Montrose Journal Covid 19 Edition
COVID-19 AND THE FUTURE OF THE FIRM -MARTIN VANDER WEYER
The pandemic broadly follows the graphs projected by scientists, yet retains the power to shock by claiming the lives of many who were young and previously healthy, as well as very many more in predicted vulnerable categories. Much the same will be true as the economic impact of lockdown and trade disruption sweeps through the business world in the coming months. Weak firms and those in already threatened sectors - high-street retail, most obviously - will fail in their thousands. But many good businesses will also be taken before their time, to borrow Boris Johnson’s phrase: for lack of customers or components or safe working conditions, or for the simplest but cruellest reason, shortage of cash.
Others will survive in radically changed form. Some - airlines likely first in line - will end up wholly or partially nationalised. If bad debts become a pandemic of their own, another round of taxpayer-funded bank bail-outs must be a possibility, despite strong recapitalisation and improved risk management over the past decade. Rescue takeovers will be common in many areas too, as competition regulators relax constraints in the hope of preserving jobs and fertilising recovery. A first example is the provisional decision of the UK’s Competition and Markets Authority to reverse its previous stance and allow Amazon to take a stake in Deliveroo, the food delivery service that has warned it will collapse unless it receives urgent new investment.
Meanwhile, some sectors, and many individual entrepreneurs, will prosper. With restaurants closed and families stuck at home, supermarket grocery sales have boomed, and behind them many domestic food processors and suppliers will do well too - though farmers complain, as ever, of being unfairly squeezed. Efficient online retailers of all kinds, from giant Amazon to small specialist seedsmen, DIY and barbecue suppliers, have huge opportunities. Likewise logistics and parcel delivery operators.
As for telecoms, broadband and online entertainment providers, they have probably never had it so good. Netflix subscriptions soar and the controversial Chinese manufacturer Huawei is at pains to point out that as home data use has increased by 50 per cent, it has boosted equipment supply to ‘help keep Britain online’. Anyone with a competitive product in what used to be the niche video-conferencing market is now a potential or actual billionaire: step forward Eric Yuan of San Jose, California, founder of the suddenly ubiquitous Zoom Video Communications, whose shares have risen 150 per cent since the first Covid-19 cases were reported in Wuhan.
And of course the bioscience, pharma and healthcare supply sectors have been galvanised - to play their parts in the race for vaccines and effective mass tests, and to meet the challenges of keeping health services operating on all fronts. Not all will be winners, but massive increases in procurement budgets are flowing their way.
A very different corporate landscape ahead, then, against a bleak background of high unemployment, high state dependency, restricted movement and public anxiety. For chief executives, that dictates new priorities and demands adapted skills - and a new narrative of ‘purpose’. Nostrums and metrics that were fashionable pre-virus - in relation to supply chains, human resources, research budgets, balance-sheet ratios, tax minimisation, executive incentives and shareholder rewards, indeed pretty well every big item on the boardroom agenda - will look irrelevant or inappropriate in the new era. And though many companies will have performed heroic feats during the crisis, still the popular mood of disgruntlement with capitalism that has fermented since the 2008 crash will grow as the pandemic’s impacts are felt to have fallen hardest on the disadvantaged while causing little pain to the corporate elite, who may also stand accused of risking lives in their eagerness to see employees return to work.
What does all this mean in practice? The first question must be ‘Is globalisation dead?’, to which the sensible answer is ‘Let’s hope not, because it’s the greatest engine for poverty alleviation yet invented’. The pharma industry, for one, may actually become more globalised (once the short-term scramble to secure national supplies subsides), with more cross-border mergers to combine R&D. The automotive industry, already advanced in planning for transition to electric vehicles, is highly unlikely to revert to building whole cars from local parts in single countries. Much of the fashion trade will have no business model left if it cannot source cheap garments from Bangladesh, Vietnam and Cambodia. Globalised sourcing will gradually resume, but smart operators will secure multiple supply lines to avert breakdowns while also buying loyalty from key suppliers, all of which means additional cost.
Likewise in human resources. Employee welfare is rightly a top priority during the crisis and will continue to be so afterwards: hollowed-out, low-cost business models built on ‘gig economy’ self-employed workers and zero-hours contracts will be more frowned upon than ever. All aspects of health and safety at work, not just anti-virus measures, will be in the spotlight. Job creation - with capacity to cover for isolating absentees while the virus persists - will be more valued than robotisation that abolishes jobs. All of which again means higher costs and lower productivity.
And what of the dichotomy between the conventional duty to shareholders to pay the least amount of tax the law allows and the perceived social duty to make a fair tax contribution wherever profits arise, particularly when public finances are exceptionally strained. That argument will surely come back to bite the likes of Amazon, Facebook and Netflix with renewed force. Incentives and reliefs will spur recovery at local level but headline corporate tax rates are likely to rise as governments scrabble for revenues, and the OECD’s effort to suppress ‘profit-shifting’ between jurisdictions, which it says causes lost tax revenues of as much as $240 billion a year, will at last gather momentum. One way or another, expect to see digital multinationals paying more tax.
