Dear Puritans:

Most people seem to agree that the book The Puritan Gift is a useful contribution to the debate on society and the economy. What people fail to grasp is the importance of what Andrew Grove (and others) call ‘managerial leverage’ (see page 104). Everyone assumes that, if you cut government expenditure, you have to cut government services, and vice versa. With a proper sense of purpose and the right approach (not easy to achieve), you can expect both to cut expenditure and to increase the quality and range of services.

It all comes back to that all-important concept: managerial culture, which our book seems to describe. We argue that America’s managerial culture reached a peak of excellence at the mid twentieth century, which provides a model for the whole world. You could call it the Drucker or the Deming approach – both men embodied and exemplified that culture. There are now 14 Drucker Institutes in China, which gives me a sense of hope for that country.

I will attempt to develop this theme when I address the Transformation Forum on May 20 at 11.20 am. I have never been a keynote speaker before! Wish me well.

Best -

Will Hopper

Dear Puritans:

You may have seen an interesting article in today’s FT by Tony Jackson. As we all know, major banks in the US posted attractive earings in the first quarter of 2009, leading to a rise in the price of their shares. What now emerges is that they did so by writing down the value of their debts — ‘marking to the market’.

There is some justification for this. Let us suppose that Bank A issued bonds to an amount of $100 million five years ago, and that these instrucments are on paper repayable at that figure in another five year. However, let us also suppose that they are simultaneously standing at 10% of face value in the market place. If Bank A buys its own bonds in at 10% of their face value, it will wipe out $90 million of its debt, leading to a genuine, $90 million increase in the value of its net assets. From a strict accounting point of view, this approach is apparently correct. On the other hand, it misleads because it creates the impression that Bank A’s underlying business is returning to profitability whereas the reverse is the truth — the bonds stand at a huge discount because it is close to bankruptcy. Are they large banks not once again misleading the public? O tempora, o mores!

Best — Will Hopper

Dear Puritans:

Very few people seem to appreciate the significance of managerial leverage in public services. Everyone understands that a well-managed company in the private sector can achieve much more than a poorly-managed company. Indeed, if the poorly-managed company is losing money, and if making or losing money is the criterion, then the well-managed company can achieve infinitely more than the badly managed one.

There is very little understanding that the same principle applies in public services. Instead, there is a crude assumption of a more or less one-to-one ratio between input and output. In other words, if you wish to increase the range of services provided by the state, or to improve the quality of a service already provided, you have to make a (vaguely) proportionate increase in expenditure. This is simply untrue. A well-managed government department can achieve ten or even a hundred times as much as a badly managed one, just like a private company. Consequently it is entirely possible to reduce the financial input by say 30% and increase the output by that same 30%.

The problem is that you cannot change the quality of management overnight. However, there are ‘work-arounds’. On page 219 of The Puritan Gift, we proposed that the United States should model its new healthcare service on the Veterans Administration and appoint ex-military doctors to run it. (The original suggestion actually came from Paul Krugman.) Should we not do the same in the UK? Of course (once again), the nature of the ‘output’ and the method of transmission are likely to change once we have put into the driving seat managers who have (a) learned the ‘craft’ of management and (b) possess ‘domain knowledge’ of medicine. They may change the nature and purpose of the whole organisation.

Dear Puritans:

Lord Taverne (the first Director of the Institute for Fiscal Studies, of which I was Founder Chairman) has proposed that all companies should report the ratio of salaries of senior executives to the average wage of the lowest 10% of their employees. He argues that this would shame executives into rewarding themselves more modestly. I heartily agree with his proposal. On page 108 of The Puritan Gift, my brother and I draw attention to the fact that the CEOs of US companies are paid 475 times the wages of an ordinary worker, which compares with eleven times in Japan and twelve times in Germany. Are American CEO’s really (475/11 =) 43 times more efficient than their Japanese oppos? The comparable British ratio is said to be 130. Are British CEOs really (130/11=) 12 times more efficient than their Japanese oppos?

Lord Browne was paid a huge bonus in his last year of office as CEO of BP because his remuneration package was tied to the compay’s reported earnings — but those earnings had risen sharply not because of his efforts but because the oil price had soared, for which he carried no responsibility. Lord Taverne’s initiative deserves strong support from all political parties.

Best wishes

Will Hopper, co-author The Puritan Gift

Dear Puritans:

Paul Myners, Financial Services Secretary to the UK Treasury, has accused institutional shareholders of being ‘absentee landords’ and failing to involve themselves constructively in the managment of listed companies. It seems to me that this is only a half truth; as we explain on page 225 of The Puritan Gift, the great age of American capitalism occurred when shareholdings were widely dispersed and the shareholders were largely inactive. By default, therefore their outlook was ‘long term’. Since this coincided with a culturally long-term attitude on the part of senior managers, the outcome was highly beneficial for all concerned.

Things went wrong around 1980 when over half of shares passed into the hands of institutional investors, who demanded that each company publish ever-rising quarterly earnings per share, whatever the cost to the health of the company or the economy, and punished those companies that did not comply by dumping their shares. Group think and financial cosmetics became the order of the day.

However, Myners is half right. We are not going to go back to the state of affairs which existed at the mid-twentieth century. Institutional investors will continue to hold the majority of shares. It is therefore highly desirable that they should abandon their ‘group think’ approach and start to take part in an intelligent debate on how companies are run. Above all, they should insist that the managers take a long-term view. If they cannot, the next best thing is that they become inactive, like the private investors who dominated the scene before 1980.

