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 / Winter 2006 / Issue 45(originally published by Booz & Company)


The Productivity Riddle

Professors Bloom and Van Reenen studied management practices at more than 700 manufacturing firms in the United States, the United Kingdom, France, and Germany. They adopted a well-established survey of management practice, in which they asked such questions as, “How do you track production performance?” and “Do senior managers get rewards for bringing in and keeping talented people in the company?” Using the responses to their questions and publicly available data, they scored the quality of management practices, grouped into four categories, for each firm. Operations management practices included process improvement, lean manufacturing practices, documentation (the ways in which production problems were exposed and fixed), and the use of dialogue among production teams. Targets as practices centered on the choice of financial and nonfinancial goals; the survey asked about targets’ reasonableness, transparency, and interconnection. Monitoring practices emphasized individual performance tracking and follow-up. Finally, incentives as practices addressed compensation, links between promotion and individual performance, and responses to poor individual performance.

The study found that higher management scores were indeed associated with higher productivity, return on equity, and market capitalization relative to book value. The researchers also found that low measures (all else being equal) correlated with the likelihood that the company in question had failed. Moreover, the general management approach, as set by the firm’s leaders, was the dominant “management” influence on performance. Intriguingly, this research shed light on international differences in firms’ performance. Companies in the United States and Germany had persistently higher management scores than their counterparts in the same industries in other countries. The authors concluded that this strength derived principally from U.S. and German practices related to targets and incentives (practices that boosted flexibility and motivation, for example).

Another intriguing finding concerned family-owned businesses. When managed by members of the family, these companies tended to score particularly poorly, as if to reinforce the value of professional management. In other words, naming a family member as a leader of a company tends to be a poorer choice than recruiting an outside professional manager to do the job.

According to Professors Bloom and Van Reenen, there is one other influence on management differences: the competitiveness of the business environment. When times get tough — when the setting gets more competitive — firms with bad management earn comparatively lower profits and grow more slowly, or even exit the scene. Under the same circumstances, the comparative value of good general management rises.

Thus, the superior estimated productivity performance of American firms relative to their non-U.S. counterparts may be traced in no small part to the disciplinary effect of the U.S.’s more competitive product markets. Within individual industries, for instance, greater competition spurs the necessity to adopt best practices more quickly — or lose out. Likewise, when a nation’s consumer goods markets are opened to international trade and capital markets are loosened, this openness tends to enforce the need to adopt better management practices. To be sure, some companies don’t adopt such practices, but they face higher costs, lower sales, and extinction in the competitive race. By contrast, when competitive forces are weak, it becomes harder to bring economic discipline to bear; companies grow complacent, and fail to build the managerial capabilities that they will need in more stressful times.

Managerial choice and economic competitiveness are not mutually exclusive. In fact, they tend to reinforce each other. Companies that face competition and stay in the game gain the ability to make better choices. And companies that make better choices about management practices, as they expand their scale and scope, are more likely to face the constraints of greater competitiveness. In the end, in facing either factor, the flexibility and quality of management matters.

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