Capital Thinking Magazine

Penny-Foolish, Pound-Wise

Now's the time to invest in the innovation, education and infrastructure that will position your organization–and the economy–for growth

By Eric Schoeniger; Illustrations by Lorenzo Petrantoni

A wise man knows how to invest. Benjamin Franklin bequeathed £2,000 to the cities of Boston and Philadelphia in trusts that wouldn't mature for 200 years. Two centuries later, the payout topped $7 million.

If only your business—and the economy —had that much time. Companies need to reap the rewards of their investments quickly—and in today's economic environment that's anything but certain.

Coming out of a global recession and in the wake of shocks from political unrest and natural disasters, many companies have dithered. U.S. businesses are sitting on a near-record $1.93 trillion in cash. GDP growth in the U.S. and Europe will be meager this year, but China and India will expand by 9.6 and 8.6 percent respectively, predicts the International Monetary Fund. Vietnam and Indonesia will rise by 6.8 and 6.2 percent. Even Chile and Peru will see 6 percent growth. Opportunity awaits those with the courage to grab it.

"We're still only at about two-thirds of the peak years of 2006 and 2007 [in terms of economic activity]," says Tripp Brower, co-founder and managing partner of Capstone Partners, a placement agent that provides fundraising and advisory services to private equity firms. "But a lot of the economic wounds of 2008 and 2009 have healed, and organizations are beginning to invest."

Looking for Growth

Which sectors look promising? The answer varies according to whom you ask. Bloomberg recently predicted annual share-weighted earnings growth for industry groups in the S&P 500. Among those it pegged in double digits were telecom services, at 34.9 percent; banks, at 34.5 percent; energy, at 21.4 percent; transportation, at 20.5 percent; retailing, at 19.9 percent; and IT, at 18.6 percent.

IBISWorld, a publisher of U.S. industry research, sees the top 10 winners for 2011 as iron ore mining, investment banking, multifamily building, molybdenum and other ore mining, environmental consulting, aluminum manufacturing, car building, new-car dealers, domestic airlines, and financial planning. Some of those are likely an affront to conventional wisdom. But in general, long-term growth will center around science- and technology-focused sectors, many experts believe. "If the United States is going to remain a rich economy, its growth will have to take place in those areas," says Ram Mudambi, professor of strategic management at Temple University's Fox School of Business.

Renewable energy in particular shows promise, as consumers, businesses and governments seek to reduce energy costs, decrease reliance on overseas sources and stem global warming. But potential lies in almost every sector, from automobiles (with a 9.7 percent earnings growth predicted by Bloomberg) to media (16.3 percent) to transportation (20.5 percent). Successful companies find opportunity where others miss it. "There's no shortage of companies that will try to go where the future is, and no shortage of consultants that will tell them where that is," Mudambi says. "But companies should invest in what they know, in what they're good at."

Have a Better Idea?

Irrespective of industry, smart businesses and governments are investing in innovation, education and infrastructure—three expedients for growth. In fact, a separate innovation function is emerging in many organizations, according to a recent survey of 24 "pioneering" companies in the United States, Europe and Japan by the HEC Paris business school and Act One, a French consultancy.

Perhaps that's overdue. The amount of money consumers spend creating their own products or improving the products they buy—for example, by building a tool for a task or modifying a device for a unique purpose—is more than twice what businesses invest in product research and development, according to a recent study out of MIT's Sloan School of Management. The study looked at consumers and businesses in the United Kingdom, but the implications are broad.

For one, it suggests that companies aren't investing enough in innovation if consumers find they need to innovate on their own. Beyond that, it points to an opportunity for businesses to tap into the creativity of their customers—for example, by crowdsourcing ideas or getting customer input through social media.

