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John Hagel highlights Return on Assets...

by Metatone Thu Apr 22nd, 2010 at 04:46:37 PM EST

John Hagel is one of those "business gurus" whose work is very much a mix of the interesting and the ideological.

He has a new book out and a blog promoting it... one part of it touches on something that seems very interesting:

Edge Perspectives with John Hagel: Economic Recovery? Don't Count On It.

In our new book, The Power of Pull, we summarize the metrics that we developed for the Shift Index - the first attempt to quantify the longer-term trends that have been re-shaping the business landscape over the past four decades.  Of the 25 metrics in the Shift Index, one metric in particular stands out: return on assets for all public companies in the US.  Since 1965, return on assets has collapsed by 75% - it has been a sustained and substantial erosion in performance.  There is no evidence of any flattening of this trend, much less turning it around.

Now with a quick googling around, I can't find any figures to check on this statement.

Looking at the definition of ROA:

Return on assets - Wikipedia, the free encyclopedia

This number tells you what the company can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control. It's a useful number for comparing competing companies in the same industry. The number will vary widely across different industries. Return on assets gives an indication of the capital intensity of the company, which will depend on the industry; companies that require large initial investments will generally have lower return on assets.[1]


Return on assets - Wikipedia, the free encyclopedia

Return on assets is an indicator of how profitable a company is before leverage, and is compared with companies in the same industry. Since the figure for total assets of the company depends on the carrying value of the assets, some caution is required for companies whose carrying value may not correspond to the actual market value. Return on assets is a common figure used for comparing performance of financial institutions (such as banks), because the majority of their assets will have a carrying value that is close to their actual market value. Return on assets is not useful for comparisons between industries because of factors of scale and peculiar capital requirements (such as reserve requirements in the insurance and banking industries).

Potential caveats seem to be: Taking the economy as a whole, a change in ROA may only reflect a change in the kind of companies prominent in the economy.

However, given that it suggests new companies are more capital intensive, despite the move away from heavy industry... something does seem to be going on.

For me this seems like a key to understanding both Minsky's ideas of how economies evolve into greater financialisation and also could help explain periods like the 70s stagflation - and explaining that properly is a key to rolling back the neo-liberal tide...

Most of all, it just seems interesting... what has changed and why?

Hagel doesn't "get it". He's really just another, more sophisticated, parasite on parasites.

Financialisation contributes nothing to productivity, unless you count GDP, which sees Katrina as a positive flow of goods and services.

Bad economics AND politics. Not surprising.

The "power of pull" is bullshit terminology.

Align culture with our nature. Ot else!

by ormondotvos (ormond.otvosnospamgmialcon) on Thu Apr 22nd, 2010 at 06:37:10 PM EST
I don't know about Hagel. The foreward is by Scott Page, Professor of Complex Systems, Political Science and Economics at the University of Michigan. I know that U of M. supports inter-disciplinary approaches and economics desperately needs an interdisciplinary approach, as it has been its own little island with its own view of human nature and society for over a century.

From the forward, (click on the Shift Index link in the diary), it appears that they are trying to transcend the neo-classical paradigm. As Page notes, the "Shift Index, by name alone, calls into question the neo-classical mindset that focuses on re-equlibration."

In the next paragraph, (It is a PDF and I can't cut and paste quotes), he states:

The Shift Index resonates instead with a conceptual model of the world economy based on complex dynamics. In this framework the economy can be conceptualized as a complex adaptive system with diverse entities adaptively interacting to produce emergent patterns (and occasional large events). If one embraces the complex, dynamic nature of the economy, then the index can be appreciated in full--as a multidimensional measure of trends in the constraints and opportunities within that system. As constraints fall away and opportunities increase, old configurations become unstable and new structures emerge.

Page notes that while we are aware of trends such as an increase in the pace of innovation and increasing computing power, we didn't have quantified metrics. That is what the Shift Index is designed to supply. Some of Hagel's blog seems glib, I will grant you, but at least with the Shift Index they have attempted something worthwhile. Unfortunately, the document is only one of several and it is 138 pages long. The bios of Hagel and Davison indicate that they come out of a business consulting and writing background. John Seely Brown, JSB, is a former chief scientist and director of the Xerox Palo Alto Research Center. He is listed as "Independent Co-Director". See p. 138. Six others are listed on the title page as the Core Research Team. I suspect that JSB and the Core Research Team have developed most of the substance while Hagel and Davison are involved as the public face, especially to business. The document was produced by Deloitte.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 22nd, 2010 at 10:23:44 PM EST
[ Parent ]
Hagel :

