Investment Squeeze Compound Economic Woes

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, {complink 7473|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 {complink 379|Apple Inc.}.

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 {complink 2657|Intel Corp.} 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?

7 comments on “Investment Squeeze Compound Economic Woes

  1. jbond
    September 16, 2011

    I find it hard to believe that the recent acquisitions regarding patents and old turf are going to be enough to fuel any significant growth. In fact I think in some instances it might cause some job losses based on combining efforts and reducing costs.

    What the segment really needs is for companies to come up with some new innovations or major product improvements to draw more customers in. If consumers are being stingy, they are only going to be spending their money on something they think is a game changer. The key is going to make sure this product/s are in the right price category as to not scare people away with too much capital investment.


  2. Barbara Jorgensen
    September 16, 2011

    Companies are moving down a dangerous path. Even during the worst of times R&D spending is the last thing to go. If companies continue with this attitude we might as well cede the industry to the Chinese (or India) or the next great source of innovation. I have mixed feeling about OEMs going to ODM route. So now what is the role of OEM? Someone used this term once” Outsource Everything but Marketing.”

  3. mfbertozzi
    September 16, 2011

    It is a good point Barbara, anyway I believe the status, right now, is heterogeneous and changes region-by-region. Maybe for Western part of the globe, past strategy “make or buy?” has full become “buy”, but in addition to India or China, other regions (for example Brasil or other countries from Southern America) are taking the leadership in manufacturing.

  4. eemom
    September 19, 2011

    I agree with you Barbara.  This is indeed a dangerous path.  It is one thing for companies to horde cash and not want to invest in new employees, but if they don't invest in their future, then they basically won't have one.  I understand getting out of one market all together, as long as you heavily invest in the ones in which you decide to remain.  Consumers may be stingy with their money but they are still buying good reliable technology and products.  They just need a reason to part with their money.  If the companies that manufacture the products don't believe in their own future, why should a consumer believe in their products?

  5. Eldredge
    September 19, 2011

    In general, all other thiings being equal, businesses are more encouraged to invest when the business environment is stable and predictable. Lack of visibility to –  1) government budget  2) government regulations  3) predictability of tax code/structure –  all tends to increase the real risk for any investment decision.

  6. Mr. Roques
    September 19, 2011

    I think about that whenever a movie comes out and its a remake of the 60s, 70s, or when they make YET ANOTHER comic movie. Innovation level is not as high as we might think.

    We are being short-sighed and thinking we need to sell now and the easiest way to do it, wins… not necessarily thinking about the long term.

  7. Himanshugupta
    September 26, 2011

    If there is sizable chance that a single product would outplay the competition then there will be less change for major investment in product development. I think Microsoft is classic example which block most of the innovation. Recent example is Apple which capture most of the market share and force companies such as HP to discontinue its produt. In such scenario, executives would be wary about putting money in new product development especially during such weak economic times.

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