Business at a Crossroads Leadership_2 pptx

54 BUSINESS AT A CROSSROADS activities of multi-units. According to Chandler, this means a manage- rial hierarchy is a “defining characteristic” of the MuBE. This is simply using the assertion about costs in Proposition 1 to describe an MuBE. Administrative coordination is less costly than market coordination, but to capture such savings, an organization needs a management hierarchy, and if it has a management hierarchy it is an MuBE. Modern commentary Once again the issue here is the respective efficiencies of market and managerial coordination. Let’s agree for the sake of argument that managerial coordination, after taking full account of agency costs, was more efficient than market coordination at the time of the MuBE’s EEA in the late-19th century. The question that needs to be answered is whether that remains the case today. It is hard to be sure, but there is reason to believe it does not. The growth of outsourcing, for example, which is a competitive and thus a market coordinated business, suggests outsourcers at any rate believe it to be cheaper than insourcing. Other things being equal, the “experience curve” suggests that a company that does nothing but payroll management, for example, will do it more efficiently than the payroll department of an MuBE. The growth of joint ventures, strategic alliances, and other kinds of business partnership, which has been such a feature of the so-called “globalization” of business, also suggests that, thanks in no small part to reductions in information and communication costs stemming from advances in IT, the cost of coordinating activities between companies is falling relative to the cost of coordination within companies. Moreover, globalization has also added to intra-firm coordination costs, by encouraging national tax regimes throughout the world to introduce transfer pricing rules. These require cross-border (and some- times within border) intra-firm prices to be arm’s length (as set by markets) and so deny global MuBEs opportunities to optimize commer- cial relationships between units for tax and other purposes. Although here too, precise measurement is difficult, it also seems likely that the agency costs associated with the MuBE’s managerial hier- archies have increased substantially since the MuBE’s EEA and since Chandler was writing in the 1970s, witness the executive pay explosion, the poor record of large companies for extracting value for acquirers’ shareholders from mergers and acquisitions and, not least, the dire consequences for shareholders of the reckless and recklessly financed pursuit of growth that precipitated the 2008–09 global recession. 9780230_230941_05_cha03.indd 54 09/09/2009 10:01 3 THE STEAM-AGE CORPORATION 55 If it was the superiority of managerial coordination over market coordination that “selected” (in a Darwinian sense) the MuBE, with its species-defining managerial hierarchy, the evidence suggests that it might not have “speciated” (emerged as a new species) today, because the balance of advantage between managerial and market coordination has shifted too far since the MuBE’s EEA toward the latter. There is another question, of course. Do the differences between today’s busi- ness environment and that of the mid-19th century require us to regard the MuBE, and its “defining characteristic” of a managerial hierarchy, as an endangered species? Proposition 3 The MuBE made its appearance on the business stage when the volume of economic activities reached the level where administrative coordina- tion became more efficient, and more profitable, than market coordina- tion. Chandler saw technology, and particularly the steam engine (on railroads and in factories), as a vital catalyst in the MuBE’s evolution. “New technology made possible an unprecedented output and move- ment of goods” and larger markets were required “to absorb such output.” That’s why the MuBE “first appeared, grew and continued to flourish in those industries characterized by new and advancing tech- nology, and by expanding markets.” Modern commentary This is my favorite – a beautiful idea, similar to Stuart Kauffman’s conjecture about how life on earth began: When the number of catalyzed reactions is about equal to the number of chemical dots, a giant catalyzed reaction web forms, and a collectively autocatalytic system snaps into existence. A living metabolism crystallizes. Life emerges as a phase transition. 5 Kauffman’s idea is that life emerged when chemistry in the ancient world passed a critical level of complexity. Chandler suggests the MuBE emerged when the volume of business in the 19th century passed a critical level. The MuBE was invoked. Circumstances demanded it. It didn’t emerge gradually step by step; it snapped into existence when James Watt’s invention “made possible an unprecedented output and movement of goods.” The appearance of the MuBE was caused by a phase transition in America’s economic development. 