The capitalist’s dilemma

N.B. The following are extracts from an article published in the Harvard Business Review in June, 2014 – it remains highly relevant today

Professor Clayton Christensen and Derek van Bever of Harvard Business School  have embarked on a fascinating study into what may be holding back growth in the USA and elsewhere given ‘corporations are sitting on mountains of cash but failing to invest in innovations which might foster growth’

They identify three different types of investment in innovation which have quite different impacts on the growth of jobs and prosperity:

  • Performance improving innovations which upgrade old products or services with new and better – these create few extra jobs as customers simply buy the new versions instead of the old
  • Efficiency innovations which help companies make and sell existing offerings at lower prices – they can even reduce jobs – they can also release capital for other more-productive uses
  • Market creating innovations which create whole new classes of customers, even sectors e.g. computers – the moves from mainframes to minis to PCs to smartphones – at the start, only a rich few could afford a computer – 50 years on, just about everyone can – such innovations usually generate many new jobs, both internally to meet the increased demand and externally in supply chains

 

Key features of these market creating innovations are also:

  • They have an enabling technology that drives down costs as volume grows
  • They reach many new customers who were unable to afford the first offerings e.g. Ford’s Model T

 

The problem is that companies invest mostly in efficiency innovations which often eliminate jobs, some invest in performance improving innovations which tend to maintain the status quo, and few invest in market creating innovations which generate most new jobs and so growth

Why so?

Because the financial measures and norms used to determine the attractiveness of investments are seriously flawed – RoCE, RoNA, IRR, DCF etc. all make market creating innovations appear much less attractive because they bear fruit in five to ten years and are risky whereas efficiency and upgrade investments usually pay off in one or two years and shoulder much less risk – and most venture capitalists prefer safe bets, not adventurous punts

Indeed, the average shareholding period for external investors is only about 10 months, which pressurises executives to maximise short-term returns (or else!)

However, one might expect longer-term investors, like Pension Funds, to press for more market creating investments to secure their longer-term returns needed

Not so

Most now suffer from depressed returns, unfunded commitments and longer life expectancies – their funds are not growing fast enough to meet their obligations, so they also look for quick payoffs

Hence the capitalist’s dilemma:

‘Doing the right thing for long term prosperity is the wrong thing for most investors’

The authors put forward some worthy suggestions on changes needed:

  • Tax financial transactions to reduce high frequency trading
  • Introduce rewards for shareholder loyalty
  • Wake up business schools to teach finance and strategy together, not separately as now
  • Establish measures/ tools to analyse innovation pipelines and identify opportunities for long-term growth creating investments

 

They sign off by quoting Peter Drucker: “The point of a business is to create a customer” and ask for contributions to help devise solutions to this dilemma ‘for the long-term prosperity of us all’

Over to you

 

 

Wolf explains UK productivity gap

The great financial journalist Martin Wolf of the FT recently opined about the current state of UK productivity – disappointingly, his words offered no new insights and were simply a regurgitation of current groupthink.

He kicked off with the now well-worn cliche from Paul Krugman about productivity being ‘almost everything’ – and then trotted out a bunch of statistics about population and productivity growth, the two factors which indeed determine national prosperity levels:

  • The working-age population stats could well be reasonably accurate, and show the UK has little potential for significant growth from that quarter
  • But the national productivity stats (GDP/ labour inputs) about the UK’s relative position versus other nations are seriously flawed – nevertheless, like most important commentators, he ignores this widely accepted fact and proceeds to draw conclusions based on them

 

He rightly points out that there are big differences between the performance of ‘the best and the rest’ in all UK sectors, and that such differences appear to be growing – “a slowdown in the diffusion of knowhow and slower elimination of zombie competitors” being the received wisdom – however, this does not explain why the UK is so much worse than most others

So what’s his ‘big aha’?

