MANG452 Rise & Fall of Management Chapter 9
SEDUCTION BY THE NEW STRATEGIC MANAGEMENT
John Lombe’s first ever water powered silk mill was surely the product of strategic thinking, as was Arkwright’s cotton spinning mill. A century and a half later Henry Ford’s mass production of the Model T, established a virtuous cycle of massively reduced costs through standardization and mass production, enabling the decimation of automobile prices, thus creating the new mass markets to justify the new factories. More recently Microsoft, Apple, Intel, Amazon and Google, just as examples, have similarly blazed new ways ahead which surely represent the successful pursuit of strategy.
They all applied common sense to their business situations, as have so many other successful entrepreneurs. They did not have, and seem not to have needed, any formal knowledge of strategy as it is now taught in business schools. They were confronted with problems that needed solutions. They were not looking for intellectual challenge for its own sake. And they managed without all the panoply of analytical methods, models and tools and techniques now available.
Chandler focused on diversification as strategy. Successful companies were constrained by anti-trust legislation which limited their ability to dominate their markets, prevented competition reducing acquisitions and sometimes resulted in companies being broken up if they became too dominant by organic growth. Growing businesses were therefore forced to diversify into new markets and new activities. Prior to the 1960s, diversification was the only aspect of strategy formally acknowledged in management literature and even then standard dictionary definitions of strategy were still only expressed in military terms as ‘generalship’ or ‘ the art of war’.
Subsequently the formulation and implementation of more general strategic plans began to diffuse across industry, such strategy being defined by one leading exponent as:
‘ the pattern of decisions in a company that determines and reveals its objectives, purposes, or goals, produces the principal policies and plans for achieving those goals, and defines the range of business the company is to pursue, the kind of economic and human organization it is or intends to be, and the nature of the economic and non-economic contribution it intends to make to its shareholders, employees, customers and communities.’
Strategic management was quickly adopted by leading firms of consultants as well as business school faculty. It was invested with some theoretical ideas and made amenable to quantitative analysis and became fashionable.
But the question remained as to its true substance. On the basis of his forty year career at General Electric including two decades as CEO, Jack Welch expressed his doubts as follows:
‘Forget the arduous, intellectualized number crunching and data grinding that gurus say you have to go through to get strategy right. Forget the scenario planning, year-long studies, and hundred plus page reports. They’re time consuming and expensive, and you just don’t need them.
In real life strategy is actually very straightforward. You pick a general direction and implement like hell.’
However, picking a general direction and implementing like hell was not widely regarded as an adequate resolution of the strategy problem. It didn’t satisfy the early specialist practitioners of the art nor the academic faculty who quickly engaged with the subject. It appeared to be a new and fertile field of management expertise engaging both consultants and academic faculty. By the late 1970s, its importance was becoming recognized and it achieved a leading position on the business school curriculum, attracting both high profile faculty and substantial funds for its research. This is what is referred to here as the new strategic management which replaced the old version, ‘picking a general direction and implementing like hell’.
As an academic subject, it lacked provenance of any significance. In the spirit of true academic endeavour, faculty therefore sought to discover both strategy’s history and its underlying theory. This discovery research was not carried out with the aim of improving management practice, but of raising the status of strategic management as an academic liberal arts subject within the perceptions of their academic peers.
The earliest exemplars of writing about strategy date from around the fourth century BC. Sun Tzu was then scratching ‘The Art of War’ on strips of bamboo when China was divided into eight competing states and a number of minor principalities which were enduring a nightmare of lawlessness and chaos. War was conducted more as a way of life, a purposeless ritual governed by arcane rules and presided over by hereditary amateurs, punctuated by battles resembling disorderly mêlées which rarely produced a clear result.
Sun Tzu recognized the futility of such warfare. He argued that war, which was always costly, should only be conducted in order to achieve a ruler’s political aims. Generally, these would be related to the survival, security, expansion and/or prosperity of the ruler’s state. For Sun Tzu there was no place for war for its own sake, or total war which would only be terminated on the complete destruction of the enemy. Such total war was unknown till the 20th century.
Accounts of Philip and Alexander’s strategy at the battle of Chaeronea, around the same time, have also been referenced in the modern strategic management literature. Machiavelli too has received some attention, but the next major contribution was in the early decades of the 19th century when von Clausevitz contributed ‘On War’. At around the same time in the United States the US Military Academy at West Point began teaching the military subject from its then curiously limited experience.
More recently Liddell Hart’s ‘Strategy’ apparently drew the comment from Rommel (German high command in the Second World War) that
“the British would have been able to prevent the greatest part of their defeats if they had paid attention to the modern theories expounded by Liddell Hart before the war.”
Military strategists tended to be methodical rather than theoretical, producing pragmatic and prescriptive guidelines as to how things should be done in order to achieve victory. Much of what passed for military strategy was devoted to what might more appropriately be regarded as tactics. Bulow defined strategy as relating to military movements which were beyond the enemy’s cannon range or range of vision; tactics being such movements as were within that range.
