themselves performing better than their short-term orientated peers. They can gain more market share and customers over the companies that are slashing costs.
Although sometimes painful, thinking long-term is often the best strategy…one that could also keep you out of the impound lot!