State of the Nation's management: running to stand still

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. In the 1960s we mismanaged decline, and in the 1970s we declined to manage.’

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.

Regulations, technology, new business models and rapidly emerging markets around the world mean the business of management has never been more complex.

But are British businesses better managed than they used to be? The question may seem ridiculous at first. When, for example, Financial Director magazine launched in 1984, its 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 a management shambles.

At the same time, James Hanson and his cohort Gordon White were making a name for themselves, stalking the boardrooms of Britain and the US. 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.

But look at the chart on the next page, which shows the return on capital generated by British companies over the past 40 years. Apart from the big dip in the mid-1970s, the chart hardly seems to indicate any significant, sustained upward trend in the returns generated; likewise with the total shareholder returns chart after that. 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? 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.

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

Measuring up

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.

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. 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; 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.

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’.

Keeping your freedom

Staying out of jail has much to commend it as a management strategy ­ but it is hardly why managers go into business. 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 chairmen 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 like a blindingly obvious statement ­ 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 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, Pricewaterhouse-Coopers opened a new facility in Chicago called the ‘War Room’. It provided a structured programme in which consultants would spend perhaps two or three days with high-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. The top managers were often surprised to discover that 90% of the answers they needed were already in their organisation ­ but that they had a company culture that failed to enable (or even actively discouraged) the upwards percolation of ideas and knowledge to a level where such insight could be turned into value-creating corporate action.

In his book The Future of the Organisation, Professor Colin Coulson-Thomas describes 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.

Now consider the new type of corporate fraud that has emerged in recent years. We dubbed it ‘performance-related stress’ back in 1998 ­ a phenomenon whereby people ultimately cheat, lie and falsify documents, not to steal money, but to stay out of trouble, meet targets, 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.

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 40 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.

Performance metrics

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) dictates that they should be doing: creating real value for shareholders.

One thing many top-level managers have succeeded at over the years is getting decent remuneration for themselves. 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 fast, the board asked shareholders to let them reprice their executive share options, which by then were seriously underwater. 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.

Where’s the certainty?

Despite the wisdom in Sloan’s excellent book, General Motors today is in great difficulty and is about to be overtaken by Toyota as the world’s biggest car manufacturer. So again, the old certainties seem to have disappeared. 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 to produce an ‘enterprise governance’ framework that amalgamates good principles of corporate governance with a 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 accused of being 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.’

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 grandmasters or a couple of rank amateurs. There is only one Olympic 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 ambition, optimism and determination to compete and succeed.
And the wealth of the nation depends on it.

This is an edited version of an article that first appeared in the September issue of our sister publication Financial Director