UK: THE NEW CORPORATE CRUSADE.

UK: THE NEW CORPORATE CRUSADE. - With the fall of communism, business as the champion of capitalism no longer applies. A wider, social and economic role is now expected of the corporate sector.

by Simon Caulkin and Michael Black.
Last Updated: 31 Aug 2010

With the fall of communism, business as the champion of capitalism no longer applies. A wider, social and economic role is now expected of the corporate sector.

In 1990, a respected business writer asserted confidently that, 'We have learned more about the right way to run a business in the 1980s than in the previous half century.' Ironically, it has taken the fall of communism to qualify that optimism. As long as the battle of the world systems raged, the role and purpose of 'business' as champion and principal agent of capitalism seemed obvious. But now that the battle has been decisively settled in favour of markets - now that business has to walk the talk - a strange paradox reveals itself: there is nothing inside the champion's imposing suit of armour. We don't know how companies work, we don't even know what they should be doing. The most important institution of the capitalist West is an emperor without any clothes.

Consider: at a practical level our new insights aren't preventing companies from going bust. The corporate heroes from whom we are supposed to be learning the new lessons disconcertingly turn into dunces overnight. Nor are our new streamlined corporations making our economies any more robust. Rather the reverse: far from contributing to solutions for the great social issues, most companies today are part of the problem, obsessively pursuing an Alice-in-Wonderland logic of self-reinforcing retrenchment which improves profitability ratios at the expense of the collectivity. What's good for General Motors is definitely not good for capitalism.

With hindsight, the gains of the 1980s - quality, customer focus, responsiveness - represented quantitative rather than qualitative change. They may have speeded up the mechanics of corporate activity, but they didn't lead to better destinations. We have failed to notice how the role of the corporation changes in relation to the state in the world of markets. This failure is in danger of sending us up a dead end, generating agendas which are surreally different from the ones we ought to be addressing. The job now is to identify and activate that wider role of the corporation. As the pivotal institution of the marketised world which it has done most to bring into being, the company must assume the responsibilities it has wished on itself.

Look more closely at what has happened in the last decade. We may have learned a lot about business - but the more we know, the more we don't know. For example, we have learned that the essence of corporate activity has nothing to do with size. To be sure, it is now a truism that big is unbeautiful; economies of scale apply to production, not people. But don't applaud the end of the great bureaucracies yet: the small company is no replacement. Recent studies on both sides of the Atlantic show that small firms are fragile, pay their staff less and treat them worse than larger ones, and can't afford new technology. Moreover, their employment record is overstated. Guess what: both large and small gods having been dethroned, it is now the middle-sized company which is attracting the prayers of the faithful at the altar of economic hope.

Nor, another irony, is the heart of the company to be found in the market itself. There are two ways of co-ordinating economic activity. One is at 'arm's length', by the market; the other is by people combining in a company to do something different from, and better than,the market. In other words, the essential character of a company is that those within it have been removed from normal market interactions. Beating the market is difficult, though: Andrew Campbell, of the Ashridge Strategic Management Centre in London, has shown that in most multi-business companies, the corporate centre actually destroys much of the value (however accounted) which the individual units are creating. Guru-approved focus doesn't seem to be a reliable guide to co-ordination, either. Focused companies (IBM, the airlines) aren't immune from making faulty decisions which destroy value; successful conglomerates such as BTR and Hanson mysteriously go on being successful.

It is the difficulty of justifying corporate co-ordination which has encouraged the 1990s fashion for breaking companies up: either by demerging, hiving off, buying out, outsourcing, and subcontracting into the marketplace functions which had previously been carried out in-house; or by simulating markets internally in the manner of an ABB, with its 1,300 separate companies and 5,000 profit centres, all trading with each other at arm's length. Corporate deconstruction is big business. Research, publishing and conference company Business Intelligence estimates that by the end of the decade UK companies, urged on by the likes of Tom Peters ('Contract out everything except your soul!'), will be spending no less than £80 billion a year employing other people to run their IT, catering, transport, warehousing, credit control and even human resources, in their quest for cost efficiencies.

There are three snags with this current orthodoxy, however. First, restructuring of whatever kind doesn't create anything: as Gary Hamel and C K Prahalad recently noted in the Harvard Business Review, it 'attempts to correct the mistakes of the past, not to create the markets of the future'. All too often, it's displacement activity for that far more difficult task, and displacement activity of a highly destructive kind: Hamel and Prahalad point out that Britain's vaunted 'productivity miracle' of the 1980s was produced almost entirely by restructuring (read: slashing the manufacturing workforce) rather than increasing output. The victory was Pyrrhic: 'In effect, British companies surrendered global market share.'

