Invest or Harvest: Dilemma Reexamined
Ashish Sood, Vijay Govindarajan, Anup Srivastava, and Birendra Mishra, 2019, 19-127-08
From PepsiCo to Ford Motor Company and others, companies face a dilemma – should they continue to milk the rewards from their established brands or invest and reinvent themselves to compete with startups like Uber and Waymo? Almost every manager faces the dilemma of whether to focus on making current profits from existing competencies or to shift focus to creating new competencies for building new markets and disrupting existing ones.
In this report, Ashish Sood, Vijay Govindarajan, Anup Srivastava, and Birendra Mishra examine the dilemma of how to allocate scarce resources between consumption and investment, exploitation and exploration, and value appropriation and creation.
They investigate this by studying how stock markets respond to unexpected shifts in firms’ focus from value creation to appropriation and vice versa. This question remains largely unexamined in prior literature because of a limitation in financial reporting - only about 30% of firms release information on both R&D and advertising expenses in their annual reports, and they provide even scantier details on the other intangible investment activities.
The researchers developed a method to measure the impact of tradeoffs between value appropriation and value creation to support current operations (value appropriation) or to produce future benefits (value creation). They separate SG&A expenses into those that produce current benefits and those that are intended to generate value beyond the current period. By examining 159,041 observations of companies listed on U.S. stock exchanges from 1971–2014, they find that a shift in strategic emphasis from value creation to value appropriation is associated with negative stock returns.
These results suggest that shareholders do not favor sudden shifts in firms’ focus, from creating new competencies to exploiting existing ones. This finding runs contrary to the idea that shareholders are obsessed with current profits at the cost of long-term value.
These findings differ by industry. The most negative shareholder reactions from sudden shifts occur for high-technology industries, such as electronics, information technology, communications, computers, and biotechnology. For low-technology industries, such as forestry, agriculture, and restaurants, a shift in strategic focus is associated with positive returns.
Nevertheless, the authors find that firms are better off harvesting value in periods of unusually good performance. That is, when a product finds unexpected success or market conditions turn favorable, firms are better off focusing on exploiting that opportunity to earn current profits.
These findings have important implications for strategy and management. In general, firms should focus on value creation, on constantly rebuilding strategy, brands, patents, customer relations, market intelligence, organizational technology, and human capital. However, on certain rare occasions, when the firm strikes gold, firms should shift their focus almost entirely to producing, launching, distributing, and securing markets for those products.
Ashish Sood is Associate Professor of Marketing, University of California Riverside. Vijay Govindarajan is Coxe Distinguished Professor at Tuck School of Business, Dartmouth College. Anup Srivastava is Canada Research Chair in Accounting and Capital Markets at Haskayne School of Business, University of Calgary. Birendra Mishra is Professor of Accounting, University of California, Riverside.
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