Overtaken by technology, the distinction between the strategic and the tactical or operational remained. Clausewitz argued that strategy was concerned with using battle for the purposes of war, which was ‘simply the continuation of policy by other means, while tactics were concerned with the use of armed forces in battle.
Military strategists produced many much quoted gems concerning the conduct of warfare, the relations between the sovereign and the general and the management of armies. Sun Tzu advised generals to be subtle and insubstantial, silent and invisible. In order to win you must know when to fight and when not to, and you must know how to use both large and small forces. Moreover, a successful general must be able to unite all his troops to focus on achieving the purpose of the war. The prescriptions were translated in such general terms that they could be readily applied to modern business situations.
Though winning without fighting was perhaps the most widely quoted of Sun Tzu’s ideas, most were actually concerned with the conduct of battle. He was concerned that generals should know and understand all they could about the enemy and the environment as well as the strengths and weaknesses of his own forces. He emphasized that war and its battles were conducted only so as to achieve the political objective which was passed down to the military; it was not for the military to define the strategic objective.
The parallels between war and competition have been widely recognized and Sun Tzu’s argument for what he referred to as ‘moral action’ motivated by enlightened self-interest seen as potent. Moral action drove relationships between different stakeholders such as the ruler, the general, the officers, the troops and the local population, not just between states. Such relationships were built on trust, and Sun Tzu advocated only the pursuit of objectives which could gain the enthusiastic support of all stakeholders. Such a leader would have to be ‘wise, sincere, humane, courageous, and strict’ a combination of characteristics with which Barnard, Brown, Drucker, Welch and many others may well have agreed.
Clausewitz was also concerned with ‘such imponderables as the soldiers’ morale and the commanders’ psychology’ and even Machiavelli held that, ‘you will still need the goodwill of the people to keep a principality’. Strategic aims, either an extraneous given, or a management decision, would not be achieved if the people in an organization were not acting in their pursuit. The effectiveness of the strategy process was dependent on the people in the organization, whether an army or a business.
Though military strategy did not offer a coherent body of theory applicable to modern non-military organizations, it did identify a simple strategy process, implicit in the writings of Sun Tzu, Clausewitz and others. The process started with the definition of the aim. This was the starting point for all the military strategists, given to them by their political masters. Sun Tzu then suggested success would depend on knowing the enemy, yourself, the ground and the weather. He emphasized the importance of military intelligence in gathering all this knowledge and understanding. Finally, based on this understanding, decisions were necessary as to the appropriate action to be taken. This then boiled down to a deceptively simple process which could be generalized as “objectives – external analysis – internal analysis – action”. This four stage strategy process was subsequently detectable in most published approaches to strategy.
Strategy’s history was almost entirely military and not very profound. It hardly satisfied the needs of academic faculty any more than did Jack Welch’s dismissive summary. Academic interest was therefore drawn to consider the possibility of underlying theory. Theory is perhaps a rather portentous term to describe the relatively lightweight underpinnings of strategic management. They ranged from practical routines, or even checklists, to those approaches extracted from economic theory.
The entrepreneurial model, for example, rested on the entrepreneur’s originating identification of a customer need that the business was set up to satisfy in some way better, or at less cost, than existing competitors and the development of special capabilities to maintain and develop that superlative mode of satisfying the customer need.
The life cycle model adapted from general systems theory was based on the phases of birth, growth, maturity and decline through which all systems processed. It suggested the purpose of all systems was to achieve and maintain maturity, since that was when systems achieved maximum and most efficient energy conversion. In business terms, it was the phase in which most profit and most surplus cash were generated. The objective of the life cycle model would therefore be to ensure a succession of products or businesses which achieved the leadership position in their markets during their maturity phase. To do this would require knowledge of when the life cycle phases were going to occur, in particular when the growth phase would change to maturity. Such directional changes were notoriously difficult to predict; forecasts tending to be based on a continuation of current trends. Understanding the shape and size of the industry life cycle and the particular company’s position on it would therefore be important in deciding the appropriate action to ensure leadership ahead of the change of phase to maturity.
The initial portfolio model introduced by the Boston Consulting Group in the 1960s also followed the four stage model. Its aim was to achieve a lasting and balanced portfolio of products or businesses. Its external analysis was concerned with the growth rate of the market and the position of the company’s leading competitor. Internal analysis was focused on measuring the company’s experience, relative to that of its leading competitor, in producing and selling the product. And the actions were focused on decisions to buy, sell or hold products or businesses.
Porter’s ‘competitive strategy’ applied microeconomic theory to what he referred to as ‘industry analysis’. Being based on economic theory, the model implicitly assumed profit maximization as the ‘strategic’ objective. The model was based on the not too profound equation that profit is equal to income less cost. Therefore, maximizing profit involved achieving either the lowest costs or the highest prices.
His external analysis assessed the extent to which the arcane assumptions of perfect competition applied in a particular market: the intensity of competition between existing competitors; existence of barriers to entry to and exit from the market; existence of substitute products; bargaining power of suppliers and customers. Porter’s internal analysis focused on the direct and indirect activities of a firm and assessed the cost of each activity and, as though it was possible, the profit margin which each such activity contributed.
