Why do companies die? Some, like Peregrine, which used to be Hong Kong’s largest investment bank (and the delightfully named Safe and Steady taxi firm to which it lent Dollars 260 million), are just gamblers – their business model assumes the chips will fall one way up when they don’t they are, by definition, sunk.

But others, like the shrinking albeit extant Laura Ashley, are killed off by varying combinations of poor strategy, misreading of the market and bad appointments. Personal greed, corruption and hubris are other regular killers of companies.

Less attention, however, is generally paid to companies that manage themselves to death – like a smoker insisting that cigarettes are good for the health, such companies destroy themselves by clinging to a lethally misconceived idea of what corporate wellbeing is.

After Hanson last year, the latest in this line is Westinghouse. Extensive obituaries of the 111-year-old firm, one of the US’s most famous engineering names, cited bad management as the cause of death.

This is in one sense true, but the culprit was not a mistake but a doctrine, a doctrine still held remarkably dear by consultants (and imposed with particular regularity on their public-sector clients struggling to make sense of private-sector disciplines).

The fallacy is this: companies operate in markets, so the more they organise themselves internally to operate as markets, the more effective they will be. Wrong: companies and markets are different, each with its own distinct operating logic.

Why companies exist at all is the subject of a large and impressively abstruse branch of economic debate. To simplify grossly, the traditional line is that in the beginning there were markets, and companies are merely a necessity for those economic parts markets cannot reach – restraining human opportunism and carrying out complex co-ordinating tasks, for example.

But more recent thinking gives firms a more positive role. A vibrant economy, the theory goes, is an ecology in which both companies and markets play different, and complementary, parts. Briefly, markets wring the maximum value out of existing resources by allocating them to the most efficient uses. Markets are about static efficiencies.

Companies, on the other hand, create dynamic efficiencies – pushing economies to new levels of size and sophistication by creating fresh resources for markets to operate on. In a word, companies innovate – something markets can’t do.

In constant interaction, the company proposes, the market disposes. Company innovation and market competition combine to power the engine of economic growth.

To innovate, companies need to provide a refuge or shelter from market forces within which their employees have the time and space in which to dream up new products or new ways of making existing ones they need to create space in which people can think about the future.

To understand the point, consider 3M, a notably innovative company. From a strictly market point of view, 3M’s ’15 per cent rule’, under which employees can spend that amount of time on their own pet projects, is wilfully inefficient and robs shareholders of 15 per cent of their immediate returns.

From a dynamic point of view, however, this ‘inefficiency’ is crucial – it gives employees leeway in which they can create the new products on which the company’s future growth depends. And 3M commits itself to gaining at least 30 per cent of its revenue from products introduced in the past three years.

Now back to Westinghouse. The difference between it and 3M – or one-time rival GE – was not inferior technology, less intelligent people or old-fashioned management. It was that, at least latterly, Westinghouse thought of itself as a market.

Westinghouse managers, according to Sumantra Ghoshal and Christopher Bartlett in The Individualized Corporation, ‘bought and sold businesses, created internal markets wherever they could, and dealt with their people with market rules.’ By doing so, however, they destroyed their own uniqueness – the company’s ability to create value in a way that markets cannot.

‘All they could do was strive for squeezing more efficiencies out of everything they did. Their strategy focused entirely on productivity improvement and cost-cutting. They were unable to innovate… because the logic of the market they adopted internally did not allow for creation beyond the efficiency of existing activities.’ Markets always operate more cheaply than companies, because they don’t have to invest in the future or a vision, and can root out inefficiencies by reallocating resources among available options. But this is precisely why companies which attempt to compete on these terms, such as Westinghouse, are bound to lose in the long run.

Paradoxically, it is only by sacrificing some immediate efficiences – allocating resources to uses which do not yield the maximum instant return – that companies can secure their, and the economy’s, future.

Companies that act like markets don’t – can’t – last. In the effort to beat the market at its own game, firms like Hanson , Scott Paper and Westinghouse end up outsourcing, hiving off and rationalising until there is nothing left.

Shareholder gains from this process (the invariable justification) are strictly short term: the company’s former shareholders then have to go and find a company that does believe in the future, such as 3M or GE.

Indirect support for the view of the company as something more than a pale shadow of the market can be found in a timely compendium of research recently published by the Centre for Tomorrow’s Company*.