9780230_230941_05_cha03.indd 55 09/09/2009 10:01 56 BUSINESS AT A CROSSROADS This proposition expands the first two. It says in effect that the effi- ciency of market coordination on the one hand and managerial coordi- nation on the other is volume-sensitive. You don’t need the latter while the volume of activity remains below a certain level, but once it exceeds that level, a phase transition occurs and you can’t manage without it. The MuBE was a solution to the production and distribution challenges created by technology-driven growth in the size and complexity of firms. We do not see technology in the same way nowadays. It appears more generally capable to us. By reducing costs and prices, and thereby stimulating demand, it can create new management problems, but it can also solve them. As Chandler acknowledged, if the U.S. railroads had recognized the potential of the electric telegraph a few years earlier, as their counterparts in England had done, the collision on the Western Railroad in 1841 might have been prevented. Charles Wheatstone and William Cooke patented the electric telegraph as an alarm system in May 1837, and demonstrated the technology in July of that year, between Euston and Camden stations, in London. Their invention entered commercial use on the Great Western Railway over the 13 miles from Paddington to West Drayton in April 1839. It was not until 1843 that Samuel Morse’s Magnetic Telegraph Company was given permis- sion to build an experimental line along the Baltimore & Ohio Rail- road’s right-of-way between Baltimore and Washington. In our own time, the internet, e-mail and broadband communica- tion have enormously increased the efficiency of market coordination and the volume of activity small firms can handle efficiently. The digiti- zation of information transmitted across broadband networks has trans- formed the economics of scale in many industries, ranging from banking to travel. The internet has made possible new forms of self-organizing association between individuals and small firms that have already created large and sophisticated products, such as the Linux operating system and Wikipedia (see Chapter 7), which previously only large, integrated MuBEs could have developed. What technology brought together yesterday, it can rend asunder today. Why the MuBE thrived Propositions four to eight explain the MuBE’s growth – how and why it survived, spread and became dominant. The extent to which these propositions seem at odds with today’s environment, begs questions about whether the MuBe can continue to thrive in its current form. 9780230_230941_05_cha03.indd 56 09/09/2009 10:01 3 THE STEAM-AGE CORPORATION 57 Proposition 4 Traditional partnerships were reformed or disbanded when a partner left, but once a managerial hierarchy had been created, it became a source of “permanence, power and continued growth,” and the MuBE acquired “a life of its own.” The managerial hierarchy transcends indi- viduals. When managers depart, they’re replaced. “Men came and went. The institution and its offices remained.” Modern commentary This proposition is obviously true. An MuBE does acquire “a life of its own” and a much more substantial life than that of the broom the caretaker used for 20 years, during which time he replaced the handle twice and the brush head six times. While managers come and go, the MuBE accumulates its own substance in the form of tangible assets (plant, buildings, cash, inventories, and so on), and intangible assets (intellectual property – patents, brands, logos – and what Karl-Erik Sveiby called “customer capital” [customer loyalty], and “structural capital” [processes, accounting systems, and so on]). 6 In its early years the MuBE did not just accumulate substance; its managers hungered for it, and transformed business from a project- to a process-based activity. Production processes, for making iron and steel, for instance, had played a vital role in the Industrial Revolution, but it wasn’t until the age of mass production and the adoption of F. W. Taylor’s “scientific management” approach in the early 20th century that business itself became a continuous process rather than a set of discrete projects. The managerial hierarchy’s hunger for permanent substance led to a gathering together of business activity; a great integration. Most commentators have seen this as necessary and inevitable. Business was at a crossroads, according to Sir John Clapham. As it became more complex and companies became concerned with many technologies a choice had to be made: either there must be an elaborate fitting together of the products of many specialised firms or single many-sided firms must do most of the essential work themselves, as government dockyards had always done. 7 The widespread adoption of the MuBE as the solution to the problem of complexity added more substance to the new species by 9780230_230941_05_cha03.indd 57 09/09/2009 10:01 58 BUSINESS AT A CROSSROADS requiring new systems and processes to replace market coordination. It was the emergence of the MuBE, and the consequent need for infor- mation about transactions within organizations, that led, for example, to the development of management accounting. Before then, according to Thomas Johnson and Robert Kaplan, almost all business transactions were “between an owner–entrepreneur and indi- viduals who were not part of the organization; raw material suppliers, labor paid by piecework, and customers.” There was no need to establish “costs” when everything was priced by the market. 