Strategy, for Porter, was then simply a matter of breaking out of the assumed position of competitors in a competitive market, for example by achieving lower costs or higher prices, or by focusing on a less competitive sub-segment of the market where some monopolistic characteristics might be achieved.
A rather more sophisticated application of economic theory to business strategy was achieved through the ‘resource based’ approach. The weight of resource based strategy was on the acquisition, development and exploitation of difficult to copy resources which might be the source of sustainable competitive advantage. The foundation of this approach lay deep within economic theory, going back to Ricardo, and was initially brought to the knowledge of academic strategists through the work of Edith Penrose in 1959. It was later developed by Wernerfelt and others in the 1980s and consistently promulgated in the pages of the Strategic Management Journal. As the importance of off balance sheet knowledge based resources increased so the resource based approach has become more pervasive. All it lacked to become the overwhelmingly dominant strategic model among consultants, academic faculty and practitioners alike was some fashionable language and a memorable graphic.
A more widely used and quoted strategy model was that outlined by Prahalad and Hamel which straddled both resource based and market based approaches. This model went beyond the simple economics of profit maximizing and acknowledged and responded to the importance of people in the achievement of strategy. The four stage process was implicit in their approach: the strategic aim or intent being to beat competitors, external analysis involving a focus on technologies and competitors, internal analysis focusing on what they referred to as ‘core competencies’. The strategic action for Prahalad and Hamel was to develop and exploit the ‘core competencies’ and create new ‘competitive space’ by a process of ‘leverage and stretch’. This model not only analyzed both markets and resources but its strategic action endeavoured to address progress in both, through the motivation, if not inspiration, of people.
The above brief outlines serve largely to emphasize the simplistic nature of strategic management theories and to confirm their adherence to the generalized four stage strategy process. General systems theory, microeconomics, portfolio theory and resource based theory all provide ample opportunity for interesting complication, but the reality is simple and is not at all dependent on quantitative sophistication or deep qualitative analysis. Practitioners were influenced by these various models with differing, though limited, strategic effect.
The most significant effect of the new focus on strategic management was to disengage top management from the day to day problems of running a business. Day to day management was concerned with the needs and aspirations of employees and customers, and the potential for technologies to satisfy those needs and aspirations. The focus of strategic management was quite elsewhere.
Long Range Planning in Practice
Management’s focus on strategy was born of necessity. The most successful of the large diversified companies which had been studied by Chandler, typically, had small central head quarters taking decisions relating to the allocation of scarce resources between business activities, decisions that could not be avoided. Initially this allocation role was achieved through a process of capital budgeting which agreed planned capital expenditures usually over a five year time horizon.
Agreeing how to allocate resources between businesses necessitated those involved in the agreement to have some knowledge and understanding of the relative merits of the different candidate businesses. Business merits might logically include such issues as the inherent profitability of the business, its forecast future growth, the level and rate of its technological development, and some perception of the risk levels involved. Moreover, knowledge and understanding must also include some awareness of the relative strengths of the business within its industry in terms of its market or technological position.
The agreement of a ‘long range’ plan of capital expenditure, critical as it was to the direction of a business, also had other ramifications. Expenditure on capital items when funds were limited could reduce the level of funding available to other business activities. Additionally, though it might have a beneficial impact on a firm’s ability to maintain its position technologically and in the market and therefore to survive and prosper in the long term, the short term profit impact of capital expenditure was invariably negative. It was widely held that major capital projects took around seven years before they produced the same level of profitability as an existing business; for completely new diversified projects the delay could be considerably longer.
It was only a small logical step to extend such capital expenditure plans to full five year projections, involving not just capital expenditure but also full forecasts of the profit and loss account, balance sheet and cash flows. Such long range financial plans became fashionable in large diversified businesses during the 1960s. At that time, electronic data processing was in its infancy. There were no personal computers and spread sheets. Database type programmes had been custom written for particular purposes, but were not generally available even on mainframes. Research universities, for example, devoted space to ‘statistics laboratories’ which had suites of physically huge calculating machines, far less powerful than a $5 pocket calculator of today, and which required a trained engineer to reset a machine if a user ever were to divide a number by zero. Computer programmes were still typically entered on punched cards for input to the computer. Though there were exceptions, for the most part mainframe computer systems were occupied in such administrative tasks as payroll calculation, order processing and inventory control.
Under these circumstances the development of a five year corporate plan for a business of any complexity was a huge clerical task, carried out, or at least supervised by, professional planning specialists then starting to be turned out by America’s leading business schools. The completion of the corporate plan based on detailed five year forecasts of all the inputs, showed a projection of profit and cash flow, the ‘bottom line’ of which may well not at first have been an acceptable result. Changes would have to be made, possibly the growth forecast increased, or capital expenditures delayed, in order to produce an acceptable projection of business performance. The recalculation of the five year plan would involve the same manual accounting labour as the original. Recalculation three or four times or more became an annual nightmare requiring armies of accounting clerks working excessive hours of overtime to achieve rather pointless deadlines. The whole process had little to do with strategy and had limited impact on the way a company developed. The alternative approach was simply to miss out the whole planning process. Though equally short on strategic implications, this at least avoided the substantial costs and time wasted generating the plan.
