Low Margins and Short-Term Thinking
October 6, 2011
Margins are razor thin in the window and door industry. I suspect that most companies' cash reserves are too low for comfortable sleeping. Why is that? Margins in the fenestration market are set by large firms playing a “contribution to margin” game. Everyone else has to react to the prices at the bottom.
For the most part, small companies can get a little more margin through service and value-added offerings. But that only works to increase average margins by maybe 10 percent. As a result. the industry never has much of a cash reserve for cushioning against an economic downturn. Actually, it’s surprising that the industry has weathered the weak market as well as it has.
Margins are a secondary consideration for the big guys, where market share is the mantra. This philosophy manifests a focus on the “exit strategy,” instead of a long-term view. For some reason, investment bankers pay a premium for companies with number one market share. At least that is my observation. Standard evaluations have always been based on EBIDTA, but I also think a key consideration for many buyers is how fast can the company be propped up for resale. That means the purchased company is probably going to curtail any investments with a long horizon.
Most large firms in the United States have defaulted to this myopic view. They are looking to “flip” the latest acquition for yet another big cash payout. This thinking is fortified by the capital gains tax structure. An investment banker knows that they can buy a company and hold it for one year and potentially sell it at a profit and only pay 15 percent in capital gains. So, for the last decade, many companies' investment horizon has been progressively shortened. Companies, and people, have entered our industry who, I’ll submit, have no intention of making a career in the industry.
The phenomenon is not limited to the window business, of course. It is evident in all of America’s business thinking. And that is the problem. In the United States, our investment horizon is really less than five years. In China, meanwhile, the thinking is long term. But China has a unique centralized decision making authority that will never be implemented in the US. (And for the record, I don’t think we want such a system). In order for us, as a nation, to take a long term view, we have to implement tax policy that pushes people to take a longer term view.
I am hesitant to put out any numbers in this article, because they will only be rebutted and attacked. In general, I do think the U.S. needs to take a look at our capital gains rate and our corporate tax rate. We need to make it more attractive for American investment capital to be left in corporate America to grow American industry.
I really think we should reverse the tax rate. That is, corporate rates should be 15 percent and capital gains rates should be in the range of 38 percent. In this way, there is an incentive to roll profits back into the company: invest in equipment and invest in people. If profits are dispersed out of the company, then raise the personal tax rate of the individuals which are likely to own a company. This way the true incentive is to forego taking cash out of the business.
This would work for the small business owner as well as the corporate giants. If we would have implemented such a strategy 10 years ago, there is no question in my mind, that our industry would have withstood the economic body blows much better. Right now, there is much bias for manufacturing to leave the United States, and that needs to change. The only way to change it, in my opinion, is through tax policy. (Parenthetically, we need a free market, we do not need to increase tariffs.)
Hypothetically, if this tax change were to happen tomorrow–which it won’t–will we leap out of this economic stall in the near future? Absolutely not. I think this economic malaise will be here for many years to come. We have to ride out the path of the pendulum. We have to buckle down as a nation and get competitive. Not just in the window and door business, but everywhere. We are a great nation, filled with great people and great freedoms. We will prevail. We just need to build for the future. And that will be by American ingenuity and American business and American true grit.