8 When managers hungry for more substance brought previously subcontracted processes “in house,” costs ceased to be adequately revealed by prices, and had to be identified and managed. The task of management was created by vertical integration; the replacement of outworkers and subcontractors by employees. It occurred initially in only a few industries like textiles, iron and steel making, railroads, shipbuilding and retailing. Elsewhere firms adapted to the growing complexity by modifying rather than aban- doning the subcontracting system. Johnson and Kaplan refer to John Buttrick’s account of the “inside contracting” system used in the mid- 19th century by the Winchester Repeating Arms Company: the management of a firm provided floor space and machinery, supplied raw material and working capital, and arranged for the sale of the finished product. The gap between raw material and finished product, however, was filled not by paid employees arranged in the descending hierarchy so dear to the hearts of personnel experts but by contractors, to whom the production job was delegated. They hired their own employees, supervised the work process, and received a piece rate from the company for completed goods. The income of a contractor consisted of the difference between his wage bill and his sales to the company, plus the day pay he earned as an employee himself. The company’s largest single expense was the amount paid to the contractors for finished goods. 9 It was the appearance of vertically integrated MuBEs at the end of the 19th century that turned managerial hierarchies into sources of “permanence, power and continued growth.” These days, the case for vertical integration is much less self-evident. There was always a risk that, in substituting Chandler’s “visible hand” of management for Smith’s “invisible hand” of markets, and switching management atten- tion from price to cost, managers would come to rely too much on their cost accounting systems, lose touch with markets and make pricing 9780230_230941_05_cha03.indd 58 09/09/2009 10:01 3 THE STEAM-AGE CORPORATION 59 mistakes. This is why the activity-based costing reform of management accounting, advocated by Robert Kaplan and Robin Cooper 10 in the late 1980s, caused such a stir and why today’s conventional wisdom is that firms should focus on their “core competencies” and subcontract or outsource all other functions to specialists. It is generally accepted these days that in normal times no amount of substance will guarantee the “permanence, power and continued growth” of firms making the wrong products at the wrong price. The “in normal times” qualification is necessary, because, as recent events have shown, substance in the form of large numbers of jobs can induce governments struggling to combat recession to shore up failing MuBEs with taxpayers’ money. Proposition 5 As the tasks of salaried managers in management hierarchies became more technical and professional, the criteria for their selection and promotion came to be based on training, experience and ability rather than on kinship or money, and managers could conceive of “a lifetime career involving a climb up the hierarchical ladder.” Modern commentary One of the most striking developments in corporate employment over the past two decades or so has been the disappearance of “the job for life.” Following the downsizings and de-layering of the early 1990s, and the new wave of job losses during the 2009 recession, very few managers now see climbing the same company hierarchy as a lifetime career. Hierarchy-climbing, these days, is more diagonal than vertical; more a matter of leaving one hierarchy and joining another at a higher level, with a better pay package. The manager has become a mercenary moving from company to company and industry to industry, in a constant search for better pay and more status. The mobility of the modern manager is partly a consequence of more active “head-hunting” by the executive search consultants, hired to help their clients win the so-called “war for talent.” But the seeds of managerial disloyalty were sown long ago. When management became a profession, its various sub-professions, such as finance, manufacturing, HR and marketing, became portable and dedicated to the service of MuBEs general, rather than particular MuBEs. As Harvard Business School professor John Kotter pointed out, the then new MuBEs were complaining about shortages of qualified staff to run their organizations as early as the 1860s. 11 9780230_230941_05_cha03.indd 59 09/09/2009 10:01 