THE DTI’S inquiry into the call-centre industry, announced last month by Patricia Hewitt, will have plenty to get its teeth into. Call centres are at the heart of a number of issues, all more interesting than the simplistic ‘India eats our jobs’ theme that has recently been hogging the headlines.

As a new report for the Health and Safety Executive (www.hse.gov.uk) again confirms, much call-centre work is white collar production-line activity – repetitive, fragmented and subject to the iron control of automated systems. As such, call centres exemplify the fundamental sin of Anglo-Saxon management: the separation of work from decision-making, with consequent automatic disengagement of hearts and minds. Exporting these jobs to Asia just makes the separation explicit: ‘They are organisationally as well as physically distant,’ says Warwick Business School Professor Harry Scarbrough, head of a national research programme on the evolution of business knowledge (www.ebkresearch.org).

This kind of call centre is set up not primarily to create knowledge or value but to process codified and standardised information at the lowest possible cost, he notes. This is what mass production is. In these circumstances, offshoring (in the ugly jargon) to low-cost locations is as inevitable as the fact that any advantage will last only as long as it takes for a competitor to buy the same technology and hire the same operators.

Defending UK call centres on the grounds that UK agents take 25 per cent more calls an hour, as an industry spokesperson tried to do, is almost comically irrelevant. As industry iconoclasts like Vanguard Consulting’s John Seddon (www.lean-service.com) have established, at least half the work of most call centres currently consists of trying to fix problems that shouldn’t have occurred in the first place and over which they have no control. The proper response is not to fix faster – ‘doing the wrong thing righter’ – but to prevent the problems happening in the first place. This is almost impossible to do at long range, but in any case the way contracts are drawn up – on the basis of transaction and activity levels rather than value – gives no incentive to prevent problems.

The fact is that in its current shape, the call centre industry is a ‘solution’ devised by outsourcers and the IT industry (often one and the same) to fix symptoms whose causes they can’t reach and have no interest in solving. In this perspective call centre location is sublimely irrelevant. As psychologist Abraham Maslow once remarked, ‘If something isn’t worth doing well, it isn’t worth doing at all.’

Call centres don’t have to be damaging and unfulfilling places to work, any more than factories do. Indeed, using the same principles as good factories – thinking of organisations as systems for delivering value to customers and devising measures to support that purpose – a few companies have learned to use call centres as essential instruments for diagnosing issues and improving customer service. IT habitually plays a much less dominant role and people can use their full range of skills. Employees are tightly integrated with the rest of the company and much less likely to be outsourced or exported.

The performance of the majority of call centres calls into question the DTI’s boast that they represent ‘one of our service sector success stories’. Their 400,000 jobs often provide poor value for customers and employees. They also appear to do little for the productivity of the service sector as a whole.

According to new research by the Advanced Institute of Management (www.aimresearch.org) it is now much-vaunted services that are holding back the UK’s productivity performance. Although the overall gap with the US remains at 40 per cent, it is no longer manufacturing which is the main contributor: in fact, apart from machinery and equipment, especially computers, UK factories have now made up most of the difference. At the same time some of the service industries in which the UK is supposed to be most competitive, including retail and financial services – a heavy user of outsourcing and call centres – have been falling back. These two sectors now account for fully one third of the total productivity gap with the US, according to AIM.

In an even wider context, the inevitable export of commodity call centre services to India and elsewhere only highlights the need to accelerate the UK’s shift towards a globally successful knowledge-based economy, believes Scarbrough. There is always movement of activities along the value chain as IT systems encode and standardise previously inaccessible knowledge and allow it to be processed anywhere on the globe. What’s important is to retain and encourage innovation and knowledge-creating activities.

In the long term, UK call centres will only survive if they are doing something that can’t be replicated anywhere else.

The Observer, 18 January 2004

PHEW. That’s the festivities over for another year, then. But though you may be dismayed by the commercialism and appalled at the state of your liver, this column can give you good reason to take heart from your participation in the annual orgy of giving and receiving: you are helping to blow a Father-Christmas-shaped hole in conventional management theory and practice.

No, really.

Everything a firm does, from the way it decides strategy or manages people to its structure and board constitution, reflects some management theory.

Strategy is based on Michael Porter’s ‘Five Forces’, the nature of the firm on transaction-costs theory, and so on. In turn those theories are founded on some fundamental assumptions about individual human nature. And the most fundamental assumption in management is that human beings are members of the race Homo economicus, rational maximisers of self-interest.