However, the process did have some implications. Firstly, since the plans themselves were written in financial language, the importance of accounting was substantially raised in those companies which engaged with long range financial planning. Secondly, it was not immediately obvious how devoid of strategic impact the plans were. They looked as though they mattered, projecting as they did the company’s performance over a five year period. They appeared to flag up potential problems and issues and helped with ‘strategic communication’ across the organization. They made the alternative, not planning, seem unprofessional and even irresponsible. Especially was this so as the financial projections were supported by qualitative analysis of the threats and opportunities facing a company and its strengths and weaknesses in dealing with the threats and opportunities. From this SWOT analysis then programmes of action could be specified which went far beyond long range capital expenditures and five year budgets. Thus a complete Ansoffian bureaucracy was created with the inevitable resulting in what Mintzberg aptly described as ‘paralysis by analysis’.
A further more insidious impact of the new emphasis on long range planning was to move the centre of gravity of management a little further away from the fundamental preoccupations of management with the resources at its disposal, notably its people. Managers who supervised the development, manufacture and marketing of physical products or services appeared to be distanced a little further from the top of large businesses where the important ‘strategic’ decisions were made. Those that headed up big companies, at least in the Anglo-Saxon world, were drawn not from those with industry specific specialist technological training and graduate level expertise but more probably from those with higher level business school degrees or professional qualifications in accounting or the law. These appeared better fitted for assessing and deciding the sort of deals which the business portfolio approach required.
The leading management consultancies, such as Boston Consulting Group, McKinsey and Company, Booz, Allen and Hamilton and A T Kearney, were at the forefront of developments in strategic management. While practitioners laboured with the bureaucratic monster that their accountants had created, the consultancies offered streamlined versions which assisted management to focus on the key strategic decisions which were still seen as related to the allocation of resources.
The first consultancy model to achieve almost global acceptance was that devised by Boston Consulting Group based on its interpretation of learning curve data analysis for twenty four undifferentiated commodities (eg transistors, diodes, crude oil, pvc, etc). Boston found, not surprisingly, that the more of a commodity that was produced by an industry, the lower the cost of its production. They were more precise about the commodities they chose: unit costs reduced by between 20% and 30% every time total cumulative production doubled. In young fast growing industries, total production would be doubled quickly and costs therefore also reduce quickly. In mature slow growth industries, the reverse would be true. The competitor with the leading market share of a fast growth industry would enjoy fastest decline in costs and therefore, assuming a set market price as would be the case for a commodity product and all other things being equal, they would be the most profitable competitor in that market.
This was hardly revolutionary. Empirical evidence from the Strategic Planning Institute’s PIMS (Profit Impact of Marketing Strategy) database had been published indicating a similar finding:
‘a business’s share of its served market (both absolute and relative to its three largest competitors) has a positive impact on its profit and net cash flow.’
Boston went further, even developing a differential equation for evaluating the net present value of an increment in market share, the spurious precision serving to camouflage the crude approximation or fundamental inaccuracy of the basic market share / profit relationship.
Drucker challenged the relationship pointing out that in many industries,
‘the largest company is by no means the most profitable one … the second spot, or even the third spot is often preferable, for it may make it possible for that concentration on one segment of the market, on one class of customer, or on one application of the technology, in which genuine leadership often lies.’
From this simple if dubious foundation, the first portfolio model was derived. It enabled business headquarters to decide the allocation of resources on the basis of just two business characteristics: the growth rate of the served market, and the market share of the business relative to its largest competitor. These two dimensions defined a matrix divided into four quadrants and according to where a subsidiary business was positioned on the matrix so resources would be allocated to it. If it were high growth, it would consume a lot of cash just to keep up, but if it had a high share of that market, it would generate cash also (Boston labelled such as ‘stars’). If it had a small share, it would be a net cash consumer (‘problem children’). If the business served a mature low growth market, it would not consume so much cash, but if it had a low relative market share it wouldn’t generate much either (‘dogs’), though if it had a large share it would be a net cash generator (‘cash cows’). The position on the matrix therefore enabled strategic management to categorize their various businesses: those to invest in, those to draw cash from, those to try to improve and those to be closed down or sold off. Those are the standard portfolio decisions of ‘buy’ (ie increase investment), ‘sell’ (ie reduce investment) and ‘hold’ (ie maintain investment).
These were important decisions for strategic management, and portfolio models – Boston was the first of several similar – enabled them to be taken on purely clinical objective grounds and at the same time cut the bureaucracy involved in the former financial planning system. At least that was how it was intended.