While the need for businesses to innovate can't be overstated, there's a place for government too. "Funding research through grants and loan guarantees is an important role for government, especially when capital markets are constrained," says Greg Johnson, a partner in Patton Boggs' Denver office. "Otherwise, there's no one to provide the money, and money is the mother's milk of innovation." But government should probably let the market sort out which innovations will succeed. "Government needs to put in place policies that encourage and, more important, don't discourage innovation," says Nick Allard, a partner in Patton Boggs' Washington office. "But government doesn't have a strong track record at picking specific winners and losers."

Teachable Moment

Any business or government that wants to lead in innovation will have to invest in educating its future innovators. And there's evidence to suggest the United States is falling behind. China ranks among the top 10 nations in the Programme for International Student Assessment, an evaluation of performance in reading, math and science. So do Finland, and Canada. Not so the United States, which stands at or below average among the 65 countries listed.

There's a spectrum of learning, ranging from training in a specific role to a traditional liberal arts education. And both have a place in a healthy economy. "Pure education stimulates critical thinking, which is nonspecific but extremely portable," Fox's Mudambi says. "Someone who gains critical-thinking capabilities will be a better employee, not because they have a particular industry knowledge but because they learn faster."

But even in a knowledge economy, there's a market for workers with technical skills. "You can only use so many lawyers and MBAs," Johnson notes. "You'll always need skilled manufacturing people. And by the way, those people often come out of community colleges, which are one of the most underappreciated resources in our economy."

There's a clear role for government here, as well, and not just at the state and federal levels. "City and municipal governments also need to focus on education," says Yost Conner, a partner in Patton Boggs' Washington office. "If people's kids aren't getting a good education in a city, the families leave. And that reduces the tax base; it reduces the workforce."

If You Build It

Education and innovation will take the economy only so far. Both business and government rely on infrastructure—"and if you look at the condition of our highways and bridges and ports, it's shocking," Conner laments.

With that in mind, President Obama, Democrats and Republicans in Congress, and business and labor leaders have all recently called for the creation of an independent bank to provide loans for infrastructure projects of national stature.

As a public good, infrastructure is the natural bailiwick of government. But business should also look for infrastructure investments that can benefit them—such as citywide wireless Internet access that delivers advantages to employees and employers alike.

Likewise, companies need to invest in their own infrastructures—in particular, in information technology. "Companies have put off investing in IT over the past two or three years," Conner notes. "They now need to upgrade their information technology to prepare for the future." Allard agrees. "There are massive new legislative programs in health care and financial services, and major developments in areas like clean energy," he says. "And all of them will require substantial investment in information technology."

That investment can enable new opportunities. For example, the state attorneys general recently issued a proposed settlement regarding home-mortgage foreclosures. "One way to look at it is as nearly 60 pages of regulations and punishments," Allard says. "But another way is as future business opportunities. If borrowers need to be able to track all their documents online, or if you need to have real-time access to all the players in a foreclosure, that creates opportunities that don't currently exist."

We Can Work It Out

Particularly when it comes to infrastructure, business can't do it alone. But neither can government. "There are situations where public-private partnerships can be effective," Brower says. "If government provides part of the capital that goes into an initiative and the private sector provides the expertise, that can be a winning strategy."

Examples of these synergies are growing. For example, the Virginia Department of Transportation and two companies, Fluor and Transurban Group, are partnering to finance, design, build and operate high-occupancy vehicle lanes. Vehicles with three or more passengers can use the lanes at no charge. But anyone can use them by paying an extra toll. "The state improves traffic flow more quickly than it could through traditional funding methods, and the companies make a profit," Conner explains.

Similarly, real estate developers are investing in the partial privatization of military housing. "It's a good solution," Conner says, "because real estate development is something these private companies do well but the government hadn't been doing well. The developer benefits from the flow of rents, and the government benefits from better-quality military housing."

Ultimately, business and government alike are waking up to the notion that they can't sit still, despite a climate of uncertainty. They need to assess the opportunities, analyze the risks and act. Or as Ben Franklin once put it: "You may delay, but time will not."