Homo economicus has been softened a bit round the edges over the years. Since people plainly aren’t omniscient, rationality is acknowledged to be bounded rather than complete. But the direct and indirect consequences of an uncompromisingly economic view of human nature still fundamentally affect the life of organisations.

One outcome is the idea of the company as a hierarchy. Despite lip service to participation, the deep-down archetype is that managers know ‘more’ and ‘best’, and that their job is to control employees and make sure they do as they are told.

Another consequence of the Homo economicus view is that the interests of employees and managers, and managers and owners, differ. From there it is a short step for theory (but a very large step for mankind) to agency theory. Agency theory – the notion that the interests of ‘agents’ (managers) need to be aligned with the overriding goal of ‘principals’ (shareowners) for maximum returns by a range of incentives and punishments – is central to Anglo-Saxon corporate governance.

It is behind the splitting of the chairman and chief executive jobs, the perceived need for independent directors, and much else in the combined codes. It is the justification for high executive pay, stock options, and all the other lucrative incentives for managers to pursue shareholder value.

So theory governs practice. But suppose theory is wrong?

Back to Christmas. In a delightful piece of seasonal research, a US economics professor gravely announced last month that Christmas was ‘inefficient’. Recipients, he discovered, generally put a lower value on the presents they receive than the donor has paid. In terms of efficiency, he concluded, it would be much better for the giver to hand over the cash and let the receiver do her or his own choosing.

Of course. The only surprise is that anyone could be surprised. Christmas is one more proof of what is perfectly obvious to everyone except economists and management theorists: homo economicus is a caricature that exists only in the world of theory. Homo economicus would not tip taxi-drivers he’ll never see again, offer expensive presents to people who may not reciprocate, or indulge in any of the spontaneous acts that brighten every day. In short, if homo economicus existed, Christmas wouldn’t.

The truth is that in real people self-interest co-exists with other more generous behaviours and impulses, such as integrity, trust and altruism. Some serious management writers are now beginning to ask why these positive qualities shouldn’t be admitted into theory alongside the negatives – and what it would do to the shape of our companies if they were.

After all, an organisation based on a single dimension of human complexity is likely to be as much of a travesty as the original assumption. It would be narrow, undersocialised and undernourishing to the spirit at best, at worst brutal and driven to destruction: Enron, WorldCom and Sunbeam Electric, for example.

Is it possible to conceive of an alternative – a company that, as it were, believed in Father Christmas? In her new book The Democratic Enterprise, London Business School professor Lynda Gratton quotes Warren Bennis: ‘It is possible that if managers and scientists continue to get their heads together in organisational revitalisation, they might develop delightful organisations – just possibly.’

Given the dominant theory, it’s not surprising that delightful role models are rare. But a few exist – indeed, some have figured in this column (see box, left). But even from these small numbers, it’s plain that their common features are the exact opposite of what the dominant theory assumes.

Since these companies have a shared purpose, agency theory and its logic of incentives and punishment don’t apply. Being based on trust and respect, they don’t need a hierarchical authority system. People other than managers can contribute to ideas and strategy. Founded on an organisational vocation, these companies don’t buy and sell other companies, financial engineer or outsource at the drop of a hat.

In short, they can be something more than strictly economic units, and that’s because they are based on a more balanced, and realistic, view of human nature than the one-eyed assumptions that currently prevail.

It’s thus not just in religious terms that Christmas redeems. Delightful organisations depend on the same impulses. So keep up the festive inefficiency – and have a cheerful New Year.

The Observer, 11 January 2004

MANUFACTURING is not generally speaking a matter of life and death. But it was in Iraq, where the non-delivery of ceramic plates for an army flak jacket was in at least one case the difference between the two.

A report earlier this month by the National Audit Office sets out a damning catalogue of logistics shortcomings that casts a deep shadow over the overall success of the military mission.

Some troops in Iraq lacked basics such as desert boots or clothing, were given body armour without the armour and had no protection against chemical and biological attack, says the report. Meanwhile, tanks and other machinery had to be cannibalised to provide spare parts for front-line equipment.

In some cases supplies existed but no one knew where – up to 200,000 sets of plates for flak jackets ‘seemed to have disappeared’, according to the NAO. In other cases the gamble of reducing operational stocks to cut costs backfired because ‘the Department could not engage with industry early enough to allow the required items to be delivered in time’.

