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Unmanageable Management?

December 20, 2009

Noam Scheiber recently delved into a sadly unplumbed line of economic inquiry in his latest piece in The New Republic.  He asks what economic strength America still possesses in the wake of the rise of the business school-trained manager.  Knowing many friends in this industry, and having come to this conclusion upon wondering where America’s “competitive advantage” currently exists, I found the article particularly poignant and accurate. The problem is that our competitive advantage is now reduced to American managers’ ability to squeeze out accumulated profits, leverage assets, and cook the books. Our economic focus has shifted from long-term growth and empire to short-term profitability by any means necessary.

By the 1980s, the conglomerate boom was reversing itself. Investors began seizing control of overgrown public companies and breaking them up. But this task was, if anything, even more dependent on fluency in financial abstractions. The leveraged-buyout boom produced a whole generation of finance tycoons—the Michael Milkens of the world—whose ability to value corporate assets was far more important than their ability to run them.

The new managerial class tended to neglect process innovation because it was hard to justify in a quarterly earnings report, where metrics like “return on investment” reigned supreme.

Our entrepreneurial spirit is still strong in the digital world, I hope.  But one might note that the success stories of these industries typically only grow into empires by remaining largely private and immune to the pressures imposed by public shareholders (e.g., Google, Facebook, Twitter), while most of the failures are those that raised public capital and attention and tried to do maximize profit without building the necessary infrastructure to stay ahead of the razor-sharp competitive curve imposed by the pace of technological advancement.  Of course, the conventional wisdom of capitalism is that such shareholders are forces for good in corporate management, keeping check on managers’ tendency to extract from the corporation.  But when one looks back to the older style of management, the managers all grew from being experts at understanding the core products being offered by the institutions they stewarded.  Today’s managers are admittedly more “competitive” in that their expertise lies in understanding finance and how to create temporary or perceived profitability, which is really all a diversified shareholder can be expected to demand from management.

Harvard business professor Rakesh Khurana, with whom I discussed these questions at length, observes that most of GM’s top executives in recent decades hailed from a finance rather than an operations background. (Outgoing GM CEO Fritz Henderson and his failed predecessor, Rick Wagoner, both worked their way up from the company’s vaunted Treasurer’s office.) But these executives were frequently numb to the sorts of innovations that enable high-quality production at low cost. As Khurana quips, “That’s how you end up with GM rather than Toyota.”

Again, capitalism left alone to its natural ends displays a tendency to over-leverage itself.  I hope I am wrong about this idea, but now what do we do with that wisdom?

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3 Comments leave one →
  1. slickricks permalink*
    December 20, 2009 2:54 pm

    Relatedly, Tim Harford recently explained why “being nice” has real economic value, and therefore makes America an economically competitive environment for doing business:

    A recent paper by economists Jeff Butler, Paola Giuliano and Luigi Guiso finds that for an individual, there’s an optimal level of trust in others. Too little and you’re over-conservative, missing opportunities; too much and you get screwed.

    In MBAs we trust? Uh oh.

  2. January 6, 2010 12:04 pm

    This is a point that a lot of people made in the 80s too when the PE boom was happening. I think the idea that America has become financiers rather than operators / innovators is a valid one but there are benefits as well. The PE boom was a boom driven by financial innovation, similar to the tech boom being driven by tech innovation. Bubbles occur when dumb money chases ideas they are not entirely knowledgeable with the ideas they are chasing (i.e. PE bust and Tech bust). These “finance guys” aren’t going into companies and breathing hot air, the value they create for a company is very real (i.e. cash) and they defining processes around capital use within a company. Similar to Toyota making better cars because they have optimize the engineering and manufacturing processes, American companies are capitalizing more effectively because PE guys are optimizing the capital structure of the companies they take over.

    They also broke up businesses that had no business being together. Why did Nabisco own Duracell and why did Duracell own Gillette!? Those are fundamentally different businesses that should have been broken up. Similarly, they combined or “rolled up” businesses that should be together. They used money to finance the deals, but the intrinsic value lies in the long-term strategy of a company.

    I don’t think GM’s demise came from the fact that their leaders were “finance guys” (and to be honest, GM was a car company but their finance arm was very large), they had a slew of other problems they were not able to solve – union negotiations, innovation, etc. Also, high US tariffs on auto imports forced Japan to really get costs down. Ford is doing seemingly well in the US auto market and I would say it’s a 60/40 chance that their leaders are ex “finance guys” as well.

    As Durant eloquently put it, “Men who can manage men, manage men who can only manage things. Men who manage money, manage all.”

    • slickricks permalink*
      January 6, 2010 5:47 pm

      A well-put point, Steven. It’s absolutely true that once-monolithic institutions are subject to toppling due to factors that lie outside of the mere acts of overleveraging due to finance-raiders (and GM is probably an excellent example) because all institutionalized parties have gained power through organization. Whether unions, politicians, shareholders, litigants, or anyone else, it doesn’t only take an inferior product or terrible mismanagement to make a once pristine company fail. But what really worries me are the implication that finance has on the pure approach or theory to economic efficiency because finance can almost always create a short-term (and short-sighted) supra-competitive result. What I mean to say is that a financier that strips a company of its accumulated equity and distributes it to shareholders has obviously moved closer to “profitability” and even toward resolving the classical “principal-agent problem,” which is why such agents will be competitive in the marketplace for management.

      Perhaps a more relevant, down-to-earth example is the way that funds that bought those opaque subprime mortgage instruments containing traunches of worthless debt were almost “forced” into doing so because they had to compete to retain investors’ capital and offer supra-competitive returns on the money. The same might be said due to the influence of financiers who enter management and make the bottom line look great without regard to the minimum operating capital required to keep the operations afloat, let alone growth at a maximum. Again, you might respond that growth is simply one mode a company might be in at any given time, and that might well be true assuming you can easily diversify, but I do feel as though something might be lost by an automatic assumption (not that this was your point, Steven) that certain kinds of companies don’t necessarily need someone with a strong operations background to successfully manage the institutions that may have more second- and third-order effects to any given decision.

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