Dear Puritans:

One of my favourite sayings (and it is one that Ken and I originated) is that ‘Statistics are a wonderful servant and an appalling master.’ It appears on page 125 of The Puritan Gift. One major problem with our world today is that it worships statistics as a method of control. If one can judge by a letter from a Mr Keith Isaacson in yesterday’s Financial Times, this approach is now threatening the lives of Scottish children. It seems that Scottish dentists are not rewarded for fitting orthodontic braces to children unless they undertake an X-ray — a rule which does not apply in neighbouring England. Consequently Scottish children are subjected to a large amount of unnecessary radiation, increasing the risk of cancer in later life for those who live north of the Border.

Dear Puritans:

An interesting aspect of ‘The Puritan Gift’ as a book is that almost every news item that one reads seems to lead back to it. A recent item about the Japanese manufacturer Sharp provides an example. In what Ken and I called ‘The Years that the Locust Ate’ (1971 – 1995), American manufacturers ‘offshored’ manufacturing to Asian countries where the cost base was lower. The immediate effect on their P&L was positive, for reasons that are obvious. However, they made the strategic error of ‘offshoring’ the technology with the manufacturing. Within a decade, there would in many cases be no one left in the parent company who knew how to make the articles in question. The Asian beneficiaries of this trick were able to say, in the words of Don McLean’s immortal song (1971): ‘Bye, bye American Pie’, Drove my chevy to the levee but the levée was dry’.

Because of the rise of the yen against the euro and the dollar, Sharp finds itself in much the same position today as American manufacturers of the 1970s. It faces three options. It can continue manufacturing in Japan as at present and lose money, perhaps going bankrupt. It can offshore the manufacturing and the technology as the Americans did, losing out in the long run to overseas competitors. Or it can offshore the manufacturing but retain the technology. Put thus baldly, the answer has to be: go for the third option, but that leads at once to the practical question: how do you do it?

The answer has to be a mixture of measures. One simple approach will be for Sharp to manufacture in Japan to meet Japanese demand, which is less affected by movements in exchange rates than overseas demand. This will provide only a partial solution since competitors will produce goods cheaply outside Japan and sell them into the Japanese market, partly undermining Sharp’s strategy. However, those who manufacture in Japan to meet Japanese demand will benefit from lower transport costs, shorter supply routes, a better understanding of the wishes of the domestic consumer and perhaps even brand loyalty.

A more profound answer lies in maintaining Japan’s traditional quality of management. The 1970s, when America started offshoring manufacturing on a large scale, was also the era when the ‘financial engineers’ began to take over from the ‘mechanical engineers’ in the upper ranks of American manufacturing. The ‘new men’ regarded technology as a commodity to be bought in when it was required, not as something which they had to master themselves. As long as Japanese companies are run either by techonogists or at least by people who have a profound respect for technology, they can ‘offshore’ manufacturing with a degree of confidence. The all-important know-how will remain deeply imbedded in the culture of the parent. Who knows? — one day Sharp may find that the balance of advantage lies in bringing it all back home. Not long ago Kenwood Yamagata, the Japanese maker of home and car electronic equipment, did exactly that when it repatriated the manufacture of portable minidisc playersfrom lower-cost Malaysia (see page 252 of ‘The Puritan Gift’).

Does The Puritan Gift shed light on the subject raised in the previous post?  Our book is ulimately about how decisions are made and put into practice. That being so, we have to say that is is very sad how the current crisis was allowed to come into being and then worsen while everybody sat on their hands. It has been plain for years that trouble for brewing. It would have been right and proper for the Fed to prepare a series of contingency plans for different courses of action based on different assumptions: if A occurs, then we do X; if B occurs, then we do Y; and if C occurs, we do Z. Instead the world economy flew into a dark cloud of uncertainty with its metaphorical radar switched off. One great lesson from this series of events is that the authorities responible for ruling this world must  engage in contingency planning in the future.

However, that is not where we are at present. There is an old Irish joke about a tourist who goes up to a peasant farmer and asks how to get to Dublin. ‘If I wanted to go to Dublin’, replied the peasnt, ‘I would not start from here!’ The point of the story is that the tourist had to start from ‘here’. Likewise we have to start from here, not from where we would like to be.

 

 

 

 

 

Meatime

Dear Puritans,

A week ago I promised to explain why I was optimistic  about the outlook for the global economy in the light of the G20 meeting. Let us start by looking at the dangers that face the world and then ask ourselves if we are addressing them in a proper an adequate way.

In the last three years a crisis that started off financial  (in the Credit Crunch) became economic (as GDP fell) and then social (as millions became unemployed). The big question is whether it will now go political in a serious sense as electorates respond with anger to the resultant suffering and, if so, what political form it will take.

There is a major predecent that is not helpful.  The Great Depression of the 1930s preceded and in part caused the Second World War; without it is most unlikely that Hitler would have been returned to power in 1934. If our current recession degenerates into a 1930s-style Depression, for which there must be at least one chance in five, there is a real danger that a worldwide conflict will break out. One chance in five is serious odds; we have therefore to plan on the assumption that the worst can happen — and then take steps to avoid it.

There is another precedent that gives me comfort. It is worthwhile to look up “Concert of Europe’ in Wikipedia. From 1814 to 1914, the Concert  constituted a kind of informal world government  consisting of the then Great Powers This is where I get optimistic. More later.

 

 

Will Hopper