It was left to File on Four , a BBC radio programme, to spell out the sombre cost in human terms: some soldiers were crippled by boots that were the wrong size or fell to bits, while others preferred to buy their own equipment. Sergeant Steve Roberts, a tank commander who had ironically spent hundreds of pounds on his own kit, was killed after he gave up his body armour to more exposed infantry troops and his pistol jammed.

War, says Professor Mike Sweeney, a manufacturing specialist at Cranfield Management School, is the ultimate test of process and personnel management. In this perspective it emerges strikingly poorly from comparisons with another famous victory, England’s triumph in the rugby World Cup. In his autobiography, captain Martin Johnson reflects on the remarkable change in attitude wrought by coach Clive Woodward’s decision that the England players would no longer have to cart around their own luggage, stay in the cheapest hotels or travel cattle-class between fixtures.

It was the moment they began to be treated as world-beaters, Johnson says, that it dawned on the team that they could and should be. The new conditions weren’t a reward they were the measure of ambition and a means to the end of allowing them to concentrate 100 per cent on the job in hand. By contrast: ‘If you send me out in a hostile and dangerous environment with poor basic equipment and underprepared, what does that say about my value? What does that do for morale?’ asks Professor Sweeney.

The parallel is apt, agrees defence analyst Paul Beaver. ‘It’s boots on the ground that win battles – individual soldiers, not people sitting pushing buttons in fancy machinery,’ he says. ‘It’s utterly unacceptable that we are asking soldiers, sailors and airmen to put their lives at stake without giving every one of them the best possible equipment,’ – for the cost, he calculates, of about two joint-strike aircraft.

The UK has been extremely lucky to emerge from the conflict so lightly, Beaver believes. In several cases, skimpy preparations meant the margin between success and disaster was wafer-thin. For instance, the assault brigade with the crucial task of preventing Iraqi troops from blowing up the Ramallah oilfields got new machine guns the day before and had no time to practise with them beforehand.

Another source describes a frantic hunt for combat identification tape when it was discovered that US battle troops couldn’t recognise the profiles of British vehicles. It took an enterprising A rmy major to bypass Treasury rules and buy up the last remaining world stocks, and contractors and soldiers working through the night to get the job done, according to this report. Beaver says: ‘Essential supplies should be in the right place at the right time – people running around with Amex cards isn’t good enough. ‘Just-in-time’ is too often just too late – as it was, inexcusably, for Steve Roberts.’

Daniel Jones, a consultant and author of Lean Thinking , notes that beginners often jump on just-in-time logistics because they mistakenly think it is easy to do and automatically involves the drastic reduction of inventory costs. ‘It’s about linking activities in an unbroken stream, not running down stocks,’ he says. ‘It would be crazy to run down stocks below the level at which they can be quickly replenished.’

Professor Sweeney, who has experience of army thinking, argues strongly that the current defence department approach to supply is at odds with battlefield reality. He points out that rapid response – as all recent conflicts involving UK forces have been – requires an ‘agile’ supply chain which can react equally quickly.

The corollary is that previous price-driven supply relationships won’t work. Instead, says Sweeney, the department needs close partnership arrangements enabling strategic stockholding of items that take a long time to make, and steady building of supplier capacity, both human and mechanical, to turn on a sixpence when needed.

The other essential, observers agree, is the vastly improved tracking and control of supplies. At one stage 1,000 containers full of urgent supplies were reportedly floating around the Gulf but no one knew what was in them or their exact whereabouts. This led to massive over-ordering as commanders on the ground reordered goods already in transit, at higher priority. Just 8 per cent of top-priority orders were delivered on time, according to the NAO. This, too, is inexcusable. The ‘beer game’, which graphically illustrates the pitfalls of supply-chain mismanagement, is a first-year business-school exercise. Meanwhile, Jones observes, ‘consignment tracking isn’t rocket science any more – you can look up the location of a FedEx or UPS package on the web in real time’.

Supermarket groups routinely track delivery and inventory levels of 40,000 stock items with huge seasonal fluctuations – computer systems to do so have been around for years. What the multiples can do for trainers and toys, the department ought to be able to do for boots and body armour – in deadly earnest.

