Management SummaryStern Stewart Research // Volume 38

Capital is in short supply and 2009 will evidently not be a good year for the real economy. The financial and money market crisis forces companies, which until recently were growing at full speed, to initiate drastic cuts to their investment budgets. Of course everyone is also talking about the opportunities, which result from this crisis. Low acquisition prices and anti-cyclical growth strategies are long-term value drivers. But unfortunately this is only in theory. Things look very different in practice: complete investment stoppages or undifferentiated 30% reductions throughout all activities characterise the management agenda in a manner seldom seen in the past.

Whilst in the past few years of the boom period it was possible to set multiple investment priorities, things turn out to be very different in this crisis. The underlying dilemma: fresh capital is generally invested in precisely those areas where it was also to be found in the past; the bottom-up process of capital allocation once again directs capital in the hands of the mature units – especially in periods of crisis.

In total five typical traps can be observed when it comes to capital allocation in practice:

1. The reinvestment trap: A fixed percentage of annual depreciation used as a base investment budget
2. The cycle trap: The returns of the past as an allocation key for the future
3. The opportunity trap: The “loudest” shout from below wins the game
4. The “Cash is King” trap: Decentralised use of the generated cash flows
5. The responsibility trap: An absence of top-down financial targets and a lack of capital costs in performance measurement

These traps can be avoided by means of a consistent top-down steering as well as the active management of the business portfolio. Those companies that depart from old conventions and demonstrate strategic leadership will be successful in the long term.