The global financial crisis
prompted many companies to pull in their horns, hoard cash, trim costs, and
take a wary view of large investments. Yet the same crisis ushered in a new age
of capital superabundance. Bain & Company’s Macro Trends Group carefully
analyzed the global balance sheet and found that the world is awash in money.
Global capital balances more than doubled between 1990 and 2010 — from $220
trillion (about 6.5 times global GDP) to more than $600 trillion (9.5 times
global GDP). And capital continues to expand. Our models suggest that by 2025
global financial capital could easily surpass a quadrillion dollars, more than
10 times global GDP.
Capital superabundance,
combined with tepid economic growth, has produced historically low capital
costs for most large companies. For much of the 1980s and 1990s, for instance,
the average cost of equity capital for large U.S. corporations hovered between
10% and 15%. Today, the average cost of equity capital sits at close to half
that: just 8% for the roughly 1600 companies comprising the Value Line Index.
And the after-tax cost of debt for many large companies is close to the rate of
inflation. So, in real terms, debt financing is essentially free.
The ready access to low-cost
capital should change the way business leaders think about strategy, and in
particular the relative value of improving profit margins versus accelerating
growth. When capital costs are high, strategies that expand margins are almost
always better than strategies that accelerate growth. When money is expensive,
a dollar today is worth a lot more than a dollar tomorrow — or even the promise
of many dollars tomorrow. But when capital costs are low, the time value of
money is low. So the promise of more dollars tomorrow (through growth) exceeds
the value of a few extra dollars next quarter. In these circumstances,
strategies that generate faster growth create more value for most companies
than those that improve profit margins.
Read more
on... Stop
Focusing on Profitability and Go for Growth
Author: Michael
Mankins
