Are companies better managed than they were?

Chancellor Gordon Brown neatly summed up the post-war
history of British management in a
speech
to the Confederation of British Industry last year: “In the 1950s we managed
decline,” he said. “In the 1960s we mismanaged decline and in the 1970s we
declined to manage.”

He stopped there, but perhaps he might have added that in the 1980s we
managed to let management manage again; in the 1990s we managed to start
recovering after the recession that followed the Lawson boom; and in the new
millennium we managed to cope with compliance.

The business of management has never been more complex. Regulations,
technology, new business models and rapidly
emerging markets
around the world all create difficult hurdles for today’s managers.

And yet, the question has crossed my mind a lot in recent months: are British
businesses better managed than they used to be? The question may seem ridiculous
at first: when, for example, this magazine launched in 1984 our first interview
was with the finance director of British Telecom, which was on the threshold of
the biggest privatisation the London Stock Exchange had ever seen. BT at the
time was little more than a management shambles; the company had only just
figured out what all its assets were and where they were.

At the same time,
James
Hanson and his cohort Gordon White were making a name for themselves,
stalking the boardrooms of Britain and America. They had plenty of
under-performing businesses to choose from as they sought opportunities to make
a killing by introducing some basic management targets and controls (plus a few
judicious sell-offs that would help recoup their acquisition outlay).

But look at the return on capital generated by British companies over the
past 40 years, apart from a big dip in the mid-1970s – a truly black period of
economic mismanagement and ‘stagflation’ – there has been hardly
any significant, sustained upward trend in the returns generated by British
industry; likewise with total shareholder returns. So are British companies
better managed than they used to be?

Note that the question isn’t: “Are today’s managers better than their
predecessors?” Of course, as we have said, the business of management is clearly
much more complicated than it used to be. But the problem is, if managers fail
to master the complexities of the day, are their companies any better managed?
Or are managers, like Alice in Wonderland, having to run much faster simply to
stand still? If nothing more is actually being achieved, then in what sense can
we say that companies are better managed than they were?

And is there anything that can be done to help businesses generally to raise
their game, to generate greater returns in aggregate? The question is crucial as
the pensions crisis looms: greater longevity alone means that we will spend a
smaller proportion of our lives living off our salaries and a greater proportion
living off our savings. Adam Smith realised some 230 years ago that the wealth
of a nation rests on the exchanges that take place between tradesmen, workers
and farmers, so it’s important that we grow our national wealth to sustain us in
our old age.

More recently, the highly respected business commentator Christopher Fildes
remarked that companies used to outlive people. Now it’s the other way round.
That creates huge challenges for the way we will increasingly rely on our
savings and our investments in ‘UK plc’.

A recent report by Deloitte entitled
Measuring
up reflects on executive pay and performance in the FTSE-350. One of
its many interesting conclusions is that it is “increasingly difficult” for a
top-performing company to remain in the top rank. Deloitte’s analysis revealed
that a company that has upper quartile performance in two consecutive three-year
periods has a probability of just 21% of achieving this position in the next
performance cycle, compared to a 38% probability for companies previously in the
lower quartile. This seems to suggest that there is something a bit cyclical
going on, or even random – or perhaps that top-performing businesses have
in-built failings that prevent them from recognising and responding to newer
challenges.

It’s not as if there hasn’t been a real drive to improve the management of
British companies over the years. Hanson’s era came to an end, in part, because
many once-sluggish businesses had ‘Hansonised’ themselves, rather than waiting
for a pair of corporate buccaneers to do it for them. Hanson started breaking
itself up in the mid-1990s.

The complexity fad

Nor has there ever been such a boom in the management business. Clicking on
the ‘management’ category on Amazon.co.uk generated a list of 134,824 books –
and absolutely everything is there: from business planning to teaching elephants
to dance, to wondering what five frogs are doing on a log, to biographies of
Richard Branson, to searching for some cheese that’s been moved, to leadership
lessons from the art of war – and even one book that I refused to even peek at,
entitled Jesus CEO. Ever in search of that one elusive untapped technique that
will provide competitive advantage, however fleeting, managers everywhere
provide a ready market for everything from penetrating analyses of industrial
organisation to Japanese-style comic book guides to Warren Buffett’s investment
philosophy.

But never mind the bookshelf fads. Business managers have got stuck into the
real thing: we’ve had business process re-engineering exercises that have gone
horribly awry; major enterprise resource planning (ERP) technology
implementations that were abandoned after tens of millions of pounds were
wasted; supply chain systems that failed to stack the shelves; outsourcing
contracts so complicated that it takes half the Greek alphabet to devise the
mathematical formulae underlying the service level agreements; sour derivatives
deals so bewildering that even companies with otherwise unimpeachable management
reputations such as Procter & Gamble had to admit in court that they didn’t
actually understand what they were getting themselves into, blaming
Bankers
Trust for misleading them, instead; and mergers and acquisitions so
hideously overpriced that the CEOs’ grandchildren will never see any value
generated by those deals.