By simply comparing the UK with its international competitors (using more spurious data) he spots two fundamental UK weaknesses which explain most of the prevailing productivity gaps:

  • Lack of investment in capex – “physical investment in machines, buildings, ICT and R &D, is very low” – but how much more would be needed to close any gaps (£10bn, 100bn, 1000bn?) – and what of Robert Gordon’s claims that the days of major new productivity-improvement inventions are over?
  • Lack of investment in human capital – “skills overall remain highly deficient” – there is indeed a serious mismatch between the skills organisations need and what kids now study but nobody knows the size of these gaps, nor the potential % GDP and productivity benefits if they were closed, nor the amounts to be invested by whom – all we do know is too many kids (50% was the target) sally off for a very-expensive three year stint at university to graduate in subjects many employers don’t want

 

The biggest problem facing all organisations, and nations, is not lack of investment but lack of good performance measures and the knowhow to find and implement solutions to productivity problems and opportunities highlighted

At present:

  • Most have only some 20% of the performance measures they need – and they’re mostly financial
  • Most could improve productivity by at least 20%, some over 50%, either by upping output/ sales and/ or reducing inputs/ costs
  • Most do not need any major investment to get these results – instead, they should first focus on cutting existing waste and then optimising use of their existing resources, both of which could involve only modest extra investment in human capital and new systems
  • Only then should they consider any major investment in best practices and/ or new technology

 

The fact is most UK organisations (80% = ‘the rest’) perform well below their potential – they could make giant productivity improvement strides if only they had the right measures and knowhow – but such a message is the biggest elephant in the productivity room

 

MIRACLE solution to productivity puzzle?

The US is worried about the puzzle of their flat output/ GDP and productivity growth following the 2008 financial crisis, yet employment has risen

Likewise the UK and other G7 nations

They had all expected growth to ‘revert to trend’ by now and be at least 2% per annum, not approach zero as seems to be happening

Interestingly, all G7 nations are suffering in much the same way which must offer a clue as to what’s going on

Explanations offered by a variety of experts include:

  • M = Mismeasurement of GDP, a seriously flawed statistic:
    • GDP doesn’t count many of the things we value in life e.g. free internet services
    • And it counts incomes realised by financial and oil companies before allowing for associated costs later
  • I = Innovation – Major technological innovations have peaked:
    • Artificial Intelligence, driverless cars and Twitter are seen as no match for the gains made from electricity, the internal combustion engine and telephones – at least, not yet
    • But productivity can even dip upfront as new innovations are introduced but returns are slow to build – there can be a time lag between invention, trial and error, prototypes and launch through to widespread adoption e.g. electric motors and light bulbs had little impact over the period 1890 to 1920
  • R = The Rest – Vanguard firms continue to improve, the rest do not
    • Either there’s a lack of diffusion of transformational (digital) technologies from the best to the rest in all/ most sectors – it always takes time, often many years
    • If it’s truly general purpose like electricity or computers, most other organisations need time to be convinced and seek demonstrable proof before they ‘keep up with the Joness – then they take the plunge which can mean re-structuring and re-training of staff
    • Laggard firms,  including zombies, comprise some 80% in all sectors – most do little to try and catch up, not least because current very low interest rates put little pressure on them to become more profitable, even enabling some to stay alive rather than letting creative destruction do its work
  • A = Admin – Government/ EU regulations have been mushrooming:
    • Some say they’re stifling corporate efforts to improve
    • Others say well-intentioned social welfare programmes are keeping people from moving to better jobs
  • C = Capex – A slowdown in productivity-enhancing investments, much due to the corporate hangover still being suffered following the financial crisis as banks restricted lending whilst they shored up balance sheets and companies were concerned about uncertain economic outlooks, Brexit included
  • L = Labour – An influx of cheap labour has deterred many companies from investing in productivity-enhancing equipment and systems plus others have indulged in ‘labour hoarding’ to avoid high outplacement costs and in expectation of imminent demand rises
  • E = Exports – Outside the G7 there is a huge ‘Rest of World’ market waiting to be developed and itching to catch up rather than fall further behind – but exports still only account for a small percentage of total output