Among other sources it cites a well-known study by Stanford University which compares some of the US’s outstandingly successful companies of the past 50 years (3M, Boeing, Merck, Motorola and GE, among others) with their corresponding also-rans (Norton, McDonnell Douglas, Pfizer, Zenith and, yes, Westinghouse).

The outstanding companies scored highly on such features as historical continuity of values and management, investment in people, purposeful progress and evolution, and investment for the long term – none of them characteristic of markets.

The most significant finding, however, is that despite also ranking highly for ‘objectives beyond profit’, over a period of 50 years, these companies financially outperformed their rivals almost sevenfold, and the stock market by a massive 15 times.

The moral: you can beat the market – but only by doing what a company does, not by trying to ape the market.

NOT content with the welter of ugly acronyms much beloved of businesses as measures of performance, American companies are inventing yet more. According to a recent survey by the US Institute of Cost Management Accountants, nearly two-thirds of companies are losing faith in accounting-based performance measures and seeking new ‘value criteria’ to get a better handle on their businesses.

Driving the stampede to the new measures (or ‘metrics’ as they are fashionably known) is the obsession with shareholder value, itself booted merrily along by the tidal swell of management share options. What performance measurements best correlate with movements in a company’s share price? How can a company boost the share price and shareholder value?

This is much more than a debate about measuring performance. How companies measure value determines how they are run. In its golden years, for example, Hanson measured the performance of all its businesses in terms of return on capital employed. It worked – but only for a time. When the world and the stock-market changed, Hanson didn’t, and self-destructed on its own performance metric.

Michael Black, the vice-president of management consultancy CSC Index, tells of a bank that bought a growing life insurance firm and imposed a strict return-on-capital regime. It was the wrong test to use: any growing insurance company will eat capital because costs come early, whereas returns take longer. But management remuneration was tied to return on capital, so it fired the sales force and the firm stopped growing. After four years return on capital (and managers’ pay) had soared – but the insurance business was worth half its original price. Says Black: ‘The bank had in effect paid the managers to destroy the company.’

For many managers and investors the easiest and most familiar measure – profit – has long lost legitimacy because it is easy to manipulate and backward-looking.

There are several contenders for the new favoured measure, and they all involve measuring business cash flows against the cost of generating them.

Most fashionable is probably Economic Value Added,the offering of New York consultancy Stern Stewart, which boasts 250 corporate customers, including Coca-Cola and AT& T in the US and Lucas Varity and Burton in the UK.

Its greatest rival is ‘cashflow return on investment’, or CFROI, promoted by the Boston Consulting Group and HOLT Value Associates.

Price Waterhouse claims a rush of European converts, from banks to utilities, to its ValueBuilder, a software-based process that aims to provide a breakdown of the cashflow variables. It identifies seven ‘drivers’, which can be changed to show, for example, how sales growth or working capital will affect shares. Price Waterhouse says it can be used to incorporate shareholder-value principles into decision-making at both divisional and plant as well as board level.

Since all the methods are based on the same figures, the argument is not over arithmetical ‘correctness’ but managerial appropriateness.

EVA, being a yearly measure, is widely used in the US as the basis for management remuneration schemes CFROI, which gives historical trends, is useful for the investment community, while ValueBuilder, claims Phillips, is compatible with both while giving an added strategic dimension.

Although some companies boast impressive success using the new metrics, observers counsel against putting too much faith in one version. Each has advantages and disadvantages and produces different winners and losers. Monsanto, the US chemicals company, uses both EVA and CFROI as well as a ‘balanced scorecard’ of non-financial measurements to assess its performance.

BUT how useful are the new metrics? At Warwick Business School, accounting lecturer Dr Brendan MacSweeney notes the ‘narrow economic motivation’ while Dr Peter Johnson of Balliol College, Oxford, points out that the causal link between strategic choices and share price is still unproven. CSC Index’s Black warns that off-the-peg value systems end up consuming their champions if they are not adapted over time. The bravest companies, he says, invent their own metric and sell it to their stakeholders.

Guide to the new management argot

Added Value: The difference between the market value of a company’s output and the cost of its inputs.

Economic Value Added: ‘Economic’ profit, or the difference between a company’s post-tax operating profit and the cost of the capital invested in the business.

