US businesses are sunk in a quagmire, hanging on tightly to their pots of gold even as it becomes clear that what the economy needs is companies willing to bet portions of their cash on developing, manufacturing, and selling the next "must-have" products.
In a report, McKinsey & Co. acknowledged what's wrong with the US economy. It is still wobbling from a year-old financial disaster; skittish consumers are reluctant to open their checkbooks; and businesses, despite being flush with cash, are reluctant to hire, contributing to the high unemployment level.
The antidote to all these problems is corporate investment, but that is the one thing executives are most reluctant to commit to right now, according to McKinsey. Executives polled believe their companies "should be investing more."
So why aren't they? There are many reasons for the reluctance by business executives to commit to a greater level of investment. Before reviewing these, however, I want to briefly focus on an even more troubling conclusion from the report: companies are under-investing in product development. Although this research is not specifically about the electronics industry, it's still worrying to think it could apply to the sector.
The electronics industry thrives on innovation. The products that will this year drive up semiconductor sales to the expected record of $314.4 billion in 2011, according to a World Semiconductor Trade Statistics (WSTS) forecast, were introduced only in the last five years and include the iPod, the iPhone, and the iPad tablet PC, all from Apple Inc. (Nasdaq: AAPL).
The industry body predicts chip revenue will continue to rise, climbing to a new record of $338.4 billion by 2012. How would the industry achieve these lofty heights if companies like Intel Corp.
(Nasdaq: INTC) were to severely cut capital expenditure, or if Apple had not fired up its innovation engine to power up the digital music player, smartphone, and tablet PC markets?
Yet the industry is in danger of doing this. Some companies are moving out of certain market segments because the competition is too stiff -- as in the case of HP, which wants to dump its PC business -- or because high capital requirements would drain current cash holdings and increase the fragility of their operation. The electronics industry is flush with cash, but executives remain edgy and reluctant to spend money on transformative acquisitions or take a chance on new technologies. We have all become over-cautious and risk-averse.
According to the McKinsey report:
Executives also reported a high degree of loss aversion in the investment decisions they'd observed. They exhibited the same tendency themselves, even when the value they expected from an investment appeared strongly positive. When asked to assess a hypothetical investment scenario with a possible loss of $100 million and a possible gain of $400 million, for example, most respondents were willing to accept a risk of loss only between 1 and 20 percent, although the net present value would be positive up to a 75 percent risk of loss. Such excessive loss aversion probably explains why many companies fail to pursue profitable investment opportunities.
As McKinsey noted, "stingy" investment actions are rampant in the industry. The only sizable acquisitions anyone can recall in the electronics sector, for instance, have centered on efforts to protect old turfs through the purchase of patents held by other manufacturers. (See: Google Draws New Battle Line With Bid to Buy Motorola and Google Cries Foul Over 'Bogus' Patents .)
Will actions like these alone fuel growth?