60 BUSINESS AT A CROSSROADS The University of Pennsylvania responded to the new skill shortage in 1881, by founding the Wharton School of Finance and Commerce to offer an undergraduate management degree. Similar schools were set up in California, Chicago, and elsewhere before the end of the 19th century and in 1908 the Harvard Business School (HBS) was founded to offer a masters degree in business administration (MBA). George Baker, head of what would become Citicorp, was impressed by the Harvard school and in 1925 gave it the money to construct an eight-building campus. The following year, 58,000 students taught by 2,500 faculty at 132 American schools majored in business. Most of them joined large MuBEs. It was inevitable, given the inspiration for the schools and the desti- nations of their graduates, that intimate relationships would develop between “B-schools” and large firms. This was particularly true at Harvard. The library is named after George Baker, the MBA classrooms are Aldrich and Rockefeller (Standard Oil), the dining hall is Kresge (K-Mart), executive programs are taught in Cumnock (J. P. Stevens) and the faculty office building is Morgan (Morgans Guaranty and Stanley). As Kotter explained: Harvard received donations from big corporations to support its programs and research. It also obtained access to study interesting business problems and to write teaching cases. The first major piece of social science research conducted by professors at HBS was possible only with the cooperation of a Western Electric (AT&T) factory in the Chicago area. In return, the School trained people to assume managerial careers in big companies and helped those busi- nesses to gain access to students through an on-campus lecture series and a job placement program. The American business schools played a vital role in the evolution of managerial capitalism, by providing the skills Chandler’s MuBEs needed to perfect the new system of administrative coordination. They were and they remain the officers’ training colleges for large companies. Harvard Business School was and remains to big business what West Point is to the U.S. Army. Two regrettable consequences followed from the close relationships between big business and the B-schools. The first is that standard management principles, philosophies and strategies prevail throughout big business and all large companies tend to become enamored with new management fashions, such as the focus 9780230_230941_05_cha03.indd 60 09/09/2009 10:01 3 THE STEAM-AGE CORPORATION 61 on shareholder value and financial engineering that some say was partly responsible for the credit crisis, at the same time. If all large companies follow the advice of an academic in a Harvard Business Review article, and use derivatives to manage risks, for example, the entire industrial system becomes more vulnerable than it would otherwise be to the kind of shock it endured in 2007–08. Philip Delves Broughton, holder of a Harvard Business School MBA, excoriated his alma mater in an article in the Sunday Times in March 2009. He pointed out that HBS alumni had been involved in several pre-crash scandals, including Enron, and recalled that one HBS case study being used while he was there was on the Royal Bank of Scotland, a prominent U.K. casualty of the banking crisis. “Every trendy business school idea was being implemented, it seemed, while what really mattered – the bank’s risk assessment, cash flow and capital struc- ture – was going to hell.” 12 The second regrettable consequence of a close relationship between large companies and the B-schools is that the management discourse became dominated by the concerns of big business, and very little attention was paid to the corporate undergrowth, from where tomorrow’s indus- tries, companies and business models are likely to emerge. As Kotter put it: Small businesses were mostly left out of this relationship. They were not in the job market for young managers every year. They had little money to donate to HBS. Besides, they wanted street-smart gener- alists more than the analytical specialists who tend to be the product of universities. By training the troops MuBEs needed to operate their new system of managerial coordination, the business schools also contributed to the MuBE’s “permanence, power and continued growth.” They became a vital part of what I call the “CEO system” (see Chapter 6). Proposition 6 As the MuBEs grew in size and diversity, and their managers became more professional, management became separated from ownership. The traditional, capitalist firm was very much a personal enterprise. From the start the company required more managers than a family or its associates could provide. When a company raised new capital to finance growth, it was common in the early 19th century for investors to put representatives on the board and share major decisions with managers. Chandler called 9780230_230941_05_cha03.indd 61 09/09/2009 10:01 62 BUSINESS AT A CROSSROADS this system “financial capitalism,” and