Second, if you believe in the market as ordering principle, where does the fragmentation stop? The apparently universal law of market simulation is that it is always possible to find someone who can perform a set of tasks better outside the organisation than in. Whatever the rationale, the centrifugal result is the same. Having split itself in two, ICI is now considering the flotation of EVC, its European PVC business, jointly owned with Enichem of Italy. And Zeneca, with its paints to seeds to pharmaceuticals, is as justifiable or unjustifiable a combination as the original ICI was. The logical conclusion of this tendency is the ideal envisaged by Peters: millions of one-person entities organising themselves in the marketplace in 'virtual companies' through a web of electronic networks.

But although this kind of co-ordination by the market rather than by bureaucracy may seem attractive, companies are rediscovering (third snag) that it also has costs - precisely those costs which were the justification for establishing companies in the first place: most obviously the other fellow's profit margin, less conspicuously the need to co-ordinate interests which now diverge from your own. Transaction costs are externalised, not abolished - indeed, sometimes they are increased. A recent study of outsourcing shows that contracting out IT requirements to specialist companies always caused problems, often worse than the ones it solved. And if the market is the best co-ordinator, why are companies rushing to mitigate its effects with supply-chain 'partnerships' and strategic alliances - equally problematic proxies for the vertical and horizontal integration which, to the applause of markets and gurus alike, they have spent so much time unravelling?

Finally, we know that, equally paradoxically, corporate success is not to do with the single-minded pursuit of profit. A long-term Harvard study now proves it: companies which explicitly put their shareholders first do less well for their shareholders than companies which balance the interests of all their stakeholders. In the UK, 25 of the UK's top companies, not previously noted for adherence to any militant tendency except the capitalist one, have reached a similar insight. Their interim report for the RSA's 'Tomorrow's Company' inquiry concludes that sustainable competitive performance in the future will depend on a 'licence to operate' awarded not by shareholders, as now, but by all stakeholders equally.

Where does all this leave us? Not, as Professor Charles Handy ruefully remarks in his latest book, 'where we hoped to be.' An important reason for the confusion is mistaken assumptions about the role of states, markets and corporations. Under the regime of markets, it is no longer the role of governments to assume direct responsibility for solving social problems, as assumed for the past 200 years. At the extreme, the collapse of the Soviet bloc is a demonstration of the failure of the state's project to do just this. Rather, it is the role of governments to establish and sustain rules which encourage companies (and other organisations) to find those solutions.

In a 1984 essay, Peter Drucker noted that the increasing inability of governments to deal with the social needs of contemporary society was creating a major opportunity for 'the most flexible and most diverse of non-governmental institutions, business.' The responsibility of business, he argued, 'is to tame the dragon, that is, to turn a social problem into economic opportunity and economic benefit, into productive capacity, into human competence, into well-paid jobs, and into wealth.' Drucker's insight - the part that companies must play in the 'true mixed economy of the future' - runs directly counter to the apocalyptic Friedmanite view that broadening the scope of management concerns to ends other than profit will bring about the end of free society as we know it. But this is the result of a misapplication of the economics of markets to the company itself. As we have seen, although markets are its habitat, the company is not itself a miniature version of the market, but a refuge from it - indeed, as the rest of the world becomes progressively marketised, this is one of its most precious attributes.

The vestigial values of the past are still too strong to allow most companies to sense the extraordinary opportunity they now have to replace our lost sense of community. Yet the past decade has seen a steady burgeoning of firms which are converting social responsibilities into business opportunities in the Druckerian sense. The most obvious examples are in health and the environment. In health, the regulated partnership between the drug companies and NHS is an unregarded prototype for the new mixed economy. (Interestingly, it has also been outstandingly successful commercially: under its auspices the UK has generated not one but four or even five world-class pharmaceutical companies.) Similarly, a cocktail of environmental regulation and legislation is encouraging the formation of a 'green' business sector which did not exist 20 years ago.

Even Drucker might be surprised at some of the other, indirect ways in which a minority of forward-looking companies are advancing the public interest by their own efforts to maintain their corporate integrity. The contemporary imperatives for sustainable business are well put in the Interim Report of the RSA's Tomorrow's Company inquiry: to survive and prosper, 'tomorrow's company must be able to learn fast and change fast. To do this, a winning company must inspire its people to new levels of skill, efficiency and creativity, supported by a sense of shared destiny with customers, suppliers and investors,' not to mention the community as a whole on which it depends for a supportive operating environment. What does this mean in practice?

John Ruskin's jaundiced observation was that 'There is hardly anything in the world that some man cannot make a little worse and a little cheaper.' The compact with the customer reverses this pessimistic dynamic because it demands quality - not just words, but a working philosophy for replicating and improving it. In a business setting quality is more than its own reward: it pays, as a large number of well-documented cases shows. The quality movement originated in the company not the public sector, where only now, with the Citizen's Charter, a paler version of the quality concept is beginning to make an impact.

