How to Set a Rational Frequency for Earnings Forecasts

In June of this year, financial titans Jamie Dimon and Warren Buffet argued in the Wall Street Journal that short-termism is harming the economy. They called on public companies to reduce or even eliminate their quarterly earnings guidance, because it “often leads to an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability.” Instead, Dimon and Buffet encouraged public companies to focus on the future-oriented activities that increase competitiveness and build long-term prosperity for a stronger society. I couldn’t agree more. Without long-term thinking, lean management as we know it would not exist today.

Perhaps the most underrated factor that led to the development of lean management is that Toyota and other Japanese public companies behave very differently in regards to the stock market and their shareholders. The lack of concern for quarterly earnings and their effect on share price allowed them to invest in R&D, overseas expansion, retention and development of people, customer service, and other proof points of long-term thinking. Had Toyota put a similar level of attention to quarterly earnings as its American competitors, TPS would have grown into at best a pretty-good-but-not-world-beating management approach.

Simply put, companies and leaders of companies who are under pressure to meet financial targets based on guesses made 90-days ago will be forced to make bad long-term decisions as they approach the earnings reporting date. They may cut back on hiring, training, investment in technology upgrades, R&D, marketing or be forced to divert resources away from solving systemic problems in quality and safety. Corners are cut to meet quarterly earnings forecasts, but what goes around comes around. These companies and their shareholders pay a higher price later.

Setting targets and checking whether we are meeting them is important, but not all-important, especially when we may be missing our targets due to factors beyond our control. In lean thinking we say “good processes bring good results”. When we manage short-term via quarterly earnings, the thinking becomes “bring good results now, even if have to break a few processes”.

The article makes an important point that information about a company’s performance toward its strategic goals should be provided “on a timeline deemed appropriate for the needs of each specific company and its investors” rather than on an arbitrary 90-day cycle. Taking a page out of the practice of Toyota Kata, analysts should be asking the management of public companies these 5 questions

1. What is the target condition for earnings?
2. What is the actual condition of earnings?
3. What obstacles do you think are preventing you from reaching the target condition? Which of these obstacles are you addressing now?
4. What is your next step? What do you expect from this experiment?
5. When can we go and see what you have learned from taking that experiment and its effect on earnings?

Instead, conversation around 1 – 4 often is a combination of theater, misdirection, manipulation of information to fit earnings forecasts, wishful thinking, obfuscation, guesswork or even outright deception. Question #5 is not asked at all, because we are locked into a 90-day review cycle that has no basis in the reality of how organizations, markets, or human society works. It would be much better to ask each CEO, “When can we check back with you to see what you have learned from taking these steps to overcome obstacles to close the gap between the actual earnings condition and the target earnings condition?”

Investment bankers may argue that a public company CEO could say “I’ll let you know in about 365 days,” instead of in 90 days, leaving stock analysis in the dark. In reality, shareholders would take their money out of public companies that did not report on results of their experiments on some reasonable cycle.

These Toyota Kata questions can be asked by the CEO to their executive team, the executives to their managers, and so forth, leading to a common frame of thinking in terms of setting review dates for gap closure actions. People would support a company strategy if they saw how timely results from their “next step” experiment contributed to earnings, whose reporting frequency was not the mad scramble every 90 days to “make the numbers” but based rationally on the stack-up of outputs from various experiments across the organization.