The Power of Pull suggests that we are going through a fundamental shift in the source of economic value creation.  In the past, economic value creation depended on proprietary knowledge stocks.  The challenge for any company was to acquire some proprietary knowledge, rigorously protect it to make sure no one else had access to it, and then as efficiently as possible extract the economic value from this proprietary knowledge stock for as long as possible.  As change accelerates and uncertainty grows, though, knowledge stocks depreciate at a more rapid rate.  In this kind of environment, the key to economic value creation shifts to the ability to participate in a growing number of diverse knowledge flows [!] to more rapidly refresh our knowledge stocks.

Diversity is the key to economic and political evolution.
by Cat on Fri Apr 23rd, 2010 at 02:48:20 PM EST
[ Parent ]
ROA is a classic example of how to create a narrative with little or not substantive content which appears to be significant.

The implication is ZOMG! ROA is falling! Very bad!

It's reductive (what about other metrics?), superficial (is ROA a real problem compared to a corporate culture based on piracy, exploitation and fraud?) and melodramatic (ZOMG!)

The melodrama is the most substantial component - and I don't mean that flippantly. If you want to persuade someone that what you're saying is significant, you load it with strong emotion - or better yet, you create a narrative framework in which listeners can discover and generate the strong emotion for themselves, and persuade themselves that it's their idea.

Hagel is certainly doing that, very effectively. As for the Shift Index, any paper that uses definitions like these:

Creative Class
  • Super-Creative Core: Computer science and mathematics; architecture and engineering; life, physical, and social sciences; education, training, and library management; and arts, design, entertainment, sports and media studies.
  • Creative: Management; business and financial operations; law; healthcare and technical fields; high-end sales and sales management.

and then goes on to say that super-creatives are super earners really isn't living in the same reality as the rest of us.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Apr 22nd, 2010 at 11:26:13 PM EST
What, are you challenging the well-known and universally agreed upon fact that teachers and librarians are super-earners?  As an educator, I am personally offended by any statement which challenges my ranking amongst the highest income brackets.  Why, I almost earn enough to be worth taxing!
by Zwackus on Sun Apr 25th, 2010 at 09:23:22 AM EST
[ Parent ]
I guess it's all about the changing nature of 'assets' in a knowledge economy.

So that a business with hard assets like property, buildings etc can be assessed and priced over many years, whereas a people business is as good as the contracts that lock in the 'human assets'

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Apr 23rd, 2010 at 04:53:03 AM EST
A more appropriate reference is Principles of Accounting. No subscription required. See Ch. 3

THE MEANING OF "ECONOMIC" INCOME:  Economists often refer to income as a measure of "better-offness." [e.g. "benefit"] In other words, economic income represents an increase in the command over goods and services [e.g. "demand"]. Such notions of income capture a business's operating successes, as well as good fortune from holding assets that may increase in [marketable, transaction] value [e.g. "fungibility"].

What is an asset? The meaning of asset is firstly categorized.

  • a tangible property by which people produce income. Examples are real property (natural resources, plant, equipment). See PPE
  • an intangible property by which people produce income. Examples are goodwill, designs or IP, securities (equity contracts), obligations (liability contracts).

What is capital? Capital is a categorical name for all economic stocks --tangible and intangible-- to which people assign transaction "benefits" in general. Cash, or money, is one class of capital. Cash is a unit of measurement. It is an intangible property, neither asset nor liability; although one can hold its physical form, its transaction value is wholly fungible. Colloquially speaking, people frequently do not differentiate cash equivalence and typology of economic stock. Thus "capital intensity" is not of itself a meaningful description of the economic goals and activity of a speaker. Accordingly, many are unaware of the extent to which cash obligations impair "net income" or the extent to which owners rely on continuous financing as a substitute for revenue attributable to assets in production.

THE MEANING OF "ACCOUNTING" INCOME:  Accounting does not attempt to measure all value changes...

The purpose of accounting, regardless of methodology, is to record value changes in terms of cash equivalences a/k/a currency-denominated amounts

FLOWING IN --revenue a/k/a gross income a/k/a sales a/k/a turnover a/k/a return a/k/a earnings a/k/a receivables;

and FLOWING OUT --expenses incurred a/k/a short-term liability and long-term liability a/k/a obligations or paid a/k/a costs a/k/a spending-- of an enterprise a/k/a economic activity

during a specified period of time.