Simon.caulkin@observer.co.uk

Missing in action: catalogue of failure

* Body armour plates, 200,000 of which ‘seem to have disappeared’ since the Kosovo war

* Desert boots and clothing – a quarter of the Desert Rats fought the campaign in Northern European kit

* Nerve agent detector units – 40 per cent shortfall

* Nuclear, biological and chemical kit ‘misappropriated’ from supplies by troops desperate to get hold of them

* Spares for tanks and howitzers – German equipment is being cannibalised instead

* £14m worth of ammunition written off because of ‘reduced life expectancy’ in high temperatures also air-conditioning units

* ‘A robust tri-service inventory system… and an information system to support this technology’ even though the need has been known ‘since the Gulf Conflict in 1991’ (‘Operations in Iraq – Lessons for the Future’, MoD)

The Observer, 21 December 2003

THE COMPANY is an inevitable and remarkable invention. A prodigious amplifier of human effort, it is certainly ‘the most important organisation in the world,’ as John Mickelthwait and Adrian Wooldridge note in their brisk and entertaining The Company: A Short History of a Revolutionary Idea

It is the company, not blind market forces, that carries on the innovation and trade that push economies forward. As London Business School’s Professor Sumantra Ghoshal has shown, there is a strong correlation between national prosperity and the proportion of population working in relatively large companies. We live in an organisational, not a market, economy. It is the combination of companies and markets that did for communism, not military might.

Historically, too, the company has been a force for civilisation, thriving best in conditions of trust, honesty and respect for contracts. It provides people with identity and community as well as economic livelihood.

Yet this ‘unsettling organisation’, as Mickelthwait and Wooldridge call it, also has a dark side. Even though the company saw off the challenge of central planning, the end of history has turned out to be more eventful than many predicted. Part of the reason for that is the contradictions at the heart of our present-day corporations.

During the past two decades the shareholder-first principle has increasingly pitched companies into conflict with societies’ social and environmental priorities.

Pleading the pressure of capital markets, companies have plunged into an infernal cycle of ‘asshole management’: the pursuit of ever-increasing speed and efficiency in the name of shareholder value that has had the effect of dehumanising work, damaging the environment and stripping management of its moral dimension. The abuses at Enron, Tyco and WorldCom are the direct outcome of this reductionism.

Hence the paradox that although we are more dependent on the corporation than ever, and its potential for good has never been more urgently needed, it is going through a traumatic crisis of legitimacy.

Companies and those who run them have rarely been more distrusted – in polls of ethical standing, managers come out lower than politicians or journalists. Liability lawsuits – for obesity, firearms violence, even global warning – are piling up.

Does this matter? Yes, it does. With its Dr Jekyll and Mr Hyde sides struggling for supremacy, the company is standing at one of its periodic crossroads.

As Mickelthwait and Wooldridge show, this is not the first time that corporate excesses have been followed by a legal and emotional backlash. The cause of the joint-stock company may have been set back a century by the distrust engendered by the South Sea Bubble, for instance.

It wasn’t until 1844 that companies were freed of the need to obtain a special charter and 1856 before limited liability was automatically granted.

This time round, companies’ hasty adoption of corporate social responsibility programmes is not saving them from the increasing attention of regulators determined to limit surprise and prevent abuses.

Yet addressing the negative problem may run the danger of throwing out the positive, too. As Ghoshal points out, there is no evidence that (for example) splitting the top job or increasing the number of independent directors has any effect on company performance.

Meanwhile, these arrangements institutionalise the breakdown in trust between business and society, a trust that is at the heart of overall success and is abandoned at our peril, as Business in the Community chairman David Varney recently noted.

There is an alternative, however, which involves rejecting the determinism that lies at the heart of asshole management and returning to first principles. As history shows, the marvel of the company is that it is a separate ‘legal person’. It is this entity that owns corporate assets, not shareholders, whose rights are restricted to residual cash flows.

So the company has both the right and the obligation to fix its own purpose, to which employees contribute human capital and shareholders financial capital. It can choose to be an engine of stewardship rather than expropriation, a ‘collaborative’ organisation in which the interests of stakeholders converge in the knowledge that human wellbeing is integral to its purpose, not a tacked-on programme.

Because purpose is shared, it can operate on distributed initiative and leader ship rather than hierarchical command and control trust rather than sharp incentives.

The choice is a poignant one, because the paths diverge. Crucially, management’s starting assumptions are self-fulfilling. An organisation run on ‘asshole-management’ principles breeds people motivated by greed and power who don’t care how they get it – in a word, ‘assholes’. Enron is the locus classicus. The converse is also true.

