Middle market executives are clearly less bullish than they were a year ago. Since the first quarter of 2018, the percentage who are highly or very confident in their local economy fell from 94% to 88%; confidence in the U.S. economy dropped from 87% to 80%; and confidence in the global economy sank from 82% to 70%. From 2012 through 2018 the trend lines for confidence had gone nowhere but up. Now they are nosing down.
Not so revenues, which grew 8.7%, the second-highest recorded in 29 quarters of the MMI. And while job growth has been slowing, 5.6% is robust and remains well within the range it has occupied for the last two years. Then why the less optimistic outlook?
A look inside the Middle Market Indicator data suggests a few causes—and points the way to a few paths executives might follow to secure strong growth. Last quarter, we observed that negative outlook (as expressed in the Short Term Index) was unchanged, but positive outlook had fallen: “As of now, executives don’t see things getting worse; but fewer think things are getting better.” That outlook has now shown up in results, not just predictions. Asked about overall company performance, only 5% say performance deteriorated, which is the same as last quarter and the average for the last two years. But the percentage saying business improved dropped from 73% to 67% compared to three months ago. Similarly, despite the near-record average growth rate, the percentage of companies reporting higher growth fell. And the percentage of companies reporting 5% or faster growth declined from sixty-three to fifty-eight.
This suggests that middle market executives are beginning to experience the environment economists have forecast, in which growth slows but does not turn negative.
With less wind in their sails, executives will have to do more to propel growth on their own, a concept we explored in-depth in our DNA of Middle Market Growth report. The report identifies the most important growth drivers within management’s control and shows how the fastest-growing middle market companies assemble those drivers to fuel their success. Companies cannot—or will not—achieve growth goals just by adding more muscle: With unemployment negligible and wage costs rising, middle market hiring forecasts have fallen in each of the last four quarters and are the lowest they have been in two years. Nor do the data show a surge in capital spending, which might be a way to increase output whatever the number of workers. With some quarterly variation, the percentage of companies that say they added a new plant or facility in the previous year has long held steady, at about twenty; in fact, it declined to 17% this quarter. Instead of adding to headcount or buying equipment, executives will need to find productivity gains by developing the skills of the workforce they have and improving management processes, both of which show up in the DNA growth drivers report.
Innovation is another proven driver of growth. Indeed, investment in R&D has been trending slowly up. It reached a record high, 9.8% of revenue, in the first quarter of 2019. This compares to an average of 8.1% for the previous four years—a substantial increase. It appears that companies have shifted the mix of R&D, too, and are placing more emphasis on entirely new products and services, as opposed to improvements in existing offerings. The latter is still where executives expect to see the biggest impact from innovation spending, but it has declined quite a bit relative to the impact of new offerings.
Exploring and exploiting the opportunities of digitalization appears to be another path to growth—and an especially rewarding one. This quarter we asked executives, “Is your organization’s digital vision clear and comprehensive, widely understood, and used to guide strategic decisions?” People who agreed with that statement lead companies whose average annual growth rate was 10.5% Companies whose leaders were neutral or disagreed grew 6.0%. The digitally driven added jobs more than twice as fast as the others: 7.3% vs 3.1%. The pattern holds in all industries: The road to growth is paved with 1s and 0s. As middle market executives confront what they believe will be a slowing—but still growing—economy, they are placing their bets on inventing new products and services, and harnessing technology to improve both revenue and costs.