To each firm, its own pace to market

Gonçalo Pacheco de Almeida, Professor of Strategy and Business Policy - April 7th, 2015
To each firm, its own pace to market by Gonçalo Pacheco de Almeida HEC Paris

“For many years, business executives in industries ranging from IT to entertainment have been very vocal about the benefits of speed, but they are typically silent about the cost of going faster,” says Gonçalo Pacheco de Almeida. In response to this gap, he and his co-researchers have figured out how firms can precisely estimate the cost of project acceleration and thus determine the most efficient pace at which to proceed. 

Gonçalo Pacheco de Almeida ©HEC Paris

Professor Gonçalo Pacheco de Almeida joined HEC Paris in 2011, having previously taught at New York University’s Stern School of Business (United States), the Institut d’Etudes (...)

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As it is said, “time is money.” The incentive for companies to move fast has always seemed obvious, with a one-day delay in the launch of a new computer or car calculated in the 1990s to translate into a $1 million revenue loss. But there is another side to the equation — the cost of speed. “Most research has focused on the benefits of greater speed without paying enough attention to the cost of moving quickly,” says Gonçalo Pacheco de Almeida. He and his colleagues studied the trade-off between speed and cost in the context of oil and gas plant construction, where strict regulations and standards mean qualitatively equal final products. They found that every firm has an intrinsically “right” speed at which to proceed to market. Any deviation from this pace is costly, whereas the right speed generates market value and competitive advantage. 

The speed/cost trade-off 

 Why is it more costly to move faster? According to Pacheco de Almeida, one reason is information loss. “In order to accelerate, companies carry out typically sequential processes in a parallel manner, and this prevents a step-by-step flow of information.” As a result, mistakes, rework, and even information loss become more frequent. Secondly, costs increase with speed due to “diminishing returns.” Pacheco de Almeida explains, “When firms want to accelerate, they throw more people at a project. If they are developing a new technology, they get more engineers involved. More people mean more coordination costs, so productivity or return on each person’s work diminishes.”   That said, the benefits of getting to the market faster than others are very real. “Generally speaking, estimated revenue losses due to longer times to market are major incentives for firms in any industry to go fast. In our study, we saw that a one-percent decrease in economic activity or GDP growth rate led to a 50-day slowdown in plant construction. This deceleration is significant and comparable to what happens when plant size is tripled. On the other hand, we discovered that a firm capability to be 1 month (5%) faster than the industry average increased the company’s market value by $214 million.” Pacheco de Almeida emphasizes that the study’s findings are not merely theoretical. “We were able determine the exact monetary value of speed for every firm in our sample. We found out which firms increased their value by accelerating, and which firms decreased it. At the extremes, we found that Exxon Mobil gained the most value by doing things faster, whereas BP destroyed the most value by doing things faster.” Interestingly, some of the speed-associated weaknesses that Pacheco de Almeida and his colleagues observed at BP were later reported as related to the 2010 BP oil spill. 


Guillemet

Every firm has an optimal speed at which to proceed to market. Any deviation from this pace is costly, whereas the right speed generates market value and competitive advantage.

Governance impacts the value of speed 

According to the study, corporate governance and firm debt levels most significantly moderate the impact of speed on firm value. “Better governed firms are able to create more value from speed,” affirms Pacheco de Almeida. “Good governance means good decision-making processes, which in turn enable a firm to find its intrinsically right speed of movement.” More often than not, when business managers are making decisions about building a plant or entering a market, they focus primarily on price and volume issues. They do not typically analyze whether it is truly worth getting a foothold in a new market within 12 months, for example, when they expect it to take 24 or 36 months to be able to operate efficiently. However, faster is not always better. “Finding the right speed requires subtle analysis of the speed/cost trade-off and involves doing often-neglected homework about cost. Managers need to ask — and answer — the question, ‘How much more will it cost us to go faster?’ The good news is that they have the answers in-house! Data from previous projects will show exactly how much it has cost the firm to accelerate in the past, and this information can be directly applied to estimate acceleration costs for current projects.” 

The key role of debt

The second factor that influences the value of speed for a company is firm debt. “Firms with higher debt typically have higher interest and discount rates. This lowers incentives to invest and/or to move fast.” Investment decisions are indeed usually made by comparing short-run investment costs and future revenue, so the fact that higher debt will automatically decrease the present value of future revenue makes it less worthwhile for a firm to invest in getting involved in a market as quickly as possible. This is not necessarily problematic, says Pacheco de Almeida: “For a firm with high debt, the right speed may be lower than the industry average. Going faster would imply overspending and thus destroying shareholder value.” The important thing is to understand this dynamic and include it in the cost/revenue speed equation to make the most effective decision. 

Pacheco de Almeida emphasizes that, up to now, the issue of speed has been over-simplified, and his study contains messages that previously have not been diffused. “Managers have been told, ‘Go fast!’ but our study shows that speed should be analyzed in relative terms. Moreover, managers need to know that the ‘right’ speed varies. Every firm has an intrinsically optimal pace, and any departure from this pace will be costly.” In addition, the study shows how a known model (Random Coefficient Model) can be applied in the field of strategy to enable better understanding of differences between firms. “Our method makes it possible to identify specific differences between firms. This insight can be used to analyze competitive advantage and consider different firm strategies. Academics will also find it very useful for selecting appropriate firms for case studies.” 1

[1] Gonçalo Pacheco de Almeida is currently collaborating on a paper about using random coefficient models to study strategic differences between firms and effectively select firms for case studies.

Based on an interview with Gonçalo Pacheco de Almeida and on “The Right Speed and Its Value” by Gonçalo Pacheco de Almeida, Ashton Hawk, and Bernard Yeung (Strategic Management Journal , no. 36, 2015)

Practical applications
Practical applications

The study shows that intrinsic speed capabilities are a competitive advantage that augment firm value and have a synergistic relationship with firm-level characteristics, including corporate governance and capital costs.

• Faster is not always better. Managers must consider both sides of the cost/speed equation. They can use in-house data on previous projects to find out exactly how much acceleration has cost their firm in the past.

• Firms can use the same data on previous acceleration costs to discover and build up their intrinsic speed capability.

• To implement changes in corporate governance, and specifically in decision-making processes (i.e., to integrate cost/speed analysis), managers can use the tangible data from previous projects to illustrate the need for intangible yet value-enhancing changes.    



Methodology
Methodology

To test the relationship between firm speed and value, the researchers developed a proxy for intrinsic speed capabilities using data from worldwide oil and gas facilities (2,659 new plant construction projects from 1996 to 2005). They then used a random-parameter model to analyze data on investment and timing in 847 firm subsidiaries in 99 countries.