Individual entrepreneurs may succeed or fail, but when taken in aggregate, this speedy and resilient culture of entrepreneurship supports economic stability, if only because those who succeed tend to learn from experience (and each other). Twenty-five years ago, when a large firm had shortages or gluts in inventory, it might have taken weeks to uncover the imbalance. Companies responded to those imbalances by buying or building excessive stocks of inventory; then, in downturns, they cut production much more sharply than would have been needed had inventory knowledge been current. Today, entrepreneurs and managers routinely apply information technology to respond in real time.
Nowhere is this entrepreneurial contribution to economic stability more evident than in financial services. Deregulation, coupled with innovative technologies, has fostered the development of financial products, such as asset-backed securities and credit default swaps, that make possible a much greater spread of risk than was previously available.
Some observers have concluded that this pace of productivity growth is unsustainable. But conversation with many business leaders suggests that there is still more room for productivity growth in most companies. This is bolstered by a body of recent economic research that finds large and persistent differences in productivity performance across firms — within and across countries. Consistent application of better management thinking and practices will have important effects on business and the economy.
Choice and Competitiveness
To truly understand the productivity riddle, we need to take a “micro” perspective and look, with an economic eye, at the behavior of individual firms. We need to ask why some gain in productivity consistently while others do not. For many years, economists have tried to attribute differences among companies’ performance to workers’ skills, information technology investment, or even the quality of available capital. But even after controlling for these factors, important and unexplained differences in productivity performance remain.
As far back as the early 1960s, economists identified these differences, collectively called “fixed effects,” but merely attributed them to variations in managerial quality without exploring the effects of any specific management practices on firm performance. It remained for business schools to identify the sources and examples of high-quality management practices, and for consulting firms to conduct de facto “on-the-ground” experiments implementing particular management innovations. And it was only a small group of economic historians, such as Alfred D. Chandler Jr. and David Landes, who stressed professional management as a key factor in the rise of U.S. industry, relative to that in France or the United Kingdom, in the early 20th century.
Through the lens of economics, management is, at heart, a choice made by each firm. To alter that choice is costly; when a firm changes management, it requires additional personnel, time, attention, and other resources. The decision makers who lead the firm must trade off these costs against the benefits they expect. That is why, if all other factors are equal, the new management practices most likely to be adopted are those that promise the greatest cost reduction. In capital-intensive companies, these tend to be those practices that most improve the efficiency of plant and equipment. In companies where highly skilled workers are integral to a firm’s financial performance, practices related to incentives and human capital will probably be perceived as more beneficial.
If this theory is correct, then in a knowledge-intensive economy, the firms with better practices for process techniques, goal setting, performance evaluation, and human resources management should be found, by reasonably objective observers, to exhibit generally better performance. And indeed that correlation was found in recent research by economists Nick Bloom of Stanford University and John Van Reenen of the London School of Economics. (Read their 2006 paper, “Measuring and Explaining Management Practices Across Firms and Countries.”)