To increase sales and profits in this environment, executives need to rediscover the concept of economic profit.
March 01, 2024
Yaroslav Danylchenko/Stocksy
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While many executives and investors were thrown by last year’s interest rate increases, the cost of capital needn’t be a threat. Companies that integrate the cost of capital into their strategy and planning reap real benefits. When something is cheap, people waste it. With the cost of capital back to normal levels, it’s simply irresponsible not to make it a management discipline that changes the way you do business. To do that, executives need to rediscover the concept of economic profit (EP) — that is, revenue minus not just operating and administrative costs, but also the cost of the capital needed to produce that revenue. The authors have found that executive teams that bring the disciplines of the capital market inside a corporation deliver shareholder returns more than 50% above their industry peer indexes. That staggering difference attests not just to the value created by managing with economic profit, but also to the value squandered by ignoring it.
How should businesses cope with today’s higher cost of capital? Many executives and investors were flummoxed by last year’s interest rate increases. Indeed, when our colleagues surveyed 3,100 executives about forces that had disrupted their business last year, interest rates and inflation topped the list. When the executives were asked about threats to their business in 2024, interest rates and inflation again led the list, ahead of other issues such as politics, regulation, AI, or climate change.
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Scott Gillis is a partner and managing director in the Corporate Strategy and Transformation Practice at AlixPartners and coauthor of Beliefs, Behaviors and Results: The Chief Executive’s Guide to Delivering Superior Shareholder Value.
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Lee Mergy is a partner and managing director in the Corporate Strategy and Transformation Practice at AlixPartners and coauthor of Beliefs, Behaviors and Results: The Chief Executive’s Guide to Delivering Superior Shareholder Value.
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Joe Shalleck is a partner and managing director in the Corporate Strategy and Transformation Practice at AlixPartners and coauthor of Beliefs, Behaviors and Results: The Chief Executive’s Guide to Delivering Superior Shareholder Value.
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Read DuPriest is a partner and managing director in the Corporate Strategy and Transformation Practice at AlixPartners.
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Copyright for syndicated content belongs to the linked Source : Harvard Business – https://hbr.org/2024/03/adapt-your-strategy-to-higher-interest-rates