saw it as a transitional stage between “family” and true “managerial” capitalism consisting of two symbiotic components – a characteristic institution, in the MuBE, and a characteristic profession, in the salaried manager. Modern commentary Chandler’s conjecture that what he calls “financial capitalism” is an inter- mediate stage does not specifically preclude coexistence, but it does imply some sort of progression from a primitive to a more sophisticated capi- talist system, an important consequence of which is the separation of ownership from control. Control remains with owners in “family/entre- preneurial capitalism,” is shared with investors in “financial capitalism” and is surrendered to managers in “managerial capitalism.” An example of this development process is provided by the story of the British company, Vickers-Armstrongs, at the end of this chapter. Increasing scale is the impetus behind the progression. The larger the business and the higher the volume of transactions, the more sala- ried managers were required to administer and coordinate, and the thicker the wedge driven between ownership and control. Adolf Berle and Gardiner Means had identified what they called the “divorce of ownership and control” 13 44 years before Chandler intro- duced his concept of “managerial capitalism.” As Berle put it later: stockholders, though still politely called “owners,” are passive. They have the right to receive only. The condition of their being is that they do not interfere in management. 14 But there was nothing new about this. As we saw in Chapter 2, Adam Smith noted (in 1776) that owners of joint stock companies “seldom pretend to understand anything of the business of the company … [and] receive contentedly such half-yearly or yearly dividends as the directors think proper to make them.” The divorce of ownership and control should be seen, not as an important development in the early 20th century, but as an intrinsic quality of the joint stock company, which only became evident and worthy of comment after the joint stock company became the dominant corporate form. In Smith’s time the Berle and Means observation would not have been worthy of comment, because the joint stock company played only a small part in economic life. It was an insight of the first importance in the 1930s, however, because by the end of that decade the joint stock company accounted for over 50 percent of U.S. business, and over 90 percent of manufacturing output. 9780230_230941_05_cha03.indd 62 09/09/2009 10:01 3 THE STEAM-AGE CORPORATION 63 Chandler implied that the MuBE, with its characteristic managerial hierarchy, was a culmination of some kind. New companies are still being created by entrepreneurs, but those that survive and prosper are destined to develop into MuBEs. As evolutionists say: ontogeny (the development of the individual) recapitulates phylogeny (the evolution of the species). The corporate population of a modern economy always includes firms at all stages of development, but those at the “entrepreneurial,” “family” and “financial” stages are, if they survive, just passing through, Chandler appears to suggest, on their way to the ultimate “managerial” stage. The idea that Chandler’s MuBE is an ontogenetic and a phyloge- netic culmination (“the end of corporate history,” to adapt Fukuyama’s title – see Note 2, Chapter 1) was probably more plausible when Chan- dler was writing than it seems today. Some of today’s largest companies, such as Rupert Murdoch’s News Corporation and Sir Richard Bran- son’s Virgin Group, seem to combine aspects of entrepreneurial and family capitalism with those of managerial capitalism. Others that have been, or may be acquired by private equity groups, seem to exemplify Chandler’s financial capitalism. The enormous growth of debt financing during the past two decades suggests financial capitalism was not, or is no longer, as transitional as Chandler supposed, although Harvard Business School professor, Rakesh Khurana, sees this neo-financial variant as a new, post-managerial stage, which he calls “investor capitalism”(see Chapter 6). The practice of paying executives with stock options, which remains widespread despite rules that require them to be treated as expenses in company accounts, seems like and is intended to simulate a return to “entrepreneurial capitalism.” This is not to suggest that Chandler’s “managerial capitalism” was a misconception, or to deny that there is a tendency for companies to acquire managerial hierarchies as they grow and thus to develop into MuBEs. It’s simply to say that this pattern of development is neither inevitable nor irreversible. Moreover, if the thickness of the wedge driven between ownership and control is measured by the extent to which stock ownership is dispersed – such that no single shareholder owns enough equity to exercise effective control over managers – managerial capitalism is only truly dominant even today in the U.S. and the U.K. The belief, in the 1970s, that a corporate form that only began to play a significant role in industry after 1860 and still accounted for less than a quarter of American output in 1900 was the “end of corporate history” may have had something to do with the role that governments played in business over the subsequent five decades. 