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Make it strategic! Financial investment logic is not enough

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Abstract

Profitability is not the main driver of capital investment decision-making; financial evaluation tools often play a secondary role in corporate investment choices; businesses do not follow capital finance theory prescriptions, contrary to what mainstream claims; the strategic character of investments has a heavier decisional weight than profitability. These findings are based on a review of different streams of literature (mainly organizational finance and strategic decision-making) which is described in the second part of the paper, after a first part summarizing the main stances of mainstream energy economics and the main findings of the alternative literature on energy-efficiency investments. Yet, what is a strategic investment? To fill the existing conceptual gap, we propose a definition of strategic investment and a new theoretical framework to analyze investment projects. An example of applying this framework to an energy-efficiency project is described. The partial influence of financial factors and the importance of strategic factors in investment decisions entail several implications for energy-efficiency practitioners, scholars, and public program developers, which are described in the last part of the paper.

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Notes

  1. A short description of these capital budgeting tools is given in the section on Capital Investment Decision-Making Literature, below.

  2. US Department of Energy’s Industrial Assessment Centers

  3. Heating Ventilation Air-Conditioning

  4. There is little empirical work on this subject even in the field of finance research. On this point, see the next section on Capital investment decision-making literature, page 9.

  5. I have freely translated from the original: “La décision d’investissement n’occupe …qu’une place très faible dans les analyses théoriques [micro et macroéconomique]” (Guerrien 2002).

  6. I have freely translated from the original: “Investir, dans le langage de la stratégie, renvoie à des choix de trajectoires de développement de l’entreprise (construire, s’implanter, conserver, se retirer d’un marché, absorber, s’allier, etc.)” (Desreumaux and Romelaer 2001, p. 61).

  7. I have freely translated from the original: “On prend conscience de l'intérêt d'investir quand on constate un écart entre ce qui devrait être et ce qui est […]. L'investissement est une réponse. Quelle est la question? Une ambition identifiable. Sans stratégie, sans projet connu, l'émergence de bons projets est rendue peu probable. C'est dans l'identification des vrais problèmes que réside l'essentiel du processus” (De Bodt and Bourquin 2001, p. 127).

  8. For instance, out of the 25 strategic decisions studied by Mintzberg, Raisinghani, and Theoret (1976), 22 were investment decisions.

  9. Investment profitability measures the relationship between the capital invested and the income which ensues from the investment.

  10. For a good description of capital budgeting methods, I advise the following reading: “Finance for Managers” pp. 140–170. Harvard Business Essential. Harvard Business School Press, Boston, MA (2003).

  11. For every investment project, 98% of surveyed companies use more than one and 88%, more than two methods of evaluation.

  12. “…the analytic mode, clearly distinguishing fact and value in the selection phase. It postulates that alternatives are carefully and objectively evaluated, their factual consequences explicitly determined along various goal, or value, dimensions and then combined according to some predetermined utility function—a choice finally made to maximize utility” (Mintzberg et al. 1976, p. 258).

  13. On the contrary, Alkaraan and Northcott (2006) find that financial evaluation techniques are applied indistinctly to all investments, whether strategic or non-strategic. Yet, they note that companies seem to look for a balance between strategic criteria, mostly qualitative, and financial criteria, in their evaluation of investment projects.

  14. See sections on “Defining strategic” and on “Competitive advantage” below.

  15. “Investments were considered strategic if they had a significant potential for improving corporate performance. As such, a strategic investment is important in terms of actions taken and/or resources allocated” (Van Cauwenbergh et al. 1996, p. 169)

  16. Researchers distinguish two levels of elaboration of strategy (Hafsi and Thomas 2005; Johnson and Scholes 1999; Porter 1985): global strategy—huge orientations defined at corporate or business level, and the functional or operational strategies which determine the resource allocations necessary to implement strategic orientations defined at the global level. Global level is responsible for positioning with regard to competitors; functional level is in charge of productivity and organizational efficiency. In other words, global strategy level is in charge of effectiveness, while functional strategy level is in charge of efficiency. “Efficiency is about doing things the right way. It involves eliminating waste and optimizing processes. Effectiveness is about doing the right things. There is no point in acting efficiently if what you are doing will not have the desired effect. A good strategy will blend both efficiency and effectiveness”. (Wikipedia, article “Strategic Management”, http://en.wikipedia.org/wiki/Strategic_management).

  17. Freely translated by me; originally “à entretenir le caractère unique du produit aux yeux du client” (Ramanantsoa 1997, p. 3041).

  18. “Overall the argument that specific VRIN resources per se are themselves the source of competitive advantage misidentifies the true source of advantage. That is, the specific characteristics of resources per se are neither necessary nor sufficient conditions for competitive advantage” (Bingham & Eisenhardt 2008, p. 254).

  19. “Which consists of a range of activities that can be broadly grouped into efforts to improve the product and the process” (Porter 1985, p. 42).

  20. RBV considers non-substitutability as a core component of a strategic character of a resource or a combination of resources, summarized in the VRIN acronym: Valuable, Rare, Inimitable, and Non-substitutable. See above in the same section.

  21. “…both practitioners and researchers need a walking stick, a common walking stick. For the practitioners of strategy the objective is to guide decisions and their implementation, while for the researcher in strategy the objective is to develop the approach to find the general patterns behind these decisions and their implementation, and to generate heuristics that provide the link from patterns (theories) to practice in specific situations, that is to inform and guide practice” (Hafsi and Thomas 2005, p. 513).

  22. My own PhD research, in fact, aimed at testing this hypothesis. Its results will be described in a subsequent paper.

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    Catherine Cooremans

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Cooremans, C. Make it strategic! Financial investment logic is not enough. Energy Efficiency 4, 473–492 (2011). https://doi.org/10.1007/s12053-011-9125-7

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