The reality was that it crystallized the divide between top strategic management on the one hand and day to day operational management on the other. Adoption of the portfolio system announced the rules of a strategy game which were as transparent to the subsidiary business managers as they were to the strategists at headquarters. Managers whose businesses were identified as ‘dogs’ would naturally wish to change that designation in order to increase financial support from the centre. A simple way to do this was to change the definition of the served market so that it could be seen as a higher growth segment. All subsidiary management strategic effort would therefore be devoted to convincing top management of the new definition. Strategic planning therefore became a field of combat between strategic and operational managers, a dichotomy further exacerbated by the establishment of business school educated elites set up in headquarters’ corporate planning departments, who had limited contact with the people and issues of general management and no necessity for talking directly to labour, yet being directly influential with top management to whose jobs they in due course succeeded. The more mundanely educated and industry trained operational line managers thereby lost expectation of succession to the top.
A further reality was that no business could be adequately understood simply through knowledge, even if it was accurate, of just two variables: market growth and relative market share. The decisions based on this partial understanding, or misunderstanding, were therefore likely to be seriously flawed. Nevertheless, the Boston portfolio successfully diffused through 1970s industry, and was the basis of many business divestment and closure decisions. As noted by Drucker and others, many of the divested businesses turned into exciting successes once freed of the portfolio-instigated repression.
Adopting the portfolio approach to strategy changed the nature of business itself. The strategic focus was no longer on the development of a coherent business which might satisfy the long term needs of its stakeholders. The new emphasis was on creating, realizing, or even ‘squeezing out’ shareholder value, an ambiguous concept relating both to the firm’s market capitalization and its ability to pay dividends, frequently interpreted as being a short term, even immediate, concept, which certainly did not refer to management’s responsibility to be concerned with the survival and long term prosperity of the company as an autonomous entity.
The new strategic management role was to divest ‘dog’ business units, cut out surplus or underused assets where possible, identify and acquire under-valued assets or businesses and ‘improve’ them by cutting out any costs, such as R&D, which did not have an immediate payback. The relatedness or industrial logic of such combinations of business units in a portfolio was not of great concern since membership might only be temporary. The centre would limit its involvement in the business units to identifying surplus assets and deploying specialist ‘locum’ managers to sort out underperforming businesses, or organize their disposal or closure. Thus a deal making mentality was established.
Such a portfolio business would minimize the costs of the centre by having only a small corporate staff, with business unit CEOs having a high degree of autonomy, being paid substantial bonuses for achieving clear financial targets with the expectation of low rewards, or loss of position, if targets were not achieved.
Such portfolio based strategic business management was the first of many approaches to strategy implemented by the consultancies and adopted by academic business school faculty. Subsequent models added to the number of input variables and finessed the outputs beyond Boston’s simple prescriptions, but the variations were of limited practical significance. Though the models became increasingly complex and apparently more precise in the spirit of Boston’s own differential equation valuing market share, in truth the analysis remained crude and inaccurate, creating more the false impression of additional understanding, rather than any genuine new insight. However they clearly increased the focus on mergers and acquisitions.
Mergers and Acquisitions
Mergers and acquisitions (m&a) was the commonly used term, acquisition being where firm A acquired more than 50% of firm B, and merger being where firm A and firm B joined forces to create firm C which was a new legal entity. Though the term m&a has persisted, the vast majority of such transactions have always been in the form of acquisition rather than merger.
Economists noted that new industries quickly attracted lots of small competitors which persisted through the industry’s main growth phase. Then when growth slowed and the industry embarked on its mature phase there was a shake out period with some firms leaving the industry and many others consolidating through m&a to form a smaller number of bigger operators. These then continued till the industry went into decline when there would be a further fall out period of m&a leaving only a small number of competitors to dominate what was left.
Competitors engaging in the process of industry concentration through m&a might be driven by industrial logic. If competition law allowed, firms could achieve an improved market and technological position more rapidly by m&a than by normal organic growth. This would allow firms to achieve economies of scale in production, distribution and promotion as well as add to their financial strength and might also provide access to strategic patents and other intellectual capital. On the other hand, if prevented from that strategy by anti-trust legislation, firms would be forced to pursue their growth by diversifying away from the existing industry and would therefore acquire an established position and expertise in a new industry participating in its concentration process.
Such m&a had occurred in waves, in the United States the first being around 1897-1904 seeing a great industry concentration with the formation of, for example, DuPont, International Harvester, US Steel among many other newly formed big businesses. This occurred despite the Sherman Antitrust Act of 1890. A second wave of horizontal industry concentrating m&a lasted from roughly 1916 till the Wall Street crash of 1929. After that m&a activity remained subdued for around three decades till a substantial wave of diversification and conglomeration m&as in the 1960s saw the formation of such firms as ITT, Gulf & Western, Litton Industries and others.
Parallel waves of m&as were experienced in Britain where, by the late 1960s, a form of acquisitive financial conglomerate (AFC) was emerging, largely controlled by individuals who had achieved a substantial element of ownership. Some of the AFC activity undoubtedly resulted in the turnaround of underperforming businesses. The true extent of such improvements is difficult to estimate, but its possibility is a justification for AFC activity which has often had a wholly negative effect both on the acquired business and the economy as a whole.
