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


The Productivity Riddle

Interestingly, in the work by Professors Bloom and Van Reenen, these relationships hold even if one controls for CEO compensation (as a proxy for the management ability of people at the very top). In other words, it’s the quality of management throughout the company that matters for firm performance, not just the quality of most senior executive leaders.

The results reported by Professors Bloom and Van Reenen will probably attract attention in economic circles. They suggest that variation in management quality “explains” many of the differences in firm-level productivity. Such a striking correlation between management quality and productivity raises questions about the development of management practices, the choices that managers make about practices, and the value of managerial talent in executing these practices. It also suggests that the connections among competitive conditions, management, and performance are highly significant indicators of which companies will succeed and which will fail.

Nondestructive Creation
The idea that management matters has broad implications. It suggests, for example, that financial management is important not so much as a means of tracking and overseeing individual companies, but as a vehicle for improving their productivity and performance. It also suggests that managers could best improve their results, and policymakers could best improve their economic climates, by focusing on two management practices: “learning managing” and “managing learning.”

By “learning managing,” I mean the conscious adoption of methods, such as lean production or better human resources processes, that deploy technology, financial capital, and employees’ time more effectively. The research I have already mentioned demonstrates that the quality of a firm’s management can be adapted, most importantly in that management quality improves in the face of increasing competitive pressures. But the precise nature of how managers adapt to competition requires further study. According to one important economic model of entrepreneurship and management (see “Selection and the Evolution of Industry,” by Boyan Jovanovic, Econometrica, May 1982), business managers learn, through the course of their transactions over time, how well their chosen management practices adapt to a changing market. They continually consider whether to remain in business; like species succumbing to extinction, the poor performers drop out. In a compelling extension of this view, best practices also change over time within companies, as managers respond to sales results and higher competition spurs them to innovate. As a consequence, productivity differences will matter even for well-established firms that last a long time in the marketplace.

Assessment of how “learning managing” occurs is a significant topic for research. For example, the delineation between the art of leadership (or, if you prefer, general management skill) and the science of management (or specific management practices) may be somewhat artificial. The most important distinguishing factor for U.S. firms may be their flexibility in identifying and capturing opportunities, which could result from either individual genius or training in operational capabilities. Recent evidence indicating that productivity will increase along with the number of MBA holders in a firm — MBA degrees presumably stressing broad flexibility and general management abilities — is suggestive in this regard.

Another potentially significant line of inquiry would be the links among three phenomena: corporate governance (especially the competition for corporate control), day-to-day management practices, and the productivity of individual companies. For example, what role do investments by private equity firms play in improving managerial quality? Although many private equity investments are associated with financial restructuring, they may have their greatest impact on productivity growth through the managerial changes that they put in place.

A separate avenue of inquiry is “managing learning,” by which I mean the systematic development of management skills and knowledge, inside and outside business, and in society as a whole. Do talented managers learn high-quality management practices in business school or through interaction with other firms in the competitive process? Are the most successful managers generalists who adapt flexibly to best practices, or specialists who apply a particular skill base? Further study of data on firms and their managers and management practices over time would help answer these questions. And it would also help inform regional and national efforts to improve management skills, including those going on in emerging nations such as India and China.

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