Follow the Productivity Trail to Earnings Growth
Productivity never really goes out of style. In a world of scarce earnings growth, companies purveying productivity can be especially important in helping investors blaze new trails to profitable pockets of equity markets.
Companies are generally motivated to improve productivity. Reducing costs or sharpening performance typically requires investment, though the willingness and ability to pay for productivity gains fluctuates over time, depending on the health of a company or industry. For example, the energy sector has been under acute pressure to improve productivity over the past year because low oil prices have compressed profits drastically. Yet ironically, this makes it harder to fund efficiency moves.
Productivity can be enhanced in various ways. Frequently, these involve substituting physical capital for labor to improve performance. By automating processes or upgrading machinery, a manufacturer might increase production in the same facility from 100 units per day to 120 units per day at a similar cost.
Shining a Light on Productivity
Light-emitting diode (LED)–based lighting presents a timely example. As the costs of LED chips have fallen, the adoption of LED light bulbs and fixtures has accelerated, though it still remains quite low. While these products may initially cost more than traditional lighting, the total cost of ownership is much lower and they are a “green” product, as they consume less energy.
However, the impact on companies is complex. Some hardware suppliers may benefit from the new demand, while utilities could face lower electricity sales (Display). At the same time, the ongoing shift to digital lighting opens up new potential applications. Generally, while innovation in an industry often occurs across multiple dimensions, those that are more differentiated tend to be more durable—and more interesting for investors—in our view. We believe that finding the structural winners from changes like these can lead investors to sources of superior returns.
More Sensitive, More Connected
The proliferation of sensors is another case in point. Sensors are increasingly being incorporated into products to capture information for detailed analysis. And they add new weapons to the productivity arsenal by providing further insight into performance and elucidating previously unappreciated improvement opportunities.
Sensors are transforming industries such as auto manufacturing. Efforts by carmakers to meet increasingly stringent fuel economy and safety regulations are prompting manufacturers to add sensors to vehicles, as well as other new content, such as electric motors, cameras, radar, and incremental microprocessing capability These will reduce average fuel consumption per mile (Display) and facilitate features like automatic emergency braking, which can reduce accidents (and the associated costs) and should ultimately enable full autonomous vehicle operation.
High smartphone proliferation is already enabling “mobility as a service” (also called “shared mobility”), in which people without cars can hail a ride from just about anywhere. As travel cost per mile improves, this could potentially redefine car ownership over time as more people outsource the capital-intensive ownership to others.
Better Service, Better Value: Restaurants to Retailers
Mobility and wireless connectivity are powerful agents for productivity gains. They can also help squeeze out unnecessary costs and generate incremental market opportunities to innovators. For example, diners are increasingly ordering meals in advance online from wherever they are, helping restaurants understand each customer better, and reducing waiting times.
New service models are sprouting up to cost-effectively help people with an array of everyday tasks, from meal preparation to bill paying. Retailers and transportation companies are using sensors, wireless connectivity and asset-management software to extract higher utilization rates from their networks, while also improving safety and customer-service levels. We believe that we are still in the early innings of combining data capture, analysis and mobility to drive efficiency and improve customer experience.
In a world of sluggish economies, it’s easy for investors to lose faith in growth. But in the corporate world, change is always unfolding beneath the surface. By driving down costs or increasing service offerings, productivity gains help consumers, producers or both. Investors who can pinpoint companies with the potential to improve productivity can find attractive investment opportunities—even in difficult market conditions.
This article previously appeared in Institutional Investor.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.