Companies managed by autonomous management, independent of both capital and labour, still prospered, but the new AFCs mingled among them. The AFC owner-controllers referred to themselves in the language of entrepreneurship. Their focus was not however on building a lasting enterprise, but rather more on achieving substantial personal wealth at the expense of other stakeholders. They were becoming more sophisticated in their relationship with the stock exchange, learning how to engage in creative accounting to boost price earnings ratios and therefore raise their share’s price above sector average levels to better equip them for aggressive acquisitions.
Similar developments were apparent in the United States where in 1973 the first substantial hostile deal was completed with the merger of Inco-ESB followed by United Technologies hostile acquisition of Otis Elevator and the Colt Industries take over of Garlock. By the mid 1970s, hostile take-overs had become a substantial part of m&a activity and new ways of achieving hostile deals were being developed, aided by the professional advice and participation of investment banks.
The first British wave of ‘asset stripping’ acquisitions was underway from the early 1970s. Slater Walker Securities, for example, was the centre of one network of acquisitive satellites, whose main function was to acquire companies, dispose of disposable assets, frequently for a large proportion of the original cost of acquisition, ‘release’ the people who worked the assets, and retain, in most cases, just the core of the acquired business. This was held on a tight rein, starved of research and development and severely restricted in capital expenditure, before going on to the next big deal. Slater Walker was one of several such AFCs. Jessel Securities, Trafalgar House, Hanson Trust, Lonrho and many others were at that time in the same category. While business success required commitment to an industry, its technologies, its customers and suppliers and to achieving leadership within that setting, AFC success was dependent on having no such commitments but a willingness to move in and out of industries without hesitation if the immediate balance sheet impact was advantageous.
The distinctions between AFCs, and corporations driven by industrial logic were best made by simply identifying which strategy was dominant: wealth creation or wealth ownership. From the macro perspective of the economy as a whole, it was clear that wealth creation was of greater importance. Provision for health, education, defence and social services were all financed by the proceeds of wealth creation and strategies for wealth creation. By comparison, wealth ownership provided few wider benefits. Indeed it was likely that the financial focus of firms driven by wealth ownership was likely to reduce wider benefits. This arose not only from the short term cost cutting focus which led to immediate rises in unemployment, but also to disinvestment and a direct focus on tax avoidance as a major component of corporate strategy and in some cases the prime reason for acquisition, for example Trafalgar’s acquisition of Cunard, or the more recent machinations of private equity groups to reduce and avoid tax liabilities.
AFCs proved to be a short lived means of enriching their founding owner-controllers, rarely outlasting the demise of their founding entrepreneur. Leading AFC operator of the time, Sir James Goldsmith, suggested the fate of all AFC’s would be to die with their founders.
The fourth wave of American m&a activity, from 1984-89, had similarly little to do with industry concentration or industrial logic of any kind. It was characterized by ‘the use of aggressive takeover tactics, leveraged buyouts and junk bond financing.’ The character of this m&a wave, like that of the British asset strippers of the 1970s, was driven by the accumulation of personal wealth at the expense of the other stakeholders and the destruction of the companies which fell victim to their raids.
This financial and non industrial approach to m&a action, though punctuated by the bear markets of the late 1990s continued through till the collapse of the credit bubble in 2007/8. The means of financing became more sophisticated and the avoidance of taxation more comprehensive, but the fundamental activity, the purchase of company shares funding for which was ultimately charged to the acquired company, the disposal of assets and people and the accumulation of substantial wealth by the business owner-controller-speculators remained fundamentally unchanged since the 1970s.
Drucker’s views on hostile takeovers were clear:
‘If enough stockholders take what amounts to a bribe, the raider captures the company and quickly unloads on it the debt he incurred in the takeover … the victim ends up paying for his own execution. … Fearful of raiders, companies began practicing defensive capitalism … More and more of our businesses … are not being run for business results but for protection against the hostile takeover …The fear of the raider demoralizes and paralyzes.’
The changing of management control without ownership to owner-controlling speculator was facilitated by the new top management strategic perspective which emphasized deal making for quick results rather than the painstaking and progressive building of a business for the benefit of all stakeholders. The result was to ‘hollow out’ many traditional businesses leaving them without the resources which had been painstakingly accumulated over the years, but burdened with massive debt and unable to withstand even small downturns in demand without large scale redundancy.
It was in large part justified by the promulgators of the new neo-classical economic theory expounded by von Mises, Hayek, Friedman and others who emphasized the importance of business to maximize shareholder wealth, shareholders being the owners of the private property which was the company.
The deal making mentality and the focus on realizing and squeezing out value so as to make as much money for shareholders as possible led inevitably to the possibility of outsourcing ‘non-core’ activities previously completed within the company. The potential benefit might arise from the activity being completed better and at lower cost by specialists. Moreover it might enable some of the assets involved to be sold and the proceeds either re-invested more profitably elsewhere or returned to shareholders. Drucker himself argued for outsourcing on the grounds that mundane jobs such as cleaning which offered no career structure if done in house, might present opportunities for promotion if conducted by a specialist cleaning business. Outsourcing could therefore be good for the people involved.