Which company will provide the next evolutionary chapter? The odds are on the assholes, because that’s where the weight of conventional theory lies. But that’s not inevitable: as Mickelthwait and Wooldridge usefully remind us, legally the company was shaped by political decisions – and political decisions can reshape it as well.

The Observer, 14 December 2003

LAST month Network Rail announced that it was bringing all its pounds 1.3 billion annual maintenance business in-house and restructuring itself around its main routes – that is, to fit with its operating company customers. A total of 18,500 people will be transferred from the private engineering companies to the track operator in the biggest shake-up since rail privatisation in the mid-1990s. The move is also unusual. Insourcing of any kind runs so counter to trends that it is worth stopping to ponder what it means.

Conventional wisdom of the past 20 years is that the more companies can outsource routine tasks to specialist providers, the better. ‘Outsource everything except your soul!’ exhorted Tom Peters. What started with catering, security and other low-level tasks now embraces training, logistics, IT and even HR. IT outsourcing particularly is now a massive business.

The argument for outsourcing is that it imports market discipline. ‘You can see what the service costs and change the provider if you aren’t satisfied,’ says Iayn Clark of International Strategic Management, a provider of specialist services for ad hoc assignments – due diligence for banks and high-level training, for example – for which organisations cannot cost-effectively maintain full-time teams. In theory, too, specialised providers of ‘commodity’ services should be able to do it more cheaply through focus, economies of scale and access to the latest technologies.

But, as ever, the reality is more complicated. Even a cursory look at the literature reveals that at least half of all outsourcing projects fail to live up to expectations. Only a few save substantial amounts, and even outsourcing providers suggest cost-cutting is not the place to start. Once the profit margin of the provider and cost of managing the contract – anything from 4.5 to 10 per cent of the fee – are taken into account, the figures look a lot less attractive.

Experience also shows, counterintuitively, that it is rash to outsource something you do badly or don’t know much about. Faced with a supplier whose core competence is negotiating contracts and knowing what the costs really are, you’ll end up locked in and paying too much in the long term if not in the short. This is the paradox of outsourcing: to do it properly you have to know as much about the function as the provider, in which case why not do it yourself.

But why would you want to do routine stuff in-house? Back to Network Rail. In this case, what suffered was not cost (at least not directly) but quality. Faced with declining payments to take account of anticipated efficiency savings, the companies protected shareholders and prof its by cutting costs at the sharp end, with unfortunate results for the operation as a whole, to say the least.

Network Rail’s predecessor, Railtrack, was also fatally split, with the needs of shareholders fighting for priority with those of the network. Boundaries between companies are shifting all the time. There will always be a flow of work in and out. But it should be guided by principle, not fashion.

And what happened to the rail network is a classic example of outsourcing for the wrong reason: the fashionable fallacy of treating companies as if they were markets. The idea was that by contracting in the market, and managing those contracts, Railtrack (as it then was) would be able to use its maintenance resources more efficiently. And not just for maintenance: there was so much outsourcing going on at one stage, according to one employee, that the company had outsourced the outsourcing process.

But companies aren’t markets. They obey different operating logic and have different roles. Markets evolve blindly, guided by the invisible hand towards the most efficient short-term use of resources. Unfortunately, although Railtrack didn’t realise it, there is no guarantee that short-term efficiency coincides with the larger purpose of the company. For companies do have purpose. That is their point. They are intentional entities. They can choose to sacrifice some short-term efficiencies for the sake of innovation that increases their store of resources in the long term.

Ironically, it is only now that it is no longer a private-sector company in the normal sense that Network Rail can develop that long-term dynamic efficiency by focusing on the things it should be doing: hence the reorganisation. ‘Our focus is now on engineering: rebuilding and maintaining the railway,’ says a spokesperson.

Having already taken one contract back in-house, precisely to get a hands-on feel for how maintenance was being managed and costed, Network Rail believes it can save pounds 200 million to pounds 300m from the overall bill – and do it better.

But even if it weren’t cheaper in the short term, if Network Rail is to build its organisational vocation as a great engineering company – which it must do for long-term efficiency – then maintenance has to be in-house.

Renewal stays outside (as it was in the days of British Rail), but understanding maintenance will enable it to make more informed and timely decisions about rebuilding, Network Rail believes. Maintenance is its soul, and has to be treated with due reverence.