As to balance sheets, there will be intense focus on resilience in the form of capital strength and cash reserves - reversing a trend in which activist shareholders have castigated managements for ‘cash hoarding’. Figures published by the FT show only around 10 per cent of FTSE100 and 15 per cent of S&P 500 companies holding net cash (as opposed to net debt) positions, compared to more than 50 per cent of companies in Japan’s Topix index - leading to predictions that Japan Inc will accelerate out of the lockdown recession faster than the west. But Japan’s cash-keeping prudence is also a reason why its long-term returns on equity have tended to be lower than the west’s, and that too is an indicator of future performance.
Meanwhile credit will be scarcer, corporate bond investors will be warier, and one concept that will be way out of fashion is that of ‘excess capital’ available for distribution to shareholders in exceptional dividends or share buybacks. The latter, widely practiced in the US and increasingly so in the UK, have long been regarded with suspicion as a device which, by artificially boosting earnings per share and underlying share prices, also happens to boost the ‘performance-related’ rewards of the executives taking the buyback decisions. At the same time, money taken out in buybacks is money not spent on advanced technology or R&D: attention has focused, for example, on US ‘Big Pharma’, which collectively spent more on buybacks than research from 2006 to 2015 and again in 2018.
If buybacks are controversial, dividends shouldn’t be, at least not in normal times: they are the rewards for risk-capital that actually make capitalism work. But not so now, according to parts of the media reflecting hostile public sentiment: companies that have taken government grants to furlough staff, or used guaranteed loan and commercial paper schemes to ease cashflows, or asked for bailouts, should think twice before distributing pre-crisis profits to shareholders. Cases in point have included easyJet, which claimed it was legally bound to pay a £174 million dividend, including £60 million for founder-shareholder Sir Stelios Haji-Ioannou, while asking for state support at the same time; and Irish-based building materials group CRH which went ahead with a €510 million dividend after accepting state support for laid-off workers. A MarketWatch report of the CRH story provides a neat summary of the issues: ‘While like-for-like group sales in the first quarter rose 3 per cent and it will pay a dividend, it has postponed the share buyback programme until further notice and introduced a range of measures to conserve cash, including cutting senior management and board pay.’
That brings us to the equally hot topic of executive pay in a time of plague. Should bosses take cuts to show empathy with laid-off workers, even if no jobs are preserved by the relatively small sums saved? The answer, in the interest of defending capitalism’s good name as well as for obvious human reasons, is that they probably should. Airline bosses such as Shai Weiss of Virgin Atlantic (giving up 20 per cent) and Ed Bastian of Delta (no salary for six months) were quick to set an example; in the City of London, the fund manager Schroders has urged bosses of its investee companies to ‘share the pain’ and set up a scheme for its own executives to donate part of their salaries to virus relief. Wall Street’s detractors meanwhile accuse Goldman Sachs of extreme insensitivity in awarding its chief executive David Solomon a 20 per cent rise to $27.5 million.
Solomon is often compared to Jamie Dimon of JPMorgan Chase, who took a much smaller pay rise for a much bigger profit performance than Goldman’s in 2019 and who led a pre-virus initiative in top US corporate circles to redefine the ‘purpose’ of capitalism in more socially aware, less shareholder-value-driven terms. Dimon’s Time article published for January’s Davos meeting, entitled ‘Unless We Change Capitalism, We May Lose It Forever’, was already a seminal text and ‘Purpose before Profit’ was fast becoming a fashionable mantra before the pandemic, largely in response to pressure for more urgent action on climate change.
For the coming two years at least, ‘Purpose’ will be redefined in terms of contribution and social responsibility displayed in response to the pandemic. One benchmark has been set by the pharma giant GlaxoSmithKline in announcing a collaboration with French rival Sanofi to create a Covid-19 vaccine that they aim to manufacture at the rate of ‘hundreds of millions of doses annually’ by the end of 2020, adding that the company does not ‘expect to profit from our portfolio of collaborations… during this pandemic’. Making vaccines available to the world’s poorest countries ‘including donations’ will also be a key part of GSK’s efforts as will ‘protecting the health and wellbeing of our people and managing our global supply chains to support patients and consumers’. No mention of shareholders - but for a company with vital resources to offer and much better survival odds than those in many other sectors, that surely feels right for the times.
Shareholders deserve a slice of sympathy too, however, as they contemplate an era of low or negative returns from companies facing the combination described here of depressed markets, higher operating costs, tighter credit conditions and higher taxes. Even when represented at one remove by large investment institutions, shareholders are ultimately people with families and neighbours, who will perhaps more readily subscribe, in current circumstances, to the idea that companies should have a strong sense of social purpose alongside the profit motive which defines their existence in the first place. But when the virus crisis is over - as I wrote recently in The Spectator - ‘the surviving beacons of capitalism will also need to re-assert the older mantra that profit is healthy because it pays taxes and pensions and fertilises economic growth; and that risk-capital must be properly rewarded or it will wither away.’
The writer is business editor of The Spectator. His next book, The Good, the Bad and the Greedy: Why We've Lost Faith in Capitalism, is due to be published by Biteback in late 2020.