Not only that but the new neo-classical economic theory had a sophisticated theoretical argument in transaction cost economics which supported outsourcing to ‘the market’ to provide goods and services if they could not be done better or cheaper in-house.
An early example of outsourcing was to management consultancy. Firms needing special expertise to solve a particular issue would not necessarily wish to employ that expertise permanently just to provide a one off solution. Fred Taylor may have sorted out the best way to move pig iron, but Bethlehem Steel would not necessarily wish to retain his services as a permanent employee.
By 2004, management consultancy had grown to become a £115bn a year global business, Britain alone spending over £10bn. Spending on governmental and not for profit consulting in Europe was £8.1bn, of which £1.9bn was in Britain. Various studies have indicated a high degree of waste involved in this vast expenditure, as much as 60% wasted because it was not implemented or not needed in the first place.
Moreover, the waste was not limited to ineffective assignments. The consultants learned a lot on every job they undertook. Their careers developed through these invaluable experiences gained at the client’s expense. They came, they learned, they charged and they took all their experience and learning away with them. And they left behind a management that was little the wiser for all the experience generated by the assignment, and probably including key members of the organization who were more than a little disenchanted by the exercise. Furthermore the use of consultants by top management who were becoming increasingly remote from day to day operations, only served to increase that distance and reduce the level of trust between the top and operations.
If an assignment was completed in-house by permanent staff, it would have been an opportunity for the organization’s own people to gain a broader experience than they would ever have gained in their normal daily work. The benefit of this would be difficult to exaggerate: working on just one change assignment would have inculcated a critical approach to work. It would have invited people to challenge the accepted ways of doing things and to develop better ways and, most importantly, of implementing those improvements. That way, not only would the disenchantment have been avoided, but the learning would have stayed in house. Moreover, the prospects of successfully implementing a solution would have been maximized if it were the organization’s own people who were responsible from start to finish. Even if the right person, or people, were not available in the company to undertake the project, it would still most likely have been cheaper to recruit than to pay consultancy fees. In that way the skills and capabilities of the permanent staff would have been enhanced and they would have embarked on a morale building virtuous cycle of improvement.
Elements of these positive and negative aspects of outsourcing are inevitably present in most such decisions. The Friedmanite insistence on the unavoidable inefficiency of public provision led in Britain to the mandatory tendering of many public services, notably within the National Health Service. But the problem in such private public provision was predictable in the clash of cultures. Cleaning hospital wards may be done cheaper by a profit oriented organization, but less thoroughly. The rise in infections such as MRSA, which coincided with this outsourcing, resulted in the new mega-hospitals becoming, in the public mind, centres of disease and infection rather than being associated with the improvement of health and curing of disease.
Nevertheless, there are some real potential benefits from outsourcing. Offloading responsibility for back office activity and getting it done at lower cost by specialists could allow a firm to focus all its attention on the core activity in which the firm has a distinctive competence which is the source of its competitive advantage. But the motivation for outsourcing is confused. The practical costs and benefits may not be persuasive one way or the other. But the opportunity to realize some assets provides a short term benefit for shareholders which may often be the main justification.
The danger is that outsourcing can become a syndrome, the immediate benefits obscuring longer term effects which may well be overwhelmingly adverse. The decisive issue is the integrity and motivation of those deciding on the outsourcing: is it for short term cash benefit of shareholders, or for the long term best interests of the organization and its stakeholders?
Automating Middle Management
Most of the specialist areas of management outlined in chapter six have since benefited from advances in IT and computer systems as well as web based facilities. Some functions, such as materials control, production scheduling and control, order processing and quality management and management accounting have been largely automated with the need for discretionary decisions becoming almost peripheral. In other areas, notably in marketing and marketing research IT systems have been largely supportive.
The first steps in this automation process were taken in the 1960s when computers replaced punched card accounting machines in stock control, payroll, maintenance of personnel records and the like. From there it was a short step to envisaging all management information being automated in a single integrated management information system (MIS) which would record, control, simulate and report whatever was asked of it. However, the benefits from such systems proved elusive and the attempts at their implementation were expensive in terms of both hardware and software development and their operation frequently in excess of hardware capability.
The more practical way forward was to attack sub units of such a system. Initially this was done by systems analysts capturing the essence of existing manual systems which was subsequently programmed in one of various computer languages. It was a laborious process, subject to considerable error of both systems analysis and computer programming. Such custom written systems were subsequently replaced, in all but the very largest systems, by standard packages incorporating all manner of facilities which could be accessed for any particular application.
These standard programmes started off in manufacturing with separate stock control and order processing systems. They were subsequently integrated and combined with production planning and purchasing modules to form what was referred to as a materials requirements planning (MRP) system. The aim of such an integrated system was to replicate the management responsibilities of planning the purchase of materials, scheduling production activities, providing delivery schedules to ensure materials and products were available for production and delivery to customers, and consistent with that, maintaining the minimum levels of inventory and work in progress.