Market Value Added: The difference between a company’s market capitalisation and the total capital invested – thus the stock market wealth created (assuming positive MVA).

CFROI: Compares inflation-adjusted cash flows to inflation-adjusted gross investments to find cash-flow return on investment.

Total Shareholder Return: What the shareholder actually gets, ie, changes in capital value plus dividends.

There is more to Hanson’s demerger than the mortality of two ageing predators. Logical to the last, Hanson illustrates with unusual clarity the dead end of Eighties red-meat capitalism. 

What went wrong? After all, for all its unfashionableness, Hanson demonstrates considerable management virtues.

For instance, contrary to much punditry, Hanson understands more about management focus than most of its confreres in the FT-SE 100.

Its focus is on management style. Rather than invest in related industries to pursue strategic synergies (a concept which exists in theory but not in practice, like England’s running game at rugby), Hanson has concentrated on buying firms that, although industrially unrelated, can all be run in the same way: with great operating freedom but little investment, no R&D, fast return and fierce financial controls.

Using this focus, Hanson has made routine an exercise that more industrially ‘focused’ companies regularly flunk: acquisitions. A study by the Economist Intelligence Unit confirms that making acquisitions work is largely a matter of experience and knowing what you want to get out of them. Hanson excels at both.

So here is the paradox. Hanson epitomises the economist’s conception of what a capitalist company should be. It prowls the market for corporate control, buying underperforming, undervalued assets and willingly selling them on to anyone who values them more highly. And it runs its companies for maximum short-term profit in the express interests of shareholders.

Yet this is a company on which the market has turned its back. Despite the highest dividends in the FT-SE 100, Hanson ‘s share price has fared miserably in the 1990s.

There are good mathematical reasons why it is harder now for Hanson to prosper, the chief of these being sheer size. (Again contrary to conventional wisdom, there are still plenty of terrible companies out there to acquire it’s just that after a decade of cost-cutting they are already partly ‘ Hansonised ‘ and thus no longer bad in ways that Hanson can easily cure.)

The underlying reason for Hanson ‘s fall from grace, though, is a remarkable shift in stock market values. The markets no longer believe that the best way to serve shareholder interests is to focus exclusively on the calculus of finance. They are beginning to accept the proposition that in the long term the best investment returns may come from companies that establish relations of trust with employees, customers, suppliers and community as well as shareholders. In short, they have bought the stakeholder argument.

The fate of Hanson, the ultimate shareholder-driven company, is the answer to those who continue to denounce stakeholder theory as a dangerous delusion and demand that management concentrate solely on the interests of the shareholder. Hanson’s end is as logical as its life. Those that live by the market have little option but to die by it.

THE REAL scandal about Cedric Brown’s leaving deal is that people still haven’t got it. In an attempt to pull back the curtain, here are some all too infrequently asked questions about pensions:

1 How about some figures?

Equitable Life says that to buy an annuity of pounds 247,000 (Brown’s pension) would cost pounds 4 million today. Other estimates put the value of his salary increase last year in pension terms at more than pounds 3m.

2 Where does the money come from?

The company pension fund, obviously, built up of the invested contributions of both the company and individuals.

3 But if large salary increases impose such a huge burden, how can the company fund it without putting up pension contributions?

Good question. If every British Gas employee stayed 40 years (like Brown), enjoyed steady pay rises and retired on a salary of three-quarters of final earnings, as is theoretically possible, contributions would have to rise. In practice, however, most people change jobs three or four times. This devastates their pension entitlements, and the company’s obligations, thus creating the leeway to top-up top people as they approach retirement. In other words, attrition of the lower orders is what makes it possible.

4 But doesn’t this give unscrupulous companies an incentive to prune their middle ranks?

You bet it does. The way pensions are loaded in favour of directors distorts the labour market. It bears particularly heavily on the over-fifties who, in pension terms, are expensive to employ. So age discrimination has an economic base. Unless the pensions issue is tackled head on, all campaigns to persuade employers to hire older workers will be pointless.

5 So pensions are set to become an increasingly important economic, social and management issue?

Yes – if we wake up to what is going on.

THERE is more to Hanson‘s demerger than the mortality of two ageing predators. Logical to the last, Hansonillustrates with unusual clarity the dead end of Eighties red-meat capitalism.

What went wrong? After all, for all its unfashionableness, Hanson demonstrates considerable management virtues.

