Listen to this article
Like computer software, management is the invisible technology that keeps modern organisational economies working. Most of the time, as with software, we take it for granted. But from time to time, it crashes.
In the UK, HM Revenue & Customs “lost” 43 per cent of incoming phone calls in 2008-09, and this year got more than a million tax calculations wrong. This might cause us to curse – as we do when the computer goes down. But when – much worse – banking managers so radically miscalculate risk and misallocate resources that they almost bring the world tumbling down, it is time to ask whether it is not just a few lines of code, but the whole operating system that is out of whack.
If the banking crisis were a one-off malfunction we might think it a price worth paying for an otherwise well-functioning system. But how well does it work? Take the measure by which companies like to be judged: return to shareholders. For years, managers have been told that their job is to give prominence to the returns they deliver to shareholders. And that is what they have duly done.
Since the 1980s, the share of corporate profits in national income and the proportion of those profits distributed to shareholders have grown markedly. Meanwhile, share buybacks, another form of profit distribution, have come from nowhere to reach the equivalent of 90 per cent of total US profits in 2007, and an astonishing 280 per cent in 2008. (Prominent among the spendthrifts were Wall Street banks that then went bust or had to be bailed out.)
Well, bully for shareholders, you might think. Yet when Roger Martin, dean of the Rotman School at the University of Toronto, did the calculation for Harvard Business Review, he discovered a paradox. Between 1933 and 1976, when they were supposedly playing second fiddle to managers, shareholders of the S&P 500 banked compound annual real returns of 7.6 per cent. Over the next 30 years, however, that return dropped to 5.9 per cent – a considerable worsening of performance at a time when they were meant to be in the driving seat. Why?
By putting shareholders first, managers are, by definition, placing other stakeholders second. To put it another way, increasing corporate profit has been squeezed out of the share going to employees, suppliers and customers.
Yet while ploys such as holding down wages, outsourcing and playing suppliers off against each other may relatively increase shareholder returns (including incentivising managers through stock options) in the short term, they are hardly motivating to anyone else. Apathetic employees make it harder for managers to sustain product quality; fraying quality and value undermine consumer trust. Few Americans – hardly the world’s fiercest anti-capitalists – have any confidence in big business or believe it contributes to society, according to recent polls. And just 20 per cent of workers say they are engaged in their work; 80 per cent, therefore, are going through the motions.
Against this inertia, growing revenue demands ever more effort and expense. US companies now spend $300bn on advertising. Instead, to keep returns up and shareholders happy, chief executives have increasingly resorted to the easier option of cutting costs – not just jobs, but also R&D and investment. Already crimped by City and Wall Street demands for dividends, investment as a share of national output has fallen since the 1980s in the US; in the UK, the measure places the country near the bottom of the international league table. In this context, falling long-term shareholder returns are inevitable.
Optimising one part of a system at the expense of the others is self-defeating. At best, it generates inefficiencies (lowering shareholder returns, for example); at worst, it causes the system to crash (the banks, for example).
“How to protect the economy and the environment: find any CEO who still thinks profits come first and put him (or her) in jail now,” London Business School’s professor Gary Hamel recently wrote on Twitter.
More positively, reversing the usual logic, John Mackey, chief executive of Whole Foods Market, the US grocer, argues that the way to do best for all stakeholders, including shareholders, is to optimise the company as a whole; consistent with the research of James C. Collins and Jerry I. Porras, whose book Built to Last: Successful Habits of Visionary Companies showed how companies with a purpose other than shareholder value made more money for shareholders than those that put shareholders first.
Objectively speaking, Vince Cable, the UK business secretary, was right: the rise in bank crashes, combined with declining returns to shareholders, suggest that capitalism is not working as well as it should. If that is the case, external constraints – better regulation, for example – may help keep the show from veering off the road.
But the main remedy has to be internal: a rewrite of the software to place not managers or shareholders but the company itself at the centre of concern. Time, in short, for a management reboot.