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