9780230_230941_05_cha03.indd 63 09/09/2009 10:01 [...]... that he saw it as a development equivalent, in its significance and permanence, to the Industrial Revolution that preceded it Revolution implies more radical change than evolution; a discontinuity rather than an adaptation With the benefit of hindsight, it doesn’t seem that way today The emergence of the MuBE and managerial capitalism seems more like an adaptation to the circumstances of the steam age... person has all the income National Gini coefficients are calculated by various organizations including the United Nations (UN) and the U.S Central Intelligence Agency (CIA) In the following tables and analysis I have used CIA figures, published in The World FactBook, because they are more up to date and comprehensive It’s no surprise that several Scandinavian countries appear in the top ten most equal countries... he called the MuBE as far more than a mere abstraction around and within which the invisible hand of the market allocated resources and coordinated activity in the ways envisaged in classical microeconomics He saw the MuBE as a potent economic agent, with its own beliefs, desires and intentions, and he understood that, like elephant herds that have turned woodlands into savannah by stripping the bark... managers of a few large enterprises coordinated flows of goods and resources through the processes of production and distribution in every major U.S industry “By then,” Chandler concluded “the managerial revolution in American business had been carried out.” 66 Business at a Crossroads Modern commentary Chandler’s characterization of the transition from entrepreneurial to managerial capitalism as a. .. “national champion” firms has played, and still plays in continental Europe, in national industrial policies since World War II; and recent job-preserving rescues of America’s “big three” automakers, demonstrate that governments have felt obliged to ensure the survival of some big businesses that might otherwise have failed Although the partial nationalizations of big banks during the 2008 crash were... inequalities and concentrations of economic power in the hands of small elites in capitalist states He was so worried by the threats these posed to what he called the “social basis” of respect that he modified the model of liberalism he had described 30 years earlier in A Theory of Justice 4 the decadent corporation 71 Having lost his faith that liberal principles could be realized in a “capitalist... Pulitzer and Bancroft prizes It was the first to address the questions of why the institution that dominates the global economy emerged when it did, what qualities have sustained it, and what advantages over the “invisible hand” of the market, to which Adam Smith assigned the prime coordinating role, have enabled MuBEs and their managers to achieve the dominance they enjoy today Chandler saw the institution... inequality began rising again By the time of Kuznets’s death in 1985 it was close to its putative development peak in the late 1930s, and it has kept on rising The same is true of the U.K Inequality has been rising steadily, apart from a brief dip in the late 1990s, and is currently at a historic high As the table below of OECD and other selected Ginis shows, not all mature economies have Scandinavian-style... ingenuous We are at a watershed The status quo doesn’t work any more Rawls was concerned with the basis of a fair society We should heed his warning about the erosion of the “social basis” of respect I sometimes wonder if things might have turned out differently, if Harvard Business School had asked Rawls to talk to its MBA classes from time to time He was only down the road after all, at Harvard University... self-respect – are to be distributed equally unless an unequal distribution of any or all of these goods is to the advantage of the least favored.1 What could be simpler? A fair and just society, according to Rawls, is not an egalitarian society Equality is the basic principle, but Rawls’s “difference principle” permits a certain amount of inequality if and insofar as it is of benefit to the disadvantaged Abilities . 0 .26 20 05 Bolivia 0.59 20 06 Malta 0 .26 20 07 Haiti 0.59 20 01 Albania 0 .27 20 05 Brazil 0.57 20 05 Germany 0 .27 20 06 Paraguay 0.57 20 08 Source: CIA, The World FactBook, updated April 2, 20 09. In major. a gathering together of business activity; a great integration. Most commentators have seen this as necessary and inevitable. Business was at a crossroads, according to Sir John Clapham. As. describe an MuBE. Administrative coordination is less costly than market coordination, but to capture such savings, an organization needs a management hierarchy, and if it has a management hierarchy