Strategy in the Age of Superabundant Capital3 March, 2017 / Articles
For most of the past 50 years, business leaders viewed financial capital as their most precious resource. They worked hard to ensure that every penny went to funding only the most promising projects. A generation of executives was taught to apply hurdle rates that reflected the high capital costs prevalent for most of the 1980s and 1990s. And companies like General Electric and Berkshire Hathaway were lauded for the discipline with which they invested.
Today financial capital is no longer a scarce resource—it is abundant and cheap. Bain’s Macro Trends Group estimates that global financial capital has more than tripled over the past three decades and now stands at roughly 10 times global GDP. As capital has grown more plentiful, its price has plummeted. For many large companies, the after-tax cost of borrowing is close to the rate of inflation, meaning that real borrowing costs hover near zero. Any reasonably profitable large enterprise can readily obtain the capital it needs to buy new equipment, fund new product development, enter new markets, and even acquire new businesses. To be sure, leadership teams still need to manage their money carefully—after all, waste is waste. But the skillful allocation of financial capital is no longer a source of sustained competitive advantage.
The assets that are in short supply at most companies are the skills and capabilities required to translate good growth ideas into successful new products, services, and businesses—and the traditional financially driven approach to strategic investment has only compounded this paucity. Indeed, the standard method for prioritizing strategic investments strives to limit the field of potential projects and encourages companies to invest in a few “sure bets” that clear high hurdle rates. At a time when most companies are desperate for growth, this approach unnecessarily forecloses too many options. And it encourages executives to remain committed to investments long after it’s clear that they’re not paying off. Finally, it leaves companies with piles of cash for which executives often find no better use than to buy back stock.
Strategy in the new age of capital superabundance demands a fundamentally different approach from the traditional models anchored in long-term planning and continual improvement. Companies must lower hurdle rates and relax the other constraints that reflect a bygone era of scarce capital. They should move away from making a few big bets over the course of many years and start making numerous small and varied investments, knowing that not all will pan out. They must learn to quickly spot—and get out of—losing ventures, while aggressively supporting the winners, nurturing them into successful new businesses. This is the path already taken by firms innovating in rapidly evolving markets, but in an era of cheap capital, it will become the dominant model across the business economy. Companies that practice this strategy will have the edge so long as capital remains superabundant—and according to our analysis, that could be the case for the next 20 years or more. In this article, we outline what it takes to produce great results in this new world. We begin by taking a closer look at the data.
A World Awash in Money
Many of today’s business leaders cut their teeth in a period of relative capital scarcity and high borrowing costs. In the early 1980s, double-digit federal-funds rates prevailed, and corporate debt and equity securities traded at high premiums. Although the required rate of return on stocks and bonds returned to more “normal” levels by the end of the decade, capital costs remained high. Our research suggests that for most large public companies, the weighted average cost of capital, or WACC, exceeded 10% for most of the 1980s and 1990s.
But the world changed following the financial collapse in late 2008. Central bank interventions pushed interest rates in many countries to historic lows, where they remain nearly a decade later, owing to tepid economic growth. Many executives believe that the current interest rate environment is temporary and that more-familiar capital market conditions will reassert themselves soon. Our research, however, leads to the opposite conclusion.
Using public data and proprietary economic models, Bain’s Macro Trends Group examined how the quantity and scale of assets on the world balance sheet have evolved over time. We found that global financial assets (which more or less represent the supply of capital invested or available for investment in the real economy) grew at an increasingly rapid pace—from $220 trillion in 1990 (about 6.5 times global GDP) to some $600 trillion in 2010 (9.5 times global GDP). We project that by 2020 the number will have expanded by half again—to about $900 trillion (measured in 2010 prices and exchange rates), or more than 10 times projected global GDP. At this rate, by 2025 global financial assets could easily surpass a quadrillion dollars. We see two factors principally accounting for the continuing trend:
Growing financial markets in emerging economies.
Although prospects for growth in advanced economies are relatively weak, the financial markets in China, India, and other emerging economies have only started to develop. Our analysis indicates that these nations will account for more than 40% of the increase in global financial assets from 2010 to 2020. And the data suggests that emerging economies will continue fueling growth in financial capital well beyond 2020.
An expanding number of “peak savers.”
There are important demographic factors at work that will reinforce the superabundance of financial capital. Specifically, the population of 45- to 59-year-olds is critical in determining the level of savings (versus consumption) in the global economy. People in this age bracket have moved past their prime spending years and make a higher contribution to savings and capital formation than any other age group. These “peak savers” will represent a large and growing percentage of the global population until 2040, when their numbers will slowly begin to decline.
The combination of these factors leads us to conclude that through 2030 (at least), markets will continue to grapple with capital superabundance. Too much capital will be chasing too few good investment ideas for many years.
Moreover, as the supply of financial capital has increased, its price has fallen precipitously. In 2008 the cost of borrowing began to decline in response to central bank intervention. Today, facing a dearth of attractive investment opportunities, large banks have been forced to accept riskier projects as investment grade. Even high-yield “junk” bonds are trading at historic lows. All told, the marginal cost of debt for many large companies is now as low as 3%. This means that the after-tax cost of borrowing is at (or below) the rate of inflation—implying that in real terms, debt is essentially free.