In short, management has found newer and bigger ways to completely screw up –
ways that probably go far beyond acceptable business risk – and so often the
problem has been a fatal combination of ‘must do’ faddishness and a woefully
inadequate level of comprehension, itself arising out of a skewed perception of
risk and opportunity cost. That adds up to management failure, in anyone’s
reckoning.

What’s been particularly striking in the last few years is how the corporate
governance industry has mushroomed – though it’s remarkable that the business of
corporate governance has so little to do with the business of management.
Sarbanes-Oxley has generated great numbers of surveys about how Sarbanes-Oxley
is an overreaction to a small number of (admittedly large and damaging)
corporate excesses. (Perhaps it was ever thus: the
Cadbury
Report of 1992 also fuelled great debate about the role of regulation in
stifling management, but there is no recorded instance of a company having gone
out of business as a result of taking on an extra non-executive director.)

The effort that has gone into compliance with the US legislation is truly
extraordinary. It is certainly true that ‘the pendulum has swung too far the
other way’, as countless directors and consultants will plead. There is little
to compare to this graphic (if slightly exaggerated) anecdote: the divisional FD
in a FTSE-100 pharmaceutical company once told me that his company was regulated
to the hilt by the US Food and Drug Administration and by every other health
agency in the world – “but thanks to Sarbanes-Oxley our group FD can go to jail
if our marketing director fiddles his expenses”.

Governance and ethics

Staying out of jail has much to commend it as a management strategy – but it
is hardly why managers go into business in the first place. Yes, many companies
are trying to make a virtue of the legislation by installing better systems that
yield better management information – but the legislative bias is on controls,
not insight. A recent survey by executive recruitment firm Russell Reynolds
Associates found that most company chairman thought the current corporate
governance framework had had no positive impact on financial performance. It
wasn’t a unanimous view, however: one respondent said that “increased attention
to detail, increased discipline and improved quality of debate” were all
performance-enhancing side-effects of better corporate governance.

While debate rages as to whether good governance results in better
management, research by the
Institute
of Business Ethics suggests that companies that have a code of ethics
generate more profit, have less volatility in their share rating and can raise
capital more cheaply than comparable businesses without such a code. “Having a
code may be said to be a significant indicator of consistent management,” the
researchers concluded – though the devil’s advocate might argue that companies
that are running well are the ones that can afford the time to draft such codes,
while struggling businesses have more urgent things to be getting on with.

At heart, management is about people. Now that may sound likes a glib
statement of the blindingly obvious – but it is often the most overlooked part
of management’s role. How do people make decisions? What are they trying to
achieve at work? What makes them believe in ideas that everyone else regards as
hare-brained? Why do people not cut their losses more quickly when circumstances
change? What do we want people to do – and is that in conflict at all with what
we actually reward them for doing?

These aren’t particularly new or insightful questions – but they still often
sit devoid of satisfactory answers. It’s one reason why, a few years ago,
Financial Director playfully suggested that, in future, a psychology degree
would be more important than an MBA qualification.

At the end of the 1990s PricewaterhouseCoopers opened a new facility in
Chicago called the ‘War Room’. Strip away all the funky furniture and dotcom-era
multimedia technology and what was left was a structured programme in which
consultants would spend perhaps two or three intensive days with the very
highest-level executives of a client organisation who felt that their company
needed to be ‘fixed’ in some way. The consultants typically did a lot of work
prior to this session, talking with people throughout the organisation. What the
top managers were often surprised to discover was that 90% of the answers they
needed were actually already in their organisation – but that they had a company
culture that failed to enable (or maybe even actively discouraged) the upwards
percolation of ideas and knowledge to a level where such insight could be turned
into value-creating corporate action.

Such a failure to ‘learn’ from the knowledge, experience and expertise that’s
already within an organisation must represent a management failing of the
highest order. Professor Colin Coulson-Thomas describes in his book The Future
of the Organisation companies where: “People claimed to be ‘busy bees’, but few
had time to think. People wrote reports to line managers rather than thinking,
talking, sharing and learning, either among themselves or with customers.” Such
businesses failed to learn or to innovate, and all creative energy was drawn
into solving particular problems, not adding value.

No-theft fraud

Now consider the new type of corporate fraud that has emerged in recent
years. When we wrote about it in 1998 we dubbed it ‘performance-related stress’
– a phenomenon whereby people ultimately cheat, lie and falsify documents, not
to steal money in the old-fashioned way, but to stay out of trouble, to meet
targets, to avoid the humiliation and privations of being sacked for
under-performance. In such frauds, people hide a small problem, yet knowingly
risk creating a very much bigger one – and all because of managers who put more
store by what’s in the budget rather than what’s actually achievable.

When the £50m false accounting scandal blew up at DIY retailer Wickes in the
mid-1990s, for example, there wasn’t a copper penny or a piece of plasterboard
that wasn’t exactly where the audited accounts said they should be; but deals
with suppliers that ought to have been booked as two- or three-year arrangements
were all taken into ‘year one’ to boost the profit & loss account – and it
happened because of the culture that put so much focus on meeting targets for
‘supplier rebate’ deals. There have been plenty of such accounting scandals
since then – including, to my knowledge, one company where a subsidiary
manufactured a huge machine costing £4m for a client that didn’t exist: the
divisional MD kept hoping to land a big contract and save his bacon. He didn’t.