Further development of MRP as MRPII saw the added ability to handle monetary quantities including standard cost information which allowed the system to automate product estimates and quotations, analyze and report cost control information and provide the primary inputs to the management accounting systems as well as provide some business planning facilities.
These computerized systems, so long as the information fed into them was accurate, provided better inventory control and production scheduling which enabled improved delivery performance to be offered to customers. In addition, they also offered better quality control information and so improved quality at the same time as optimizing inventories and work in progress which reduced working capital requirements and enabled faster production and delivery. But as with all computer systems their success depended on the quality of data inputs: garbage in – garbage out.
MRPII was developed a stage further with Enterprise Resource Planning (ERP) which is still in use in 2009, based on a single common database holding all the information needed for a comprehensive set of business functions including manufacturing, supply chain management, full accounting and financial planning, human resource management and customer relationship management (CRM), vestiges of which are experienced by all customers of modern internet based suppliers such as Amazon.
ERP is a modular software system rather than the originally envisaged management information system which was designed from the beginning as an integrated whole. ERP is intended to allow all business departments to store and access data in real-time. Standard ERP modules provide a wide variety of facilities so that any particular business can make use of what ever particular modules or combinations of modules are needed to control and improve the processes of their particular business. Problems arise when standard modules do not quite meet requirements and custom written code is added which is not accommodated by subsequent versions of the standard product. For whatever reason, it is common experience that such computer based systems still appear prone to error and under-performance which short comings multiply as the scale of system increases.
This brief explanation shows how progressively, and with mixed results, middle management was to a substantial degree automated out of existence, and with it were lost the real training grounds for future top management. Drucker had argued for the decentralization of large scale business largely so that young managers might be trained and given experience in real decision making and having real responsibility without taking company threatening risks. But the automation of management in these various functional areas destroyed many of these job training possibilities. The ever flattening corporate management of the 1990s left Drucker concerned that the leadership-development purpose of decentralization was in the course of being lost; as he put it himself: ‘flat organizations don’t permit managerial farm teams’.
Automation also changed the nature of the management task. Purchasing, materials control, production control and the other functions which were computerized still needed managing to ensure their satisfactory performance, but their management had become more technical and less inter-personal.
With such changes in management work becoming more pervasive and the consequent removal of opportunities for on the job training, managers were necessarily drawn increasingly direct from business schools and research universities with a management qualification such as a first degree in business studies or an MBA, but limited practical experience. Furthermore the management degrees were taught by academic faculty who themselves lacked practical experience, now being third and fourth generation academic management teachers, subjected to assessment according to academic criteria and who therefore found it necessary to use management texts replete with case studies and ‘practical’ exercises written by other academics similarly lacking in practical experience. And it was from these ranks that top managers had to be appointed, having had much less contact with real problems and real people in the workplace.
Strategic Management Mindset
The change in perspective from general to strategic management was fundamental to management’s fall. Paradoxically it resulted in a change of perspective from the long term to the short. Hayes and Abernathy reported in 1980 how American managers’ focus on short term costs rather than long term technology, and using analytical detachment rather than hands on experience, was leading to what they referred to as a ‘disinvestment spiral’ where investment in new technology was delayed or avoided altogether for immediate cash reasons, which only led to a loss of competitive strength either through the lack of product performance or increasing marginal cost of production, which cumulatively led to ‘economic decline’. This short term orientation was further manifested by the way senior management were appointed largely from outside, and assessed over short time periods. Successful senior managers in America typically moved jobs within three to five years and so had to achieve success within that time period. As noted elsewhere major projects, especially ones involving significant innovation, only come to fruition over very much longer periods.
Hayes and Abernathy cited the portfolio system of central ‘control’ as inhibiting long term investment in technological innovation. They contrasted technology’s achievements, for example, the laser, xerography and transistors, with the trivia such as new shape potato crisps and feminine hygiene deodorant, produced by the new orthodoxy, a risk averse financial orientation to marketing.
The reasons why American managers had adopted this new orthodoxy were several. Firstly, there had been a dramatic increase in financial and legal executives getting to the top of American corporations in preference to those with technical or other industry specific experience. Secondly, companies had increasingly hired top management from outside, often from outside their industry. Such managers had necessarily managed their companies simply on the basis of financial information and controlled their development without technical knowledge on the basis of oversimplified decision rules of thumb such as to “invest in businesses which dominate their markets and sell those that don’t”.
These were the strategic managers and this was their mindset. The consequent focus on deal making, particularly mergers and acquisitions, was therefore not surprising since the top managers expertise was largely limited to finance. But it had done substantial damage to many of the United States’ leading companies as well as Britain’s, leading them to neglect their core technologies and rendering them vulnerable to attack by more technologically focused competitors. The automobile industry was then, as now, a prime example.
Since then the short term orientation of top management has been further emphasized. Firstly this was by the explosion in hostile takeovers driven wholly by short term financial aims and justified by the new neo-classical theory; secondly by top management’s growing detachment from industry and business arising from the new strategic management led orientation to portfolio management; and thirdly by the seduction of that top management to follow the injunction to maximize shareholder wealth rather than accepting any broader responsibilities.