For instance, contrary to much punditry, Hanson understands more about management focus than most of its confreres in the FT-SE 100.

Its focus is on management style. Rather than invest in related industries to pursue strategic synergies (a concept which exists in theory but not in practice, like England’s running game at rugby), Hanson has concentrated on buying firms that, although industrially unrelated, can all be run in the same way: with great operating freedom but little investment, no R& D, fast return and fierce financial controls.

Using this focus, Hanson has made routine an exercise that more industrially ‘focused’ companies regularly flunk: acquisitions. A study by the Economist Intelligence Unit confirms that making acquisitions work is largely a matter of experience and knowing what you want to get out of them. Hanson excels at both.

So here is the paradox. Hanson epitomises the economist’s conception of what a capitalist company should be. It prowls the market for corporate control, buying underperforming, undervalued assets and willingly selling them on to anyone who values them more highly. And it runs its companies for maximum short-term profit in the express interests of shareholders.

Yet this is a company on which the market has turned its back. Despite the highest dividends in the FT-SE 100, Hanson ‘s share price has fared miserably in the 1990s.

There are good mathematical reasons why it is harder now for Hanson to prosper, the chief of these being sheer size. (Again contrary to conventional wisdom, there are still plenty of terrible companies out there to acquire it’s just that after a decade of cost-cutting they are already partly ‘ Hansonised ‘ and thus no longer bad in ways that Hanson can easily cure.)

The underlying reason for Hanson ‘s fall from grace, though, is a remarkable shift in stock market values. The markets no longer believe that the best way to serve shareholder interests is to focus exclusively on the calculus of finance. They are beginning to accept the proposition that in the long term the best investment returns may come from companies that establish relations of trust with employees, customers, suppliers and community as well as shareholders. In short, they have bought the stakeholder argument.

The fate of Hanson, the ultimate shareholder-driven company, is the answer to those who continue to denounce stakeholder theory as a dangerous delusion and demand that management concentrate solely on the interests of the shareholder. Hanson’s end is as logical as its life. Those that live by the market have little option but to die by it.

THE REAL scandal about Cedric Brown’s leaving deal is that people still haven’t got it. In an attempt to pull back the curtain, here are some all too infrequently asked questions about pensions:

1 How about some figures?

Equitable Life says that to buy an annuity of pounds 247,000 (Brown’s pension) would cost pounds 4 million today. Other estimates put the value of his salary increase last year in pension terms at more than pounds 3m.

2 Where does the money come from?

The company pension fund, obviously, built up of the invested contributions of both the company and individuals.

3 But if large salary increases impose such a huge burden, how can the company fund it without putting up pension contributions?

Good question. If every British Gas employee stayed 40 years (like Brown), enjoyed steady pay rises and retired on a salary of three-quarters of final earnings, as is theoretically possible, contributions would have to rise. In practice, however, most people change jobs three or four times. This devastates their pension entitlements, and the company’s obligations, thus creating the leeway to top-up top people as they approach retirement. In other words, attrition of the lower orders is what makes it possible.

4 But doesn’t this give unscrupulous companies an incentive to prune their middle ranks?

You bet it does. The way pensions are loaded in favour of directors distorts the labour market. It bears particularly heavily on the over-fifties who, in pension terms, are expensive to employ. So age discrimination has an economic base. Unless the pensions issue is tackled head on, all campaigns to persuade employers to hire older workers will be pointless.

5 So pensions are set to become an increasingly important economic, social and management issue?

Yes – if we wake up to what is going on.

HANSON arouses strong passions. Over the years the market has loved it, happily sanctioning its claims to be able to extract more value from targeted companies than incumbent management. Critics, on the other hand, charge that in the building, as opposed to the extraction, of value, Hanson is mediocre: in concentrating on short-term returns to shareholders it short-changes the future.

What few dispute, however, is the fitness of Hanson ‘s stripped-down management style to its purpose of maximising shareholder value. A headquarters of 120 people for a group with 80,000 employees concerns itself solely with finance: providing they meet stringent financial targets, operating managers are highly autonomous.

Coordination by the market rather than by hierarchy has the virtues of simplicity and economy. But it has drawbacks too. Lateral communication (for spreading best practice) is difficult. And since there is no group personnel department, how does Hanson find good people in its companies to fill management vacancies around its divisions and companies? Simple – and apt. It runs a competition.