The Observer, 30 November 2003

WHY has Tetra Pak, the very private Swedish packaging firm owned by the Rausing family, launched a pounds 4 million national advertising campaign, its first ever? The company concedes that it is an unusual step for a firm that has no direct relationship with consumers.

The short answer is that Tetra Pak wants to persuade us of the environmental and food goodness benefits of buying milk and juice in its paper-based cartons. So far so normal. But a longer answer says something very interesting indeed about responsibility and sustainability – not as an irrelevant business cost, as many claim it is, but as a strategic competitive weapon.

First, some background. Tetra Pak, founded in the 1950s, is one of the world’s largest packaging companies for milk, juices and other drinks. It produces 100 billion aseptic cartons a year worldwide, equal to 5 per cent of the overall market for liquid food packaging.

Tetra Pak has always had a strong sustainability streak. Founder Reuben Rausing was prompted to devise the original tetrahedron-shaped carton by observing the massive waste of food through perishing as it moved through the supply chain. ‘Packaging should save more than it costs,’ he said. The firm’s current strap line ‘Protects what’s good’ refers both to the carton’s claimed food-protection qualities and to the fact that, being paper-based, it is a renewable resource.

The reason for calling attention to these properties now is, as the company freely admits, competitive. In its core market – dairy – carton is coming under increasing pressure from plastic. Paper needs to fight back. But what makes the campaign of general as well as particular significance is the terrain the company has chosen to fight on.

Shifting the competitive arena from, say, price to environmental performance certainly entails costs – not just pounds 4 mil lion to raise the awareness of the UK public, but the hugely greater costs of making sure the company can actually meet its environmental claims. These are: ensuring and certifying sourcing from sustainable forests, increasing eco-efficiency and becoming carbon-neutral in manufacturing, and improving the UK’s lamentable record in carton recycling. Through the UK trade association, it has helped set up this country’s first reprocessing plant capable of separating carton substrate from its thin protective layers of aluminium and plastic.

The conservative view of this social and environmental do-gooding, articulated by economist David Henderson and Martin Wolff of the the Financial Times and traceable back to Milton Friedman, is that it is not just a distraction but a dangerous dereliction of the duty to maximise value for shareholders. The business of business is business if shareholders want to clean up the environment, they can choose to do so themselves.

Tetra Pak challenges this head on because in effect it makes a business case for environmental responsibility. As a new study by Forum for the Future for the DTI, Sustainability and Business Competitiveness , points out, the business case has hitherto been as elusive as rugby player Jason Robinson – definitely there, but impossible to pin down and quickly out of sight. Tetra Pak hauls it back into view, while the report suggests how it works in practice.

Briefly, the study supports recent findings by the Work Foundation and others that shareholder value is best served by not putting shareholder value first (which is one kind of answer to the corporate social responsibility conservatives). It also reiterates the importance of intangible assets: in a competitive and increasingly weightless economy, companies need to orchestrate ‘unique, or hard-to-replicate, capabilities, competencies and quasi-assets’ to innovate their way out of competition and stay ahead of the game.

This pretty much describes Tetra Pak’s strategy. It accepts the costs of improving its environmental performance because it plays to and reinforces its distinctive strengths. Both plastic and carton are cheap and technically recyclable, offering little potential for differentiation. But only carton comes from renewable resources. So Tetra Pak has an obvious interest in increasing consumer awareness of the issues around renewability and recycling.

But it also has an interest in meeting its promises. Reputation, as the report points out, is now understood to be an important source of competitive advantage. To support it, the company obliges itself to upgrade its manufacturing performance. It also has powerful incentives to innovate both to lower costs and to make it possible to make even higher environmental claims. That is indeed what it is doing, seeking in the long term to find renewable alternatives to aluminium and plastic.

In this perspective Tetra Pak’s environmental spending makes sense as an investment, not a self-imposed expense, since it thereby makes itself more sustainable in the future. This is the other answer to the CSR doubters, and it suggests, provided useful measures can be developed, that ‘corporate sustainability management [could shift] out of public affairs into business strategy,’ according to the report. This is about internal management, not external reporting. ‘Our view is that management of key stakeholders and environmental impacts is central to the successful management of many companies.’

Tetra Pak’s experience demonstrates another important proposition: the importance of the interaction between regulation and markets. Part of its business case is indirectly made by the regulatory obligation to recycle, which plastic manufacturers met with PET containers. Carton manufacturers then had to seek competitive advantage on another front: with further environmental improvements.