The compact with employees means equipping them to use the available tools for quality and innovation - ie, education and learning. RSA and other research amply indicates that this is no longer an option ('If you think education is expensive, try ignorance,' as one American CEO has put it). In the US one of the corporate trail-blazers was Motorola, which set up its educational effort because without it employees were unable to handle new quality techniques. Since then Motorola's educational spending has burgeoned; but far from being a cause for concern, the company estimates that the initiative is generating a staggering 3,300% return on each dollar spent. In this country, Rover, ICL and Unipart have established their own 'universities' or 'learning businesses'. Remarkably, Rover is trading job security for employee commitment to continued learning. Admittedly, there is no final guarantee that jobs will survive; failure to learn, however, is an almost certain guarantee that they won't. Unencumbered by professional baggage and the producer interest, companies like these are doing a remarkable job of compensating for the deficiencies of the state system, conducting some of the most creative educational work anywhere.

The compact with the community involves both of the above. It also requires commitment to the environment, and sure enough, some companies are pushing ahead of legislation to adopt higher environmental standards. The recycling of BMW and Mercedes cars is an example. Again, advanced companies are proving that environmental concern brings more than philosophical reward: getting it right first time is as powerful a generator of savings in environmental costs as in quality costs.

Not surprisingly, debate over this apparent extension of the management agenda has been intense. It is scarcely coincidence that business ethics, or the whole basis of business's contract with society, has emerged as a key subject of scrutiny in the 1990s. The growth of ethics courses is one of the features of recent business-school development, and a year ago London Business School appointed Britain's first professorship in the subject, endowed by Dixons. Consultancies have grown up to advise companies on their ethical stance, and major firms such as NatWest have drawn up formal ethical codes of conduct. Few firms can now ignore the ethical question, simply because the costs of unethical conduct are so high - as many of the most dramatic business failures of the last decade testify. Quality (including quality of life), education, the environment, ethics - this is a remarkable agenda for current commercial concern. As the market becomes pervasive, embracing much of what used to be the public sphere, it is important to recognise the extent to which the company has become a central forum - for many people perhaps the only one - for discussing such issues. 'The job is the new neighbourhood,' as one manager has put it. The company is becoming the medium of practical politics, the government the medium of markets.

The primary goal of this emerging corporate politics - and the most urgent element in the intersection of society's and the company's interests - is something that only the corporation can provide: innovation, the creation of new value propositions to offer to the market. Innovation - 'the act that endows resources with ... capacity to create wealth,' in Drucker's phrase - is poorly understood and utterly neglected by conventional economics. But it is clear that markets can't innovate; they make judgements on propositions submitted to them, but they do not of themselves create or 'bring forth' anything.

Nor can governments - because markets won't let them. They are prisoners of a system which does not permit them to direct and co-ordinate economic activity as a corporation does - as a corporate state, in fact. The implosion of the centrally planned states is the most extreme example of this veto, but in the West the intractability of unemployment is ample testimony to the powerlessness of governments everywhere to act in defiance of markets.

Unemployment, expressed as the failure to match unused resources with unmet needs, is the most striking measure of the 'innovation deficit'. As W Edwards Deming always insisted, unemployment is a managerial failure - 'If factory workers are unemployed - or anyone, for that matter - it is because of bad management, and not because unemployment is inevitable.' It is therefore the job of the corporation to solve it, by filling the innovation gap. Japanese managers realise this. They also realise that innovation, as opposed to invention, is a group activity: the collective work of a corporate community which submits the values it believes in to the market in the shape of a new product or service. With customary vigour, Tom Peters describes entrepreneurship as 'unreasonable conviction based on inadequate evidence'. Venture capitalists may wince, but it captures the essence of innovation, at last gaining recognition as the spark which fires the motor of economic growth. No amount of market research can justify in advance industry-creating innovations like the Walkman, the PC, or even chilled fresh recipe dishes from Marks and Spencer. The original estimate of the number of computers required worldwide was five. Innovation is a collective act of faith, and by definition acts of faith are only undertaken by believers.

Some people rest their hopes for innovation on the 'virtual company', believing that the liberation of self-motivated talent will outweigh the extra difficulties (and costs) of co-ordination. This seems extremely optimistic. The example of the small company is not encouraging, and in any case the concept assumes an understanding of project management which currently does not exist, either in theory or in practice. The real challenge for the company in the 1990s is not to break itself up in a futile attempt to pursue the market (the opposite of innovation), but, what is much harder, to hold itself together to lead it.

The capacity for self-organisation and self-recreation becomes even more important in the light of new investigations in the applicability of chaos theory to management. In this perspective, the current vogue for deconstruction on the altar of the market is more like self-immolation - worse than irrelevant, profoundly destructive of the ability to adapt to new competitive conditions, and of the collective effort to create value. As US Labor Secretary (and Harvard professor) Robert Reich has remarked, people usually forget that 'perfect competition - the economist's Rosetta stone - eventually strips away all profits, causing even the best of businesses to fold'. To say that a company is first and foremost a 'working community' (Charles Handy) or an exercise in 'productive co-operation' (Professor Tony Watson, Nottingham Business School) is therefore not wistful nostalgia but an urgent statement of management and economic basics.

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