Every year Hanson chooses two ‘Annual Achievers’ (one in the UK, one in the US) from around 150 applicants in the operating divisions.

The winning criteria have nothing to do with qualifications or potential, and everything to do with achievement: ‘Not the future, but strictly what you’ve done in the past,’ says Peter Harper, the main-board director in charge of the scheme.

For Hanson , the aim of the competition is simple. It wants to identify management talent that otherwise would go unnoticed by the centre. ‘It’s a safety net to pick up people who would not come up through the normal channels,’ says one manager.

Once that talent is pinpointed, Hanson is as ruthless as you would expect in ‘robbing Peter to pay Paul’: promoting the achievers to new hotspots and leaving their places free to be competed for by other would-be achievers. Previous award winners have ‘usually gone on to higher things’, says Harper. The first award-winner in 1983 now runs the industrial services division. Another is on secondment to the DTI’s innovation unit.

The other purpose is to expose operating managers to the Hanson Group, which they would normally never meet. (Hanson ‘s US chief, Lord White, used to boast that he never set foot in the operating companies it is a principle that even the most senior operating managers do not go on the Hanson board.)

This year’s winner is Ken Fredericks, leaf and technical manager at Imperial Tobacco, who developed a series of measures which have made Imperial’s cigar-making capacity ‘the best in Europe’, acquiring BS 5750 in the process and increasing productivity by 63 per cent. Fredericks agrees that Hanson ‘s budget-setting is ‘horrific’, but adds that ‘we have never submitted a major capital expenditure proposal that has been turned down’ – a surprise in view of Hanson ‘s reputation.

Fredericks’ prize: three weeks in the US. But this is Hanson: one of those weeks will be work.

Hanson arouses strong passions. Over the years the market has loved it, happily sanctioning its claims to be able to extract more value from targeted companies than incumbent management. Critics, on the other hand, charge that in the building, as opposed to the extraction, of value, Hanson is mediocre: in concentrating on short-term returns to shareholders it short-changes the future.

What few dispute, however, is the fitness of Hanson ‘s stripped-down management style to its purpose of maximising shareholder value. A headquarters of 120 people for a group with 80,000 employees concerns itself solely with finance: providing they meet stringent financial targets, operating managers are highly autonomous.

Coordination by the market rather than by hierarchy has the virtues of simplicity and economy. But it has drawbacks too. Lateral communication (for spreading best practice) is difficult. And since there is no group personnel department, how does Hanson find good people in its companies to fill management vacancies around its divisions and companies? Simple – and apt. It runs a competition.

Every year Hanson chooses two ‘Annual Achievers’ (one in the UK, one in the US) from around 150 applicants in the operating divisions.

The winning criteria have nothing to do with qualifications or potential, and everything to do with achievement: ‘Not the future, but strictly what you’ve done in the past,’ says Peter Harper, the main-board director in charge of the scheme.

For Hanson , the aim of the competition is simple. It wants to identify management talent that otherwise would go unnoticed by the centre. ‘It’s a safety net to pick up people who would not come up through the normal channels,’ says one manager.

Once that talent is pinpointed, Hanson is as ruthless as you would expect in ‘robbing Peter to pay Paul’: promoting the achievers to new hotspots and leaving their places free to be competed for by other would-be achievers. Previous award winners have ‘usually gone on to higher things’, says Harper. The first award-winner in 1983 now runs the industrial services division. Another is on secondment to the DTI’s innovation unit.

The other purpose is to expose operating managers to the Hanson Group, which they would normally never meet. (Hanson ‘s US chief, Lord White, used to boast that he never set foot in the operating companies it is a principle that even the most senior operating managers do not go on the Hanson board.)

This year’s winner is Ken Fredericks, leaf and technical manager at Imperial Tobacco, who developed a series of measures which have made Imperial’s cigar-making capacity ‘the best in Europe’, acquiring BS 5750 in the process and increasing productivity by 63 per cent. Fredericks agrees that Hanson ‘s budget-setting is ‘horrific’, but adds that ‘we have never submitted a major capital expenditure proposal that has been turned down’ – a surprise in view of Hanson ‘s reputation.

Fredericks’ prize: three weeks in the US. But this is Hanson: one of those weeks will be work.