(e.g., land is recorded at its purchase price and that historical cost amount is maintained in the balance sheet, even though market value may increase over time -- this is called the "historical cost" principle). Whether and when accounting should measure changes in value has long been a source of debate among accountants.  Many justify historical cost measurements because they are objective and verifiable.

The meaning of the metric ROA is practicably indifferentiable from ROI a/k/a return on equity (ROE). Equity always denotes legal title of ownership interest, i.e. claim on enterprise (the economic project) return. Both measure income produced by, or attributable, to one or more assets during a specified period. Both measure profitablity of enterprise economic activity. The wiki article makes no distinction between assets types, although a typical, conservative ROA "reference portfolio" will exclude income attributed to intangible assets. (Activity Based Cost (ABC) accounting for example is a forensic examination of revenue terms, ergo profitability.) In fact the ROE formula contains the expression of ROE.

ROE = ROA x financial leverage
    = (net income/assets) x (assets/shareholders' equity)
    = (net income/sales x sales/assets) x (assets/shareholders' equity)

Others submit that market values, however imprecise, may be more relevant for decision-making purposes. Suffice it to say that this is a long-running debate, and specific accounting rules are mixed. For example, although land is measured at historical cost, investment securities are apt to be reported at market value. There are literally hundreds of specific accounting rules that establish measurement principles; the more you study accounting, the more you will learn about these rules and their underlying rationale.

Diversity is the key to economic and political evolution.
by Cat on Fri Apr 23rd, 2010 at 12:16:10 PM EST
But it makes no sense to claim that ROI has fallen, unless you're taking a broad-brush average across the entire economy.

It's more likely that ROI has been concentrated within specific industries while others have been left to rot.

And it's difficult to do accurate accounting for any economy where military spending is such a huge part of government expenditure. What's the ROI/ROA of the Pentagon's budget?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Apr 23rd, 2010 at 12:39:46 PM EST
[ Parent ]
NB. "In fact the ROE  formula contains the expression of ROE." s/b "In fact the ROE a/k/a ROI formula contains the expression of ROA." ROA is a factor of ROE ergo ROI. "Analysts" may employ the formulae to describe profitability of any size enterprise a/k/a economic activity. That is one proprietor or a corporation employing 30,000 individuals and owing 12,000 equity owners.

re: "a broad-brush average across the entire economy."

This is exactly how macroeconomists, in general, report "national" accounting income amounts. Consider calculation of a mean: sum of addends divided by number of addends. In this application, total reported revenue divided by number of reporting firms; then calculate "national" ROA according to the formula (above) assigning total values, either reported or estimated by statistical method, corresponding to each variable in the expression.

The procedure may be refined by segregating (grouping) sums of reported or estimated earnings according to national industry code (NIC).

re: "it makes no sense to claim that ROI has fallen"

The absurdity of the value proposition is self-evident. Operations on mean values do not reveal characterics of constituents' businesses or "accounting income" ergo ROA a/k/a ROE a/k/a ROI.

re: What's the ROIEA of the Pentagon's budget?

I don't know. Who knows? Who would dare define, for example, DoD equity or DoD "net income" or profitability in terms of say refundable tax credits, royalty receipts, or lives defended? Useful life of an F-15?! Interesting in fact is the political history of directors of the general accounting office (GAO) to, you know, actually institute GAAP reporting of federal business. David Walker who was endorsed by McKinney, iirc, was the last comptroller general to fight over intellectual coherence. He resigned before fulfilling his term.

Diversity is the key to economic and political evolution.

by Cat on Fri Apr 23rd, 2010 at 02:09:59 PM EST
[ Parent ]
David Walker served from 1998 until March, 2008. I would submit that he got out while the getting was good.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 23rd, 2010 at 03:14:03 PM EST
[ Parent ]
But it makes no sense to claim that ROI has fallen, unless you're taking a broad-brush average across the entire economy.

But the claim is that ROI has declined generally, if not in all sectors of the economy. It is also my impression that this decline in profitability is pretty much conventional wisdom and my surmise that the whole neo-com financialization project was a response to enable elites to continue to extract 18% profits via bubbles and socialization of losses.

They think 18% is a birthright and managed to continue getting it in the financial sector via fraud and by convincing homeowners to extract "wealth" from the counterfeit increased value of their homes, in the process masking the lack of growth elsewhere by pumped up profits in FIRE, which went preferentially to them.  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 23rd, 2010 at 03:25:06 PM EST
[ Parent ]

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