You can’t expect people to march to the left if you reward them for looking
to the right, as Joel Stern, of the well-known Stern Stewart consultancy once
told us. Stern Stewart did more than any other firm to introduce the concept of
‘economic
value added’ to the boardroom. The principles behind EVA – that management
has to be accountable for the capital consumed in a business and that such
capital must incur a nominal ‘charge’, not unlike interest – were in business
school textbooks in the 1960s. And Alfred Sloan – whose influence on management
systems was as great as Henry Ford’s impact on manufacturing processes – wrote
forty years ago in his book, My Years With General Motors, about how Detroit’s
biggest car company was using very similar measures in the 1920s.

Pay for the job

But none of this was at all widespread until the 1990s when Stern Stewart
figured out how such performance metrics could be adapted to form the basis of
executive and employee remuneration. You want people to generate profits, while
being careful about how they use capital investment? Then reward them for doing
so. Suddenly, managers and other employees start doing things that the
capital
asset pricing model (CAPM) – the central node of corporate finance theory –
dictates that they should be doing: creating real value for shareholders. Stern
Stewart’s own research suggests that companies that used EVA as a performance
measure significantly outperformed the market, while those that adopted EVA as
part of the remuneration programme performed best of all.

One thing many top level managers have succeeded at over the years is getting
decent remuneration for themselves. Executive pay has unquestionably outstripped
almost every business measure in the past few years – total shareholder returns,
average wages, whatever. No question, too, that an upward adjustment was needed,
not least once managers were given the opportunity to earn their pay as the
power of the union barons was curtailed.

In 2001, when Marconi’s share price was falling faster than the laws of
gravity allowed for, the board asked shareholders to let them reprice their
executive share options that were by then seriously under water. It was
important they be able to do so, chairman Roger Hurn told the AGM, because “All
our competitors offer welcome packages of share options”. One very insightful
private shareholder stood up and objected: “Isn’t it a myth that share options
work to incentivise people?” she asked. “Otherwise we wouldn’t be in this mess.”
The other shareholders loved her.

Marconi’s fall brings to mind the embarrassment that resulted within just a
few years of publication of
In
Search of Excellence, which has been a best-seller since 1982. The authors
analysed more than 40 successful companies and identified eight core themes that
ran through them, such as ‘a bias for action’ and ‘sticking to the knitting’.
Subsequently, featured companies such as NCR, IBM, Wang, Xerox and Atari all ran
into trouble. What had been regarded as newly-discovered management certainties
appeared to be falling apart.

Despite the wisdom in Alfred Sloan’s excellent book, GM today is in great
difficulty and is about to be overtaken by Toyota as the world’s biggest car
manufacturer. GE is still in good health, but former head Jack Welch’s guiding
principles were recently attacked as “tired” in Fortune. So again, the old
certainties seem to have disappeared. Are there any certainties in management?
Is there anything that can be done consistently to improve the management of
businesses? The Chartered Institute of Management Accountants recently worked
with the International Federation of Accountants (IFAC) to produce an
‘enterprise
governance’ framework that seeks to amalgamate good principles of corporate
governance with a strong focus on performance management. The report includes
case studies of success and failure as diverse as Marks & Spencer’s
“complacency” to Bank of Nova Scotia’s “successful risk management” to a
Canadian manufacturer that was alleged to be a front for organised crime. Within
the enterprise governance framework, the CIMA strategic scorecard encompasses
strategic position, strategic options, strategic implementation and strategic
risks.

Whatever the worth of such a framework may ultimately prove to be, it
certainly seems to be the case that some sort of structure is necessary. Neither
employee ‘creative anarchy’ nor the ‘cult of the CEO’ are likely to result in
well-managed businesses. As management writer Robert Heller recently wrote: “An
organisation’s success or failure depends on the strength of management at all
levels and in all functions. A ‘well-managed company’ can’t just mean one with a
brilliant and forceful boss.”

Raising standards

Time and again over the years, we’ve asked finance directors how they manage
large, complex – almost unwieldy – businesses as are found in the FTSE-100.
Invariably the answer comes back: good systems and good people, throughout the
organisation.

The challenges managers face aren’t getting any easier so the quality of
management has to be on an ever-upward learning curve. But the irony is that
managers compete against other managers – both within their organisation and
with commercial rivals. As managers individually raise their game, the intensity
of battle increases. A chess match produces just one winner, regardless of
whether it’s a battle between two grand masters or a couple of rank amateurs.
There is only one Olympics gold medal for the 100 metres.

So, while managers may be getting better and smarter, competition between
them soon erodes hard-won gains. We may never see a sustained upward trend in
the overall return on capital. Managers will be running like mad just to stand
still, motivated by their in-built ambition and optimism and determination to
compete and succeed.

And the wealth of the nation depends on it.