There is an even larger implication, however. Tetra Pak is one example of the power of market forces to generate environmental innovations when that’s what is driving competition. It follows that ‘if there is a strong case for corporate sustainability, then business could play a major role in environmental protection and social development’ – a point also made in a recent report by AccountAbility. That may seem a long way from an ad for a milk carton, but to adapt the pay-off from one of them: ‘No business is environmentally perfect, but at least we’re working on it.’

The Observer, 23 November 2003

‘WE’RE just not a high-performance economy. We don’t want it enough,’ says Rebecca Harding, lead researcher on a ground-breaking study of UK productivity by the Work Foundation.

The report, The Missing Link: From Productivity to Performance , was sponsored and led by business and takes a novel line on a problem that has dogged the UK for well over a century, defying the best efforts of countless panels, task forces, commissions of inquiry and academics. UK productivity lags behind that of the US, France and Germany by 15-25 per cent depending on the measure used, a gap that makes everyone in the country pounds 6,000 worse off, according to a Treasury calculation.

Why has the gap been so persistent? Part of the reason, suggests the report, lies in the different language economists and companies use to frame the issue. Economists tend to attribute productivity differences to quantitative factors such as capital investment and workforce skills, both areas in which the UK trails. That may be true as far as it goes, but it’s not very far. Unlike markets, which evolve blindly, companies are entities that make choices about organisation and strategy. So they need to be looked at through a lens that tries to identify why they don’t make the choices that lead to higher productivity, and what actions they could take to do so.

Fundamentally, the report found that companies simply don’t see productivity as a useful measure. High performance is seen as a much more useful way of approaching issues of underperformance, say the researchers, who have constructed an ambitious ‘high-performance index’ to measure the difference between good and poor performers and indicate where the latter need to raise their game.

The Work Foundation identified five areas that companies need to manage to drive high performance and business success: customers and markets, shareholders and governance, stakeholders, people, and innovation and creativity. Measuring companies across these broad areas, says Harding, yielded some startlingly consistent results.

At top level, as Harding suggests, the UK is too attached to the status quo to be a high-performance economy. The gap is as much one of creativity and innovation as productivity, with performance undermined by risk- aversion and low skills. Unlike in other countries, the institutional framework is fragmented, so that partnership is rare.

And having exhausted the market reforms of the 1980s, too many companies are still trying to improve performance by making people work harder rather than smarter, with swiftly diminishing returns.

However, the findings at firm level also provide important pointers to what it takes to move forward. First and most significant, top performance is holistic. Not only are high performers consistently superior over all five areas than the laggards, they manage the interdependencies between them better, so that the total is more than the sum of its parts.

Focusing disproportionately on just one of the areas, such as shareholder value, is likely to damage performance. By the same token, ramping up capital investment is not the answer. ‘This disposes of one-dimensional management fads and silver bullets,’ says Harding. Instead, ‘high performance requires an integrated approach, optimising strategy and delivery rather than ‘cherry-picking’ objectives.’

In turn, the key to delivering the synergies is people. The report says: ‘Managing the spaces in between can only be achieved by a workforce that sees the big picture and is enabled and motivated to act, with middle managers able to translate strategy into workforce goals.’

Also necessary (and often lacking) are ambition and adaptability. Aspiration provides the will and stamina to adapt, and adaptability is needed to ride the shocks. Depressingly, just 43 per cent of the sample had an explicit growth goal. The evolving organisation is held together by a common purpose focused on growth and risk-taking, well summed up by Will Hutton as ‘organisational vocation’.

The benefits of high performance for productivity are strikingly large. The Work Foundation model shows that companies in the top half of the index are 42 per cent more productive than the bottom quartile. The average UK firm is 25 per cent off the productivity pace of the top performers. Every 1 per cent improvement across the five areas is reflected in a 0.7 per cent productivity gain.

The implications of the work are clear and in some respects common sense. When it comes down to it, productivity is not about economists’ measures of quantities of capital and labour, but qualitatively how well they are combined and managed.

The biggest intangible is management, and there is no ‘solution’ to underperformance and low productivity that does not engage with the reality of the UK’s woefully undereducated and untrained management cadre.

In turn, enlightened holistic management needs a supportive governance framework that doesn’t put the shareholder cart before the company horse. Shareholder value, like productivity, is the result of high performance, not the cause of it.

The Observer, 16 November 2003

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.