 

Each of the above probably has some impact on apparent national productivity levels, especially GDP mis-measurement, but none explain why there has been a dramatic slowdown ‘across the board’

As ever, as soon as there’s more than one (credible) explanatory variable for an issue, and no clear understanding about their interactions and effects, then it’s open season for all sorts of forecasts and explanations

Hence we get so many conflicting views from so many learned commentators

Basic steps to big improvements

There are various acronyms on offer for how to go about improvement projects viz:

  • PDCA from TQM – Plan, Do, Check, Amend
  • DMAIC from Six Sigma – Define, Measure, Analyse, Improve, Control
  • SREDIM from Work Study – Setup, Record, Examine, Develop, Implement, Maintain

 

All boil down to much the same process

Managers, whatever their level and team size, need to take just five basic steps to make big productivity improvements viz

1. Produce punchy corporate plans i.e. one page summaries for all employees – if they exist, they’re not seen or understood by most managers, never mind employees – most lie unused, gathering dust on shelves once written

2. Instal a set of performance measures – most managers have lots of measures but lack 80% of the measures they need

3. Analyse the potential to improve – most managers don’t know how to do this, not least because they don’t have good measures to start with

4. Run special improvement projects – again, most managers don’t know how to do this – and, if any projects are started by in-house teams, most run out of stamina to finish the course well before big improvements are achieved

5. Employ CI – Continuous improvement – most in the West ignore the huge benefits possible from seeking to improve any and everywhere, on a daily basis

It’s little wonder productivity improvement is slow at best, whatever the organisation – or nation

 

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Why do national productivity gaps persist?

Philip Hammond, UK Chancellor of the Exchequer, is forever saying: “It takes a German worker four days to produce what a UK worker makes in five”

Others say much the same about French workers

But such claims are not new, they’ve been made over the last 30 years at least

We already know the ONS data on which such claims are based are seriously flawe:

  • Whole sections of the economy are ignored, such as household activities or the consumer surplus obtained from freebies offered via the likes of iPhones
  • Other sections are difficult to measure such as public sector outputs so assumptions are made that their costs can be thought equivalent
  • And other sections take time to collect and verify all quarterly data so estimates are made which can involve significant errors

 

That said, many economists still think the ONS data is worthy of use, at least to indicate the order of productivity gaps and basic trends

Not so anyone else in the UK or G7 however, particularly managers who together are most responsible for a nation’s collective productivity performance

Hence, big national changes are never made, and apparent 20% productivity gaps are never closed – instead, G7 economies just continue to chug along at the same speed as before whilst their experts mutter about the need for ‘more capital intensity and greater investment in R&D’ to close any gaps

Shame on those managers, unaware and unconcerned about their individual productivity performance, never mind their nation’s

One things is for sure – it’s not their workers who are to blame – given the same working methods and gear, each nation’s workers are about as productive as each other, whatever the sector

It’s the mix of sectors in the different economies and the overall unemployment rate that makes the big difference between the UK and both France and Germany, say:

  • If one nation has more and bigger high-productivity sectors than another then the overall productivity of the former will seem much better than the latter
  • And if one nation has a lower unemployment rate (UK = 4.3%) than another (France = over 10%), if this percentage falls, previously unemployed workers (usually less skilled, less productive) will be mopped up by the market but this will lower the nation’s overall productivity level

 

It’s why Japan apparently has a much worse national productivity level than the UK, despite the many world-class manufacturers in their midst

Conclusions:

  • The apparent big productivity gaps between the UK and some G7 nations can be mostly explained by their different mix of sectors
  • Such mixes cannot be radically changed overnight – that will take decades if such changes are desirable, which might explain the persistence of the apparent UK 20% productivity gap
  • As long as the mix in each nation plays to its strengths, then productivity improvements may well be needed within each of their sectors, particularly in the long tail of companies usually found in each one
  • Huge opportunities to improve productivity would seem to lie everywhere